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https://www.courtlistener.com/api/rest/v3/opinions/4623457/	Joseph E. Seagram & Sons, Inc., Transferee, v. Commissioner of Internal Revenue, RespondentJoseph E. Seagram & Sons, Inc. v. CommissionerDocket No. 5310-64United States Tax Court46 T.C. 698; 1966 U.S. Tax Ct. LEXIS 48; August 31, 1966, Filed 48 Decision will be entered under Rule 50. Corporation A, in order to withdraw from business in Kentucky, contributed its Kentucky assets, including its inventories of liquor, to its Kentucky subsidiary, corporation B. Both corporations used the last-in, first-out method of inventorying goods, maintaining the inventories in layers consisting of acquisitions by month. Held, that corporation B "acquired" the contributed inventories, within the meaning of section 472(b), I.R.C. 1954, at the time of contribution, rather than at the times they were acquired by corporation A, and that it is not required, as determined by the respondent, to retain in its inventory records the identity of corporation A's LIFO layers and integrate them into its own corresponding monthly LIFO layers. Josiah Willard and David Sachs, for petitioner.Charles M. Greenspan and Irving Bell, for respondent. Atkins, Judge. ATKINS698 The respondent determined that petitioner is liable, as transferee of assets of the Calvert Distilling Co. (successor by merger to Julius Kessler Distilling Co., Inc.), for a deficiency in income tax for the taxable year ended July 31, 1959, in the amount of $ 360,466.80. The petitioner 49 concedes that it is liable as transferee for any deficiency properly due, but contests the amount of the deficiency. The only issue for decision is whether liquor inventories which petitioner transferred to its subsidiary, Julius Kessler Distilling Co., Inc., in 1957 as a contribution to capital, were properly treated by the latter as acquisitions of inventory at the time of the transfer, under the last-in, first-out (LIFO) method of inventorying goods, or whether it should have treated such inventories as having been acquired at the times acquired by its parent.FINDINGS OF FACTSome of the facts have been stipulated and are incorporated herein by this reference.The petitioner is an Indiana corporation engaged in the business of distilling, blending, and bottling liquors, with its principal office at New York, N.Y. It is a wholly owned subsidiary of Centenary Distillers, Ltd., a Canadian corporation, which in turn is a wholly owned subsidiary of Distillers Corporation-Seagrams, Ltd., also a Canadian corporation.The petitioner is transferee of the assets of the Calvert Distilling Co. (hereinafter referred to as Calvert) which was the successor by merger to Julius Kessler Distilling 50 Co., Inc. (hereinafter referred to as Kessler). The petitioner is liable as transferee for any deficiency in income tax determined to be due from Calvert.699 On August 1, 1935, a corporation known as Gallagher & Burton, Inc., was formed under the laws of the State of Kentucky to engage in the business of distilling, blending, and bottling liquors. It became a subsidiary of the petitioner in 1939. On September 30, 1956, Julius Kessler Distilling Co., Inc., an Indiana corporation which was also a subsidiary of the petitioner, was merged into Gallagher & Burton, Inc., and the latter's name was changed to Julius Kessler Distilling Co., Inc., which is the Kentucky corporation referred to herein as Kessler. Kessler filed its income tax return for the taxable year ended July 31, 1959, with the district director of internal revenue for the Manhattan District of New York.Early in January 1957, it was decided that Edgar Bronfman, then a Canadian citizen, should be elected president of the petitioner. Bronfman did not become a U.S. citizen until March 9, 1959. The laws of Kentucky prohibit an alien from being an officer or director of a liquor company doing business in that State. ( Ky. Rev. Stat. sec. 243.100(4)). 51 The petitioner was licensed to do business in Kentucky and had operating assets there. Following discussions among the petitioner's officials as to how best to permit Bronfman to become petitioner's president without violating Kentucky law, it was decided that the petitioner should cease doing business in Kentucky, and that this should be accomplished by making a capital contribution of substantially all its assets in Kentucky to Kessler, its Kentucky subsidiary. The only purpose in making the corporate contribution was to accomplish the above objective. The decision to make the contribution was not made in expectation of, or for the purpose of obtaining, any tax benefit to either the petitioner or Kessler. It was contemplated at that time that the capital contribution would be permanent or indefinite in duration, and not a temporary transfer.On January 24, 1957, Bronfman was elected president and a director of petitioner by its board of directors. On January 31, 1957, the petitioner made a capital contribution to Kessler of substantially all of its assets located in Kentucky. Such assets had a net book value of $ 17,500,000, and consisted of liquor inventories with an aggregate 52 cost basis to petitioner of $ 13,780,453, and the petitioner's plant and other properties located in Louisville, Ky. On January 31, 1957, prior to the contribution, petitioner's liquor inventories had an aggregate cost basis of $ 52,773,881 and Kessler's liquor inventories had an aggregate cost basis of $ 6,256,261. On the same day, the petitioner ceased to do business in Kentucky and formally withdrew as a foreign corporation doing business in Kentucky. All alcoholic beverage licenses and permits held by the petitioner in Kentucky were terminated and Kessler was substituted as the holder of such licenses.Prior to and at the time of the capital contribution by the petitioner to Kessler of liquor inventories and other property, Kessler used the 700 last-in, first-out (LIFO) method of inventorying liquor, pursuant to section 472, I.R.C. 1954. It maintained four LIFO inventory classification: Bulk-in-bond whisky; bulk-in-bond spirits; bulk whisky tax paid; and domestic case goods tax paid. These LIFO inventories were maintained in "layers" or increments, each layer consisting of a month's acquisition of each class of inventory. Its layers were priced by reference to the actual cost 53 of the goods acquired in order of acquisition by month. The petitioner used the same LIFO inventory method as was used by Kessler, except that the petitioner maintained a fifth inventory classification: Bulk-in-bond gin. The capital contribution from petitioner to Kessler on January 31, 1957, included the inventories in all five classes. Kessler accounted for these contributed inventories in each of the five classifications as single acquisitions as of February 1, 1957, at the total cost of each class to the petitioner, without retaining the identity of the petitioner's LIFO layers or increments, and without integrating them into its own corresponding monthly LIFO layers. It included the entire amount of contributed inventory within each classification in its LIFO layer for that classification for February 1957. The cost for each gallon of each class of inventory acquired on January 31, 1957, was determined by Kessler by dividing the total cost to petitioner of all the gallons acquired within each class by the number of gallons acquired in each respective class.After the above capital contribution, Kessler continued its previous business activities. It also continued the production 54 which the petitioner had previously conducted in Kentucky in substantially the same manner as it had been previously conducted by the petitioner, but Kessler's name was used on barrels of bulk liquors, and the bottling of Seagram 7-Crown whisky was discontinued at the Louisville, Ky., plant. The nature of the blending operation was and is such that the distilling corporation does not necessarily use all its own distillates exclusively in its own labeled brands and, accordingly, frequently purchases distillates from and sells distillates to both affiliated and nonaffiliated companies to complete the blending process. Since the largest selling brands of the petitioner and its affiliated companies are those of "Seagram" and "Calvert," the major portion of the distillates produced at the Louisville, Ky., plant both before and after January 31, 1957, were used by or ultimately sold to the petitioner and sold to Calvert, and ultimately sold under these labels.On November 28, 1958, the State of incorporation of Kessler was changed from Kentucky to Delaware. On November 30, 1958, Joseph E. Seagram & Sons, Inc., a Delaware corporation which was a subsidiary of the petitioner, was merged 55 into Kessler.701 On July 31, 1960, Kessler was merged into Calvert. Such merger had not been contemplated at the time of the capital contribution by petitioner of its Kentucky assets to Kessler in January 1957. 156 At the time of this merger there remained in the LIFO inventory accounts of Kessler an aggregate value of $ 10,771,466 of inventories which had been contributed to it by the petitioner on January 31, 1957, such amount being computed in accordance with Kessler's manner of treating the inventories so contributed by the petitioner. On December 31, 1962, Calvert was dissolved and its assets were transferred to the petitioner. This dissolution was not contemplated at the time of the capital contribution of January 31, 1957. At the time of the dissolution of Calvert there remained in its LIFO inventory accounts an aggregate value of $ 10,771,466 of inventories which had been contributed by petitioner to Kessler on January 31, 1957, such amount being computed in accordance with Kessler's and Calvert's manner of treating the inventories so contributed by the petitioner. 2In the notice of deficiency the respondent determined that, pursuant to section 472(a) and (b), I.R.C. 1954, and section 1.472-3(d), Income Tax Regs., Kessler should retain in its inventory records for tax purposes 57 (for its taxable years ended July 31, 1957, 1958, 1959, and 1960) the identity of petitioner's LIFO layers or increments within each class of inventory and integrate such layers by date into the existing layers within each similar class of inventory held by Kessler both before and after the capital contributions. Such adjustment resulted in a decrease of $ 159,225 in the cost of goods sold by Kessler in the taxable year in question, namely, the taxable year ended July 31, 1959, and an increase in its taxable income for such year in the same amount. Such adjustment in the inventory accounts resulted in decreases in Kessler's cost of goods sold in its taxable years ended July 31, 1957, 1958, and 1960, in the respective amounts of $ 324,958, $ 84,979, and $ 186, and also resulted in net increases in its taxable income (and consequently in net decreases in its net operating losses) for such years in the same respective amounts. Such inventory adjustments by the respondent with respect to Kessler's taxable years ended July 31, 1957, 1958, and 1960, resulted in a reduction of the net operating 702 loss deduction available to Kessler for its taxable year ended July 31, 1959, in the aggregate 58 of $ 410,123.OPINIONIn accordance with section 362, I.R.C. 1954, 359 the basis of the liquor inventories contributed by the petitioner to Kessler remained the same in its hands as it was in the hands of the petitioner. However the petitioner contends that this does not require that Kessler treat such inventories as having been acquired by it at the times acquired by the petitioner. In other words, it is its contention that Kessler is not required to retain in its inventory records for tax purposes the identity of petitioner's LIFO layers or increments within each class of inventory contributed and integrate them into its own corresponding monthly layers within each similar class of inventory. Rather, it contends that under the LIFO method authorized by section 472, I.R.C. 1954, 460 the contributed inventory should be treated as "acquired" in the taxable year ended July 31, 1957. In this connection it points out that the statute makes no distinction between inventory acquired by production or purchase and inventory acquired in any other manner, such as by capital contribution. The respondent on the other hand determined, and contends, that where, as here, both the petitioner and its subsidiary Kessler employed the same method of inventorying goods it should not be considered that the contributed inventory was "acquired" by Kessler in the taxable year ended July 31, 1957, but should be considered as having been acquired by Kessler at the times acquired by the petitioner.As a general rule a corporation and its stockholders are deemed separate entities and this is true in respect to tax problems. New 703 v. Helvering, 292 U.S. 435">292 U.S. 435, and Burnet v. Commonwealth Improvement Co., 287 U.S. 415">287 U.S. 415. While the Government may look at actualities and either recognize or disregard the corporate form where such corporate form is unreal or a sham ( Higgins v. Smith, 308 U.S. 473">308 U.S. 473), so long as the corporation is organized for a business 61 purpose or is carrying on business activity, it remains a taxable entity separate from its shareholders. Moline Properties, Inc. v. Commissioner, 319 U.S. 436">319 U.S. 436; and National Investors Corporation v. Hoey, (C.A. 2) 144 F.2d 466">144 F. 2d 466. In the instant case both the petitioner and Kessler were carrying on business activity and were recognized as separate taxable entities by the respondent. We must, therefore, view the petitioner and Kessler as entirely separate entities. We must also accept the transaction between them at face value unless it was a sham or in substance something other than what it purported to be. The evidence clearly establishes that the transfer of the inventory was not intended as a mere temporary transfer. By the same token, it did not constitute a step in an integrated transaction having as its purpose the later recovery of such inventory by the petitioner. The evidence also clearly establishes, and we have found as a fact, that the transaction was not entered into for the purpose of gaining a tax benefit for either the petitioner or Kessler. In these circumstances we cannot accept the respondent's view that it should be considered that Kessler acquired the inventories 62 at the times they were acquired by the petitioner. Rather, we think it must be concluded that Kessler "acquired" the inventories, within the contemplation of section 472(b), at the time of the contribution.Section 381 of the Code 564 does not support the respondent's position. 704 That section provides that upon the acquisition of inventories of a corporation by another corporation in certain liquidations of subsidiaries and in certain reorganizations such inventories shall in general be taken by such corporation on the same basis on which such inventories were taken by the distributor or transferor corporation. However, such section makes no reference whatever to acquisitions of inventory by way of a contribution to capital or in a transaction of the type described in section 351 of the Code (namely, a transfer, in exchange for stock or securities, to a corporation controlled by the transferor). In the congressional committee reports in connection with section 381, I.R.C. 1954, it was made clear that section 381 was not intended to affect the carryover treatment of items or tax attributes in corporate transactions not specifically mentioned in the section, 665 and that no inference is 63 to be drawn from the enactment of section 381 with respect to whether, in other situations, any item or tax attribute is to be given carryover treatment. Nor are there any other specific statutory provisions or regulations 7 with respect to the manner of treating inventories contributed by a corporation to its subsidiary.A case not precisely in point, but which we consider governing in principle, is Textile Apron Co., 21 T.C. 147">21 T.C. 147. In that case the taxpayer, in a tax-free exchange under section 112(b)(5), I.R.C. 1939 (predecessor to sec. 351 of the 1954 Code), acquired the business and all the assets, including inventories, of three proprietorships owned by the same person. The three proprietorships had used the 66 LIFO method of inventorying goods, and the taxpaper claimed the right to carry over the transferors' LIFO method of inventorying goods. In that case we held that since the taxpayer had failed to file an application to use the LIFO method it was required to use the first-in, first-out method of inventorying goods. In so holding we stated in part:Since the petitioner was under no obligation to use the same method of computing costs as that employed by its predecessors, it is obvious that permission granted to its predecessors on the basis of stated methods of cost computation 705 should not extend to the petitioner, who was free to employ an entirely different method of cost computation.The petitioner argues that since it was required, as a transferee in a 112(b)(5) tax-free exchange, to record its opening inventory in 1946 at the transferor's basis, n4 it was also required to use the transferor's method of valuing inventories. This is clearly not the case. The transferor's method of computing inventory valuation had no continuing effect on the petitioner. It merely served as a means of determining the basis of the transferred assets. n5 * * [Footnotes omitted.]Similarly here, since 67 Kessler was an entity separate from the petitioner, the latter's method of computing inventories, including its computation of layers of LIFO inventory, had no continuing effect upon Kessler. It should be added that for present purposes we see no essential difference between the acquisition of inventory in a tax-free exchange such as was involved in the Textile Apron Co. case and the acquisition of inventory by contribution such as is involved in the instant case.In view of the foregoing we conclude that Kessler is not required to retain in its inventory records the identity of petitioner's LIFO layers or increments within each class of inventory contributed to it by petitioner and integrate them into its own corresponding monthly layers of inventory, as determined by the respondent.The respondent contends that Kessler's method of treating the contributed inventory resulted in a distortion of income, pointing out that Kessler was a subsidiary of the petitioner, that both Kessler and the petitioner employed the LIFO method of inventorying goods, that in 1962 the petitioner reacquired approximately 78 percent of the inventory originally contributed by it to Kessler (although conceding 68 that this ultimate result was not contemplated when the contribution was made), and that Kessler was thus able to inflate its cost of goods sold. He refers to the provision of section 472(a) of the Code which states that the use of the LIFO method shall be in accordance with such regulations as the Secretary or his delegate may prescribe as necessary in order that the use of such method may clearly reflect income, and to section 1.472-3(d), Income Tax Regs., which states "the propriety of all computations incidental to the use of such method [LIFO], will be determined by the Commissioner in connection with the examination of the taxpayer's returns," and contends that he was justified in requiring Kessler to retain in its inventory record the identity of the petitioner's LIFO layers or increments within each class of inventory contributed and integrate them into its own corresponding monthly LIFO layers. However, in view of our conclusion that, within the meaning of section 472(b) of the Code, Kessler "acquired" the contributed inventory in its taxable year ended July 31, 1957, we think that its treatment of the contributed inventory did not distort its income.Decision will be entered 69 under Rule 50. Footnotes1. When it began operations the petitioner had a policy of organizing a separate distilling corporation and a separate selling corporation for each brand of whisky produced, such as Kessler, Seagrams, Calvert, and Four Roses. This resulted in a cumbersome corporate structure which the petitioner wanted to simplify. In 1954 the selling corporations were combined, but it was considered necessary in view of the existing regulations with respect to labeling distilled spirits, to maintain separate distilling companies in order to keep the brands entirely separate. It was not until Sept. 1, 1959, that Regs. No. 5, relating to Labeling and Advertising of Distilled Spirits, was amended to provide for the use of "any trade name shown on the distiller's permit * * at the time the spirits were distilled, irrespective of the name under which they were actually distilled." It then became feasible to combine the distilling companies and still maintain before the public the separate brand labeling that was deemed desirable.2. The record does not disclose how the petitioner treated the acquired inventories.↩3. Sec. 362 of the Code provides:(a) Property Acquired by Issuance of Stock or as Paid-in Surplus. -- If property was acquired on or after June 22, 1954, by a corporation -- (1) in connection with a transaction to which section 351 (relating to transfer of property to corporation controlled by transferor) applies, or(2) as paid-in surplus or as a contribution to capital, then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain recognized to the transferor on such transfer.↩4. Sec. 472 of the Code provides, in pertinent part, as follows:(a) Authorization. -- A taxpayer may use the method provided in subsection (b) * * * in inventorying goods specified in an application to use such method filed at such time and in such manner as the Secretary or his delegate may prescribe. The change to, and the use of, such method shall be in accordance with such regulations as the Secretary or his delegate may prescribe as necessary in order that the use of such method may clearly reflect income.(b) Method Applicable. -- In inventorying goods specified in the application described in subsection (a), the taxpayer shall: (1) Treat those remaining on hand at the close of the taxable year as being: First, those included in the opening inventory of the taxable year (in the order of acquisition) to the extent thereof; and second, those acquired in the taxable year;(2) Inventory them at cost; and(3) Treat those included in the opening inventory of the taxable year in which such method is first used as having been acquired at the same time and determine their cost by the average cost method.↩5. Sec. 381, dealing with "Carryovers in Certain Corporate Acquisitions," provides in pertinent part, as follows:(a) General Rule. -- In the case of the acquisition of assets of a corporation by another corporation -- (1) in a distribution to such other corporation to which section 332 (relating to liquidations of subsidiaries) applies, except in a case in which the basis of the assets distributed is determined under section 334(b)(2); or(2) in a transfer to which section 361 (relating to nonrecognition of gain or loss to corporations) applies, but only if the transfer is in connection with a reorganization described in subparagraph (A), (C), (D) (but only if the requirements of subparagraphs (A) and (B) of section 354(b)(1) are met), or (F) of section 368(a)(1),the acquiring corporation shall succeed to and take into account, as of the close of the day of distribution or transfer, the items described in subsection (c) of the distributor or transferor corporation, subject to the conditions and limitations specified in subsections (b) and (c).* * * (c) Items of the Distributor or Transferor Corporation. -- The items referred to in subsection (a) are: * * * (5) Inventories. -- In any case in which inventories are received by the acquiring corporation, such inventories shall be taken by such corporation (in determining its income) on the same basis on which such inventories were taken by the distributor or transferor corporation, unless different methods were used by several distributor or transferor corporations or by a distributor or transferor corporation and the acquiring corporation. If different methods were used, the acquiring corporation shall use the method or combination of methods of taking inventory adopted pursuant to regulations prescribed by the Secretary or his delegate.↩6. H. Rept. No. 8300, 83d Cong., 2d Sess., p. A135, and S. Rept. No. 1622, 83d Cong., 2d Sess., p. 277, each states in part:"The section is not intended to affect the carryover treatment of an item or tax attribute not specified in the section or the carryover treatment of items or tax attributes in corporate transactions not described in subsection (a). No inference is to be drawn from the enactment of this section whether any item or tax attribute may be utilized by a successor or a predecessor corporation under existing law."7. In this connection, it may be pointed out that at the present time there is a proposal (25 Fed. Reg. 13914 (1960)) to adopt a regulation ( sec. 1.381(c)(5)-1(e)(2), Income Tax Regs.) which states in part that where an acquiring corporation is required or permitted to use the last-in, first-out method the base-year inventories and any layers of increment for such inventories prior to the date of the transaction must be retained. However, such proposed regulation has reference to only transactions of the type described in sec. 381↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623459/	The National Power Machinery Company v. Commissioner.National Power Mach. Co. v. CommissionerDocket No. 3285.United States Tax Court1944 Tax Ct. Memo LEXIS 119; 3 T.C.M. (CCH) 934; T.C.M. (RIA) 44294; September 14, 1944119 Henry S. Gottfried, Esq., 1114 Hippodrome Bldg., Cleveland, O., for the petitioner. Thomas F. Callahan, Esq., for the respondent. HILL Memorandum Findings of Fact and Opinion HILL, Judge: This proceeding is for the redetermination of deficiencies for the year 1941 as follows: Income tax, $10,330.98, declared value excess profits tax, $6,134.78, and excess profits tax, $32,443.92. The sole issue is whether or not the respondent erred in disallowing certain amounts paid the petitioner's two principal officers as compensation for their services during 1941. Other adjustments to petitioner's income made by the respondent have been conceded. The tax returns of petitioner for the year 1941 were filed with the collector for the 18th district of Ohio. Findings of Fact Petitioner is an Ohio corporation with its principal office and place of business at 1914 Scranton Road, Cleveland, Ohio. It was incorporated in 1918 and succeeded to a partnership operated by two brothers, S. W. Kohn and B. R. Kohn. In August 1941 these men changed their name to "Kern". For many years petitioner was engaged in the salvage and junk business, including the salvaging of small motors. Towards the end of 1940120 petitioner entered into the heavy machinery field and engaged in the buying and selling of steam driven generating units, steam turbine units, rotary converters, rotary generator sets, diesel generating units, and other heavy machinery. During 1941 B. R. Kern was president, treasurer and a director and at all times during that period was the owner of 54 percent of petitioner's stock. S. W. Kern was vice-president, secretary and a director during this time and at all times mentioned owned 27 1/2 percent of its stock. He was an electrical engineer. J. W. Kohn, a third brother, owned 17 1/2 percent and G. W. Rosenberg, a director, owned 1 percent of petitioner's stock. J. W. Kohn was not active in the business but took a shareholder's interest in the conduct of petitioner's affairs. Sometime during 1941 the capital of petitioner was increased from $10,000 to $50,000 but the respective interests of the stockholders were not changed. B. R. Kern and S. W. Kern devoted their entire time to the business of petitioner and during 1941 worked long hours every day of the week in developing customers' contacts, ferreting out machines for sale, and otherwise making arrangements for the buying121 and selling of this type of machinery. Prior to 1941 the average working day of each of these men was from 6 to 8 hours. In 1941 this amount of time was doubled. L. J. Kern, son of B. R. Kern, was employed by petitioner as a "spotter" in locating and reporting on available machinery in various parts of the country. He was an electrical engineer but had no authority to buy or sell on behalf of petitioner. Total sales of petitioner for 1941 amounted to $644,494.33. Total sales of petitioner in 1940 amounted to $168,709.36. The compensation paid by petitioner to B. R. Kern and S. W. Kern for the years 1937 to 1941, inclusive, is as follows: B. R. KernS. W. Kern1937$ 5,000.00$10,000.0019387,500.007,500.0019394,000.007,500.00194015,000.0014,500.00194158,709.2152,257.68 The only dividend ever paid was during 1941 in the sum of 6 percent based on petitioner's earnings for 1940. At a special meeting of the board of directors held April 8, 1941, the directors, B. R. Kern, S. W. Kern and G. W. Rosenberg, authorized a salary for B. R. Kern of $20,000 annually plus 6 percent of the gross sales of petitioner. B. R. Kern did not vote on this resolution. 122 At the same meeting, S. W. Kern was voted a salary of $20,000 plus 5 percent of petitioner's gross sales. S. W. Kern did not vote on this resolution. The resolutions authorizing the compensation of B. R. Kern and S. W. Kern are as follows: "Whereas, B. R. Kohn, as President and Treasurer of The National Power Machinery Company has initiated a new technique in the purchase of electrical machinery, and "Whereas, this technique has been applied to the new policy of the Corporation, which has changed from small motor dealing and junk salvaging to the handling of large electrical machines, and "Whereas, B. R. Kohn has traveled extensively to purchase more machines and larger machines and in many cases secured the release of equipment for resale prior to schedule, and "Whereas, this new technique as applied by B. R. Kohn has been a major factor in consummating more business in the first quarter of 1941 than for the entire year of 1940, and "Whereas, the best interests of the Corporation will be served by offering an incentive to B. R. Kohn to continue his untiring efforts to increase the business and profits of the Corporation. "Therefore, be it resolved that B. R. Kohn be voted a123 salary of $20,000.00 per year, plus 6% of the gross sales of the Corporation for the year 1941. * * * "Whereas, S. W. Kohn, as Vice President and Secretary of this Company has traveled extensively in order to personally close large deals and has cooperated faithfully with the President to make the new policy of the Company successful, and "Whereas, S. W. Kohn, by such cooperation and by his knowledge of Electrical installations and his special ability in applying this knowledge in the sale of machinery, has increased machinery sales for the first quarter of 1941 exceeding the entire year of 1940, and "Whereas, the volume of business done by The National Power Machinery Company and the profits derived therefrom, depend not only on the efforts of the President but also on the cooperation, ability and application of S. W. Kohn, and "Whereas, in the opinion of this Board, the best interests of this Company will be served by offering the same type of incentive to S. W. Kohn as had already been voted to B. R. Kohn. "Therefore, be it resolved that S. W. Kohn be voted a salary of $20,000.00 per year plus 5% of the gross sales of the Corporation for the year 1941." In September124 1941, B. R. Kern met H. Kahn, the treasurer of Consolidated Products Co., a New York concern, for the first time although Kahn had known of the Kerns through trade publicity and articles appearing in trade journals. At that time Kahn told B. R. Kern that Consolidated wanted him or his brother, S. W. Kern, to handle Consolidated's power equipment department. On October 9, 1941, Kahn wrote B. R. Kern as follows: "In line with my conversation with you while you were in my office recently, I would like to have you or S. W. think over the proposition I made to you to work for our Company. "We are in urgent need of someone qualified as yourselves in the purchase and sale of power equipment, particularly in the complete field as indicated in the write-up the Surplus Record gave you boys in their September issue. "The salary mentioned between $20,000.00 and $25,000.00 per year, plus a commission of say 7 1/2% of the total sales, should make it attractive for either you or S. W. to give it serious consideration. "Please advise when you can come to New York to discuss the matter further." On October 11, 1941, B. R. Kern advised Kahn that the proposition was not acceptable to S. W. Kern125 or himself. The petitioner reported a net income for 1941 of $99,696.19. The salaries of $20,000 allowed B. R. Kern and S. W. Kern by the respondent are reasonable compensation for the services rendered by them to petitioner during the year 1941. Opinion The sole question for our determination is whether or not respondent erred in disallowing $70,966.89 of a total of $110,966.89 deducted by the petitioner in its income and excess profits tax returns for 1941 as compensation for services rendered by B. R. Kern and S. W. Kern. The contention of the petitioner is that the increased sales were the result of longer working days on the part of these men, a new business technique invoked by B. R. Kern and their experience and contacts generally. It is pointed out that a competitor, Consolidated Products Company, was paying its president upwards of $50,000 annually based on salary and a percentage of gross sales. It is also pointed out that this concern through its treasurer, H. Kahn, offered either B. R. or S. W. Kern a position with Consolidated at a salary of $20,000 to $25,000 annually plus 7 1/2 percent of gross sales and that if this offer had been accepted by either of them, 126 his income would have been thereby greatly increased. The dividend payment and the large earnings of petitioner after the payment of dividends and salaries are offered in support of its position. It is further argued that the resolutions of the board of directors of April 8, 1941, create a presumption of reasonableness and that the respondent has not overcome this presumption. The respondent argues that the petitioner is a family corporation, that B. R. and S. W. Kern are brothers and own over 80 percent of petitioner's stock, that they are also directors and that, therefore, their dealings with petitioner are subject to careful scrutiny. He further argues that there is no evidence of what would be reasonable compensation for the services rendered by the Kerns and no explanation of what their duties and services were. He points out that as stockholders the Kerns would get the profits in any event and states that the tax consequences of petitioner's action was the dominating factor in the setting up of the compensation arrangement. He also urges that the conversion of this country's industry to a war footing made the selling of power machinery and heavy equipment easy and that incentive127 plans and the long established contacts of the Kerns meant little or nothing. The petitioner has the burden of proving the reasonableness of the salaries paid and that these amounts were paid as compensation for services actually rendered. ; ; . When it appears that the recipients of corporate compensation are also the owners and directors the evidence must be sifted carefully to determine whether the so-called compensation for services is not in reality a distribution of profits. , and cases cited; . The correctness of the action of the respondent in this type of proceeding is a question of fact. . His determination is prima facie correct and to refute it there must be evidence as to the value of the services rendered by the recipients and the amounts paid in similar businesses128 for similar work. , (reversed on other grounds, ); ; The resolution of the board of directors is entitled to weight but it is not conclusive and where a family corporation is involved its value is lessened. ; The testimony offered as to the exact nature of the services rendered by the Kerns or the activities engaged in by them was hazy. No attempt was made to segregate the sales and purchases made by either of them and an adequate description of their respective duties and responsibilities was lacking. The "new technique" was not explained in any way. There was no evidence as to the size of the business of petitioner except the dollar volume of sales for 1940 and 1941. The number of its employees, the complexity and scope of its operations were not before us. No evidence was introduced129 as to the amount generally paid by similar concerns for similar work. In family corporations, such as petitioner, one of the criteria in determining the reasonableness of salaries is whether a stranger's services would be worth the amounts claimed and whether a similar concern or a competitor would place a like value on such services. ;;, affirmed , certiorari denied . The negotiations (if they may be called that) with Kahn of Consolidated standing alone are unimportant, as is the amount paid Consolidated's president. No evidence was introduced as to the comparable sizes of petitioner and Consolidated. A description of the duties, responsibilities or other activities of the president of Consolidated is lacking. The sales volume of Consolidated, the number of its employees, the size of its operations would have been helpful in comparing these businesses to determine if the amounts paid by Consolidated were commensurate 130 with the compensation paid by petitioner. See The discussion with Kahn and his subsequent letter of October 9, 1941, in our opinion, are not sufficient to establish the value of the Kerns' services. The salaries of the Kerns prior to 1940 were relatively small. While the earning record of petitioner for the years immediately preceding 1941 was not before us, petitioner's dividend record is not impressive. One dividend of $6 a share in the face of earnings for 1941 of nearly $200 a share is not a sufficient showing of a dividend paying policy which could rebut the contention of the respondent that the earnings of petitioner were distributed in another fashion. We are not satisfied that the contract of April 9, 1941, was the result of arm's length bargaining between the petitioner and the Kerns to secure their services. B. R. Kern testified that the tax consequences of this arrangement were not discussed. His statement is not contradicted but we can not refrain from pointing out that the tax savings features should have been apparent without discussion. The respondent has allowed B. R. Kern and S. W. Kern $20,000 each as 131 compensation for the year 1941. These sums are not insignificant and compare very favorably with their compensation for 1940 and earlier years. In spite of the longer hours worked by the Kerns, the increased sales and the change in the character of the business urged by the petitioner, we can not say that the respondent's determination was in error. Moreover, it is common knowledge that a greatly increased demand was created for iron, steel and other metal scrap and for a wide variety of used metal machinery as a result of the acceleration of the defense program in 1941 and subsequent years. It is not improbable, therefore, that the increase in volume of business in the taxable year over that of 1940 was largely due to such increased demand, availed of by petitioner through increasing its capital and broadening its scope of operation. To compensate its executive officers for their added responsibility and work thus entailed petitioner increased the salaries (exclusive of commissions) of B. R. Kern and S. W. Kern from $15,000 and $14,500, respectively, to $20,000 each. We are not convinced that the disallowance by respondent of a deduction for the compensation of the officers named132 in excess of $20,000 each was erroneous. On the other hand, it appears to us from the whole picture presented by the evidence that a salary of $20,000 each to the Kerns was not less than the reasonable value of their services. Accordingly, the determination of the respondent is sustained. Decision will be entered for respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623460/	JOSEF MAATUK, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentMaatuk v. CommissionerDocket No. 5350-80.United States Tax CourtT.C. Memo 1982-487; 1982 Tax Ct. Memo LEXIS 259; 44 T.C.M. (CCH) 932; T.C.M. (RIA) 82487; August 24, 1982. 259 Held: Respondent's disallowance of petitioner's claimed business expense and casualty loss deductions sustained. Josef Maatuk, pro se. Mary Schewatz, for the respondent. IRWINMEMORANDUM FINDINGS OF FACT AND OPINION IRWIN, Judge: Respondent determined a deficiency of $144 in petitioner's Federal income tax for 1977. The issues for our decision are: (1) whether petitioner is entitled to a deduction for miscellaneous business expenses in the claimed amount of $1,280; and (2) whether he is entitled to a deduction for a casualty loss in excess of the amount allowed by respondent. FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. The stipulation of facts and the attached exhibits260 are incorporated herein by this reference. Petitioner Josef Maatuk was a resident of Santa Monica, California, at the time the petition was filed in this case. He timely filed his 1977 Federal income tax return. In 1976, Joseph Maatuk received a Ph.D. degree in engineering. In 1977, he began an engineering consulting business. On his 1977 income tax return petitioner claimed a miscellaneous business expense deduction for the following items and amounts: Search of job1 $ 510Travel280Technical Books410Education80$1,280Respondent disallowed this deduction in full on the basis that it had not been established that any amount was expended for ordinary and necessary business expenses. Petitioner also claimed a casualty loss deduction of $750 relating to the theft of a ring. Respondent disallowed $500 of the claimed loss on the basis that no greater amount had been substantiated as a deductible loss. OPINION The issues for our decision are whether petitioner has substantiated any261 amount as an allowable miscellaneous business expense deduction or any amount greater than $250 as an allowable casualty loss deduction. No testimony or other evidence was presented at trial as to the claimed casualty loss and so we assume petitioner has conceded the issue. The sole evidence introduced by petitioner to substantiate his claimed business expense deduction was a copy of a receipt from Leisure Travel International purportedly for the purchase of an airline ticket and also a letter from Martin Marietta Corporation stating that petitioner visited the Denver Division of the corporation concerning possible employment on April 1, 1977. The only information on the document that is legible is that Leisure Travel International disbursed an amount to an unnamed carrier on "3/30." The name of the customer, the year, the place of origination and the destination are either not stated or are illegible. Mr. Maatuk admitted at trial that he had no other receipts or other documentary proof of payment for his claimed business expenses. Petitioner testified that he did not keep any records of his business expenses because he was inexperienced in business management, did not believe262 in checking accounts prior to 1978 and was not aware that he was required to be able to substantiate deductions claimed on his income tax return. Petitioner made no attempt to provide the Court with any additional information as to when, where or why any of the claimed expenses were incurred or how they were related to his engineering consulting business. Rather, his testimony at trial and his brief were devoted to attempting to convince the Court of respondent's unreasonableness in refusing to accept his estimation of his business expenses. We were not persuaded. Deductions from income are a matter of legislative grace and a taxpayer must meet the specific statutory requirements for any deduction claimed. New Colonial Ice Co. v. Helvering,292 U.S. 435">292 U.S. 435 (1934). In addition, the burden of proof is on the taxpayer in this proceeding to demonstrate his entitlement to the deductions disallowed by respondent. Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933); Rule 142(a), Tax Court Rules of Practice and Procedure.Section 162(a) 2 provides that "[t]here shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the263 taxable year in carrying on any trade or business * ." Section 1.162-17(d)(2), Income Tax Regs., provides as follows: (2) The Code contemplates that taxpayers keep such records as will be sufficient to enable the Commissioner to correctly determine income tax liability. Accordingly, it is to the advantage of taxpayers who may be called upon to substantiate expense account information to maintain as adequate and detailed records of travel, transportation, entertainment, and similar business expenses as practical since the burden of proof is upon the taxpayer to show that such expenses were not only paid or incurred but also that they constitute ordinary and necessary business expenses. Petitioner is a highly educated person with a doctorate degree in engineering. We find his claimed ignorance of even minimal recordkeeping in his business dubious and, in any event, of no consequence in affecting the outcome of this proceeding. The law is clear that, in the absence of substantiation, respondent may disallow claimed deductions. 264 3Decision will be entered for respondent.Footnotes1. Although the stipulation states that petitioner claimed $500 as a job search deduction, according to the 1977 return, the correct amount claimed was $510.↩2. All statutory references are to the Internal Revenue Code of 1954, as amended and in effect during the year at issue.↩3. Petitioner devotes much of his brief to protesting the fact that additional expenses were incurred by him in litigating this case. In addition, he comments that the Government's money was ill spent pursuing a mere $144 deficiency. We note that this controversy could have been easily avoided by petitioner if he had maintained the required records.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623461/	APPEAL OF ASSOCIATED GAS & ELECTRIC CO.Associated Gas & Electric Co. v. CommissionerDocket No. 2296.United States Board of Tax Appeals2 B.T.A. 263; 1925 BTA LEXIS 2495; June 30, 1925, Decided Submitted May 6, 1925. 2495 1. A liability accrues in the year in which demand for payment may be and is lawfully made. 2. Under the facts in this case, ownership of 68 per cent of the voting stock, unsupported by other conditions indicating control of the other stock, is not control of substantially all of the stock. Francis J. Sweeney, Esq., for the taxpayer. P. S. Crewe, Esq., for the Commissioner. LOVE 263 Before STERNHAGEN, LANSDON, GREEN, and LOVE. This appeal is from a determination of a deficiency in income and profits taxes for the year 1919 in the amount of $6,694.99. The taxpayer submits the following assignments of error: (a) The refusal of the Commissioner to allow a deduction of a fee paid to Day & Zimmerman, alleging same to have accrued in 1919. (b) The refusal of the Commissioner to permit the filing of a consolidated tax return for the calendar year 1919 by the taxpayer herein and the Kentucky Public Service Co.FINDINGS OF FACT. The taxpayer was on the accrual basis in 1918 and 1919. Some time during the year 1918, exact time not determined, the taxpayer employed Day & Zimmerman to make an examination of the Associated2496 Gas & Electric Co. and its subsidiaries, and make report to Montgomery & Co., bankers. 264 On January 31, 1919, the taxpayer received from Montgomery & Co. a bill or statement and entered the item on its journal, thus: Surplus$5,700Bills payable$5,700To record invoice of Day & Zimmerman dated 12/31-1918. For examination of Assoc. G. & E. Co. and subsidiaries and paid by Montgomery & Co. on January 9, 1919, and demand note @ 6% given to Montgomery & Co. Jan. 31-1919 by Assoc. G. & E. Co. The demand note above referred to was paid by the taxpayer in 1919. The taxpayer deducted said payment as a necessary expense in its income-tax return for the year 1919. There is no controversy as to the payment of this item or that it was necessary expense. The Commissioner contends that it accrued in 1918 and should be allocated to that year's return. On the question of affiliation, the Board finds that on January 1, 1919, the Kentucky Public Service Co. had capital stock outstanding as follows: SharesPreferred stock4,250Common stock8,562At that time the taxpayer owned stock of the Kentucky Public Service Co. as follows: 2497 SharesPreferred stock4,250Common stock5,728During the year 1919 taxpayer acquired 122 additional shares of the Kentucky Public Service Co. common stock. The minority common stock of the Kentucky Public Service Co. was held in small amounts by a number of persons widely scattered as to residence. There was no evidence as to who, if anyone, voted any of said minority stock. The preferred stock carried no voting rights except as to placing encumbrance on the assets of the company on a parity with or superior to the outstanding preferred stock. During the year 1919 the officers of the respective companies were as follows: Taxpayer company.Kentucky Public Service Co.PresidentJ. H. PardeeJ. A. Mange. Vice presidentsS. J. McGeeS. J. McGee.I. MangeC. A. Greonidge.R. B. MarshallT. W. Moffett.H. D. Fitch.Secretary-treasurerT. W. MoffettH. B. Brown.Board of directorsWilliam Dignan, jrWilliam Dignan, Jr.J. I. MangeJ. I. Mange.J. H. PardeeJ. H. Pardee.R. L. MontgomeryH. D. Fitch.J. G. WhiteC. A. Greonidge.265 DECISION. The deficiency should be recomputed in2498 accordance with the following opinion. Final determination of the Board will be settled on consent or on 10 days' notice, under Rule 50. OPINION. LOVE: While it is an admitted fact that the services rendered by Day & Zimmerman were rendered during the year 1918, the bill for same was not made until December 31. It was not paid by Montgomery & Co. until January 9, 1919, and not received by the taxpayer nor entered on its books in any manner until January 31, 1919. It was not recognized by the taxpayer as an obligation until January 31, 1919, and hence the Board holds that that expense accrued in 1919. On the question of affiliation, it will be noted that more than 31 per cent of the common stock of the Kentucky Public Service Co. was held by persons over whom the taxpayer exercised no control, and it was not shown that any stockholder of the taxpayer exercised any control over that minority stock. It will also be noted that the preferred stock carried no voting rights, except for special purposes. In these circumstances, a control of 68 per cent of stock, unsupported by other conditions, is not a control of substantially all of the stock. The two corporations named2499 were not affiliated during the year 1919.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623462/	Rubber Research Inc., a Minnesota Corporation v. Commissioner.Rubber Research, Inc. v. CommissionerDocket No. 419-67.United States Tax CourtT.C. Memo 1969-24; 1969 Tax Ct. Memo LEXIS 271; 28 T.C.M. (CCH) 118; T.C.M. (RIA) 69024; February 3, 1969, Filed Harry H. Peterson, 738 Midland Bank272 Bldg., Minneapolis, Minn., forthe petitioner. Robert F. Cunningham, for the respondent. TANNENWALDMemorandum Findings of Fact and Opinion TANNENWALD, Judge: Respondent determined a deficiency in petitioner's income tax for the taxable period ending March 31, 1962 in the amount of $65,480 and an addition to tax pursuant to section 6651(a) 1 in the amount of $16,370. After certain concessions by petitioner, the principal issue is whether petitioner realized a gain upon the receipt of 136,500 shares of stock in a subsidiary in exchange for an exclusive sublicense. A secondary issue is whether petitioner is liable for an addition to tax pursuant to section 6651(a) because of a failure to file an income tax return for the taxable period ending March 31, 1962. Findings of Fact Some of the facts are stipulated and are found accordingly. Petitioner is a corporation organized under the laws of Minnesota whose principal place of business at the time of filing the petition herein was Minneapolis, Minnesota. Petitioner did not file a corporate income tax return for the period273 ending March 31, 1962. At all times relevant herein, petitioner held an exclusive license covering certain chemical processes and patents pertaining thereto for the treatment of synthetic and natural rubber. Rubber Research Elastomerics, Inc. (hereinafter Elastomerics) is a corporation organized under the laws of Minnesota on April 7, 1961 with its principal office at the same address as that of petitioner. Elastomerics filed a corporate income tax return for the taxable year ending March 31, 1962 with the district director of internal revenue, St. Paul, Minnesota. 119 Under its exclusive license, petitioner granted a sublicense to Elastomerics on February 5, 1962 providing for the exclusive right to manufacture, use, and sell products employing chemical processes for the alteration, treatment, and improvement of the chemical properties of synthetic and natural rubber in exchange for 136,500 shares of Elastomerics stock, plus a royalty. Petitioner subscribed for the Elastomerics stock on January 20, 1962; Elastomerics authorized the stock issuance on February 3, 1962; and petitioner formally accepted the stock on February 15, 1962. Elastomerics placed the sublicense on its274 books at a value of $136,500. Petitioner's adjusted basis in the sublicense was zero. On December 20, 1961, Elastomerics filed an application with the Minnesota Commissioner of Securities for the registration of 119,270 shares of stock with a par value of $1 per share, which was approved on January 16, 1962. During the period April 8, 1961 to the date of such approval, Elastomerics had received subscriptions for at least 61,980 shares at $1 per share from seventeen subscribers. Between January 16 and February 17, 1962, an additional 12,900 shares were sold to seven individuals at $1 per share. By March 31, 1962, only 14,222 of the 262,500 authorized shares remained unissued. The sale and promotion of Elastomerics stock was handled on a private basis. The stock was not offered or sold on any stock exchange, nor was an underwriter or broker engaged to sell Elastomerics stock at any time pertinent to this case. Petitioner received the advice of counsel as to the various legal, including tax, aspects of the transaction. Ultimate Findings of Fact The fair market value of Elastomerics stock on February 5, 1962 was $1 per share. Petitioner's failure to file a return for the taxable275 year ending March 31, 1962 was not due to reasonable cause. Opinion Involved herein is a determination of the tax consequences to petitioner of its transfer of an exclusive sublicense to Elastomerics in exchange for 136,500 shares, or slightly more than 50 percent of the latter's stock. Petitioner originally alleged in its petition that the transaction constituted a nontaxable transfer under section 351. At trial and on brief, petitioner abandoned this contention and now relies upon the simple assertion that, although a taxable type of transaction occurred, the circumstances were such that the gain was incapable of being computed and therefore no tax should be imposed. Petitioner argues that both the sublicensing agreement and the Elastomerics shares received in exchange were incapable of valuation at the critical date. As to the sublicensing agreement, petitioner overlooks the fact that gain on a taxable exchange is determined by measuring the value of the property received (i.e., the Elastomerics shares) against the adjusted basis of the property transferred (i.e., the sublicensing agreement). Section 1001. Under the circumstances herein, adjusted basis is founded upon cost, 276 not value. Section 1011. There is not the slightest evidence in this record that petitioner had any investment in the sublicensing agreement and we have accordingly found its adjusted basis to be zero. As to the value of the Elastomerics shares, we think that petitioner has utterly failed to overcome the presumptive correctness of respondent's determination of $1 per share on the critical date. Indeed, we think the evidence affirmatively supports such determination and we have accordingly found as a fact that the shares had that value. Cf. Arc Realty Co., 34 T.C. 484">34 T.C. 484 (1960), affirmed on this issue 295 F. 2d 98 (C.A. 8, 1961). Petitioner objected to several items purporting to relate to value which respondent was permitted to introduce into evidence on the ground that they related to transactions and determinations other than on the critical date. It is sufficient for us to note that, although not per se determinative of value, all of the transactions and determinations were sufficiently proximate in time to the critical date to be probative on the question before us. Petitioner's contention that various sales should not have been considered because they277 were to friends of key corporate personnel must be rejected. In the first place, the price on a sale to friends can be as easily below as above fair market value. Standing alone, as they do on this record, such sales may properly be taken into account in making an ultimate determination of value. Secondly, even if such sales were not considered, we would affirm respondent's determination because petitioner has 120 failed to present any other probative evidence on this point. 2Nor can we accept petitioner's assertion on brief that the critical date is April 24, 1961 instead of February 5, 1962. The entire sequence of events, as revealed by the record herein, clearly supports the latter date, to say nothing of the statements of petitioner's counsel at the trial. Petitioner's reliance on Helvering v. TexPenn Co., 300 U.S. 481">300 U.S. 481 (1937), is totally misplaced. In suggesting an alternative ground for its decision, the Supreme Court emphasized "the peculiar circumstances of this case" and the "terms of a restrictive agreement making a sale [of stock] impossible.278 " See 300 U.S. at p. 499. The element of substantial restraint or alienation has been the significant consideration in subsequent applications of the Tex-Penn principle. United States v. State Street Trust Co., 124 F. 2d 948 (C.A. 1, 1942); compare Harold B. Kuchman, 18 T.C. 154">18 T.C. 154 (1952), with W. H. Weaver, 25 T.C. 1067">25 T.C. 1067, 1080 (1956); see Arc Realty Co., supra, 34 T.C. at p. 493. In this case, there is not the slightest indication of any such restraint or other peculiar circumstances as would justify our refusal to determine a value. Cf. Victorson v. Commissioner, 326 F. 2d 264 (1964), affirming a Memorandum Opinion of this Court; William H. Husted, 47 T.C. 664">47 T.C. 664 (1967); W. H. Weaver, supra. With respect to the addition to tax under section 6651(a), it is clear that every corporation is required to file a return when due, irrespective of whether it has gross income. Section 6012; section 1.6012-2(a)(1), Income Tax Regs. The record shows that petitioner received extensive advice of counsel as to the taxability of the transaction herein. But even if we accept279 the proposition that, under certain circumstances, advice of counsel may be sufficient to show that failure to file a return was due to "reasonable cause and not willful neglect," there is no indication that any of the advice which petitioner received related to its obligation to file a return. Nor has petitioner offered any other evidence which might have provided a basis for concluding that its failure to file satisfied the exception of section 6651(a). Consequently, respondent's determination of the addition to tax must be sustained. Logan Lumber Co. v. Commissioner, 365 F. 2d 846, 855 (C.A. 5, 1966), affirming on this issue a Memorandum Opinion of this Court; Lee Lash Co., 6 B.T.A. 165">6 B.T.A. 165 (1927); J. Hudson McKnight B.T.A. 165 (1927); J. Hudson McKnight, Conlorez Corporation, 51 T.C. - (Dec. 24, 1968). Decision will be entered for the respondent. Footnotes1. All references, unless otherwise specified, are to the Internal Revenue Code of 1954.↩2. Petitioner's claim on brief that it was prevented from so doing is completely belied by the record.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623464/	ACME CONSTRUCTION CO., INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentAcme Constr. Co. v. CommissionerDocket No. 7017-93United States Tax CourtT.C. Memo 1995-6; 1995 Tax Ct. Memo LEXIS 4; 69 T.C.M. (CCH) 1596; January 9, 1995, Filed 4 Decision will be entered under Rule 155. For petitioner: Lewis T. Barr and William H. Baughman, Jr.For respondent: J. Scott Broome. COLVINCOLVINMEMORANDUM FINDINGS OF FACT AND OPINION COLVIN, Judge: Respondent determined a $ 122,188 deficiency in petitioner's Federal income tax for the taxable year ending April 30, 1990 (fiscal year 1990). The sole issue for decision is whether petitioner may deduct as reasonable compensation amounts it paid to David Horth in fiscal year 1990. The following chart shows the contentions of the parties and the amount allowed by this opinion: Allowable Deductionfor Compensation Paidto David Horth inFiscal Year 1990 Petitioner's position$ 442,150Respondent's position108,272Amount of deduction442,150allowed by this opinionRespondent's position reflects compensation for services rendered in fiscal year 1990 only. Petitioner's position reflects payments for services rendered in fiscal years 1983 to 1990. Section references are to the Internal Revenue Code in effect during the year in issue. Rule references are to the Tax Court Rules of Practice and Procedure. FINDINGS OF FACT Some of the facts have been stipulated5 and are so found. 1. Petitioner's BackgroundPetitioner is a closely held corporation the principal place of business of which was in Cleveland, Ohio, when it filed the petition. Petitioner specialized in railroad construction, reconstruction, and rehabilitation and related site preparation; switchwork and electrical work, earth excavation, compacting and rolling, and embankment construction; and storm and sanitary sewer reconstruction. Petitioner did most of its work in the Cleveland area, but also worked in New York, Pennsylvania, West Virginia, Kentucky, Indiana, Michigan, and Ohio, and occasionally in Maryland, Virginia, and Illinois. Petitioner is one of several construction companies that have been operated by members of the Horth family in Cleveland, Ohio. Homer Horth operated Acme Construction Co. (Acme I) in the Cleveland area during the 1920s. Acme did rail construction, reconstruction, rehabilitation, and related work. It operated in various forms under Homer Horth's control until the early 1950s when Homer Horth retired. Homer Horth's sons, John F. Horth and Kenneth Horth, and an unrelated person, Jack Frish, operated Acme I as a partnership after Homer6 Horth retired. They incorporated the partnership and created Acme Construction, Inc. (Acme II), on July 22, 1968. Acme II operated until December 1982, and dissolved on October 12, 1984. On October 13, 1962, John F. Horth's wife and children and Kenneth Horth's wife and children formed a separate corporation called Horth Contractors Corp.Horth Contractors Corp. owned construction equipment which it leased to Acme I. In May 1978, all but four shareholders of Horth Contractors Corp. sold their stock to Horth Contractors Corp. The remaining shareholders were John F. Horth's wife Janey and son David Horth, and Kenneth Horth's sons, Peter Horth and John D. Horth. After another transfer and redemption in December 1982, David Horth owned 50 percent, Peter Horth owned 33 percent, and John D. Horth owned 17 percent of Horth Contractors Corp.2. David HorthDavid Horth worked as a laborer for Acme II while he was in high school. He later operated heavy construction equipment for Acme II. He continued to work for Acme II while he attended college, sometimes as a field foreman. He worked for Acme II for seven summers and did nearly every field job. David Horth received a bachelor's7 degree in civil engineering and a master's degree in construction engineering and business management from Stanford University. After he finished his graduate studies, he worked full time for Acme II. He began as a payroll clerk and worked in various financial and managerial capacities. He learned project estimating and bidding from his uncle. 3. PetitionerIn 1982, David and Peter Horth went into the rail construction business for themselves. On December 17, 1982, they renamed Horth Contractors Corp. Its new name was Acme Construction Co., Inc. (petitioner or Acme III). David Horth was president, treasurer, and a director of petitioner in December 1982. Peter Horth was vice president, assistant secretary, and a director at that time. Louis Paisley, a nonfamily member and petitioner's outside legal counsel, was secretary and a director. Neither David Horth nor Peter Horth was an officer or director for petitioner or Horth Contractors Corp. before December 1982. John D. Horth has not participated in petitioner's management. Both David and Peter Horth prepared bids for petitioner. Petitioner did the same type of work as Acme II. It had many of the same customers. 8 Petitioner hired many of Acme II's employees. Petitioner operated at the same location as Acme II. Petitioner began performing construction work immediately after it was formed. David and Peter Horth were not petitioner's highest paid employees. For example, in 1984 and 1986 petitioner paid Carl Eberhardt union scale, which was more than it paid either David or Peter Horth. David and Peter Horth discussed their compensation levels. Bonding companies and credit sources required petitioner to conserve cash. David and Peter Horth recognized the need to conserve cash. Peter Horth wanted his and David Horth's compensation to be relatively low. David Horth believed that he was undercompensated, but went along with Peter Horth until Peter Horth resigned as a director. On January 1, 1983, petitioner had $ 437,628 in cash, $ 505,658 in assets (less accumulated depreciation for equipment and machinery), $ 23,386 in liabilities, and $ 474,397 in retained earnings. From 1983 through 1990, David Horth worked 12 to 14 hours per day, 5 and sometimes 6 days a week. He traveled up to 40,000 miles a year. He used his car, and later a van equipped as a mobile office with a telephone and9 computer, to prepare bids while being driven from site to site. In fiscal year 1990, petitioner had about 100 employees. 4. Horth Contractors Co.David, Peter, and John D. Horth formed a partnership called Horth Contractors Co. (the partnership) on July 1, 1985. David Horth owned 50 percent, Peter Horth owned 33-1/3 percent and John D. Horth owned 16-2/3 percent of the partnership. The partnership bought the real property where petitioner's office is located from Kenneth Horth and John F. Horth on July 1, 1985. The partnership gave the sellers a $ 325,000 note. The partnership did not distribute any cash to the partners due to its debt service. Before the partnership bought the real property, petitioner rented it from Acme II. Petitioner was responsible for maintaining the partnership's property. 5. Redemption of Peter Horth's StockBy 1988, David and Peter Horth had different business philosophies. David Horth suggested to Peter Horth that one of them leave petitioner. David and Peter Horth did not have any buy and sell agreements. In September 1988, Peter Horth decided to leave. David and Peter Horth went to petitioner's legal counsel and asked him to10 prepare documents for petitioner to buy Peter Horth's stock. Peter Horth also bought John D. Horth's stock. Peter Horth retained separate legal counsel to represent him in his withdrawal from petitioner. On December 11, 1988, Peter Horth resigned as an employee of petitioner. He did not perform any services or receive any compensation after December 1988. However, he continued to serve as a director of petitioner. Petitioner's counsel and Peter Horth's counsel negotiated the withdrawal. They prepared documents, such as a redemption agreement, security agreement, and shareholder consent, which the parties signed on April 2, 1990. On April 2, 1990, petitioner redeemed all of Peter Horth's shares, including the shares that John D. Horth had owned. Peter Horth resigned as a director on March 29, 1990, after which David Horth was petitioner's only director and shareholder. 6. David Horth's CompensationThe following chart compares David Horth's compensation with petitioner's gross and net income: David Horth'sPetitioner'sBaseYearGross IncomeNet IncomeCompensationBonusRetirement1983- 0 - $ 101,510 $ 8,500-0- -0-1984$ 3,027,045236,688 35,750-0- $ 5,43819853,697,644347,168 41,590-0- 6,23919862,574,675(41,678)41,60015,0008,49019873,820,994(94,243)43,929-0- 6,43119884,528,89762,097 41,760-0- 6,16919894,975,680192,646 56,600-0- 6,24019904,330,871603,771 42,150400,00030,00011 Petitioner paid the $ 400,000 1 bonus payment to David Horth in fiscal year 1990 in two checks of $ 200,000 each. One check bears the notation "Bonus Past Service from 5/01/83 - 4/30/89". The other says "Bonus FYE 4/30/90". Petitioner's payments to David Horth in fiscal year 1990 were compensation for his services to petitioner in fiscal year 1990 and earlier years. Petitioner did not use a method or formula to calculate the amount it paid to David Horth for fiscal year 1990. 7. Petitioner's Return and Respondent's DeterminationPetitioner deducted $ 42,150 as base salary and $ 400,000 as a bonus for a total of $ 442,150 for compensation it paid to David Horth in fiscal year 1990. Respondent determined that it was unreasonable for petitioner to pay David Horth12 more than $ 108,272 for services rendered in fiscal year 1990. The notice of deficiency contained no explanation for the amount respondent determined was reasonable. OPINION 1. BackgroundA taxpayer may deduct "a reasonable allowance for salaries or other compensation for services actually rendered". Sec. 162(a)(1). Compensation payments are deductible if they are: (1) Reasonable, and (2) purely for services. Sec. 162(a)(1); Elliotts, Inc. v. Commissioner, 716 F.2d 1241">716 F.2d 1241, 1243 (9th Cir. 1983), revg. and remanding T.C. Memo 1980-282">T.C. Memo. 1980-282; sec. 1.162-7(a), Income Tax Regs. We must consider the facts of each case in deciding whether a taxpayer meets the requirements for deducting compensation paid under section 162(a)(1). Estate of Wallace v. Commissioner, 95 T.C. 525">95 T.C. 525, 553 (1990), affd. 965 F.2d 1038">965 F.2d 1038 (11th Cir. 1992). Respondent determined that petitioner should not have paid David Horth more than $ 108,272 in fiscal year 1990. Respondent did not explain the basis for that amount. Respondent's determination is presumed to be correct, and petitioner bears the13 burden of proving that the amounts which are more than allowed by respondent are reasonable compensation for services. Rule 142(a). If petitioner proves respondent's determination is wrong, the Court must then decide the amount of reasonable compensation. Pepsi-Cola Bottling Co. v. Commissioner, 61 T.C. 564">61 T.C. 564, 568 (1974), affd. 528 F.2d 176">528 F.2d 176 (10th Cir. 1975). Respondent contends petitioner failed to carry its burden of proving the compensation was reasonable and that the payments were for services to petitioner. 2. Reasonableness of David Horth's CompensationCourts have considered many factors in deciding whether the amount of compensation is reasonable, such as: (a) The employee's qualifications; (b) the nature, extent, and scope of the employee's work; (c) the size and complexity of the business; (d) a comparison of salaries paid with sales and net income; (e) general economic conditions; (f) comparison of salaries to distributions to shareholders and retained earnings; (g) the employer's salary policy to all employees; (g) the employer's financial condition; (i) the prevailing rates of compensation for comparable14 positions in comparable companies; (j) compensation paid in prior years; (k) whether the employee and employer dealt at arm's length; and (1) whether the employee guaranteed the employer's debt. Elliotts, Inc. v. Commissioner, supra; Kennedy v. Commissioner, 671 F.2d 167">671 F.2d 167, 175 (6th Cir. 1982), revg. and remanding 72 T.C. 793">72 T.C. 793 (1979); Mayson Manufacturing Co. v. Commissioner, 178 F.2d 115">178 F.2d 115, 119 (6th Cir. 1949), revg. and remanding a Memorandum Opinion of this Court; R.J. Nicoll Co. v. Commissioner, 59 T.C. 37">59 T.C. 37, 51 (1972). No single factor controls. Mayson Manufacturing Co. v. Commissioner, supra.a. Employee's QualificationsAn employee's superior qualifications for his or her position with the business may justify high compensation. See, e.g., Home Interiors & Gifts, Inc. v. Commissioner, 73 T.C. 1142">73 T.C. 1142, 1158 (1980); Dave Fischbein Manufacturing Co. v. Commissioner, 59 T.C. 338">59 T.C. 338, 352-353 (1972). Respondent concedes that David Horth15 had a superior formal education, but argues that petitioner has not shown that it qualified him for his position with petitioner. We disagree. David Horth's civil and construction engineering and management degrees are directly related to his position with petitioner. In addition, David Horth had well-rounded employment experience with petitioner. We conclude that he was well qualified to run petitioner's business. This factor favors petitioner. b. Nature, Extent, and Scope of Employee's WorkThe position held by the employee, hours worked, duties performed, and the general importance of the employee to the success of the company may justify high compensation. Mayson Manufacturing Co. v. Commissioner, supra; see, e.g., Elliotts, Inc. v. Commissioner, supra at 1245-1246; American Foundry v. Commissioner, 536 F.2d 289">536 F.2d 289, 291-292 (9th Cir. 1976), affg. in part and revg. in part 59 T.C. 231">59 T.C. 231 (1972); Home Interiors & Gifts, Inc. v. Commissioner, supra at 1158. David Horth provided significant services as petitioner's16 chief executive officer which caused petitioner's success. He anticipated business trends. He oversaw petitioner's daily operations. His work required judgment, technical skill, and adaptability. David Horth assumed Peter Horth's duties after Peter Horth left petitioner in December 1988. Petitioner's success after Peter Horth left petitioner is strong evidence of David Horth's efficiency and ability. Respondent argues that David Horth spent less time on petitioner's work because he spent time on the partnership. The record shows that David Horth spent most of his time and effort on petitioner. He worked 12 to 14 hours per day, 5 or 6 days a week. He designed and used a mobile office to allow him to work while traveling. There is no evidence that David Horth spent much time on the partnership. We do not believe the time he spent on the partnership detracted from petitioner's success. Bidding was crucial to petitioner because about 95 percent of petitioner's business resulted from competitive bidding. Respondent agrees that petitioner's bid function is complex. However, respondent contends that David Horth shared the preparation of bids with Peter Horth and others. David17 Horth credibly testified that he prepared most of petitioner's bids. Respondent introduced no contrary evidence. The Court of Appeals for the Sixth Circuit said: "Getting and keeping customers, is, of course, the lifeblood of any business". Kennedy v. Commissioner, supra at 176. Like the employee in Kennedy, David Horth was solely responsible for soliciting every major customer for petitioner and maintaining relations with them. Respondent contends that petitioner did not rely on bidding because much of its business was from repeat customers. We disagree. Petitioner competitively bid 95 percent of its work. Repeat customers generally required petitioner to bid on jobs and awarded projects to the lowest qualified bidder. We believe petitioner had repeat customers primarily because petitioner's bids were competitive. Respondent contends that petitioner did not prove that its success in fiscal year 1990 was due to David Horth because petitioner used the completed contract method of accounting. Under this method, petitioner reported income when the contract was completed. Respondent argues that petitioner's income in fiscal year 1990 18 benefited from Peter Horth's earlier bidding efforts. We disagree because there is no evidence that any contracts were completed in fiscal year 1990 on which Peter Horth bid, and both David and Peter Horth prepared bids. Peter Horth left petitioner in December 1988, leaving David Horth to ensure that work in progress was completed properly. This factor favors petitioner. c. Size and Complexity of the BusinessCourts have considered the size and complexity of a taxpayer's business in deciding whether compensation is reasonable. Elliotts, Inc. v. Commissioner, 716 F.2d at 1246; Pepsi-Cola Bottling Co. v. Commissioner, 528 F.2d at 179; Mayson Manufacturing Co. v. Commissioner, supra.Respondent contends that petitioner was not very large. Petitioner had about 100 employees and gross sales of about $ 4.3 million in fiscal year 1990. Respondent argues that David Horth supervised 15 employees while petitioner's superintendents supervised all field labor. We are not persuaded by respondent's claim. Even if this were true, this fact would not convince us that David Horth's responsibilities19 differed from those of an active chief executive officer. Respondent argues that petitioner's business was simple except for the bid process. We disagree. Petitioner did rail construction, reconstruction, and rehabilitation and related site preparation, switchwork and electrical work, earth excavation, compacting and rolling, embankment construction, and storm and sanitary sewer reconstruction. Petitioner performed most of its work in the Cleveland area, but also worked in 10 neighboring States. The engineering, logistics, and financing of these operations are complex. Respondent contends that much of petitioner's success is due to the long history of Horth involvement in the construction industry in Cleveland. Petitioner was completely on its own by 1985. After an initial struggle, petitioner became very successful in fiscal years 1989 and 1990. We think David Horth deserves significant credit for petitioner's success. This factor favors petitioner. d. Comparison of Salaries Paid With Sales and Net IncomeCourts have compared sales and net income to amounts of compensation in deciding whether compensation is reasonable. Mayson Manufacturing Co. v. Commissioner, 178 F.2d 115">178 F.2d 115 (6th Cir. 1949).20 Respondent points out that David Horth's compensation was 73.23 percent of petitioner's profit (before taxes and officers' compensation in fiscal year 1990). However, respondent's view that Horth's compensation was unreasonable is incorrect because it fails to take into account the fact that David Horth's compensation in fiscal year 1990 was for services he rendered in and before fiscal year 1990. Also, petitioner's net income dramatically increased from about $ 62,000 to over $ 603,000 after loss years in 1986 and 1987 while gross income generally increased from about $ 3 to $ 4.5 million from 1984 to 1990. We believe David Horth's pay compares favorably with petitioner's sales and net income. Respondent argues that David Horth set his pay after he concluded that petitioner needed a large deduction for fiscal year 1990. We believe David Horth arranged for petitioner to make catchup payments to him for prior undercompensation as soon as Peter Horth resigned as a director on March 29, 1990. Thus, we do not share respondent's suspicion about the reason for the compensation. This factor favors petitioner. e. General Economic ConditionsGeneral economic conditions may affect21 a company's performance, and thus indicate the extent, if any, of the employee's effect on the company. Elliotts, Inc. v. Commissioner, supra; Mayson Manufacturing Co. v. Commissioner, supra. The parties agree that this factor is neutral. f. Comparison of Salaries With Distributions to Shareholders and Retained EarningsThe failure to pay more than minimal dividends may suggest that some of the amounts paid as compensation to the shareholder-employee is a dividend. Owensby & Kritikos, Inc. v. Commissioner, 819 F.2d 1315">819 F.2d 1315, 1322-1323 (5th Cir. 1987), affg. T.C. Memo 1985-267">T.C. Memo. 1985-267; Charles Schneider & Co. v. Commissioner, 500 F.2d 148">500 F.2d 148, 152-153 (8th Cir. 1974), affg. T.C. Memo 1973-130">T.C. Memo. 1973-130. The failure to pay dividends can be a "red flag" that invites further scrutiny by the court. Edwin's, Inc. v. United States, 501 F.2d 675">501 F.2d 675, 677 n.5 (7th Cir. 1974). However, corporations are not required to pay dividends; shareholders may be equally content with the appreciation of22 their stock caused, for example, by the retention of earnings. Owensby & Kritikos, Inc. v. Commissioner, supra; Elliotts, Inc. v. Commissioner, 716 F.2d 1241">716 F.2d 1241 (9th Cir. 1983); Home Interiors & Gifts, Inc. v. Commissioner, 73 T.C. at 1158. Respondent argues that petitioner's failure to pay dividends is strong evidence that David Horth's compensation was unreasonable. Petitioner's retained earnings increased from $ 498,732 at the beginning of fiscal year 1982 to $ 869,555 at the end of fiscal year 1990. This factor favors petitioner. g. Petitioner's Salary Policy to All EmployeesCourts have considered salaries paid to other employees of a business in deciding whether compensation is reasonable. Home Interiors & Gifts, Inc. v. Commissioner, supra at 1159. This factor focuses on "whether the entity as a whole pays top dollar to all of its employees, shareholder- and nonshareholder-employees alike." Owensby & Kritikos, Inc. v. Commissioner, supra at 1330. A longstanding, consistently applied compensation plan23 is evidence that compensation is reasonable. Elliotts, Inc. v. Commissioner, supra.David and Peter Horth were petitioner's most valuable employees, but not petitioner's highest paid employees in years before fiscal year 1990. This tends to show that David and Peter Horth had been undercompensated. Respondent argues that this fact should be discounted because petitioner's higher paid employees had more experience or were under union contracts. Respondent theorizes that those employees were accustomed to salaries set by John and Kenneth Horth at Acme II. Respondent did not introduce any evidence supporting this theory. This factor favors petitioner. h. Petitioner's Financial ConditionThe past and present financial condition of the company is relevant to deciding whether compensation was reasonable. Kennedy v. Commissioner, 671 F.2d at 174; Home Interiors & Gifts, Inc. v. Commissioner, supra at 1157-1158. Petitioner grew to become very profitable. This factor favors petitioner. i. Prevailing Rates of Compensation for Comparable Positions in Comparable Companies24 In deciding whether compensation is reasonable, we compare it to compensation paid for comparable positions in comparable companies. Elliotts, Inc. v. Commissioner, supra at 1246; Mayson Manufacturing Co. v. Commissioner, 178 F.2d at 119. Petitioner relied on expert testimony from Lanny Harer (Harer) for this factor. Harer was the only expert witness in this case. Expert witnesses' opinions may help the Court understand an area requiring specialized training, knowledge, or judgment. Fed. R. Evid. 702; Snyder v. Commissioner, 93 T.C. 529">93 T.C. 529, 534 (1989). We may be selective in deciding what part of an expert's opinion we will accept. Helvering v. National Grocery Co., 304 U.S. 282">304 U.S. 282 (1938); Silverman v. Commissioner, 538 F.2d 927">538 F.2d 927, 933 (2d Cir. 1976), affg. T.C. Memo 1974-285">T.C. Memo. 1974-285; Parker v. Commissioner, 86 T.C. 547">86 T.C. 547, 562 (1986); Chiu v. Commissioner, 84 T.C. 722">84 T.C. 722, 734 (1985). Harer analyzed compensation for comparable positions in other companies. 25 He concluded that David Horth's compensation for fiscal year 1990 was reasonable primarily because petitioner underpaid David Horth in all years before fiscal year 1990, and that petitioner could reasonably have paid David Horth at least $ 296,000 for fiscal 1990 alone. This factor favors petitioner. j. Compensation Paid in Prior Yearsi. In GeneralAn employer may deduct compensation paid in a year even though the employee performed the services in a prior year. Lucas v. Ox Fibre Brush Co., 281 U.S. 115">281 U.S. 115, 119 (1930); R.J. Nicoll Co. v. Commissioner, 59 T.C. at 50-51. To currently deduct amounts paid as compensation for past undercompensation, a taxpayer must show: (a) That it intended to compensate employees for past services from current payments, and (b) the amount of past undercompensation. Pacific Grains, Inc. v. Commissioner, 399 F.2d 603">399 F.2d 603, 606 (9th Cir. 1968), affg. T.C. Memo. 1967-7; Estate of Wallace v. Commissioner, 95 T.C. at 554. We have found that petitioner's payments to David Horth in fiscal year 199026 were compensation for his services to petitioner in fiscal year 1990 and earlier years. Petitioner deferred David Horth's compensation to build its business. Petitioner sought to preserve cash to get bonding and credit. ii. Expert TestimonyHarer testified that employers paid more for average comparable positions than petitioner paid to David Horth in fiscal years 1983 to 1989. David Horth took low pay until petitioner could pay him for past undercompensation and Peter Horth left petitioner. We believe that petitioner paid David Horth reasonable compensation in fiscal year 1990 for services he provided in fiscal year 1990 and prior years. 227 iii. Respondent's ArgumentsRespondent argues that petitioner did not undercompensate David Horth because David and Peter Horth did not agree to draw lower salaries in exchange for later catchup payments. However, an agreement or even an obligation to defer compensation is not necessary for payments to be treated as attributable to prior years. Lucas v. Ox Fibre Brush Co., supra at 119. Respondent argues that Peter Horth could not have stifled David Horth's compensation. We disagree. David Horth credibly testified that Peter Horth did just that. Petitioner was able to correct David Horth's compensation only after Peter Horth was no longer a director for petitioner. Respondent points to the fact that petitioner paid David and Peter Horth's salaries in prior years after David and Peter Horth decided the amount. Respondent argues that the fact that they chose the amount means that they were not undercompensated. We disagree. Parties can agree on an amount of compensation and still be undercompensated. See, e.g., id.; Mayson Manufacturing Co. v. Commissioner, supra.Respondent argues that there28 was no reason for petitioner to underpay David and Peter Horth in prior years. We disagree. Petitioner needed to accumulate cash to satisfy its lenders and bonding companies. Respondent argues that petitioner has no corporate records other than the check stub which show that it underpaid David Horth during the prior years. This fact does not undermine petitioner's position in the context of the Horth's family business. Courts may give little or no weight to the lack of formal board resolutions about officers' compensation in closely held corporations. E.g., Levenson & Klein, Inc. v. Commissioner, 67 T.C. 694">67 T.C. 694, 713-714 (1977); Reub Isaacs & Co. v. Commissioner, 1 B.T.A. 45">1 B.T.A. 45, 48 (1924). In Levenson & Klein, Inc. v. Commissioner, supra at 714, we said: "Closely held corporations, as is well known, often act informally, 'their decisions being made in conversations, and oftentimes recorded not in the minutes, but by action.'" citing Reub Isaacs & Co. v. Commissioner, supra.Peter Horth redeemed his stock at or below book value. Thus, respondent points29 out that Peter Horth did not receive pay for prior years when he redeemed his stock. Peter Horth retained separate counsel to represent him during the redemption. Peter Horth and petitioner agreed on terms for redeeming all of his stock. Peter Horth could have redeemed his stock for more than book value. There is no evidence of anything which would have prevented him from negotiating payment for prior years. The fact that he did not do so does not convince us that petitioner did not undercompensate David or Peter Horth in earlier years. Respondent argues that David Horth was not underpaid by petitioner because the partnership paid him cash. Respondent attempts to reconstruct partnership cash-flow by analyzing rent that petitioner paid to it. However, the partnership did not pay David Horth cash. Respondent did not consider the long-term debt the partnership incurred when it bought the property from petitioner when respondent reconstructed cash-flow. Also, respondent did not consider the partnership's need to marshal cash to redeem Peter Horth's partnership interest. Respondent suggests that the rents were for more than fair market value, but there is no evidence to support30 that contention. Respondent rejects the Robert Morris Associates' data cited by petitioner and argues that the PAS Executive Compensation Survey for Contractors 1985-91 data support respondent's position if David Horth's partnership income is combined with his pay from petitioner. As discussed above, the partnership is irrelevant to the reasonableness of income from petitioner. Also, the partnership did not distribute any cash to the partners due to its debt service. Respondent argues that David Horth controlled petitioner only after it became successful. We disagree. David Horth contributed significantly to petitioner's success. The fact that petitioner had a predecessor business does not detract from our conclusion. David Horth made petitioner very successful following 2 years of losses and then losing Peter Horth and financing ability. Thus, the fact that petitioner is not a startup venture does not detract from David Horth's contribution to petitioner's success. Respondent contends that petitioner's expert should have used data for average compensation. Harer used average comparable figures and concluded petitioner underpaid David Horth under four methods of analysis31 when he computed undercompensation for years before 1990. Harer concluded that from 1984 to 1989 petitioner undercompensated David Horth by at least $ 198,205. We conclude that this factor favors petitioner. k. Whether the Employee and Employer Dealt at Arm's LengthIf the employee and employer did not deal at arm's length, such as if the employee is the employer's sole or controlling shareholder, it suggests the amount of compensation paid may be unreasonable. Elliotts, Inc. v. Commissioner, 716 F.2d at 1246; Owensby & Kritikos, Inc. v. Commissioner, 819 F.2d at 1324. David Horth is petitioner's sole shareholder. This factor favors respondent. We closely scrutinize compensation if the employee controls the employer to see if it is something other than the purchase price of the employee's services. Owensby & Kritikos, Inc. v. Commissioner, supra at 1322-1323; Charles Schneider & Co. v. Commissioner, 500 F.2d at 152; see also Dielectric Matls. Co. v. Commissioner, 57 T.C. 587">57 T.C. 587, 591 (1972). Respondent argues that32 we should closely scrutinize petitioner's pay to David Horth in fiscal year 1990 because he is the sole shareholder and an employee. In doing so, we consider: (i) Whether petitioner and David Horth bargained freely about the compensation, and (ii) a hypothetical independent investor's perspective. Elliotts, Inc. v. Commissioner, supra.There is no evidence that the compensation to David Horth resulted from free bargaining. That leads us to inquire whether an independent investor would approve the compensation in view of the nature and quality of the services performed and the effect of those services on the investor's return on his or her investment. Owensby & Kritikos, Inc. v. Commissioner, supra at 1326-1327; Elliotts, Inc. v. Commissioner, supra at 1246. We believe an independent investor would approve of David Horth's 1990 compensation because of the good rate of return after allowing petitioner to become successful by underpaying David Horth in prior years. Harer concluded that petitioner earned a 28.3-percent pretax return on investment after paying David Horth's compensation. 33 Harer noted that if petitioner had paid David Horth $ 108,272, which is the amount respondent contends would have been reasonable, petitioner would have earned a 61.2-percent pretax return on investment, which is more than double the best performing companies comparable in size. The prime indicator of the corporation's earnings for its investors is its return on equity. Owensby & Kritikos, Inc. v. Commissioner, supra at 1326-1327. This factor is neutral. 1. Employee Guaranteed Taxpayer's DebtCourts have considered whether the employee personally guaranteed the taxpayer's debt. See R.J. Nicoll Co. v. Commissioner, 59 T.C. at 51. David Horth personally lent petitioner funds in fiscal year 1990 and prior years. He also personally guaranteed petitioner's debt. This factor favors petitioner. m. Respondent's ArgumentsRespondent points out that petitioner did not use a formula. While a formula may be further evidence of reasonable compensation, respondent cites no authority that a taxpayer must use a formula. This fact does not convince us that David Horth's compensation was unreasonable. n. Conclusion*34 Based on the above factors we conclude that $ 442,150 is reasonable compensation for David Horth in fiscal year 1990. 3. Whether Payments Are Purely for ServicesPetitioner must prove that the amounts it paid to David Horth were purely for services rendered to petitioner. Sec. 162(a)(1); Elliotts, Inc. v. Commissioner, supra; sec. 1.162-7(a), Income Tax Regs. Respondent contends that petitioner did not carry its burden of proof. We disagree. David Horth credibly testified that petitioner paid him for services. Respondent offered no contrary evidence. We conclude that the amounts petitioner paid to David Horth in fiscal year 1990 were purely for services that he rendered to petitioner. Elliotts, Inc. v. Commissioner, supra; sec. 1.162-7(a), Income Tax Regs.4. ConclusionWe hold that petitioner may deduct $ 442,150 as reasonable compensation under section 162(a)(1) in fiscal year 1990. Decision will be entered under Rule 155. Footnotes1. The difference between the amount deducted on the fiscal year 1990 return and this amount results because fiscal year 1989 compensation included $ 15,000 that was not paid. Petitioner paid but did not deduct the $ 15,000 in fiscal year 1990.↩2. Harer used average data and concluded that petitioner's pay to David Horth in fiscal year 1990 includes at least $ 198,205 for services he performed before fiscal year 1990. We believe David Horth is entitled to more than average pay especially in the later years when he turned petitioner around without Peter Horth's help. However, we believe Harer may have overstated reasonable pay for David Horth's services to petitioner in 1990 because he did not convince us that he used comparable data.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623465/	L. M. Lockhart, Petitioner, v. Commissioner of Internal Revenue, RespondentLockhart v. CommissionerDocket No. 89447United States Tax Court43 T.C. 776; 1965 U.S. Tax Ct. LEXIS 116; March 15, 1965, Filed March 15, 1965, Filed 116 Decision will be entered for the respondent. 1. "Hobby losses" from operation of a ranch were properly disallowed, sec. 270, I.R.C. 1954.2. Constitutionality of this section upheld.3. Disallowance of depreciation deduction sustained. Petitioner failed to take into account any salvage value or to show error in respondent's determination. Carl F. Bauersfeld, for the petitioner.Harold Friedman, for the respondent. Train, Judge. TRAIN776 The respondent determined deficiencies in petitioner's income tax for the years 1952 and 1954 in the amounts of $ 206,024.50 and $ 303,970.93, respectively.The issues for decision are:(1) Whether petitioner's deductions arising from the operation of a ranch in excess of petitioner's gross income from the ranch plus $ 50,000 per year plus specially treated deductions were properly disallowed under section 270 of the Internal Revenue Code of 1954; and(2) Whether depreciation claimed by the petitioner on two airplanes is allowable.FINDINGS OF FACTSome of the facts have been stipulated and are hereby found as stipulated.The petitioner, L. M. Lockhart, is an unmarried individual who presently resides in San Antonio, Tex. He formerly resided in Los Angeles, Calif. Petitioner filed his returns for 119 1952, 1953, and 1954 with the district director at Los Angeles, and his returns for 1955 and 1956 with the district director at Austin, Tex.At all times material hereto petitioner kept his books and records and filed his income tax returns on the accrual method of accounting.During the years 1952 to 1956, inclusive, petitioner owned and operated a ranch and commercial feed business located in San Bernadino County, Calif. This property, known as the Lockhart Ranch, consisted of over 2,800 acres near Barstow, Calif. Petitioner also owned an interest in a ranch in New Mexico and certain acreage in Nueces County, Tex.Petitioner was also actively engaged in the oil business. In addition to individually engaging in the business of oil production and in investment in oil and gas interests, petitioner received a salary in each of the years involved from Lockhart Oil Co. of Texas.Petitioner acquired the first part of his California ranch in 1927 or 1928. When he started the ranch, he raised alfalfa, had dairy cattle, and shipped the milk by tank truck to Los Angeles. After 777 he acquired more acreage, he put in a commercial feed mill with feedlots for feeding 8,000 head of cattle. 120 He installed a dehydration plant and a heavy compress to bale alfalfa in small bales for export in ships. He also grew wheat and installed a chemical department in connection with the manufacture of chlorophyl.During the years 1952 to 1956, inclusive, petitioner devoted as much as two-thirds of his time to the ranching and commercial feed operation in California. The Lockhart Ranch employed as many as 95 men and, on the average, about 70 men per year. The ranch also employed a ranch manager. Among the capital investments of the ranch were farming equipment, the alfalfa dehydrator, the commercial feed mill, grain-storage facilities, workshops, bachelor quarters, and messhouse. During the years involved, the cattle were marketed principally in the Los Angeles area, and the commercial feed in the form of alfalfa was also sold in the Los Angeles dairy area.On his income tax returns for the years 1952 through 1956, petitioner claimed losses resulting from operation of the Lockhart Ranch as follows:1952$ 761,288.901953518,113.661954478,572.131955289,163.301956310,805.36For each of the years 1952 through 1956, the deductions claimed by petitioner from the 121 operation of the Lockhart Ranch exceeded by more than $ 50,000 the specially treated deductions (sec. 270(b)) plus the gross income derived therefrom as follows:195219531954Total deductions $ 1,125,538.63$ 1,012,075.81$ 792,794.61Less:Gross income364,249.73493,962.15314,222.48Specially treated deductions13,516.8714,295.7218,141.60Total gross income plusspecially treated deductions 377,766.60508,257.87332,364.08Excess of deductions over grossincome plus specially treated deductions 747,772.03503,817.94460,430.5319551956Total deductions $ 623,088.06$ 556,069.58Less:Gross income333,924.76245,264.22Specially treated deductions5,008.5433,970.74Total gross income plusspecially treated deductions 338,933.30279,234.96Excess of deductions over grossincome plus specially treated deductions 284,154.76276,834.62For the years 1953, 1955, and 1956 petitioner incurred losses from his other business activities, including the oil-producing business.On his return for 1952, petitioner claimed depreciation on two airplanes used in connection with his trade or business. 122 The amounts claimed were $ 31,635.70 on a Douglas DC-3 and $ 9,512.97 on a Beechcraft, or a total claimed depreciation allowance with respect to the two aircraft of $ 41,148.67. On his return for 1954, petitioner claimed depreciation on the Beechcraft in the amount of $ 9,512.96.778 Both airplanes had been used prior to their purchase by petitioner. Depreciation on both was computed on a straight-line basis with an annual depreciation rate of 25 percent. No salvage value was assigned either aircraft by petitioner in his depreciation computation.The original cost basis of the DC-3 was $ 126,542.81. As of December 31, 1952, its adjusted cost basis was $ 20,440.56. It had been acquired in 1948 and was sold by petitioner in April 1953, along with an aircraft tractor truck, for $ 135,000. Gain on the sale of the airplane and the tractor truck was reported on the 1953 return as $ 124,309.23.The original cost basis of the Beechcraft was $ 38,051.86. As of December 31, 1952, the undepreciated cost of this plane was $ 18,330.61. It had been acquired in 1950 and was sold by petitioner in 1955, together with an airplane motor, for $ 64,200. This entire amount was reported 123 by the petitioner on his 1955 return as the gain on the sale.The respondent disallowed farm loss deductions with respect to the Lockhart Ranch in the amount of $ 697,772.03 for 1952 and in the amount of $ 410,430.53 for 1954. The respondent also disallowed depreciation deductions claimed for the years 1952 and 1954 with respect to the aircraft in the respective amounts of $ 41,148.67 and $ 9,512.96.OPINIONWith respect to the Lockhart Ranch losses, the dispute between the parties centers on the meaning of the phrase "deductions allowed" as used in the first sentence of section 270 of the 1954 Code. 1 The petitioner contends that these words necessarily refer to deductions from which the taxpayer derives a tax benefit. Thus, since during the 779 5-year period 1952-56 the petitioner had losses from his other operations in 1953, 1955, and 1956, he contends that he received no tax benefit from the ranch losses in those years and concludes therefrom that the required excess of "deductions allowed" did not occur in the 5 consecutive taxable years as specified by section 270.124 We do not agree with this construction of the statute.In Virginian Hotel Co. v. Helvering, 319 U.S. 523">319 U.S. 523 (1943), the Supreme Court rejected a similar tax benefit construction of the word "allowed" as used with respect to depreciation in the determination of the basis for gain or loss. We see no reason to depart from that rule here, particularly when to do so would warp the plain purpose of the statute.Section 270, and its predecessor section 130 of the Internal Revenue Code of 1939, was adopted originally as an amendment by the Senate Finance Committee and became part of the Revenue Act of 1943. The debate on the floor of the Senate explained that the amendment was designed to deal with so-called "hobby losses." (90 Cong. Rec. 224-232 (1944).) Nowhere in the rather extensive debate was there the slightest suggestion of a tax benefit rule such as is now advanced by petitioner. Rather it was made clear that the tests set out in the section were for the purpose of determining whether the particular loss activity was to be treated as an ordinary trade or business or not.The Finance Committee's own explanation of the provision stated, in part:125 Thus, under the committee bill, if a taxpayer conducted a trade or business for five consecutive years, and in each of such years he had a net loss of $ 50,000, his tax liability for each of such years would have to be recomputed and only $ 20,000 of such net loss could be applied against his other income for that year. [S. Rept. No. 627, 78th Cong., 1st Sess., p. 27 (1943).]780 It is significant that the quoted language makes the occurrence of net losses of given amounts over a period of years the operative fact, not whether or not those losses had actually been used to offset otherwise taxable income from other sources.Of course, while petitioner argues that he derived no tax benefit from the Lockhart Ranch deductions in 1953, 1955, and 1956, the actual existence of a tax benefit cannot be determined in the absence of information as to the existence of loss carryovers and carrybacks, and, on this aspect of the matter, petitioner remains completely silent. Moreover, petitioner does not suggest how, in applying the tax benefit rule for which he argues, specific items of deduction are to be identified as having given rise to a tax benefit.We also note that, while petitioner126 does not point this out, the acceptance of his position would require that he have had taxable income from all other sources in each of the 5 consecutive years involved in an amount at least equal to $ 50,000 plus the specially treated deductions. Only thus would he have received tax benefits which would equate with the "deductions allowed" as used in section 270. Therefore, petitioner is in effect seeking to add an entirely new test to the statute. He would have applicability of section 270 turn, not simply upon the earnings history of the loss operation, but also upon the profit characteristics of the rest of a taxpayer's activities. Such an approach is proscribed by the regulations which state categorically: "For the purposes of section 270, each trade or business shall be considered separately." Sec. 1.270-1(a)(4), Income Tax Regs.We agree with petitioner that Congress' major concern in the enactment of section 270 was to prevent the offsetting of otherwise taxable income. However, we do not agree when he states on brief that "the statute is only intended to apply where there is a tax benefit involved." Petitioner would have us confuse the "applicability" of the section 127 with its tax consequences. Section 270 is "applicable" and the taxpayer's taxable income is recomputed irrespective of the tax result. Obviously, if no tax increase results from that recomputation in any given year, then there is no redetermination of tax. That Congress itself considered the tests for applicability of section 270 and the requirement for recomputation separate from and not interdependent upon a tax redetermination is borne out by the fact that the former are found in subsection (a) and the latter in subsection (c).Petitioner also argues that section 270, as construed by the respondent and, as set out above, by this Court, is unconstitutional. He contends that, since the section is an integral part of the income tax, its constitutionality must be tested by the 16th amendment (citing Eisner v. Macomber, 252 U.S. 189">252 U.S. 189 (1920)) and not by the general taxing power, and that the holding of Penn Mutual Indemnity Co., 781 32 T.C. 653">32 T.C. 653 (1959), affd. 277 F. 2d 16 (C.A. 3, 1960), is not applicable. However, petitioner's analysis is the very one which we rejected in Penn Mutual128 . We pointed out there that the 16th amendment did not confer any new power of taxation nor did it put any new limits on that power. We stated:The 16th amendment merely made it clear that income taxes, regardless of the source of the income, were not subject to the apportionment requirement. * * [32 T.C. 653">32 T.C. 653, 665.] 2Under this view of the 16th amendment, petitioner has failed to disclose any basis for our holding section 270 to exceed the constitutional power to tax. (Petitioner specifically refuses to ground his argument upon whether the tax at issue is direct or indirect.) Petitioner also argues that section 270, as applied here, results in an arbitrary taking of property in violation of the fifth amendment. The grounds for this claim are not clear. Certainly, it is well established that deductions are a matter of legislative grace. Stanton v. Baltic Mining Co., 240 U.S. 103">240 U.S. 103 (1916); Burnet v. Thompson Oil & G. Co., 283 U.S. 301">283 U.S. 301, 304 (1931); Helvering v. Ind. Life Ins. Co., 292 U.S. 371">292 U.S. 371, 381 (1934); New Colonial Co. v. Helvering, 292 U.S. 435">292 U.S. 435, 440 (1934);129 White v. United States, 305 U.S. 281">305 U.S. 281, 292 (1938); Commissioner v. Sullivan, 356 U.S. 27">356 U.S. 27, 28 (1958). Here Congress has not disallowed all deductions as would be the case with respect to personal, living expenses. Sec. 262. Nor has Congress allowed the deduction of losses here only to the extent of the gross income from the operation as with respect to gambling transactions. Sec. 165(d). Indeed, under section 270, deductions are disallowed only if they exceed the gross income from the loss operation plus $ 50,000 plus specially treated deductions.Petitioner testified that he entered into and conducted the Lockhart Ranch operation as a business for profit. However, in addition to losses ranging several hundred thousand dollars in each of the 5 years 1952-56, the record130 is devoid of any evidence whatever that the Lockhart Ranch was ever operated at a profit in any year since its acquisition in the late 1920's.Far from being arbitrary, section 270 represents a reasonable exercise of the taxing power. We hold the section constitutional. The respondent is sustained on this issue.The sole remaining issue concerns the depreciation of petitioner's airplanes. Section 23(l) of the 1939 Code and section 167 of the 1954 Code both provide for a reasonable allowance for exhaustion, wear and tear, and obsolescence of property used in the trade or business. The regulations provide that an asset shall not be depreciated 782 below a reasonable salvage value under any method of computing depreciation. 3131 Salvage value cannot be estimated at zero where the item actually will have a substantial resale value at the end of the useful life to the taxpayer, and where salvage value exceeds undepreciated cost, no further depreciation is allowed. Bell Lines, Inc., 43 T.C. 358">43 T.C. 358 (1964); Brandtjen & Kluge, Inc., 34 T.C. 416 (1960); Joseph W. Brown, 40 T.C. 861">40 T.C. 861 (1963).Furthermore, where the taxpayer fails to assign a salvage value to an asset, he has the burden of proving that the commissioner erred in treating actual sales price as indicative of salvage value. Joseph W. Brown, supra;C. L. Nichols, 43 T.C. 135">43 T.C. 135 (1964).In this case salvage was not taken into account and the effect of the Commissioner's determination is merely to prevent depreciation charges from reducing the adjusted cost basis of the airplanes below reasonable salvage value.Petitioner offered no evidence on salvage value. The only evidence presented by petitioner goes to useful life. But if the useful life adopted by the petitioner is considered proper, it is evident from 132 the record that substantial salvage value should have been taken into consideration. The record clearly sustains respondent's determination. C. L. Nichols, supra.Decision will be entered for the respondent. Footnotes1. All statutory references are to the Internal Revenue Code of 1954 unless otherwise indicated.SEC. 270. LIMITATION ON DEDUCTIONS ALLOWABLE TO INDIVIDUALS IN CERTAIN CASES.(a) Recomputation of Taxable Income. -- If the deductions allowed by this chapter or the corresponding provisions of prior revenue laws (other than specially treated deductions, as defined in subsection (b)) allowable to an individual (except for the provisions of this section or the corresponding provisions of prior revenue laws) and attributable to a trade or business carried on by him for 5 consecutive taxable years have, in each of such years (including at least one year to which this subtitle applies), exceeded by more than $ 50,000 the gross income derived from such trade or business, the taxable income (computed under section 63 or the corresponding provisions of prior revenue laws) of such individual for each of such years shall be recomputed. For the purpose of such recomputation in the case of any such taxable year, such deductions shall be allowed only to the extent of $ 50,000 plus the gross income attributable to such trade or business, except that the net operating loss deduction, to the extent attributable to such trade or business, shall not be allowed.(b) Specially Treated Deductions. -- For the purpose of subsection (a) the specially treated deductions shall be taxes, interest, casualty and abandonment losses connected with a trade or business deductible under section 165(c)(1), losses and expenses of the trade or business of farming which are directly attributable to drought, the net operating loss deduction allowed by section 172, and expenditures as to which taxpayers are given the option, under law or regulations, either (1) to deduct as expenses when incurred or (2) to defer or capitalize.(c) Redetermination of Tax. -- On the basis of the taxable income computed under the provisions of subsection (a) for each of the 5 consecutive taxable years specified in such subsection, the tax imposed by this subtitle or the corresponding provisions of prior revenue laws shall be redetermined for each such taxable year. If for any such taxable year assessment of a deficiency is prevented (except for the provisions of section 1311 and following) by the operation of any law or rule of law (other than section 7122, relating to compromises), any increase in the tax previously determined for such taxable year shall be considered a deficiency for purposes of this section. For purposes of this section, the term "tax previously determined" shall have the meaning assigned to such term by section 1314(a)(1).(d) Extension of Statute of Limitations. -- Notwithstanding any law or rule of law (other than section 7122↩, relating to compromises), any amount determined as a deficiency under subsection (c), or which would be so determined if assessment were prevented in the manner described in subsection (c), with respect to any taxable year may be assessed as if on the date of the expiration of the time prescribed by law for the assessment of a deficiency for the fifth taxable year of the 5 consecutive taxable years specified in subsection (a), 1 year remained before the expiration of the period of limitation upon assessment for any such taxable year. [Emphasis supplied.]2. See also dissent in Penn Mutual which is in complete agreement with this construction of the 16th amendment. 32 T.C. 653, 677et seq↩.3. Sec. 1.167(a)-1 Depreciation in general. * * The allowance is that amount which should be set aside for the taxable year in accordance with a reasonably consistent plan (not necessarily at a uniform rate), so that the aggregate of the amounts set aside, plus the salvage value, will, at the end of the estimated useful life of the depreciable property, equal the cost or other basis of the property as provided in section 167(g) and § 1.167(g)-1. An asset shall not be depreciated below a reasonable salvage value under any method of computing depreciation. * * * [Emphasis supplied.](b) Useful life. * * * Salvage value is not a factor for the purpose of determining useful life. * * * The estimated remaining useful life may be subject to modification by reason of conditions known to exist at the end of the taxable year and shall be redetermined when necessary regardless of the method of computing depreciation. * * (c) Salvage. (1) Salvage value is the amount (determined at the time of acquisition) which is estimated will be realizable upon sale or other disposition of an asset when it is no longer useful in the taxpayer's trade or business * . However, if there is a redetermination of useful life under the rules of paragraph (b) of this section, salvage value may be redetermined based upon facts known at the time of such redetermination of useful life. * * If the taxpayer's policy is to dispose of assets which are still in good operating condition, the salvage value may represent a relatively large proportion of the original basis of the asset. However, if the taxpayer customarily uses an asset until its inherent useful life has been substantially exhausted, salvage value may represent no more than junk value. Salvage value must be taken into account in determining the depreciation deduction either by a reduction of the amount subject to depreciation or by a reduction in the rate of depreciation, but in no event shall an asset (or an account) be depreciated below a reasonable salvage value.[Similar regulations appear under the 1939 Code. See sec. 39.23(1)-1, 2, and 5, Regs. 118.]↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623467/	DANIEL I. RHODE AND SALLY RHODE, ET AL., 1 Petitioners v COMMISSIONER OF INTERNAL REVENUE, Respondent Rhode v. CommissionerDocket Nos. 29749-85, 21395-87, 23091-87, 23545-87, 28413-87.United States Tax CourtT.C. Memo 1990-656; 1990 Tax Ct. Memo LEXIS 731; 60 T.C.M. (CCH) 1535; T.C.M. (RIA) 90656; December 31, 1990, Filed 731 Decisions will be entered under Rule 155. Mervin M. Wilf, for the petitioners. John A. Guarnieri and David A. Breen, for the respondent. RUWE, Judge. RUWE2190 MEMORANDUM FINDINGS OF FACT AND OPINION In these consolidated cases, respondent determined deficiencies and additions to tax in petitioners' Federal income taxes as follows: 2191 Addition to TaxPetitionersDocket No.Year(s)DeficiencySec. 6653(a) 2Daniel I. Rhode and29749-851980$ 30,877.00$ 1,544.00Sally RhodeArthur Abrahams and21395-8719806,381.00319.05Barbara AbrahamsEdgar Hurst and23091-8719802,060.00103.00Sara Jane Hurst3 198114,128.70 Arthur B. Becker and23545-87198011,178.00558.90Gloria O. BeckerEllis L. Elgart and28413-8719804732 16,051.00802.55Sivia V. ElgartRespondent further determined that petitioners are liable for the increased rate of interest, under section 6621(c), for each of their taxable years in issue. 5The issues for decision are: (1) Whether petitioners are entitled to charitable 733 contribution deductions under section 170 for donations of various types and quantities of books to qualifying charitable organizations and, if so, the amount of the allowable deduction; (2) whether petitioners are liable for the additions to tax under section 6653(a) for negligence or intentional disregard of rules and regulations; and (3) whether petitioners are liable for the increased rate of interest under section 6621(c) for substantial underpayments of tax attributable to tax motivated transactions. FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulation of facts, as supplemented and amended, and attached exhibits are incorporated herein by this reference. At the time they filed their petitions in these consolidated cases, petitioners resided in Pennsylvania. Petitioners filed their joint Federal income tax returns for taxable year 1980 with the Internal Revenue Service Center in Philadelphia, Pennsylvania. All petitioners used the cash receipts and disbursements method of accounting. Unless otherwise indicated, the term "petitioners" shall hereinafter refer collectively to Mr. Rhode, Mr. Abrahams, Mr. Hurst, Mr. Becker, and Mr. Elgart. 734 Publishers Distributors, IncorporatedMr. Elgart has been a certified public accountant for over 37 years, and is a partner in the accounting firm of Elgart, Dickler and Company, C.P.A.'s (Elgart, Dickler and Company). In 1979, one of Mr. Elgart's clients, Dr. Joe Mendels, informed him of an Internal Revenue Service letter ruling that allowed a taxpayer to claim a charitable contribution deduction for a donation of books to a qualifying charitable organization. Based upon this letter ruling, Mr. Elgart decided that several of his clients might benefit from similarly structured transactions. In July 1979, Mr. Elgart, Dr. Mendels, and Arthur N. Dickler, a partner in Elgart, Dickler and Company, organized a corporation, under the laws of Pennsylvania, called Publishers Distributors Incorporated (PDI). Mr. Elgart held the office of president; Dr. Mendels held the office of vice president; and Mr. Dickler held the office of secretary/treasurer. The outstanding stock of PDI was owned as follows: Mr. Elgart, 37.5 percent; Dr. Mendels, 50 percent; and Mr. Dickler, 12.5 percent. The overall plan was for PDI to purchase books directly from publishers at substantially less than their retail 735 catalog price and resell these books to clients of Elgart, Dickler and Company. PDI's resale price would generally be slightly greater than its purchase price but substantially less than the retail catalog price. The clients would in turn donate these books, one year later, to various qualifying charitable organizations 2192 and claim a charitable contribution deduction in the amount equal to the retail catalog prices of the books donated. Mr. Elgart contacted clients whom he thought would benefit from the charitable contribution deductions. He also contacted several qualifying charitable organizations in order to determine whether they would be interested in the proposed PDI program. In late 1979, PDI entered into separate written agreements giving it an option to purchase "overrun books" and "overrun college texts" from five different publishers. "Overrun" books and texts generally represented the publishers' excess inventory of various titles that the publishers believed could not be sold through the normal market. 6 These publishers were: Ashley Books, Inc. (Ashley Books); the Institute for the Study of Human Issues, Inc. (ISHI); Random House, Inc. (Random House); Raven Press Books, 736 Ltd. (Raven Press); and Viking Penguin, Inc. (Viking Penguin). In the written agreement between Random House and PDI, Random House granted to PDI an option to purchase all of its "Overrun College Texts." The term "overrun college texts" was defined in the agreement as "all college textbooks published by Seller's College Division having catalog prices of $ 13 or more which Seller desires to sell, donate, transfer or otherwise dispose of other than through its normal channels of distribution and other than in the ordinary course and conduct of Sellers business." Under the agreement, Random House was to give PDI written notice setting forth the titles, catalog prices, and quantities of books that were available for purchase by PDI as overrun college texts. In addition, the notice was also to state the purchase price for PDI, which was not to exceed 25 percent or be less than 16 percent of the catalog price of the overrun college texts. After receipt of the notice from Random House, PDI had 90 days 737 in which to exercise its option to purchase the books listed in the notice. Random House was required under the agreement to continue to offer additional copies of titles purchased by PDI for sale through its normal channels of distribution for 12 months after PDI purchased the overrun college texts. If the number of copies of these titles sold by Random House during the ensuing 12-month period was less than 50 percent of the number of copies purchased by PDI, then PDI had the right to either substitute other titles for those that failed to meet this sales quota, or cancel its purchase of those particular titles. The term of the agreement was for 3 years. The agreement was executed by the parties on November 2, 1979. Mr. Elgart signed the agreement on behalf of PDI. Prior to execution of the agreement between Random House and PDI, Random House had provided several lists of college texts that would be available for purchase by PDI as overrun college texts. PDI provided the potential donees with lists of texts which would be available, and the donees indicated which books they would like to receive. Based upon the selections of the donees, PDI selected the books to be purchased. 738 On December 20, 1979, PDI purchased 17,963 overrun college texts for a purchase price of $ 44,955.32, which reflected a cost equal to 16 percent of the existing catalog prices. PDI's purchase consisted of 21 different titles that ranged in quantities of 530 to 1,036 copies per title. Most of the titles purchased by PDI were listed in either Random House's June 1980 and 1981 Books in Print catalogs, or in the 1980 and 1981 Borzoi Books, Alfred A. Knopf, catalogs. 7The written agreements that PDI entered into with the other four publishers, Ashley Books, ISHI, Raven Press, and Viking Penguin were generally the same. The agreements were signed by Mr. Elgart on behalf of PDI. In the agreements, each publisher granted to PDI an option to purchase "overrun 739 books," which were defined as: "Overrun Book" or "Overrun Books" shall mean and refer to: (i) all books published by Seller presently being sold by Seller at wholesale for sale at retail to the general public in single copies based upon recommended retail list sales prices established by Seller and published in Seller's present book catalog (the "Catalog Price"); (ii) having a Catalog Price for each book of not less than Five Dollars ($ 5.00) per volume; (iii) which books Seller desires to sell, donate, transfer or otherwise dispose of other than through Seller's normal wholesale channels of sale and distribution and other than in the ordinary course and conduct of Seller's business; and (iv) are books which the Seller agrees will remain in its catalogs and/or its suggested retail price lists for a period of thirteen (13) months following Seller's notice to Buyer pursuant to Paragraph 2.1 hereof at the prices in existence in such catalogs or price lists at the time such notice is given. 8740 2193 Under the agreements with PDI, the publisher was required to send to PDI a list of its overrun books that were available for sale. In this notice, the publisher would grant to PDI a 90-day option to purchase the books listed therein. The purchase price of the overrun books to PDI was not to be less than 16 percent or greater than 20 percent of the catalog prices of the overrun books. 9Upon receipt of the lists of available books, PDI provided potential donees with the lists, and the donees indicated which books they wished to receive. Based upon these selections, PDI selected the books to be purchased. After the purchase of overrun books by PDI, the publisher was required to sell additional books of the same titles through its normal channels of distribution during the 12-month period following PDI's purchase. If the number of copies of a title sold by the publisher during the ensuing 12-month period was less than 50 percent of the number of copies of the same title purchased by PDI, then PDI741 had a right to exchange copies of that title for those of another overrun book. With the exception of Raven Press, the term of the agreement between PDI and each publisher was 5 years. The term of the agreement between PDI and Raven Press was 3 years. The written agreement between PDI and ISHI was executed on October 26, 1979. In December 1979, PDI purchased 4,067 overrun books for a purchase price of $ 13,232.12, which reflected a cost equal to 18 percent of the catalog prices of the overrun books. PDI's purchase consisted of 23 titles that ranged in quantities from 41 to 1,000 copies per title. The overrun books that PDI purchased were scholarly texts published for specialized reading audiences. With the exception of one title, all of the titles purchased were listed in ISHI's Fall-Winter 1979-1980 catalog, and in ISHI's 1981 catalog. 10The written agreement between PDI and Viking Penguin was executed on November 16, 1979. On December 13, 1979, PDI purchased 16,826 overrun books from Viking Penguin for 742 a purchase price of $ 19,916.27, which reflected a cost equal to 16 percent of the existing catalog prices. PDI's purchase consisted of 24 different titles from Viking Penguin that ranged in quantities from 472 to 1,218 copies per title. The books purchased by PDI were children's books which are targeted for a reading audience from preschool through high school ages. With the exception of one title, all of the titles that PDI purchased appear to have been listed in Viking Penguin's 1980 and 1981 junior books catalogs. 11The written agreement between PDI and Ashley Books was executed on December 13, 1979. PDI purchased 5,434 overrun books for a purchase price of $ 8,281.61, which reflected a cost equal to 16 percent of the catalog prices of the overrun books. PDI's purchase consisted of 66 titles that ranged in quantities from 50 to 583 copies per title. The books purchased were trade books, which are general interest books that are sold through wholesale and retail booksellers that serve libraries and the general public. With the exception 743 of one title, all of the titles purchased by PDI appear to have been listed in either Ashley Books' 1979 or 1981 catalog. 12The written agreement between PDI and Raven Press was executed on December 14, 1979. On December 14, 1979, PDI purchased 4,206 overrun books for a purchase price of $ 30,027.30, which reflected a cost equal to 20 percent of the existing catalog prices of the overrun books. 13744 PDI's purchase consisted of 41 different titles that ranged in quantities from 47 to 160 copies per title. The overrun books purchased by PDI were medical text and reference books, and were all listed in the 1979 Raven Press catalog. 14A summary of the quantity of books, number of titles, the price paid by PDI to each of the five publishers, and the price paid by PDI as a percent of the catalog prices of the books purchased is as follows: 2194 QuantityTitlesPurchasePublisherPurchasedPurchasedPricePercent Random House17,96320$ 44,955.3216ISHI4,0672313,232.1218Viking Penguin16,8262419,916.2716Ashley Books5,434668,281.6116Raven Press4,2064130,027.3020Purchases from PDI by PetitionersDuring 1979, petitioners Rhode, Abrahams, Hurst, and Becker were clients of Elgart, Dickler and Company, and were contacted by Mr. Elgart about the PDI program. All petitioners purchased books from PDI in late 1979. The books that PDI sold to petitioners Rhode, Abrahams, Hurst, and Becker averaged 27 percent of the catalog prices of the books purchased. Mr. Elgart 745 purchased his books from PDI at PDI's cost of purchasing the books from the publisher. Prior to their participation in the PDI book donation program, Mr. Elgart discussed with the other petitioners the purported favorable tax consequences of purchasing books from PDI and subsequently donating them to qualifying charitable organizations. Petitioners also received from PDI an offering memorandum and a tax opinion letter. Petitioners each read the offering memorandum and tax opinion letter prior to purchasing their respective books. The offering memorandum and tax opinion letter explained that in order to claim a charitable deduction in excess of the cost of the books, the books would have to be considered capital gain property in the hands of the donors and, therefore, the donors would have to hold the books for at least one year. Section 170(e)(1) provided that the amount of any charitable deduction was to be reduced by the amount of gain which would not have been long-term capital gain if the contributed property had been sold by the taxpayer at its fair market value. The offering memorandum also contained the following: It is further anticipated that such Purchasers will claim 746 that the fair market value of the Books donated, at the time of donation, is approximately equal to the then current Catalog Prices for such Books. * * It must be emphasized that a determination as to a particular Title's fair market value is a purely factual one, and no opinion is expressed with respect to the fair market value of any Titles within a parcel of Books, whether at the time of purchase or at the time of donation. The Corporation cannot and does not in anyway assure that the fair market value claimed by a Purchaser with respect to a specific Title within a parcel will withstand an Internal Revenue Service challenge or audit. * * * Neither Mr. Elgart nor Mr. Dickler has had previous experience in the buying or selling of books. * * * No ruling of the Internal Revenue Service has been obtained or requested with respect to the tax consequences of a purchase of Books, and the opinion of tax counsel is not binding upon the Internal Revenue Service. * * * * * * There can be no assurance that the book publishers' Catalog Prices at the time of donation of the Books will be a conclusive or even a material factor in the ultimate determination of the fair market value of the Books. 747 * * It must be emphasized that the market which exists for the types of Books composing the parcels is specialized and has been developed by the various book publishers over a period of years at considerable expense. It is highly unlikely that any Purchaser, without the benefit of an established marketing outlet, could market the Books purchased from the Corporation without incurring substantial expenses. Therefore, a prospective Purchaser should not acquire a parcel or parcels of Books based upon an expectation that he could resell such parcel or parcels at a profit. The Corporation will not participate or assist the Purchaser in any way with respect to the marketing or reselling of the Books. The tax opinion letter that PDI furnished to petitioners was prepared by counsel for PDI and contained the following: * * * no assurance can be given that, if the matter is litigated, the Internal Revenue Service would not be successful should it take the position that the value of the books was lower than the list price of the books in the publishers' catalogs. * * * In view of the variety of consequences arising from a charitable contribution of property, * * * each prospective purchaser 748 of books is urged to consult with his own tax advisor as to the particular consequences to such purchaser 2195 of the acquisition and disposition of books * * .Petitioners each purchased their books from PDI by executing a separate written Agreement of Sale with PDI. All of the agreements of sale executed between PDI and the respective petitioners were identical. The agreement of sale provided that the individual purchaser was not obligated to donate the books to any particular agency, but rather could dispose of the books in any manner. However, in the event that the contemplated gift was made, the individual petitioner was to transfer title to the donee, f.o.b. the warehouse, and simultaneously make a cash contribution to the donee in order to pay for shipping and handling. The agreement of sale allowed the individual petitioners to exchange any "nonconforming titles" for other books owned by PDI. Nonconforming titles were defined as a book in which the catalog price at the time of purchase had decreased more than 5 percent, or a book that was removed from the current catalog, or a book that failed to sell at retail at the catalog price in quantities at least equal to 50 percent 749 of the total number of books that PDI purchased from the particular publisher. Attached to each agreement of sale was a Bill of Sale that indicated the amount paid by each petitioner and the quantities and titles of each book purchased. Mr. Rhode purchased the following books from PDI: 15QuantityTitlesCatalogPurchasePublisherPurchasedPurchasedPricePriceRandom House40520$ 6,259.75$ 1,780.42ISHI267236,107.001,736.96Viking Penguin1,331249,821.802,793.55Ashley Books3,9566637,051.4510,538.18Raven Press11758,265.502,350.89Total6,076138$ 67,505.50$ 19,200.00Mr. Abrahams purchased 1,093 books from PDI on December 27, 1979, for a total purchase price of $ 6,400. Of the 1,093 books that Mr. Abrahams purchased, 841 of the books were published by Random House, and 252 of the books were published by Raven Press. The Random House books consisted of 20 titles 750 and the Raven Press books consisted of 33 titles. The combined catalog list price of the books that Mr. Abrahams purchased was $ 22,501.45. Mr. Hurst purchased 1,240 books, consisting of 24 titles, on December 24, 1979, from PDI for a total purchase price of $ 2,200. All the books that Mr. Hurst purchased from PDI were published by Viking Penguin. The total catalog list price of the books was $ 9,106. Mr. Becker purchased 2,867 books, consisting of 7 titles, from PDI on December 18, 1979, for a total price of $ 6,400. All the books that Mr. Becker purchased were published by Viking Penguin. The total catalog list price of the books that Mr. Becker purchased was $ 22,500.65. Mr. Elgart purchased 721 books, consisting of 30 titles, from PDI on December 27, 1979, for a total purchase price of $ 4,000. All of the books that Mr. Elgart purchased from PDI were published by Raven Press. The total catalog list price of the books that Mr. Elgart purchased was $ 22,505.50. Petitioners did not take physical possession of any of the books that they purchased. PDI made arrangements with the publishers and various warehouses for storage of the books for petitioners for a period of 13 months. 751 Petitioners were responsible for the costs of storage. With the exception of the Raven Press and ISHI books, all the books were stored for petitioners in the warehouses of the individual publishers. The Raven Press Books were stored in the International Book Service, Inc. warehouse, and the ISHI books were stored at the Haddon Craftsmen Distribution Center. Donation of Books by PetitionersIn his capacity as president of PDI, Mr. Elgart wrote to the other petitioners on December 5, 1980. He instructed them to mail a letter to their respective charitable donee and to mail another letter to the warehouse where their books were stored. Sample letters were provided with the applicable names and addresses. The sample letter that petitioners were to mail to their respective charitable donee contained the following: I am pleased to advise you that I am contributing, effective December 27, 1980, the following books to aid you in the performance of your service to the community. The schedule enclosed indicates the name of the publisher, 2196 title, quantity, and where the books are presently warehoused. A copy of my letter to the warehouse advising them of the transfer of title to these books 752 to you is enclosed. Warehousing costs are paid until mid-January, 1981. Accordingly, I would suggest that you promptly instruct the warehousing firm where and how you would like these books packaged and shipped. I have enclosed my check for $ as an unrestricted contribution which of course can be used to cover costs of packing and shipping. The sample letter that petitioners were to send to the warehouse or warehouses where their books were stored contained the following: Please be advised that the following books that you are holding for me have been gifted to: * * * effective December 27, 1980. I understand that storage costs are paid for these books until late in January 1981. You should receive packaging and shipping instructions from [Charitable Donee] before that date. They will pay all packaging and shipping charges. Petitioners mailed letters in conformity to the sample letters to their respective donees and to their respective warehouses prior to December 27, 1980. Each petitioner also enclosed checks to cover the costs of packing and shipping. Each of the donees accepted the contributed books and checks in accordance with the letters and the previous arrangements 753 that had been made by Mr. Elgart. On their 1980 joint Federal income tax returns, petitioners each reported that they had made a charitable contribution of the books that they purchased from PDI, in the previous year, to the following organizations: PetitionersOrganizationDaniel I. Rhode andUnited Way of Southeastern PennsylvaniaSally RhodeArthur Abrahams andUnited Negro College FundBarbara AbrahamsEdgar Hurst andFederation Day Care ServicesSara Jane HurstArthur B. Becker andThe New York Public LibraryGloria O. BeckerEllis L. Elgart andUnited Way of Southeastern PennsylvaniaSivia V. Elgart The following schedule summarizes petitioners' claimed charitable contribution deductions for the books in question: Claimed ValueAmount ofPetitionersCostof ContributionDeduction Claimed 16754 Daniel I. Rhode and$ 19,200$ 67,505$ 59,726Sally RhodeArthur Abrahams and6,40022,50017,380Barbara AbrahamsEdgar Hurst and2,2009,1069,106Sara Jane HurstArthur B. Becker and6,40022,61522,615Gloria O. BeckerEllis L. Elgart and4,00022,50022,500Sivia V. ElgartEach petitioner in these consolidated cases used the publishers' catalog prices in determining the value of their donations of books. Petitioners' 1980 joint Federal income tax returns were prepared by Elgart, Dickler and Company. Mr. Elgart did not have any experience in book publishing or in book appraisals prior to 1979. None of petitioners in these consolidated cases obtained an independent appraisal of the books that they purchased from PDI. In his statutory notices of deficiency, respondent disallowed the amounts of petitioners' claimed charitable contribution deductions that were attributable to their book donations. 2197 OPINION The first issue for decision is whether petitioners are entitled to charitable contribution deductions for their respective donations of books to the United Way of SoutheasternPennsylvania, the United Negro College Fund, Federation Day Care Services, and The New York Public Library. Deductions are 755 a matter of legislative grace and petitioners bear the burden of proving that they are entitled to any deduction claimed on their returns. New Colonial Ice Co. v. Helvering, 292 U.S. 435">292 U.S. 435, 440 (1934); Rule 142(a). Section 170(a) allows a deduction for charitable contributions to any entity described in section 170(c). A contribution is made at the time delivery is effected. Sec. 1.170A-1(b), Income Tax Regs. In determining the existence and timing of a charitable contribution, the analysis applied is the same as the analysis applied in determining the existence and timing of a gift. DeJong v. Commissioner, 36 T.C. 896">36 T.C. 896 (1961), affd. 309 F.2d 373">309 F.2d 373 (9th Cir. 1962). This Court has consistently held that there are six essential elements of a bona fide inter vivos gift. These six elements are: (1) A donor competent to make a gift; (2) a donee capable of accepting a gift; (3) a clear and unmistakable intention on the part of the donor to absolutely and irrevocably divest himself of the title, dominion, and control of the subject matter of the gift, in praesenti; (4) the irrevocable transfer of the present legal title and of the dominion and control of the entire gift to the donee, so that 756 the donor can exercise no further act of dominion or control over it; (5) a delivery by the donor to the donee of the subject of the gift or of the most effectual means of commanding dominion of it; and (6) acceptance of the gift by the donee. Guest v. Commissioner, 77 T.C. 9">77 T.C. 9, 15-16, (1981); Weil v. Commissioner, 31 B.T.A. 899">31 B.T.A. 899, 906 (1934), affd. 82 F.2d 561">82 F.2d 561 (5th Cir. 1936). In these consolidated cases, there is no dispute that the organizations to which petitioners purportedly donated books were qualified charitable organizations as described under section 170(c). Moreover, there is no dispute that the first two elements of an inter vivos gift have been satisfied. Petitioners argue that they made completed gifts of books to the respective charitable donees on December 27, 1980, thereby entitling them to charitable contribution deductions for taxable year 1980. Petitioners claim that they followed Mr. Elgart's instructions and each mailed letters in December 1980, similar to the PDI sample letters. Petitioners argue that these letters manifest their unmistakable intent to make a gift, and are also effective to transfer legal title to the respective charitable donees. Petitioners 757 acknowledge that the books were not physically delivered to the charitable donees during 1980, but argue physical delivery is not necessary where it would be impractical. In making this argument, petitioners contend that the letters that they mailed effected a constructive delivery of the donated books. Respondent agrees that a gift of tangible property can be effected by a writing where manual delivery is not practical. See In re Pyewell's Estate, 334 Pa. 154">334 Pa. 154, 5 A.2d 123">5 A.2d 123 (1939); Mardis v. Steen, 293 Pa. 13">293 Pa. 13, 141 A. 629">141 A. 629 (1928). However, respondent argues that petitioners have failed to prove that they sent the letters upon which they rely to establish that completed gifts were made in December 1980. Respondent emphasizes that, with the exception of petitioners Abrahams and Becker, petitioners failed to even produce copies of the letters sent to the donees. Respondent also points out that petitioners failed to produce all of the letters notifying the warehouses where the books were stored. While this evidentiary shortcoming might prove fatal in certain circumstances, we believe that the totality of the evidence in these consolidated cases is sufficient to show that petitioners sent 758 letters in conformance with the PDI sample letters to both the donees and the warehouses in December 1980. The plan to contribute the books was formulated over a year prior to December 27, 1980. Execution of the plan was orchestrated by Mr. Elgart who located publishers who were willing to sell books, ascertained the titles available, located the prospective donees, determined which titles the prospective donees wanted to receive, and obtained a legal opinion on the tax aspects of the plan. Each petitioner invested substantial sums of money in the plan during 1979. In December 1980, Mr. Elgart provided detailed instructions regarding how to effect the gift. All petitioners testified that they followed the December 1980 instructions and sent gift letters to the respective donees and warehouses in December 1980. The donees acknowledged the December 27, 1980, receipt of the gifts. There was evidence that many, if not all, of the books were physically delivered to the donees in 1981. Under these circumstances, we find that petitioners sent letters to the donees and the warehouses pursuant to the instructions which Mr. Elgart sent on December 5, 1980. Respondent argues that even if 759 petitioners have proven that the letters were sent, the letters do not express a present intent to make an immediate gift. Respondent argues that the language used in the letters merely expresses an intention to make a gift in the future and, therefore, does not transfer dominion and control over the books to the charitable donees. As a result, respondent contends that petitioners' 2198 purported gifts were not completed until actual delivery of the books to the charitable donees. Respondent contends that In re Pyewell's Estate, supra, and Mardis v. Steen, supra, are distinguishable from the instant cases, because those cases involved writings which indicate a present intention to pass the right of possession to the donee. Respondent relies on three cases to support his proposition that petitioners' letters did not effect an enforceable transfer of the books to the donees on December 27, 1980. Each case involved whether there had been a completed inter vivos gift prior to the deceased donor's death. In re Estate of Evans, 467 Pa. 336">467 Pa. 336, 356 A.2d 778">356 A.2d 778, 781 (1976), involved a purported inter vivos transfer of the contents of decedent's safe deposit box. The decedent had given physical possession 760 of the safe deposit box keys to the purported donee. However, because the safe deposit box remained registered in the decedent's name, the purported donee could not have gained access to the box even with the keys. The court held that there was no inter vivos gift because decedent "never terminated his control over the box." In re Estate of Evans, 356 A.2d at 782. (Emphasis added.) Chadrow v. Kellman, 378 Pa. 237">378 Pa. 237, 106 A.2d 594">106 A.2d 594, 597 (1954), involved a written joint tenancy agreement whereby the decedent granted a purported donee joint ownership in, and the right to withdraw contents from, a safe deposit box. The agreement was on a form prepared by the bank. However, the decedent never gave the purported donee the key to the safe deposit box. The court held that since the purported donee "never" had access to the box during the decedent's lifetime, there was neither actual nor constructive delivery. Carr v. MacDonald, 70 R.I. 65">70 R.I. 65, 37 A.2d 158">37 A.2d 158 (1944), involved an alleged inter vivos gift of bank accounts by a decedent shortly before her death. The court held that there was no completed gift. It was clear that the decedent expressed an intent to make a gift of the bank accounts, but 761 was advised that she needed to execute certain forms and, therefore, postponed completing the gift at the time, and died prior to effectively completing the gift. None of the three cases relied upon by respondent indicate that a writing, otherwise sufficient to effect a completed gift, is insufficient when the specified effective date is several days after the date upon which the written instrument was executed. Here, it is clear that both the donors and donees intended and believed that the letters to the donees and the custodians of the books, transferred ownership of the books effective December 27, 1980. Under these circumstances, we can see no reason why the gifts should not be considered completed on that date. 17 See Pronzato v. Guerrina, 400 Pa. 521">400 Pa. 521, 163 A.2d 297">163 A.2d 297, 300 (1960); In re Rynier's Estate, 347 Pa. 471">347 Pa. 471, 32 A.2d 736">32 A.2d 736 (1943). We find that the letters which petitioners sent to the donees and the custodians of the books in December 1980, demonstrate a present intention to pass ownership and the right to possession of the books effective December 27, 1980 and that the donees, who had previously selected the book titles that they wished to receive, accepted the books from 762 petitioners pursuant to the terms contained in petitioners' letters. If a charitable contribution is made in property other than money, the amount of the allowable deduction is the fair market value of the property at the time of the contribution, reduced as provided in section 170(e)(1). Sec. 1.170A-1(c)(1), Income Tax Regs. Fair market value is defined as "the price at which the property would change hands between 763 a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts." Sec. 1.170A-1(c)(2). The determination of fair market value of an item of property is a question of fact. Goldstein v. Commissioner, 89 T.C. 535">89 T.C. 535, 544 (1987); Skripak v. Commissioner, 84 T.C. 285">84 T.C. 285, 320 (1985); Zmuda v. Commissioner, 79 T.C. 714">79 T.C. 714, 726 (1982), affd. 731 F.2d 1417">731 F.2d 1417 (9th Cir. 1984). Petitioners bear the burden of proving the fair market value of their donated books. Rule 142(a). Section 170 and the regulations promulgated thereunder are silent as to the market to be used in determining the value of donated property. It has been recognized that the valuation test for charitable contribution deduction purposes is generally the same as that used for estate and gift tax purposes. United States v. Parker, 376 F.2d 402">376 F.2d 402, 408 (5th Cir. 1967); Anselmo v. Commissioner, 80 T.C. 872">80 T.C. 872, 881-884 (1983), affd. 757 F.2d 1208">757 F.2d 1208 (11th Cir. 1985). The test for estate and gift tax valuation, under the regulations, provides that the fair market value of an item of property is to be determined in the market where such items are "most commonly sold to 764 the public." Sec. 20.2031-1(b), Estate Tax Regs.; sec. 25.2512-1, Gift Tax Regs. In the 2199 normal situation, a sale "to the public" refers to a sale to the "retail customer who is the ultimate consumer of the property." Anselmo v. Commissioner, supra at 882. In Lio v. Commissioner, 85 T.C. 56">85 T.C. 56, 70 (1985), affd. sub nom. Orth v. Commissioner, 813 F.2d 837">813 F.2d 837 (7th Cir. 1987), we stated that the sale to the ultimate consumer is any sale to those persons who do not hold the item for subsequent resale. See Goldman v. Commissioner, 388 F.2d 476">388 F.2d 476, 478 (6th Cir. 1967), affg. 46 T.C. 136">46 T.C. 136 (1966). The appropriate market is determined from the facts and circumstances of each particular case. Lio v. Commissioner, supra.After identifying the appropriate market, fair market value is determined by the amount that consumers would pay, in this market, for the items in question on the date of contribution. Goldstein v. Commissioner, supra; Lio v. Commissioner, supra.Petitioners argue that the appropriate market for determining the fair market value of their donated books is the retail market where the consumer purchases books at catalog prices. Petitioners rely upon our decision in Skripak v. Commissioner, supra, 765 in which we were required to value scholarly reprint books. In Skripak, the taxpayers participated in a book contribution program whereby they purchased scholarly reprint books from Reprints, Inc. (RPI), and subsequently donated the books to various small rural public libraries. RPI purchased the books from BFL Communications, Inc. (BFL). The taxpayers each claimed a charitable contribution deduction for their donation of books which was approximately three times the amount they paid to purchase the books. We found that the appropriate market was the "retail market place, comprised largely of institutional buyers (libraries) and, to a minor extent, of individuals seeking a specific scholarly text." Skripak v. Commissioner, supra at 322. We rejected, however, the taxpayers' argument that the fair market value of the books donated was equal to the catalog retail list prices of the books. Petitioners have distinguished Skripak by contending that the titles of books that they contributed to the respective charitable organizations were sold in substantial quantities to other consumers during the years 1980 through 1987. Thus, unlike Skripak where we found that there were no substantial 766 sales by BFL to other consumers, petitioners argue that the fair market value of the books in question here is their catalog prices. In Skripak, however, we also found the taxpayers' method of valuation flawed because their method ignored the fact that the reprint books represented BFL's excess inventory, under which circumstance the ultimate consumer would have received a substantial discount. In addition, the taxpayers also failed to consider the weakness of the reprint book market. Skripak v. Commissioner, supra at 325-326. We also noted that, even if we had accepted BFL's catalog list price at face value, the sheer number of books to be valued for each taxpayer would have required a substantial discount from that price. Skripak v. Commissioner, supra at 325. Petitioners have relied upon expert witnesses to establish that the book titles contributed by petitioners would have sold at their catalog prices in the retail market place during 1980. We are not bound by the opinion of any expert witness when that opinion is contrary to our own judgment. Barry v. United States, 501 F.2d 578">501 F.2d 578, 583 (6th Cir. 1974); Chiu v. Commissioner, 84 T.C. 722">84 T.C. 722, 734 (1985). We may accept or reject 767 expert testimony as we find appropriate in our best judgment. Helvering v. National Grocery Co., 304 U.S. 282">304 U.S. 282, 295 (1938); Silverman v. Commissioner, 538 F.2d 927">538 F.2d 927, 933 (2d Cir. 1976), affg. a Memorandum Opinion of this Court. It is unrealistic to suggest that the catalog retail list prices accurately measure the fair market value of the books donated by petitioners. The PDI offering memorandum itself cautioned petitioners that it was "highly unlikely" that they could resell the books at catalog prices, and that they should not purchase the books with the expectation of being able to resell them at a profit. In most cases, the publishers determined that the book titles sold to PDI were overstocked and could not be sold through normal channels. In the case of ISHI books, the publisher thought the books could be sold, but only over a long period of time of ten or more years. In lieu of waiting for many years to possibly sell all of the ISHI books, the publisher decided to sell to PDI to realize immediate cash. The present value of the ISHI books would, of course, be affected by the inability to sell them for many years. Respondent's expert witnesses valued some of the books based 768 upon a hypothetical sale to a consumer in the "remainder" market. 18 However, there is no evidence in the record before us indicating that the titles that were donated were sold in the remainder market. In most instances, it appears that the publishers were trying to 2200 avoid the sale of these particular titles in the remainder market. Respondent's experts determined that some of the books should be valued at what petitioners paid for them and, in some instances, opined that certain books had little or no value at all. We find that neither the remainder market nor the retail market, where books are sold at catalog list prices, is the appropriate market in which to determine the fair market value of the "overrun" books and college texts which petitioners donated. We conclude that the ultimate consumers 769 of the books in issue were those persons who purchased books from PDI. It is clear from the evidence in the record before us that petitioners purchased books from PDI for the purpose of making subsequent donations to charitable organizations. The publishers and, in turn, PDI sold the books with the understanding that petitioners intended to donate the books to charitable organizations. Petitioners claim to have donated their books to a qualified charitable organization during taxable year 1980. Under these circumstances, it is clear that petitioners did not purchase books from PDI for resale. Petitioners were, therefore, the ultimate consumers of the PDI books. Lio v. Commissioner, 85 T.C. at 68-69. Thus, the appropriate market for determining the value of the "overrun" books and college texts is the market which was created by PDI. See Hunter v. Commissioner, T.C. Memo. 1986-308. The most probative evidence of the fair market value of the donated books is the amount petitioners paid for them, especially since petitioners acquired their books only one year prior to the time of contribution. Goldstein v. Commissioner, 89 T.C. at 546; Chiu v. Commissioner, supra; Lio v. Commissioner, supra.770 Petitioners do not argue that any appreciation in value occurred from the date of acquisition to the date of contribution, and we do not believe that any appreciation in value did occur. We find that the fair market value of the donated books, therefore, is the same as the amount each petitioner paid for them when they were purchased from PDI. Additions to Tax and Increased InterestThe next issue for decision is whether petitioners are liable for the additions to tax under section 6653(a), as determined by respondent. Section 6653(a) imposes an addition to tax, in an amount equal to 5 percent of the underpayment, if any part of any underpayment is due to negligence or intentional disregard of rules and regulations. Respondent's determination is presumed correct and petitioners bear the burden of proving otherwise. Bixby v. Commissioner , 58 T.C. 757">58 T.C. 757, 791-792 (1972); Rule 142(a). Negligence within the meaning of section 6653(a) has been defined as the failure to do what a reasonable and ordinarily prudent person would do under the circumstances. Neely v. Commissioner, 85 T.C. 934">85 T.C. 934, 947 (1985). Petitioners Rhode, Hurst, Abrahams, and Becker, argue that they are not liable for the 771 addition to tax for negligence or intentional disregard of rules and regulations because they relied in good faith upon the advice of Mr. Elgart. They argue that Mr. Elgart was conversant with Federal income tax law and carefully researched and planned the PDI book contribution program. In some circumstances, a taxpayer may not be liable for the addition to tax for negligence or intentional disregard of rules and regulations if he relied in good faith, albeit erroneously, upon the advice of a tax expert. Ewing v. Commissioner, 91 T.C. 396">91 T.C. 396, 423 (1988); Nelson v. Commissioner, 19 T.C. 575">19 T.C. 575, 581 (1952). Under the circumstances of these consolidated cases, however, we do not find that petitioners Rhode's, Hurst's, Abrahams', and Becker's reliance upon the tax advice of Mr. Elgart is sufficient to carry their burden of proof. The offering memorandum given to petitioners "emphasized that a determination as to a particular Title's fair market value is a purely factual one, and no opinion is expressed with respect to the fair market value" (emphasis added) of the books, and that "Neither Mr. Elgart nor Mr. Dickler has had previous experience in the buying or selling of books." It went on 772 to caution that catalog prices might not be conclusive "or even a material factor in the ultimate determination of the fair market value of the Books" and that petitioners could not reasonably expect to resell the books at a profit. Each petitioner in these consolidated cases received and read the offering memorandum that warned that the fair market value of the books may not be equal to their respective catalog prices at the time of donation. None of petitioners, including Mr. Elgart, obtained an independent appraisal of the books that they had purchased despite being fully aware of the fact that there were serious questions about their valuation method. Under the circumstances of these consolidated cases, we find that petitioners failed to prove that their action conformed to what a reasonable and ordinarily prudent person would do under the circumstances. See Goldstein v. Commissioner, 89 T.C. at 550; Weintrob v. Commissioner, T.C. Memo 1990-513">T.C. Memo. 1990-513. Accordingly, we find petitioners liable for the additions to tax under section 6653(a) as determined by respondent. The final issue for decision is whether petitioners are liable for the increased rate of interest 2201 under section 6621(c). 773 Section 6621(c) provides that with respect to interest payable under section 6601, an increased rate of interest is imposed when there is a "substantial underpayment" (exceeds $ 1,000) "attributable to one or more tax motivated transactions." The additional interest accrues after December 31, 1984, even though the transaction was entered into prior to the enactment of section 6621(c). 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); Solowiejczyk v. Commissioner, 85 T.C. 552">85 T.C. 552 (1985), affd. per curiam without published opinion 795 F.2d 1005">795 F.2d 1005 (2d Cir. 1986). A "tax motivated transaction" includes "any valuation overstatement" as defined in section 6659(c). Sec. 6621(c)(3). Under section 6659(c), a valuation overstatement is present if the value of any property claimed on a return is 150 percent or more of the amount determined to be the correct valuation of such property. We have found that petitioners overstated the value of their donated books by more than 150 percent of the amount determined to be the correct valuation. We, therefore, find that each of the petitioners is liable for the increased rate of interest for taxable year 1980 to the 774 extent that the underpayments attributable to the tax motivated transaction exceed $ 1,000. This will have to be determined pursuant to the Rule 155 computation. Decisions will be entered under Rule 155. Footnotes1. The cases of the following petitioners are consolidated herewith: Arthur Abrahams and Barbara Abrahams, docket No. 21395-87; Edgar Hurst and Sara Jane Hurst, docket No. 23091-87; Arthur B. Becker and Gloria O. Becker, docket No. 23545-87; and Ellis L. Elgart and Sivia V. Elgart, docket No. 28413-87.↩2. Unless otherwise indicated, all section references are to the Internal Revenue Code as amended and in effect for the taxable years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩3. Petitioners Edgar Hurst and Sara Jane Hurst have conceded the entire amount of deficiency and respondent has conceded the addition to tax, under section 6653(a)(1) and (2)↩, for taxable year 1981. . Section 6653(a) was amended by the Economic Recovery Tax Act of 1981 (ERTA), and divided into section 6653(a)(1) and (2) applicable to taxes the last date prescribed for payment of which is after December 31, 1981. Pub. L. 97-34, sec. 722(b)(1), 95 Stat. 342-343. Accordingly, respondent determined the additions to tax for the Hursts' 1981 taxable year, under section 6653(a)(1) in the amount of $ 706.44, and under section 6653(a)(2)↩ in the amount of 50 percent of the interest due on $ 14,128.70.4. Respondent incorrectly computed the amount of the deficiency for the Elgarts' 1980 taxable year. The parties have agreed to prepare a Rule 155 computation for the Court's consideration in entering a decision in docket No. 28413-87.5. Former section 6621(d) was redesignated as section 6621(c)↩ pursuant to section 1511(c), Tax Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2744. Respondent has conceded that petitioners Edgar Hurst and Sara Jane Hurst are not liable for the increased rate of interest for taxable year 1981.6. In the case of the Institute for the Study of Human Issues, Inc. (ISHI), the publisher believed the "overrun books" could be sold, but only over a long period of time of ten or more years.↩7. Alfred A. Knopf books are distributed by Random House. Based upon the title codes of the books purchased by PDI, the following titles do not appear to have been listed in either catalog in 1980 or 1981: "American Political System"; "LT Psychology"; "Modern Marketing"; "Social Problems"; "Understanding Psychology"; and "U.S. to 1877." The titles, "Anthropology, 2 ed." and "General Anthropology" were listed only in the 1980 catalogs.↩8. In the agreement between Raven Press and PDI, the catalog price was not to be less than $ 15.00 per book. In addition, Raven Press did not agree that overrun books would remain in its catalog for a period of 13 months after notice was given to PDI.9. In the agreement between Raven Press and PDI, the purchase price to PDI of the overrun books was a flat 20 percent of the catalog price.↩10. The evidence in the record does not show that the title "From Field to Factory: Community Structure and Industrialization in West Bengal" was listed in ISHI's 1981 catalog.↩11. The evidence in the record does not show that the title "Walk Rabbit Walk" was listed in the Viking Penguin 1981 junior books catalog.↩12. The evidence in the record does not show that the title "The Little Red Schoolhouse" was listed in either catalog. Ashley Books' 1980 catalog was not offered into evidence.↩13. Jt. Ex. 46-AT reflects 4,106 books purchased by PDI. This exhibit does not reflect, however, the purchase of 100 copies of "Progress Chemical Fibrinolysis, Vol. 3" as indicated on the invoice found at Jt. Ex. 36-AJ. Moreover, Jt. Ex. 146-EP shows this book as being donated by petitioners, Elgart, Rhode, and Abrahams and other participants in the PDI program. This exhibit indicates, however, that PDI purchased 4,234 books from Raven Press. Though all parties have stipulated to these exhibits, the only invoice from Raven Press entered into evidence shows that 4,206 books were purchased.14. Catalogs from Raven Press for 1980 and 1981 were not introduced into evidence.↩*. Represents the price paid by PDI as a percent of the catalog prices of the books purchased.↩15. We note that the Agreement of Sale between Mr. Rhode and PDI was executed before the date when PDI purchased the books from the five different publishers. When PDI purchased the books from the five publishers, Mr. Rhode acquired title to the books that he purchased from PDI at that time. See McKee v. Ward, 289 Pa. 414">289 Pa. 414, 137 A. 599">137 A. 599↩ (1927).16. The lesser deductions claimed by petitioners Rhode and Abrahams reflect the 30 percent limitation of section 170(b)(1)(C)(i) on contributions of certain capital gain property. Petitioners Rhode and Abrahams designated on their respective 1980 joint Federal income tax returns the unused portions of their claimed contribution of books of $ 7,779 and $ 5,120, respectively, as a carryover into subsequent taxable years.17. The question of whether or not petitioners could have revoked the gifts between the date the letters were mailed and December 27, 1980 is not before us. The fact is that no such revocation was attempted and, on December 27, 1980, both the donors and donees intended and believed that ownership of the books passed to the donees pursuant to petitioners' long-standing plan. The policy behind the requirement that a gift be completed by delivery is to avoid a mistake and to protect alleged donors from fraudulent claims. Where the donor and the donee both acknowledge the gift, and no third party is involved in the transaction, the reason for actual delivery is absent. Hengst v. Hengst, 491 Pa. 120">491 Pa. 120, 420 A.2d 370">420 A.2d 370, 371 (1980); see Sandler v. Commissioner, T.C. Memo. 1986-451↩.18. Generally, a title is "remaindered" when it is no longer profitable for the publisher to keep that particular title in print. The publisher will sell its remaining inventory of the title to a wholesaler who will subsequently offer the books to retail outlets at a new recommended "sale" price. The new "sale" price ranges from 10 to 40 percent of the original publisher's catalog price.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623480/	APPEAL OF C. F. HOVEY CO.C. F. Hovey Co. v. CommissionerDocket No. 5448.United States Board of Tax Appeals4 B.T.A. 175; 1926 BTA LEXIS 2351; June 22, 1926, Decided Submitted February 11, 1926. 2351 The value of good will paid in to a corporation for shares of capital stock determined. Frank J. Albus, Esq., for the petitioner. F. O. Graves, Esq., for the Commissioner. SMITH 175 Before SMITH, JAMES, 1 LITTLETON, and TRUSSELL. This appeal is from the determination of a net deficiency of $3,943.95 in income and profits tax for the three years ended 176 January 31, 1917, January 31, 1918, and January 31, 1920, as follows: Deficiency in taxOverassestmentFiscal year ended -January 31, 1917$68.92January 31, 1918$1,127.81January 31, 19202,885.06Total4,012.8768.92The point in issue is the exclusion from invested capital of $200,000 for good will acquired with shares of stock in 1914. FINDINGS OF FACT. The taxpayer is one of the oldest, if not the oldest department store in New England. It began business on May 1, 1838. Since 1847 it has occupied its present location on Summer Street, only one or two doors from Washington Street, in Boston, Mass. The store is located in the heart of the retail shopping district2352 of the city. It was incorporated in September, 1914, with a capital stock of $1,000,000, $800,000 of which was issued for tangible assets and $200,000 for good will. At the time of incorporation the store dealt in general dry goods, dress goods, wash goods, shoes, ladies' wear, children's wear, and men's goods. The average yearly capital and average yearly earnings of the business from 1848 to 1914 were $1,276,361.46 and $184,373.40, respectively; corresponding figures for the period 1900 to 1914, inclusive, were $1,404,595.44 and $171,951.83, respectively; and for the period 1910 to 1914, inclusive, were $1,199,691.11 and $34,911.35, respectively. The percentage of earnings to average capital for the entire period of sixty-six years was 14.45 per cent. For the years prior to 1909 the percentage earned was on the average considerably in excess of 15 per cent. Percentages for the years 1909 to 1913 were as follows: Year:Per cent19098.5919108.3919112.451912.9719131.46Operations resulted in a small net loss for the year 1914. Although the profits during the period 1909 to 1914 were less than for any corresponding period in the history2353 of the company, there was a steady increase in the number of customers at the store and a steady increase in the number of customers' accounts. 177 There were special reasons for reduced profits during the period 1909 to 1914. During this period the Jordan-Marsh Co. had built an annex with an entrance on Summer Street, which entrance was across the street from the taxpayer's entrance. During the period also, Filene's, Inc., had opened a large store on Washington Street in the neighborhood. The entire department store business in the city was, moreover, subject to the keenest competition during this period as the result of the operations of one Henry Siegel and one Butler. The former had built a large store a little farther south on Washington Street than the junction of Summer and Washington Streets, and Butler had gotten possession of Gilchrist's, another large department store on Washington Street, and had also opened two other stores in the city, one on Tremont Street and one on Winter Street. Both Siegel and Butler carried on extensive advertising programs and conducted a price-slashing campaign that eventually carried them both into bankruptcy. Siegel's store2354 was in bankruptcy prior to 1914, and Butler, as a result of financial troubles, committed suicide in November, 1912. The stocks of merchandise carried by the stores operated by Siegel and Butler were thrown upon the market in bankruptcy sales, with the result that for a year or two the department stores in Boston made small profits. In September, 1914, the outstanding capital stock of the taxpayer was $1,000,000. It stood at the same amount until after January 31, 1919. On January 31, 1920, the total outstanding capital stock was $2,000,000. OPINION. SMITH: The only question presented by this appeal is the value for invested capital purposes of the good will of the C. F. Hovey Co. paid in to the taxpayer corporation in exchange for $200,000 of its capital stock in September, 1914. The Commissioner has disallowed the claim of the taxpayer for any invested capital in respect of this asset, upon the ground that it has not proven any cash value for it; that for a period of five years prior to 1915 the taxpayer had operated at a small profit and operated at an actual loss in the year 1914. The taxpayer contends on the other hand that the good will of the company paid in for2355 shares of stock had a cash value of at least $200,000 in September, 1914. We think that the fact that the business of the C. F. Hovey Co. during the period 1909 to 1914 was not particularly profitable does not prove that the good will did not have a cash value. The value of good will may not be indicated by the profits of a business for a short period. In the case of ; , 178 it was held that good will may have a value although there have been no past profits. The distinction between "profits" and "good will" was determined in the case of ; , wherein the court said: The distinction between the two [profits and good will] is obvious. Profits are the gains realized from trade; good will is that which brings trade. A favorable location of a mercantile establishment, or the habit of customers to resort to a particular locality, will bring trade. This advantage may be designated by the term "good will." What the trader gains from the trade so acquired are "profits." 2356 In determining that the good will of C. F. Hovey Co. had no value in September, 1914, the Commissioner considered the results of operations for a period of five years only. We think that no definite number of years can be made to apply to all cases. In , it was held that the length of the period to be considered is to be determined in each particular case. The number of years to be considered is not a question of law but one of fact. ; ; ; . It will be noted from the findings of fact that for the period from 1900 to 1914 the average yearly capital of the C. F. Hovey Co. was $1,404,595.44 and the average yearly earnings $171,951.83. If this period be taken as the basis for the computation of the value of the good will, instead of the five-year period used by the Commissioner, and an 8 per cent return be considered a fair return on tangibles, the excess average annual earnings for the period applicable to good will is $59,584.19, which capitalized upon a five-year2357 purchase basis, as was done in the , gives a value for the good will in excess of $200,000. In this appeal we do not, however, have to rely entirely upon the basis of earnings for the purpose of arriving at a cash value of the good will in 1914. There has been introduced in evidence the deposition of Maurice Wrigley, director and treasurer of the Jordan-Marsh Co. Relative to the value of the good will of the taxpayer he testified as follows: Q. Mr. Wrigley, with your experience in the dry goods business, would you state what, in your opinion, is a fair figure for the good will of the Hovey Company as of 1914? A. Well, of course, I am not familiar with the Hovey Company balance sheets, and I don't know anything about the Hovey Company business as of those dates. As I remember, the Hovey Company is one of the oldest establishments of Boston, ranking as high as any in the early days of the 80's and 90's; in fact, in the early 90's, the Hovey Company was a very high-grade store and held at that time high-grade trade. The old Back Bay people of 179 Boston naturally were on the Hovey clientele list. It had2358 a good name and a good reputation. When you go down to 1914, the Hovey Company conducted a wholesale business and a retail business; they stressed, of course, wholesale in the early years. In the later years, from my observation, I would say that in the retail end they did not keep up the same merchandise grades as before, although I believe they held the old clientele. I think to this day they are holding a good part of the clientele of the old Hovey store. Q. With your experience in the dry goods business, would you be willing to express your opinion as to what the good will might have been worth in 1914 in dollars and cents? A. Well, you see that is really something you have to get to some extent through financial statements of condition to express an opinion as to the good will of the business, but it seems to me that if anyone wanted to buy Hovey's store there would be a good will in the name alone of C. F. Hovey Company which would have quite some value. I should think the Jordan-Marsh Company if they were an outsider coming into Boston wanting to buy the store would be willing to pay considerable merely for the name of C. F. Hovey Company with that class of store, 2359 because it was a store similar to ours and with a clientele considered to be high grade; and if we were going to come to Boston, to buy a business of that kind we would be quite willing to pay a good deal just for the Hovey name. Q. Regardless of any reference to balance sheets that might give you something concrete upon which to place a valuation for good will, would you be willing to express any opinion as to the value of the good will of Hovey Company in 1914 - that is, in dollars and cents? A. Well, I could only say that, speaking in connection with ourselves, if we were outsiders, I should think that Jordan-Marsh Company would no doubt be willing to give a quarter of a million dollars for the good will that was there - you know there is a business already established. It is an old concern. It had the cream of the trade of Boston; and Hovey's reputation had not suffered, to my knowledge, up to 1914. I don't know anything about their business results. There was the Hovey business with a very high reputation, and it seems to me that to any one coming in, that name was a valuable name and carried under that name Boston's best clientele. I think if we took the Hovey store*2360 we would develop that name and have a very good prestige in the name alone. We think that the evidence satisfactorily establishes that the good will of the C. F. Hovey Company paid in to the taxpayer corporation in September, 1914, for $200,000 of capital stock had a cash value on that date of $200,000. Order of redetermination will be entered on 15 days' notice, under Rule 50.Footnotes1. This decision was prepared during Mr. James' term of office. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623481/	Estate of Adolph J. Koch, George Koch, Executor v. Commissioner.Estate of Koch v. CommissionerDocket No. 108007.United States Tax Court1943 Tax Ct. Memo LEXIS 363; 1 T.C.M. (CCH) 898; T.C.M. (RIA) 43170; April 13, 1943363 Gerald S. Chargin, Esq., for the petitioner. Arthur L. Murray, Esq., for the respondent. MELLOTTMemorandum Findings of Fact and Opinion MELLOTT, Judge: This proceeding involves a deficiency in estate tax in the amount of $22,544.18. Respondent determined that decedent had made transfers, in contemplation of death and within two years prior to his death, of property having an aggregate value of $204,442.51. He included this amount in gross estate under section 811 (c) of the Internal Revenue Code. Inasmuch as $79,001.53 of the amount referred to had been transferred by decedent to a trust for the benefit of his grandson, this amount was also determined to be includible in gross estate under section 811 (d) of the Internal Revenue Code. Petitioner contends that neither determination is correct. Two other issues were raised by the pleadings. One relates to the refusal of the respondent to allow the deduction of $500, alleged to be an additional sum payable to decedent's housekeeper and nurse. The other, not referred to in the notice of deficiency but set out in the petition, relates to an anticipated expenditure for attorney's fees in this proceeding. These issues appear to have been364 abandoned since neither is discussed by petitioner upon brief; but if they have not been abandoned they must be decided against petitioner for failure to present any evidence in support of them. Findings of Fact Adolph J. Kock, hereinafter referred to as the decedent, died testate on June 29, 1939, at the age of 84 years. He was then a resident of San Jose, California. His son, George A. Koch, is the duly qualified executor of his estate. An estate tax return was filed with the collector of internal revenue for the first district of California on October 19, 1939. It states that the "business or occupation" of decedent at the time of his death was "retired". Decedent's wife, Elizabeth Koch, predeceased him. He was survived by a son, George A. Koch, and two grandsons, Kenneth Koch, the son of George, and Ralph J. Swickard, the son of his daughter, Hilda. Ralph's mother died at the time of, or shortly after, his birth. The decedent and his wife, after the death of their daughter, supported in their household their grandson, Ralph, until he reached the age of seventeen or eighteen years, when he went to live with his father, his stepmother and her son by a prior marriage. Decedent365 was very anxious that Ralph should have the best educational advantages, and that he should go to Stanford University where his other grandson, Kenneth, was a student. Ralph entered Stanford University in the fall of 1938, and on September 21, 1938, the decedent gave him a check for $500 for his tuition. This amount is not in issue in this proceeding. The decedent was a man of considerable means. Between 1913 and 1938 he made several gifts to his son George. In 1913 he gave him some flats, valued at $30,000, for a wedding present. Between 1913 and 1930 he gave him at least $10,000. In 1930 he gave him $40,000 to enable him to go into the stock and bond business. None of these amounts is in issue in this proceeding. During the latter part of 1931 or the early part of 1932 decedent told his attorney that he was planning to make a gift to his son George of approximately $100,000 in securities, because the latter had sustained substantial losses in the failure of the stock and bond firm of which he had been a partner. The attorney advised that because of the failure of the firm George had a contingent liability and would probably lose any property which might be transferred outright366 to him at that time. He therefore recommended that decedent make a will in which any property intended for George would be tied up so that his creditors could not reach it. Following this advice, the decedent, on February 23, 1932, executed a will which provided that, in the event of his death, the inheritance intended for George would remain in a spendthrift trust. After George was discharged in bankruptcy of debts amounting to about $1,000,000, the decedent, on July 25, 1935, executed another document which, with codicils, became his last will and testament. He provided therein for three specific bequests, $5,000 to his brother and $1,000 each to his sister-in-law and niece. The remainder of his property was devised and bequeathed to his son George and his grandson, Ralph. Ralph's half was to be held in trust by George, the latter being directed to pay out of the income such amounts as he should deem necessary for the support, maintenance and education of Ralph until he should reach the age of twenty-one years, at which time one fourth of the trust estate was to be delivered to him. The trustee was given the power in his discretion to deliver the remainder of the trust property367 to the beneficiary at any time after he had reached the age of twenty-five years, and, if he did not exercise this discretion, the trust was to cease and terminate when Ralph reached the age of thirty years, at which time he was to receive all of the trust property remaining in the hands of the trustee. This will was amended by a codicil dated March 3, 1937, which made certain changes in the time when part or all of the trust estate was to be delivered to Ralph by the trustee. On December 20, 1938, decedent made an absolute gift to his son of property which, on the date of the decedent's death, had a value of $79,290.98. On the same date decedent made a gift in trust for the benefit of his grandson Ralph of properties which, on the date of decedent's death, had a value of $79,001.53. Decedent's son George was named as trustee in the trust instrument. Under its provisions he was directed to pay out of the Income of the trust such amounts as he deemed necessary for the support, education and maintenance of Ralph until he became twenty-one years of age, and thereafter he was to pay Ralph the income of the trust until he reached the age of twenty-five, at which time all of the trust368 property was to be turned over to him and the trust was to terminate. No power to change, alter or amend the trust was reserved in the settlor. Decedent, during the month of January, 1939, made absolute gifts to George and Ralph of cash and other properties, the value of which on the date of his death was $23,150 and $21,000 respectively. The decedent paid Federal gift taxes on the gifts referred to above in the amounts of $7,547.06 for 1938 and $5,374.12 for 1939. Additional codicils were added by the decedent to his will on December 24, 1938, January 18, 1939, and February 9, 1939. They referred to the specific bequests in his will of $1,000 each to his sister-in-law and niece, and $5,000 to his brother, stated that these amounts had been given to them on the respective dates, and that they were advancements made "in lieu of" and "in payment of" the bequests during his lifetime. After making these transfers, which amounted to $209,442.51, the decedent retained, until the time of his death, cash and other properties having a total value of $142,605.39. About five or six years prior to his death, the decedent, while crossing a street in San Jose, California, was struck by an 369 automobile. The injury sustained by him probably broke a muscle and caused an inside hemorrhage over his right hip. During the six or eight weeks following the accident, the attending physician withdrew from the injured side several quarts of fluid. The injury left the decedent with a large depression in his right side, and thereafter the side bothered him. At times he would say: "This automobile injury has come back on me." He complained of having a "rheumatism pain", and had an electric ring which he sat on and put around him. He said the ring soothed and helped him. Prior to the automobile accident the decedent had always enjoyed good health, had never been bedridden or hospitalized, and had seldom required the attention of a physician. On May 18, 1938, the decedent had a paralytic stroke, and, for a time, was unable to use his left hand and left lower extremity. He had fallen, while alone, but had managed to get to his bed where he was found by his housekeeper and nurse, who called the doctor. The nurse told the doctor that the decedent's son wanted him to visit the decedent every day so she could tell him (he residing in another city) how his father was getting along. During 370 the period from May 21 to June 22, 1938, the doctor visited the decedent twenty-eight times. At the time of his last call, on June 22, 1938, decedent's left leg had improved and he was able to stand by the bed with the use of crutches for support. He was not able to walk unassisted at that time. For a while he had to have someone help him into his automobile when he went riding. His condition improved, however, and his limp "cleared up almost entirely." Decedent was a member of the Knights Templar organization, and it furnished him with a wheel chair, which was kept in his garage. The wheel chair was used some; but decedent did not like to ride in it and his nurse did not like to push it. He was very independent, often refused proffered assistance, and at times walked without his cane. After his illness in 1938 the decedent spent much of his time sitting on the porch of his home or in the front room, looking out of the window. He usually retired early and got up early. He was always in good spirits and never talked about death. He was a director of a building and loan association, and during the year 1938, missed only two of the monthly meetings of the directors. He participated 371 actively in the discussions at these meetings. In the early part of 1939, he visited the offices of the association "a couple of times" and on at least one occasion told the counsel for the association that he had walked down. The office was five blocks from decedent's residence. During 1939, decedent shaved himself with an electric razor, and had his hair cut at a barber shop approximately once every three weeks. He frequently walked to the barber shop, which was a block from his home. On the night before Christmas of 1938, decedent walked down to the Masonic Temple with his housekeeper and nurse. He personally attended to all the details of the Christmas breakfast of the Knights Templar organization, of which he was in charge, and took great pains to see that all of the tables were fixed right, that the ladies waited on the tables, and that the hams were cut right. He also made a little talk to the members. He attended the Christmas breakfast in a wheel chair. His nurse "took him down" to the Masonic Temple where the breakfast was served. From June 22, 1938, until the date of his death the decedent was not treated by any doctor, except that on December 26, 1938, he received treatment372 for an inflamed eye. The decedent died on June 29, 1939. The cause of death was extra peritoncal hemorrhage due to rupture of the left hypogastric artery, which could have been caused by a fall in the bathroom the morning of his death. Contributory causes were chronic interstitial nephritis with cystic degeneration of the right kidney and senility. The contributory causes, other than senility, were revealed by an autopsy. The decedent had never complained of, or been treated for, the conditions disclosed by the autopsy. The respondent determined that all of the gifts and transfers made by the decedent during the period December 20, 1938, to the date of his death, except the $5,000 given to his brother, were made in contemplation of death. He therefore increased the gross estate by the aggregate amount thereof ($204,442.51). The transfers by the decedent, aggregating $204,442.51, were made in contemplation of death. Opinion The principal issue is whether respondent erred in determining that the transfers were made in contemplation of death and hence that the value of the property transferred is to be included in gross estate under section 811 (d) of the Internal Revenue Code. 373 1 The question is essentially one of fact, to be determined from a consideration of all the pertinent facts and circumstances, First National Bank of Boston v. Commissioner, 63 Fed. (2d) 685; Flack v. Holtagel, 93 Fed. (2d) 512; but the respondent has the advantage of two rebuttable presumptions - one, that his determination is correct, Wickwire v. Reinecke, 275 U.S. 101">275 U.S. 101; Welch v. Helvering, 290 U.S. 111">290 U.S. 111 [3 USTC, and the other given by the statute, since the transfers were of a material part of decedent's property and were made by him without consideration within two years prior to his death. 374 Finding has been made that the transfers were in contemplation of death. Conclusion must therefore be reached that the respondent committed no error in including the value of the property in decedent's gross estate. The evidence, in our judgment, clearly supports the finding, independent of the presumptions to which reference has been made. A brief resume of the evidence and the principles established by decided cases will not be amiss. "Contemplation of death", as used in the statute, requires that the triers of fact apply a subjective test and attempt to ascertain from the available facts "the state of mind" of a donor whose lips have been sealed by death. United States v. Wells, 283 U.S. 102">283 U.S. 102. Decided cases, at best, are of comparatively slight aid; for the facts are varied as the personalities of the donors. Collectively they suggest that all proper evidence, even circumstantial, should be considered, Farmers' Loan & Trust Co. v. Bowers, 68 Fed. (2d) 916, certiorari denied 293 U.S. 565">293 U.S. 565; and "hardly any fact is too minute for consideration." Paul, Federal Estate and Gift Taxation, p. 244375 and note. "The differentiating factor must be found in the transferor's motive. * * the motive which induces the transfer must be of the sort which leads to testamentary disposition." "There can be no precise delimitation of the transfers embraced within the conception of transfers in 'contemplation of death' as there can be none in relation to fraud, undue influence * * * or other familiar legal concepts * * ." United States v. Wells, supra. What was decedent's motive in making transfers of approximately 60 percent of his properties when he was nearly 84 years of age? Petitioner urges that the purpose of the transfer to the grandson, Ralph, was to make certain that he would get a college education at Stanford University and to set him up in business later. The purpose of the transfer to the son, George, is said to have been to carry out a policy, long pursued by decedent, of making liberal gifts to him during his lifetime and to equalize the gifts to him with the gifts to the grandson. No attempt is made to explain his motive in advancing the time of payment of the $1,000 bequests to his sister-in-law and niece. Respondent insists that the transfers376 were made at a time when advanced age and incapacitation must have suggested to decedent that the end was drawing near, that they were strictly in accordance with the intention indicated by him in his last will, and that they were testamentary in character. There is no dispute concerning the value of the transferred properties.Twelve witnesses, including three physicians, several neighbors of decedent, his son, his attorney, and his housekeeper and nurse, testified at length with reference to his physical condition, his activities, and statements made by him both before and after the transfers were made. There is some conflict in the testimony of these witnesses with reference to whether the decedent was hit on the right or the left side at the time of the automobile accident, and the nature of his illness in 1938. The evidence indicates that the decedent's injuries as a result of the automobile accident were to his right side and we have so found. It is also clear that the decedent suffered a paralytic stroke in May, 1938, which affected the left side of his body; and, while he had partially recovered from it, the after effects, together with the disability resulting from the automobile377 accident and general senility, had caused him to become pretty much of an invalid. The burden was on the petitioner to show that decedent's gifts in December, 1938, and January, 1939, were motivated by impulses primarily associated with life. United States v. Wells, supra. There is very little evidence in the record upon which to rest a finding that any of his gifts were in this category. The implication from most of the evidence is to the contrary. In his will executed in 1935, decedent, after making specific bequests of $1,000 each to his sister-in-law and niece and $5,000 to his brother, provided that one half of the residue of his estate should go to his son and that the other one half should go to a trust created for the benefit of his grandson, Ralph. The gifts made by him in December, 1938, and January, 1939, made the same disposition of approximately sixty percent of his properties. His sister-in-law, niece and brother each received the same amount that would have been received under the will; and absolute gifts of securities having a value of $102,440.28 were made to George, while securities having a value of $100,001.53 were transferred to, 378 or for the benefit of, Ralph. The time and manner in which the transfers were made indicate that they were substitutes for testamentary dispositions of decedent's property. In the case of the gifts to his sister-in-law, niece and brother, he was careful to point out that they were "in lieu of" the provisions made for them in his will. It was unnecessary to make similar statements concerning the gifts to his son and grandson since the will provided that each was to receive one half of the residue of his estate and any transfers made to them during decedent's lifetime merely diminished the residuary estate. It is a significant fact, however, that the decedent followed the intention expressed in his will of dividing his property, per stirpes. Examining in more detail the contentions made by petitioner and the evidence relied upon in support of them, it will be noted that Ralph entered Stanford University in the fall of 1938, at which time decedent gave him a check for $500 to pay his tuition. Ralph's age at that time is not shown; but it is obvious he was less than twenty-one. Decedent must have known, in the latter part of 1938, that Ralph had no immediate need for any large 379 sum of money and that several years would elapse before he could embark on a business career. So long as decedent lived he was in a position to furnish Ralph with funds required, either for his education or for business. He had made adequate provision in his will to take care of Ralph's needs after his death. We do not doubt that decedent wanted Ralph to become "a good business man and not a fiddler," as some of the witnesses stated, and that his intention was to make Ralph "absolutely independent". That, however, does not satisfactorily explain why he should have advanced the time of enjoyment by Ralph of such a substantial portion of his property. The record is devoid of any intimation that he was endeavoring to school his grandson in the handling of money and inference is to the contrary; for the major portion of the property given to him was to be administered by his uncle, as trustee, and the trustee was to pay out of the income only such amounts as he should deem necessary for the boy's "support, education and maintenance." Inasmuch as the trust then created for Ralph was in essence the same as the trust which was to be set up after decedent's death, it is difficult to see why380 it was created, if it were not for the reason determined by the respondent. The gifts to the son seem to be in the same category. Petitioner urges that one reason for the gifts to him was decedent's desire to give him an amount equal to that given to Ralph. An intention to divide his estate equally between George and Ralph is clearly evidenced by the terms of decedent's will; and the fact that he provided each should receive approximately the same amount of his property when he made the gifts in December, 1938, and January, 1939, shows that there was no change in this plan. This, however, does not explain the decedent's motive in advancing the time of the enjoyment of George's share of his property. The contention that the gifts to the son were but a continuation of a policy of more than thirty years of making liberal gifts to him is also not proved. It is true that decedent had given George $30,000 as a wedding present in 1913, $10,000 some time between 1913 and 1930, and $40,000 when he went into business in 1930; but there is no evidence that the decedent had made any gifts to George after 1930 until the gifts now in issue were made. In our judgment the gifts to George in 1938381 and 1939 cannot be attributed to any long continued policy or practice. They, like the gifts to Ralph, appear rather to have been made as substitutes for and in lieu of testamentary disposition of his property. Petitioner attempted to picture decedent as being in good physical condition during the latter part of 1938 and the early part of 1939 when the gifts were made. Some of the evidence relied upon is that with reference to the Christmas party of the Knights Templar, the fact that he attended some of the meetings of the board of directors of the building and loan association, made some trips to the barber shop, was able to get about his home, and took a few automobile rides. An examination of all of the evidence in connection with these events militates against petitioner. Thus, the record shows that the breakfast was attended in a wheel chair and that the decedent was then suffering from the effect of the partial stroke as well as from the earlier automobile accident. On some of the occasions when he attended the directors' meetings he was brought there in an automobile furnished by the association. When he determined to make the gifts in December of 1938 he had George secure382 the stocks and bonds from his safety deposit box and bring them to him at the house. He then had George call his attorney on the phone and in response thereto the attorney called at decedent's home to discuss with him the details of the trust which he intended to create for Ralph. On at least some of the trips to the barber shop the decedent was assisted by his housekeeper and nurse. It is no doubt true that decedent was of a jovial disposition and did not discuss death at any length with those with whom he associated; but he must have known that the sands of life were fast running out, that his life expectancy was short and that it was highly desirable his house be put in order. He was almost 84 years of age when the gifts were made - his exact age at the time of death was 84 years, 3 months and 5 days - and was spending most of his time in a chair on the porch or at the front window of his home. The normal activities of a busy life had all but ceased. He was tax conscious, as is indicated by the fact that he deliberately divided the gifts between 1938 and 1939 in order to minimize his tax liability. It would be closing our eyes to the obvious to hold that thoughts of death did not383 enter into his mind and motivate the transfers. While age alone is not a decisive test, Flack v. Holtagel, supra, it may well tip the scales where other facts strongly point to testamentary disposition. The present record, in our judgment, supports respondent's determination that the gifts made by decedent in December, 1938, and January, 1939, were in contemplation of death as that term is defined in United States v. Wells, supra. We therefore respectfully decline to disturb it. In view of the conclusion which has been reached, it is unnecessary to discuss or decide the second question, i.e., whether the value of the property transferred in trust on December 20, 1938, should be included in the gross estate of decedent under the provisions of section 811 (d) of the Internal Revenue Code. Judgment will be entered for the respondent. 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. - To the extent of any interest therein of which the decedent has at any time made a transfer, by trust or otherwise, in contemplation of or intended to take effect in possession or enjoyment at or after his death, or of which he has at any time made a transfer, by trust or otherwise, under which he has retained for his life or for any period not ascertainable without reference to his death or for any period which does not in fact end before his death (1) the possession or enjoyment of, or the right to the income from, the property, or (2) the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom; except in case of a bona fide sale for an adequate and full consideration in money or money's worth. Any transfer of a material part of his property in the nature of a final disposition or distribution thereof, made by the decedent within two years prior to his death without such consideration, shall, unless shown to the contrary, be deemed to have been made in contemplation of death within the meaning of this subchapter:↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623482/	Raymond E. Sampson and Geneva Sampson v. Commissioner.Sampson v. CommissionerDocket No. 3874-69 SC.United States Tax CourtT.C. Memo 1970-212; 1970 Tax Ct. Memo LEXIS 147; 29 T.C.M. (CCH) 927; T.C.M. (RIA) 70212; July 27, 1970, Filed 147 Raymond E. Sampson, pro se, 12,132 U.S. Route 42, Cincinnati, Ohio. Rudolf L. Jansen, for the respondent. TANNENWALDMemorandum Findings of Fact and Opinion TANNENWALD, Judge: Respondent determined a deficiency of $152.70 in petitioners' income tax for 1967 for failure to substantiate the deduction of medical expenses and charitable contributions. Petitioners are husband and wife and had their legal residence in Cincinnati, Ohio, at the time of the filing of the petition herein. They filed a joint Federal income tax return for 1967 with the district director of internal revenue, Cincinnati, Ohio. That return claimed: (1) $186.00 as the total cost of medicines and drugs and a deduction therefor of $61.68, representing the excess of the claimed cost over one percent of petitioners' adjusted gross income, i.e., $124.32. (2) $423.04 as medical expenses for doctors, hospital service, and the like, and a deduction therefor of $111.76, representing the excess of the claimed expenses over three percent of adjusted gross income, i.e., $372.96. (3) $702.00 for charitable contributions, of which $52.00 was claimed as a biweekly contribution to the United Appeal and $650.00148 as cash contributions at the rate of $12.50 per week. At the trial, petitioners were unable to present any written evidence of payment of 928 the aforesaid amounts, with the exception of $173.04 in medical expenses represented by checks and which respondent conceded. Nor was petitioner Raymond E. Sampson, in response to questioning by the Court, able to name any persons to which such payments were made or to specify any individual amounts which went to make up the totals claimed beyond some $60 for vitamin pills and the alleged $2 biweekly payment to the United Appeal. Petitioners' entire case rests upon two grounds. First, they assert that, during the course of the audit of the return, a representative of respondent agreed to allow the claimed deduction. Even if we were satisfied that petitioners have proved the existence of such agreement (which we are not), it would not, in any event, be binding upon respondent. E. g., Botany Worsted Mills v. United States, 278 U.S. 282">278 U.S. 282 (1929); Cleveland Trust Co. v. United States, 421 F. 2d 475 (C.A. 6, 1970), affirming 266 F. Supp. 824">266 F. Supp. 824 (N.D. Ohio 1966); Country Gas Service, Inc. v. United States 405 F. 2d 147149 (C.A. 1, 1969); Earle C. Parks 33 T.C. 298">33 T.C. 298, 302 (1959); George H. Baker, 24 T.C. 1021">24 T.C. 1021, 1024 (1955). Second, petitioners make the claim that deductions for the same items in larger amounts were allowed by respondent in prior years. From this they conclude that we should accept such allowances as proof of reasonableness and therefore of expenditure thereof by petitioners for 1967. But this is simply another way of saying respondent should be bound by his actions with respect to prior years. The cases clearly reject any such rule of law. E.g., Walker, v. Commissioner, 362 F. 2d 140 (C.A. 7, 1966), affirming two Memorandum Opinions of this Court; Booth Newspapers, Inc., 17 T.C. 294">17 T.C. 294 (1951), affirmed per curiam, 201 F. 2d 55 (C.A. 6, 1952). Moreover, even if we assume that petitioners in fact expended the amounts claimed on returns for other years, 1 this would not constitute proof that expenditures were in fact made in the amounts set forth on the 1967 return. 150 The burden of proof was on petitioners. Rule 32, Tax Court Rules of Practice. Petitioner Raymond E. Sampson was the sole witness. After carefully evaluating his testimony, we remain unconvinced that petitioners expended any amounts for medical expenses and charitable contributions other than $173.04 for doctors, hospital service, and the like and possibly $60.00 for vitamins. 2 Neither of these amounts is sufficient to entitle petitioners to any deduction. Decision will be entered for the respondent. Footnotes1. Petitioner testified as to amounts claimed as deductions in years both prior and subsequent to 1967, but offered no proof (other than some employer withholding statements indicating deductions withheld for contributions to the United Appeal in post-1967 years) that the expenditures were actually made.↩2. We express no opinion as to whether vitamins purchased without a doctor's prescription constitute medical expenses. Cf. Marshall J. Hammons, a Memorandum Opinion of this Court dated Nov. 24, 1953; Rev. Rul. 55-261, 1 C.B. 307">1955-1 C.B. 307↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623484/	THE HOWARD HUGHES COMPANY, LLC, f.k.a. THE HOWARD HUGHES CORPORATION, AND SUBSIDIARIES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent; HOWARD HUGHES PROPERTIES, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentHoward Hughes Co., LLC v. Comm'rDocket Nos. 10539-11, 10565-11.United States Tax Court142 T.C. 355; 2014 U.S. Tax Ct. LEXIS 21; 142 T.C. No. 20; June 2, 2014, FiledDecisions will be entered for respondent.Ps are in the residential land development business and develop land in and adjacent to Las Vegas, Nevada. Ps sell land to builders and, in some cases, individuals, who construct and sell houses. Ps generally sell land through bulk sales, pad sales, finished lot sales, and custom lot sales. In bulk sales, Ps develop raw land into villages and sell an entire village to a builder. Ps do not otherwise develop the sold village. In pad sales, Ps develop villages into parcels and sell the parcels to builders. Ps do not develop within the sold parcels. In finished lot sales, Ps develop parcels into lots and sell whole parcels of finished lots to builders. In custom lot sales, Ps sell individual lots to individual purchasers or custom home builders, who then construct homes. In all instances, Ps do not construct residential dwelling units on the land they sell. During the years at issue, Ps reported income from purchase and sale agreements under the completed contract method of accounting. R alleges Ps' contracts are not home construction contracts within the meaning of I.R.C. sec. 460(e). R further contends the land sale contracts are not long-term construction contracts and are not eligible for the long-term percentage of completion method of accounting under I.R.C. sec. 460.Held: Ps' bulk sale and custom lot contracts are long-term construction contracts.Held, further, Ps' contracts are not home construction contracts within the meaning of I.R.C. sec. 460(e), and Ps may not report gain and loss from these contracts using the completed contract method of accounting.21 Stephen F. Gertzman, Kevin L. Kenworthy, Steven R. Dixon, Mary W.B. Prosser, and Sat Nam S. Khalsa, for petitioners.Ronald S. Collins, Jr., Bernard J. Audet, Jr., and John R. Gilbert, for respondent.WHERRY, Judge.WHERRY356 WHERRY, Judge: These cases, consolidated for trial, briefing, and opinion, are before the Court on petitions for redetermination of Federal income tax deficiencies. Respondent determined deficiencies for the 2007 and 2008 tax years of petitioner the Howard Hughes Co., LLC (THHC) (formerly the Howard Hughes Corp. & Subsidiaries (Old THHC)), and deficiencies for the 2007 and 2008 tax years for petitioner Howard Hughes Properties, Inc. (HHPI). The issue for consideration concerns the proper method of accounting for income from certain contracts. Respondent alleges that, with respect to most of petitioners' contracts, petitioners must use the percentage of completion method of accounting instead of the completed contract method of accounting. Petitioners, however, contend that because their contracts qualify as home construction contracts within the meaning of section 460(e)(6), they properly reported income on the completed contract method.1 Respondent further alleges that certain other contracts22 are not long-term contracts or construction contracts and that petitioners cannot account for the gain or loss from these contracts under section 460.FINDINGS OF FACTThe parties' stipulation of facts and supplemental stipulation of facts, both with accompanying exhibits, are incorporated herein by this reference. At the time petitioners filed the petitions, their principal place of business was Dallas, Texas. Their main business operations, however, are in Las Vegas, Nevada.Company BackgroundWhen Howard Hughes died in 1976, his portfolio of assets, owned by Summa Corp., included land which was then outside 357 the city of Las Vegas, Nevada. In the 1980s this land was selected for development. The land was called Summerlin, which was the maiden name of Mr. Hughes' paternal grandmother. Summerlin was divided into three geographic regions: Summerlin North, Summerlin South, and Summerlin West.In 1996 the Rouse Co. (Rouse), a publicly traded corporation based in Columbia, Maryland, acquired23 the assets of the Hughes estate, including Howard Hughes Properties LP (HHPLP), which owned Summerlin. Effective January 1, 1998, Rouse elected to be treated as a real estate investment trust (REIT) in 1998. As part of this conversion Rouse organized HHPI, which in turn purchased the undeveloped acreage in Summerlin North and South from HHPLP. In December 1997 HHPLP had distributed Summerlin West to Old THHC. In 2004 General Growth Properties, Inc. (GGP), a publicly traded REIT, acquired Rouse by merger. During the tax years at issue, GGP was the general partner in a limited partnership, which, through another limited partnership, the Rouse Co. LP, and a limited liability company, Rouse LLC, owned HHPI and the Hughes Corp., which in turn owned Old THHC.In 2009 GGP and its affiliated entities filed for bankruptcy under chapter 11 of the U.S. Bankruptcy Code. Effective December 31, 2009, Old THHC converted from a corporation to a Delaware limited liability company, which is petitioner THHC in these cases. As part of the plan of reorganization in 2010 GGP spun off the part of its business that owned Summerlin. A newly formed entity, the Howard Hughes Corp., an entity distinct from Old24 THHC, ended up owning, as second- and third-tier subsidiaries, HHPI and THHC. THHC owns Summerlin West, and HHPI owns Summerlin North and Summerlin South to the extent that these properties have not yet been sold to third parties.SummerlinDuring the years at issue petitioners were in the residential land development business. They generated revenue primarily by selling property to builders who would then construct and sell homes. In some cases, they also sold property to individual buyers who would then construct single-family 358 residential homes. The land petitioners sold and still sell is part of a large master-planned community known as Summerlin.Summerlin comprises approximately 22,500 acres on the western rim of the Las Vegas Valley, about nine miles west of downtown Las Vegas. As of the end of 2010 approximately 100,000 residents lived in 40,000 homes in Summerlin. At completion, petitioners expect Summerlin to house approximately 220,000 residents. While Summerlin is largely residential, it is a fully integrated community, which means it includes commercial, educational, and recreational facilities. It contains about 1.7 million square feet of developed retail space, 3.2 million25 square feet of developed office space, 3 hotels, and health and medical centers. It has 25 public and private schools, 5 higher learning institutions, 9 golf courses, parks, trails, and cultural facilities.Summerlin North and Summerlin West are, as a result of annexation, part of the city of Las Vegas, and Summerlin South is in Clark County, Nevada. The first residential land sales in Summerlin North took place around 1986, and by the years at issue HHPI had fully developed Summerlin North. The first land sales in Summerlin South took place in 1998, and the first land sales in Summerlin West took place in 2000. Each of these three geographical regions is further divided into villages, each of which averages about 500 acres. Villages are further divided into parcels, or neighborhoods, which contain the individual lots. These cases involve only petitioners' sales of land in Summerlin South and Summerlin West.Petitioners' sales generally fell into one of four categories: pad sales, finished lot sales, custom lot sales, and bulk sales.2 In a pad sale, petitioners, after dividing the village into parcels, constructed all of the infrastructure in the village up to a parcel boundary. Petitioners26 then sold the parcel to a buyer, who was usually a homebuilder. The builder, with petitioners' approval, was responsible for all of the infrastructure (such as streets and utilities) within the parcel and subdividing the parcel into lots. In a finished lot sale, petitioners also divided the village into parcels. They then further 359 constructed any additional needed parcel infrastructure, divided the parcels into lots, and sold the neighborhoods to a buyer, usually a homebuilder. In finished lot sales, petitioners constructed all of the infrastructure up to the lot line. In both the pad sales and the finished lot sales, petitioners contracted with homebuilders through building development agreements (BDAs). The BDAs were more than just simple sales contracts that, for consideration, pass title. We discuss the parties' responsibilities infra. In doing so, we do not purport to cover all of the details but simply address some important aspects of the BDAs.Custom lot sales were essentially the same as finished lot sales except that petitioners sold27 the individual lots. The buyers of these individual lots were individuals who were contractually bound to build a residential dwelling unit.3 The purchase sales contracts required the individuals to agree that they would occupy the home for at least one year or, if the home was sold before then to a third party, to pay additional consideration of 10% of the third-party price. Finally, in a bulk sale, petitioners sold an entire village to a purchaser. The purchaser was responsible for subdividing the village into parcels and lots and for constructing all of the infrastructure improvements within the village.Even though the builders were ultimately responsible for building and selling homes to the end user--the homebuyer--petitioners28 marketed to the homebuyers. Petitioners' marketing strategy embodied the idea of the master-planned community, and they viewed Summerlin as a brand that evokes thoughts of an attractive lifestyle and community. But petitioners did not bear the sole burden of the marketing cost. In fact, their agreements with the builders required the builders to pay into an advertising program promoting Summerlin. The builders paid, upon the close of escrow of a home sale, a fee equal to 1% of the purchase price.360 We discuss infra the general process THHC and HHPI undertake in their home development business. Much of the trial was devoted to the details of the process, and we by no means purport to address every step. Our intention is not to discount those important steps not addressed but to provide a general picture of how the development process worked.Developing Summerlin--EntitlementsPetitioners were parties to master development agreements with Las Vegas, Nevada, and Clark County, Nevada, that govern the planned development of Summerlin West and Summerlin South, respectively. These long-term, 30-year agreements assure petitioners that they will be able to develop the land in accordance with the29 agreements and remove any necessity to negotiate development agreements and entitlements village by village.Summerlin WestLas Vegas, pursuant to powers delegated by the State of Nevada by chapter 278 of the Nevada Revised Statutes, adopted in April 1992 the City General Plan, which is a master land use plan. HHPLP and Las Vegas signed a development agreement (LVDA) in February 1997. The LDVA was recorded in the Clark County, Nevada, Recorder's Office and was approved by the Las Vegas City Council. Along with approvals and plans referenced within the agreement, the LVDA governed land development in Summerlin West. Las Vegas also amended its City General Plan to incorporate the Summerlin West General Development Plan, which conceptualized future development of Summerlin West, and rezoned Summerlin West from a rural district to a planned community district.The Summerlin West Development Standards, attached to the LVDA, set minimum requirements for development, including "residential densities; building height and setbacks; signage; landscaping; parking and open space requirements; as well as procedures for site plan review and for modifying the Planned Community Program." The LVDA states that development of Summerlin West will30 occur in phases called villages. The owner has to prepare and submit for city approval a Village Development Plan for each village. A village 361 traffic study and a village drainage study also had to accompany the village development plan.Initially, the LVDA permitted 20,250 residential units, 5.85 million square feet of office, retail, or industrial space uses on 508 acres of land, golf courses featuring up to 90 holes of golf, and related facilities. Other uses described in the Summerlin West General Development Plan were also contemplated. The LVDA required HHPLP to maintain medians but allowed HHPLP to assign that responsibility to homeowners associations. HHPLP granted the city the right to construct traffic signals, turn lanes, and similar improvements as necessary. The LVDA also required HHPLP to donate land to the city and construct a fire station on that land and to donate up to five acres of land to the city for a satellite government center. In addition, HHPLP was to donate land to the city for a public park with sports and recreational facilities and assume the cost of constructing a sewer interceptor. With respect to traffic and transportation, the LVDA required HHPLP to31 provide, or at least provide adequate assurance that it would provide, standard improvements in connection with each village. Standard improvements were "mitigation measures and improvements required for intersections and roadways immediately adjacent to the Planned Community." HHPLP also agreed to dedicate land needed for the right of way to the city for a major arterial road, the Summerlin Parkway extension.In November 2003 Old THHC, as the successor in interest to HHPLP, and the city amended the LVDA to require Old THHC to allocate a certain minimum amount of recreational space per 1,000 residents, construct a neighborhood pool, and design and construct a police substation with a helicopter landing pad. The amended LVDA also increased the allowed number of residential units from 20,250 to 30,000. Petitioner THHC was and is, as successor in interest to Old THHC, subject to the LVDA as amended.Summerlin SouthClark County, Nevada, pursuant to the powers delegated by the State of Nevada, adopted the Clark County Master Plan in 1983. It and HHPLP also signed and recorded a development agreement (CCDA) in February 1996 to govern the development of Summerlin South. Before the CCDA, 362 Clark32 County had amended its County Master Plan to include the Land Use and Development Guide for Summerlin's Southern Comprehensive Planned Community (Land Use and Development Guide). Clark County also rezoned Summerlin South from a rural district to a planned community district.The CCDA provided that Summerlin South would be developed in accordance with the Summerlin Master Plans, which consisted of the Land Use and Development Guide, a Summerlin Master Parks and Public Facilities Plan, a Summerlin Master Transportation Plan, and a Summerlin Master Drainage Plan. As with the LVDA, the CCDA envisioned development by phases called villages, and HHPLP agreed to submit a Village Development Plan before beginning development of a village. HHPLP also agreed to submit with the Village Development Plan a traffic study, a drainage study, and a parks and public facilities plan.Under the CCDA, Summerlin South could contain up to 18,000 residential dwelling units, 740 acres for nonresidential private uses, 90 holes of golf and related facilities, 3 hotels/casinos, and other land uses and facilities. The CCDA obligated HHPLP to construct a fire station, donate up to 5 acres of land for a satellite33 government center, which may include the fire station, and dedicate up to 20 acres of land for a community sports park. The CCDA also obligated HHPLP to submit the Master Parks and Public Facilities Plan, which was to generally identify the location and development timing of parks, trails, and public spaces systems. HHPLP also was to submit a Master Transportation Study, provide the necessary improvements to mitigate the development's traffic impact, provide village access roads for each village, and bear all public and private expenses, such as roadway construction, lighting, drainage, signage, and landscaping expenses related to Summerlin South's internal roadway network. The CCDA further required HHPLP to prepare a technical drainage study and construct flood facilities which were to be integrated where possible with the trails and parks systems.The parties, Clark County and HHPI, as successor in interest to HHPLP, have amended the CCDA three times, most recently in July 2005. The most recent amendment increased the number of permissible residential dwelling 363 units to 32,600. In return, HHPI agreed, inter alia, at its expense to purchase and provide a 100-foot aerial fire truck with34 operating equipment; design, construct, and convey a second fire station; and convey 2.5 acres of land to the county for a third fire station. In addition, HHPI agreed to convey 25 acres or more of land to the county for recreational purposes or 30 acres or more for a sports park to be designed and constructed by HHPI, and a community center and outdoor aquatic center to be designed and constructed by HHPI.Developing Summerlin--Covenant, Conditions, and RestrictionsPetitioners and their predecessors in interest recorded Master Declarations, which govern use of the land by subsequent owners. These declarations, also known as covenants, conditions, and restrictions (CC&Rs), not only imposed use restrictions and protective covenants, but also created homeowners associations. The Master Declarations served as the governing documents for the homeowners associations. The declarations applied to an initial set of properties within Summerlin, but allowed petitioners to annex property, thereby expanding the community subject to the declarations.The Master Declarations provided for the establishment of village subassociations through new declarations. The subassociation declarations supplemented35 the Master Declarations. These subassociations were responsible for owning and maintaining certain common elements and/or exclusive amenities associated with a neighborhood and for enforcing their own covenants, conditions, and restrictions. A neighborhood, which could include a gated community, consists of properties which share exclusive amenities or common areas.The Summerlin South Master Declaration established the Summerlin South Design Review Committee. This committee had to approve "construction, alteration, grading, additions, excavation, modification, decoration, redecoration or reconstruction of an Improvement or removal of any tree in any Phase of Development". The Summerlin West Master Declaration established a similar review process. In both cases, petitioners retained control over the review process until such time as they no longer owned an interest in the 364 respective Summerlin West and Summerlin South geographic regions.Developing Summerlin--VillagesPetitioners developed Summerlin in village phases starting with the villages adjacent to existing development to take advantage of the infrastructure. Subsequent villages could likewise take advantage of the additional infrastructure36 created by the adjacent villages.Generally, the first step in petitioners' development activities was to survey the property and create and file a parcel map. The parcel map broke off a village-size piece for development and sale by petitioners. Petitioners also had to grant easements for utilities and drainage and dedicate public streets. The parcel map reflected these easements and dedications.Often, Clark County or Las Vegas imposed obligations on petitioners with respect to street grading, surfacing, and alignment and provisions for drainage, water quality and supply, sewerage, and particular lot designs. Before developing the land, petitioners prepared and filed a tentative map. Along with this map, petitioners conducted technical studies, such as traffic and drainage studies, and established a village development plan, which is required by the LVDA and the CCDA and established the specific zoning, uses, and entitlements within the villages. Normally, the governing agency required petitioners to design and construct the improvements on the tentative map as a condition of approval of the map. But in certain cases, petitioners requested waivers. For instance, if a road was not immediately37 necessary, petitioners could request a waiver delaying construction until it was necessary. In addition, the tentative maps did not show all of the improvements that petitioners would construct on the parcels. For instance, they did not show landscaping, wall, and dry utility improvements.Petitioners also prepared improvement plans for the improvements shown on the tentative maps. It took about nine months to one year to prepare these plans and for the governing agency to review and approve them.Once the various governmental bodies approved the tentative map, petitioners were required to also submit a final 365 subdivision map. In the case of pad sales, the builders also had to prepare and submit tentative and final maps to further subdivide the pad land into lots. The pad purchase contracts governing pad sales also required the builders to first submit these maps to petitioners for approval.The final map showed roads and easements that petitioners intended to dedicate to the public. These easements included those for wet utilities, such as sewer and water, and dry utilities, such as electric, telecommunications, and gas. Absent a Special Improvement District (SID), the approving governmental38 body could require petitioners to enter agreements whereby petitioners posted bonds to ensure completion of the agreed upon improvements. These improvements may have included streets, alleys, curbs, gutters, sidewalks, medians, streetlights, traffic signals, sewer systems, drainage facilities, open space improvements, trails, parks, and landscaping. Petitioners obtained and posted bonds based on the unit rate times required material as determined by the agency that requires the bond. The agency commented on and required modifications to or approved the bond, and it exonerated petitioners only when the improvements were fully constructed and inspected and the agency took ownership.Petitioners also used tax-exempt SIDs financing to finance construction of some Summerlin infrastructure improvements. In a project financed by SID bonds, petitioners did not have to post performance bonds. These SID bonds financed public improvements such as street, water, sewer, and storm drainage improvements. Petitioners were entitled to reimbursement from the money raised from the sale of the SID bonds when they incurred the relevant construction costs, subject to the approval of the relevant municipal39 authority. Special assessments on the property within the SID covered the scheduled bond payments. SID financing was not available to cover dry utilities, landscaping, and walls. Summerlin West and Summerlin South contain seven SIDs. The total amount of the SID bonds was $183,685,000.366 Villages at IssueRespondent's determinations concern income from 107 BDAs440 for the sale of land in 9 of petitioners' villages. Those villages are: Village 13 (Summerlin Centre), Village 14B (The Gardens), Village 15B (Siena), Village 16 (The Mesa), Village 18 (The Ridges), Village 19 (Summerlin Centre West), Village 20 (The Vistas), Village 23A/B (The Paseos), and Village 26 (Reverence). All of the villages except Villages 15B, 19, and 26 contained land sold in pad sales.5 Finished lot sales occurred in Villages 16, 18, 19, 20, and 23.Also at issue are 279 custom lot contract sales. All custom lot contracts involved the sale of lots in Village 18. Of the custom lot contracts, 94% were entered into and closed in the same tax year. The remaining custom lot contracts closed in the tax year following the one in which they were entered into.The parties have agreed that Villages 16, 18, 20, and 23 are generally representative of the villages at issue. The parties have also agreed on a BDA that is representative of finished lot sales (Ladera BDA), a BDA that is representative of pad sales (Lyon BDA), and two custom lot contracts, Redhawk and Arrowhead, that are generally representative of the custom lot contracts at issue.In addition to the pad sales, the finished lot sales,41 and the custom lot contracts, petitioners also sold villages 15B and 26 in bulk sales essentially equivalent to very large pad sales. Within the boundaries of the property sold in a bulk sale, petitioners do nothing. Rather, the purchaser is responsible for all development. With respect to Village 26, known as Reverence, the first half of the sale to Pulte Homes, Inc., now 367 known as Pulte Group, Inc., occurred in December 2006, just before the 2007 housing market collapse, and neither petitioners nor the purchaser have done any work on this property. In fact, the sale of Village 26 was to occur in two parts, but the purchaser defaulted on the second half of the contract. With bulk sales, petitioners still incurred regional costs that benefit the two villages, such as costs for water lines, regional drainage, and road extensions.Common Improvements GenerallyThe BDAs, loan agreements, governmental laws, and other legal obligations required petitioners to build common improvements in Summerlin. These improvements included rough grading, roadways, sidewalks, utility infrastructure such as water, sewer, gas, electricity, and telephone, storm water drainage, parks, trails, landscaping, entry42 features, signs, and perimeter walls. Upon completion of a common improvement, petitioners transferred ownership or granted easements to the respective community association or, where appropriate, the municipality. Generally, community associations received some roads, swimming pools, open spaces, and medians, whereas the municipalities received police stations, fire stations, other roads, traffic signals, and street lights.Some of these improvements were necessary for construction of the dwelling units. The allocable costs attributable to petitioners' improvement construction activities exceeded 10% of the various total contract prices. Petitioners designed all of the common improvements in an effort to make Summerlin an attractive community. In addition, petitioners monitored and maintained approval control over all construction in Summerlin, including construction of the dwelling units.Representative ContractsFinished Lot Sale--Ladera BDAWith respect to the BDAs, the parties stipulated that these contracts are construction contracts within the meaning of section 460(e)(4). The Ladera BDA is a purchase and sale agreement between HHPI and KB Home Nevada, Inc. (KB Home), for finished lots in Village43 16 in a neighborhood called Ladera. The Ladera BDA called for the land sale to be 368 completed in three phases. Village 16, known as The Mesa, consisted of a mix of residential uses including single family and multifamily units. The style of The Mesa drew its inspiration from the mountains in the backdrop, and petitioners required builders to use natural building materials, such as stone, and to include at least two outdoor living spaces per residence.In addition to the purchase price, the Ladera BDA entitled HHPI to certain participation payments as well as payments tied to power company refunds. HHPI received a lot premium participation payment equal to 50% of the lot premium less a credit calculated by reference to any commission paid to an unrelated broker. HHPI also received a payment equal to the greater of 3% of the net sale price or HHPI's percentage share, 38% of the net sale price less the finished lot costs.6 The power company refund payments stemmed from the fact that HHPI paid the Nevada Power Co. to construct electric feeder lines. As homeowners subscribed to electrical service, the power company refunded all or part of the costs. HHPI assigned the rights to the refunds to44 KB Home but then required KB Home to make three lump-sum payments equal to the estimated amount of the refund.The Ladera BDA required HHPI to develop the parcel into finished lots. HHPI constructed all of the infrastructure up to the individual lot lines. Thus, wet and dry utilities were "stubbed" to the lot boundaries. HHPI was also responsible for the streets and street improvements such as traffic signals, the driveway depressions, the perimeter and retaining walls, entry monumentation, and landscaping. HHPI also graded the parcel, including the lots. And HHPI agreed to construct a community park with a swimming pool, for which KB Home paid HHPI a community park fee of $2,000 per residence.Improvement plans governed the work HHPI had to perform as part of the contract. HHPI, through the engineering firm G.C. Wallace, Inc. (GCW), created their plans, one for each phase, for approval by Clark County, the public utilities, and other agencies. The plans governed the curbs,45 gutters, 369 and other paving improvements, street signs, streetlights, driveway depressions, and wet utilities, such as sewer mains, manholes, water mains, fire hydrants, and water and sewer service stubbed to each lot. Another set of plans prepared by the utility companies governed the dry utilities, such as telephone and gas. In addition, HHPI was responsible for any improvement necessary for the issuance of a building permit or certificate of occupancy and for landscaping, design, and construction of perimeter and screen walls, entry monumentation, and community open space.On the purchaser's side, the Ladera BDA obligated KB Home to build dwelling units subject to a development declaration and a development plan. The BDA also annexed the property to the Summerlin South Community Association, making KB Home also subject to the CC&Rs of that association. The development declaration, entered at the time of closing of phase 1, contained a number of additional restrictions on KB Home. The declaration allowed KB Home to construct only single-family homes in accordance with a development plan. The declaration preserved HHPI's control over design of homes and landscaping by requiring that46 they conform to HHPI's residential design criteria for The Mesa Village and to the landscape standards. The design criteria governed everything from lot grading to home finishes.The declaration required KB Home to create a development plan. The development plan had to describe landscaping improvements as well as building improvements. With respect to the plans for the homes, the declaration required KB Home to create a concept plan, with floor plans and sketches of the home exteriors visible from the street, preliminary and final plot plans, which showed the location of the home and other improvements on the lot, an architectural materials sample board, which included samples of the building materials to be used, and a marketing signage plan, which contained details on all signage.The development plan was subject to the approval of HHPI. If HHPI or a governmental agency disproved or rejected an item as not being in conformity with the development plan, KB Home was obligated to correct the defect at its own cost. In addition to requiring KB Home to construct single-family homes in a certain manner, the Ladera BDA also required KB Home to construct sidewalks, driveways, 370 model homes,47 interior screen walls, curb scribes, and water meters.Pad Sale--Lyon BDAThe second purchase and sale agreement is an example of a pad sale. This agreement was between Old THHC and William Lyon Homes, Inc. (Lyon), for the sale of Parcel M in Village 20. As part of this agreement, THHC transferred fee simple title to Lyon subject to a number of encumbrances, including the Summerlin West Master Declaration, a supplemental declaration of annexation, a development declaration, and the Summerlin West Development Agreement. The agreement limited Lyon to constructing single-family homes.The agreement also placed substantial restrictions on Lyon's use of the property. The supplemental declaration of annexation subjected Parcel M to the CC&Rs in the Summerlin West Master Declaration and imposed its own restrictions, such as those governing satellite dishes and signs. Similarly, the development declaration required Lyon to submit a development plan for THHC's approval before it could begin any construction. The development declaration also required improvements to conform to an architectural concept plan, a preliminary plot plan, an architectural materials sample board, a final plot plan, a marketing48 signage plan, and the Summerlin Design Standards. If any item did not conform to the development plan or was otherwise defective, Lyon had to, at its own cost, correct the problem.The agreement also required Lyon to build entry monumentation and landscaping, a minipark, and pedestrian access ways. The parties agreed to share costs of boundary walls between the property and adjacent parcels if the parties thought such walls were desirable.THHC, as part of the agreement, agreed to perform all other obligations, except those inuring solely and specifically to the subject property or specifically under the LVDA necessary for the purchaser's project. THHC also agreed to construct the roads bordering the parcel, Vista Run Drive and Trail View Lane, and associated roads, curbs, gutters, and street lighting. The agreement further required petitioners to construct a perimeter boundary wall along the roads bordering the property and to stub the wet and dry utilities to the parcel.371 Custom Lot ContractsThe parties provided two custom lot contracts for the sale of property in Village 18 to individual purchasers through custom lot contracts. Each custom lot contract involved the sale of a lot(s)49 in one of seven neighborhoods in Village 18, known as The Ridges. The two representative contracts were for the sale of a lot in the Arrowhead neighborhood and for the sale of a lot in the Redhawk neighborhood. These contracts are representative of the other custom lot contracts at issue in these cases.Each contract sold a lot described in final maps recorded with the Office of the County Recorder of Clark County, Nevada. The contracts required the purchaser to build a single-family home on the lot. In addition, the contracts stated that HHPI must construct or have constructed certain improvements and the individual lot purchaser is to be solely responsible for other lot improvements. For instance, section 7 of the Arrowhead contract stated in part:HHP's Improvements. HHP has installed roads providing access to the Lot, together with underground improvements for sanitary sewer, potable water, telephone, natural gas and electric power. All such utility improvements have been stubbed out to the Lot. It shall be Purchaser's responsibility to activate water service * * prior to commencing construction on the Lot. Purchaser is responsible for all utility connections from the property line to Purchaser's50 Home and for making all necessary arrangements with each of the public utilities for service. Purchaser acknowledges that HHP is not improving the Lot and has not agreed to improve the Lot for Purchaser except as provided in this Section 7. Purchaser will be responsible for finish grading and preparation of the building pad and acknowledges that HHP has not agreed to provide any grading of the Lot beyond its present condition.Section 7 of the Redhawk contract was substantially similar, but it implied that HHPI's work was not yet completed at the time of the purchase and sale agreement.As part of the custom lot contract, HHPI explicitly stated that it "made no representations or warranties concerning zoning * * or the future development of phases of Arrowhead, The Ridges or the surrounding area or nearby property". A similar provision was in the Redhawk contract. The contracts also contained integration clauses. Paragraph 23 of the representative contracts stated:372 This Agreement constitutes the entire agreement and understanding between Purchaser and HHP with respect to the purchase of the Lot and may not be amended, changed, modified or supplemented except by an instrument in writing signed by both51 parties. This Agreement supersedes and revokes all prior written and oral understandings between Purchaser and HHP with respect to the Lot.But the purchasers also initialed a page of the custom lot contracts that states: "ALL OF THE DOCUMENTS LISTED BELOW ARE IMPORTANT TO THE PURCHASE OF THE LOT, SHOULD BE READ BY THE PURCHASER AND, AT THE CLOSE OF ESCROW, SHALL BE DEEMED TO HAVE BEEN READ AND APPROVED BY PURCHASER. * * * PURCHASER HEREBY ACKNOWLEDGES RECEIPT OF COPIES" of those listed documents. Among the documents that purchasers acknowledged receipt of and were deemed to have read are CC&Rs, articles of incorporation, and bylaws of the Summerlin South Community Association, copies of the recorded subdivision map for the neighborhood in which the lot was located, the neighborhood design criteria, and a public offering statement.752 The purchasers and the purchased lots were subject to the various CC&Rs that govern Summerlin South, Village 18, and the subassociation within Village 18, and they were contractually required to conform their lot to the relevant architectural declaration. The architectural declaration required that all construction on the lot be approved by HHPI. If HHPI delegated the approval power to a review committee for The Ridges, then that committee must approve the declaration. In addition, the CC&Rs for the Village 18 association granted access to homeowners to their lots by way of one of two circular roadways accessible by two guard houses and private gates, all of which were to be designed and constructed by HHPI, including associated landscaping. These improvements became common elements owned by the community association as did other elements such as entry 373 features, recreational facilities, landscaped medians, and cul-de-sacs.The recorded subdivision maps identified the common areas, including private roads such as Drifting Shadow Way and Sun Glow Lane, which were granted to the relevant community association. These maps also showed53 the location of storm drain easements and flood control and drainage channel right-of-ways. The neighborhood design criteria contained maps showing the walls and fences HHPI had to construct. The design criteria also contained a map that showed a community and fitness center, which the parties stipulated was available to residents of Village 18. The public offering statements not only stated that the private roads, guard houses, and landscaping improvements are to be owned by the community association, but they also recited that HHPI was responsible for utility connections to the lots and landscaping improvements in common lots.Tax ReportingFor the years at issue, petitioners used the completed contract method of accounting in computing gain or loss from their contracts for sale of residential real property in Summerlin West and South intended for residential buildings planned to contain four or fewer residential units per building.854 Petitioners reported gain from BDAs, custom lot contracts, and the bulk sale agreements, when they incurred 95% of the estimated costs allocable to each BDA, custom lot contract, or bulk sale agreement.Petitioners broke down estimated BDA costs into three categories: direct village costs, regional costs, and finished lot costs. Direct village costs consisted of the cost for the common improvements that benefit only the village that was the subject matter of the contract. These costs included the following cost categories: planning; engineering; inspection, testing, and processing; rough grading; water/sewer storm drain; street improvements; dry utilities; walls/fencing; landscaping; parks; deposits; other; and contingency. Regional 374 costs consisted of common improvements that benefited more than one village and included the following cost categories: regional water, regional sewer, regional drainage, regional roads, regional traffic signals, regional entry features, regional annual costs, regional other costs, and townwide arterial costs. Finished lot costs were the costs that benefit only the neighborhood or parcel in which the finished lots were located.Petitioners used the engineering firm GCW to calculate55 most cost estimates. For the actual construction cost categories, the "hard costs", GCW used a market price unit rate for each improvement, which was based on its experience with past bids as well as prevailing bond rates. The unit rate generally reflected labor and materials cost for the relevant improvement. The unit rate was applied differently to different improvements. For instance, GCW applied the unit rate based on length for improvements such as curbs, sewer lines, and sidewalks, on area for improvements such as paving and some landscaping, and on number of units of a designated improvements such as street lights and fire hydrants. "Soft costs", or costs other than the actual construction costs such as engineering, inspection, testing, and processing, were calculated as a percentage of the hard costs.For regional water costs, GCW allocated the costs to villages according to the percentage of village acreage in the relevant water zone. GCW assigned costs to each water zone for water mains, pump stations, reservoirs, and inlet and outlet pipes in the water zone. For regional sewer costs, GCW allocated the cost among villages in proportion to their acreage. These costs included56 costs for the sewer systems, including pipes and mains, paving, manholes, flowmeters, and traffic controls. Drainage, regional roads, regional entry features, regional annual, regional other, and townwide arterial costs were all also allocated in proportion to village acreage. Traffic signal costs, however, were allocated to the village(s) adjacent to the street corners (for example, one-fourth to each corner at a four-way intersection) of the relevant signal and then prorated by acreage.For the finished lot costs, petitioners and GCW used a formula based on historical actual costs. This formula yielded 375 an estimated incremental cost of improvements of $40,000 per lot.DeficienciesFor the tax years at issue, petitioners reported income from the sale of land within Summerlin using the completed contract method of accounting. Under petitioners' methods of accounting, each BDA, custom lot contract, and bulk sale agreement was a home construction contract, and they were not completed within the meaning of section 460 until petitioners incurred 95% of the direct and indirect costs allocable to the agreement or contract.Respondent issued notices of deficiency to both petitioners. As part of his determinations,57 respondent changed petitioners' methods of accounting from the completed contract method of accounting to the percentage of completion method of accounting. Respondent adjusted petitioners' income as followsPetitioner20072008TotalTHHC$209,875,725$19,399,420$229,275,145HHPI156,303,16837,192,046193,495,214The total additional cumulative taxable revenue THHC would have recognized through its 2008 tax year under the percentage of completion method of accounting is $239,897,451. The difference between this number and the total $229,275,145 adjustment in the notice of deficiency is due to adjustments for (1) gain recognized in the 2003 tax year pursuant to a prior audit, (2) overreported gain for nonexempt development activities, and (3) underreported gain for nonexempt development activities.The total additional cumulative taxable revenue HHPI would have recognized through the 2008 tax year under the percentage of completion method of accounting is $231,791,739. The difference between this number and the total $193,495,214 adjustment in the notice of deficiency is due to (1) gain recognized in the 2003 tax year pursuant to a prior audit, (2) overreported gain for nonexempt development activities,58 and (3) overreported gain for exempt development activities.376 Respondent's adjustments resulted in his determination of the following deficiencies:Petitioner20072008THHC$73,456,504$6,789,797HHPI50,633,55413,228,620Petitioners timely petitioned this Court for redetermination, and a trial was held in Las Vegas, Nevada.OPINIONI. Burden of ProofGenerally, the Commissioner's determination of a taxpayer's liability for an income tax deficiency is presumed correct, and the taxpayer bears the burden of proving that the determination is improper. SeeRule 142(a); Welch v. Helvering, 290 U.S. 111">290 U.S. 111, 115, 54 S. Ct. 8">54 S. Ct. 8, 78 L. Ed. 212">78 L. Ed. 212, 2 C.B. 112">1933-2 C.B. 112 (1933). If a taxpayer's method of accounting does not clearly reflect income, section 446(b) allows the Commissioner to change the taxpayer's method of accounting to one that does clearly reflect income. The Commissioner is granted broad discretion in determining whether an accounting method clearly reflects income, and that determination is entitled to more than the usual presumption of correctness. Commissioner v. Hansen, 360 U.S. 446">360 U.S. 446, 467, 79 S. Ct. 1270">79 S. Ct. 1270, 3 L. Ed. 2d 1360">3 L. Ed. 2d 1360, 2 C.B. 460">1959-2 C.B. 460 (1959); RECO Indus., Inc. v. Commissioner, 83 T.C. 912">83 T.C. 912, 920 (1984). The question of whether a particular accounting method clearly reflects income is a question of fact. Sam W. Emerson Co. v. Commissioner, 37 T.C. 1063">37 T.C. 1063, 1067 (1962).To prevail, the taxpayer must establish that the Commissioner abused his discretion in changing the method of accounting. Prabel v. Commissioner, 91 T.C. 1101">91 T.C. 1101, 1112 (1988), aff'd, 882 F.2d 820">882 F.2d 820 (3d Cir. 1989). But the Commissioner may not59 change a taxpayer's method of accounting from an incorrect method to another incorrect method. Id. Nor may the Commissioner change a taxpayer's method of accounting "[w]here a taxpayer's method of accounting is clearly an acceptable method" and clearly reflects income. Id.377 II. Custom Lot Contracts and Bulk Sale Agreements as Long-Term ContractsFirst, we must determine whether petitioners' contracts are long-term contracts. The parties stipulated that the BDAs are long-term construction contracts. The notices of deficiency determined deficiencies as if all of petitioners' contracts were long-term contracts. On brief respondent has departed from that determination and contends that the custom lot contracts and the bulk sale agreements are not long-term contracts. Generally, the Court will not allow a party to raise an issue on brief if consideration of that issue would surprise and prejudice the opposing party. Chapman Glen Ltd. v. Commissioner, 140 T.C. 294">140 T.C. 294, 349 (2013). Because we do not think that petitioners need additional evidence to respond to the new issue and respondent has not carried the issue, we address it below. See id. (looking to "the degree to which the opposing party is surprised by the new issue and the opposing party's need for additional60 evidence to respond to the new issue" to determine prejudice). As to new issues, respondent bears the burden of proof. SeeRule 142(a)(1).A. Custom Lot ContractsRespondent alleges that none of petitioners' custom lot contracts qualify even for accounting under the percentage of completion method because they are not long-term contracts. Initially, respondent contends that many of the contracts were entered into and closed within the same tax year and they therefore cannot be considered long term within the meaning of section 460. Second, respondent contends that because petitioners did not have a legal obligation to perform the construction activities contemplated by the contracts, the contracts are not construction contracts. Petitioners, on the other hand, first assert that the contracts are complete, for the purposes of section 460, when they incur at least 95% of the total allocable contract costs attributable to the contract's subject matter. They also contend that their contracts are construction contracts that impose legal obligations upon them.A long-term contract is "any contract for the manufacture, building, installation, or construction of property if such contract is not completed within the taxable year61 in which such 378 contract is entered into." Sec. 460(f)(1). The relevant regulation provides that the date a contract is completed is the earlier of(A) Use of the subject matter of the contract by the customer for its intended purpose (other than for testing) and at least 95 percent of the total allocable contract costs attributable to the subject matter have been incurred by the taxpayer; or(B) Final completion and acceptance of the subject matter of the contract.Sec. 1.460-1(c)(3)(i), Income Tax Regs. But taxpayers determine the contract completion date "without regard to whether one or more secondary items have been used or finally completed and accepted." Sec. 1.460-1(c)(3)(ii), Income Tax Regs. In addition, the regulation directs taxpayers to "consider all relevant facts and circumstances" in determining whether final completion and acceptance has occurred. Sec. 1.460-1(c)(3)(iv), Income Tax Regs.If the subject matter of the custom lot contracts is solely the sale of the piece of land, then petitioners' custom lot contracts would be complete upon close of escrow. The custom lot contracts do indeed provide for the sale of a piece of land, but they also reference numerous other documents, including CC&Rs, development plans, and subdivision maps. Under Nevada law, "'[w]ritings which are made a part of the contract by annexation62 or reference will be so construed; but where the reference to another writing is made for a particular and specified purpose, such other writing becomes a part for such specified purpose only.'" Lincoln Welding Works, Inc. v. Ramirez, 98 Nev. 342">98 Nev. 342, 647 P.2d 381">647 P.2d 381, 383 (Nev. 1982) (quoting Orleans M. Co. v. Le Champ M. Co., 52 Nev. 92">52 Nev. 92, 284 P. 307">284 P. 307 (Nev. 1930)). However, if the reference "indicates an intention to incorporate * * [the documents] generally, such reference becomes a part of the contract for all purposes." Id.The custom lot contracts contain a page whereon the purchaser(s) acknowledge receipt of copies of numerous documents, which are listed on the page.9 We believe that this 379 sentence incorporates the documents listed, and, because there is no indication that the reference is for a specific purpose, we incorporate these documents generally.After reviewing the custom lot contracts, the documents referenced therein, and the testimony regarding Summerlin as a master-planned community marketed as such by petitioners, we are convinced that the subject matter of the contracts encompasses63 more than just the sale of the lot. The costs incurred for a custom lot contract are not really different from the costs for the finished lot sales. At the time of trial, petitioners still had to complete a water service line, traffic signals, landscaping, and construction of a park. Therefore, we agree that final completion and acceptance does not necessarily occur at the close of escrow, but rather occurs when final completion and acceptance of the subject matter of the contracts, which includes improvements whose costs are allocable to the custom lot contracts, occurs. Cf. Shea Homes, Inc. & Subs. v. Commissioner, 142 T.C. 60">142 T.C. 60, 104 ( 2014). Consequently, petitioners are entitled to account for the gain or loss from these contracts on the appropriate long-term method of accounting under section 460 to the extent the contracts are not completed within the taxable year in which they are entered into.In so holding, we reject respondent's contention that the contracts impose upon petitioners no separate legal obligation to complete the required improvements. The regulations provide that a contract is a long-term contract under section 460 "if the manufacture, building, installation, or construction of property is necessary for the taxpayer's contractual64 obligations to be fulfilled and if the manufacture, building, installation, or construction of that property has not been completed when the parties enter into the contract" and the contract is not completed within the contracting year. Sec. 1.460-1(b)(1), (2)(i), Income Tax Regs.; see also Foothill Ranch Co. P'ship v. Commissioner, 110 T.C. 94">110 T.C. 94, 98-99 (1998).For contracts that provide for the provision of land, the regulations also contain a de minimis rule, under which if the allocable costs attributable to construction activities do not exceed 10% of the total contract price, the contract is not a construction contract under section 460. Sec. 1.460-1(b)(2)(ii), Income Tax Regs.380 To calculate the allocable costs, the regulation allows a taxpayer to "include a proportionate share of the estimated cost of any common improvement that benefits the subject matter of the contract if the taxpayer is contractually obligated, or required by law, to construct the common improvement." Id. Petitioners' allocable costs attributable to construction activities exceed the 10% threshold. Respondent appears to read this regulation as requiring a taxpayer to have a legal obligation independent of any other preexisting duty.While we agree with respondent that work completed by petitioners at the time the contracts are entered into cannot transform a contract65 into a construction contract under section 460, we disagree that the statute and the regulations necessarily require that all construction activity obligations be solely enforceable because of the contract. Respondent believes that section 1.460-1(b)(2)(i), Income Tax Regs., codifies the common law preexisting duty doctrine. Therefore, he says that because petitioners are already obligated by statute to complete various improvements, the obligations are not contractual obligations.The preexisting duty rule states that "a promise to do that which the promisor is already legally obligated to do is unenforceable." Johnson v. Seacor Marine Corp., 404 F.3d 871">404 F.3d 871, 875 (5th Cir. 2005). Nevada follows the preexisting duty rule. Cnty. of Clark v. Bonanza No. 1, 96 Nev. 643">96 Nev. 643, 615 P.2d 939">615 P.2d 939, 944 (Nev. 1980). The Nevada Common-Interest Ownership Act requires sellers, such as petitioners, to complete all improvements depicted on any site plan or similar documents except those labeled "NEED NOT BE BUILT", Nev. Rev. Stat. sec. 116.4119(1) (1991), and provides purchasers with a cause of action, id. sec. 116.4117 (1997).10It is not clear that the preexisting duty rule applies in these cases. The contracts between petitioners and the purchasers are valid66 contracts with valid consideration independent of the duties with respect to the development. Second, while the Nevada statute does indeed seem to grant 381 purchasers a cause of action if petitioners fail to construct improvements as shown on site plans or plats, the statute explicitly provides: "The civil remedy provided by this section is in addition to, and not exclusive of, any other available remedy or penalty." Id. sec. 116.4117(5). Therefore, it is uncertain whether a Nevada court would apply the preexisting duty rule to petitioners' contracts. See Johnson, 404 F.3d at 875 ("[A]s long as the contracting parties gain some legally enforceable right as a result of the contract which they previously did not have, consideration is present[.]"). The public policy concerns that underpin the pre-existing duty rule do not seem to be present here.11In addition, we do not agree with respondent that section 1.460-1(b)(2), Income Tax Regs., codifies the preexisting duty rule. The regulation67 clearly states that "how the parties characterize their agreement (e.g., as a contract for the sale of property) is not relevant" in determining the existence of a section 460 construction contract. Sec. 1.460-1(b)(2)(i), Income Tax Regs.; see also Koch Indus., Inc. & Subs. v. United States, 603 F.3d 816">603 F.3d 816, 822 (10th Cir. 2010) (citing the regulation). As to the allocable costs attributable to common improvements in the de minimis rule, the regulation does not require that the obligation be solely contractual. Sec. 1.460-1(b)(2)(ii), Income Tax Regs. Rather, the regulation allows a taxpayer to include the allocable costs "if the taxpayer is contractually obligated, or required by law, to construct the common improvement." Id. Nothing in the regulation requires that the contract be the sole source of the obligation, and, in fact, it indicates the opposite--that the obligation may be noncontractual.B. Bulk Sale ContractsRespondent similarly contends that the bulk sale contracts do not qualify as long-term construction contracts under section 460. Specifically, respondent alleges that petitioners have not established that they were obligated to construct anything under these contracts. Respondent bases this position 382 on his belief that the terms of the bulk sale contracts are unknown and that petitioners failed to carry their burden of proving that the contracts68 are entitled to a long-term contract method of accounting.We disagree that the bulk sale contracts are substantially different from the pad sale BDAs. The parties stipulated that the pad sale BDAs are construction contracts. The bulk sale agreements are merely pad sale BDAs on a larger scale. The record supports this conclusion. We heard credible testimony from the vice president of finance for petitioners that the bulk sale contracts were BDAs and that petitioners were obligated to build the same types of common improvements that benefited the property sold, such as regional water lines, traffic signals, and detention basins. Thus, we hold that these contracts too are construction contracts that may be accounted for under section 460 as long-term contracts to the extent consistent with this Opinion.III. Completed Contract Method of AccountingBecause the Court has concluded that all of petitioners' contracts are long-term construction contracts, we turn to the question of whether the contracts are home construction contracts. Section 460(a) provides generally that taxpayers must determine taxable income from long-term contracts under the percentage of completion method of accounting. Under this method of accounting,69 taxpayers generally recognize gain or loss throughout the duration of the contract. Seesec. 1.460-4(b), Income Tax Regs. (rules concerning percentage of completion method). But in some instances taxpayers may account for income from certain construction contracts under other methods of accounting such as the completed contract method. Sec. 460(e).This section provides an exception to the percentage of completion method of accounting for home construction contracts and an exception for other construction contracts where the taxpayers complete the contract within 24 months and meet a gross receipts test. Sec. 460(e)(1)(A) and (B). The parties have stipulated that most of petitioners' contracts are construction contracts as defined in section 460(e)(4). Petitioners do not contend that they qualify for the second exception, 383 so the question before us is whether petitioners' contracts qualify as home construction contracts.Deferral of income tax, like exemptions and deductions, is a matter of legislative grace, and exceptions to the normal income recognition rules must be strictly construed. See, e.g., Bingler v. Johnson, 394 U.S. 741">394 U.S. 741, 752, 89 S. Ct. 1439">89 S. Ct. 1439, 22 L. Ed. 2d 695">22 L. Ed. 2d 695 (1969) ("[E]xemptions from taxation are to be construed narrowly[.]"); Estate of Bell v. Commissioner, 928 F.2d 901">928 F.2d 901, 903 (9th Cir. 1991) ("The deferral [of estate tax payment] benefits of section 6166 are a 'matter of legislative grace' that is similar to the benefits70 conferred by other statutory provisions dealing with deductions, exemptions and exclusions from tax. Thus, a strict and narrow construction should be applied to the deferral benefit provisions[.]"), aff'g92 T.C. 714">92 T.C. 714 (1989).The parties disagree over whether contracts such as petitioners', where the seller does not build the house or any improvements on the lot, qualify as home construction contracts. Section 460(e)(6) defines a home construction contract as follows:(A) Home construction contract.--The term "home construction contract" means any construction contract if 80 percent or more of the estimated total contract costs (as of the close of the taxable year in which the contract was entered into) are reasonably expected to be attributable to activities referred to in paragraph (4) with respect to--(i) dwelling units (as defined in section 168(e)(2)(A)(ii)) contained in buildings containing 4 or fewer dwelling units (as so defined), and(ii) improvements to real property directly related to such dwelling units and located on the site of such dwelling units.For purposes of clause (i), each townhouse or rowhouse shall be treated as a separate building.We refer to this definition as the 80% test. Paragraph (4) referred to by section 460(e)(6)(A) provides: "For71 purposes of this subsection, the term 'construction contract' means any contract for the building, construction, reconstruction, or rehabilitation of, or the installation of any integral component to, or improvements of, real property." Sec. 460(e)(4). The statute defines dwelling unit by cross-reference as "a house or apartment used to provide living accommodations in a building or structure, but does not include a unit in a hotel, motel, or other establishment more than one-half of the units in which are used on a transient basis". Sec. 168(e)(2)(A)(ii).1272 384 The parties do not dispute that pursuant to the contracts, agreements, and government development rules, the structures to be ultimately built upon the land petitioners sell in the contracts at issue are dwelling units.Importantly, however, petitioners did not build homes on the land they sold, nor did qualifying dwelling units exist on the sold land at the time of the sales. Petitioners have not established that at the time of each sale qualifying dwelling units would ever be built on the sold land. The bulk sale agreement for Village 26 is especially troubling as no construction had yet occurred years later73 and, because the purchaser-builder defaulted on the contract, THHC still owned half of the village. As far as we know, no qualifying dwelling units will ever be built on these lands,1374 and 385 deferral of income from contracts that might not ever result in qualifying dwelling units seem entirely inappropriate under these circumstances. Cf. Shea Homes, Inc. & Subs. v. Commissioner, 142 T.C. at 105-106) (permitting deferral of income from contracts where the completed qualifying dwelling units were, themselves, included in the property being sold and giving rise to the asserted taxable income). Petitioners close the contracts and receive revenue without needing to build a single home. In Shea Homes, the taxpayers closed their contracts only after a certificate of occupancy had been issued and simultaneously with the purchaser's taking possession of their house. Id. at 79. Petitioners are under no contractual obligation to build homes as their contracts are merely for the sale of land, developed to varying degrees, to builders or individual customers who may eventually build homes on that land.In respondent's mind, the definitions foreclose petitioners from using the completed contract method of accounting. Only the section 460(e)(4) costs directly associated with building the actual house or improvements thereto qualify for purposes of meeting75 the 80% test. Petitioners assert that construction activity costs count in meeting the 80% test even though they do not build the four walls or roof of a dwelling unit. Under their interpretation, the "allocable costs" include the costs of required infrastructure and common improvements attributable to the dwelling units. Even if true, this point, without more, would not be determinative of their right to use section 460(e).The starting point for interpreting a statute or a regulation is its plain and ordinary meaning unless such an interpretation "would produce absurd or unreasonable results". Union Carbide Corp. v. Commissioner, 110 T.C. 375">110 T.C. 375, 384 (1998). Undefined words take their "ordinary, contemporary, 386 common meaning". Hewlett-Packard Co. & Consol. Subs. v. Commissioner, 139 T.C. 255">139 T.C. 255, 264 (2012).A. Costs Attributable to Dwelling UnitsSection 460(e)(6) defines a home construction contract, as of the end of the taxable year when the contract was entered into, by reference to the estimated total contract costs attributable to construction activity "with respect to" (i) dwelling units and (ii) improvements to real property directly related to the units and located on the site of the dwelling units. The regulations clarify that the allocable contract costs to be included in the 80% test must be attributable to the construction of the units and the76 improvements thereto. Sec. 1.460-3(b)(2)(i), Income Tax Regs.14What does the statute mean when it says "attributable to" construction activities "with respect to" dwelling units and improvements directly related to real property? Sec. 460(e)(6)(A). Respondent asserts that only costs incurred in the actual construction of the dwelling units or their related real property improvements count. Respondent contends that the home construction contract exception requires the taxpayer to build dwelling units or to build improvements to real property directly related to and located on the site of such dwelling units.Petitioners claim the statute contemplates a broader definition of home construction costs. Under their interpretation, they believe that their costs benefit dwelling units and real property improvements related to and located on the site of such dwelling units. Because the costs benefit dwelling units, petitioners contend that the costs are therefore attributable to the dwelling units and that these costs should count towards meeting the 80% test. Under petitioners'77 view, because all of their development costs are attributable to construction activity with respect to dwelling units and real property improvements related to and located on the site of 387 those dwelling units, section 460(e) is applicable even though they do not construct the dwelling units.Petitioners assert that because the costs are allocable to the contracts and because the costs benefit the property sold to the homebuilders and ultimately to individual buyers, the costs are attributable to construction activities with respect to the dwelling units or real property improvements. This conclusion follows, according to petitioners, because the statute does not confine the availability of the completed contract method of accounting to those taxpayers who build the dwelling units' "sticks and bricks" and/or real property improvements related to and located on the dwelling units' lots.Petitioners' interpretation of the statute would make any construction cost tangentially related to a dwelling unit or real property improvement related to and located on the site of the dwelling unit a cost to be counted in determining whether a contract is a home construction contract. Without petitioners' development78 work, the pads and lots would be mere patches of land in a desert. Petitioners' work may indeed be necessary for the ultimate home to feasibly be built and occupied.But these correlations do not mean that those costs are necessarily incurred "with respect to" qualifying dwelling units. "With respect to" implies a stronger proximate causation than petitioners' interpretation permits. The prepositional phrase "with respect to" can mean "as regards: insofar as concerns: with reference to". Webster's Third New International Dictionary 1934 (2002). So the construction activities that count towards meeting the 80% test are defined by reference to the dwelling unit. The phrase does not imply a correlation as loose as proposed by petitioners, nor does it encompass real property improvement activities that are merely related to land which at some indeterminate future time may perhaps become the site of a qualified dwelling unit(s). Consequently, petitioners have failed to establish that such construction costs are incurred with respect to qualifying dwelling units.At most the statute is ambiguous, and we look to section 1.460-3(b)(2)(i), Income Tax Regs., which clarifies the statute. "Attribute" as used in the regulation means "to79 explain as caused or brought about by: regard as occurring 388 in consequence of or on account of". Webster's Third New International Dictionary 142. The word implies causation, and as used in the regulation, the plain meaning of "attribute to" is "caused by".15 None of these costs, in our view, are attributable to the construction of the dwelling units, because petitioners do not intend to build such units and neither the units nor the real property improvements related to and located on the site of the dwelling units have yet been built. The regulation is reasonable, and we conclude it forecloses petitioners' interpretation. See Chevron U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837">467 U.S. 837, 842-843, 104 S. Ct. 2778">104 S. Ct. 2778, 81 L. Ed. 2d 694">81 L. Ed. 2d 694 (1984).Congress added the exception for home construction contracts in 1988. Technical and Miscellaneous Revenue Act of 1988 (TAMRA), Pub. L. No. 100-647, sec. 5041, 102 Stat. at 3673. Senator Dennis DeConcini and Representative Richard T. Schulze were concerned that homebuilders would have to recognize income not yet received and that costs would no longer match revenues. 134 Cong. Rec. 20722-20723 (Aug. 5, 1988) (Sen. DeConcini); 134 Cong. Rec. 29962-29963 (Oct. 12, 1988) (Sen. DeConcini); 134 Cong. Rec. 20202 (Aug. 3, 1988) (Rep. Schulze).80 While the conference report is ultimately silent as to why the exception was added in its final form, it is clear that the intended beneficiaries of this relief measure were taxpayers involved in "the building, construction, reconstruction, or rehabilitation of" a home and not land developers who do not build homes, even if essential development work paves the way for, and thus facilitates, home construction. TAMRA sec. 5041.16389 That Congress changed the wording of section 460(e)(4) from "reasonably81 expected to be attributable to the building, construction, reconstruction, or rehabilitation of" to "reasonably expected to be attributable to activities referred to in paragraph (4)" only confirms our view. Omnibus Budget and Reconciliation Act of 1989, Pub. L. No. 101-239, sec. 7815(e)(1)(A) and (B), 103 Stat. at 2419. This change added "the installation of any integral component to, or improvements of, real property" to the list of construction activity. Id. The purpose of this change was to ensure that costs incurred in installing integral components such as heating or air conditioning systems were qualifying costs. H.R. Rept. No. 101-247, at 1411 (1989), 1989 U.S.C.C.A.N. 1906, 2881; Staff of J. Comm. on Taxation, Description of Technical Corrections Proposed to the Technical and Miscellaneous Revenue Act of 1988, The Revenue Act of 1987, and Certain Other Pension-Related Tax Legislation 4 (J. Comm. Print 1989).17Congress intended to extend this relief provision only to taxpayers who have some direct dwelling construction costs, as defined in section 460(e)(4).In summary, the terms "with respect to", sec. 460(e)(6)(A), or "attribute * * * to", sec. 1.460-3(b)(2)(i), Income Tax Regs., do not qualify contracts as home construction82 contracts when petitioners do not construct the home, prove that a qualifying dwelling unit was built, or, in the case of pad and bulk sales, even develop the immediate neighborhood. We do not agree with petitioners' assertion that the term "dwelling units" encompasses more than the home. Petitioners urge us not to confine "dwelling unit" to the structure built on the lot and would instead have that term encompass all the relevant infrastructure that makes the unit suitable for habitation. The regulations clarify this point by providing a separate relief provision for such common improvements. Sec. 1.460-3(b)(2)(B)(iii), Income Tax Regs. We recognize the potential tension with our Opinion in Shea Homes, Inc. & Subs., and we address such concerns infra.390 B. Section 406(e)(6)(A)(ii) Real Property ImprovementsWe disagree with petitioners that the statute allows their construction activity costs to qualify because they are related to and located on the site of the dwelling units. "Site", according to petitioners, means Summerlin, not the individual lot on which a house is later built. Petitioners reason that because the statute uses the plural of dwelling unit--"on the site of such dwelling units"--but does not use the plural of "site", then the statute83 necessarily envisions a development, like Summerlin, containing multiple dwelling units and requires that a site be more than the lot upon which the dwelling unit is built. Be that as it may, this argument is not controlling here because it ignores the fact that the statute allows a construction contract for a building with four or fewer dwelling units to still be considered a home construction contract. Sec. 460(e)(6)(A)(i). Such a building would necessarily consist of dwelling units (plural), but would sit on a single site.Petitioners read the preposition "on" in the phrase "on the site" to connote proximity. Indeed, "on" can be used to indicate contiguity. Webster's Third New International Dictionary 1574 ("location closely adjoining something"). But "on" is also used "to indicate position over and in contact with that which supports from beneath". Id. By using the phrase "at the site" in the regulations, respondent did not necessarily interpret "on" to indicate proximity rather than the narrower usage. While "at" can be used "to indicate presence in, on, or near", id. at 136, we do not think that in choosing the word "at", as opposed to a phrase like "on or nearby", the regulation intended to interpret "on84 the site" broadly.Even if we were to view the statute as ambiguous in its use of "on the site of", the Secretary has resolved any ambiguity through regulatory gap-filling. And we are required to defer to an agency's permissible interpretation of an ambiguous statute. Chevron U.S.A., Inc., 467 U.S. at 842-843.The Secretary believed that the statutory phrase might prevent taxpayers from counting the costs of common improvements towards the 80% test, and as a result many large homebuilders might be unable to qualify for the completed contract method of accounting for home construction 391 contracts. He rightly ameliorated this problem by adopting section 1.460-3(b)(2)(iii), Income Tax Regs., which allows taxpayers to count such costs as part of the cost of building dwelling units for the purposes of the 80% test. The regulation reflects a permissible--inescapable in our minds--construction of the statute, and we defer to that construction. See id.1885 The costs petitioners incur are, if anything, common improvement costs as defined in section 1.460-3(b)(2)(iii), Income Tax Regs.The regulations make clear that taxpayers may include the allocable share of these common improvement costs in the cost of the dwelling units. Id. But we agree with respondent that the taxpayer must at some point incur some construction cost with respect to the dwelling unit to include these costs in the dwelling unit cost. We do not believe that section 1.460-3(b)(2)(i) and (iii), Income Tax Regs., allows a taxpayer with zero direct construction costs with respect to dwelling86 units to simply add common improvement costs for the purposes of the 80% test. Rather, the regulation states that the taxpayer may "include" such costs. Sec. 1.460-3(b)(2)(iii), Income Tax Regs. The regulation allows the taxpayer to include only the share of the common improvement costs allocable to the dwelling unit. Id. If the taxpayer does not construct or intend to construct qualified dwelling units, there is no allocable share of common improvement costs.392 Petitioners have no dwelling unit costs in which to include the common improvement costs. The costs petitioners incur are not the actual homes' structural, physical construction costs. Nor are they costs for improvements "located on" or "located at" the site of the homes. Therefore, petitioners may not include these costs in testing whether 80% of their allocable contract costs are attributable to the dwelling units and real property improvements directly related to and located on the site of the yet to be constructed dwelling units.After reviewing the plain and ordinary meaning of the statute and the regulation, we conclude that petitioners' contracts and agreements do not qualify as home construction contracts.1988 89 Recently, we held that availability to homebuilders 393 of87 the completed contract method of accounting is "generously broad and reflects a deliberate choice by Congress that home construction contracts should be treated differently", but only as to homebuilders. Shea Homes, Inc. & Subs. v. Commissioner, 142 T.C. at 107-108. As for other construction contracts, "[t]he completed contract method of accounting is a narrow exception to the legislated rule that most long-term contracts must now be accounted for under the percentage of completion method of accounting", which should be strictly construed. Id. at 107. Petitioners were not homebuilders, and their contracts were not home construction contracts. Petitioners cannot account for gain or loss from these contracts using the completed contract method of accounting.C. Shea HomesIn Shea Homes, we held that the subject matter of the home construction contracts of the taxpayers, developers who both developed land and built homes, included the home, the lot on which the home sat, and the common improvements and amenities. Therefore, we held that in testing contract completion, the taxpayers were entitled to apply the use and 95% completion test by using the contract costs, after including the allocable share of the costs of the common improvements and amenities of the development or development phase which included the dwelling unit(s).In reaching this conclusion, we looked in part at the definition of home construction contract to inform our understanding of the regulation's use of "subject matter" of the contract. We concluded that section 460(e)(6)(A) defined a home construction contract, and that "the regulations expand this definition to allow taxpayers90 to include 'the allocable share of the cost that the taxpayer reasonably expects to incur for any common improvement.'" Shea Homes, Inc. & Subs. v. Commissioner, 142 T.C. at 102 (quoting section 1.460-3(b)(2)(iii), Income Tax Regs.). We believed that the fact that the regulations expanded the universe of costs to be considered when deciding whether a contract qualified as a home construction contract was "at minimum instructive" when deciding when that contract is subsequently completed.But at no point in Shea Homes did we say that a home construction contract could consist solely of common improvement 394 costs. The starting point in Shea Homes was that the taxpayers' contracts were for the construction of qualifying dwelling units. Those taxpayers developed land and built homes, and so when testing whether their contracts were home construction contracts, they were permitted by the regulations to add to the costs of the dwelling units they constructed their common improvement costs. And, when testing the contract completion date, they looked to when they incurred 95% of the costs of the subject matter of the contract.Our Opinion today draws a bright line. A taxpayer's contract can qualify as a home construction contract only if the taxpayer builds, constructs, reconstructs, rehabilitates,91 or installs integral components to dwelling units or real property improvements directly related to and located on the site of such dwelling units. It is not enough for the taxpayer to merely pave the road leading to the home, though that may be necessary to the ultimate sale and use of a home. If we allow taxpayers who have construction costs that merely benefit a home that may or may not be built, to use the completed contract method of accounting, then there is no telling how attenuated the costs may be and how long deferral of income may last. We cautioned in a footnote in Shea Homes, Inc. & Subs. v. Commissioner, 142 T.C. at 109 n.24 ), that there is a temporal component to the home construction contract exception and contract completion.2092 We think it consistent with congressional intent that a line should be drawn here so as to exclude petitioners' contracts, when we cannot conclude that qualifying dwelling units will ever be built.395 Of course, the contract does not necessarily have to be for the actual sale of a home. The regulations make clear that a subcontractor's contract may qualify as a home construction contract. For instance, a subcontractor who does the electrical work inside the home may have a home construction contract. Petitioners attempt to characterize their relationship with the homebuilders as a general contract or subcontractor relationship. In an interesting and innovative twist, petitioners try to characterize themselves as the subcontractor in the relationship, as if the builders are subcontracting out all of93 this infrastructure and extra-home development work to petitioners. But this is not the relationship the parties have chosen. See Commissioner v. Nat'l Alfalfa Dehydrating & Milling Co., 417 U.S. 134">417 U.S. 134, 149, 94 S. Ct. 2129">94 S. Ct. 2129, 40 L. Ed. 2d 717">40 L. Ed. 2d 717 (1974) ("[W]hile a taxpayer is free to organize his affairs as he so chooses, nevertheless, once having done so, he must accept the tax consequences of his choice, whether contemplated or not, and may not enjoy the benefit of some other route he might have chosen to follow but did not." (Citations omitted.)).IV. ConclusionPetitioners' contracts are not home construction contracts within the meaning of section 460(e). Petitioners may not account for these contracts using the completed contract method of accounting. The custom lot contracts and the bulk sale agreements are, however, long-term construction contracts for which petitioners, if those contracts are entered into in a year before their completion, may use a permissible method of accounting for long-term contracts, such as the percentage of completion method.The Court has considered all of the parties' contentions, arguments, requests, and statements. To the extent not discussed herein, the Court concludes that they are moot, irrelevant, or without merit.Decisions will be entered for respondent.Footnotes1. Unless otherwise noted, all section references are to the Internal Revenue Code of 1986, as amended and in effect for the years at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩2. The parties disagree over whether the bulk sales contracts are in substance different from the pad sales contracts. We resolve this issue infra↩.3. The parties stipulated that the sales in all custom lot contracts were made to "an individual purchaser". A review of the list of custom lot contracts, however, reveals that some of the buyers appear to be builders (e.g., Executive Home Builder, Six Star Construction, Inc., and PMR Homes, Inc.). This apparent discrepancy may result from the meaning of "individual purchaser" but is irrelevant to our ultimate holding. For simplicity, we will rely on the parties' stipulation.↩4. The parties provided a stipulated exhibit that purports to be a list of BDAs at issue. This list of 130 BDAs includes 23 contracts for sales in Village 14A. But the parties also stipulated that petitioners recognized the gain on BDAs involving Village 14A in 2000. Other stipulated exhibits, such as a map highlighting the villages at issue and the calculations attached to the 30-day letters, also reveal that the contracts for sales of land in Village 14A are not in issue. We disregard the contracts from Village 14A in arriving at the total number of BDAs at issue.5. The parties disagreed over whether Villages 18 and 19 contained land sold in pad sales. This dispute is immaterial to our ultimate holding, but we find that the weight of the evidence suggests Village 18 contained land sold in pad sales whereas Village 19 did not.↩6. As used in the contracts, net sale price means the gross sale price less credit for any lot premium and any costs of amenities, such as swimming pools. Finished lot costs is the purchase price KB Home paid for the lot.↩7. The parties did not provide copies of the attachments to the two representative custom lot contracts. Rather, they provided the attachments to a different custom lot contract, which involved the sale of a lot in The Azure community in Village 18. The parties have stipulated that these attachments are generally representative of the exhibits attached to a contract for the purchase and sale of a custom lot in Village 18.8. For example, petitioners did not use the completed contract method of accounting to account for gain or loss from the sale of property upon which large multiunit apartment and commercial buildings were ultimately to be built.9. As previously noted, the page reads in part: "ALL OF THE DOCUMENTS LISTED BELOW ARE IMPORTANT TO THE PURCHASE OF THE LOT, SHOULD BE READ BY THE PURCHASER AND, AT THE CLOSE OF ESCROW, SHALL BE DEEMED TO HAVE BEEN READ AND APPROVED BY PURCHASER."↩10. We note that Nev. Rev. Stat. sec. 116.4117↩ (1997) has been amended numerous times since it was enacted in 1991. We refer to the statute as amended and in effect for the years in which the contracts were entered into.11. In fact, the Nevada Common-Interest Ownership Act appears to enable parties other than those in contractual privity with the developer to have standing to institute a lawsuit. SeeNev. Rev. Stat. sec. 116.4117(2)↩ (allowing suit to be brought by a unit's owner, not just the original purchaser of the land from the developer).12. The relevant regulation largely follows the statute. It defines home construction contracts as follows:(i) In general.--A long-term construction contract is a home construction contract if a taxpayer (including a subcontractor working for a general contractor) reasonably expects to attribute 80 percent or more of the estimated total allocable contract costs (including the cost of land, materials, and services), determined as of the close of the contracting year, to the construction of--(A) Dwelling units, as defined in section 168(e)(2)(A)(ii)(I), contained in buildings containing 4 or fewer dwelling units (including buildings with 4 or fewer dwelling units that also have commercial units); and(B) Improvements to real property directly related to, and located at the site of, the dwelling units.(ii) Townhouses and rowhouses.--Each townhouse or rowhouse is a separate building.(iii) Common improvements.--A taxpayer includes in the cost of the dwelling units their allocable share of the cost that the taxpayer reasonably expects to incur for any common improvements (e.g., sewers, roads, clubhouses) that benefit the dwelling units and that the taxpayer is contractually obligated, or required by law, to construct within the tract or tracts of land that contain the dwelling units.Sec. 1.460-3(b)(2), Income Tax Regs.↩13. We note that in a case of an insolvent builder, a bankruptcy court may direct the trustee of the bankruptcy estate to petition the local government for rezoning. See In re Lloyd, 37 F.3d 271">37 F.3d 271, 274 (7th Cir. 1994) (affirming the bankruptcy court's direction to the trustee to seek to rezone property from agricultural to residential to allow the debtor a homestead exemption). We also note that the Summerlin West and the Summerlin South development agreements with Las Vegas and Clark County have been amended from time to time by the parties. Thus, contractual promises or obligations of third parties alone are, at least in this factual context, insufficient to ensure that qualifying dwelling units will in fact be constructed on the sold land. When it comes to yet-to-be completed common improvements, presumably bonds are posted, whereas the purchasers of the land do not post or purchase bonds promising construction of homes. We cannot therefore conclude that governmental zoning and entitlement agreements and land sale contracts alone are enough to meet petitioners' evidentiary burden of establishing that the qualifying dwelling units requirement of sec. 460(e)(6)(A)↩ is or will be met.14. Petitioners do not challenge the regulations, and accordingly we give them their due deference. Seesec. 460(h); Mayo Found. for Med. Educ. & Research v. United States, 562 U.S. , , 562 U.S. 44">562 U.S. 44, 131 S. Ct. 704">131 S. Ct. 704, 713, 178 L. Ed. 2d 588">178 L. Ed. 2d 588 (2011) (applying to regulations the test announced in Chevron, U.S.A. Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837">467 U.S. 837, 842-843, 104 S. Ct. 2778">104 S. Ct. 2778, 81 L. Ed. 2d 694">81 L. Ed. 2d 694 (1984)); cf. Shea Homes, Inc. & Subs. v. Commissioner, 142 T.C. 60, 98↩ n.18 (2014).15. Cf. Lawinger v. Commissioner, 103 T.C. 428">103 T.C. 428, 435 (1994) (discussing the definition of "attributable to" in the context of sec. 117(m) of the Internal Revenue Code of 1954 and sec. 108(g)(2)(B) of the Internal Revenue Code of 1986↩).16. The Congressional Record reveals that Chairman Rostenkowski of the House Ways and Means Committee, when moving to suspend the rules so that the House could adopt the Conference Committee Report on H.R. 4333, stated that the conference report exempted "single family homebuilders from the provision" that restricted the completed contract method of accounting. 134 Cong. Rec. 33112 (Oct. 21, 1988). Likewise, Representative Archer, the ranking House Conference Committee member, stated in support of the conference report: "I was particularly pleased that we changed the 'completed contract method of accounting' provisions under current law to exempt single family residential construction--thereby reducing the cost of homes." Id↩.17. We cite the Joint Committee on Taxation's report for its persuasive merit. See United States v. Woods, 571 U.S. , , 134 S. Ct. 557">134 S. Ct. 557, 568, 187 L. Ed. 2d 472↩ (2013).18. In addition, the legislative history supports our interpretation of "site" as limited to the site of the home. The conference committee report states:[A] contract is a home construction contract if 80 percent or more of the estimated total costs to be incurred under the contract are reasonably expected to be attributable to the building, construction, reconstruction, or rehabilitation of, or improvements to real property directly related to and located on the site of, dwelling units in a building with four or fewer dwelling units. * * * [Emphasis added.]H.R. Conf. Rept. No. 100-1104 (Vol. II), at 118 (1988), 1988-3 C.B. 473, 608. This sentence clearly shows that Congress used "dwelling units" in the plural as opposed to the singular in sec. 460(e)(6)(A)(ii)↩ because a construction contract for a building with four or fewer dwelling units could qualify as a home construction contract. Congress did not intend the plural to expand the definition of "site" from the geographic limitations of the immediate lot to the geographic boundaries, and even beyond, of the whole development.19. We also do not think that respondent's current position is inconsistent with the Internal Revenue Service (IRS) material petitioners cite. For instance, the IRS Non-Docketed Service Advice Review they referenced does not say that a home construction contract need not involve the building of a home. 2003 IRS Non-Docketed Service Advice Review 20006 (Jan. 18, 2003). Rather this document states that the activities enumerated by sec. 460(e)(4) encompass more than just building a house, such as rehabilitating a home or installing integral components. Id. As mentioned supra, when Congress changed sec. 460(e)(6) to reference para. (4), thereby including "the installation of any integral component to, or improvement of, real property" in the qualifying costs of sec. 460(e)(6), it intended to allow taxpayers who build components such as air conditioning and heating systems to potentially qualify their construction contracts as home construction contracts. Omnibus Budget Reconciliation Act of 1989, Pub. L. No. 101-239, sec. 7815(e)(1)(A), 103 Stat. at 2419; H.R. Rept. No. 101-247, at 1411 (1989), 1989 U.S.C.C.A.N. 1906, 2881. For an explication of the IRS' current position, see Tech. Adv. Mem. 200552012 (Dec. 30, 2005), indicating that the IRS believes the home construction exception is only available to the party who actually builds or produces a dwelling unit. Consequently, a land developer who did not build any dwelling unit(s) could not qualify.We recognize that the proposed regulations, which would redesignate sec. 1.460-3(b)(2)(iii), Income Tax Regs., as sec. 1.460-3(b)(2)(iv), if adopted, would expand the scope of the qualifying costs. Proposed Income Tax Regs., 73 Fed. Reg. 45182 (Aug. 4, 2008). These regulations would modify the definition of "improvements to real property directly related to, and located on the site of, the dwelling units" by including costs of common improvements within that definition even if the contract does not provide for the construction of any dwelling unit(s). Id. Not only does the preamble to the proposed regulations explicitly caution taxpayers not to rely on these regulations, id↩. at 45181, but by negative inference they add credence to our view that petitioners' position is unsupported by the wording of the current statute and regulation.20. The regulations caution that "taxpayers may not delay the completion of a contract for the principal purpose of deferring federal income tax." Sec. 1.460-1(c)(3)(iv)(A), Income Tax Regs. In these cases, petitioners would often build infrastructure as needed. For instance, the costs of a road or a water line that is anticipated to benefit a village may upon request, see supra↩ p. 16, not be incurred for many years. This may lead to a situation where the contract completion date could be substantially delayed. We do not suggest that developers intentionally build ghost towns by building out infrastructure in excess of demand, but we suggest that such costs would not necessarily be a proper part of a home construction contract. This is especially important for contracts qualifying for the completed contract method of accounting where such a delay coupled with just-in-time, as-needed improvements construction indeterminately defer recognition of income.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623487/	Western Credit Company, Inc., a Corporation, Petitioner, v. Commissioner of Internal Revenue, RespondentWestern Credit Co. v. CommissionerDocket No. 82457United States Tax Court38 T.C. 979; 1962 U.S. Tax Ct. LEXIS 63; September 28, 1962, Filed 63 Decision will be entered for the respondent. Held, "contract charges" made by a nonregulated small loan company to help cover the high cost of investigating credit, the increased risk involved, etc., in such business, constitute interest and personal holding company income. Randall64 Swanberg, Esq., for the petitioner.Joseph D. Holmes, Jr., Esq., for the respondent. Drennen, Judge. DRENNEN979 Respondent determined that there is due from petitioner deficiencies in personal holding company surtax and in income tax for the periods and in the amounts following:YearTaxAmount 1949Personal holding company$ 3,596.071950Personal holding company3,501.651951Personal holding company5,305.841952Personal holding company4,348.271953Personal holding company4,872.2719541 Income 5,133.69Jan. 1 -- Apr. 30, 19551 Income 1,400.87May 1 -- Apr. 30, 19561 Income 3,855.70The only issue for decision is whether petitioner is liable for tax as a personal holding company.FINDINGS OF FACT.Some of the facts have been stipulated and are found accordingly.Petitioner is a corporation, incorporated in 1948 under the laws of Montana, with its principal place of business in Great Falls, Montana. 980 It filed Federal income tax returns for the calendar years 1949 through 1954, for the tax period January 1 through April 30, 65 1955, and for the taxable year ended April 30, 1956, with the collector or district director of internal revenue, Helena, Montana. Petitioner did not file personal holding company returns for any of the above tax periods.During each of the tax periods here involved, more than 50 percent in value of the outstanding stock of petitioner was owned by five or fewer individuals.Petitioner, during the periods in controversy, was engaged in the business of making small loans to individuals. The State of Montana had no statutes specifically relating to small loan, personal finance, or mortgage loan companies. Petitioner was operated under the general corporation statutes of the State of Montana. All of petitioner's gross income, except a small amount of rentals, was derived from borrowers in the operation of this business.When a potential borrower came into petitioner's office, he was interviewed by petitioner's manager who determined whether an application for a loan was warranted. Many persons were refused loans on the basis of the manager's interviews, and applications were not taken from them. If the person submitted an application, the manager prepared a work or scratch sheet66 as he explained the details of the loan to the borrower. This worksheet, containing figures written by the manager, showed the amount of the loan together with the calculation and amount of charges, and became a part of petitioner's records and files.One of the charges computed on the sheet when the loan was made was termed a "contract charge" and was equal to $ 10 if the principal amount of a loan was $ 100 or less, and was $ 15 or 3 percent of loan principal, whichever was greater, for a loan in a principal amount exceeding $ 100.Another of the charges computed on the sheet was a "carrying charge" equal to 1 percent per month of the principal sum, calculated in advance, for the duration of the loan when a loan was for $ 100 or more, or $ 1.67 per month when the principal of the loan was under $ 100. This charge was computed separately from the contract charge.Petitioner's manager also computed additional charges on the worksheet, consisting of filing or recording fees regarding chattel mortgages securing the loan, insurance premiums for life insurance on the borrower's life, and premiums for insurance covering an automobile, if the loan was to be secured by a chattel mortgage67 on a car.If the loan application was accepted, the borrower executed a promissory note in a face amount equal to the total of the amount of the loan, the carrying charge, the contract charge, and any other charges or fees collected, which note was payable in equal monthly installments over a stated period. No breakdown of the face amount appeared 981 on the note, and it provided only for interest at the rate of 8 percent per annum after maturity until paid.Petitioner's manager, in detailing a loan for a borrower, always explained that the amount of the contract charge would be "used up" in processing the application for the loan. If the borrower made payment of his loan before the installments were due, he received a rebate for a proportionate part of the carrying charge, but he received no rebate of any part of the contract charge.Petitioner investigated the credit of every borrower and always checked the identity, value, and title of the property which was to serve as collateral for the loan. Petitioner accepted as collateral various types of tangible personalty, such as automobiles, furniture, equipment, and livestock. If the collateral was furniture, petitioner's 68 manager often went to the borrower's home to check the furniture as well as the living standard of the borrower. If the collateral was equipment or livestock, a trip to the borrower's place of business or farm was required. Often the collateral was an automobile which the borrower wanted to buy with the proceeds of the loan. Petitioner's manager checked the motor and serial numbers of the car itself. This often necessitated a trip to the lot where the car was being sold. Petitioner subscribed to a service which published current used-car prices, and petitioner's manager used this service, together with information obtained from the seller and from personal inspection of the car, to arrive at loan value. Petitioner also subscribed to a service which published the automobile registration and title laws of each State, and this service was used to check title of cars licensed out of State. In order to obtain title and license for an automobile in Montana, it was necessary to pay property tax on the vehicle. Petitioner's manager handled the payment of taxes and fees, and the claiming of tax credits on out-of-State cars, and the obtaining of licenses and titles in order that petitioner's69 chattel mortgage on the car would be in order. The manager took powers of attorney from borrowers in order to make application for title.The credit investigation of a borrower generally started with a check with the local credit bureau of which petitioner was a member. Petitioner's manager could often find from the bureau the borrower's creditors, after which he would spot check with some of the creditors to find out if the information given him by the borrower had been correct and to discover the borrower's paying habits. Sometimes the bureau had no record for the borrower. This was usually the case if the borrower was from out of town or if he had recently moved to Great Falls. In such case, petitioner's manager had to telephone or otherwise contact whatever creditors the borrower had given as references or the credit bureau in the borrower's home city, or refer the matter to the local credit bureau for forwarding to the out-of-town 982 bureau. In either case, petitioner incurred toll charges for the telephone calls or an additional charge by the local credit bureau, which charged petitioner amounts based on the work involved in handling an inquiry.In case of a consolidation70 loan, petitioner paid the borrower's creditors directly, in many instances by delivering checks to them in discharge of the borrower's debts. Petitioner in such cases obtained releases of security instruments such as chattel mortgages. Often these releases were prepared by petitioner.Sometimes, petitioner performed services for customers by taking wage assignments from them, collecting portions of their incomes, and discharging their debts from the collected wages.Except for the contract charge and the carrying charge, petitioner did not charge borrowers for the foregoing services. The contract charge was intended to defray petitioner's expenses incurred in performing those services, although there was no direct relation between the amount of the contract charge and the cost of performing services in connection with any particular loan.Receipts from borrowers were applied first to principal, until principal was paid in full, after which the receipts were entered on petitioner's records under the following categories:1. Collected fees.2. Bad debt recovery (including principal of the bad debt).3. Extra interest collections (used on extensions of loans).4. Insurance premium71 income.5. Miscellaneous income (recording fees, notary fees, etc.).6. Overages.The account entitled "collected fees" included receipts from both the contract charge and the carrying charge. Petitioner reported gross income in the foregoing categories during the periods under review. 1In each of the tax periods involved, the total sum of the contract charges exceeded 20 percent of petitioner's gross income.The expenses petitioner incurred in the operation of its business were covered by all the income received. Neither the contract charge, the carrying charge, nor any other charge was specifically allocated on any of petitioner's books and records to any particular expense of the business. The expenses incurred72 by petitioner in the operation of its business were itemized on its tax returns and include salaries, interest, advertising, rent, filing fees, rebates, bad debts, and other expenses normally incurred in the operation of a business.983 On the death of Frank M. Wallace, one of the original incorporators of petitioner, in 1951, his stock in petitioner descended to his widow and two children, from whom the present owners of the corporation purchased the stock on July 28, 1954, under a contract the terms of which limit the right of the corporation to declare dividends.Respondent determined that at least 80 percent of petitioner's gross income for each tax period involved was derived from interest and its stock was owned by not more than five individuals so that petitioner was subject to the personal holding company surtax.ULTIMATE FINDING.Petitioner has failed to show that more than 20 percent of its gross income in any of the tax periods involved was other than personal holding company income.OPINION.The only issue is whether petitioner's gross income from contract charges constitutes "interest" within the meaning of section 543(a)(1) of the 1954 Code, 2 and its predecessor73 section 502(a) of the 1939 Code, thereby qualifying as "personal holding company income." The parties have stipulated that petitioner's gross income from contract charges exceeded 20 percent of petitioner's gross income in each of the tax periods involved, so if this income is not interest, less than 80 percent of petitioner's gross income will qualify as personal holding company income and petitioner will not be liable for the surtax. 374 On the other hand if the income from contract charges is interest, the parties agree petitioner was a personal holding company. 4This question was before the courts in several cases in the late 1930's and the early 1940's, but unfortunately the sequence of the decided 984 cases, and the lack of any recent cases on the point, leaves the answer somewhat uncertain.The statute does not define interest. The Supreme Court has defined interest as the "amount which one has contracted to pay for75 the use of borrowed money," Old Colony R. Co. v. Commissioner, 284 U.S. 552">284 U.S. 552 (1932), and as "compensation for the use or forebearance of money," Deputy v. du Pont, 308 U.S. 488">308 U.S. 488 (1940), and in both cases assumed that Congress used the word in the tax statute in its ordinary sense. Section 1.543-1(b)(2), Income Tax Regs., continuing a provision of prior regulations, 5 states merely that interest "means any amounts, includible in gross income, received for the use of money loaned."In Noteman v. Welch, 108 F. 2d 206 (1939), the Court of Appeals for the First Circuit held that a 3-percent-per-month flat charge made by a small loan company, covering interest as well as other charges as allowed by Massachusetts law, was all interest for personal holding company tax purposes. The court pointed out that, despite testimony to the effect that 1 percent was considered a reasonable profit to76 the lender and 2 percent would roughly cover the whole operating expenses of the lender, the charge was a blanket charge made against all borrowers, whether services were rendered or not, and that to a large extent the services which the charge was supposed to cover were rendered, not to the borrower, but to the lender itself, in deciding whether to make the loan, and in safeguarding the loan after it was made. The court also noted that "Judging from the description of the taxpayer's business in the record it seems that the only real consideration which the ordinary small borrower receives is the use of the money, and certainly, from his point of view, that is what he pays for." The court concluded that petitioner had not proven that more than 20 percent of its gross income, which all came from the borrowers, was for something other than interest, so the taxpayer was a personal holding company.Soon after the Noteman case was decided the Board of Tax Appeals in Seaboard Small Loan Corporation, 42 B.T.A. 715">42 B.T.A. 715 (1940), and in several unpublished Memorandum Opinions, held that fees charged by small loan companies ostensibly for investigating, closing, 77 and servicing loans were interest. These cases were decided on the authority of Noteman without further discussion. Next the Third Circuit in Girard Inv. Co. v. Commissioner, 122 F. 2d 843 (1941), reversing an unpublished opinion of the Board of Tax Appeals on another point, noting that this was the second attempt (Noteman being the first) of small loan companies to avoid application of the personal holding company tax, again held that the charges made to cover the high costs of the small loan business were interest. The court appears to have concluded that the word "interest" as used 985 in the personal holding company statute was intended to include not only "pure" interest but "nominal" interest as well which would include amounts charged to cover the increased costs of the "effort of administration" and the "insecurity of payment" in the small loan business.Shortly thereafter the Board of Tax Appeals, in Seaboard Loan & Savings Association, Inc., 45 B.T.A. 510">45 B.T.A. 510 (1941), again held that "investigation" fees of 2 percent charged on each loan, although separately stated to the borrower and segregated78 on taxpayer's books, were in fact interest under the personal holding company law. The Court relied on Noteman, Seaboard Small Loan, and Girard Inv. Co. and said that all questions raised in the instant case were raised in Noteman and decided against taxpayer, and noted that substantially all the services charged for were for the benefit of the lender, not the borrower, and the only consideration received for the amounts paid by the borrower was the money loaned. Also in 1941 the Board held in R. Simpson & Co., 44 B.T.A. 498">44 B.T.A. 498 (1941), affirmed per curiam 128 F. 2d 742 (C.A. 2, 1942), certiorari dismissed 321 U.S. 225">321 U.S. 225 (1944), that interest charged by a pawnbroker was interest under the personal holding company law, saying that every argument advanced by taxpayer was considered unfavorably in Noteman and that efforts to distinguish Noteman because of the difference in operation of the two businesses were unavailing because they failed to impeach the underlying principle. The Court of Appeals affirmed per curiam on the authority of Noteman.In 1943 the Tax Court, in several unpublished79 opinions, relying entirely on the above cases, also held that statutory investigation fees charged by small loan companies constituted interest.Also in 1943, in Workingmen's Loan Ass'n v. United States, 49 F. Supp. 25">49 F. Supp. 25 (D. Mass. 1943), the same district judge who had decided the Noteman case again held that fees charged by a small loan company under authority of the same Massachusetts statute for "investigation, indentification, inspection and appraisal," and charged to all borrowers without agreement for some actual service to be rendered to the borrowers, were interest. The court felt there was no essential difference between the facts there involved and the facts in Noteman. However, by decision rendered April 18, 1944, Workingmen's Loan Ass'n v. United States, 142 F. 2d 359 (1944), the First Circuit reversed the District Court and held that the charges involved in that case were not interest under the personal holding company law. The opinion, written by the same judge who wrote the opinion in Noteman, found that the facts in the present record were significantly different from the facts in 80 Noteman so that the latter case was not controlling. It pointed out that its holding in Noteman was on the basis that it was impossible from the record to allocate any definite portion of 986 the charges to services rendered to borrowers which were properly separable from interest, and that taxpayer had failed to sustain its burden of proving that over 20 percent of its gross income was derived from sources other than interest. However, the court said it had recognized in Noteman that charges made by lenders in connection with making loans are not necessarily all interest and a loan contract may properly call for rendition of specified services by the lender, for which the lender makes a separate charge in addition to interest, for which the borrower would otherwise have to pay a third person.The opinion went on to point out that in the instant case the taxpayer had the practice of separating what it regards as the interest charges from charges for services to borrowers in investigating, identifying, inspecting, and appraising the credit and security of the borrower; that this "initial charge" is made known to the borrower before the loan is consummated and is 81 collected in advance as a flat sum which does not vary with the duration of the loan, it is adjusted to the amount and type of loan, is a customary and usual charge made by concerns engaged in the small loan business, and is specifically allocated, by agreement with the borrower, to the expense of "investigation, identification, inspection and appraisal." The only factual distinction from the Noteman case specifically mentioned in the opinion was that in Noteman "the blanket charge for 'expenses' was fixed at 2% a month on the unpaid balances and ran along during the whole life of the loan." "In view of the stipulated facts," the court held for the taxpayer.With Noteman thus seemingly undermined, the Court of Appeals for the Eighth Circuit, affirming a Memorandum Opinion of this Court in Bond Auto Loan Corp. v. Commissioner, 153 F. 2d 50 (1946), held that a $ 20 "extra hazard" flat charge authorized to be made by automobile loan companies by State law was interest under the personal holding company tax statutes, relying on the Noteman case for support. The opinion simply noted that Workingmen's Loan Ass'n had held that the initial82 charges there involved were not interest, but made no effort to distinguish the two cases.We find no published opinions dealing with the question of whether service charges made by small loan companies qualify as interest under the personal holding company laws since Bond Auto Loan Corp. v. Commissioner, supra. This is in all likelihood due to the fact that since 1938 the personal holding company sections of the internal revenue laws have contained provisions exempting regulated small loan companies from personal holding company status if 80 percent of their gross income is "lawful interest" received from loans made to individuals, and they meet the other requirements of the law. 6987 However, this Court in General American Life Ins. Co., 25 T.C. 1265">25 T.C. 1265 (1956), did cite Bond Auto Loan Corp.v. Commissioner and Seaboard Loan & Savings Association, Inc., both supra, as support for holding that penalty charges collected for prepayment of mortgages constitute interest income to the mortgagee, saying that regardless of the nomenclature used, "the common denominator present throughout is that the charges83 were, in fact, a part of the cost to the borrowers for the use of the lenders' money," and, if so, it is interest.To complete the resume, the Commissioner of Internal Revenue, in Rev. Rul. 57-540, 2 C.B. 318">1957-2 C.B. 318, ruled that finance or service charges imposed on borrowers by a finance company, which do not warrant a charge separate from that for use of borrowed money, constitute interest under the personal holding company law, relying on Noteman and comparing Workingmen's. However, in Rev. Rul. 57-541, 2 C.B. 319">1957-2 C.B. 319, the Commissioner distinguished Noteman and cited Workingmen's in ruling that charges made by a finance company as financing fees for servicing FHA and VA loans do not constitute personal holding company income.Were it not for Workingmen's Loan Ass'n v. United States, supra, we would have little difficulty in holding, on the84 clear weight of authority, that the charges here involved are interest under the personal holding company law. However, since the charges here involved are in some respects similar to those involved in Workingmen's and the court in that case reached the opposite conclusion on the facts than it had reached in the Noteman case, which case has been the foundation case for most of the subsequent decisions on the point, we do not feel we can decide this case without careful consideration of the Workingmen's case.Here, as in Workingmen's, the contract charge is a fixed amount computed in advance, adjusted to the amount of the loan, made known to the borrower in advance as a "used" charge, which is not related to the duration of the loan and is not refundable on prepayment. On the other hand, here the contract charge is not allocated for specific services, while in Workingmen's it was apparently specifically "allocated, by agreement with the borrower, to the expense of 'investigation, identification, inspection and appraisal'" of the credit and security of the borrower; and the charge here is not actually collected in advance. But it seems to us these distinctions85 are more imaginary than real, are more of form than substance, unless it is shown that the charge is actually used to cover the cost of the services specified, and those specified are services to the borrower rather than to the lender or services normally required in the operation of a small loan business. We do not think the mere fact that the contract designates certain uses to which the funds will be put makes the charge any 988 less a fee paid by the borrower for use of the lender's money, unless it is shown that the charge was actually used for such purposes and the charge is justifiably a charge to the borrower separate from interest. Unless such can be shown, we believe the service charges made by small loan companies must be considered interest because basically the nature of the small loan company business is to make a profit in the form of interest on money loaned and the borrower is interested only in obtaining the loan and pays whatever is required of him to get the use of the lender's money. And this is so even though the charge is not a mere cloak to hide usury but is a charge allowed by statute to cover the high cost of operating a small loan business and the86 greater risks involved.So while the contract charges involved in this case are somewhat similar in form to those involved in the Workingmen's case, and the total thereof is stipulated to constitute more than 20 percent of petitioner's gross income, we do not think the evidence proves that all of this income or a part thereof constituting at least 20 percent of petitioner's gross income is a charge truly separable from interest. While the evidence tends to indicate that the cost to petitioner of performing the various functions mentioned above possibly equaled the total it received from contract charges, the evidence provides no basis for determining the cost of performing services that can clearly be said to be rendered for the borrower as distinguished from the general cost of operating a business of this nature. We do not believe that fees charged the borrower, whose only concern is obtaining the use of lender's money, to defray the ordinary and necessary expenses incurred by the lender in conducting a small loan business are truly separable from interest. Consequently, we must conclude that at least 80 percent of petitioner's gross income in the tax periods involved constituted87 interest and personal holding company income under the applicable statutes. If the charges had been for specific services which the borrower would otherwise have to pay a third person to render, the situation might be different.In fact the evidence in this case, and the facts in the other cases cited above, would seem to indicate that because of its nature a small loan business cannot be operated at a profit if it charges only the interest authorized under usury statutes. This is supported by the fact that most, if not all, of the State statutes regulating small loan companies permit them to charge interest or fees or a combination of both which exceed the rates allowable under the usury laws. But the fact that the excess charges are authorized by State law to cover the additional costs of operating small loan businesses does not mean they do not constitute interest under the internal revenue laws. We suspect that the term "lawful interest" used in the provisions of section 542(c) of 989 the 1954 Code exempting regulated small loan companies recognizes this and was used to avoid the issue here raised.While we recognize the equities of petitioner's plea, all of the cases88 cited above stand for the proposition that the personal holding company tax applies to small loan companies, even though they are operating companies, if they fall within the ambit of the statute. We must hold for respondent on this issue.Decision will be entered for the respondent. Footnotes1. The personal holding company surtax was computed as part of the income tax for these periods.↩1. On the returns the amounts in these categories were shown as gross income under the general heading "revenue," and it was not indicated nor is it contended that the amounts collected by petitioner for specific charges, incurred by petitioner in the capacity of an agent, did not constitute gross income.↩2. SEC. 543. PERSONAL HOLDING COMPANY INCOME.(a) General Rule. -- For purposes of this subtitle, the term "personal holding company income" means the portion of the gross income which consists of: (1) Dividends, etc. -- Dividends, interest, royalties (other than mineral, oil, or gas royalties), and annuities. * ↩3. SEC. 542. DEFINITION OF PERSONAL HOLDING COMPANY.(a) General Rule. -- For purposes of this subtitle, the term "personal holding company" means any corporation (other than a corporation described in subsection (c)) if -- (1) Gross income requirement. -- At least 80 percent of its gross income for the taxable year is personal holding company income as defined in section 543, and(2) Stock ownership requirement. -- At any time during the last half of the taxable year more than 50 percent in value of its outstanding stock is owned, directly or indirectly, by or for not more than 5 individuals. * *↩4. Petitioner admits it cannot prove that the "carrying charges" were not interest. The petition raised issues of whether petitioner was exempt from classification as a personal holding company because there were contractual limitations on petitioner's right to declare dividends, because petitioner was not incorporated with the intent to avoid income tax to its shareholders, and because petitioner was a personal finance or loan company exempt under section 542. These contentions have been abandoned, except petitioner makes passing reference on brief to the lack of intent to avoid tax on its shareholders. No specific explanation is given why petitioner is not exempt under section 542↩ except such as can be gleaned from the evidence.5. Sec. 39.502-1(b), Regs. 118.↩6. See sec. 542, I.R.C. 1954↩, and predecessor section of the 1939 Code.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623488/	J. S. HATCHER, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. A. BARNETT, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Hatcher v. CommissionerDocket Nos. 28742, 28743.United States Board of Tax Appeals18 B.T.A. 632; 1930 BTA LEXIS 2617; January 6, 1930, Promulgated 2617 Guy Mason, Esq., C. R. McAtee, Esq., and Robert A. Littleton, Esq., for the petitioners. Eugene Meacham, Esq., for the respondent. VAN FOSSAN 632 This proceeding is brought to redetermine the deficiencies in income tax of J. S. Hatcher and A. Barnett for the year 1922 in the sums of $566.14 and $12,912.08, respectively. The cases involve the same question and were consolidated for hearing and decision. the petitioners allege that the respondent erred in adding to income the sums of $17,242.55 and $67,295.23, respectively, as alleged dividends received by them in the taxable year. FINDINGS OF FACT. On January 1, 1902, a corporation known as the Barnett Lumber Co. was organized under the laws of the State of Nebraska, under a 633 20-year charter, with capital stock of $100,000, divided into 1,000 shares of the par value of $100 each. Prior to May 19, 1919, Albert Barnett (known in this proceeding as A. Barnett) owned 488 1/3 shares and B. M. Frees owned 511 2/3 shares thereof. On January 1, 1907, a corporation known as the J. S. Hatcher Co. was organized under the laws of the State of Nebraska, under a 25-year charter, with capital2618 stock of $100,000 divided into 1,000 shares of the par value of $100 each. Prior to May 19, 1919, J. S. Hatcher, A. Barnett, and B. M. Frees each owned 333 1/3 shares thereof. On January 3, 1907, a corporation known as the Warren Lumber Co. was organized under the laws of the State of Colorado, under a 20-year charter, with capital stock of $100,000 divided into 1,000 shares of the par value of $100 each. Prior to May 1, 1919, U. J. Warren, A. Barnett, and B. M. Frees each owned 333 1/3 shares thereof. Prior to May 19, 1919, the petitioner, A. Barnett, and B. M. Frees had an understanding that in the event either stockholder desired to withdraw from the Barnett Lumber Co. the other would purchase his stock therein. The record discloses no reference to a similar agreement, as between Barnett and Frees, controlling the disposition of their respective holdings of stock in the other two corporations. Sometime prior to January 1, 1919, the health of Frees became impaired and he indicated his desire to withdraw from all three corporations. Accordingly, he entered into the following contracts with Barnett under date of May 19, 1919. MCCOOK, NEBR., May 19, 1919.Agreement2619 for sale of Stock. This agreement made this 19th day of May, 1919, in triplicate, between B. M. Frees of San Diego, California, party of the first part and A. Barnett, of McCook, Nebraska, party of the second part, witnesseth: - that the party of the first part in consideration of the covenants to be performed by the party of the second part, agrees to sell to said party of the second part Stock as hereinafter described, and subject to the following conditions. Five Hundred Eleven and two-thirds Shares of the Capital stock of the Barnett Lumber Company, McCook, Nebraska. A dividend of thirty per cent on said Capital Stock to be paid January 2nd, 1921. A dividend of thirty per cent on said Capital Stock to be paid January 2nd, 1922. After the said mentioned dividends have been declared and paid the said party of the second part agrees to pay to said party of the first part one hundred five and 69/100 Dollars per share for said stock amounting in all to Fifty Four Thousand Seventy Eight and 5/100 Dollars. Also three hundred thirty three and one-third shares of the capital stock of J. S. Hatcher & Company, of McCook, Nebraska, on the following conditions. A dividend of seven2620 per cent on the capital stock of said company is to be declared and paid January 2nd, 1921. A dividend of seven per cent on the 634 said capital stock is to be paid January 2nd, 1922. After the above described dividends have been declared and paid said party of the second part is to pay to the said party of the first part One Hundred and 90/100 Dollars per share for said stock, amounting in all to thirty three thousand six hundred thirty three and 33/100 Dollars. Also, three hundred thirty three and one-third shares of the capital stock of the Warren Lumber Company of Fort Morgan, Colorado, subject to the following conditions. A dividend of sixty five per cent on the Capital Stock of the said company to be declared and paid January 2nd, 1921. A dividend of sixty five per cent to be declared and paid January 2nd, 1922, and after the above described dividends have been declared and paid the said party of the second part agrees to pay to the said party of the first part One Hundred Seven and 35/100 Dollars per share for said Capital Stock, amounting to Thirty five Thousand Seven Hundred Eighty three and 33/100 Dollars. Also, one hundred and ninety shares of the capital2621 stock of L. W. Cox & Company, of Scottsbluff, Nebraska, subject to the following conditions. A dividend of seventy per cent on Capital Stock to be declared and paid January 2nd, 1921. A dividend of seventy per cent on Capital Stock to be declared and paid January 2nd, 1922. After the above mentioned dividends have been declared and paid said party of the first part agrees to pay to the said party of the second part One Hundred Forty One and 51/100 Dollars per share for said Capital Stock, amounting to Twenty Six thousand eight hundred eighty six and 90/100 Dollars. The said above described payments for stock amounting to One hundred fifty thousand three hundred Eighty one and 61/100 Dollars are to be paid by promissory notes signed by A. Barnett and dated January 3rd, 1922, with interest at six per cent per annum. Said notes are to be dated at McCook, Nebraska, and payable to B. M. Frees at 2700 2nd St., San Diego, California. One for thirty thousand dollars due on or before January 3rd, 1923; one for thirty thousand dollars due on or before January 3rd, 1924; one for thirty thousand dollars due on or before January 3rd, 1925; one for thirty thousand dollars due on or before2622 January 3rd, 1926; and one note for thirty thousand three hundred eighty one and 61/100 Dollars, dated at McCook, Nebraska, January 3rd, 1922, and payable on or before January 3rd, 1927, to B. M. Frees, at 2700 2nd St., San Diego, California, with interest at six per cent per annum from date until paid. B. M. FREES. It is agreed between the party of the first part and the party of the second part that the above described Stocks, together with copy of this contract, are to be placed escrow at the First National Bank, of McCook, Nebraska, to be held by them and delivered to said party of the second part on his complying with the terms of the contract, and on his delivering to said Bank the notes as above described. This contract to be binding upon the parties hereto, their heirs, executors, administrators and assigns. Witness our hands and seals this 19th day of May, 1919. ,Party of the First PartM. R. M. SHERRY, (Witness, Party of the First Part)A. BARNETT, Party of the Second PartM. R. M. SHERRY, (Witness, Party of the Second Part)635 Shortly after the execution of the above contract Barnett entered into contracts with2623 Warren and Hatcher, whereby he would become the owner of an equal amount of capital stock in the Warren Lumber Co. and J. S. Hatcher Co., respectively, upon the withdrawal of Frees from those corporations. Frees died in May, 1920, and thereafter the transactions were carried on with his personal representatives. The stock certificates representing the stock owned by Frees in the three corporations were signed in blank on the date of the above contract and, with the contract, were placed in escrow in the First National Bank at McCook, Nebr. On January 2, 1922, the last so-called dividend was paid and notes were executed pursuant to the terms of the contract of May 19, 1919. The notes aggregated $80,000, less than the amount then contractually due, Frees having withdrawn or borrowed more than the amount of the dividends set forth in the agreement. Thereupon the stock certificates representing the capital stock of Frees as set forth in the said contract were canceled and new certificates issued to the remaining stockholders in proportion to their respective interests. The terms of the agreement of May 19, 1919, were complied with in substance, although payments by bookkeeping2624 intries or otherwise were anticipated in some instances. Frees utilized the Barnett Lumber Co. as a vehicle for carrying on some of his personal transactions. He borrowed money from that corporation and dealt with the Warren and Hatcher Co. by means of entries on the books of the Barnett Co. From May 19, 1919, until January 2, 1921, no payments were made to Frees under the contract of May 19, 1919, but he was paid interest at the rate of 6 per cent from January 1, 1919, on the amounts of his investment in the several corporations. Likewise, he was charged interest on his borrowings or withdrawals from the Barnett Company and indirectly through that company from the two other corporations. The dividends paid to Frees by the three corporations were made from the surplus funds of those companies and practically consumed his share of such funds. No corresponding dividends were declared to the other stockholders in those corporations. Payments of the dividend and interest charges contemplated by the contract of May 19, 1919, were made by appropriate bookkeeping entries on the books of the three corporations. All transactions under that contract were carried on through the2625 three corporations and payments to Frees made thereunder were effected by the corporations either by direct payments, borrowings or withdrawals reflected in proper entries on the books of those corporations. 636 The personal account of Frees on the books of the Barnett Lumber Co. shows the following debit balances: December 31, 1919$178,724.34December 31, 192082,297.44December 31, 192195,776.85During 1922 that account was closed by reason of the credits made to it representing the so-called dividends from surplus declared and paid by the three corporations. In the year 1922 the amount charged to surplus by the Barnett Lumber Co., together with one-half of the amount so charged by the Hatcher and Warren Co., aggregated $69,193.49. Later it was discovered that $3,796.52 of this sum had been paid from surplus accumulated prior to February 28, 1913, and one-half of that amount, or $1,898.26, was deducted from the said surplus charges, leaving the sum of $67,295.23, which was considered by the respondent as income of A. Barnett. Similarly the respondent found that the surplus account of the J. S. Hatcher Co. had been charged with an aggregate2626 of $19,140.81, representing a so-called taxable dividend to Hatcher, but $3,796 thereof had been paid from surplus accumulated prior to February 28, 1913, and one-half of that amount, or $1,898.26, was deducted from the above surplus, leaving the sum of $17,242.45 which was considered by the respondent as income to the said Hatcher. No appropriate resolutions were passed by the several corporations authorizing the payment of the dividends provided for in the contract of May 19, 1919, or of the interest paid to Frees on the amounts invested therein by him. Dividends of 20 per cent and 10 per cent on the capital stock of the Barnett Co. and the Hatcher Co., respectively, were declared on January 3, 1921, and January 17, 1921. Such action was in the period during which the Frees estate received 6 per cent interest on his investment in the several businesses as represented by the capital stock originally owned by Frees. OPINION. VAN FOSSAN: The sole issue in this proceeding is whether or not the amounts paid to the personal representative of B. M. Frees during the year 1922 by the Barnett Lumber Co., the J. S. Hatcher Lumber Co., and the Warren Lumber Co. out of the surplus2627 of those corporations, in proportion to Frees' interests therein, constitute dividends taxable to Barnett and Hatcher because made and used for their benefit. On its face the contract of May 19, 1919, was a personal agreement between B. M. Frees and A. Barnett for the sale of certain 637 stock by the former to the latter. That contract, however, contains provisions impossible of fulfillment without recourse to the rights and powers of the makers as stockholders and officers of the corporations mentioned therein. In order to arrive at a correct interpretation and application thereof it is proper that we consider the relationship of the parties to the contract and other pertinent facts and circumstances which may throw light on the underlying purpose and intention. The evidence shows clearly that Frees desired and intended to withdraw from the Barnett, Hatcher, Warren, and Cox companies his full interest therein. The value of that interest was to be determined by adding his proportionate share of the surplus to the par value of the stock and was to be paid to him in installments. The value of the interest of the remaining stockholders in those corporations after his2628 withdrawal remained the same as before. In order to effect such purpose Frees and Barnett entered into the contract of May 19, 1919, as embodying the plan by which it could be accomplished most effectively. Other interested stockholders of the corporations mentioned therein acquiesced in the arrangements and assisted in carrying them out. Certain intracorporate informalities in procedure were cured by the agreement, express and implied, of all stockholders. Dividend distributions were made neither ratably nor by the proper and usual methods governing corporate actions. We have held, however, that such irregularities will not affect the taxable status of those benefited thereby unless the rights of third persons are impaired (), and that by unanimous agreement among the stockholders of the corporation the profits may be divided and distributed other than ratably among the stockholders. (.) While the contract of May 19, 1919, in its terms was a personal one between Frees and Barnett, yet it is apparent that it was utilized, and probably intended, as a means of acquiring on behalf2629 of the several corporations the interest in them owned by Frees. Shortly after May 19, 1919, Barnet entered into contracts with Warren and Hatcher in accord with that purpose. The bookkeeping entries show that the corporations paid to Frees the approximate amount of his proportion of the surplus on hand on January 1, 1919. During the period from January 1, 1919, to January 1, 1922, Frees and his personal representatives borrowed and received advances of considerable sums from the several corporations. During 1922 the several corporations completed the payments from surplus as contemplated by the contract of May 19, 1919, and later the 638 deferred purchase money notes were paid in full to the Frees estate. So far as the record shows, all payments for Frees' stock in the corporation were made from the funds of those companies. The cancellation of the old Frees' stock certificates and the issuance of new certificates to the remaining stockholders in the three corporations did not serve to increase the value of their holdings. Each stockholder merely owned more shares of stock, worth in the aggregate, however, the same as before the disposal of the Frees stock. Whatever*2630 gain or profit from this transaction was derived accrued to Frees or to his estate. In their capacity as stockholders in the corporations, Barnett and Hatcher received no taxable dividends therefrom under the contract of May 19, 1919, or through Frees' withdrawal from the companies. Their financial status was not changed. They held a larger proportionate interest in a small aggregate of assets. They neither gained nor lost by the transaction. In our opinion, the method employed to accomplish Frees' withdrawal from the Barnett Lumber Co., the J. S. Hatcher Lumber Co., and the Warren Lumber Co. did not result in taxable gain to the petitioners. Reviewed by the Board. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623489/	JAMES P. CARR and YVONNE C. CARR, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentCarr v. CommissionerDocket Nos. 7668-79, 1532-80.United States Tax CourtT.C. Memo 1981-289; 1981 Tax Ct. Memo LEXIS 453; 42 T.C.M. (CCH) 77; T.C.M. (RIA) 81289; June 15, 1981. James P. Carr, pro se. James A. Nelson, for the respondent. FEATHERSTONMEMORANDUM OPINION FEATHERSTON, Judge: Respondent determined deficiencies in petitioners' Federal income taxes for 1977 and 1978 in the respective amounts of $ 380 and $ 309.52. The issue for decision is whether petitioners, in applying the income averaging provisions to determine their liabilities for 1977 and 1978, were required to compute "base period income" for each of the years prior to 1977 by increasing taxable income for those years in the amount of $ 3,200 as directed by section 1302(b)(3). 454 1The facts are stipulated. At the time the petitions in these consolidated cases were filed, petitioners James P. Carr and Yvonne C. Carr were legal residents of Tacoma, Washington. They filed their joint Federal income tax returns for 1977 and 1978 with the Ogden Service Center, Ogden, Utah. Petitioners employed the income averaging provisions of sections 1301 through 1305 in computing their tax liabilities for 1977 and 1978. In computing their "base period income" for each year prior to 1977 included in the base period, however, petitioners failed to increase taxable income for each such prior year by the amount of petitioners' zero bracket amount ($ 3,200) 2 for the taxable year as directed by section 1302(b)(3). That section in the form in which it was in effect in 1977 and 1978 is as follows: (3) Transitional rule for determining base period income.--The base period income * * for any taxable year beginning before January 1, 1977, shall455 be increased by the amount of the taxpayer's zero bracket amount for the computation year. Respondent determined that the zero bracket amount ($ 3,200) increase in taxable income for pre-1977 years was required and, on that ground, determined the disputed deficiencies. Petitioners have not filed a brief but stated when the case was submitted that they rely upon the allegations in their petitions. Their petitions appear to recognize that the language of section 1302(b)(3) prescribes the increase, but alleges that the effect of the section is to lay a "selective and discriminatory tax increase" in 1977 and the 3 following years for those individuals, including petitioners, who itemized deductions in prior years (base period years) and qualified for income averaging under section 1302. The petitions allege that Congress did not intend such discrimination. We must sustain respondent's determination. Basically, the income averaging method involves 5 taxable years--the "computation year" for which the tax is calculated and the "base period years" which are the immediately preceding 4 taxable years. The first step, the one which is here in dispute, in applying the method is the456 determination of "averageable income," i.e., the excess of the current year's taxable income over a base amount. In general terms, the base amount is 120 percent of the average taxable income for the 4 base period years. Under section 1302(b)(3), quoted above, in computing the averageable taxable income for the base period years, the taxable income for each pre-1977 base period year is increased by the taxpayer's zero bracket amount for the current computation year. This increase in pre-1977 base period years was required because it was thought to be the most practical method of making pre-1977 taxable incomes comparable to post-1976 taxable incomes, which are determined by taking the zero bracket amount into account. S. Rept. No. 95-66 (1977), 1 C.B. 484">1977-1 C.B. 484, accompanying the Tax Reduction Act of 1977, Pub. L. 95-30, 91 Stat. 127, which initiated the zero bracket concept, explains: Income averaging.--The bill's change in the definition of taxable income also requires technical adjustments in the Code provisions for income averaging. In order to leave taxpayers in a position similar to that which they would occupy if the definition of taxable income were not457 changed by the bill, their taxable income must be adjusted for years prior to those beginning in 1977, when the change in the definition of taxable income becomes effective. The simplest method for giving taxpayers essentially the same access to and the same advantages from income averaging as they enjoy under present law is to increase their pre-1977 base period taxable income, that is, their taxable income for taxable years beginning in 1973, 1974, 1975, and 1976, by their zero bracket amount. Although the zero bracket amount added to the pre-1977 taxable income generally exceeds a taxpayer's standard deduction for each of those years, the use of a single flat amount is simpler than determining four separate standard deductions. Furthermore, any lost tax savings to a taxpayer because of adding in the zero bracket amount instead of a standard deduction results in only a slightly higher taxable income, and after averaging, will involve only a deminimis amount, probably well under $ 20. By making the adjustments backwards to prior years, the need for these adjustments will eventually disappear as present law taxable income years (that is, taxable years before 1977) drop458 from the four base years. In addition, this adjustment will prevent an undesirable one-time surge in the number of taxpayers eligible for income averaging in 1977. If no adjustment were made for pre-1977 years, not only would the taxpayer using averaging in 1977 have a higher averageable income, but more taxpayers would be artificially eligible because they would be comparing new taxable income from which no reduction for a standard deduction has been made, with the present law taxable income for four prior years when taxable income was reduced by a standard deduction. We conclude from this explanation in the Senate committee report that petitioners are mistaken in their contention that Congress did not intend to require the adjustment prescribed by the language of section 1302(b)(3). The Congress decided, this report indicates, that "the use of a single flat amount [the zero bracket amount] is simpler than determining four separate standard deductions." The report also shows that section 1302(b) would deny some taxpayers the full benefit of income averaging during a limited period but the conclusion was that any "lost tax savings to a taxpayer because of adding in the zero459 bracket amount instead of a standard deduction" would result in a deminimis tax increase. This judgment is one for the Congress, not the courts, to make. If petitioners intended to allege in their petitions that section 1302(b)(3) is unconstitutional, we think they are also mistaken in that position. "The power of Congress in levying taxes is very wide, and where a classification is made of taxpayers that is reasonable, and not merely arbitrary and capricious, the Fifth Amendment can not apply." Barclay & Co. v. Edwards, 267 U.S. 442">267 U.S. 442, 450 (1924); Barr v. Commissioner, 51 T.C. 693">51 T.C. 693, 695 (1969). The income averaging provisions are intended to ameliorate the effect of the progressive tax rates on fluctuating incomes. The transitional rules of the section, required because of the redefinition of taxable income occasioned by the adoption of the zero bracket concept, apply to all taxpayers alike who utilize the income averaging provisions. They are designed only to cover the pre-zero bracket years falling in the base period. We think the explanation quoted above from the Senate committee report shows clearly that the provisions are not arbitrary460 and capricious. To reflect the foregoing, Decisions will be entered for the respondent. Footnotes1. All section references are to the Internal Revenue Code of 1954, as in effect during the tax years in issue, unless otherwise noted.↩2. See sec. 63(d) in the form in which it applied to taxable years beginning before Jan. 1, 1979.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623490/	GLORIA J. GOODSMAN, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent; JAMES R. GOODSMAN AND MARILYN E. GOODSMAN, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentGoodsman v. CommissionerDocket Nos. 24229-81, 24912-81.United States Tax CourtT.C. Memo 1985-596; 1985 Tax Ct. Memo LEXIS 29; 51 T.C.M. (CCH) 64; T.C.M. (RIA) 85596; December 10, 1985. 29 Held: Petitioner in docket No. 24229-81 contributed the majority of the support for her two children in 1978, and, therefore, is entitled to two dependency exemptions. Held further, petitioners in docket No. 24912-81 are not entitled to the two dependency exemptions in issue. Joseph Falcone, for the petitioner in docket No. 24229-81. Michael Oesterle, for the petitioners in docket No. 24912-81. Roberta M. Hamm, for the respondent. WHITAKERMEMORANDUM FINDINGS OF FACT AND OPINION WHITAKER, Judge: Respondent determined a deficiency in the Federal income tax30 of Gloria J. Goodsman (docket No. 24229-81) for the calendar year 1978 in the amount of $321.00. The deficiency determined for the calendar year 1978 in the Federal income tax of petitioners James R. Goodsman and Marilyn E. Goodsman (docket No. 24912-81) is in the amount of $565.00. The two cases were consolidated for trial, briefing, and opinion. The deficiencies arise out of the fact that Mrs. Gloria J. Goodsman and petitioners James R. and Marilyn E. Goodsman each claimed dependency exemptions for the two children of Mrs. Gloria J. Goodsman (Mrs. Goodsman) and her former husband Mr. James R. Goodsman (Goodsman). They were divorced in 1976. For convenience our Findings of Fact and Opinion are combined. Some of the facts have been stipulated and are so found. At the time each petition in this case was filed, all petitioners were residents of Ypsilanti, Michigan. A divorce decree awarded custody of the two children to Mrs. Goodsman and they resided with her in her residence in Ypsilanti during the entire year of 1978. She, therefore, is the custodial parent. At that time the children were, respectively, ages 9 and 7. Goodsman was required by the decree of divorce to pay31 child support for the two children and to make other payments for their benefit. During the year 1978 he paid the total sum of $4,212 for the benefit of both children or $2,106 per child. Under section 152(e)(2)(B), 1 as in effect for the year 1978, a noncustodial parent who provides $1,200 or more for support of a child during a calendar year is entitled to claim that child as a dependent unless the custodial parent clearly establishes that he or she has provided more for the support of the child during the year than the noncustodial parent. The parties have stipulated that Goodsman paid $2,106 for the support of each of the two children, which is more than $1,200 each. Therefore, he is entitled to claim each child as a dependent unless Mrs. Goodsman has "clearly established" that she provided more than $2,106 of the support for each child during the year. This is the factual issue for our determination. It largely depends on whether or not it is appropriate to take into account the fair rental value of the house occupied during the year by Mrs. Goodsman and the children as a contribution by her to the support of the children. Respondent is essentially a stake holder. 32 The residence was the joint residence of Mrs. Goodsman and Goodsman immediately prior to the divorce and we assume, although it is not clear on this record, that title to the house was in their names as joint tenants with right of survivorship. In any event, the decree of divorce converted the title into their names as tenants in common but provided that Mrs. Goodsman: Shall hereafter have the sole right of possession of said premises with no other permanent occupants or residents other than cross-plaintiff [Mrs. Goodsman] and children so long as she pays all maintenance, taxes and insurance, and mortgage payments on the same. Said property shall at such time as [Mrs. Goodsman] remarries, the youngest child reaches 18 or the wife vacates the property, be sold and the proceeds from such sale shall be divided equally between the parties. With respect to property owned as tenants in common, the normal rule is that each co-owner is considered to have contributed support equally, neither parent being entitled to claim the fair rental value. ; . This33 Court has recognized an exception to this rule where the divorce decree provides that the custodial parent is entitled to exclusive use and occupancy of the residence. In such case, the custodial parent is deemed to have contributed to the support of each child that portion of the entire rental value of the residence allocable to each. . Counsel for Goodsman seeks to distinguish Bruner on the basis of and . We do not agree that either Carter or Godier are applicable to the facts of this case. In Godier there was at best an oral agreement as to the use of the residence by the custodial parent until such time as the property was sold. In Carter, legal title to the residence was vested in the noncustodial parent by the divorce decree. We applied Oklahoma law and determined that in that circumstance the residence was furnished by the noncustodial parent as support for the children. Neither case is on point. We, therefore, conclude that Mrs. Goodsman is entitled to claim a pro rata part34 of the full rental value of the house as part of the support furnished by her for the benefit of the two children. Based on the testimony of Mrs. Goodsman's expert, we find that the fair rental value of the house in 1978, unfurnished with a tenant paying the cost of utilities, was between $500 and $525. For a furnished house, the rental would have been $600 to $625. Under the divorce decree, almost all of the furniture and furnishings were awarded to Mrs. Goodsman; hence, the house must be treated as furnished. We conclude that the rental value in 1978 was $600 a month plus utilities. The parties have stipulated that during 1978 Mrs. Goodsman paid $305.76 for electricity, $409.82 for 11 months of gas, and $76.95 for water and sewer service. However, there was no evidence as to the actual amount of the November payment to Michigan Consolidated Gas Company. As we are entitled to do under , we estimate that the November gas bill would have been the average of the months of October and December or the sum of $29.87. Thus, the total payments for utilities during the year 1978 were $822.40 and the rental value plus35 utilities amounts to $8,022.40. Since on this record the total lodging costs are allocable equally to the three persons residing in the house, the value of lodging furnished to each child by Mrs. Goodsman is the sum of $2,675. 2 The parties have further stipulated that Mrs. Goodsman paid to Michigan Bell Telephone Company during the year a total sum of $352.93. Since each of the monthly bills varied substantially, there must be toll charges included with the basic telephone service costs. We have no evidence, however, as to what those costs are nor do we have any evidence as to the extent to which the telephone may have been necessary or desirable for children ages 7 and 9. We, therefore, decline to consider the payments for telephone service as part of the utilities furnished with the house. The testimony reflects that food for the custodial parent and the two children cost approximately $60 per week or $3,120 per year.The children during the year 1978 did spend some time with the noncustodial parent. Thus, we find that $900 per child per year was spent for food, school lunches, and away from home meals. Clothing, including dry cleaning, we estimate for each child at $400 per36 year and hair cuts, allowances, and other miscellaneous expenses at $75 per child. Vacation and recreational expenses were incurred for each child in the estimated amount of $250 per year. Finally, in the case of the son, an additional $120 was incurred for rental of a musical instrument. Thus the total support for each child paid by Mrs. Goodsman during the year 1978 was in the case of the daughter not less than $4,300 and in the case of the son not less than $4,420. 3 Mrs. Goodsman has thus clearly established that during the year 1978 she provided more support for each of her two children without taking into account the fact that the county provided health insurance for her and for the two children as part of her salary as a school teacher. It is unclear whether or not this element should be taken into account, but it is immaterial in this case. Mrs. Goodsman is entitled to claim both children as dependents for the year 1978. *37 Decision will be entered for the petitioner in docket No. 24229-81.Decision will be entered for the respondent in docket No. 24912-81.Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended and in effect during the year in issue, and all rule references are to the Tax Court Rules of Practice and Procedure.↩2. The fact that Mrs. Goodsman paid the mortgage and insurance on the house is not taken into account since these items are included within the fair rental value. She also testified that maintenance amounted to approximately $100 and she may well have incurred costs for lawn care, etc. We have taken those facts into account in determining the fair rental value. ↩3. We have used our best judgment, based upon the record, to arrive at these amounts, making "as close an approximation" as we could, "bearing heavily" against petitioner Mrs. Gloria J. Goodsman, all in accordance with .↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623491/	GARY J. SMITH, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentSmith v. CommissionerDocket No. 6838-78.United States Tax CourtT.C. Memo 1979-315; 1979 Tax Ct. Memo LEXIS 211; 38 T.C.M. (CCH) 1224; T.C.M. (RIA) 79315; August 14, 1979, Filed 211 Gary J. Smith, pro se. Thomas G. Hodel, for the respondent. FEATHERSTONMEMORANDUM OPINION FEATHERSTON, Judge: Respondent determined the following deficiencies and additions to tax for 1975 and 1976: IncomeAdditions to Tax YearTaxSec. 6654Sec. 6653(a)Sec. 6651(a)1975$1,108$ 55.40$ 24.1119762,785$79.21139.25608.50The notice of deficiency is based on a determination that petitioner "had net income from wages in 1975 and 1976 of $8,083.31 and $14,263.06 respectively from Fountain Sand and Gravel Co.", none of which was reported in proper income tax returns for those years. The Court was careful to explain to petitioner that the burden of proof rested with him to establish that the notice of deficiency was erroneous, but he offered no evidence to show that respondent erred in determining the amount of his income or deductions or in determining the additions to tax. Petitioner has failed to carry his burden of proof. Welch v. Helvering,290 U.S. 111">290 U.S. 111, 115 (1933). The petition consists in large part of isolated sentences quoted from numerous Supreme Court opinions. Most of212 the quotations deal with the privilege against self-incrimination guaranteed by the Fifth Amendment to the Constitution. Petitioner's contention that the proceeding before this Court violated such a privilege is without merit. He was informed by respondent's counsel that, to counsel's knowledge, no criminal proceedings against petitioner are in progress. This action was instituted by petitioner ostensibly to determine his income tax liability, and an apparently baseless claim of the Fifth Amendment privilege cannot stand in the way of making that determination. See Hartman v. Commissioner,65 T.C. 542">65 T.C. 542, 547 (1975); Figueiredo v. Commissioner,54 T.C. 1508">54 T.C. 1508, 1513 (1970). Finally, at the trial petitioner devoted most of his time to an attack upon the jurisdiction of the Court to hear and decide his case. There is no merit in his argument in this respect. Burns, Stix Friedman & Co., Inc. v. Commissioner,57 T.C. 392">57 T.C. 392 (1971). To reflect the foregoing, Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623492/	H. Dale Gunther and Marie M. Gunther, Gene W. Gunther and Lois H. Gunther, James L. Bjorkman and Penelope A. Bjorkman, Peter C. Gunther and Mary Lou Gunther, Donald S. Robinson and Pamela G. Robinson, Prudence G. Hillier, and Gary B. Gunther, Petitioners v. Commissioner of Internal Revenue, RespondentGunther v. CommissionerDocket No. 11115-84United States Tax Court92 T.C. 39; 1989 U.S. Tax Ct. LEXIS 5; 92 T.C. No. 5; January 19, 1989; As amended February 2, 1989 January 19, 1989, Filed 5 Decision will be entered for the petitioners. Petitioners controlled corporations C and B. Petitioners transferred to C all of their B stock and received in return securities (11-year debentures) and C stock. Held, sec. 351, I.R.C. 1954, operates to preclude application of sec. 301 dividend treatment; under sec. 351(a), petitioners' gains on the transactions are not recognized. Haserot v. Commissioner, 41 T.C. 562 (1964), and 46 T.C. 864">46 T.C. 864 (1966), affd. sub nom. Commissioner v. Stickney, 399 F.2d 828 (6th Cir. 1968), followed. James M. Neis, Thomas P. Fitzgerald, and Susan Cisle, for the petitioners.Warren P. Simonsen, for the respondent. Chabot, Judge. Nims, Parker, Whitaker, Korner, Shields, Hamblen, Cohen, Swift, Williams, Wells, Whalen, and Colvin, JJ., agree with the majority opinion. Parr, J., concurring. Gerber and Williams, JJ., agree with this concurring opinion. Wright, J., dissenting. Clapp, Jacobs, and Ruwe, JJ., agree with this dissent.6 CHABOT39 Respondent determined deficiencies in Federal individual income tax against petitioners for 1981 as follows: 40 PetitionersDeficiencyH. Dale Gunther and Marie M. Gunther$ 185,019Gene W. Gunther and Lois H. Gunther185,353James L. Bjorkman and Penelope A. Bjorkman1,200Peter C. Gunther and Mary Lou Gunther1,372Donald S. Robinson and Pamela G. Robinson1,609Prudence G. Hillier651Gary B. Gunther4,479After concessions by respondent, 1 the issue for decision is whether an exchange of stock held by petitioners in Galesburg Builders Supply Co. (hereinafter sometimes referred to as Builders) for stock and corporate debentures in Gunther Construction Co. (hereinafter sometimes referred to as Construction) is a transaction governed by sections 304, 302, and 301 or by section 351.7 FINDINGS OF FACTSome of the facts have been stipulated; the stipulations and the stipulated exhibits are incorporated herein by this reference.When the joint petition was filed in the instant case, all the petitioners resided in Galesburg, Illinois.Petitioners H. Dale Gunther (hereinafter sometimes referred to as Dale) and Gene W. Gunther (hereinafter sometimes referred to as Gene) are brothers. 2 Penelope A. Bjorkman, Peter C. Gunther, Pamela G. Robinson, and Prudence G. Hillier are Dale's children. Gary B. Gunther and Linda Gunther are Gene's children. Although Linda Gunther was also involved as a participant in the transaction in issue, she is not a petitioner in the instant case. (Dale, Dale's children, Gene, and Gene's children are hereinafter sometimes referred to collectively as the Gunthers.)8 Both Construction and Builders are Delaware corporations; each has its office and principal place of business at Galesburg, Illinois. Since about 1920, Construction or its 41 predecessor has been engaged in the highway and heavy construction business, while Builders or its predecessor has been engaged in the building supply business. Construction, which generally operates within a 60-mile radius of Galesburg, does both asphalt paving and concrete construction. Builders' principal product is ready-mixed concrete.At all relevant times, Construction's directors were Gene, Dale, Lois H. Gunther, and Marie M. Gunther. At all relevant times, Construction's officers were as follows:PresidentGeneVice presidentDaleSecretaryPeter C. GuntherTreasurerGeneAssistant secretary/controllerRobert T. FultonRobert T. Fulton (hereinafter sometimes referred to as Fulton), Construction's chief financial officer, is unrelated to the Gunthers and has never owned any stock in Construction or Builders.About 25 percent (and sometimes as much as 40 percent) of Construction's revenues were attributable to projects that required quality ready-mixed concrete. Builders was Construction's9 sole source of quality ready-mixed concrete. If Construction did not have a ready and dependable supplier of quality ready-mixed concrete, then Construction would have been precluded from successfully bidding on projects requiring the use of concrete. Not only would this have allowed competitors to perform the concrete portion of projects requiring both ready-mixed concrete and asphalt, but in Fulton's opinion would have put Construction at a competitive disadvantage when bidding against asphalt paving contractors.During 1981, Construction was Builders' largest customer, accounting for about 15 percent of Builders' revenues.Late in the summer of 1980, Dale, Gene, and Fulton met to discuss the financial condition of both Construction and Builders. At that time, Builders was losing money. The three of them concluded that Builders' economic viability was threatened by declining sales and diminishing profit margins resulting from the rapid deterioration of the Galesburg economy as well as from increased competition. 42 To ensure Builders' survival, to assure Construction of a reliable source of quality ready-mixed concrete, and to facilitate working capital infusions, Dale, 10 Gene, and Fulton determined that it would be in the best interests of both companies to reorganize the companies and make Builders a wholly owned subsidiary of Construction.In December 1980, Fulton, on behalf of Construction, engaged Construction's independent auditors and tax consultants, Peat, Marwick, Mitchell & Co. (hereinafter sometimes referred to as PMM) to determine the structure and to implement the proposed reorganization. Fulton had been employed in PMM's audit division at their Peoria and Galesburg, Illinois, offices for 5 years before joining Construction; he participated in the meetings with PMM. James D. Stuckey of PMM recommended to Fulton that Builders' shareholders transfer their Builders stock to Construction in exchange for stock and debentures in Construction. PMM advised Fulton that such an exchange was tax free under section 351.Before January 2, 1981, the outstanding stock in Builders was held as shown in table 1. 3Table 1NumberPercentageIndividualof sharesType of stockownershipDale650.0000 Common50 Gene650.0000 Common50 Gary B. Gunther13.4275 Class A preferred25 18.5725 Class B preferred25 Linda Gunther13.4275 Class A preferred25 18.5725 Class B preferred25 Pamela G. Robinson6.71375Class A preferred12.59.28625Class B preferred12.5Penelope A. Bjorkman6.71375Class A preferred12.59.28625Class B preferred12.5Peter C. Gunther6.71375Class A preferred12.59.28625Class B preferred12.5Prudence G. Hillier6.71375Class A preferred12.59.28625Class B preferred12.511 43 Before January 2, 1981, the outstanding stock in Construction was held as shown in table 2.Table 2NumberPercentageIndividualof sharesType of stockownershipDale738.0000 Common50 Gene738.0000 Common50 Gary B. Gunther13.4275 Class A preferred25 11.1425 Class B preferred25 Linda Gunther13.4275 Class A preferred25 11.1425 Class B preferred25 Pamela G. Robinson6.71375Class A preferred12.55.57125Class B preferred12.5Penelope A. Bjorkman6.71375Class A preferred12.55.57125Class B preferred12.5Peter C. Gunther6.71375Class A preferred12.55.57125Class B preferred12.5Prudence G. Hillier6.71375Class A preferred12.55.57125Class B preferred12.512 Only the owners of the common stock of Builders and Construction had voting rights. The Class A and Class B preferred stock of each corporation were nonvoting.On January 2, 1981, Construction had earnings and profits of more than $ 569,000, and Builders had earnings and profits of $ 527,998. On that date, Builders' shareholders exchanged all of their Builders stock for the amounts and classes of Construction stock shown in table 3.Table 3NumberIndividualof sharesType of stockDale12.0000 CommonGene12.0000 CommonGary B. Gunther13.4275 Class A preferred.5000 Class B preferredLinda Gunther13.4275 Class A preferred.5000 Class B preferredPamela G. Robinson6.71375Class A preferred.25000Class B preferredPenelope A. Bjorkman6.71375Class A preferred.25000Class B preferredPeter C. Gunther6.71375Class A preferred.25000Class B preferredPrudence G. Hillier6.71375Class A preferred.25000Class B preferred44 In addition to the above stock, Builders' shareholders also received, in exchange for all of their Builders stock, 17-percent debentures issued by Construction due 11 years and 1 day from the date of issuance, 13 January 2, 1981. 4 The debentures were issued in the face amounts shown in table 4.Table 4IndividualAmount of debentureDale$ 270,000Gene270,000Gary B. Gunther7,250Linda Gunther7,250Pamela G. Robinson3,625Penelope A. Bjorkman3,625Peter C. Gunther3,625Prudence G. Hillier3,6255 569,000No other property or cash was distributed to Builders' shareholders. No liabilities were transferred to Construction by any transferor. After the transfer on January 2, 1981, the outstanding stock in Construction was held as shown in table 5.Table 5NumberPercentageIndividualof sharesType of stockownershipDale750.0000 Common50 Gene750.0000 Common50 Gary B. Gunther26.8550 Class A preferred25 11.6425 Class B preferred25 Linda Gunther26.8550 Class A preferred25 11.6425 Class B preferred25 Pamela G. Robinson13.42750Class A preferred12.55.82125Class B preferred12.5Penelope A. Bjorkman13.42750Class A preferred12.55.82125Class B preferred12.5Peter C. Gunther13.42750Class A preferred12.55.82125Class B preferred12.5Prudence G. Hillier13.42750Class A preferred12.55.82125Class B preferred12.514 45 At the time of the transaction on January 2, 1981, Construction and Builders intended to continue operating their respective businesses in the same manner in which the businesses were conducted before the date the transaction was contemplated.Petitioners did not report any gain or loss from the exchange of the Gunthers' stock in Builders for stock and debentures in Construction. Construction has paid the interest payments on the debentures to the Gunthers when due, and petitioners have reported the interest payments as taxable income15 in the year received.The January 2, 1981, transaction was essentially equivalent to a dividend.OPINIONRespondent contends that the exchange of stock in Builders for stock and debentures in Construction was a redemption through the use of a related corporation under section 304, and that the face amount of the debentures was essentially equivalent to a dividend under section 302. Accordingly, respondent determined that the debentures that Construction distributed to the Gunthers constituted dividends in the face amounts of the debentures, as shown in table 6.Table 6PetitionersAmountsH. Dale Gunther and Marie M. Gunther$ 270,000Gene W. and Lois H. Gunther270,000James L. Bjorkman and Penelope A. Bjorkman3,625Peter C. Gunther and Mary Lou Gunther3,625Donald S. Robinson and Pamela G. Robinson3,625Prudence G. Hillier3,625Gary B. Gunther7,250Petitioners contend that the exchange of stock, for stock and debentures, was tax free under section 351. In making this assertion, petitioners contend that existing case law, the legislative history of sections 304 and 351, and general principles of statutory construction show that when a 46 transaction16 falls within both sections 304, 302, and 301 (on the one hand), and section 351 (on the other hand), then section 351 overrides sections 304, 302, and 301.We agree with petitioners.Section 3046 provides that, under certain circumstances, the purported sale of a taxpayer's stock to a corporation that the taxpayer controls is to be treated as a distribution 47 in redemption of the acquiring corporation's stock. In order for section 304 to require this result, both of two conditions must be present. Firstly, one or more persons must have been in "control" of each of the two corporations. Sec. 304(a)(1)(A). Secondly, one of the corporations, in exchange for property, must have acquired stock in the other corporation from the person so in control. Sec. 304(a)(1)(B).17 "Control" is defined in section 304(c)(1) as the ownership of stock possessing at least 50 percent of the total combined voting power of all classes of stock entitled to vote or at least 50 percent of the total value of shares of all classes of stock. Section 304(c)(2) expressly provides that the section 318(a)7 attribution rules relating to the constructive ownership of stock apply in determining whether control is present.18 With respect to both Construction and Builders, Gene and Dale each owned 50 percent of the common voting stock, while the remaining shareholders, all of whom were the children of either Gene or Dale, are considered to own by attribution the 50-percent stock interest owned by their 48 respective fathers. Sec. 318(a)(1)(A)(ii). Similarly, Gene and Dale are considered to own by attribution the stock owned by their respective children. Sec. 318(a)(1)(A)(ii). Because the Gunthers had control of both Construction and Builders, we conclude that the first condition, as set forth in section 304(a)(1)(A), has been satisfied.We also conclude that the second condition, as set forth in section 304(a)(1)(B), has been satisfied. That section requires that, in exchange for "property", 8 one of the corporations acquire stock in the other corporation from the person so in control. In the instant case, Construction, in exchange for property (debentures), acquired the stock of Builders from the Gunthers, the persons in control of both corporations.19 The tax consequences of a section 304(a)(1) redemption are governed by section 302. 920 Section 302(a) provides that if a 49 redemption of stock meets any of the tests provided in section 302(b), the redemption shall be treated as a distribution in exchange for stock. If none of the tests of section 302(b) is met, then section 302(d) applies to treat the redemption as a distribution under section 301. 10 Under section 301, the distribution is to be treated as ordinary income to the extent of the distributing corporation's earnings and profits. (Sec. 301(c); sec. 316(a). 11)21 Under section 302(a), a redemption is treated as a distribution in exchange for stock where: (1) It is not essentially equivalent to a dividend (sec. 302(b)(1)); (2) the distribution is substantially disproportionate with respect to the shareholder (sec. 302(b)(2)); or (3) the redemption is in complete redemption of all of the stock of the corporation owned by the shareholder (sec. 302(b)(3)). In applying section 302(b), section 304(b)(1) provides that reference is to be made to each shareholder's ownership of the stock in the issuing corporation, in this case Builders, and that the attribution rules of section 318 apply. 12Sec. 302(c); sec. 304(b)(1).22 50 Section 302(b)(1) applies to a redemption if it "is not essentially equivalent to a dividend." As we recently stated, in Cerone v. Commissioner, 87 T.C. 1">87 T.C. 1, 18 (1986) --in United States v. Davis, 397 U.S. 301">397 U.S. 301 (1970) * , the Supreme Court held that: (1) The constructive ownership rules of section 318 apply to dividend equivalency determinations under section 302(b)(1); (2) redemptions of stock held by a sole shareholder, including a "constructive" sole shareholder, are always essentially equivalent to a dividend under section 302(b)(1); (3) business purpose is irrelevant in determining dividend equivalency under section 302(b)(1); and (4) in order to avoid dividend equivalency, the redemption must result in a "meaningful reduction" in the shareholder's proportionate interest in the corporation.In the instant case, before the redemption, each of the shareholders owned directly or through attribution 50 percent of Builders voting stock. Pursuant to section 318(a)(1), Dale's 50-percent common voting stock interest in Builders is attributed to each of Dale's children, and Gene's 50-percent common voting stock23 interest in Builders is attributed to each of Gene's children. After the redemption, the same shareholders through attribution continued to own 50 percent of Builders' voting stock. Construction actually owned 100 percent of Builders common voting stock. Dale and Gene each actually owned 50 percent of Construction common voting stock. Pursuant to sections 304(b)(1) and 318(a)(2)(C), one-half of Construction's 100-percent ownership interest in Builders voting stock is attributed to Dale and the other half to Gene. Pursuant to sections 318(a)(1) and 318(a)(5)(A), Dale's and Gene's 50-percent constructive ownership interests in Builders are reattributed to each of their respective children. Both before and after the redemption, the same shareholders, actually or constructively, owned 50 percent of Builders voting stock. Thus, each shareholder retained the same amount of control over Builders. No one shareholder obtained control over Builders following the redemption. The parity of control between the shareholders remained the same. There was no meaningful reduction in 51 any shareholder's interest. We conclude that the redemption is essentially equivalent to a dividend24 under section 302(b)(1). See Estate of Schneider v. Commissioner, 88 T.C. 906">88 T.C. 906, 943-944 (1987), affd. 855 F.2d 435">855 F.2d 435 (7th Cir. 1988); Niedermeyer v. Commissioner, 62 T.C. 280">62 T.C. 280 (1974), affd. 535 F.2d 500">535 F.2d 500 (9th Cir. 1976).The instant case does not come within either of the specific "safe harbor" provisions of paragraphs (2) and (3) of section 302(b). Section 302(b)(2) requires, inter alia, that the shareholder own less than 50 percent of the total combined voting power of all classes of stock entitled to vote. Section 302(b)(3) requires a complete redemption of all the stock owned by the shareholder. As previously discussed, each shareholder constructively owned 50 percent of Builders stock after the redemption. Consequently, we conclude that the redemption does not meet the requirements of either paragraph (2) or paragraph (3) of section 302(b). 1325 Because the redemption of stock in this case does not come within the provisions of any of the paragraphs of section 302(b), section 302(d) treats the redemption as a distribution of property to which section 301 applies. Section 301(c)(1) provides that "That portion of the distribution which is a dividend (as defined in section 316) shall be included in gross income." Under section 301(b)(1)(A), the amount of any distribution to a noncorporate shareholder is equal to the amount of money received, plus the fair market value of other property received. Section 316 in turn defines a dividend as any distribution of property made by a corporation to its shareholders from current or accumulated earnings and profits. See note 11, supra. Section 304(b)(2)(A) states that the determination of the amount which is a dividend is made by reference to the earnings and profits of the acquiring corporation (which in the instant case is Construction). The parties have stipulated, and we have 52 found, that Construction's earnings and profits exceeded $ 569,000 at the time of the transfer, and the fair market value of the debentures at the time of their issuance totaled $ 398,300. Thus, 26 respondent's position is that the combined operations of sections 301, 302, 304, 316, and 318 call for dividend treatment with respect to the debentures that the Gunthers received from Construction. 1427 Petitioners, however, assert that the exchange of Builders stock for stock and debentures in Construction is governed by section 351 and further argue that the Congress did not intend for section 304 to apply to transactions also falling within section 351.Section 351(a) provides that no gain or loss shall be recognized if (1) property is transferred to a corporation by one or more persons solely in exchange for stock or securities in that corporation and (2) immediately after the exchange the transferors of the property are in control of the corporation. 15 For purposes of section 351, "control" means ownership of stock possessing at least 80 percent of the combined voting power of all classes of stock entitled to vote and at least 80 percent of the total number of shares of all other classes of stock of the corporation. Sec. 351(a); sec. 368(c). 1629 In the instant case, one or more persons (the Gunthers) transferred property (Builders stock) to a controlled 53 corporation (Construction) solely in exchange for stock and securities (11-year debentures) in the controlled corporation. Where there is more than one transferor of property, as was the case here, the transaction28 will qualify under section 351 if the transferors as a group are in control of the corporation immediately after the exchange. Accordingly, we conclude that the transaction before us here also falls within the parameters of section 351. 17This brings us to the issue of whether the literal language of section 351 operates to preclude dividend treatment under section 301. Petitioners, relying on the legislative history of section 351, emphasize that the predecessor of section 351 originated in the Revenue Act of 1921 for30 the express purpose of permitting business to go forward with the readjustments required by existing business conditions. Cf. S. Rept. 67-274, at 11-12 (1921), 1939-1 C.B. (Part 2) 181, 187. They contend that the Gunthers have done nothing more than change the form of their investment in Builders. Further, petitioners argue that the "except" clauses in sections 302(d) (note 9, supra) and 301(a) (note 10, supra) recognize that other sections, such as section 351, may limit what otherwise might be characterized as dividends. Further, petitioners urge us to follow the holding in Haserot v. Commissioner, 41 T.C. 562 (1964) (hereinafter sometimes referred to as Haserot I), remanded 355 F.2d 200">355 F.2d 200 (6th Cir. 1965), decision reviewed and reissued 46 T.C. 864">46 T.C. 864 (1966) (hereinafter sometimes referred to as Haserot II), affd. sub nom. Commissioner v. Stickney, 399 F.2d 828">399 F.2d 828 (6th Cir. 1968), and thus find that section 351 governs where the transaction falls literally within the provisions of both sections 304 and 351.On answering brief, 31 respondent states that he "does not refute petitioners' contention that the exchange of Builders stock for Construction stock is nontaxable under section 351." Respondent maintains, however, that the 54 Gunthers went beyond the purpose of section 351 by having Construction issue debentures, an act which, respondent argues, brings petitioners "within the provisions of section 304." Respondent asserts that because section 304 is more specific with respect to bailouts, section 304 controls over section 351. In support of his argument, respondent alleges that although petitioners stated that the form of the Gunthers' business has not changed, in actuality petitioners avoided paying tax on $ 569,000 worth (see note 14, supra) of dividends. It is respondent's view that the Gunthers' purpose in the instant transaction was to: (1) Facilitate an infusion of capital into Builders by Construction; (2) transfer debt equal to earnings and profits to the shareholders; (3) obtain an interest deduction for future distributions; and (4) convert ordinary income into capital gains which is deferred for 11 years.This Court considered the precise issue of whether section 351 takes precedence32 over dividend treatment under section 301 in Haserot I and Haserot II. 18 In Haserot I, we were confronted with the typical brother-sister redemption. The taxpayer owned actually and constructively (pursuant to sec. 318) more than 50 percent of the outstanding stock of two corporations, Northport and Gypsum. The taxpayer also owned directly more than 80 percent of the outstanding stock of another corporation, the Company. In accordance with a bona fide business purpose, the taxpayer transferred all of the stock of Northport and Gypsum to Company in exchange for 2,432 shares of authorized but unissued Company stock and $ 64,850 in cash. The transaction fell within the provisions of both sections 304 and 351. We agreed with the taxpayer that section 351 took precedence over dividend treatment under section 301, thus causing the payment received to be treated as a payment in exchange for stock, giving rise to capital gains treatment.33 Because we determined that section 351 controlled the transaction, we did not address in Haserot I the issue of 55 dividend equivalence under section 302(b)(1). On appeal, the Court of Appeals for the Sixth Circuit remanded for a determination as to whether the transaction was essentially equivalent to a dividend, within the meaning of section 302(b)(1). 355 F.2d at 200, 201. On remand, in Haserot II, we held that the distribution of cash to the taxpayer was essentially equivalent to a dividend under section 302(b)(1), but, in light of the limited mandate on remand, we did not reconsider our prior opinion as to the applicability of dividend treatment under section 301. 46 T.C. at 872. Thus, notwithstanding our holding of dividend equivalence on remand, we did not alter our earlier decision for the taxpayer.However, Judge Tannenwald, 19 speaking separately, believed that the issue of whether section 351 operated to preclude dividend treatment under section 301 warranted reconsideration. After concluding that section 304 applies to sales as well as exchanges, and that section 304 does not require that an acquisition34 be solely for property in order for that section to apply, Judge Tannenwald took issue with the taxpayer's assertion that, because of the phrase "except as otherwise provided" in sections 302(d) and 301(a), section 351 rather than 301 controlled. Judge Tannenwald concluded as follows (46 T.C. at 877-878):Doubtless the statute would have been clearer if Congress had directly connected the "except" clauses by placing them immediately after the phrases "such redemption" and "a distribution." Nevertheless, I believe that the "except" clauses of sections 302(d) and 301(a) relate to the terms "redemption" and "distribution" in the respective subsections and are therefore limited to the provisions dealing with such situations. Such reasoning allows the permissiveness of section 351 to yield to the preventive policy of section 304. * * * It best achieves the underlying legislative intent and policy and, in my opinion, more nearly reflects the manner in which Congress would have "straightened this ruck out if they had come across it." * * *35 In reaching the above conclusion, Judge Tannenwald emphasized that the Senate, which added the "except" language to the statute, was still primarily concerned with 56 avoidance devices which had proved successful under the Internal Revenue Code of 1939, and that the transfer of stock of brother-sister corporations was one such device with which the Congress was concerned. A holding that section 351 controlled, in Judge Tannenwald's view, would invite the mischief which sections 304, 302, and 301 were intended to prevent because the extraction of corporate earnings at capital gains rates would be available to an 80-percent or greater shareholder but not to a 50 to 79-percent shareholder. Accordingly, Judge Tannenwald opined that a judicially created safe harbor from section 304 was contrary to the statute which explicitly applies to all shareholders controlling 50 percent or more of a corporation. Haserot II, 46 T.C. at 877-878.The Court of Appeals for the Sixth Circuit, to which Haserot II was appealed, affirmed without dissent the Tax Court's opinion in Haserot I and disagreed with Judge Tannenwald's contention that sections 304, 302, 36 and 301 controlled over section 351. Commissioner v. Stickney, 399 F.2d 828 (6th Cir. 1968). After noting that the applicability of section 304 is determined by "laboring through a labyrinth of related sections" and is not self-executing, the Court of Appeals emphasized that section 304 must be read in pari materia with related sections, particularly with section 301. Because section 301 contains "except as otherwise provided" language, the Court of Appeals concluded that section 301 mandated a finding that section 351 controlled. 399 F.2d at 834. The Court of Appeals also determined that control was not the sole criteria in determining the applicable section, but rather because the application of section 304 "is limited to sales," section 351 which "by its express provisions extends its application to exchanges," must therefore apply to the exchange in issue.In affirming Haserot II, the Court of Appeals adopted Judge Train's analysis in Haserot I (41 T.C. at 570) and concluded its opinion as follows (399 F.2d at 834-835):Particularly able arguments were heard37 in this case, and counsel stopped just short of agreeing that Commissioner was contending his construction of statutes to be correct because that was what Congress should have said. If our logic seems to support that contention it is sufficient to respond that Congress did not say it, but did utter the 57 clearly applicable language enacted as Section 351. Had Congress intended the Section 304(a) treatment to apply to such situations as the present one that end could have been accomplished by a specific affirmative enactment, or by a negation of 351 application.In the original opinion of the Tax Court, Judge Train stated:"We have no reason to believe that Congress has any intent with regard to the fact pattern in this case. However, the statements in sections 301(a) and 302(d), 'except as otherwise provided in this chapter' [or subchapter] of the Code, indicate that Congress made the policy decision that dividend treatment will result from the application of Section 302 only if no other provision in the relevant parts of the Code requires other treatment. Section 351 has no such limitation. That section is, by its terms, applicable. That section provides for tax treatment38 of the payment in question in a manner other than and different from the distribution treatment provided for by sections 302(d) and 301. Consequently, the very words in the latter sections preclude dividend treatment in this case."We are in accord with this determination, and accordingly affirm the decision of the Tax Court.Five years later, the conflict between sections 304, 302, and 301 (on the one hand) and section 351 (on the other hand) was considered by the Court of Appeals for the Ninth Circuit in Rose Ann Coates Trust v. Commissioner, 468">480 F.2d 468 (9th Cir. 1973), affg. 55 T.C. 501">55 T.C. 501 (1970). In that case, the shareholders of WIP transferred their stock interest in WIP to CAM for a promise to pay a specific amount of cash plus interest in installments over a 10-year period. A few days after CAM acquired the WIP stock, CAM dissolved WIP, acquired WIP's assets, and assumed WIP's liabilities. The taxpayers reported the transaction as a sale of their WIP stock, with their gain taxable at capital gains rates. The Commissioner treated the transaction as a redemption by a related corporation under section 304(a)(1) and, 39 pursuant to sections 302(d) and 301, the value of the installment contract (see note 14, supra) was treated as a distribution taxable as a dividend.This Court did not reach the issue of whether section 351 controlled over sections 304, 302, and 301 because we concluded that the installment sales contract was not a "security" within the meaning of section 351. However, the Court of Appeals chose to address the overlap between those sections. The Court of Appeals stated (480 F.2d at 472) that "even assuming arguendo that these agreements 58 are 'securities' under § 351, we are convinced that the provisions of § 351 are overridden by those of $ 304 and that, accordingly, § 304 and not § 351 applies to this transaction. SeeHenry McK. Haserot, 46 T.C. 864">46 T.C. 864, 872 (1966), (Tannenwald, J.) (separate opinion)."The conflict between the Court of Appeals for the Sixth Circuit and the Tax Court (on the one hand) and the Court of Appeals for the Ninth Circuit (on the other hand) has been resolved by section 226(a)(1) of the Tax Equity and Fiscal Responsibility Act of 1982, Pub. L. 97-248, 96 Stat. 490. This legislation, 40 effective for transfers occurring after August 31, 1982, in taxable years ending after that date, changes the statutory coordination of sections 304, 302, and 301, and 351 so that, in situations such as that presented in the instant case, section 351 would not apply. This change was part of a revision of sections 304 and 306, with modifications relating to debt-financed acquisitions by operating corporations, changes as to which a corporation's earnings and profits are looked to in determining dividend status, modifications as to which shareholders are taken into account in determining common control, and exceptions for bank holding companies. The Joint Statement of Managers explains the revisions in some detail (H. Rept. 97-760 (Conf.) 541-543 (1982), 2 C.B. 635">1982-2 C.B. 635-636).Although the Congress has now spoken on this issue, the taxable year involved in the instant case is 1981, before the effective date of the 1982 Act amendments. In the 15 years since the Court of Appeals' Coates Trust opinion, neither this Court nor, apparently, any Court of Appeals, has addressed the question. Respondent urges us in the instant case to reconsider the issue of41 which section controls here for pre-1982 Act cases. Petitioners, on the other hand, argue that even if they have "found a hole in the dike," the proper remedy was the statutory provision enacted in TEFRA and not a decision by this Court in favor of respondent.We have reconsidered the matter. We conclude that Haserot I, as affirmed by the Court of Appeals for the Sixth Circuit, was correct and we will not overrule our opinion therein.59 The instant case is one of many in which several statutory provisions apparently apply to a single set of facts, and the different statutory provisions lead to different bottom lines. In such situations, we must act as "traffic cop", and determine which of the provisions is to take precedence or how the provisions may be harmonized.Sometimes, it becomes apparent that the Congress was aware of the problem and provided a clear, unambiguous rule to govern our traffic-cop activities. This was the situation in, for example, Pallottini v. Commissioner, 90 T.C. 498">90 T.C. 498 (1988), where the Congress' traffic-cop rule was expressed by way of repealing one of the two conflicting statutory provisions. In Watt v. Alaska, 451 U.S. 259">451 U.S. 259 (1981),42 the Supreme Court was faced with conflicting statutes enacted more than 40 years apart. No statutory provision plainly directed which statute was to govern. The Supreme Court had to act as traffic cop and write its own rule because of the failure of the Congress to do so. The majority of the Supreme Court concluded that the statutes could best be harmonized by the later statute's giving way to the earlier one. In Millsap v. Commissioner, 91 T.C. 926">91 T.C. 926 (1988), the majority concluded that we were faced with a similar situation and concluded that the earlier statute should give way to the later one.In Watt v. Alaska, supra, and in Millsap v. Commissioner, supra, the Courts had to examine the policies that the Congress sought to further by each of the conflicting statutes and had to determine what traffic-cop rule would be likely to more faithfully serve what the courts thought to be the more important of the Congress' policies. The courts had to do so because the Congress failed to do so. In contrast, in Pallottini, the Congress plainly provided the rule and it was not for us to determine43 whether the Congress' policies could be better served by a different rule.The instant case is more like Pallottini than it is like Watt v. Alaska, supra, and Millsap. In the instant case, it is clear that the literal language of section 351 provides one answer, while the literal language of sections 304, 302 (except the first phrase of subsection (d) thereof), and 301 (except the first phrase of subsection (a) thereof), provides a vastly different answer. Here, too, we must assume the role 60 of traffic cop, and determine what traffic-cop rule we should apply.In Pallottini v. Commissioner, we stated as follows (90 T.C. at 502-503):The lesson we take from both the majority and the dissenters in Watt v. Alaska, supra, is that, in order to resolve conflicts in enacted laws, we should first look to the texts of the statutes themselves. Recourse may then be had to congressional intent, as may be deduced from the legislative history, to resolve any uncertainties that may remain after we have examined the statutes. When we apply this lesson to the instant case, the answer is 44 clear.The statutory provisions we look to in the instant case set forth two traffic-cop rules. As we pointed out in Haserot I, the language of sections 302(d) and 301(a) precludes the application of section 301 in situations where any other sections in subchapter C are applicable; section 351 contains no such limitation. Consequently, the very words of sections 302(d) and 301(a) preclude dividend treatment when a transaction also falls within section 351. Haserot I, 41 T.C. at 570.Thus, the instant case is not like Watt v. Alaska, supra, and Millsap, in which the courts had to create the traffic-cop rules. In the instant case, the rules are embedded in the statute itself. The Congress made the choice. Respondent simply does not like the choice that the Congress made. "Courts are not authorized to rewrite a statute because they might deem its effect susceptible of improvements." Badaracco v. Commissioner, 464 U.S. 386">464 U.S. 386, 398 (1984). We will adhere to our decision in Haserot I. We conclude, under the facts of this case, that nonrecognition treatment under section 351 takes45 precedence over dividend treatment under section 301.Respondent argues on answering brief that "petitioners went beyond the purpose of section 351 by issuing debentures, and this act clearly brings petitioners within the provisions of section 304. Thus, by petitioners [sic] own actions, they made the transaction taxable under section 304, and since section 304 is more specific with respect to bailouts than section 351, section 304 does control." Respondent has not favored us with any authority for his legal conclusion that section 351 does not contemplate issuance 61 of debentures. We conclude that section 351 clearly contemplates the issuance of debentures. The fact that debentures are issued may affect the taxability of the transaction under section 351 but does not automatically preclude that transaction from falling within section 351. See notes 1 & 17, supra.Although respondent emphasized Congress' concern with eliminating the avoidance devices, he put forth no new arguments or references to legislative history that would cause us to depart from our previous determination that section 301 dividend treatments yields in situations where the broader language of section46 351 also applies.Respondent argues, as he did in Haserot I, that literal application of section 351 in the instant case leads to an absurd result contrary to the intent of the legislature because shareholders who own 80 percent or more of a corporation can avoid section 304 and bail out earnings and profits under section 351; while shareholders who own 50 to less than 80 percent of a corporation would be subject to section 304 and would be unable to bail out earnings and profits. In reaching our decision in Haserot I, we acknowledged this concern and stated as follows (41 T.C. at 570):We recognize that this interpretation of the Code implies that brother-sister corporation redemptions may be so arranged that they continue to be subject to special scrutiny and possible dividend treatment only if the controlling party has less than 80-percent control -- that greater control (with concomitant greater power for mischief) may confer the benefits of capital gains treatment. Congress might have provided that sections 301, 302, and 304 controlled or at least had coordinate status with other provisions of subchapter C. It might have provided for dividend47 or ordinary income treatment in the event of section 351 "boot." However, Congress chose to subordinate the dividend path of sections 302(d) and 301(a) to other provisions of the subchapter and, unlike the "boot" provisions of sections 356(a)(2), Congress chose to treat section 351(b) "boot" as a payment in exchange. [Fn. ref. omitted.]Although there is no indication that the Congress focused on the fact pattern of the instant case or that of Haserot, it is clear that the Congress did focus on traffic-cop rules regarding the Code sections involved in the instant case.H.R. 8300, the Internal Revenue Code of 1954, as reported by the Ways and Means Committee on March 9, 1954, did not include the "except as otherwise provided" 62 language that ultimately appears in sections 301(a) and 302(d). Instead, the Ways and Means version of section 301(a) provided that section 301(a) is "subject to the provisions of section 302 (relating to redemption of stock) and section 306 (relating to distributions of securities and property)." Section 301(d) provided a cross-reference to section 353 for "special rules relating to distributions received from inactive corporations." Section48 302(b) provided that "To the extent that a distribution of property by a corporation to a shareholder in redemption of participating or nonparticipating stock is not within subsection (a), it shall be treated as a distribution of property as provided in section 301." Section 302(d) provided the same cross-reference to section 353 as did section 301(d). Section 304(a) directed the reader to section 302(a)(4) in the case of redemption and section 301 in the case of distributions. Finally, section 351(c)(4) of the Ways and Means bill provided as follows:(4) In the case of the receipt of property in connection with an exchange under this section which has the effect of the distribution of property under section 301, see such section.The House of Representatives passed the bill on March 18, 1954, without changing any of the foregoing provisions.Thus, under the House bill, sections 301, 302, and 304 would give way only to certain enumerated other provisions. Also, under the House bill, section 351 would give way to section 301 in situations such as those we face in the instant case and that we faced in Haserot.On June 18, 1954, the Finance Committee reported amendments to H.R. 49 8300, which made the following changes to the foregoing provisions:(1) Section 301(a)'s references to sections 302 and 306 were replaced by "Except as otherwise provided in this chapter". Section 301(d)'s cross reference to section 353 was replaced by section 301(f)(3)'s special rule as follows:(3) For distribution in corporate organizations and reorganizations, see part III (sec. 351 and following).(2) Section 302(b)'s language was replaced by the following:(d) Except as otherwise provided in this subchapter, if a corporation redeems its stock * * * such redemption shall be treated as a distribution of property to which section 301 applies.63 Section 302(d)'s cross reference to section 353 was eliminated.(3) Section 304(a) directed the reader to sections 302 and 303, instead of 302(a)(4) and 301.(4) Section 351 no longer had any reference to section 301.On July 2, 1954, the Senate passed H.R. 8300, with the foregoing Finance Committee revisions intact. The Conference Committee agreed to the Senate amendment (amendment No. 82) with some modifications that do not apply to any of the foregoing provisions. H. Rept. 83-2543 (Conf.) 8-11, 34-41 (1954). The provisions 50 then were enacted in the form in which they were reported by the Conference Committee.Thus, although the Congress probably did not consider the fact pattern now before us, the Congress did consider a set of traffic-cop rules that would have subordinated section 351 to section 301 and its possibilities of dividend treatment. The Congress specifically rejected that set of traffic-cop rules. Instead, the Congress wrote traffic-cop rules that plainly subordinate the section 301 dividend rules to other provisions "in this chapter", i.e., in chapter 1 (which plainly includes section 351).As part of the Tax Equity and Fiscal Responsibility Act of 1982, the Congress modified the traffic-cop rules. This modification is set forth in the margin. 2051 A comparison of 64 what the Congress did, with the rule that Judge Tannenwald proposed in Haserot II (set forth supra, following footnote reference 19), and what respondent has proposed in his revenue rulings, 21 reveals that the Congress' revision is vastly different from the rewriting proposed in Haserot II.The Congress' 1982 Act revision is far more limited than the earlier proposals. In addition, the Congress believed that it was necessary to exclude two detailed categories of situations from even the very narrow rule of new section 304(b)(3)(A). In the Deficit Reduction Act of 1984 (paragraphs (2), (3)(A), (3)(B), and (4) of section 712(1), Pub. L. 98-369, 98 Stat. 494, 953), the Congress further fine-tuned the carefully limited 1982 Act modifications of the traffic-cop rules.The Congress has the constitutional responsibility and institutional capability to bring to bear conflicting views of proper tax policy, as well as conflicting views of pragmatic politics and practical administrability. We have neither the constitutional responsibility nor the institutional capability.We must fill in gaps in the statute or resolve conflicts between provisions when the statute does not provide the answer, if it is necessary to do so in order52 to resolve the case before us. We should not revise the statute, when the statute does provide the answer, merely because we believe we could have done a better job.In its unanimous opinion in Crooks v. Harrelson, 282 U.S. 55">282 U.S. 55, 60 (1930), the Supreme Court gave us the following advice as to tax statues:65 Courts have sometimes exercised a high degree of ingenuity in the effort to find justification for wrenching from the words of a statute a meaning which literally they did not bear in order to escape consequences thought to be absurd or to entail great hardship. But an application of the principle so nearly approaches the boundary between the exercise of the judicial power and that of the legislative power as to call rather for great caution and circumspection in order to avoid usurpation of the latter. Monson v. Chester, 22 Pick. 385">22 Pick. 385, 387. It is not enough merely that hard and objectionable or absurd consequences, which probably were not within the contemplation of the framers, are produced by an act of legislation. Laws enacted with good intention, when put to the test, frequently, and to the surprise of 53 the law maker himself, turn out to be mischievous, absurd, or otherwise objectionable. But in such case the remedy lies with the law making authority, and not with the courts. See In re Alma Spinning Company, L.R. 16 Ch. Div. 681, 686; King v. Commissioners, 5 A. & E. 804, 816; Abley v. Dale, L.J. (1851) N.S. Pt. 2, Vol. 20, 233, 235. And see generally Chung Fook v. White, 264 U.S. 443">264 U.S. 443, 445; Commr. of Immigration v. Gottlieb, 265 U.S. 310">265 U.S. 310, 313.More recently, the Supreme Court's almost-unanimous opinion in Badaracco v. Commissioner, 464 U.S. at 398, told us the following about tax statutes:The cases before us, however, concern the construction of existing statutes. The relevant question is not whether, as an abstract matter, the rule advocated by petitioners accords with good policy. The question we must consider is whether the policy petitioners favor is that which Congress effectuated by its enactment of § 6501. Courts are not authorized to rewrite a statute because they might deem its effects susceptible of improvement. 54 See TVA v. Hill, 437 U.S. 153">437 U.S. 153, 194-195 (1978). * * In both Harrelson and Badaracco, the Supreme Court rejected taxpayers' pleas for "interpretations" that would straighten out perceived "rucks" in the texture of the statute. In the instant case, we reject respondent's call for such judicial repairs. The Congress has straightened out the ruck; as the 1982 Act's text shows, it did so with evident awareness of problems that had not been presented to this Court and it did so prospectively only.Accordingly, because petitioners' exchange of stock in Builders for stock and securities in Construction is governed by section 351, we hold that petitioners correctly reported no gain or loss on the exchange on their respective 1981 Federal income tax returns.66 To reflect the foregoing,Decision will be entered for the petitioners. PARRParr, J., concurring: While I believe that the separate opinion of Judge Tannenwald in Haserot II and the dissenting opinion in this case are better reasoned and would reach a more appropriate result, I nevertheless concur in the result reached by the majority. If we were writing on a clean slate, 55 I would have supported the opposite result. Petitioners, however, were entitled to rely on Haserot I which we published and the Court of Appeals for the Sixth Circuit affirmed more than 24 years ago. Additionally, Congress has generally resolved this issue in section 226(a)(1) of the Tax Equity and Fiscal Responsibility Act of 1982, Pub. L. 97-248. WRIGHTWright, J., dissenting: The majority upholds our decision in Haserot v. Commissioner, 41 T.C. 562">41 T.C. 562 (1964) (Haserot I), and maintains that congressional intent is best served by holding that when both section 351 and section 304 apply, section 351 should control. I respectfully dissent. I agree with the separate opinion of Judge Tannenwald in Haserot II, and I believe that Haserot I was wrongly decided when written and that we should not uphold it now.The majority compares the role of a "traffic cop" at an intersection to our task as a court because we both must direct the paths of two conflicting forces. While the majority quite correctly notes that occasionally the Court must decide between apparently conflicting statutory directives, the majority is mistaken in thinking that56 our "traffic-cop" 67 role permits only one solution. The majority states that here we have been given a "clear, unambiguous rule to govern our traffic-cop activities" (majority opinion at 59) as if we patrolled an intersection where only one light was green at a time. Unfortunately, if I may extend the majority's analogy, our "traffic-cop" is faced with green lights in both directions and the choice of which lane should take priority is far from clear.The majority stresses that the legislative history of H.R. 8300, ultimately the Internal Revenue Act of 1954, contained directions for interpreting the overlap between section 351 and sections 301 and 302. The majority notes that the Senate Finance Committee amended the House bill but failed to discuss the relationship between sections 351 and 304. From this omission the majority draws the inference that Congress meant for section 351 to control when in conflict with section 304. However, the converse inference can just as easily be drawn. We conclude that Congress considered only the relationship between section 351 and sections 301 and 302 when enacting the amended legislation. Congress' silence on the interaction between57 sections 351 and 304 certainly should be read as an oversight and not as an expression of intent.The majority's decision rests largely on its conclusion that the "literal language" of sections 304 and 351 allows no other result. However, an interpretation of "literal language" which leads to an absurd and irrational result should not be strictly followed. Rather than literally reading the statute to produce an absurd result, we should consider several possible interpretations of the statute, examine their effect, look to the legislative history, and adjudicate what interpretation carries out the legislative purpose. See United States v. Gilmore, 372 U.S. 39">372 U.S. 39, 44-45 (1963); Ziegler v. Commissioner, 70 T.C. 139">70 T.C. 139, 143 (1978); Doing v. Commissioner, 58 T.C. 115">58 T.C. 115, 129 (1972). See also J.C. Penney Co. v. Commissioner, 37 T.C. 1013">37 T.C. 1013, 1017 (1962), affd. 312 F.2 655 (2d Cir. 1962) (in interpreting statutes, it is the Court's function to construe the language so as to give effect to the intent of Congress).The legislative history of sections58 351 and 304 demonstrates that section 304 of the 1954 Code was Congress' 68 response to the tax-avoidance possibilities inherent in sales of stock of one controlled corporation to another corporation controlled by the selling shareholders. S. Rept. 1622, 83d Cong., 2d Sess. 238-240 (1954). The genesis of section 304 can be found in section 208 of the Revenue Act of 1950, which added section 115(g) to the Internal Revenue Act of 1939, for the purpose of controlling redemptions by a subsidiary from a parent. In enacting this section, Congress intended to prevent the sale or exchange treatment in cases in which assets of a subsidiary are withdrawn from corporate solution in exchange for stock of its parent. See. H. Rept. 2319, 81st Cong., 2d Sess. (1950), 2 C.B. 380">1950-2 C.B. 380, 420; S. Rept. 2375, 81st Cong., 2d Sess. (1950), 2 C.B. 483">1950-2 C.B. 483.After enactment of section 115(g), however, the same tax-avoidance possibilities, previously problematic in the parent-subsidiary situation, continued to arise in the brother-sister relationship, where both the issuing corporation and the acquiring corporation were controlled by the same 59 interests. Recognizing this, one of the objectives of the draftsmen of the Internal Revenue Code of 1954 in creating section 304 was to prevent tax avoidance by "sales of stock between corporations owned by the same interests." S. Rept. 1622, supra at 45. Accordingly, the enactment in 1954 of section 304, which was designed to apply to brother-sister transactions as well as those between a parent and a subsidiary, precludes such abuses by characterizing the transaction for tax purposes so that the cash or other property received by the shareholders is not treated as the proceeds of a sale or exchange which would permit capital gains treatment. Specifically, section 304 fragments the transaction into two parts: (1) The stock which is transferred to the acquiring corporation is treated as a contribution to capital, and (2) the cash or other property received brings the transaction under the scrutiny of section 302. See generally Kerr v. Commissioner, 326 F.2d 225">326 F.2d 225, 228-229 (9th Cir. 1964); Wiseman v. United States, 259 F. Supp. 90">259 F. Supp. 90, 93-94 (D. Me. 1966), affd. per curiam 371 F.2d 816">371 F.2d 816 (1st Cir. 1967);60 Radnitz v. United States, 187 F. Supp. 952">187 F. Supp. 952 (S.D.N.Y. 1960), affd. per curiam 294 F.2d 577">294 F.2d 577 (2d Cir. 1961); B. Bittker & J. Eustice, Federal Income Taxation of Corporations and Shareholders, sec. 9.30-9.32 (5th ed. 1979).69 The majority's interpretation of the interplay between sections 304 and 351 renders section 304 meaningless. Even though securities can normally be received without tax under section 351, the transfer to a controlled corporation of a related corporation's stock presents clear "bailout" opportunities because the corporation can later repay the securities without triggering dividend consequences to the holder. Secondly, the securities may be immediately marketable, raising problems analogous to the preferred stock bailouts which prompted the enactment of section 306. Further, if section 351 controlled the exchange for securities, a corporation could later retire the securities and, under section 1232, no dividend consequences would be triggered. Perhaps the most curious result of the majority's view is the special treatment unreasonably accorded to a particular group of shareholders. Under the majority's61 view, when both sections 351 and 304 apply, shareholders who own between 50 and 79 percent of a closely held corporation are prevented from bailing out corporate earnings by section 304, while shareholders with 80 percent or more would be protected from the anti-bailout sanction of section 304. Because the anti-bailout provision was clearly intended to reach all shareholders holding 50 percent or more of the outstanding stock, there is no sensible explanation for this absurd result.While it appears that Congress did not provide for or contemplate the possible conflict between sections 351 and 304, one of the principal rules of statutory construction is that if an unreasonable result is produced by one of several interpretations of a statute, that is a reason for rejecting that interpretation in favor of another which would produce a reasonable result. Rosado v. Wyman, 397">397 U.S. 397 (1970); Commissioner v. Brown, 380 U.S. 563">380 U.S. 563 (1965); Worthy v. United States, 328 F.2d 386">328 F.2d 386 (5th Cir. 1964). The law favors a rational and sensible construction. American Tobacco Co. v. Patterson, 456 U.S. 63">456 U.S. 63, 71 (1982).62 Thus, while the intention of the legislature must be ascertained from the words used to express it, the manifest reason and obvious purpose of the law should not be sacrificed to a literal interpretation of such words. Harrison v. Northern Trust Co., 317 U.S. 476">317 U.S. 476 (1943). To weave sections 304 and 35170 together to produce a uniform and rational result, section 351 must give way in a situation which encapsulates the very problem which Congress sought to control by enacting section 304. As Judge Tannenwald noted in Haserot II, "Such reasoning allows the permissiveness of section 351 to yield to the preventive policy of section 304. * * * It best achieves the underlying legislative intent and policy and, in my opinion, more nearly reflects the manner in which Congress would have 'straightened this ruck out if they had come across it'." 47 T.C. at 877-878.The majority's final point is that any decision other than theirs exceeds the bounds of our proper judicial activity. The finding that section 304 should control when sections 351 and 304 conflict, is apparently outside the bounds of statutory construction and63 "We should not revise the statute, when the statute does provide the answer, merely because we believe we could have done a better job." (Majority opinion at 64.) I submit to the majority that interpreting and clarifying unanticipated statutory conflict is the very business of a court and not an example of unjustifiable "judicial repairs."Of perhaps greater significance, I would today overrule Haserot v. Commissioner, an old and established case. Haserot v. Commisisoner does not, however, represent a venerable and inviolate principle upon which tax planners have relied. Soon after Haserot I was issued, respondent issued a nonacquiesence in Rev. Rul. 73-2, 1 C.B. 171">1973-1 C.B. 171. To extend the majority's analogy, our "traffic-cop" is placed at an intersection where there is not, and indeed has never been, any traffic. Moreover, the Ninth Circuit went out of its way to decline to follow Haserot v. Commissioner, and instead agreed with Judge Tannenwald's separate opinion. Rose Ann Coates Trust v. Commissioner, 480 F.2d 468">480 F.2d 468 (9th Cir. 1973). To quote Justice Frankfurter "Wisdom often never comes, and64 so one ought not to reject it merely because it comes too late. Since I now realize that I should have joined the dissenters * * , I shall not compound the error by pushing that decision still farther." Henslee v. Union Planters National Bank, 335 U.S. 595">335 U.S. 595, 600 (1949). For the foregoing concerns, I respectfully dissent. Footnotes. By Order of the Chief Judge, this case has been reassigned to Judge Herbert L. Chabot for opinion and decision.↩1. At trial, respondent conceded that the corporate debentures received by petitioners are not "boot" for purposes of sec. 351 and further that the provisions of sec. 453 do not apply.Unless indicated otherwise, all section, subchapter, and chapter references are to sections, subchapters, and chapters of the Internal Revenue Code of 1954 as in effect for the year in issue.↩2. Petitioners Dale and Marie M. Gunther; Gene and Lois H. Gunther; James L. Bjorkman and Penelope A. Bjorkman; Peter C. Gunther and Mary Lou Gunther; and Donald S. Robinson and Pamela G. Robinson are each husband and wife, respectively.↩3. On Jan. 2, 1981, Builders stock was a capital asset held for more than 1 year in the hands of each Builders shareholder. The aggregate bases of Builders stock held by petitioners immediately before the transfer on Jan. 2, 1981, were as follows:↩Class A preferred$ 5,371Class B preferred7,429Common130,0004. In order to determine the exchange ratio, Fulton prepared a "workup" of the supposed book value of both Builders and Construction as of Dec. 31, 1980. Once the preferred shareholders had been given an equivalent value of stock and debentures, 24 shares of Construction common stock (which were authorized but unissued) were then issued, with the balance allocated to the debentures.↩5. The aggregate net fair market value of these debentures on Jan. 2, 1981, was $ 398,300.↩6. Sec. 304 provides, in pertinent part, as follows:SEC. 304. REDEMPTION THROUGH USE OF RELATED CORPORATIONS.(a) Treatment of Certain Stock Purchases. -- (1) Acquisition by related corporation (other than subsidiary). -- For purposes of sections 302 and 303, if -- (A) one or more persons are in control of each of two corporations, and(B) in return for property, one of the corporations acquires stock in the other corporation from the person (or persons) so in control,then (unless paragraph (2) applies) such property shall be treated as a distribution in redemption of the stock of the corporation acquiring such stock. In any such case, the stock so acquired shall be treated as having been transferred by the person from whom acquired, and as having been received by the corporation acquiring it, as a contribution to the capital of such corporation.* * * (b) Special Rules for Application of Subsection (a). -- (1) Rule for determinations under section 302(b). -- In the case of any acquisition of stock to which subsection (a) of this section applies, determinations as to whether the acquisition is, by reason of section 302(b), to be treated as a distribution in part or full payment in exchange for the stock shall be made by reference to the stock of the issuing corporation. In applying section 318(a) (relating to constructive ownership of stock) with respect to section 302(b) for purposes of this paragraph, sections 318(a)(2)(C) and 318(a)(3)(C) shall be applied without regard to the 50 percent limitation contained therein.(2) Amount constituting dividend. -- (A) Where subsection (a)(1) applies. -- In the case of any acquisition of stock to which paragraph (1) (and not paragraph (2)) of subsection (a) of this section applies, the determination of the amount which is a dividend shall be made solely by reference to the earnings and profits of the acquiring corporation. * * (c) Control. -- (1) In general. -- For purposes of this section, control means the ownership of stock possessing at least 50 percent of the total combined voting power of all classes of stock entitled to vote, or at least 50 percent of the total value of shares of all classes of stock. If a person (or persons) is in control (within the meaning of the preceding sentence) of a corporation which in turn owns at least 50 percent of the total combined voting power of all stock entitled to vote of another corporation, or owns at least 50 percent of the total value of the shares of all classes of stock of another corporation, then such person (or persons) shall be treated as in control of such other corporation.(2) Constructive ownership. -- Section 318(a) (relating to the constructive ownership of stock) shall apply for purposes of determining control under paragraph (1). For purposes of the preceding sentence, sections 318(a)(2)(C) and 318(a)(3)(C)↩ shall be applied without regard to the 50 percent limitation contained therein.[The subsequent amendments of this provision (by sec. 1875(b) of the Tax Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2085, 2894; by secs. 712(l)(1), 712(l)(2), 712(l)(3), 712(l)(4), 712(l)(5)(A), and 712(l)(7)(B) of the Deficit Reduction Act of 1984, Pub. L. 98-369, 98 Stat. 494, 953-955; and by secs. 226(a)(1)(A), 226(a)(2), and 226(a)(3) of the Tax Equity and Fiscal Responsibility Act of 1982, Pub. L. 97-248, 96 Stat. 324, 490-492) do not apply to the instant case.]7. Sec. 318(a) provides, in pertinent part, as follows: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 -- * * (ii) his children, grandchildren, and parents. * * (2) Attribution from partnerships, estates, trusts, and corporations. -- * * (C) From corporations. -- If 50 percent or more in value of the stock in a corporation is owned, directly or indirectly, by or for any person, such person shall be considered as owning the stock owned, directly or indirectly, by or for such corporation, in that proportion which the value of the stock which such person so owns bears to the value of all the stock in such corporation.(3) Attribution to partnerships, estates, trusts, and corporations. -- * * (C) To corporations. -- If 50 percent or more in value of the stock in a corporation is owned, directly or indirectly, by or for any person, such corporation shall be considered as owning the stock owned, directly or indirectly, by or for such person. * * (5) Operating rules. -- (A) In general. -- Except as provided in subparagraphs (B) and (C), stock constructively owned by a person by reason of the application of paragraph (1), (2), (3), or (4), shall, for purposes of applying paragraphs (1), (2), (3), and (4), be considered as actually owned by such person.↩8. Sec. 317(a) provides as follows:SEC. 317. OTHER DEFINITIONS.(a) Property. -- For purposes of this part [i.e., part I, secs. 301-318], the term "property" means money, securities, and any other property; except that such term does not include stock in the corporation making the distribution (or rights to acquire such stock).↩9. Sec. 302 provides, in pertinent part, as follows: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), or (3) 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.(2) Substantially disproportionate redemption of stock. -- (A) In general. -- Subsection (a) shall apply if the distribution is substantially disproportionate with respect to the shareholder. * * (3) Termination of shareholder's interest. -- Subsection (a) shall apply if the redemption is in complete redemption of all of the stock of the corporation owned by the shareholder.(4) Application of paragraphs. -- In determining whether a redemption meets the requirements of paragraph (1), the fact that such redemption fails to meet the requirements of paragraph (2) or (3) shall not be taken into account. If a redemption meets the requirements of paragraph (3) and also the requirements of paragraph (1) or (2), then so much of subsection (c)(2) as would (but for this sentence) apply in respect of the acquisition of an interest in the corporation within the 10-year period beginning on the date of the distribution shall not apply.(c) Constructive Ownership of Stock. -- (1) In general. -- Except as provided in paragraph (2) of this subsection, section 318(a) shall apply in determining the ownership of stock for purposes of this section. * * (d) Redemptions Treated as Distributions of Property. -- Except as otherwise provided in this subchapter [i.e., subchapter C, secs. 301-385 (sec. 386 having been added in 1984)], if a corporation redeems its stock (within the meaning of section 317(b)), and if subsection (a) of this section does not apply, such redemption shall be treated as a distribution of property to which section 301 applies.[The subsequent amendments of this provision (by secs. 222(c)(1), 222(c)(3), and 222(c)(4) of the Tax Equity and Fiscal Responsibility Act of 1982, Pub. L. 97-248, 96 Stat. 324, 478-479) do not apply to the instant case.]↩10. Sec. 301 provides, in pertinent part, as follows:SEC. 301. DISTRIBUTIONS OF PROPERTY.(a) In General. -- Except as otherwise provided in this chapter [i.e., ch. 1, secs. 1-1399], a distribution of property (as defined in section 317(a)) made by a corporation to a shareholder with respect to its stock shall be treated in the manner provided in subsection (c). * * *(c) Amount Taxable. -- In the case of a distribution to which subsection (a) applies -- (1) Amount constituting dividend. -- That portion of the distribution which is a dividend (as defined in section 316↩) shall be included in gross income.11. SEC. 316. DIVIDEND DEFINED.(a) General Rule. -- For purposes of this subtitle [i.e., subtitle A, secs. 1-1564], the term "dividend" means any distribution of property made by a corporation to its shareholders -- (1) out of its earnings and profits accumulated after February 28, 1913, or(2) out of its earnings and profits of the taxable year (computed as of the close of the taxable year without diminution by reason of any distributions made during the taxable year), without regard to the amount of the earnings and profits at the time distribution was made.Except as otherwise provided in this subtitle, every distribution is made out of earnings and profits to the extent thereof, and from the most recently accumulated earnings and profits. To the extent that any distribution is, under any provision of this subchapter, treated as a distribution of property to which sec. 301↩ applies, such distribution shall be treated as a distribution of property for purposes of this subsection.12. Under sec. 318(a)(1), the family attribution rules, the shares held by an individual may be attributed directly or indirectly as being owned by that person's spouse, children, grandchildren, and parents. With respect to corporations, sec. 318(a)(2)(C) provides that if at least 50 percent of the value of the stock in a corporation is owned directly or indirectly by or for any person, that person is considered to own a proportionate interest of all of the outstanding stock of the corporation. A special rule in sec. 304(b)(1) provides that the 50-percent ownership restriction on attribution under sec. 318(a)(2)(C) is not applicable in cases to which sec. 304 applies. In addition to the above attribution rules, the children would be treated as owning their parents' stock in Builders by virtue of sec. 318(a)(5)(A), which reattributes the parents' attributed ownership under sec. 318(a)(2)(C)↩ in Builders to the children.13. Sec. 302(c)(2) provides that, under certain circumstances, the family attribution rules of paragraph (1) of sec. 318(a) can be waived in determining if a shareholder has completely terminated his or her interest under sec. 302(b)(3). Sec. 302(c)(2) does not provide for a waiver of any of the other attribution rules of sec. 318(a). Hence, even if family attribution under sec. 318(a)(1) were waived in the instant case, sec. 302(b)(3) would not be satisfied because, pursuant to the corporate attribution rules of sec. 318(a)(2)(C) and 304(b)(1), Construction's ownership of Builders stock is attributed to each of the Gunthers in proportion to the value of the stock that individual owns in Construction; this attribution prevents any of the Gunthers from satisfying the complete redemption requirements of sec. 302(b)(3)↩.14. On opening brief, respondent contends that the notices of deficiency are correct in that the Gunthers are to be charged with an aggregate of $ 569,000 of dividends. See tables 4 and 6, supra. Petitioners point out on answering brief (as they had in their petition) that, even if the Gunthers are to be charged with dividends, the correct amount would be only $ 398,300, the stipulated aggregate fair market value of the debentures. Under sec. 301(b)(1)(A), if the transaction is treated as a distribution, then the aggregate amount of the distribution is the fair market value of the debentures -- $ 398,300. Rose Ann Coates Trust v. Commissioner, 55 T.C. 501">55 T.C. 501, 514 (1970), affd. 480 F.2d 468">480 F.2d 468, 474↩ (9th Cir. 1973); see B. Bittker & J. Eustice, Federal Income Taxation of Corporations and Shareholders, par. 7.40 (5th ed. 1987).15. Sec. 351(a) provides as follows:SEC. 351. TRANSFER TO CORPORATION CONTROLLED BY TRANSFEROR.(a) General Rule. -- No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation and immediately after the exchange such person or persons are in control (as defined in section 368(c)↩) of the corporation.16. SEC. 368. DEFINITIONS RELATING TO CORPORATE REORGANIZATIONS.(c) Control. -- For purposes of part I (other than section 304), part II, this part, and part V, the term "control" means the ownership of stock possessing at least 80 percent of the total combined voting power of all classes of stock entitled to vote and at least 80 percent of the total number of shares of all other classes of stock of the corporation.[The subsequent amendments of this provision (by sec. 1804(h)(1) of the Tax Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2085, 2806-2807; and by sec. 64(a) of the Deficit Reduction Act of 1984, Pub. L. 98-369, 98 Stat. 494, 584) do not apply to the instant case.]↩17. Neither side argued the issue of whether the debentures were properly characterized as securities for purposes of sec. 351, but in any event, we conclude that they so qualify. See D'Angelo Associates, Inc. v. Commissioner, 70 T.C. 121">70 T.C. 121, 134 (1978), citing Camp Wolters Enterprises, Inc. v. Commissioner, 22 T.C. 737">22 T.C. 737 (1954), affd. 230 F.2d 555">230 F.2d 555 (5th Cir. 1956); B. Bittker & J. Eustice, Federal Income Taxation of Corporations and Shareholders, par. 3.03[2] (5th ed. 1987) (notes with a 5-year term or less rarely qualify as "securities," while a term of 10 years or more ordinarily is sufficient to bring them within sec. 351(a)). Respondent conceded that the debentures are not "boot" for purposes of sec. 351. See note 1, supra↩.18. Since our decision in Haserot I, we have not had occasion to directly address the conflict between sec. 304 and 351. In Rose Ann Coates Trust v. Commissioner, 55 T.C. at 512, affd. on other grounds 480 F.2d at 472, 473, we held that sec. 351 was inapplicable to a transaction that was otherwise governed by sec. 304 because the taxpayers-transferors did not receive stock or securities in exchange for property, as required by sec. 351(a). Similarly, in Brams v. Commissioner, T.C. Memo 1983-25">T.C. Memo. 1983-25, affd. 734 F.2d 290">734 F.2d 290, 292-293 (6th Cir. 1984), the taxpayer did not satisfy the 80-percent-control requirement of sec. 351↩.19. Judge Train wrote the opinion in Haserot I; he had resigned from this Court by the time the Court of Appeals remanded the case. 44 T.C. III. Whereupon, the case was reassigned to Judge Tannenwald. Judge Tannenwald wrote the unanimous opinion of the Court in Haserot II (46 T.C. 864">46 T.C. 864), and also wrote a separate opinion (46 T.C. at 872-878), in which he was joined by Judge Simpson↩.20. Sec. 226(a)(1)(A) of Pub. L. 97-248, 96 Stat. 324, 490-491, provides as follows:SEC. 226. AMENDMENTS RELATING TO BAILOUTS THROUGH USE OF HOLDING COMPANIES.(a) Amendments to Section 304. -- (1) Coordination of sections 304 and 351. -- (A) Subsection (b) of section 304 (relating to special rules for application of subsection (a)) is amended by adding at the end thereof the following new paragraph:"(3) Coordination with section 351. -- "(A) Property treated as received in redemption. -- Except as otherwise provided in this paragraph, subsection (a) (and not part III) [i.e., secs. 351-368] shall apply to any property received in a distribution described in subsection (a)."(B) Certain assumptions of liability, etc. --"(i) In general. -- Subsection (a) shall not apply to any liability --"(I) assumed by the acquiring corporation, or"(II) to which the stock is subject, if such liability was incurred by the transferor to acquire the stock. For purposes of the preceding sentence, the term 'stock' means stock referred to in paragraph (1)(B) or (2)(A) of subsection (a)."(ii) Extension of obligations, etc. -- For purposes of clause (i), an extension, renewal, or refinancing of a liability which meets the requirements of clause (i) shall be treated as meeting such requirements."(C) Distributions incident to formation of bank holding companies. -- If --"(i) pursuant to a plan, control of a bank is acquired and within 2 years after the date on which such control is acquired, stock constituting control of such bank is transferred to a BHC in connection with its formation."(ii) incident to the formation of the BHC there is a distribution of property described in subsection (a), and"(iii) the shareholders of the BHC who receive distributions of such property do not have control of such BHC,then, subsection (a) shall not apply to any securities received by a qualified minority shareholder incident to the formation of such BHC. "(D) Definitions and special rule. -- For purposes of subparagraph (C) and this subparagraph --"(i) Qualified minority shareholder. -- The term 'qualified minority shareholder' means any shareholder who owns less than 10 percent (in value) of the stock of the BHC. For purposes of the preceding sentence, the rules of paragraph (3) of subsection (c) shall apply."(ii) BHC. -- The term 'BHC' means a bank holding company (within the meaning of section 2(a) of the Bank Holding Company act of 1956)."(iii) Special rule in case of BHC's formed before 1985. -- In the case of a BHC which is formed before 1985, clause (i) of subparagraph (C) shall not apply."↩21. Rev. Rul. 73-2, 1 C.B. 171">1973-1 C.B. 171. See also Rev. Rul. 78-422, 2 C.B. 129">1978-2 C.B. 129↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623493/	GWENDOLYN LEE HOOKS, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentHooks v. CommissionerDocket No. 14720-92United States Tax CourtT.C. Memo 1993-437; 1993 Tax Ct. Memo LEXIS 446; 66 T.C.M. (CCH) 797; September 20, 1993, Filed 446 Decision will be entered under Rule 155. Gwendolyn Lee Hooks, pro se. For respondent: Charles Graves. PETERSONPETERSONMEMORANDUM OPINION PETERSON, Special Trial Judge: This case was heard pursuant to the provisions of section 7443A(b)(3) and Rules 180, 181, and 182. All section references are to the Internal Revenue Code in effect for the year in issue. 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 1989 in the amount of $ 1,013. After a concession by respondent, the issues for decision are: (1) Whether petitioner is entitled to a claimed deduction for charitable contributions in excess of the amount allowed by respondent; and (2) whether petitioner is entitled to a claimed deduction in the amount of $ 8,880 for tax consultation fees. Some of the facts have been stipulated and are so found. The stipulation of facts and attached exhibits are incorporated herein by reference. Petitioner resided in Kansas City, Missouri, at the time her petition was filed. Petitioner is a teacher, and during the year in issue she earned $ 21,186 while employed by the School447 District of Kansas City, Missouri. During the year in issue petitioner had no financial investments of any kind. Petitioner prepared her own Federal income tax return for taxable year 1989. We first address petitioner's entitlement to her claimed charitable contribution deduction. During 1989 petitioner and her son regularly attended religious services in Kansas City at the Metropolitan Missionary Baptist Church, the Emmanuel Baptist Church, and the True Vine Missionary Baptist Church. On her tax return for taxable year 1989, petitioner claimed a charitable contribution deduction for cash contributions made to these churches in the amount of $ 1,320. In the notice of deficiency, respondent allowed a deduction for petitioner's claimed charitable contributions only in the amount of $ 520. Petitioner has no records substantiating any amount of her claimed charitable contributions, but nonetheless contends she is entitled to the full amount of her claimed charitable contribution deduction. Petitioner bears the burden of proving her entitlement to her claimed charitable contribution deduction. New Colonial Ice Co. v. Helvering, 292 U.S. 435">292 U.S. 435, 440 (1934).448 Generally, contributions of money to or for the use of a religious organization, such as petitioner's churches, are deductible sums. Sec. 170(c); Henson v. Commissioner, T.C. Memo 1979-110">T.C. Memo. 1979-110. However, in order to be fully deductible such contributions must be substantiated in some manner. Henson v. Commissioner, supra; sec. 1.170A-13(a)(1), Income Tax Regs. Still, even where such substantiation is lacking (as in the present case), we may find that a taxpayer is candid, forthright and credible, conclude that some contribution actually was made, and approximate a reasonable allowable sum for deduction. Cf. Cohan v. Commissioner, 39 F.2d 540">39 F.2d 540 (2d Cir. 1930). In this case we indeed find that petitioner was candid, forthright and credible, and we are convinced that she made cash contributions to churches she attended throughout 1989. However, using our best judgment and bearing heavily against petitioner, whose inexactitude is of her own making, we conclude that respondent has already approximated a reasonable allowable sum for deduction by allowing petitioner to deduct $ 520 of her 449 claimed charitable contributions. Accordingly, we hold that petitioner is not entitled to deduct any amount of her claimed charitable contributions in excess of the amount allowed by respondent. Cohan v. Commissioner, supra; Wren v. Commissioner, T.C. Memo. 1984-456. We next address petitioner's claimed deduction for tax consultation fees. Petitioner bears the burden of proving her entitlement to her claimed deduction for these fees. New Colonial Ice Co. v. Helvering, supra.On her 1989 return, petitioner claimed a deduction for fees paid to Mr. Charles Burrell (Mr. Burrell) for tax counseling in the amount of $ 8,880. Petitioner argues that the fees she paid are fully deductible under section 212(3) because Mr. Burrell's counseling helped her to prepare her 1989 return. Respondent contends that the fees are not deductible in any amount because petitioner has failed to substantiate her expenses. Further, lack of substantiation notwithstanding, respondent argues that the fees petitioner paid to Mr. Burrell are nondeductible because they were not "ordinary and necessary" and 450 "paid or incurred during the taxable year * * in connection with the determination, collection, or refund of any tax". Sec. 212. With regard to substantiation, we agree with respondent that besides petitioner's self-serving testimony, there is no evidence in the record substantiating her claimed expenditure of $ 8,880. Still, as we noted previously in this opinion, we find petitioner to be candid, forthright, and credible, and based on the record in this case we are convinced that she paid certain sums to Mr. Burrell on a regular basis during the year in issue. However, we need not approximate a reasonable sum which petitioner expended since we agree with respondent that, based on the record in this case, whatever amount petitioner paid to meet with Mr. Burrell is not deductible under section 212(3). The record is clear in this case that during the year in issue petitioner met with Mr. Burrell each month for lessons on how to "understand the tax laws and how they affected [her]". These meetings were intended to be educational, and they focused on explaining to petitioner the nature of the Federal tax system and the manner in which certain sections of the code are generally 451 interpreted. In petitioner's words, she "was getting educated on the different tax codes and the tax laws and how I, as a taxpayer, what rights I have and what rights I do not have." To be deductible under section 212, an expense must be "ordinary and necessary", "reasonable in amount", and reasonably and proximately related to the purpose of the expense. Wassenaar v. Commissioner, 72 T.C. 1195">72 T.C. 1195, 1202 (1979); sec. 1.212-1(d), Income Tax Regs. While it is uncontested that petitioner's meetings with Mr. Burrell aided her in preparing her 1989 return, it is clear that the purpose of the meetings was to educate petitioner. It is well settled that such educational-type expenses are neither "ordinary and necessary" nor reasonably related to a taxpayer's preparation of her return. Wassenaar v. Commissioner, supra; sec. 1.212-1(f), Income Tax Regs. Since we conclude that petitioner's meetings with Mr. Burrell were not "ordinary and necessary", we need not address whether whatever sum petitioner may have paid to Mr. Burrell for his services was "reasonable in amount". Based on the foregoing, we hold that petitioner is 452 not entitled to a deduction in any amount under section 212(3) for the fees she paid Mr. Burrell during the year in issue. In consideration of respondent's concession in this case, Decision will be entered under Rule 155.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623494/	MAUREEN PATRICIA WILSON, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentWilson v. Comm'rNo. 1026-07LUnited States Tax Court131 T.C. 47; 2008 U.S. Tax Ct. LEXIS 22; 131 T.C. No. 5; September 10, 2008, Filed22 P did not timely request a hearing with R's Appeals Office with respect to a proposed levy action. As a result, that office held an equivalent hearing with respect to that proposed action. Thereafter, R's Appeals Office sent P a document entitled "NOTICE OF DETERMINATION CONCERNING COLLECTION ACTION(S) UNDER SECTION 6320 and/or 6330" in which that office recited those facts. In the document that R's Appeals Office sent P, that office concluded that it was sustaining the proposed levy action and that P was not entitled to seek judicial review of the conclusions in that document. Inconsistently, R's Appeals Office concluded in the document that it sent P that P was entitled to seek judicial review of the conclusions therein by timely filing a petition with the Court.Held: The document that R's Appeals Office sent P does not embody a determination under sec. 6330, I.R.C.Held, further, that document is not a valid notice of determination under sec. 6330, I.R.C., that P is entitled to appeal under sec. 6330(d)(1), I.R.C.Held, further, the Court does not have jurisdiction over this case.Maureen Patricia Wilson, Pro se.Laura Daly and A. Gary Begun, for respondent.Chiechi, Carolyn P.CAROLYN 23 P. CHIECHI47 CHIECHI, Judge: This case is before the Court on its Order dated May 30, 2008 (Court's Show Cause Order), in which the Court ordered each party to file a written response to that Order showing why this case should not be dismissed for lack of jurisdiction. We shall make the Court's Show Cause Order absolute and dismiss this case for lack of jurisdiction.The record establishes and/or the parties do not dispute the following.Petitioner's address shown in the petition in this case was in Belleville, Michigan.On June 29, 1998, respondent assessed against petitioner a trust fund recovery penalty under section 66721 of $ 37,560.77 that was attributable to the respective unpaid Federal tax liabilities of New Wave Communications, Inc., for 48 the periods ended June 30, 1996, through September 30, 1997. 224 (We shall refer to any unpaid assessed portion of that penalty, as well as interest as provided by law accrued after June 29, 1998, as petitioner's unpaid liability.) On June 29, 1998, respondent issued to petitioner a notice of balance due with respect to petitioner's unpaid liability.On July 19, 2003, respondent issued to petitioner a final notice of intent to levy and notice of your right to a hearing (notice of intent to levy) with respect to petitioner's unpaid liability.Petitioner did not submit to respondent Form 12153, Request for a Collection Due Process Hearing, until March 6, 2006. Thereafter, respondent granted petitioner an equivalent hearing with respondent's Appeals Office (Appeals Office) with respect to the notice of intent to levy.On December 20, 2006, the Appeals Office issued to petitioner a document (Appeals Office December 20, 2006 document) that included a form letter entitled "NOTICE OF DETERMINATION CONCERNING COLLECTION ACTION(S) UNDER SECTION 6320 and/or 6330" (section 6330 determination form letter). The Appeals Office is supposed to use that form letter where it makes a determination under section 6330 to sustain a proposed collection action. 325 See Internal Revenue Manual (IRM) pt. 8.22.1.1.1.2.1(4) (Oct. 19, 2007). The section 6330 determination form letter contains certain boilerplate language that states in pertinent part:We have reviewed the collection actions that were taken or proposed for the period(s) shown above. This letter is your Notice of Determination, as required by law. A summary of our determination is stated below. The attached statement shows, in detail, the matters we considered at your Appeals hearing and our conclusions about them.If you want to dispute this determination in court, you must file a petition with the United States Tax Court within 30 days from the date of this letter.49 The section 6330 determination form letter also contains certain information specific to the taxpayer to whom it is issued, such as the name and the address of the taxpayer, the type of tax at issue, the tax period at 26 issue, and the Appeals Office's "Summary of Determination" regarding the action proposed to collect the taxpayer's tax liability.The Appeals Office December 20, 2006 document contained the boilerplate language discussed above. That document also contained the following "Summary of Determination" that pertained to petitioner:Collection Due Process (CDP) requested regarding the proposedlevy action. The request was received 3/10/2006. LT 1058 was sent to the taxpayerQs [sic] last known address on 7/19/2003.Therefore, the request made was not timely. Based on the telephone conference and the administrative file the collection action is sustained.See the attached Appeals Case Memorandum.The Appeals case memorandum included as part of the Appeals Office December 20, 2006 document stated in pertinent part:* Per review of computer transcripts, the CDP notice Letter 11 (LT-11) Final Notice -- of Intent to Levy, and Notice of Your Right to a Hearing was sent by Certified Mail, Return Receipt Requested, to the taxpayer's last known address, which was also the address, indicated on the CDP hearing request. The date of the notice was July 19, 2003.* IRC 6330 * * * allows a taxpayer to raise any 27 relevant issues relating to the unpaid tax or the proposed levy at the due process hearing. The Form 12153, Request for a Collection Due Process Hearing was received March 10, 2006, which was more than 30 days from the date of the LT11. Although the taxpayer's request was not timely regarding the levy, the taxpayer was granted an Equivalent Hearing -- equivalent in all respects except that the taxpayer will not have the right to judicial review. Therefore, the decision of Appeals will be final regarding the Notice of levy.On June 4, 2008, respondent filed a response to the Court's Show Cause Order (respondent's response). Although the Court ordered petitioner to file a response to that Order, she did not do so.On July 8, 2008, the Court held a hearing on the Court's Show Cause Order. There was no appearance by or on behalf 50 of petitioner. Counsel for respondent appeared and was heard.On July 22, 2008, respondent filed a supplement to respondent's response. In respondent's response as supplemented, respondent indicates that it is respondent's position that the Court does not have jurisdiction over the instant case.Our jurisdiction under section 6330(d)(1) depends upon the issuance of 28 a valid notice of determination and a timely filed petition. Offiler v. Commissioner, 114 T.C. 492">114 T.C. 492, 498 (2000). In Offiler, the Court addressed whether it had jurisdiction under section 6330(d)(1) where the taxpayer had failed to request timely a hearing with the Appeals Office under section 6330. The Court held in Offiler that (1) because the taxpayer there involved did not timely request such a hearing, "Appeals made no determination pursuant to section 6330(c)", id. at 497, and (2) "Because there was no Appeals determination for this Court to review, there is simply no basis for our jurisdiction under section 6330(d)", id. at 498. See also Moorhous v. Commissioner, 116 T.C. 263">116 T.C. 263, 269-270 (2001); Kennedy v. Commissioner, 116 T.C. 255">116 T.C. 255, 261-263 (2001).In determining whether the Court had jurisdiction under section 6330(d)(1) in Lunsford v. Commissioner, 117 T.C. 159">117 T.C. 159 (2001), the Court restated the principle set forth in Offiler that its jurisdiction under that section depended upon the issuance of a valid notice of determination and a timely filed petition. Id. at 161. According to the Court in Lunsford, "Our jurisdiction under section 6330(d)(1) * * is established when there is a 29 written notice that embodies a determination to proceed with the collection of the taxes in issue, and a timely filed petition." 4Id. at 164. In determining whether the Court had jurisdiction under section 6330(d)(1), the Court indicated in Lunsford that there was "nothing in the notice of determination which leads us to conclude that the determination 51 was invalid." Id. at 165. The Court held in Lunsford that it had jurisdiction over that case. Id.In Craig v. Commissioner, 119 T.C. 252">119 T.C. 252 (2002), the Court addressed whether it had jurisdiction under section 6330(d)(1) where the Appeals Office had issued to the taxpayer a form decision letter 5 after the taxpayer had timely requested a hearing with that office under section 6330. 30 The form decision letter involved in Craig stated that (1) the taxpayer did not timely request a hearing with the Appeals Office under section 6330, (2) the Appeals Office granted the taxpayer an equivalent hearing, (3) the Appeals Office concluded that it was sustaining the proposed collection action, and (4) the taxpayer was not entitled to seek judicial review of the conclusions in that form letter. Id. at 256. The Commissioner of Internal Revenue, however, acknowledged in Craig that the taxpayer did timely request a hearing with the Appeals Office under section 6330. Id. at 253. The Court held in Craig that "where Appeals issued the decision letter to * * [the taxpayer] in response to * * * [the taxpayer's] timely request for a Hearing, * * * the 'decision' reflected in the decision letter * * * is a 'determination' for purposes of section 6330(d)(1)." Id. at 259. In reaching that holding, the Court indicated in Craig thatAlthough the Appeals officer concludes an equivalent hearing by issuing a decision letter, as opposed to a notice of determination, the different names which are assigned to these documents are merely a distinction without a difference when it comes to our jurisdiction 31 over this case, where a Hearing was timely requested. * ** * * The fact that respondent held with * * * [the taxpayer] a hearing labeled as an equivalent hearing, rather than a hearing labeled as a Hearing, and that respondent issued to petitioner a document labeled as a decision letter, rather than a document labeled as a notice of determination, does not erase the fact that * * * [the taxpayer] received a "determination" within the meaning of section 6330(d)(1). * * Id. at 258-259.In the instant case, the Appeals Office used a section 6330 determination form letter when it notified petitioner in the Appeals Office December 20, 2006 document of its conclusions regarding her appeal with respect to the proposed levy action. As a result, the Appeals Office December 20, 2006 52 document was entitled "NOTICE OF DETERMINATION CONCERNING COLLECTION ACTION(S) UNDER SECTION 6320 and/or 6330" and contained, inter alia, the following boilerplate language: "If you want to dispute this determination in court, you must file a petition with the United States Tax Court within 30 days from the date of this letter." However, the Appeals Office December 20, 2006 document also contained 32 the following statements that pertained to petitioner: (1) Petitioner did not timely request a hearing with the Appeals Office with respect to the notice of intent to levy; (2) the Appeals Office granted petitioner an equivalent hearing with respect to that notice; (3) the Appeals Office concluded that it was sustaining the proposed levy action; and (4) petitioner was not entitled to seek judicial review of the conclusions in the Appeals Office December 20, 2006 document.The Appeals Office December 20, 2006 document is internally inconsistent. 634 We must decide whether that document embodies a determination under section 6330. We cannot resolve that question on the basis of the Appeals Office's conclusion in the Appeals Office December 20, 2006 document that it was sustaining the proposed levy action. That is because a determination that the Appeals Office makes under section 6330 where the taxpayer timely requested a hearing under that section and a decision that the Appeals Office makes where the taxpayer did not timely request a hearing under section 6330 both will indicate that the Appeals Office is sustaining the proposed collection action. See, e.g., Lunsford v. Commissioner, 117 T.C. 159 (2001); 33 Moorhous v. Commissioner, 116 T.C. 263">116 T.C. 263 (2001). Nor can we resolve whether the Appeals Office December 20, 2006 document embodies a determination under section 6330 on the basis of the Appeals Office's having sent to petitioner a section 6330 determination form letter entitled "NOTICE OF 53 DETERMINATION CONCERNING COLLECTION ACTION(S) UNDER SECTION 6320 and/or 6330". That is because the name or the label of a document does not control whether the document embodies a determination under section 6330. See Craig v. Commissioner, 119 T.C. at 258-259.We can, however, resolve whether the Appeals Office December 20, 2006 document embodies a determination under section 6330 on the basis of the undisputed statement in that document that petitioner did not timely request a hearing with the Appeals Office under section 6330(b) with respect to the notice of intent to levy. 7In determining whether the Court has jurisdiction under section 6330(d)(1), the Court must take into consideration the jurisdictional provision in section 6330(b) prescribing the 30-day period within which a taxpayer must request a hearing with the Appeals Office.8 See Offiler v. Commissioner, 114 T.C. at 497-498. Because petitioner did not timely request a hearing with the Appeals Office with respect to the notice of intent to levy, that office did not make a determination under section 6330. See id. at 497. We hold that the Appeals Office December 20, 2006 document does not embody a determination under section 6330. We further hold that the Appeals Office December 20, 2006 *35 document is not a valid notice of determination under section 6330 that petitioner is entitled to appeal pursuant to section 6330(d)(1). Accordingly, we hold that we do not have jurisdiction over this case. 9To reflect the foregoing,An order making the Court's Show Cause Order absolute and dismissing this case for lack of jurisdiction will be entered.Footnotes1. All section references are to the Internal Revenue Code in effect at all relevant times.↩2. On Apr. 15, 2003, respondent credited a refund of $ 507 due to petitioner for her taxable year 2002 against the unpaid trust fund recovery penalty that respondent had assessed against her on June 29, 1998.3. Instead of using the section 6330determination form letter, the Appeals Office is supposed to use a form letter entitled "Decision Letter Concerning Equivalent Hearing Under Section 6320 and/or 6330 of the Internal Revenue Code" (form decision letter) where the taxpayer did not timely request a hearing with that office under sec. 6330↩ and an equivalent hearing was granted. See IRM pt. 8.22.1.3.2(3) (Oct. 19, 2007).4. In Lunsford v. Commissioner, 117 T.C. 159">117 T.C. 159, 164 (2001), the Court concluded that in determining whether the Court had jurisdiction under sec. 6330(d)(1) the nonjurisdictional provisions of sec. 6330↩, such as the provisions relating to whether there was an appropriate hearing opportunity, whether the hearing was conducted properly, whether the hearing was fair, and whether the hearing was conducted by an impartial Appeals officer, are not to be taken into consideration.5. See supra↩ note 3.6. Unlike the Appeals Office December 20, 2006 document involved in the instant case, the notice of determination involved in Lunsford v. Commissioner, supra, was not internally inconsistent. In Lunsford, there was nothing in the notice of determination involved there that led the Court to conclude that that notice was not valid. Id. at 165. Similarly, the notice of determination involved in Myong Soo Kim v. Commissioner, T.C. Memo 2005-96">T.C. Memo 2005-96, was not internally inconsistent. Like Lunsford and unlike the instant case, in Kim there was nothing in the notice of determination involved there that led the Court to conclude that that notice was not valid. In respondent's response as supplemented, respondent takes the position that Kim was wrongly decided. We need not address that position. That is because Kim↩ is materially distinguishable from the instant case.7. Petitioner does not dispute, and the record independently establishes, that petitioner did not timely request a hearing with the Appeals Office with respect to the notice of intent to levy.↩8. The instant case is thus unlike Lunsford v. Commissioner, 117 T.C. 159 (2001). In Lunsford, the Court indicated that the nonjurisdictional provisions in sec. 6330 are not to be taken into consideration in determining whether the Court has jurisdiction under sec. 6330(d)(1). Id. at 164. See supra↩ note 4.9. On June 6, 2007, respondent filed a motion for summary judgment. We shall deem that motion moot.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623495/	GAYLORD MERCANTILE CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Gaylord Mercantile Co. v. CommissionerDocket No. 13077.United States Board of Tax Appeals13 B.T.A. 702; 1928 BTA LEXIS 3203; October 1, 1928, Promulgated 3203 George E. Wallace, Esq., and Charles H. Preston, C.P.A., for the petitioner. L. A. Luce, Esq., for the respondent. LANSDON 703 This proceeding results from the determination of deficiencies in income and profits taxes amounting as follows: for the year 1919, $38.01; for the year 1920, $16.86. Petitioner alleges error with reference to the following issues: (1) The income for 1919 is overstated by an amount of $648.30, due to a failure to take into consideration the correct merchandise inventories at the beginning and the end of the taxable year; (2) the income for 1920 is overstated by an amount of $1,592.20, due to a failure to consider the correct inventory at the beginning of the taxable year; and (3) for the years 1919 and 1920 there has been a failure to allow as a deduction from income a reasonable allowance for depreciation of fixed assets. FINDINGS OF FACT. The petitioner is a corporation with its principal office at Gaylord, Minn.During the years 1919 and 1920, the petitioner owned assets as follows, and the cost thereof to petitioner, less depreciation charged off on the books, amounted as follows: Assets19191920Store building$11,000.00$11,000.00Addition in 1919213.78213.78Fixtures3,000.003,000.00Additions in 1919317.45317.45Additions in 1920161.10Heating plant865.00865.00Frame building3,000.003,000.003204 Allowances for the exhaustion, wear and tear of the above assets have been allowed as deductions from income as follows: for 1919, $721.42; for 1920, $736.94. The construction of the store building was completed in April, 1908, at a cost slightly in excess of $14,000. This store is of brick construction, which has deteriorated and the brick work will have to be renewed. At the front of the building the metal flashing around a coping has rusted away and requires renewal to prevent leaks. Fixtures were originally installed in the building in 1907 and 1908 at a cost of at least $2,900. A heating plant was installed in the summer of 1908 at a cost of approximately $1,000. The frame building was located upon a farm in Stutsman County, N. Dak., when the farm was acquired in 1911. The additions to store building in 1919 consisted of shelving and an overhead balcony in the warehouse for storage purposes. 704 The additions to fixtures in 1919 consisted of fixtures for the ready-to-wear department, racks and mirrors. At the beginning of 1919, the inventory of the petitioner was taken on the basis of the lower of cost or market. As soon as possible after January3205 1 the physical count and inspection was started and the inventory was completed as rapidly as possible throughout the month of January. As the month of January passed the taking of the inventory was hastened in order to complete the inventory by January 31. Revisions were made by way of deductions for goods sold after inventorying and the completed inventory listed the goods on hand on January 31. The inventory at the beginning of the year 1920 was taken and valued upon the same method and basis. The inventory of January 31, 1919, was valued at an aggregate of $38,406.26, from which amount was deducted an allowance amounting to $2,240.50, designed to cover contingencies or depreciation of stock, leaving a net inventory value of $36,165.76. The inventory of January 31, 1920, was valued at an aggregate of $45,491.64, from which amount was deducted an allowance for contingencies or depreciation amounting to $1,592.20, leaving a net inventory value of $43,899.40, to which was added for merchandise entered in various books and for sundry charges and claims an amount of $1,116.20, the final amount of the inventory value being $45,015.64. In the return for the calendar year 1919, 3206 the petitioner computed the cost of goods sold in consideration of an inventory at the beginning of the year amounting to $39,204.69, and at the end of the year amounting to $49,306.94. In the return for the calendar year 1920, the petitioner computed the cost of goods sold, in consideration of an inventory at the beginning of the year amounting to $49,306.94. The respondent has accepted these values without adjustment. OPINION. LANSDON: This is a case wherein the issues are purely questions of fact, yet we are confronted by a failure of the record to afford any definite basis upon which to determine that the respondent has erred. In the first and second issues the petitioner seeks to revise the amounts of the inventories at the beginning and the end of the year 1919 which it reported in its returns and which values have been accepted by the respondent. It is in evidence that the inventories actually taken were of the goods on hand on January 31 of each year, although the returns were filed on a calendar year basis. Furthermore, it appears that the values of the inventories reported in the returns differ from the actual inventories according to the 705 books. No3207 attempt has been made to reconcile these differences. From the facts before us we can not state to what extent, if any, the cost of goods sold has been erroneously reported, in either of the taxable years. The remaining issue relates to the amount of the deductions allowable for exhaustion, wear and tear. Certain book values are used by both parties in their computations, but they differ as to the annual percentage rates to be allowed in the computations. There is no satisfactory evidence that the book values were the acceptable remaining cost after deducting depreciation actually sustained or that the remaining lives of the assets may be expected to differ materially from the estimates of the respondent. Judgment will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623498/	Richard M. Pereles and Daphne L. Pereles v. Commissioner.Pereles v. CommissionerDocket No. 1364-68.United States Tax CourtT.C. Memo 1969-174; 1969 Tax Ct. Memo LEXIS 123; 28 T.C.M. (CCH) 872; T.C.M. (RIA) 69174; August 25, 1969, Filed 123 Harold R. Williams, Tennessee Bldg., Houston, Tex., for the petitioners. W. Reed Smith, for the respondent. SCOTT Memorandum Findings of Fact and Opinion SCOTT, Judge: Respondent determined a deficiency in petitioners' income tax for the calendar year 1964 in the amount of $933.98. The issue for decision is the amount, if any, of capital gain realized by petitioners on the sale in September 1964 in Brazil of an automobile. Findings of Fact Some of the facts have been stipulated and are found accordingly. Petitioners, husband and wife who were residents of Houston, Texas at the time of the filing of the petition in this case, filed a joint Federal income tax return for the calendar year 1964 with the district director of internal revenue at Austin, Texas. Sometime in 1959 Richard M. Pereles (hereinafter referred to as petitioner) met and became friends with William H. Hopkins (hereinafter referred to as Hopkins) of Houston, Texas. At that time petitioner was operating an automobile agency in Connecticut and Hopkins was president of a corporation and interested in other businesses in Houston, Texas. In early 1961 petitioner came to Washington, D.C. and accepted124 a position with the Small Business Administration. He later transferred from that position to a position with the Defense Department and later transferred to a position with the Agency for International Development. In July 1962 Hopkins purchased from a dealer in Damascus, Maryland a 1962 Ford station wagon and requested that petitioner pick the station wagon up for him from the dealer and keep it so that Hopkins could use it when he came to Washington. It was understood that in return for garaging the station wagon petitioner would be entitled to use it freely when Hopkins was not using it. The title to the station wagon was taken in the name of Tusco Corporation which was a corporation owned by Hopkins. The automobile was registered in the State of Texas and bore Texas license plates. At the time of the purchase of the automobile, Hopkins made frequent trips to Washington, D.C. Sometime about November 1962 Hopkins suffered a heart attack and ceased making regular trips to Washington. In February 1963 Hopkins directed petitioner to sell the 1962 Ford station wagon. The title to the Ford station wagon was transferred from Tusco Corporation to petitioner in February 1963 and petitioner125 applied for a Maryland title to the automobile and obtained such a title. The automobile was registered in the State of Maryland and bore Maryland license plates. Petitioner in applying for the Maryland title stated that the cost to him of the automobile had been $2,700 and that there was no lien on the automobile. Petitioner paid in 1963 a sales tax to the State of Maryland on the basis of a cost of the automobile to him of $2,700. Petitioner gave a note to 873 Hopkins for $2,700. The note had no maturity date. Petitioner never made any payment to Hopkins on the note of either principal or interest and Hopkins never demanded any payment from petitioner. Sometime in 1966 or 1967 Hopkins died. No demand for payment of the note which petitioner gave to Hopkins has been made by any representative of Hopkins' estate, and petitioner has paid no amount to Hopkins' estate with respect to the note. Shortly after acquiring the Ford station wagon in February 1963, petitioner became employed by the Agency for International Development in Washington, D.C., and in March 1963 he was transferred to Rio de Janeiro, Brazil. Petitioner was permitted to take the Ford station wagon with him to Brazil126 and the United States Government paid the transportation expenses of the station wagon in the amount of $691.65. The automobile arrived in Rio de Janeiro on July 8, 1963, and was brought into Brazil duty-free under an international agreement between the United States and Brazil. Under the terms of this international agreement and certain government regulations, if a United States Government official brought a motor vehicle into Brazil and retained it for his own use for more than one year, such vehicle might be sold dutyfree if permission to make the sale was obtained from the United States Embassy. On July 29, 1964, petitioner submitted a formal written request for permission to sell the Ford station wagon in Brazil dutyfree. This request was denied. In September 1964 petitioner sold the Ford station wagon in Brazil for $4,400. He was required to, and did, reimburse the United States Government for transportation expenses of the automobile in the amount of $691.65. At the time of the sale of the automobile petitioner was required to, and did, pay a tax of $303 to Brazil in connection with the sale. In 1964 petitioner left Brazil and also left the employ of the Agency for International127 Development. Sometime in 1965 petitioner returned to Brazil in connection with a business venture of his own. When he arrived in Brazil certain authorities of that country questioned whether the sale which he had made in 1964 of the Ford station wagon was legal. Petitioner obtained services of a lawyer, and paid and incurred expenses for legal services. The total amount of the expenses which he incurred and paid in connection with the questions raised by the Government of Brazil was approximately $1,600. Petitioner reported no gain from the sale of the Ford station wagon on his Federal income tax return for the calendar year 1964. Respondent in his notice of deficiency determined that petitioner had a gain of $4,400 from the sale of the Ford station wagon in 1964. Respondent at the trial conceded that petitioner had a basis in the station wagon of the $691.65 transportation costs for which he reimbursed the United States Government and that any gain petitioner had on the sale of the automobile was capital gain. Respondent also conceded that any amount paid by petitioner to Brazil in 1964 as taxes in connection with the sale should properly be a reduction in the sales price of128 the automobile for the purpose of computing petitioner's gain on the sale. Opinion The issue here is purely factual. Both parties recognize that petitioner realized a capital gain on the sale of the 1962 Ford station wagon to the extent, if any, that the $4,400 which he received from the sale exceeded his basis in the vehicle and his costs of the sale. Petitioner contends that he had a cost basis in the Ford station wagon of $2,700 and that the amount which he was required to pay in 1965 when the legality of the sale was questioned upon his return to Brazil should be considered either as a part of his basis in the 1962 Ford station wagon or as a reduction in the price received in 1964 for the station wagon. It is petitioner's position that he actually sustained a loss on the sale of the station wagon since the $3,405.35 of the sales price of this vehicle remaining after reducing the $4,400 actually received by the transportation cost of $691.65 and the tax paid to the Government of Brazil of $303 is less than the $2,700 cost of the vehicle to petitioner plus the $1,600 paid by petitioner in 1965 when Brazil questioned the legality of his sale of the station wagon. The record129 does not disclose the nature of the issues raised by the Government of Brazil in 1965. Petitioner testified only that questions were raised with respect to the sale and that as a result of such questions he paid $1,600 for legal services and other costs. There is not sufficient evidence in the record to determine whether 874 this payment by petitioner could be considered as in effect an adjustment to the price petitioner received for the car or whether the expenditure is deductible in computing taxable income. However, petitioner did not incur the expense or make any payment in connection therewith until 1965 and for that reason the $1,600 payment is not properly deductible in 1964 and is not a proper adjustment to the sales price of the automobile in 1964. The question with respect to the $2,700 claimed cost to petitioner of the Ford station wagon is a factual one. Petitioner does not contend that the station wagon was a gift. His position is that the note he gave to Hopkins constituted a payment of $2,700 for the station wagon. The record does not disclose why petitioner made no cash payment when the title to the station wagon was transferred to him, why Hopkins had no lien130 on the station wagon to secure payment of the note, and why no payment on the note was made either to Hopkins during his lifetime or to his estate after his death. The reasonable inference from the record is that some understanding existed between petitioner and Hopkins at the time petitioner gave Hopkins the note that payment of the note by petitioner was not expected. On the basis of this record, and particularly considering that the burden of proof of the basis to him of the automobile is upon petitioner, we conclude that petitioner realized a capital gain on the sale of the 1962 Ford station wagon in the year 1964 of $3,405.35. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623499/	E.C. and LOUISE P. WESTON, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentWeston v. CommissionerDocket No. 13088-78.United States Tax CourtT.C. Memo 1981-166; 1981 Tax Ct. Memo LEXIS 579; 41 T.C.M. (CCH) 1232; T.C.M. (RIA) 81166; April 7, 1981. 579 In Sept. 1975, P was employed as an iron worker in St. Johns, Ariz., on the construction of an electrical generating plant. When he was hired, P was reasonably sure that his employment would last at least 2 years. His employment in fact continued until May 1978, when he was dismissed for cause. Prior to his employment in St. Johns, P had for years maintained his personal residence in Phoenix, Ariz. During the period when he was employed in St. Johns, P continued to reside in Phoenix on weekends, and he resided in St. Johns during the week. Held, while P was employed in St. Johns, he was not "away from home" within the meaning of sec. 162(a), I.R.C. 1954, since his employment was not temporary; therefore, P was not entitled to deduct the expenses for meals and lodging incurred by him in St. Johns. E. C. Weston, pro se. Walter T. Thompson, for the respondent. SIMPSONMEMORANDUM FINDINGS OF FACT AND OPINION SIMPSON, Judge: The Commissioner determined a deficiency of $ 2,626.15 in the petitioners' Federal income tax for 1976. The only issue for decision is whether the expenses for meals and lodging incurred by Mr. Weston in residing near a construction site where he was employed were incurred while he was "away from home" within the meaning of section 162(a) of the Internal Revenue Code of 1954. FINDINGS OF FACT Some of the facts have been stipulated, and those facts are so found. The petitioners, E.C. and Louise P. Weston, husband and wife, resided in Phoenix, Ariz., when they filed their petition in this case. They filed their joint Federal income tax return for 1976 with the Internal Revenue Service Center, Ogden, Utah. Mr. Weston is an iron worker and a member of the Iron Workers Union. In September 1975, he was hired by the Bechtel Power Corporation, through the union hiring hall, to work on a construction project in St. Johns, Ariz. When he was hired, he had581 no right to continue to work for any specified period of time. However, the project for which he was hired was the construction of an electrical generating plant, and he knew that the iron work on such project would take more than 2 years and that he probably could continue to work there for such period. Mr. Weston in fact was employed by Bechtel until May 1978, when he was dismissed allegedly for refusal to obey orders. St. Johns, Ariz., is approximately 233 miles from Phoenix, Ariz. From approximately 1966 through the time of trial, the petitioners maintained a residence in Phoenix. There, Mrs. Weston was a school teacher. When Mr. Weston was employed in St. Johns, Mrs. Weston remained in Phoenix and continued to teach. During 1976, the year in issue, Mr. Weston lived in St. Johns during the work week and in Phoenix on weekends. On their Federal income tax return for 1976, the petitioners deducted $ 6,064 as the expenses incurred by Mr. Weston for meals and lodging in St. Johns. In his notice of deficiency, the Commissioner disallowed such deduction. OPINION The Commissioner does not dispute that Mr. Weston incurred expenses of $ 6,064 for meals and lodging in St. 582 Johns. The only issue to be decided is whether such expenses were incurred by Mr. Weston while he was "away from home" within the meaning of section 162(a). That section provides, in part: (a) In General.--There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including-- (2) traveling expenses (including amounts expended for meals and lodging other than amounts which are lavish or extravagant under the circumstances) while away from home in the pursuit of a trade or business; * * Under section 162(a), travel expenses are deductible only if incurred while a taxpayer is "away from home" in pursuit of a trade or business. Commissioner v. Flowers, 326 U.S. 465">326 U.S. 465, 470 (1946). A taxpayer's home for purposes of section 162(a) is the vicinity of his principal place of employment. Commissioner v. Stidger, 386 U.S. 287">386 U.S. 287 (1967); Kroll v. Commissioner, 49 T.C. 557 (1968); Garlock v. Commissioner, 34 T.C. 611">34 T.C. 611 (1960). When a taxpayer who has a principal place of employment goes elsewhere to take work which is "temporary,583 " and not "indefinite," his home for purposes of section 162(a) remains the vicinity of his principal place of employment, since it would be unreasonable to expect him to move his residence under such circumstances. Peurifoy v. Commissioner, 358 U.S. 59">358 U.S. 59, 60 (1958); Mitchell v. Commissioner, 74 T.C. 578">74 T.C. 578, 581 (1980); Tucker v. Commissioner, 55 T.C. 783">55 T.C. 783, 786 (1971). This Court has held that employment is temporary if its termination within a "short period" can be foreseen. Mitchell v. Commissioner, supra at 581; Michaels v. Commissioner, 53 T.C. 269">53 T.C. 269, 273 (1969); Albert v. Commissioner, 13 T.C. 129">13 T.C. 129, 131 (1949). Similarly, we have stated that employment is indefinite if its termination within a "fixed or reasonably short period of time" cannot be foreseen. Stricker v. Commissioner, 54 T.C. 355">54 T.C. 355, 361 (1970), affd. 438 F. 2d 1216 (6th Cir. 1971); Mitchell v. Commissioner, supra at 581. The present case is appealable to the Ninth Circuit, and that court has expressed a slightly different view as to the meaning of indefinite employment. 584 In Harvey v. Commissioner, 283 F. 2d 491, 495 (1960), revg. 32 T.C. 1368">32 T.C. 1368 (1959), the Ninth Circuit held that a taxpayer's employment is indefinite "if there is a reasonable probability known to him that he may be employed for a long period of time at his new station. What constitutes 'a long period of time' varies with circumstances surrounding each case." (Emphasis in original.) Under the view of this Court or that of the Ninth Circuit, Mr. Weston's employment in St. Johns was not temporary, but was indefinite. Although Mr. Weston had no employment contract and no right to continue to work on the project until it was completed, he knew that work would be available for him for at least 2 years. In addition, it is stipulated that Mr. Weston was hired through the Iron Workers Union; therefore, it is unlikely that his job could have been terminated arbitrarily. In our judgment, it is clear on such evidence that when Mr. Weston began working in St. Johns, there was a reasonable probability known to him that his job would last for a "long time" and there was little chance that his job would terminate within a "short period." What is more, even if, 585 in 1975, Mr. Weston believed his employment to be temporary, it must have become clear to him in 1976 that such employment was indefinite. The petitioners rely on Frederick v. United States, 457 F. Supp. 1274">457 F. Supp. 1274 (D.N.D. 1978), affd 603 F. 2d 1292 (8th Cir. 1979), in support of their position that Mr. Weston's employment was temporary, but that case is distinguishable. There, the taxpayers were hired in the spring of 1970 for a construction project in North Dakota. Although the employment of each of the taxpayers lasted at least 2 years, the court held that the employment of each of the taxpayers was temporary. However, the record before the court showed that "The construction industry in North Dakota is seasonal, and during the winter months * * [the employer] retained only the number of employees it needed to handle maintenance and indoor construction work." 457 F. Supp. at 1281. On the basis of such record, the court stated that when the taxpayers were hired in the spring of 1970, "it could not have reasonably been foreseen that their employment would last beyond the summer season." 457 F. Supp. at 1281. On the contrary, *586 in this case, Mr. Weston expected his employment not to terminate within a short period and to last for at least 2 years. We recognize that if the petitioners had moved their residence to St. Johns, Mrs. Weston would have had to give up her job in Phoenix. However, we have previously held that if a taxpayer is employed away from his personal residence, such employment is not considered temporary merely because the taxpayer's spouse is employed in the vicinity of the personal residence and does not desire to leave such employment. Daly v. Commissioner, 72 T.C. 190">72 T.C. 190, 196 (1979); Foote v. Commissioner, 67 T.C. 1">67 T.C. 1 (1976). Here, Mr. Weston's employment in St. Johns was clearly not temporary, and the petitioners' decision not to move to St. Johns was personal. Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623501/	LUTHER B. and BERTHA SUE NELSON, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentNelson v. CommissionerDocket No. 18807-80.United States Tax CourtT.C. Memo 1982-191; 1982 Tax Ct. Memo LEXIS 554; 43 T.C.M. (CCH) 1054; T.C.M. (RIA) 82191; April 13, 1982. Luther B. Nelson, pro se. John L. Hopkins, for the respondent. SCOTT MEMORANDUM FINDINGS OF FACT AND OPINION SCOTT, Judge: Respondent determined deficiencies in petitioners' income tax for the calendar years 1977 and 1978 in the amounts of $ 1,178 and $ 1,440, respectively, and an addition to tax for the calendar year 1978 under section 6653(a) 1 in the amount of $ 72. 2 The issue for decision is whether petitioners are entitled to deduct amounts spent by Luther B. Nelson in traveling from his home in Jasper, Tennessee, to Hartsville, Tennessee, and the costs of meals and lodging at Hartsville, Tennessee, as ordinary and necessary business expenses for the555 years 1977 and 1978. FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. Petitioners, husband and wife, filed a joint Federal income tax return for the calendar years 1977 and 1978 with the Director, Internal Revenue Service Center, Memphis, Tennessee. At the time of the filing of their petition in this case, petitioners resided in Jasper, Tennessee. Luther B. Nelson (petitioner) has lived in Jasper, Tennessee, all his life. On March 14, 1977, petitioner became employed by the Tennessee Valley Authority (TVA) as a heavy equipment operator at the Hartsville Nuclear Plant, Hartsville, Tennessee. On that day he signed a document, TVA Form 9880A, entitled "Appointment Affidavit and Conditions." Among the statements contained in this document was the following: "Trades and labor temporary construction hourly, not to extend past: 78 02 24." This same document showed that556 petitioner was affiliated with the Operating Engineers' Local 917, Chattanooga, Tennessee. Petitioner had been employed by the TVA for a short period of time in 1967. His employment papers showed that he was a veteran. Petitioner, as a member of the Operating Engineers' Local 917, received his assignment to work for the TVA at the Hartsville Nuclear Plant through the union agent of that Local. Hartsville was approximately 135 miles from Jasper. However, petitioner took the assignment at Hartsville because the union agent had been unable to find him work near Jasper for more than a few days at a time. When petitioner accepted employment at the Hartsville plant, the work on the plant was only about 5 to 6 percent completed. If construction of the plant was to be completed, there would be a need for operating engineers at the site for some time. However, petitioner and the union agent both thought that petitioner could find work closer to his home in Jasper after a few months. In fact, no such work was located for petitioner and he worked at the Hartsville plant until February 24, 1978, when he was terminated in accordance with the provision in his employment agreement. Again, 557 petitioner through his union agent attempted to locate work nearer to Jasper. When no such work was forthcoming, petitioner was sent back to the Hartsville plant. He was not immediately put back to work because his blood pressure was too high and he was required to see his doctor and wait a few weeks for his blood pressure to go down before starting work again. On March 27, 1978, he began his reemployment at the Hartsville plant site and has been continuously employed there from that date until the time of the trial of this case although he has continued to look for employment nearer to Jasper. Work on the Hartsville Nuclear Plant was begun in the mid 1970's and it was expected that it would require at least 10 years to complete the plant. Even though in 1977 officials of the TVA knew it would be about 10 years before the Hartsville Nuclear Plant would be completed, it was the policy of the TVA to employ all hourly construction workers at that plant on a temporary basis. For some time prior to 1977 and up to approximately October 1978 when the provision was deleted from the "Appointment Affidavit and Conditions" signed by hourly workers, TVA placed a date of 11 months and some558 odd days not to exceed 29 from the date of employment as the termination date of all hourly construction workers. These hourly construction workers were hired as temporary workers so that they could be dropped immediately from the TVA roles if necessary. TVA is an agency of the United States Government and at times was required by the Office of Management and Budget or a presidential directive to comply with certain employment ceilings. During the time the provision for termination of a temporary employee was contained in the "Appointment Affidavit and Conditions," officials of TVA were of the view that this provision further aided in quick termination of hourly construction employees if such quick termination were necessary. While this provision was in the appointment conditions, the temporary worker would be terminated for a period usually of approximately 10 workdays and after that brief termination period generally would be reemployed. In certain trades the chances of reemployment were well over 90 percent and for heavy equipment operators at the Hartsville plant the chances of being reemployed were better than 50 percent. When the 10-day furlough would occur, the employee559 at times would be told that he would very likely be needed and be reemployed after the 10-day break. Since the provision for termination within 11 months and 29 days was deleted from the appointments of temporary hourly construction workers by the TVA prior to February 22, 1979, which was the stated termination date of petitioner's employment under the "Appointment Affidavit and Conditions" petitioner signed in March 1978, petitioner was not terminated in 1979. Even though it is not uncommon for heavy equipment operators to be laid off during the winter months if the weather is bad, petitioner has not been laid off in the winter while working at the Hartsville plant site. When petitioner went to work at the Hartsville Nuclear Plant in March 1977, he did not know how long he would be employed at that plant but hoped to soon find work nearer to Jesper. Petitioner drove from his home in Jasper, Tennessee, to Hartsville during 1977 and 1978 while employed at the Hartsville plant site every Sunday evening and drove back to Jasper where his wife and children were living every Friday night. Petitioner paid for lodging and meals at Hartsville during the week. Petitioner on his560 Federal income tax return for the year 1977 deducted $ 5,006.20 as employee business expenses composed of $ 3,061.40 for meals and lodging and $ 1,944.80 for automobile expenses. On his 1978 Federal income tax return petitioner deducted $ 5,616.95 as employee business expenses composed of $ 3,495.35 for meals and lodging and $ 2,121.60 for automobile expenses. Respondent in his notice of deficiency disallowed these claimed deductions with the following explanation: It is held that, since the termination of your employment at this job site could not be foreseen within a fixed and reasonably short period, the employment was indefinite, rather than temporary, and any travel expenses incurred in connection therewith were nondeductible personal expenses rather than ordinary and necessary business expenses. * * * OPINION Section 162(a)(2) provides for a deduction for ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business including traveling expenses while away from home in pursuit of a trade or business. Generally speaking, a taxpayer's home for the purpose of determining whether he is away from home in pursuit of a trade or561 business within the meaning of section 162(a) is considered to be his principal place of employment. . However, when a taxpayer's employment at some location is temporary as distinguished from indefinite or indeterminate, he is considered while so employed to be away from home in pursuit of his trade or business. ; ; As we have pointed out on a number of occasions, employment is considered to be temporary where it can be expected to last only for a short period of time. ; . It is clear that petitioner in this case viewed all of his work at the Hartsville plant as temporary since he hoped to find employment nearer to Jasper, Tennessee. Petitioner testified that he believed in 1977 and 1978 that work would be available at the Hartsville plant for some time but did not know from day to day whether he would stay there. 562 The definition of "temporary" that this Court has used in determining whether an individual is entitled to deduct traveling expenses while away from home under section 162(a)(2) is not whether a taxpayer was looking for work at another location but rather how long his current employment might be expected to last. See . Petitioner testified that even though he did not know how long he would work at the Hartsville plant when he commenced his employment there in 1977, he was aware that it was likely work would be available there for a period of years. The record shows that TVA would have need for workers at the Hartsville plant for a number of years after 1977. The fact that petitioner hoped to find work in the Jasper area within a short period after he began work at the Hartsville plant site would not cause petitioner's employment at the Hartsville plant to be temporary rather than indefinite. The criteria is whether the employment, itself, is temporary not whether petitioner is looking for other employment. The fact of temporary layoffs interrupting otherwise continuous employment of a construction worker at a particular563 site has not been considered to necessarily cause the taxpayer's employment to be temporary rather than indefinite. . Considering the facts in this case against the background of our holdings in other cases, we conclude that petitioner's employment at the Hartsville plant site in 1977 and 1978 was not temporary but was indefinite. The record shows that workers in petitioner's craft were in short supply in the Hartsville area. Although the termination agreement was initially put in petitioner's employment agreement, this provision did not mean that petitioner's work at the Hartsville plant would in fact be terminated for more than a short period. The record shows that the chances of petitioner not being terminated but merely furloughed were better than 50 percent. The real basis of petitioner's position in this case is that a construction worker's job is always temporary since he will be terminated when the project on which he is working is completed. It is clear that because of this fact it might be said that a construction worker never has permanent employment. However, this lack of absolute permanence is564 not the criteria which this Court and other courts have used in determining whether a taxpayer's work is temporary as distinguished from indefinite or indeterminate. See , affd. ; , affd. . On the basis of this record, we conclude that petitioner is not entitled to deduct the expenses of driving his automobile from his home in Jasper to his work at the Hartsville plant site and the cost of his meals and lodging near the Hartsville plant site during the years 1977 and 1978 since he was not away from home in the pursuit of a trade or business within the meaning of section 162(a)(2). Decision will be entered for the respondent as to the deficiencies in tax, and for the petitioner as to the addition to tax under section 6653(a).Footnotes1. Unless otherwise indicated, all statutory references are to the Internal Revenue Code of 1954, as amended and in effect during the years here in issue. ↩2. At the trial respondent conceded that petitioner was not liable for any addition to tax under section 6653(a).↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623502/	CHARTIERS CREEK COAL CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Chartiers Greek Coal Co. v. CommissionerDocket No. 9652.United States Board of Tax Appeals10 B.T.A. 984; 1928 BTA LEXIS 3982; February 24, 1928, Promulgated 3982 1. INVESTED CAPITAL. - Paid-in surplus allowed in an amount by which the proved value of coal property paid in for stock exceeds the par value of the stock issued therefor. 2. DEPLETION. - Value of coal lands determined for depletion purposes. Paul F. Myers, Esq., for the petitioner. Maxwell E. McDowell, Esq., for the respondent. LANSDON 984 The respondent has asserted deficiencies in income and profits taxes for the years 1918 and 1920 in the respective amounts of $26,625.86 and $44,703.22. The petitioner alleges error by respondent in reducing invested capital by eliminating therefrom paid-in surplus for each of the years and in refusing to accept the value used by petitioner in computing depletion deductions. 985 FINDINGS OF FACT. The petitioner is a Pennsylvania corporation, organized February 14, 1916, and maintaining its principal office at Pittsburgh. During the taxable years and since its organization, petitioner has been engaged in the operation of a coal mine. Early in January, 1916, A. M. Marion entered into negotiations for the purchase of a coal property known as the Hazel mine, then in the hands of the3983 Union Trust Co. of Pittsburgh, Pa. The Hazel mine had formerly been owned by the Pettsburgh-Buffalo Coal Co., which had failed, and was acquired by the Union Trust Co. through foreclosure of a mortgage. It contained 620 acres or more of solid and pillar coal, which had been partly worked out, together with a tract of surface land adjoining the Pennsylvania Railroad at Canonsburg, Pa. Adjacent to the Hazel mine were 400 acres of coal land owned by the Pittsburgh Coal Co., which could profitably be worked from the Hazel mine without sinking another shaft. The Pittsburgh Coal Co. property had never been worked. On or about January 10, 1916, Marion offered to purchase the Hazel mine from the Union Trust Co., provided he could also purchase the 400-acre tract from the Pittsburgh Coal Co. Pursuant thereto, H. C. McEldowney, president of the Union Trust Co., and William I. Berryman, trust officer of the Union Trust Co., personally presented Marion's offer of $600 per acre to the chairman of the board of directors and other officers and engineers of the Pittsburgh Coal Co. The 400-acre tract in question was at that time mortgaged to the Union Trust Co. by the Pittsburgh Coal Co., 3984 and since there was no possibility of working the property in the near future, the offer of $600 per acre was accepted and Marion was so notified. Shortly thereafter and prior to January 15, 1916, Marion conferred with Samuel A. Taylor, chairman of the board of directors of the Pittsburgh Coal Co., regarding payment for the 400 acres and it was agreed that payment should be deferred for one year, during which time Marion should pay 5 per cent interest on the purchase price, together with taxes for the year 1916. The total purchase price, with interest and taxes, was to be paid on delivery of the deed one year later. The minutes of the directors' meeting of the Pittsburgh Coal Co., under date of January 26, 1916, appear as follows: Early in 1917, W. W. Keefer, a coal operator in the Pittsburgh 400 acres of coal rights adjoining what is known as the Hazel Mine, located near Canonsburg, Washington County, Pennsylvania, at a price of six hundred (600) dollars per acre, cash - submitted a map showing its location in relation to the present workings of the company, - made representations as to its tonnage possibility and necessity for the future, and recommended that in his judgment3985 it was in the interest of the company that the sale should be made, when 986 On Motion duly made and seconded, it was Resolved, That the sale of the property as submitted, described and recommended by the Chairman, be and the same is hereby approved and authorized. On January 15, 1916, a written contract was entered into between Marion and Scott Hayes, holding title for the Union Trust Co., for the sale to Marion of the Hazel mine at a total consideration of $350,000, of which $2,500 was paid in cash, $47,500 was to be paid upon delivery of the deed, $50,000 was to be paid on February 1, 1917, and $250,000 was to be paid in twenty quarterly installments of $12,500 each. The contract of sale provided that Marion might, if he so desired, designate a corporation to receive title to the property. On or before January 15, 1916, Marion entered into possession of both the Hazel mine and the 400-acre tract acquired from the Pittsburgh Coal Co. and placed men thereon to do certain work preparatory to operation of the mine. Being unable to finance the deal alone, Marion proposed to J. H. Sanford and E. C. Gerry on February 1, 1916, that if they would contribute $30,0003986 and $5,000, respectively, he would organize a corporation, transfer his coal properties to the corporation, and cause to be issued to them capital stock of a par value equal to their respective contributions. Both Sanford and Gerry thereupon on February 1, 1916, paid the amounts requested to Marion individually. An added consideration for taking these men into the business was the fact that Sanford owned two docks on the Great Lakes through which the coal might be marketed, and that Gerry, division superintendent for the Pittsburgh Coal Co., proposed to resign his position and become superintendent for the corporation to be organized. On that date, february 1, 1916, he did resign his position with the Pittsburgh Coal Co. and entered the employment of Marion, as superintendent, until the contemplated corporation could be organized. Work on the two tracts, which had already been started by Marion, was continued under the direction of Gerry. On February 14, 1916, a charter was granted by the Commonwealth of Pennsylvania to the Chartiers Creek Coal Co., and stock of a par value of $75,000 was issued to Marion or his nominees, in exchange for which he deposited $67,500 cash to the3987 credit of the new corporation, retaining $5,000 for his services in organizing the corporation, and $2,500 for his cash payment to the Union Trust Co. Marion nominated Sanford and Gerry to receive respectively 300 shares and 50 shares of capital stock of a par value of $100 a share. The first stockholders' meeting was held on February 16, 1916, when Marion offered to transfer and assign to the petitioner all his right, title and interest in and to both his contracts for the purchase of the Hazel mine and the 400-acre tract from the Pettsburgh Coal Co. The 987 offer was accepted by the petitioner and it was agreed that inasmuch as Marion had deposited $67,500 to the credit of the corporation, the latter on behalf of Marion would make the $47,500 payment upon delivery of the deed to the Hazel mine property. On February 16, 1916, at the direction of Marion, a deed was issued by the Union Trust Co. to the Chartiers Creek Coal Co. and the payment of $47,500 was made by the corporation. From February 16, 1916, the corporation, having possession of both properties, proceeded to operate them as a unit and has so operated them since that time. Certain repairs of equipment, cleaning3988 out of entries, pumping water from the mine, etc., were necessary before production of coal could be obtained. This work had been started by Marion on or about January 15, 1916, and was continued by the corporation until production was obtained early in April, 1916. By August, 1916, the mine was in full operation, including the mining of coal from the 400-acre tract. By the close of 1916 the 400-acre tract had been entered approximately 1,400 feet. The Chartiers Creek Coal Co. tendered payment of the purchase price to the Pittsburgh Coal Co. for the 400-acre tract on or about January 1, 1917, and Marion requested a deed to issue to it, but since the engineers assigned to resurvey the tract were otherwise engaged, no deed was submitted until May 25, 1917, when the purchase price of $24,000, plus interest and taxes, was paid. Recognizing the delay in submitting the deed as its fault, the Pittsburgh Coal Co. charged interest only for one year. A bond and mortgage in the amount of $253,303.50 was executed and delivered to the Pittsburgh Coal Co. in exchange for the deed, on May 25, 1917. In December, 1916, Marion, acting on behalf of the petitioner, received a bona fide3989 offer through R. T. Donaldson, who represented the Berwin-White interests, of $1300,000 cash for the two coal properties combined. A check was tendered for hand money, and in case the offer was accepted, Marion was to receive the full amount in case and clear the property of indebtedness. After consideration by the board of directors of petitioner, the offer was rejected since the future profit to be derived from operation promised to exceed the profit from an immediate sale. Early in 1917, W. W. Keefer, a coal operator in the Pettsburgh vicinity since 1890, purchased unimproved coal property, known as the "Davis lands," located near petitioner's property and in the same vein of coal. The price paid was $1,250 per acre. The Hazel mine combined with the 400-acre tract contained 1,020 acres of coal land and 200 acres of surface land, and contained 988 5,610,000 tons of recoverable coal. The value of the combined property on February 16, 1916, was: 200 acres surface land$5,000.00Plant and equipment130,595.96Coal1,164,404.041,300,000.00The respondent has disallowed petitioner's claim for a paid-in surplus and has computed depletion upon3990 a value representing the price paid to the Union Trust Co. and the Pittsburgh Coal Co. under the contracts entered into by Marion. OPINION. LANSDON: The issues involved in this proceeding are: (1) Whether certain coal lands were paid in to petitioner for stock by Marion, or whether petitioner acquired title by purchase for cash direct from the grantors named in the deeds; and (2) the proper value at the basic date, should the right to a paid-in surplus be allowed both for purpose of invested capital and depletion. Section 326(a)(2) of the Revenue Act of 1918 provides in part: SEC. 326. (a) That as used in this title the term "invested capital" for any year means * * * (2) Actual cash value of tangible property, other than cash, bona fide paid in for stock or shares, at the time of such payment, but in no case to exceed the par value of the original stock or shares specifically issued therefor, unless the actual cash value of such tangible property at the time paid in is shown to the satisfaction of the Commissioner to have been clearly and substantially in excess of such par value, in which case such excess shall be treated as paid-in surplus: * * * The respondent contends: 3991 (1) That no right to a paid-in surplus exists, since petitioner acquired title to the coal lands direct from the grantors named in the deeds, the statute of frauds making void certain oral contracts and assignments by which petitioner takes title through Marion; and (2) that cost is the proper basis for computing depletion. The petitioner contends: (1) That the oral contracts and assignments are not affected by the statute of frauds; (2) that title to the coal lands was transferred by Marion to petitioner in exchange for stock; and (3) that the value both for purposes of invested capital and depletion is the fair market value at the date paid in to petitioner for stock. The validity of three contracts and assignments is involved: (1) The written contract of sale from the Union Trust Co. to Marion for the Hazel mine; (2) the oral contract of sale by the Pittsburgh Coal Co. to Marion of the 400-acre tract; and (3) the oral assignments of 989 both properties by Marion to petitioner. With regard to the written contract for the purchase of the Hazel mine there can be little doubt that Marion acquired right, title or interest sufficient to have compelled a conveyance to him3992 by specific performance in equity. The oral contract with the Pittsburgh Coal Co. and the oral assignment by Marion to petitioner present a different situation. The only memoranda of these contracts were the minutes of the directors' meeting of the Pittsburgh Coal Co. on January 26, 1916, authorizing the sale, and the minutes of the stockholders' meeting of petitioner on February 16, 1916, accepting the assignment of the coal properties from Marion. The Pennsylvania Statutes (West Publishing Co., Edition, 1920), provide: § 20192. Parol Leases, Etc., Estate in Lands Not To Be Assigned, Etc., Except In Writing - From and after April 10, 1772, all leases, estates, interests of freehold or term of years, or any uncertain interest of, in, or out of any messuages, manors, lands, tenements or hereditaments, made or created by livery and seisin only, or by parol, and not put in writing, and signed by the parties so making or creating the same, or their agents, thereunto lawfully authorized by writing, shall have the force and effect of leases or estates at will only, and shall not, either in law or equity, be deemed or taken to have any other or greater force or effect, any consideration3993 for making any such parol leases or estates, or any former law or usage to the contrary notwithstanding; except, nevertheless, all leases not exceeding the term of three years from the making thereof; and moreover, that no leases, estates or interests, either of freehold or terms of years, or any uncertain interest, of, in, to or out of any messuages, manors, lands, tenements or hereditaments, shall, at any time after the said April 10, 1772, be assigned, granted or surrendered, unless it be by deed or note, in writing, signed by the party so assigning, granting or surrendering the same, or their agents, thereto lawfully authorized by writing, or by act and operation of law. (1772, March 21; 1 Sm. L. 389, § 1.) Attested minutes of a meeting of corporate directors authorizing the sale of property have been held a sufficient memorandum to satisfy the statute. A reference in the minutes to a survey is a sufficient description of the land if the survey may be identified by parol evidence. The memorandum need only be signed by the grantor and the taking possession of the land is a sufficient acceptance by the grantee. 3994 ; . The minutes of the Pittsburgh Coal Co. of January 26, 1916, state the sale price of the property, the number of acres, and refer to a map showing the location of the tract to be sold, but do not designate the grantee. Marion, however, entered into and continued in possession of the property until a deed was issued at his direction to a corporation organized by him. In 990 , which is a much cited Pennsylvania case, the court states: Any memorandum in writing indicative of the intent of the parties, and so precise as to enable the inquirer to ascertain the terms of the contract, the land conveyed, and the price paid for it is sufficient. Taking possession of land pursuant to an oral contract of sale, together with payment in full or in part of the purchase price, or the making of valuable improvements by the vendee, is sufficient part performance to take the contract out of the operation of the statute of frauds. 3995 Pugh v. Good, 3 W. & S. (Pa.) 56; ; ; ; ; ; 36 Cyc. 654. Marion took possession of the 400-acre tract prior to January 15, 1916, placed workmen on the premises and started work through the adjoining Hazel mine preparatory to mining operations. The respondent has cited and seems to rely entirely on the safe ; . The facts in that case are different. As stated by the court, "It is not alleged that the coal company took possession of any definitely described tract of 200 acres, or in fact, of any coal land in pursuance of the sale, or made any improvements thereon." The court also found that the memorandum or agreement failed "to definitely describe any of the boundaries." In the instant case, Marion took possession of a definitely described tract of 400 acres, agreed to pay the taxes and did certain work on the premises. 3996 Also, the corporate memorandum refers to "a map showing its location in relation to the present workings of the company." Both the oral contract of sale to Marion and the oral assignment by him to the petitioner were complied with by the parties. On direction of Marion a deed to the 400-acre tract was delivered to petitioner by the Pittsburgh Coal Co. The parties not having taken advantage of any legal defects which may have existed in the contracts, but having chosen to carry out their provisions, the validity of the contracts will be recognized by the Board. ; ; . There is no allegation that Marion was acting as promotor or agent for petitioner when he entered into the contracts for the purchase of the two coal properties and the record is clear that he was not so acting. Petitioner's organization was first contemplated subsequent to the completion of the contracts by which Marion purchased the properties. We are convinced that Marion had right, title and interest in and to the two coal properties and that such right, title and interest3997 were paid in to petitioner on February 16, 1916, for stock. 991 The petitioner contends that on February 16, 1916, when paid in for stock, the two properties had a combined value of $1,300,000, which amount exceeds the cost to Marion under the contracts of January 15, 1916, by $710,000. In , the Board held that the purchase price paid by petitioner's incorporators for limestone lands, shortly before petitioner was organized, and the land exchanged for stock, establishes the value of such lands for invested capital purposes. However, in the instant case the purchase price paid by Marion for the separate tracts does not establish the value of the two properties when combined. The Board held in , that the prices at which properties are knocked down at a sale conducted by a trustee in bankruptcy are not conclusive of the actual cash value of such assets when transferred by the purchasers to a corporation in exchange for corporate stock, and the true actual value of such properties may be proven by competent evidence. 3998 See also . The Hazel mine was purchased by Marion from the Union Trust Co., which had acquired the property through foreclosure of a mortgage. It was obliged to convert the property into cash as soon as possible and was interested chiefly in securing the return of its investment. The 400-acre tract purchased by Marion from the Pittsburgh Coal Co. was distant from the railroad, could not be worked in connection with its other property, and was heavily mortgaged to the Union Trust Co. Neither the sale by the Union Trust Co. nor the sale by the Pittsburgh Coal Co. was under such market conditions as to clearly establish the value of the property. The Hazel mine was a partly worked tract, the coal content of which was insufficient to make its operation profitable. The 400-acre tract was undeveloped, isolated from the railroad, and from mining operations of the Pittsburgh Coal Company, and of such small acreage that the development expense necessary to procure the coal prohibited its operation as a separate enterprise. Thus considered alone, neither the Hazel mine nor the 400-acre tract was a readily marketable property. When the two3999 properties were combined, however, they became very valuable. The Hazel mine property had a mine shaft and equipment in good condition, and was connected with a railway spur. The 400-acre tract provided sufficient additional coal to make the combined operation highly profitable, since there was little development expense necessary to procure coal from the 400-acre tract. The record of this appeal convinces us that the petitioner's claim of $1,300,000 is a conservative valuation of the two properties combined. The evidence to support petitioner's valuation claim consists of the testimony of three disinterested witnesses who seem to have been 992 particularly well qualified to testify with respect to the value of the property in question; proof of the sale of coal land in close proximity to petitioner's property and in the same vein of coal at a price of $1,250 per acre; and proof of the rejection by petitioner in the fall of 1916 of an offer of $1,300,000 for the combined properties. Samuel A. Taylor, a mining engineer and coal operator who was thoroughly familiar with the property, testified that he appraised the property for Marion in 1916, and that a very conservative4000 value of the two properties combined was on February 16, 1916, $1,115 per acre for the 1,020 acres of coal land. He testified that "if you had paid $1,500 an acre you would not have been paying an outside price." J. A. Donaldson, vice president of the Pittsburgh Coal Co. in charge of operations, testified on behalf of the petitioner that on February 16, 1916, the two coal properties combined were worth $1,500 per acre for the 1,020 acres of coal land. W. W. Keefer, who has been engaged as a coal operator since 1890 and is a member of American Institute of Mining Engineers, assisted in appraising the Hazel mine for the Federal court in 1914, and had for many years prior thereto been familiar with both the Hazel mine and the 400-acre tract adjoining. On February 16, 1916, the two properties combined, in his opinion, had a value of $1,200 an acre. On April 5, 1921, S. L. Clemons, valuation engineer of the Internal Revenue Bureau, submitted to the petitioner a "comment on valuation," which was approved by G. M. S. Tait, Chief, Coal Valuation Section, finding the value of the property on February 16, 1916, to be as follows: 200 acres surface land, at $25$5,000.00Plant70,000.00Equipment60,595.96Coal1,164,404.041,300,000.004001 After careful consideration of all the evidence we find the combined coal properties to have had an actual cash value of $1,300,000 on February 16, 1916, as claimed by the petitioner. This property, together with $67,500 in cash and $5,000 for services, was paid in by Marion for all the capital stock. Petitioner assumed payment of the balance of the purchase price which, including the $47,500 payment made on delivery of the deed, totaled $587,500. Deducting such amount from the total assets paid in, there remains a net value of $785,000 which was exchanged for stock of a par value of $75,000. It follows that petitioner is entitled to include in its invested capital as paid-in surplus an amount of $710,000. Depletion should be computed 993 on a valuation of $1,164,404.04, which we have found to be the value of the coal in place. The rate for computing depletion deductions is not in controversy. Reviewed by the Board. Judgment will be entered on 10 days' notice, under Rule 50.SMITH did not participate.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623449/	Joseph H. Miller and Rose B. Miller, Petitioners, v. Commissioner of Internal Revenue, Respondent. Samuel Miller and Emma S. Miller, Petitioners, v. Commissioner of Internal Revenue, RespondentMiller v. CommissionerDocket Nos. 51489, 51492United States Tax Court26 T.C. 115; 1956 U.S. Tax Ct. LEXIS 212; April 20, 1956, Filed 212 Decisions will be entered for the respondent. Dividends -- Reduction of Authorized Capital Represented by No-Par Common Stock -- Surplus Credited to Stockholders. -- A corporation reduced its authorized capital represented by no-par common stock in 1936 from $ 50,000 to $ 2,500, credited the difference to capital surplus, and over 21 months later transferred the amount from capital surplus to stockholders' accounts pro rata. A distribution to a cash basis stockholder in 1948, accounted for by the corporation as a payment on account of the balance in the account in the stockholder's name, was a dividend distribution within the meaning of section 115 (a) and (b) and taxable to the stockholder under section 22. David Perris, Esq., for the petitioners.Donald G. Corley, Esq., for the respondent. Murdock, Judge. MURDOCK 115 OPINION.213 The Commissioner determined deficiencies in the income tax of the petitioners for 1948 as follows:Docket No.PetitionersAmount51489Joseph H. and Rose B. Miller$ 1,233.1051492Samuel and Emma S. Miller7,116.98The sole issue is whether cash distributions in 1948 by the Cleveland Towel Supply Co., to Joseph of $ 2,375 and to Samuel of $ 12,125 were taxable dividends, as contended by the Commissioner, or a return of capital, as contended by the petitioners. The facts have been stipulated.116 The Joseph Millers and the Samuel Millers, each using a cash basis, filed joint income tax returns for the year in question with the collector of internal revenue for the eighteenth district of Ohio.The Cleveland Towel Supply Co., an Ohio corporation, was organized on July 14, 1928, with an authorized capital of $ 500, consisting of 100 shares of no-par common stock. 214 Its authorized capital stock was increased on July 31, 1928, to $ 250,000 of 7 per cent cumulative and nonparticipating preferred stock (2,500 shares at $ 100 par value) and $ 50,000 of common stock (500 shares no-par-value).The no-par common stock was issued as follows:SharesSamuel Miller275 (55%)$ 27,500Joseph H. Miller125 (25%)12,500Meyer H. Miller50 (10%)5,000Morris Miller50 (10%)5,000500(100%)$ 50,000The corporation's stockholders unanimously resolved on December 30, 1935: 1that whereas, the audit of the accountant of the Company shows that a reduction in the stated capital is advisable, and that the stated capital shall, therefore, be reduced by writing down the capital, which is represented by 500 shares of common non-par stock, the consideration of which had been previously fixed at $ 100.00 a share be reduced from $ 50,000.00 to $ 2,500.00 and being 500 shares of common, non-par stock, at a consideration for each share of non-par stock at $ 5.00 per share, and that the books of account shall be changed to conform to the stated capital as reduced, and the President and Secretary be authorized to proceed in accordance with the provisions215 of Section 8623-39 of the General Code of Ohio.The corporation's charter was so amended on January 17, 1936. The $ 47,500 reduction was credited on that day to capital surplus account on the books of the corporation.There was a transfer on November 1, 1937, of the amounts involved from capital surplus to separate accounts for each common stockholder on the books of the corporation in proportion to the amount of common stock held by him. The parties have stipulated that "Such transfer upon the books of the corporation did not result to any extent in a taxable distribution to the common stockholders at that time."The accounts for the stockholders were shown on the income tax returns filed by the corporation as a liability, under the caption216 "Due Stockholders."A cash disbursement of $ 10,000 was made on December 31, 1937, to the common stockholders and a corresponding debit was made to the 117 stockholders' accounts. The Internal Revenue Service treated this cash disbursement as a taxable dividend, and on October 31, 1939, the following entry was made on the corporation's books:DebitCreditSurplus$ 10,000Samuel Miller$ 5,500Joseph H. Miller2,500Meyer H. Miller1,000Morris Miller1,000To re-establish amounts due stockholders in accordance with Internal Revenue ruling that funds were not withdrawal of capital, but were considered dividends paid from earned surplus.An analysis of the stockholders' accounts is as follows:Meyer H.DateDateSamuelJoseph H.Miller andMorrisenteredpaidMillerMillerheirsMiller1. From capitalsurplus11- 1-37$ 26,125$ 11,875$ 4,750$ 4,7502. Cash disbursed12-31-375,5002,5001,0001,0003. Balance$ 20,625$ 9,375$ 3,750$ 3,7504. From earned surplus10-31-395,5002,5001,0001,0005. Balance October 31,1939$ 26,125$ 11,875$ 4,750$ 4,7506. Cash disbursed10-31-4310-28-43$ 5,000$ 5,000$ 4,750$ 4,7507. Cash disbursed10-31-4410-24-442,0001,0008. Cash disbursed10-31-455- 5-454,0001,5009. Cash disbursed9-30-477-17-473,0002,00010. Total (lines 6-10)$ 14,000$ 9,500$ 4,750$ 4,75011. Balance October 1,1947 (line 5 lessline 10)$ 12,125$ 2,37512. Cash disbursed9-30-489-16-48$ 3,000$ 1,00013. Cash disbursed9-30-4912- 1-483,0001,00014. Cash disbursed9-30-4912-30-486,12537515. Total (lines 12-14)$ 12,125$ 2,37516. Balance September30, 1949 (line 11less line 15)217 The corporation's books disclose earned surplus, net profit after taxes, and dividends paid during the indicated fiscal years, as follows:Net profitEarnedafter taxesDividendsYear endedsurplus as offor yearpaid duringyear endedendedyear endedOctober 311935$ 25,002.33$ 3,387.83$ 10,500193620,511.2713,508.9418,000193726,397.7917,886.5212,000194216,477.1621,087.8612,0001943234.917,757.7524,00019441 1,733.348,031.7510,00019451 1,511.6210,221.7210,00019463,912.8613,424.488,000September 30194729,801.7533,888.898,000194860,371.1738,579.428,000194983,374.3937,003.2218,000118 Samuel and Joseph received cash disbursements from the corporation in 1948 of $ 12,125 and $ 2,375, respectively. Those amounts were treated by them as a return of capital and were not reported on their income tax returns for 1948. The Commissioner included them in the petitioners' income as "taxable dividends" under sections 22 (a) and 115 (a) and (b) of the Internal Revenue Code.The principal argument made by the petitioners against the determinations of the Commissioner218 is that the corporation, on December 30, 1935, reduced its stated capital, represented by 500 shares of its no-par common stock, from $ 50,000 to $ 2,500; it amended its charter on January 17, 1936, to conform to this action; it thus created an indebtedness to the common stockholders of $ 47,500; and the amounts in controversy were payments made during the taxable year to discharge this indebtedness and were not dividends.The $ 47,500 was credited to capital surplus account on the books of the corporation on January 17, 1936, and it was not until November 1, 1937, that the amount was transferred on the books from capital surplus to the separate accounts of the stockholders. It could have remained indefinitely as paid-in surplus. All capital and surplus, particularly paid-in surplus, in a sense constitute obligations of a corporation to its stockholders. Such items are referred to as the stockholders' equity in the corporation. However, this does not mean that those items are an indebtedness which can be paid to the stockholders without the tax consequences of a "distribution." The question here is what are the tax consequences in 1948 of the payments in question.Section 115219 (a), as it applies to the year 1948, with exceptions not material hereto, defines dividend as "any distribution made by a corporation to its shareholders, whether in money or other property, (1) out of its earnings or profits accumulated after February 28, 1913, or (2) out of the earnings or profits of the taxable year * * ." Subsection (b) provides: "For the purposes of this chapter every distribution is made out of earnings or profits to the extent thereof, and from the most recently accumulated earnings or profits." There are other provisions of section 115 but they need not be discussed because they were not relied upon by the Commissioner or pleaded and argued by the petitioners to escape the Commissioner's determination. For example, the petitioners have not pleaded, argued, or even suggested that there was a partial liquidation affecting the common stock within the provisions of section 115 (c) and (i). Furthermore, the evidence would not support such a contention. The preferred shares were redeemed and canceled, but not the common shares. There are cases holding that a mere reduction in the authorized or stated capitalization supported by par value common stock is not 220 a cancellation or redemption 119 of the shares within the meaning of subsection (i). A. J. Long, Jr., 5 T. C. 327, affd. 155 F. 2d 847; John K. Beretta, 1 T. C. 86, affd. 141 F. 2d 452, certiorari denied 323 U.S. 720">323 U.S. 720; Mabel I. Wilcox, 43 B. T. A. 931. The petitioners' position here, where their stock had no par value, is certainly no stronger.Payment by a corporation of a debt incurred for a proper consideration in the operation of its business is, of course, not a distribution at all, but the payments in question were not of that kind. They were distributions by the corporation to its stockholders within the meaning of the word "distribution" as used in section 115. A payment of this kind made by a corporation which had no earnings or profits would still be a distribution. See subsec. (d). However, that subsection does not apply here because this corporation had earnings and profits in 1948 in excess of the total distributions which it made during that year. The words of subsection (b) that "every221 distribution is made out of earnings or profits to the extent thereof" create a conclusive statutory presumption as to the source of the distribution. Leland v. Commissioner, 50 F.2d 523">50 F. 2d 523, 525, affirming 18 B. T. A. 795, certiorari denied 284 U.S. 656">284 U.S. 656. The distributions in controversy are dividends within the meaning of subsections (a) and (b) since no other provision of section 115 applies, and they are taxable under section 22. Dunton v. Clauson, 67 F. Supp. 839">67 F. Supp. 839; A. J. Long, Jr., supra;John K. Beretta, supra;Mabel I. Wilcox, supra.The only other argument of the petitioners is in the alternative and is that, if there ever was a taxable distribution as a result of the decrease in the authorized and stated capital represented by the no-par common stock, it occurred in 1936. These taxpayers used a cash receipts basis of reporting income. They received no cash in 1936, either actually or constructively. A distribution received by a cash basis stockholder in the taxable year222 is no less taxable to him in that year merely because it was credited to his account on the books of the corporation in a prior year under circumstances which did not amount to constructive receipt at the time of the crediting. The cash in question was received for the first time for tax purposes in 1948. There is no merit to the petitioners' alternative contention. Furthermore, the parties have stipulated that the transfer of the $ 47,500 on November 1, 1937, from capital surplus to the separate accounts of each common stockholder on the books of the corporation "did not result to any extent in a taxable distribution to the common stockholders at that time." This stipulation negatives any constructive receipt at that time.Decisions will be entered for the respondent. Footnotes1. The corporate directors resolved at that time "that $ 50,000.00 of preferred stock be redeemed and paid off at $ 100.00 per share, * * and said certificates of preferred stock so redeemed [be] canceled, * * *." There is no issue here with respect to those preferred shares.↩1. Deficit.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623451/	Don Cornish and Monice C. Cornish v. Commissioner.Cornish v. CommissionerDocket No. 1454-68.United States Tax CourtT.C. Memo 1970-51; 1970 Tax Ct. Memo LEXIS 310; 29 T.C.M. (CCH) 235; T.C.M. (RIA) 70051; February 26, 1970, filed. Don Cornish, pro se, 2540 N.E. 97th, St., Seattle Wash. G. Phil Harney, for the respondent. TANNENWALDMemorandum Findings of Fact and Opinion TANNENWALD, Judge: Respondent determined a deficiency of $121.27 in petitioners' income tax for the year 1964. The sole issue for our determination is whether petitioners are entitled to deduct $630 1 as an educational expense of Don Cornish while a full-time student at the University of Washington. 311 Findings of Fact Some of the facts are stipulated and are found accordingly. Petitioners are husband and wife who had their legal residence in Seattle, Washington, at the time of filing the petition herein. They filed a joint Federal income tax return for the taxable year 1964 with the district director of internal revenue, Seattle, 236 Washington. Monice C. Cornish is a party hereto only because she filed a joint Federal income tax return with her husband for the year 1964. References to petitioner shall be deemed to refer to Don Cornish. Petitioner's formal education was acquired as follows: School, college, universityDate attendedLittle Rock High School1931-1934Phillips Exeter Academy1934-1935Yale University1935-1936Massachusetts Institute of Technology1936-1937Northwestern University1938-1939University of Washington1960-1962University of Washington1963-1965University of Arkansas1969-presentPetitioner's status, while enrolled at the University of Washington, was as follows: Dates attendedStatusSept. 1960-June 1961Full-time employee; part-time student.Sept. 1961-Aug. 1962Part-time employee; full-time student.Sept. 1963-Mar. 1965Unemployed; full- time student.312 Petitioner was employed as follows through June 1963: DatePositionNov. 1939-Feb. 1940Appliance salesman.July 1940-Mar. 1942U.S. Rubber Co., in engi- neering department.Mar. 1942-Oct. 1943Navy Department, on mag- netic mines.Oct. 1943-Apr. 1945Bendix Aviation, in re- search department spe- cializing in radio, ground speed indicators, and air navigation instruments.Aug. 1945-Oct. 1945Jordanoff Aviation Corp., in early warning sys- tems research.Nov. 1945-Jan. 1948Self-employed in attempt- ing to develop a me- chanical game called the "flix."Feb. 1948-Oct. 1949Stromberg-Carlson, in elec- tronics research on radio high-frequency circuits.Nov. 1949-July 1950Self-employed in perfect- ing and unsuccessfully attempting to sell his mechanical game.Aug. 1950-Oct. 1954Eastman Kodak, in devel- oping optics and vision instruments.Oct. 1954-May 1955Unemployed.May 1955-Sept. 1955Burroughs Laboratories, as a laboratory technician.Sept. 1955-May 1956Unemployed.June 1956-Oct. 1957Minneapolis-Honeywell, in development of aero- nautic instruments.Nov. 1957-May 1958Unemployed.May 1958-June 1963Boeing Company, as as- sistant analyst engaged in developing safety as- pects of the "Minute- man" missile.313 On May 20, 1963, petitioner was notified by his employer, the Boeing Company (hereinafter Boeing) that his salary would be reduced by $1,500 per annum as of the next payday, that his status would be changed from "regular permanent employee" to "employee on probation," and that Boeing would determine after six weeks whether petitioner's employment would be continued or terminated. Petitioner requested that this action be held in abeyance for one week so that he could complete five years of service with Boeing. This request was granted and petitioner in return agreed to, and did in fact, resign from Boeing in June 1963. When petitioner resigned his position at Boeing, he had neither a leave of absence nor a formal or informal agreement that Boeing would rehire him upon receipt of a degree in physics or mathematics. While employed at Boeing, petitioner was a member of the Society of Professional Engineers and Architects, but he had not received a degree from any college or university. In August 1963, petitioner satisfactorily completed the requirements for, and received a Bachelor of Science degree in physics from the University of Washington. In September 1963, petitioner enrolled314 as a full-time student at the University of Washington for the purpose of obtaining a Bachelor of Arts degree in mathematics. Petitioner completed the requirements for this degree in August 1964 and in September 1964 similarly enrolled for a Master's degree in mathematics. All courses taken during 1964 were in the field of mathematics. Petitioner withdrew from the University in March 1965 without receiving a Master's degree. While enrolled at the University of Washington, petitioner was not employed as a teacher, instructor, professor, or graduate assistant nor did he receive financial assistance from that institution. Between March 1965 and July 1966, petitioner sought employment with various business organizations, including Boeing, but no offers were forthcoming, although he received several interviews. Petitioner was not offered a job by Boeing, because he was not qualified for the position then available. In July 1966, petitioner determined to spend a period of time pursuing scientific studies of interest to him, namely, relativity and the so-called four-color map problem. In February 1969, he enrolled in the 237 University of Arkansas as a candidate for a Master's degree315 in mathematics. Aside from an insignificant amount of income derived from tutoring, petitioner has not worked as an employee since resigning from his position at Boeing. Ultimate Finding of Fact Petitioner was not engaged in any trade or business during the year 1964. Opinion The present controversy involves the deductibility of petitioner's expenses for completing a Bachelor's degree and beginning a Master's degree, both in mathematics. 2 Petitioner maintains that he has been in the trade or business of selling his scientific or technical services for almost 20 years and that, upon the termination of his employment at Boeing, he returned to school to maintain or improve his professional skills. Respondent's position is simply that petitioner was not engaged in any trade or business during the year in question and, alternatively, if petitioner was so engaged, his educational program was designed to meet the minimum educational requirements of future employers, making the educational expenses nondeductible pursuant to section 1.162-5, Income Tax Regs.Petitioner's employment316 with Boeing terminated in June 1963, and he had neither a leave of absence from, nor an understanding with regard to future employment at, Boeing. Immediately thereafter, in August 1963, he completed the requirements for a B.S. in physics at the University of Washington. He promptly began work on a B.A. in mathematics, which was completed in August 1964, and immediately thereafter enrolled in a program leading to a Master's degree in mathematics. Thus, his course of study encompassed work on two undergraduate degrees and one graduate degree. Petitioner withdrew from the university in March 1965 and attempted to obtain scientific or technical employment without success until the summer of 1966, when he determined to spend time studying relativity and the four-color map problem, which presumably occupied him until he enrolled at the University of Arkansas in February 1969. We must first resolve the threshold question whether petitioner was in fact engaged in a trade or business during 1964 within the meaning of section 162(a).3 In essence, this involves a determination whether, on the one hand, petitioner's sojourn at the University of Washington represented a temporary hiatus in317 his professional career as a physicist during which he intended to improve his skills or in fact did improve his skills in that capacity 4 or, on the other hand, petitioner's sojourn removed him from the trade or business of being a physicist and placed him in the category of a student for an indefinite period of time. Compare Rev. Rul. 68-591, 2 C.B. 73">1968-2 C.B. 73. Under the first alternative, his expenses might well be deductible under the rationale of Furner v. Commissioner, 393 F. 2">393 F. 2d Commissioner, 393 F. 2d 292 (C.A. 7, 1968), reversing 47 T.C. 165">47 T.C. 165 (1965), which allowed a deduction for educational expenses to a teacher who resigned her teaching position for a period of one year in order to obtain a Master's degree, at the end of which period she resumed teaching in another school district, or of Harold Haft, 40 T.C. 2">40 T.C. 2 (1963), where the taxpayer was held to have continued in the trade or business of being a salesman during a period when he was temporarily out of a job but actively seeking a new one. Under the second alternative, petitioner's expenses would at best be considered as having been made for the purpose of resuming his trade or business318 at some future date under the rationale of Canter v. United States, 354 F. 2d 352 (Ct. Cl. 1965), which disallowed a deduction for educational expenses of an employee who left the United States Public Health Service for an indefinite period (which in fact lasted almost five years) to study nursing, or Henry G. Owen, 23 T.C. 377">23 T.C. 377 (1954), which disallowed the deduction by a United States Government employee living in Washington, D.C., of the expenses of maintaining a law office in North Dakota. Compare also C. Fink Fischer, 50 T.C. 164">50 T.C. 164, 171 (1968). 319 238 Although petitioner was not gainfully occupied as a physicist during 1964, he clearly regarded himself as a member of a profession encompassing the allied fields of applied physics and mathematics. But such an association standing alone, whether measured by subjective or objective standards, is insufficient to constitute a trade or business within the meaning of section 162. Cf. Henry W. Owen, supra. We recognize, of course, that petitioner withdrew from graduate school and sought employment in 1965 and 1966 and that, even though he was not successful, such activity tends to indicate that his educational sojourn in 1964 may have been temporary in character. But petitioner himself testified that these employment-seeking efforts were generated by family pressures and depletion of available funds. Consequently, we view those activities more as an aberration in his educational pursuits than as proof of a trade or business with the educational pursuits merely ancillary thereto. Under all the circumstances herein, we are not satisfied that petitioner was merely engaged in a temporary effort to improve his skills by refreshing and fortifying his knowledge of320 the advances in technology which have pervaded all fields of scientific endeavor in recent years. Rather, we think that the record indicates that petitioner was simply a student indefinitely pursuing his general educational aspirations. In this context, we think that the rationale of Furner v. Commissioner, supra, and Harold Haft, supra, does not apply and that this case more properly falls within the ambit of Canter v. United States, supra, 5 and Henry G. Owen, supra.Petitioner's expenditures for improving his skills were nondeductible personal expenditures under section 262. Compare N. Kent Baker, 51 T.C. 243">51 T.C. 243 (1968). The fact that petitioner, after his unsuccessful efforts to obtain employment, in July 1966 began to investigate relativity and the four-color map problem does not change our conclusion. These321 endeavors, the extent of which is not specified in the record, do not limit petitioner's hiatus from the conduct of a trade or business, and therefore do not relate to the temporary versus indefinite dichotomy of petitioner's educational activities. These endeavors, while related to the general subject area of petitioner's previous employment, should more appropriately be termed a hobby, Frederick A. Purdy, 12 T.C. 888">12 T.C. 888 (1949), or, alternatively, aimed toward the development of reputation, James M. Osborn, 3 T.C. 603">3 T.C. 603 (1944), neither of which qualifies as a trade or business within the meaning of section 162. Since we have determined that petitioner was not engaged in any trade or business during 1964, we need not reach the question of whether these expenses would in fact qualify for deduction pursuant to the "improvement of skills" tests of either the 1958 or the 1967 regulations. See footnote 4, supra. Decision will be entered for the respondent. Footnotes1. Only $630 of the $750 deduction shown on the return remains at issue because of petitioners' concession at trial.↩2. There is no issue as to substantiating the amount in controversy.↩3. All references, unless otherwise specified, are to the Internal Revenue Code of 1954, as amended. 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. The subjective intention test is embodied in respondent's 1958 regulations and the objective fact test is embodied in respondent's 1967 regulations. Section 1.162-5, Income Tax Regs. Respondent has ruled that taxpayer may elect to apply either set of regulations to taxable years beginning before January 1, 1968. Rev. Rul. 68-191, 1 C.B. 67">1968-1 C.B. 67↩.5. We recognize that Canter rested on the narrow ground that the taxpayer did not have a leave of absence from her former employment. Our reliance on that case does not rest upon this ground but rather on the a fortiori rationale elaborated upon in Judge Davis' dissent. See 354 F. 2d at pp. 355-356↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623557/	William R. Sieg v. Commissioner. Harry L. Mathers and Winifred Mathers v. Commissioner.Sieg v. CommissionerDocket Nos. 303-69 SC, 1952-69 SC.United States Tax CourtT.C. Memo 1969-210; 1969 Tax Ct. Memo LEXIS 86; 28 T.C.M. (CCH) 1110; T.C.M. (RIA) 69210; October 9, 1969, Filed Robert G. MacAlister, Grant Bldg., Pettsburgh, Pa., and William C. McClure, for the petitioner in Docket No. 303-69 SC. Jay Harris Feldstein, Law & Fin. Bldg., Pittsburgh, Pa., for the petitioners in Docket No. 1952-69 SC. Gary L. Stansbery, for the respondent. DAWSONMemorandum Findings of Fact and Opinion DAWSON, Judge: In these consolidated cases respondent determined the following Federal income tax deficiencies against the petitioners: PetitionerYearDeficiencyWilliam R. Sieg1966$114.00Harry L. Mathers and Winifred Mathers1966113.92The only issue for decision is whether William87 R. Sieg or the Mathers provided more than half of the total support of Darlene Sieg during the year 1966 for dependency deduction purposes under section 151, Internal Revenue Code of 1954. Some of the facts are stipulated and are found accordingly. William R. Sieg was a resident of Pittsburgh, Pennsylvania, at the time he filed his petition herein. He filed his individual Federal income tax return for 1966 with the district director of internal revenue at Pittsburgh. On the return he claimed a dependency exemption for his daughter, Darlene. Harry L. and Winifred Mathers are husband and wife who resided in Monongahela, Pennsylvania, at the time they filed their petition herein. For the year 1966 they filed a joint Federal income tax return with the district director of internal revenue at 1111 Pittsburgh. They also claimed on their return a dependency exemption for Darlene, the daughter of Winifred. During the year 1966 Darlene, who was then 16 years of age, was in the custody of her mother and lived in the Mathers' home. Both the Mathers and William Sieg contributed to the support of Darlene in 1966. The total amount of her support in that year88 was at least $1,180. William Sieg provided $530, and the Mathers provided $650. Section 151 of the Internal Revenue Code of 1954 allows as a deduction an exemption of $600 for each dependent, and a daughter qualifies as a dependent under section 152. The deduction for the exemption is allowed to the taxpayer who provides more than half of the dependent's support during the taxable year in question. On this record, after hearing the testimony of William Sieg and Winifred Mathers, we conclude and hold that the Mathers provided more than half of Darlene's support in 1966. Accordingly, Decision will be entered for the respondent in Docket No. 303-69 SC. Decision will be entered for the petitioners in Docket No. 1952-69 SC.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4476136/	OPINION. Van Fossan, Judge: The first question arises from the loss sustained by the petitioner on the sale of 50 shares of stock in the American Distilling Company. It is petitioner’s contention that the amount of the loss is deductible in full as a part of the cost of whiskey sold or as an ordinary and necessary business expense. The ruling of the Court in Western Wine & Liquor Co., 18 T. C. 1090, in which case the author of this opinion filed a dissenting opinion, is controlling on the first issue here raised. In that case, on facts generally comparable to those here appearing, it was held that the loss incurred on the sale of the stock of the American Distilling Company was a part of the cost of the whiskey acquired; that the stock was property held for sale to customers in the ordinary course of business; and that it was not a capital asset. That case is indistinguishable in fact or principle from the present case. The second issue is in respect to the sums received by the city of Tracy from the petitioner with regard to the operation of his slot machines. The entire amount of payments was included in petitioner’s gross income and then taken as a deduction. The payments to the city were in the amount of $25 per machine per month. Some of the machines were maintained in petitioner’s cafe, others were installed in other establishments. The petitioner, who owned all of the machines, required the proprietors of the other places to pay half the amount due the city. The payments of $25 per machine were first taken out of the total proceeds from each machine and the remainder was divided equally between the proprietor and the petitioner with regard to those machines located in other establishments. The petitioner, on brief, argues that none of the amount paid to the city was includible in his gross income. To the contrary, we are of the opinion that the total of the payments made to the city on petitioner’s behalf (excluding only the portion transmitted as payments made by petitioner on account of his licensees) should be included in petitioner’s gross income. The petitioner paid $25 for permission to operate each machine in his establishment and received the total proceeds of these machines. He paid the city $12.50 for permission to operate each machine in another place of business. He received half of the proceeds from these operations. The payments were made in exchange for the city’s willingness to allow the illegal operation. The city, however, neither participated in the operation nor received any benefit exclusive of the $25 monthly payment. The city was in no sense a joint venturer or a participant with the petitioner or the other proprietors. The $25 monthly payment was not restricted to any particular source of funds. The city’s fee was dependent solely upon the number of machines in operation and it received this fee without regard to the amount or lack of profit made. The city issued neither permits nor licenses. The payments cannot be classified as taxes. The arrangement to have the payments appear upon official records as fines, or forfeited bail, was patently a sham. The filing of complaints and the fictitious prosecution of petitioner every three months did not interrupt operation of the machines. The petitioner relies upon Christian H. Droge, 35 B. T. A. 829, and Samuel L. Huntington, 35 B. T. A. 835. In both of these instances the taxpayers agreed with their wives that if any sweepstakes ticket held by them individually should win they would divide the proceeds equally. We held the husbands taxable only upon the portions of the winnings retained by them. In the present case, the petitioner merely agreed to pay $25 per month for permission to operate each machine. The city could receive, under the arrangement, no more or less than $25 per machine. It could not share in the winnings, nor could it suffer from losses as long as the machines were operated. The distinguishing factor between the cited cases and the present instance is the participation of other parties upon a joint basis in the undertaking. It cannot be said that the petitioner divided the slot machine proceeds with the city. Bather, the payments were in the nature of an unauthorized fee for allowance to operate each machine. The other cases cited by petitioner are similarly distinguishable upon the facts involved. The petitioner has failed to establish that the amount paid to the city for the operation of slot machines in his establishment and for his interest in other machines operated by his licensees was not income to him. The petitioner next contends that the amounts paid to the city, if in-cludible in income, are also deductible by him as expenses. Although the payments were made to the city itself and not to an individual, they were paid to secure the non-enforcement of the law by the city. The payments resemble the “protection payments” held nondeductible in G. A. Comeaux, 10 T. C. 201, affd. 176 F. 2d 394. The Supreme Court in Lilly v. Commissioner, 343 U. S. 90, 96, recently stated: Assuming for the sake of argument that, under some circumstances, business expenditures which are ordinary and necessary in the generally accepted meanings of those words may not be deductible as “ordinary and necessary” expenses under § 23 (a) (1) (A) when they “frustrate sharply defined national or state policies proscribing particular types of conduct,” supra, nevertheless the expenditures now before us do not fall in that class. The policies frustrated must be national or state policies evidenced by some governmental declaration of them. * * * Section 330a of the California Penal Code is as follows: § 330a. Possession or keeping of slot or card machine, card dice or dice having more than six faces: Punishment.] Every person, who has in his possession or under his control, either as owner, lessee, agent, employee, mortgagee, or otherwise, or who permits to be placed, maintained or kept, in any room, space, inclosure or building owned, leased or occupied by him, or under bis management or control, any slot or card machine * * * is guilty of a misdemeanor, and shall be punishable by a fine not less than one hundred dollars nor more than five hundred dollars, or by imprisonment in the county jail not exceeding six months, or by both such fine and imprisonment. [Added by Stats. 1911, p. 951. J Section 337 of the California Penal Code states: § 337. [Asking or receiving consideration to assist violator: Issuing license or voting for ordinance authorizing conduct of forbidden games.] Every state, county, city, city and county, town, or township officer, or other person who shall ask for, receive, or collect any money, or other valuable consideration, either for his own or the public use, for and with the understanding that he will aid, exempt, or otherwise assist any person from arrest or- conviction for a violation of section three hundred and thirty of the Penal Code; or who shall issue, deliver, or cause to be given or delivered to any person or persons, any license, permit, or other privilege, giving, or pretending to give, any authority or right to any person or persons to carry on, conduct, open, or cause to be opened, any game or games which are forbidden or prohibited by section three hundred and thirty of said code; and any of such officer or officers who shall vote for the passage of any ordinance or by-law, giving, granting, or pretending to give or grant to any person or persons any authority or privilege to open, carry on, conduct, or cause to be opened, carried on, or conducted, any game or games prohibited by said section three hundred and thirty of the Penal Code, is guilty of a felony. [Added by Stats. 1885, p. 113.] The above statutes clearly and sharply define state policy in regard to the operation of slot machines and the granting of permission by city authorities to operate such machines. The conclusion is inescapable that the payments in question are not deductible by petitioner. The payments of $12.50 per machine per month made by the proprietors of other locations through petitioner as a conduit, should not be included in his income. Petitioner derived no benefit from such payments. In return for the fee of $25, the slot machines were left free from interference by city authorities in these other locations. Petitioner’s benefit from the payments to the city was restricted to one-half the proceeds of these machines. We have included that proportion of the payments in his income. The other proprietors received benefit of the other half of the payments by receiving half the proceeds. On this point, Horace Mill, 5 T. C. 691, is applicable inasmuch as the other proprietors were participants and jointly interested in the undertaking. The arrangement by which petitioner made the payments was merely one of convenience. Reviewed by the Court. Decision will be entered vmder Bule 50.	01-04-2023	01-16-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623558/	READ PHOSPHATE CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Read Phosphate Co. v. CommissionerDocket No. 10238.United States Board of Tax Appeals13 B.T.A. 39; 1928 BTA LEXIS 3326; July 24, 1928, Promulgated 3326 Bags for containing fertilizer are properly the subject of inventory at cost or market whichever is lower. J. C. Peacock, Esq. and M. H. Barnes, C.P.A. for the petitioner. J. Harry Byrne, Esq., for the respondent MURDOCK 39 This proceeding is for the redetermination of a deficiency in income and profits taxes for the calendar year 1920, in the amount of $15,289.23. The petitioner has waived an issue in regard to invested capital, so that the single question in issue is the proper method for the valuation of the petitioner's inventory of supplies consisting of coal and bags for shipping fertilizer. Certain of the facts were stipulated. FINDINGS OF FACT. The petitioner is a West Virginia corporation with its principal offices at Savannah, Ga. It is engaged in the manufacture of fertilizer. It used bags as containers for shipping its product. A large supply of these bags was usually carried because they were imported from India, and it was necessary to contract in the early summer for delivery in the late winter or early spring. The bags were not only useful as fertilizer containers, but could be used for shipping coffee, mixed3327 feeds, and heavy chemicals and for other purposes. They were always salable for such other purposes and the petitioner when it had an oversupply sometimes sold them to bag manufacturers, to 40 competitors and occasionally to farmers. This rarely happened, however, inasmuch as it bought as conservatively as possible. The selling price of the fertilizer in bulk was approximately $10 a ton, while in bags it was approximately $12 a ton. Most of the fertilizer was sold in bags and these were not returned by the customers. The finished product was not kept on hand in bags, but was put in bags at the time of the sale, when the bags were printed, filled and shipped. The petitioner's inventory of finished goods on December 31, 1920, included only acid phosphate in bulk. The petitioner has always included bags in its inventory of supplies, and as of December 31, 1920, bags and coal were both included therein. The petitioner took its inventory for 1920 on the basis of "cost or market, whichever is lower," and reported its supply of bags as of December 31, 1920, at their market price of $54,234.35 and its supply of coal at its market price of $2,891.25. The Commissioner3328 in his final determination increased net income for 1920 in the amount of $49,760, by increasing the inventory of bags to cost, or $103,507.35 and by increasing the inventory of coal to cost, or $3,288.25. OPINION. MURDOCK: The authority for the use of inventories is contained in section 203 of the Revenue Act of 1918, as follows: That whenever in the opinion of the Commissioner the use of inventories is necessary in order clearly to determine the income of any taxpayer, inventories shall be taken by such taxpayer upon such basis as the Commissioner, with the approval of the Secretary, may prescribe as conforming as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting the income. The Commissioner's Regulations 45, in so far as pertinent to the question here involved, were as follows: ART. 1581. Need of inventories. - In order to reflect the net income correctly, inventories at the beginning and ending of each year are necessary in every case in which the production, purchase or sale of merchandise is an incomeproducing factor. The inventory should include raw materials and supplies on hand that have been acquired3329 for sale, consumption or use in productive processes, together with all finished or partly finished goods. * * * ART. 1582. Valuation of inventories. - Inventories must be valued at (a) cost or (b) cost or market, as defined in article 1584 as amended, whichever is lower. Whichever basis is adopted must be applied consistently to the entire inventory. A taxpayer may, regardless of his past practice, adopt the basis of "cost or market whichever is lower", for his 1920 inventory, provided a disclosure of the fact and that it represents a change is made in the return. * * * Our inquiry in this case must be as to whether or not under the above-quoted regulations of the Commissioner and the section of the Act the items in controversy may be inventoried. 41 In so far as the coal is concerned, no evidence was introduced as to its use, or as to the reason for its acquisition, and we affirm the action of the Commissioner. The petitioner bought bags in large quantities, ordering a year's supply in advance; when fertilizer was sold in bags the consumer was charged a higher price than when the sale was in bulk. Sometimes when the petitioner had an oversupply3330 of bags on hand it sold them as bags to bag manufacturers, to competitors, and to farmers. The petitioner never disposed of bags in any other way. They were acquired for sale or use in productive processes and we can not see that to inventory them would conflict with the best accounting practices of the trade or business. The Commissioner was in error in valuing such bags at cost instead of at market. Judgment will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623559/	Florida Peach Corporation, Petitioner v. Commissioner of Internal Revenue, RespondentFlorida Peach Corp. v. CommissionerDocket No. 6548-82United States Tax Court90 T.C. 678; 1988 U.S. Tax Ct. LEXIS 41; 90 T.C. No. 41; April 12, 1988. April 12, 1988, Filed 41 P was a debtor in a bankruptcy proceeding having filed a voluntary petition for reorganization (chapter 11) on Mar. 11, 1980. R filed a proof of claim in that proceeding for income tax liabilities of P for the taxable years ended Mar. 31, 1974, through Mar. 31, 1977. A notice of deficiency was issued on Dec. 31, 1981, for the same tax liabilities. The Bankruptcy Court entered a judgment on Feb. 8, 1982, allowing the claim of the United States, and on Feb. 22, 1982, the bankruptcy proceeding was dismissed. A timely petition was filed with this Court on Mar. 24, 1982. Held, the Bankruptcy Court had authority to decide the tax claims asserted and R is a party in privity with the United States, the party which filed a claim in the bankruptcy proceeding. McQuade v. Commissioner, 84 T.C. 137">84 T.C. 137 (1985). Held, further, that while sec. 349(b)(2) of the Bankruptcy Code provides that a dismissal of the bankruptcy case has the effect of vacating certain orders or judgments, a judgment under sec. 505 of the Bankruptcy Code is not an action enumerated under sec. 349(b)(2); accordingly, the dismissal of the bankruptcy case did not vacate the judgment under42 sec. 505 allowing the claim made by the United States for corporate tax liabilities. Held, further, R's motion for summary judgment is granted since the doctrine of res judicata precludes P from relitigating the tax liabilities previously allowed by the Bankruptcy Court. Robert Lurie (an officer), for the petitioner.Paul Horn and Francis C. Mucciolo, for the respondent. Featherston, J. Panuthos, Special Trial Judge. FEATHERSTON; PANUTHOS679 OPINIONThis case was heard by Special Trial Judge Peter J. Panuthos pursuant to the provisions of section 7456 of the Code. 1 The Court agrees with and adopts the Special Trial Judge's opinion, which is set forth below.43 OPINION OF THE SPECIAL TRIAL JUDGEPanuthos, Special Trial Judge: This case is before the Court on respondent's motion for summary judgment, filed pursuant to Rule 121. The issue for decision is whether the doctrine of res judicata applies so as to preclude petitioner from litigating the deficiencies determined by respondent in this Court.Respondent, in his notice of deficiency, dated December 31, 1981, determined deficiencies and additions to tax as follows:Additions to tax 2TYE Mar. 31 --DeficiencySec. 6651(a)(1)Sec. 6653(a)1974$ 959,400.820 $ 47,97019751,330,652.97$ 66,533.0066,53319761,386,240.870 69,312197714,397.702,879.540680 A timely petition was filed on March 24, 1982. 344 The facts are not in dispute. Petitioner Florida Peach Corp. is the same entity as was the debtor in a bankruptcy proceeding entitled "In Re Florida Peach Corp.," Case No. 80-111-BK-J-GP (Bankr. M.D. Fla., filed Mar. 11, 1980). On March 2, 1981, the United States filed an amended proof of claim in the Bankruptcy proceeding. Included in the amended claim were corporate tax liabilities of petitioner for the taxable years ending March 31, in each of the years 1974 through 1977. On or about May 19, 1981, petitioner filed an objection to the claim of the United States. On or about August 10, 1981, respondent filed a new amended proof of claim. 4 Among other liabilities, the amended proof of claim asserted income tax liabilities against petitioner as follows:TYE Mar. 31 --Tax due1974$ 9,400.8219751,330,652.9719761,386,240.8719775 14,397.0045 On February 8, 1982, the Bankruptcy Court entered a judgment under section 505 of the Bankruptcy Code dismissing petitioner's objection to the income tax claim of the United States and allowing the claim in full. This judgment was based on findings of fact which stated in part as follows:10. The United States filed timely claims for income taxes in these proceedings, with amendments thereto, claiming $ 959,400.82 due in income taxes for fiscal year ending March 31, 1974, $ 1,330,652.97 due for fiscal year ending March 31, 1975, $ 1,386,240.87 due for fiscal year ending March 31, 1976, and $ 14,397.70 6 due for fiscal year ending March 31, 1977, plus pre-petition interest.The conclusions of law stated as follows:681 6. The United States is entitled to an order dismissing the Debtor's objections and allowing the income tax claim, with costs charged to the Debtor, both by virtue of the failure of the Debtor to sustain its objections and by virtue of Rule 737 of the Rules of Bankruptcy46 Procedure, as a sanction for the Debtor's willful failure to obey the Order of November 12, 1981.On February 22, 1982, the Bankruptcy Court entered a wholly separate order dismissing the case and lifting the automatic stay imposed by 11 U.S.C. section 362 (1982).OPINIONSummary judgment is intended to expedite litigation and avoid unnecessary and expensive trials. Shiosaki v. Commissioner, 61 T.C. 861">61 T.C. 861, 862 (1974). Summary judgment is not a substitute for trial, in that disputes over factual issues are not to be resolved in such proceedings. Naftel v. Commissioner, 85 T.C. 527">85 T.C. 527 (1985); Espinoza v. Commissioner, 78 T.C. 412">78 T.C. 412, 416 (1982). Rule 121 provides that either party may move for a summary judgment in his favor upon all or any part of the legal issues in controversy. The Rule further provides that a decision shall be rendered if the pleadings, answers to interrogatories, depositions, admissions, and any other acceptable materials, show that there is no genuine issue as to any material fact and that a decision may be rendered as a matter of law. 47 There does not appear to be any dispute as to a material fact here. Accordingly, our task is to determine whether petitioner is prohibited from litigating its Federal tax liabilities in this Court due to the prior proceeding in the Bankruptcy Court. Thus, we must determine whether the doctrine of res judicata is applicable here.We initially look to the landmark case of Commissioner v. Sunnen, 333 U.S. 591 (1948). In that case, the Supreme Court stated as follows:It is first necessary to understand something of the recognized meaning and scope of res judicata, a doctrine judicial in origin. The general rule of res judicata applies to repetitious suits involving the same cause of action. It rests upon considerations of economy of judicial time and public policy favoring the establishment of certainty in legal relations. The rule provides that when a court of competent jurisdiction has entered a final judgment on the merits of a cause of action, the parties to the suit and their privies are thereafter bound "not only as to 682 every matter which was offered and received to sustain or defeat the claim or demand, but as to any other 48 admissible matter which might have been offered for that purpose." * * * The judgment puts an end to the cause of action, which cannot again be brought into litigation between the parties upon any ground whatever, absent fraud or some other factor invalidating the judgment. [Commissioner v. Sunnen, supra at 597; citations omitted.]In applying the concept of res judicata to the field of Federal income tax, the Supreme Court further stated as follows:These same concepts are applicable in the federal income tax field. Income taxes are levied on an annual basis. Each year is the origin of a new liability and of a separate cause of action. Thus if a claim of liability or non-liability relating to a particular tax year is litigated, a judgment on the merits is res judicata as to any subsequent proceeding involving the same claim and the same tax year. But if the later proceeding is concerned with a similar or unlike claim relating to a different tax year, the prior judgment acts as a collateral estoppel only as to those matters in the second proceeding which were actually presented and determined in the first suit. * * * [Commissioner v. Sunnen, supra at 598.]49 Florida Peach Corp., petitioner herein, is the same entity that was the debtor in the Bankruptcy Court proceeding. We are satisfied that while respondent was not a named party in the bankruptcy proceeding, he is a party in privity with the United States, the party who filed an income tax claim in that proceeding. McQuade v. Commissioner, 84 T.C. 137">84 T.C. 137 (1985). 7 Furthermore, there is no question but that the Bankruptcy Court had authority to decide the tax claims asserted. See 11 U.S.C. section 505(a)(1) (1982); McQuade v. Commissioner, supra at 145. It is also not disputed that the tax liabilities at issue here involve the same claim and tax years presented in the earlier proceeding.50 The question which arises then is whether the judgment of the Bankruptcy Court allowing the tax claim of the United States in full is a final judgment on the merits so as to bar relitigation. This issue was addressed in In Re Saco Local Development Corp., 711 F.2d 441">711 F.2d 441 (1st Cir. 1983), where the court found "that a 'final judgment, order, or 683 decree' under 28 U.S.C. section 1293(b) includes an order that conclusively determines a separable dispute over a creditor's claim or priority." In Re Saco Local Development Corp., supra at 445-446. The court based its finding in that case on "an uninterrupted tradition of Judicial interpretation in which courts have viewed a proceeding within a bankruptcy case as the relevant 'Judicial Unit' for purposes of finality, and a legislative history that is consistent with this tradition." In Re Saco Local Development Corp., supra.In this case, the Bankruptcy Court, in its judgment dated February 8, 1982, ordered respondent's claim for income taxes to be allowed in full, dismissed with prejudice petitioner's objection51 to that claim, and thereby settled a separable dispute. The judgment thus rendered was final and appealable. See In Re Saco Local Development Corp., supra.Petitioner's failure to appeal lays to rest his complaint on the tax matter decided. Shaheen v. Commissioner, 62 T.C. 359 (1974). 8Petitioner contends, however, that its present claim should not be dismissed on the grounds of res judicata, arguing that the Bankruptcy Court's subsequent dismissal of the bankruptcy case in its52 entirety served to vacate the prior judgment allowing the tax claim. Section 349(b)(2) of the Bankruptcy Code provides that the effect of a dismissal in bankruptcy is to vacate "any order, judgment, or transfer ordered, under sections 522(i)(1), 542, 550, or 553." The legislative history of section 349(b) provides that the purpose of that section "is to undo the bankruptcy case, as far as practicable, and to restore all property rights to the position in which they were found at the commencement of the case." H. Rept. 95-595, at 5 (1978), reprinted in 5 U.S. Code Cong. & Admin. News 5693, 6294 (1978).It would appear, however, that the impact of section 349(b)(2) of the Bankruptcy Code is limited by the language enumerating the sections to which section 349(b) applies. Opinions by the Bankruptcy Court support this interpretation. In In Re Newton, 64 Bankr. 790 (Bankr. C.D. Ill. 684 1986), the court determined that this limiting language of section 349(b)(2) is "significant" and that the debtor's claim could not be reinstated under that section because the claim did not fall under one of the enumerated sections. An identical result was reached*53 in In Re BSL Operating Corp., 57 Bankr. 945 (Bankr. S.D.N.Y. 1986).In the present case, respondent's tax claim against petitioner was allowed by the Bankruptcy Court under section 505 of the Bankruptcy Code. As in In Re Newton, supra and In Re BSL Operating Corp., supra, the Bankruptcy Code section involved here is not one of those enumerated in section 349(b)(2) of the Bankruptcy Code, and accordingly, the Bankruptcy Court's judgment allowing the claim of the United States is preserved.Respondent conceded the additions to tax under sections 6651(a)(1) and 6653(a), conditioned, however, upon a finding by us that res judicata applies to bar relitigation of the deficiency. Since we have found that res judicata applies, we deem the additions to tax determined in the notice of deficiency to be conceded.For the reasons set forth herein, respondent's motion for summary judgment will be granted.An appropriate order will be entered. Footnotes1. This case was heard pursuant to sec. 7456 (redesignated as sec. 7443A by the Tax Reform Act of 1986, Pub. L. 99-514, sec. 1556, 100 Stat. 2755) and Rule 180. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954 as amended, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩2. In his memorandum of law in support of respondent's motion for summary judgment, filed Apr. 14, 1987, respondent states that if we determine that the doctrine of the res judicata applies, then he concedes the additions to tax determined under secs. 6651(a)(1) and 6653(a)↩.3. At the time of filing the petition herein, petitioner's principal office was located at Belleview, Florida.↩4. The Aug. 10, 1981, amended proof of claim superseded all previously filed claims including the Mar. 2, 1981, amended claim.↩5. We note that the amount of the deficiency for the taxable year ended Mar. 31, 1977, differs slightly from the amount shown on the amended proof of claim. There is no explanation in the record for this discrepancy, nor do we consider it to be material since the Bankruptcy Court in its judgment utilized the same amount reflected in the notice of deficiency ($ 14,397.70).↩6. See note 5 supra↩.7. In McQuade v. Commissioner, 84 T.C. 137↩ (1985), we determined that respondent was collaterally estopped from litigating the Federal income tax liabilities of a taxpayer which had been previously litigated in the Bankruptcy Court.8. It would further appear that to the extent that the dismissal results from the imposition of sanctions by the Bankruptcy Court, such action would have the effect of a dismissal on the merits. See Fed. R. Civ. P. 37(b)(2)(C); National Hockey League v. Metropolitan Hockey Club, Inc., 427 U.S. 639 (1976); Papilsky v. Berndt, 466 F.2d 251">466 F.2d 251 (2d Cir. 1972), cert. denied 409 U.S. 1077">409 U.S. 1077↩ (1972).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623565/	Jefferson D. Robinson, Jr., by the Toledo Trust Company, Joseph W. Robinson and Richard D. Logan, Executors of the Estate of Jefferson D. Robinson, Jr., Deceased v. Commissioner.Robinson v. CommissionerDocket No. 111214.United States Tax Court1943 Tax Ct. Memo LEXIS 215; 2 T.C.M. (CCH) 379; T.C.M. (RIA) 43319; June 30, 1943215 H. A. Mihills, C.P.A., 917 Munsey Bldg., Washington, D.C., for the petitioner. W. W. Kerr, Esq., for the respondent. STERNHAGEN Memorandum Findings of Fact and Opinion The Commissioner determined a deficiency of $8,047.75 in income tax for 1939, as a result of the disallowance of deductions of worthless shares and a partially worthless note. Findings of Fact Jefferson D. Robinson, Jr., a resident of Toledo, Ohio, died on April 5, 1942. His income tax return for 1939 was filed in the 10th District of Ohio. On January 3, 1938, the Standard Electric Manufacturing Corporation (called the Mfg. Corp.) was incorporated under the laws of Ohio with an authorized capital of 20,000 shares, consisting of 19,805 shares of no-par common and 195 shares of 5 per cent cumulative $100 preferred, to manufacture and sell electric ranges, water heaters and other devices. The preferred was entitled to $5 cumulative dividends and $100 upon dissodution, before any distribution to common. The consideration for the common was fixed at $25 a share. The Mfg. Corp. was organized to and did acquire the assets and business of The Standard Electric Stove Company (called the Stove Co.) in accordance with the216 terms of an offer of Dec 1, 1937, by the Stove Co. to Joseph W. Robinson to transfer its assets and business to a new corporation in consideration of the issuance to Stove Co. shareholders of 1,779 1/2 shares of no-par common and 195 shares of 5 per cent cumulative preferred and the assumption of the Stove Co. liabilities as of August 31, 1937, together with such other liabilities incurred in the ordinary course of business after August 31, 1937, and in connection with the consummation of the proposed sale and transfer. The Robinson brothers, decedent and his brother Joseph W., owned no shares in the Stove Co. and in January, 1938, they each bought 2,000 shares in the Mfg. Corp., for which they each paid $50,000 cash. The Mfg. Corp., at the first meeting of the directors, January 3, 1938, accepted the offer and resolved that the aggregate fair value of the assets was at least $168,754.12 and that the liabilities to be assumed were $69,350.44. The $100,000 cash paid in by the Robinson brothers for their shares was used to pay off some of the assumed obligations, to purchase certain machinery and equipment at a cost of $20,177 and to carry on operations. The operations of the Mfg. 217 Corp. were unsuccessful from the beginning and additional funds were necessary. During 1938, the Robinson brothers advanced $140,400 in cash, of which the decedent advanced $65,400, taking a promissory note of the corporation dated December 1, 1938. In 1938, the Mfg. Corp. borrowed $50,000 more from the Guardian Commerce Bank in Cleveland and gave its notes, endorsed by the Robinson brothers. The plant which the Mfg. Corp. acquired from the Stove Co. was located in Toledo, Ohio, in an old three-story brick building with several different floor levels, the inside of the building being entirely of wood construction; it had one old hydraulic elevator; the plant had equipment for fabricating sheet metal but most of it was obsolete; the inventory on hand was obsolete and unbalanced without necessary parts; some of the obsolete parts had been there for 10 or 12 years and were practically worthless but were carried on the books at their original value. The merchandise acquired from the Stove Co. was found to be not salable. The burner, the principal part of an electric range, was not acceptable to principal retailers. Advertising literature had to be discarded. The purchase of a standard218 burner, instead of continuing the manufacture of its own, increased the cost of the ranges and made it necessary to redesign the entire line. Consequently, the corporation became in dire need of additional working capital. Upon the organization of the corporation, Joseph W. Robinson was elected president and the decedent vice-president. In April, 1938, Joseph W. Robinson became seriously ill and was unable to participate in the management of the business. Request for additional advances was made to the Robinson brothers but at a directors' meeting held on October 17, 1938, the decedent informed the directors that he and his brother did not wish to make further advances and that they desired to withdraw from the operation of the business. Another director, holder of 716 1/2 shares of common, thereupon took over the management. In November or December, 1938, the Robinson brothers gave the corporation a ten-year option to purchase their 4,000 common shares at $1 a share on condition that the corporation first pay the indebtedness to them of $140,400. The Robinson brothers resigned their respective offices, and a committee, consisting of the remaining officers, was formed to carry on219 the operations. The business was never profitable. The books showed net losses as of October 31, 1938, $190,985.30; as of December 31, 1938, $194,335.35, and as of December 30, 1939, $107,049. The balance sheet as of January 3, 1938, showed assets, including cash on hand and in bank of $108,781.16, accounts and notes receivable, inventories, other assets, permanent assets, patent rights and deferred charges, of a book value of $262,269.43 as against liabilities of $51,389.92, capital stock preferred $19,500 and common $144,487.50, and a surplus of $46,892.01. Its assets and liabilities as shown by its balance sheets for subsequent periods are as follows: Oct. 31, 1938Dec. 31, 1938Dec. 30, 1939Total assets (book value)$270,133.47$234,063.12$132,145.47Liabilities: Current liabilities, including Robinson notes$268,347.23$251,045.72$259,531.66Reserve for additional compensation15,450.00Reserve for advertising allowances2,063.05Capital stock: Preferred9,200.009,200.009,200.00Common144,487.50144,487.50144,487.50Surplus (Deficit)(167,351.26)(170,670.10)(283,136.74)$270,133.47$234,063.12$132,145.47After October 18, 220 1938, various steps were taken to reduce expenses and to obtain funds for operation. Advertising and selling expenses were reduced. The number of articles was cut down and standardized for use on any range. Inventories on hand December 31, 1938, were sold as quickly as possible. Equipment was sold in 1939 to obtain operating funds. Prices on obsolete merchandise were cut below cost or book value to dispose of it. A piece of unimproved and unused real estate, carried at a book value of $15,000, was in 1939 placed in the hands of a real estate agent for sale and, although the selling price was reduced to $2,000, could not be sold. By the end of 1939, the remaining inventory was not readily salable. In May, 1939, the Commerce Guardian Bank demanded payment of the two overdue notes of $25,000 each. Later, renewal notes were executed which were endorsed by the Robinson brothers. Early in 1939, some of the corporation's customers refused to deal with it because of its precarious financial condition. By May, 1939, certain suppliers extended only limited credit or demanded payment in advance or upon delivery. Efforts were again made in 1939 by the corporation to persuade the Robinson brothers221 to provide additional funds for the corporation. Attempts were made to interest outside capital to finance the corporation or to buy the business. Some of the other stockholders were approached. In September, 1939, the Robinson brothers were again approached. September 5, 1939, a report showing the financial condition of the corporation, emphasizing its "desperate situation through lack of working capital" and suggesting plans for refinancing and rehabilitation was submitted to the decedent. Subsequently, in 1939, the Robinson brothers again refused to advance any more money. The officers, having exhausted all means and sources of financial aid known to them, now felt that the situation was hopeless and that bankruptcy or receivership was inevitable. On March 18, 1940, upon the petition of a creditor of the corporation, a receiver was appointed by the Court of Common Pleas of Lucas County, Ohio. The balance sheet of the corporation as of March 18, 1940, showed total assets of $94,812.30, including the land at a $15,000 value. The aggregate liabilities to creditors shown were $242,519.71 and the deficit was $303,369.51. The receiver sold and liquidated all of the assets and property222 of the corporation and paid two dividends on claims of general creditors, the first of 6 per cent and the second and final dividend of 2 1/4 per cent distributed February 18, 1942. After the filing of his final report on March 11, 1942, and approval thereof by the court, the receiver was discharged. The decedent received 8 1/4 per cent of the face amount of his note of $65,400 and no more from the receiver. The 2,000 shares of common stock of Standard Electric Manufacturing Corporation held by decedent became worthless in 1939 and at least one-half of the $65,400 indebtedness of the corporation to decedent became worthless in 1939. Opinion STERNHAGEN, Judge: The Commissioner in determining the deficiency simply disallowed the deductions in 1939 for the worthless shares and half the worthless debt, without saying why. In his brief, it is said that there was no identifiable event showing worthlessness in 1939 and that the worthlessness was not established until a later year. We think the evidence clearly shows that the shares and the debt were not definitely worthless in 1938 but became worthless before the end of 1939, and this was the only year in which the deductions could properly*223 be taken. The decedent, who knew all the facts, would have been unduly optimistic if he had not recognized by the end of 1939 that there was no responsible ground for hope for the business to succeed and enable him to recover the $50,000 that he had invested in the shares, or that he would recover more than half of the $65,400 that he had loaned the corporation on its note. Indeed, we should suppose that he could not reasonably defend a postponement of either deduction beyond 1939. The disallowance of both the $33,333.33 deduction on account of the worthless shares and the $32,700 deduction on account of the partial worthlessness of the debt is reversed. Other adjustments are not in controversy. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623566/	RAY MORRIS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Morris v. CommissionerDocket No. 24010.United States Board of Tax Appeals15 B.T.A. 1252; 1929 BTA LEXIS 2696; April 4, 1929, Promulgated 2696 Petitioner, having filed a joint return of income for himself and wife for the calendar year 1922, is not entitled to have his tax computed on the basis of a separate return. Sanford Robinson, Esq., for the petitioner. W. Frank Gibbs, Esq., for the respondent. MORRIS1252 This proceeding is for the redetermination of the deficiency in income tax for the year 1922, of $1,983.07, of which petitioner admits liability to the extent of $911.60, leaving in controversy, $1,071.47. The only question involved is whether the petitioner and his wife, having filed a joint return for the year 1922, may have their income for that year computed upon the basis of separate returns subsequently submitted. FINDINGS OF FACT. The petitioner is a citizen of the United States and a resident of the City of New York. On March 15, 1923, the petitioner filed his income-tax return for the calendar year 1922 and in his answer to question in paragraph 3 of the return, "Is this a joint return of husband and wife?," answered "Yes." In this return the claimed net loss of the wife, amounting to $711.64, was taken as a deduction against the ordinary net income of2697 the petitioner. When this return was examined in the field, the revenue agent analyzed the net loss of the wife, amounting to $711.64, into a capital net loss amounting to $3,829.73, and ordinary net income amounting to $3,118.09. He offset the wife's loss of $3,829.73 from the sale of securities held more than two years against the petitioner's capital gains and added the $3,118.09 to the petitioner's ordinary net income, thereby subjecting this amount to surtaxes in the top brackets and increasing the tax $1,071.47 over and above what it would be if the wife's net loss of $711.64 had not been included in the return. The revenue agent's action was approved by the respondent. On or about May 17, 1926, the petitioner and his wife requested leave to file separate amended returns for the calendar year 1922, which leave was denied by the Commissioner. OPINION. MORRIS: We have heretofore held that in a case where a taxpayer has filed a single joint return of the income of himself and wife 1253 under the provisions of section 223(b)(2) of the Revenue Act of 1921, he may not thereafter have his tax computed on the basis of his separate income. *2698 ; ; affd., ; ; ; ; ; see, also, . Judgment will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623568/	JOYCE E. WEBB, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent; CHARLES L. WEBB, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentWebb v. CommissionerDocket Nos. 15858-89, 15859-89United States Tax CourtT.C. Memo 1990-581; 1990 Tax Ct. Memo LEXIS 652; 60 T.C.M. (CCH) 1229; T.C.M. (RIA) 90581; November 13, 1990, Filed 652 Decision will be entered under Rule 155. Billy C. Burney, for the petitioners. J. Craig Young, for the respondent. COUVILLION, Special Trial Judge. COUVILLIONMEMORANDUM OPINION These consolidated cases were instituted under section 7463. 1 At trial, petitioners moved, under Rule 172(c), that the cases be considered under section 7443A(b)(3) and Rule 180 et seq. Petitioners' motions were granted. 657 Respondent determined deficiencies and additions to petitioners' Federal income taxes as follows: Joyce E. Webb, Docket No. 15858-89Additions To TaxSection Section Section YearDeficiency6651(a)(1)6653(a)(1)6653(a)(2)1984$ 3,293.00--$ 164.65* 1985$ 3,108.00$ 31.85 $ 163.50* Charles L. Webb, Docket No. 15859-89Additions To TaxSection Section Section YearDeficiency6651(a)(1)6653(a)(1)6653(a)(2)1984$ 1,347.00$ 100.00$ 67.35 * 1985$ 1,472.00$ 20.59$ 73.60 * Some of the issues are common to both petitioners and other issues relate to each petitioner individually. The658 common issues are (1) substantiation of expenses attributable to petitioners' farming or horse breeding activities; (2) credits against the tax under section 21 for household and dependent care services (the child care credit) and for political contributions under section 24; and (3) the additions to tax under sections 6651(a)(1), 6653(a)(1), and 6653(a)(2). As to Mrs. Webb, the issue is her entitlement to charitable contribution deductions under section 170(a) for the two years in question. As to Mr. Webb, the issues are, for both years, his entitlement to (1) head of household filing status under section 2(b); and (2) credits against the tax for earned income under section 32(a). All other adjustments are technical adjustments affecting Mrs. Webb, which will be resolved by the contested issues: (1) Her entitlement to a credit against the tax for gasoline and special fuels under section 34(a)(1) with respect to fuel purchased in connection with her farming or horse breeding activity; (2) the earned income credit under section 32(a) for 1984; and (3) deductions for medical and dental expenses under section 213(a) for 1984 and 1985. Respondent filed answers in both cases and alleged659 affirmatively that, in the event petitioners substantiated the expenses incurred in their farming/horse breeding activities, the activities were nevertheless not engaged in for profit under section 183 and, accordingly, the deductions attributable to such activities should be limited to those allowable under section 183(b). 2660 Petitioners alleged that respondent was barred under section 6501(a) from making any assessments against them for the years at issue. Respondent affirmatively alleged otherwise and, at trial, petitioners conceded the issue. Some of the facts were stipulated and are found accordingly. The stipulations of facts and attached exhibits are incorporated by reference. At the time the petitions were filed, petitioners resided in Alabama. Petitioners were married in 1976 and divorced in 1980. They had one son, Robert Kyle Webb (Kyle), born on December 24, 1978. Mrs. Webb also had a son by a prior marriage, Marlon Blankenship (Marlon), born October 3, 1974, who lived with her during the years at issue. Mrs. Webb is a registered nurse and worked full time during 1984 and 1985. Mr. Webb drove an ambulance and also worked as a hospital orderly during the years in question. In 1978, petitioners purchased seven acres of land and a house near Mount Mariah in Lawrence County, Alabama, with the intention of using the land for horse breeding. Petitioners improved the property by building fences and a barn and bought two unregistered mares in 1978, which they bred through the stud services661 of a nearby horse farm. Mrs. Webb broke young horses for the owner of the other horse farm in exchange for stud services. Petitioners testified they realized a profit from their horse breeding activity in 1979. In 1980, Mrs. Webb suffered a serious injury to her hand while working with one of the horses. She was hospitalized for three weeks and had four surgeries. Later that year, she was thrown from a horse and broke her arm. After these incidents, petitioners sold their horses and equipment. Petitioners were divorced in May 1980. For all intents and purposes, their parting appears to have been amicable, being best described by their attorney, who explained to the Court that petitioners did not leave each other in a "blaze of gunfire." After an absence of approximately three weeks, Mr. Webb returned and moved into a small trailer located on the property, a distance of 200 or 300 feet from Mrs. Webb's house. In the divorce, Mrs. Webb was awarded custody of petitioners' son, Kyle. During 1984 and 1985, Kyle lived with Mr. Webb in the trailer near Mrs. Webb's house, although Mrs. Webb retained custody and provided most of his financial support. In late 1980, following their662 divorce, petitioners decided to resume horse breeding activities, sharing the pasture and assisting each other with labor, but with each acquiring horses individually, paying expenses individually, and realizing individual profits or losses from their separate activities. Petitioners continued horse breeding through taxable year 1985, with each realizing a profit in 1981 and losses for each taxable year thereafter. Petitioners kept no formal books or records of their horse breeding activities, although they did retain some receipts and canceled checks. Receipts and canceled checks for these expenses were provided to their return preparer, John Letson, on approximately a monthly basis. Mr. Letson prepared returns for Mrs. Webb prior to her marriage to Mr. Webb. He prepared joint returns for petitioners during their marriage and prepared separate returns for each of them after their divorce. Each year, in mid-February, petitioners delivered the Forms W-2 they received from their employers and any receipts and canceled checks relating to their horse breeding activities that had not been previously provided for preparation of their individual Federal income tax returns. Thus, 663 documents for preparation of the 1984 returns were delivered to Mr. Letson in February 1985, and documents for the 1985 returns were delivered in February 1986. Petitioners typically left the documents with Mr. Letson and returned to his office to sign the returns when notified at a later date by Mr. Letson or his employees. On at least one occasion, Mrs. Webb signed blank tax return forms, expecting the signed form to be completed later by Mr. Letson. Petitioners relied upon Mr. Letson to mail the completed, signed returns to respondent. Although petitioners provided information for the 1984 and 1985 returns to Mr. Letson prior to the unextended due dates for each year, no returns were filed for either petitioner for taxable years 1984 and 1985 until May 1986. In 1984, Mr. Letson learned he was under criminal investigation by respondent, and he cited that investigation as the reason he did not file petitioners' 1984 and 1985 returns until May 1986, although he testified the returns had been prepared prior to that date. He stated that, because of the criminal investigation, he was "afraid" to file petitioners' returns when they were due. Each of petitioners' returns for 1984664 and 1985 were dated May 5, 1986, and were received by respondent on May 16, 1986. Petitioners assumed Mr. Letson had timely filed their returns and never inquired of him whether he had filed the returns. Petitioners were unaware of the criminal investigation of Mr. Letson until 1987 and did not know Mr. Letson's failure to timely file tax returns on their behalf until they received the statutory notices of deficiency determining section 6651(a)(1) additions. Respondent's determinations are presumed correct, and petitioners bear the burden of showing respondent's determinations are in error. Welch v. Helvering, 290 U.S. 111">290 U.S. 111 (1933). However, to the extent of issues raised by respondent's affirmative allegations, the burden of proof on such issues is on respondent. Rule 142(a). Petitioners presented no evidence to substantiate the claimed expenses attributable to their horse breeding activities other than their testimony that they paid for horse feed at an unspecified cost and incurred expenses to transport feed, also in unspecified amounts. No documentary evidence of any kind was presented by petitioners. Mr. Letson testified that some of the documents given665 to him by petitioners with respect to taxable years 1984 and 1985 were lost in December 1985 in a fire that destroyed the contents of a building where they were stored. However, Mr. Letson's workpapers, prepared contemporaneously with delivery of the documents throughout 1985 and used to prepare the 1985 returns, were not destroyed, nor were documents delivered to him by petitioners after December 1985 for preparation of the 1985 returns. Additionally, Mr. Letson testified that petitioners had "gathered up some records" which they delivered to him after the date of the fire, and which he subsequently delivered to respondent pursuant to a district court order enforcing respondent's summons. 3 However, none of these documents, or any others, were made part of the stipulation or otherwise produced by petitioners for this Court's consideration. Accordingly, petitioners failed to substantiate their claimed deductions. 666 Even if petitioners had substantiated their deductions, the Court finds that their activities were not engaged in for profit under section 183. The Court is not satisfied that petitioners had an actual and honest objective of making a profit from their horse breeding activities. Both were employed full time in their respective vocations, and a good portion of Mrs. Webb's employment as a nurse was at night. Their activities in raising horses, at best, were very limited, and no evidence was presented to establish how, if ever, their activities would or could become profitable. The facts fall short of the standards prescribed in section 1.183-2(b), Income Tax Regs., in determining when an activity is engaged in for profit. Petitioners' activities were best summarized by Mr. Webb when questioned as to how much profit they realized in earlier years: "No, I don't [know]. We did not keep books, so we didn't sit down at the end of the year and say, 'here is what we made.' * * We just hoped to prosper * * * and you know whether you have done well or not at the end of the year * * * by what you have left." On this record, therefore, the Court finds that667 petitioners' activities were not engaged in for profit under section 183. The Court notes that Mr. Webb reported gross income of $ 927 and $ 1,174, respectively, for 1984 and 1985 from his horse breeding activity, and Mrs. Webb reported, respectively, for these years $ 1,430 and $ 1,416 gross income. The Court is satisfied, under Cohan v. Commissioner, 39 F.2d 540">39 F.2d 540 (2d Cir. 1930), that petitioners incurred expenses equal to the gross income reported each year from their horse breeding activities. Accordingly, petitioners are allowed, under section 183(b)(2), a deduction of expenses each year equal to the gross income reported.4Mr. Webb filed his 1984 and 1985 tax returns claiming head of household status and claimed earned668 income credits based upon petitioners' son, Kyle, having been a member of his household for these two years. Respondent disallowed the head of household status and earned income credit based upon the determination that Kyle resided with Mrs. Webb during the years at issue. "Head of household" status is available to an unmarried individual who maintains as his home a household which is the principal place of abode for his unmarried child for the taxable year. Section 2(b)(1). 5Section 32(a) provides an earned income credit for "eligible individuals," including persons entitled to claim head of household status. Section 32(c)(1)(iii). Although the record shows that Mrs. Webb had custody of him, the Court finds that, during 1984 and 1985, Kyle lived with Mr. Webb in the trailer near Mrs. Webb's house. Accordingly, Mr. Webb maintained as his home a household which was the principal place of abode for his unmarried child for the taxable years 1984 and 1985. Therefore, respondent's determinations669 on the issues of Mr. Webb's head of household status and earned income credits are not sustained. However, the dependency exemption of Kyle for both years under section 151(a) was properly claimed by Mrs. Webb, since she was the custodial parent under the decree of divorce and provided more than one-half of his support. Section 152(a); section 1.152-4, Income Tax Regs.Mrs. Webb claimed child care credits in the amounts of $ 123 and $ 510, respectively, for 1984 and 1985, under section 21, for expenses incurred for day care for her sons, Kyle and Marlon. The expenses claimed were $ 480 and $ 1,890, respectively, 670 for the years in question. Respondent disallowed the credits for lack of substantiation. Mrs. Webb described the arrangement petitioners had for child care while petitioners were at work: "If we were both at work -- I worked day shift, and Charles worked nights. So, if I was at home, I kept them. If he was at home, he kept them. And, if not, the babysitter kept them." Mrs. Webb testified that, on occasion, she paid $ 5 per day to various individuals for day care for her son, Marlon, such payments being necessary because she was employed full time as a registered nurse. However, Mrs. Webb presented no written evidence to show the amounts paid for child care and did not know how many days she had required day care services during these years. She testified that any expenses incurred for day care for Kyle were paid by Mr. Webb. Under section 21(a), a credit against the tax is allowed as a percentage of employment-related expenses incurred by a taxpayer who maintains a household which includes one or more qualifying individuals, if such expenses are incurred to enable the taxpayer to be671 gainfully employed, and such expenses are for the care of the qualifying individual. A "qualifying individual" under section 21(b)(1)(A) means a dependent of the taxpayer who is under the age of 13 and with respect to whom the taxpayer is entitled to a deduction under section 151(e). Since Mrs. Webb was employed full time during 1984 and 1985, the Court is satisfied that some amount was expended by her for the care of her son, Marlon, a qualifying individual, which enabled her to be gainfully employed. Using our best judgment under Cohan v. Commissioner, 39 F.2d 540">39 F.2d 540 (2d Cir. 1930), the Court estimates that the child care expenses paid by Mrs. Webb for Marlon were $ 300 per year for each year in question. Mrs. Webb, therefore, is allowed a child care credit for 1984 and 1985 based upon this amount. Mrs. Webb is not entitled to a credit for expenses related to child care for Kyle because his employment-related expenses were paid by Mr. Webb. Mr. Webb claimed child care credits in the amounts of $ 244 for 1984 and $ 274 for 1985 for expenses incurred with respect to Kyle. Although the Court is satisfied that Mr. Webb did pay some amount for child care expenses672 for Kyle, the credit under section 21(a) is available only if the taxpayer is entitled to the dependency exemption under section 151(e) (now section 151(c)) for the qualifying individual. Section 21(b)(1)(A). Since Mrs. Webb was entitled to the section 151(e) dependency exemption for Kyle for 1984 and 1985, Mr. Webb is not entitled to the section 21(a) credit for child care expenses for Kyle. Respondent disallowed, for lack of substantiation, political contribution credits in the amount of $ 50 claimed by petitioners on each of their 1984 and 1985 tax returns. Section 24(a) allows a credit in an amount equal to one-half of all political contributions made within the taxable year. The maximum allowable credit is $ 50. Section 24(b). The only evidence offered by petitioners on this issue consisted of their testimony that each gave $ 100 to candidates for local office in 1984. Neither petitioner could recall with certainty any political contributions made in 1985. The Court finds that petitioners673 failed to substantiate their claimed political contributions. Respondent's determinations on this issue are, therefore, sustained. Mrs. Webb claimed charitable contribution deductions of $ 250 and $ 552, respectively, for 1984 and 1985, which were disallowed by respondent for lack of substantiation. At trial, Mrs. Webb presented no evidence to support her claimed contributions. Accordingly, respondent's determination on this issue is also sustained. Respondent determined the addition to tax under section 6651(a)(1) against Mr. Webb for 1984 and 1985, and against Mrs. Webb for 1985, for failure to timely file their individual income tax returns. Returns of each petitioner for the years 1984 and 1985 were received by respondent on May 16, 1986. All four returns bore a signature date of May 5, 1986. No credible evidence of a valid request for extension of time to file the returns for either taxable year was presented by petitioners. Although the return preparer testified that he submitted a request for an extension of time to file the 1985 return, respondent's records reflect that no extension requests were received for either 1984 or 1985. Petitioners offered no explanation674 for the untimely filing other than they relied upon their return preparer to file the returns for them, and that he failed to file them timely. Section 6651(a)(1) provides for an addition to tax in case of failure to file an income tax return on the date prescribed therefor, unless it is shown that such failure was due to reasonable cause and not due to willful neglect. The failure to make a timely filing of a tax return is not excused by the taxpayer's reliance on an agent, and such reliance is not "reasonable cause" for a late filing under section 6651(a)(1). United States v. Boyle, 469 U.S. 241">469 U.S. 241, 252 (1985). Petitioners' returns were not timely filed, and no reasonable cause for the failure to timely file was shown. Therefore, respondent's determinations of additions to tax under section 6651(a)(1) are sustained. Respondent also determined additions to tax against petitioners under section 6653(a)(1) and (2). Section 6653(a)(1) applies if any part of an underpayment of tax675 is due to negligence or intentional disregard of rules or regulations. Section 6653(a)(2) applies only to that portion of an underpayment attributable to negligence or intentional disregard of rules or regulations. Negligence is the lack of due care or failure to do what a reasonable and ordinarily prudent person would do under the circumstances. Neely v. Commissioner, 85 T.C. 934">85 T.C. 934, 947 (1985). On this record, the Court sustains respondent's determination of the additions under section 6653(a)(1) and (2). The principal adjustments in these cases involved respondent's disallowance of petitioners' farming or horse breeding activities. Petitioners produced no records to substantiate the deductions claimed by them with respect to these activities. Although they claimed their records were destroyed in a fire while in custody of their preparer, they produced no records or other available evidence which would corroborate their claimed expenses. The Court doubts very seriously that petitioners had any meaningful records based on Mr. Webb's testimony that he and Mrs. Webb kept no records. Petitioners' lack of good faith is not at all enhanced by the manner in which676 they filed their separate returns with regard to their son Kyle. On Mrs. Webb's 1984 and 1985 returns, in claiming Kyle as a dependent, his name was listed as "Robert." Mr. Webb, on the other hand, in claiming head of household status for 1984 and 1985, identified the qualifying individual for whom he maintained a household as "Kyle." The child's complete name was "Robert Kyle." Since the returns of both petitioners were prepared at the same time by the same preparer, it is evident that petitioners intended to deceive respondent on this question. The deception which is implicit in the way petitioners filed their returns satisfies the Court that petitioners negligently or intentionally disregarded rules or regulations. Decisions will be entered under Rule 155. Footnotes1. All section references are to the Internal Revenue Code of 1954 as amended and in effect for the taxable years in question, unless otherwise indicated. All Rule references are to the Tax Court Rules of Practice and Procedure.↩. 50 percent of the interest due on the deficiency.↩. 50 percent of the interest due on the deficiency.↩2. The Court notes that, as to Mr. Webb's 1984 tax year, respondent disallowed the child care credit in the amount of $ 269. Although the Form 2441 of Mr. Webb's 1984 return calculated this credit at $ 269, only $ 244 was claimed on Line 41 of Form 1040 of the return. The correct amount of the adjustment, therefore, should be $ 244 instead of $ 269. Additionally, with respect to Mrs. Webb's 1984 tax year, her return for that year included a Form 3800 and computation of an investment credit of $ 535. No portion of this credit was claimed on her 1984 return; however, a notation on Form 3800 states that the credit was carried back to 1981. The notice of deficiency disallowed the investment credit and properly made no adjustment thereto with respect to the 1984 tax year, since no portion of the credit was claimed that year. However, the 1981 tax year was not addressed in the notice of deficiency; consequently, it is not known whether the investment credit was in fact carried back to that year and, if so, whether it was adjusted. The parties offered no explanation to the Court for this hiatus.↩3. Mr. Letson had initially declined to return petitioners' records to them or produce them to respondent during respondent's criminal investigation of Mr. Letson on the advice of his attorney.↩4. The Court recognizes that Mrs. Webb reported interest and taxes paid in connection with her activity for 1984 and 1985; however, since these items were not substantiated, the Court declines to find that these items are allowable as deductions under section 183(b)(1)↩.5. For taxable years beginning after December 31, 1984, the statute requires that the home be the principal place of abode for the child for more than one-half of the taxable year. Section 2(b)(1), as amended by section 423(c)(2)(A)↩, Deficit Reduction Act of 1984, 98 Stat. 799.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623569/	Kamis Engineering Company, et al., 1 Petitioners v. Commissioner of Internal Revenue, RespondentKamis Engineering Co. v. CommissionerDocket Nos. 1659-69, 1668-69, 1669-69, 1670-69, 1671-69United States Tax Court60 T.C. 763; 1973 U.S. Tax Ct. LEXIS 74; 60 T.C. No. 79; August 27, 1973, Filed 74 Decisions will be entered under Rule 50. P corporation and its wholly owned subsidiary, S, simultaneously adopted plans of liquidation and sold their assets to an unrelated third party. The proceeds of both sales were forthwith distributed to the shareholders of P. Held, that all requirements of sec. 337(a) and (b), I.R.C. 1954, having been complied with, the provisions of sec. 337(c)(2), excluding a sec. 332 liquidation from the benefit of sec. 337, are inapplicable and S is entitled to such benefit in respect of the sale of its assets. Jules Silk and Harvey N. Shapiro, for the petitioners.Howard W. Gordon, for the respondent. Tannenwald, Judge. TANNENWALD763 OPINIONRespondent determined a deficiency in income tax of $ 183,216.83 and an addition to tax under section 6651(a) 2 of $ 27,482.53 against petitioner Kamis Engineering Co. for the taxable period May 1, 1964, to January 28, 1965. The other petitioners are concededly transferees of Kamis Engineering Co., against whom deficiencies have been determined. All of the cases have been consolidated. In76 view of the concessions of the parties, the sole issue remaining for decision is whether Kamis Engineering Co. (hereinafter petitioner) is entitled to the benefit of section 337 with respect to a sale of all of its assets.All of the facts have been stipulated and this consolidated case has been submitted under Rule 30 of the Rules of Practice of this Court.Petitioner was a corporation organized on July 1, 1963, having its principal place of business in Huntingdon Valley, Pa. It was an active operating company engaged in the business of manufacturing airplane parts. It maintained its books of account on an accrual fiscal year basis ending April 30 and filed its Federal income tax return for the taxable period involved herein with the district director of internal revenue at Philadelphia, Pa.Philmont Pressed Steel, Inc. (hereinafter Philmont), was a corporation77 organized on April 21, 1958, having its principal place of business in Huntingdon Valley, Pa. It was an active operating company engaged in the business of manufacturing metal stampings for auto accessories. 764 It maintained its books of account on an accrual fiscal year basis ending April 30 and filed its Federal income tax return for the taxable period involved herein with the district director of internal revenue at Philadelphia, Pa.Foxcraft Products Corp. (hereinafter Foxcraft) was a corporation organized on April 30, 1957, having its principal place of business in Huntingdon Valley, Pa. It was an active operating company engaged in the business of distributing automobile parts and accessories. It maintained its books of account on an accrual fiscal year basis ending April 30 and filed its Federal income tax return for the taxable period involved herein with the district director of internal revenue at Philadelphia, Pa.The following schedule sets forth the names of the shareholders (hereinafter referred to collectively as shareholders) of Foxcraft and Philmont and the percentage of their stock interest in Foxcraft and Philmont:PercentPercentofofinterestinterestininFoxcraftPhilmontJack Finkle23.2025.00Beatrice Finkle Trust 16.800 Jule Finkle23.2025.00Bella Finkle Trust 16.800 Maurice Finkle18.2025.00Gertrude Finkle Trust 16.800 Arthur Finkle11.0018.42Ruth Finkle Trust 14.006.58100.00100.0078 On or before July 1, 1963, Philmont acquired 100 percent of the stock of another corporation, which it liquidated within 2 years of such acquisition, transferring the assets to petitioner in exchange for the latter's stock. As a result, Philmont became the sole shareholder of petitioner.On November 27, 1964, petitioner's board of directors adopted a resolution providing for the dissolution and complete liquidation of the corporation, which subsequently occurred on January 29, 1965. The resolution recited that the liquidation was being effected "in accordance with, to the extent that they may be applicable, Sections 332, 334(b)(2) and 337(a) of the Internal Revenue Code of 1954." A Form 966 was filed on or about December 5, 1964.On November 27, 1964, Philmont and Foxcraft, by their boards of directors, each adopted a resolution providing for their dissolution and complete liquidation, which subsequently occurred on January 29, 1965. The resolutions recited that the liquidations were being effected 765 "in accordance with the requirements of Section 337(a) of the Internal Revenue Code of 1954." Each79 corporation filed a Form 966 on or about December 5, 1964.On December 7, 1964, petitioner, Philmont, and Foxcraft entered into an agreement (hereinafter referred to as the agreement) with Gulf & Western Industries, Inc., providing for the sale to one or more subsidiaries of Gulf & Western (hereinafter referred to collectively as Gulf & Western) of all the assets, properties, and business of petitioner, Philmont, and Foxcraft, with the exception of the stock of petitioner owned by Philmont. The agreement appointed Jack Finkle as the representative of the sellers, which designation was confirmed by an agreement dated January 29, 1965, among petitioner, Philmont, Foxcraft, and the shareholders of the latter two corporations. The latter agreement contained the following provisions:2. Shareholders each hereby designate Representative as their irrevocable agent and attorney-in-fact, to receive, on their behalf from Sellers, as a liquidating dividend, through himself as Representative of Sellers, the Agreement and any and all rights accruing therefrom, and all other assets of Sellers, subject to the liabilities of Sellers under the terms of said Agreement, and any other liabilities80 of Sellers, liquidated or contingent.3. Upon approval of this Agreement by the respective Boards of Directors of Sellers, and the adoption by them of appropriate resolutions declaring that the Agreement and all rights accruing therefrom held by Representative, on behalf of Sellers, be paid and distributed, as a liquidating dividend, to Representative, as irrevocable agent for the Shareholders under this agreement, (and with respect to Kamis's rights under the Agreement, and all of its other assets, subject to its liabilities, received by Philmont as a liquidating dividend of Kamis, the further transfer of such assets and rights, subject to the liabilities of Kamis, to the Representative as agent for the Shareholders except Philmont), in the proportions hereinafter designated, subject to all remaining liabilities of Sellers, whether under the Agreement or otherwise, and whether liquidated or contingent, which liabilities Shareholders except Philmont hereby assume and agree to pay in the proportions hereinafter designated, Representative shall, and he hereby does acknowledge that thereafter he shall hold all funds received by him under the Agreement, as agent for the Shareholders except81 Philmont, under the terms of this Agreement, subject as aforesaid.* * * 5. Upon and after the execution of this agreement, * * all funds received and held by Representative under the Agreement or this agreement shall be deemed to be received by him for the account of, and as agent for, the Shareholders except Philmont, in the following proportions:A. 60.89% thereof for the Shareholders of Foxcraft in the proportions of their respective shareholdings in Foxcraft, as shown on Exhibit "A" annexed hereto and made a part hereof;B. 39.11% thereof for the Shareholders of Philmont in the proportions of their respective shareholdings in Philmont, as shown on Exhibit "B" annexed hereto and made a part hereof; it being understood that the above percentage includes Kamis's portion of the proceeds due and rights under the Agreement, which proceeds and rights have, by this agreement, and resolutions of the Directors of Kamis and Philmont, been successively distributed as liquidating dividends to their respective Shareholders, resulting in all rights of Kamis and 766 Philmont under the Agreement, and all other assets thereof, subject to all liabilities in said companies, being82 vested in the Shareholders of Philmont in the proportion listed on Exhibit "B".[Emphasis supplied.]Also on January 29, 1965, Philmont, Foxcraft, and petitioner each executed assignments of all of its assets to Jack Finkle "in consideration of the delivery to the corporate Assignor for cancellation by all of its shareholders of all of its capital stock in complete redemption thereof in furtherance of its Plan of Complete Liquidation heretofore adopted."On the same day, the transfers to Gulf & Western were effected in exchange for payments by Gulf & Western to Jack Finkle as representative.Section 337 provides, in subsection (a), that if a corporation adopts a plan of complete liquidation and distributes all of its assets within a 12-month period, "then no gain or loss shall be recognized to such corporation from the sale or exchange by it of property within such 12-month period." The section was enacted to overcome the difficulties engendered by the Supreme Court decisions in Commissioner v. Court Holding Co., 331">324 U.S. 331 (1945), and United States v. Cumberland Pub. Serv. Co., 338 U.S. 451">338 U.S. 451 (1950), and had 83 as its avowed objective the elimination of "questions arising as a result of the necessity of determining whether a corporation in the process of complete liquidation made a sale of assets or whether the shareholder receiving the assets made the sale." See S. Rept. No. 1622, 83d Cong., 2d Sess., pp. 48-49 (1954). See also J. C. Penney Co. v. Commissioner, 312 F. 2d 65 (C.A. 2, 1962), affirming 37 T.C. 1013">37 T.C. 1013 (1962), and United States Holding Co., 44 T.C. 323">44 T.C. 323 (1965), for a full elucidation of the purposes of section 337.It is clear that petitioner satisfied all of the requirements of section 337(a) and (b). Thus, if our inquiry could stop here, it would be clear that, except with respect to gain attributable to section 1245 assets which petitioner concedes to be taxable, petitioner would recognize no gain or loss on the sale of its assets to Gulf & Western. But section 337(c)(2) provides an exception to the general rule of nonrecognition contained in section 337 "In the case of a sale or exchange following the adoption of a plan of complete liquidation, if section 332385 767 applies." 84 Since Philmont was the owner of all the issued and outstanding stock of petitioner, the parties have locked horns on whether the exception applies, respondent asserting that it does and petitioner contending that it does not. 4 The issue is one of first impression for this Court. Cf. Manilow v. United States, 315 F. Supp. 28 (N.D. Ill. 1970).In resolving this issue, it is essential that both the overall purpose of section 337 and the specific purpose of the exception contained in section 337(c)(2) be kept clearly in mind. The overall purpose was to eliminate the minefield 5 created by Commissioner v. Court Holding Co., supra, and United States v. Cumberland Pub. Serv. Co., supra, by imposing only one tax where a combination of a corporation liquidation and a sale of assets occurs. See J. C. Penney Co. v. Commissioner, supra at 70; United States Holding Co., supra at 331. The specific purpose of the exception was to assure the same result and not to permit the avoidance of tax at both the parent and subsidiary levels, where the parent86 remained in existence, which would be the consequence if both section 337(a) and section 332 applied. See United States Holding Co., supra.In the instant case, one tax was clearly payable by the shareholders who ultimately received the total proceeds of the sale of the assets of all three corporations to Gulf & Western. The question is whether, as respondent contends, an additional tax should be paid by petitioner on the theory that the proceeds of the sale of its assets were constructively received by Philmont in complete liquidation of its wholly owned subsidiary and then distributed in liquidation by Philmont to its shareholders. 687 The parameters of the issue before us are clearly defined by two examples. If Philmont had not been liquidated, the exception contained in section 337(c)(2) would apply and petitioner would be taxable on the gain from the sale of its assets to Gulf & Western. If it is determined that, prior to the sale, Philmont distributed to its shareholders its stock in petitioner, section 332 would not apply, since Philmont would not have continued to own such stock "at all times until the receipt of the property [the distribution in liquidation of petitioner]" 7 and petitioner would be relieved of taxation on such gain by virtue of section 337(a).768 We think that an analysis of the facts reveals that, as of the time of the88 closing of the transaction with Gulf & Western, Philmont had distributed its shares in petitioner to Jack Finkle as representative of the shareholders of Philmont. To be sure, the precise sequence of the transactions relating to the designation of Finkle as representative, the closing of the sales to Gulf & Western, and the transfer of the proceeds to Finkle in cancellation of the stock of Philmont, Foxcraft, and petitioner is not revealed by the record. But it is established that they all took place on the same day and in all probability simultaneously. In resisting a claimed loss by a corporation where the plan of liquidation and sale occurred on the same day, respondent has sought and obtained a confirmation of his interpretation of section 337 that the exact sequence of events should be disregarded. Henry H. Adams, 38 T.C. 549">38 T.C. 549 (1962); sec. 1.337-1, Income Tax Regs. We see no reason not to adopt an equally felicitous interpretation here. By the same token, we think it reasonable to conclude that, even if Philmont's shares in petitioner should not be considered as having been transferred to Philmont's shareholders prior to the distribution of89 the proceeds, the instruments of designation of Finkle and of assignment effectively transferred the right to receive the proceeds of the sale of petitioner's assets to Philmont's shareholders. In such event, Philmont would not be considered as having been in "receipt * * of property distributed" and section 332 would not apply.Concededly, there is language in the agreement designating Finkle which seems to operate in terms of a dual distribution, first from petitioner to Philmont and then from Philmont to its shareholders. Additionally, the resolution of petitioner by which its plan of liquidation was adopted referred to sections 332 and 334(b)(2) as well as section 337, but it is significant that such reference was qualified by the phrase "to the extent that they may be applicable." But we think that these peripheral indicia should not be accorded the substantive significance advocated by respondent, particularly in light of the fact that the instrument of assignment from Philmont to its shareholders in consideration of the cancellation of its stock specifically transferred "all of the assets of the corporate Assignor," which assets included the stock of petitioner. It is 90 equally as logical to say that there was a constructive distribution of either Philmont's stock in petitioner or the proceeds of the sale of petitioner's assets to the shareholders of Philmont as it is to say that there was a constructive distribution of such proceeds by petitioner to Philmont. In short, we think that the constructive receipt theory begs the question.Respondent claims that Manilow v. United States, supra, heavily relied upon by petitioner, is distinguishable on its facts. Technically, respondent may be correct, since the parent corporation in that case 769 appears to have lacked substance, but the District Court went beyond that factual nuance and stated (315 F. Supp. at 34):The transaction in question substantially deviates from a "normal" Section 337(c)(2) parent-subsidiary liquidation. The gain realized was channeled directly and immediately to the plaintiffs, who in turn recognized their consequent tax liability at the shareholder level. To levy a double tax upon the plaintiffs because of the form and not the substance of the liquidation of the Water Company would be to ignore the express91 legislative intent of Congress. The approach advocated by the defendant traps the plaintiffs into double taxation because of the form they unwarily took in effectuating a complete corporate liquidation.The message of Manilow is loud and clear and we agree with it.Respondent also points to the recommendations of the Subchapter C Advisory Group (Revised Report on Corporate Distributions and Adjustments, 86th Cong., 1st Sess., p. 55 (Dec. 11, 1958), and Report on Corporate Distributions and Adjustments, 85th Cong., 2d Sess., p. 45 (Dec. 24, 1957)). Those recommendations, however, covered the entire gamut of subchapter C and, even in the area of the applicability of section 337 to liquidations of both parent and subsidiary, urged expansion of the nonrecognition of gain or loss beyond the situation where, as is the case here, there are simultaneous liquidations. We therefore derive no indication of legislative intent from the failure of the Congress to adopt such recommendations.The exclusionary provision of section 337(c)(2) represents a legislative shield of the revenue against the avoidance of tax at both the parent and subsidiary levels, where the proceeds from the sale92 of the subsidiary's assets are distributed to the parent in a section 332 liquidation and remain in corporate solution. It should not be turned into a legislative sword to justify the imposition of tax at both the subsidiary level and that of the shareholders of the parent, where the proceeds of the sale of the subsidiary's assets find their way forthwith into the hands of such shareholders. In short, we are satisfied that, in a case such as this, we should not be blinded by questions of technical niceties so as to thwart the intendment of the statute. See Cherry-Burrell Corp. v. United States, 367 F.2d 669">367 F. 2d 669, 672 (C.A. 8, 1966). Our conclusion that section 332 is not applicable where a simultaneous liquidation of both the parent and subsidiary is involved (cf. International Investment Corp., 11 T.C. 678">11 T.C. 678, 685 (1948), affirmed per curiam 175 F. 2d 772 (C.A. 3, 1949)), enables the respondent to extract one tax but not two and accords with both the overall objective of section 337 and the specific objective of section 337(c)(2). Manilow v. United States, supra.93 Decisions will be entered under Rule 50. Footnotes1. Cases of the following petitioners are consolidated herewith: Jack Finkle, Transferee, docket No. 1668-69; Jule Finkle, Transferee, docket No. 1669-69; Arthur Finkle, Transferee, docket No. 1670-69; and Maurice Finkle, Transferee, docket No. 1671-69.↩2. All statutory references, unless otherwise indicated, are to the Internal Revenue Code of 1954 as amended and in effect during the taxable period involved.↩1. Wife of stockholder whose name appears immediately above her name.↩3. SEC. 332. COMPLETE LIQUIDATIONS OF SUBSIDIARIES.(a) General Rule. -- No gain or loss shall be recognized on the receipt by a corporation of property distributed in complete liquidation of another corporation.(b) Liquidations to Which Section Applies. -- For purposes of subsection (a), a distribution shall be considered to be in complete liquidation only if -- (1) the corporation receiving such property was, on the date of the adoption of the plan of liquidation, and has continued to be at all times until the receipt of the property, the owner of stock (in such other corporation) possessing at least 80 percent of the total combined voting power of all classes of stock entitled to vote and the owner of at least 80 percent of the total number of shares of all other classes of stock (except nonvoting stock which is limited and preferred as to dividends); * *↩4. Respondent agrees that if the exception applies, petitioner's gain should be computed in accordance with sec. 337(c)(2)(B)↩, and the parties have stipulated the amount of that gain. Compare XIX A.B.A. Bulletin of the Section of Taxation, No. 3, p. 87 (April 1966).5. Vestigial booby traps still remain. Cf. Waltham Netoco Theatres, Inc., 49 T.C. 399 (1968), affd. 401 F.2d 333">401 F.2d 333 (C.A. 1, 1968); Rev. Rul. 69-172, 1 C.B. 99">1969-1 C.B. 99↩.6. Respondent cannot and does not contend that Philmont and Foxcraft are not entitled to the benefit of sec. 337(a)↩.7. Cf. Commissioner v. Day & Zimmermann, 151 F.2d 517">151 F.2d 517 (C.A. 3, 1945); Avco Manufacturing Corporation, 25 T.C. 975">25 T.C. 975, 979↩ (1956); Bittker & Eustice, Federal Income Taxation of Corporations and Shareholders, p. 11-30 fn. 51 (3d ed. 1971).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623570/	John T. Gauthier and Katherine J. Gauthier, Petitioners v. Commissioner of Internal Revenue, RespondentGauthier v. CommissionerDocket No. 9403-72United States Tax Court62 T.C. 245; 1974 U.S. Tax Ct. LEXIS 105; 62 T.C. No. 27; May 16, 1974, Filed 105 Rules 70 (a)(1) and 81, Tax Court Rules of Practice and Procedure. -- Held: An application for the pretrial deposition of an internal revenue agent will be denied because it would be in direct violation of the Court's rules. Failure to provide for pretrial discovery depositions is not a denial of "due process." Sec. 7453, I.R.C. 1954, provides that the Court may prescribe its own rules of practice and procedure. Sylman I. Euzent, for the petitioners.Marlene Gross, for the respondent. Dawson, Judge. DAWSON245 OPINIONOn March 21, 1974, the petitioners filed with the Court a document entitled "Application For Order Of Court To Take Deposition In Pending Case" seeking to take the deposition of Edward Maggio, an internal revenue agent, and requesting the production at the deposition of his workpapers106 upon which the respondent based his deficiency determination. Petitioners allege that they want to "obtain discovery in order, pursuant to due process requirements, to adequately prepare for the trial of this case." They assert that they are entitled to 246 elicit testimony from Mr. Maggio as to the facts, circumstances, and computations on which the deficiency is based.On April 1, 1974, respondent filed a notice of objection to the petitioners' application to take such deposition and requested a hearing thereon. A hearing was held on May 1, 1974, at which counsel for the parties presented their arguments.A deposition for the purpose of discovery, as requested by the petitioners herein, is not permitted or authorized under the Tax Court Rules of Practice and Procedure. See Rule 70(a)(1). 1 In addition, Rule 81(a) limits the use of the deposition procedure in a pending case to the perpetuation of testimony and the preservation of documents or things. Rule 81(a) also provides that depositions shall be taken only where there is a substantial risk that the person or document or thing involved will not be available at the trial of the case.107 The petitioners have made no showing to the Court that there is a substantial risk that Mr. Maggio or the documents they seek to have produced will not be available at the trial of this case. Moreover, they have not shown that the testimony and documents they seek are material to the matters in controversy and are not privileged.Petitioners make the vague assertion that the failure of this Court to provide for pretrial discovery depositions constitutes a denial of "due process." No authorities were cited. In our judgment the argument lacks merit.Section 7453, I.R.C. 1954, provides that proceedings of the Tax Court shall be conducted in accordance with such rules of practice and procedure (other than rules of evidence) as the Court may prescribe. On January 1, 1974, the Court put into effect its new Rules of Practice and Procedure, which were carefully considered and reviewed before they were promulgated. The Court, in its discretion, has decided at this time that pretrial discovery depositions are incompatible with its practice 247 and therefore rejects such procedures. In this respect the rules are procedural, not substantive, in nature.It is also noted that the petitioners*108 have not attempted to obtain the objectives of any discovery through informal consultation and communication. See Rule 70(a)(1); Branerton Corp., 691">61 T.C. 691 (1974).Accordingly, we conclude that the petitioners have not complied with the letter or spirit of the Court's rules with respect to discovery and the use of depositions in a pending case. Their application is an abuse of the Court's procedures and will be denied.An appropriate order will be entered. Footnotes1. The note (60 T.C. 1097">60 T.C. 1097) to Rule 70(a)(1) states:The discovery procedures adopted by these Rules consist of interrogatories and of production and inspection of papers and other things. In that respect, the Federal Rules have been followed in essence. Depositions have not been adopted in these Rules as a discovery device. In that respect, these Rules do not follow the Federal Rules.The new procedures introduced into Tax Court practice by these Rules are deemed sufficient to enable a party to obtain information needed to prepare for trial. Whatever additional benefits might be obtained by the use of discovery depositions would appear to be outweighed by the problems and burdens they entail for the parties as well as the Court. Provision for discovery depositions in conformity with the Federal Rules at this time would represent too drastic a departure from present Tax Court practice, with uncertain effect in view of the context of Tax Court litigation.The present Tax Court Rules have no provisions on discovery. While there are provisions in the present Rules on depositions, they have not seen extensive use, and in practice generally have been limited to special circumstances, as where witnesses have not otherwise been available.Par. (a) sets forth the allowable methods of discovery and the limitations discussed above. No similar provision appears in the present T.C. Rules.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623571/	William T. Grant, Petitioner v. Commissioner of Internal Revenue, RespondentGrant v. CommissionerDocket No. 5143-65United States Tax Court48 T.C. 606; 1967 U.S. Tax Ct. LEXIS 64; July 31, 1967, Filed 64 Decision will be entered under Rule 50. Petitioner created a number of trusts to which he transferred common stock of W. T. Grant Co. These trusts provide for income to be paid to relatives, employees, or friends for life and upon the death of the life beneficiary or the survivor of the life beneficiaries of each trust that the principal be paid over to a charity. These trusts contained the provision that dividends paid in stock of the issuing corporation of a value of less than 5 percent of the stock with respect to which issued were income and all other stock dividends were principal. Held, the provisions of the trusts with respect to 5-percent stock dividends being income did not create sufficient uncertainty as to the value of the charitable remainder or create such a possibility of diversion of the remainder interest as to require that the fair market value at the date of transfer of the stock transferred to the trusts be reduced by the per-share amount of accumulated earnings of the corporation as of that date before applying the actuarial tables contained in respondent's regulations in computing the deduction for the gift to charity. A. Chauncey Newlin and David Sachs, for 65 the petitioner.Charles M. Costenbader, for the respondent. Scott, Judge. SCOTT 607 Respondent determined deficiencies in petitioner's gift taxes for the years 1960, 1961, 1962, 1963, and 1964 in the amounts of $ 329,608.67, $ 246,799.84, $ 240,107.54, $ 210,318.07, and $ 125,157.69, respectively.The issue for decision is whether the provision in certain trusts to which petitioner made gifts of life estates to named individuals with the remainder interest to go to a charity that dividends paid in stock of the declaring corporation of a value not exceeding 5 percent of the value of the shares on which the dividend is declared shall be income, creates such a possibility of diversion of trust principal that the allowable deduction for the charitable remainder interests should be computed by applying the appropriate actuarial factors contained in respondent's Gift Tax Regulations to the fair market value of the stock on the respective dates of transfer less the per-share amount of accumulated earnings and profits of the corporation on such dates instead of to the entire fair market value of the stock on the dates of the transfers.FINDINGS OF FACTSome of the facts have been stipulated and 66 are found accordingly. The stipulated facts include as exhibits numerous documents. Since these documents are incorporated herein by finding the facts as stipulated, only such portions or provisions of these documents as are necessary to an understanding of the issue in this case will be set forth herein.Petitioner, an individual whose legal residence at the time of the filing of the petition in this case was Greenwich, Conn., filed timely Federal gift tax returns for each of the calendar years 1956 through 1964 with the district director of internal revenue, Hartford, Conn., and timely paid the gift taxes shown to be due on such returns.At various times during the years 1956, 1957, 1958, and 1960 through 1964, petitioner transferred shares of common stock of W. T. Grant Co. to irrevocable trusts for the benefit of various individuals other than himself as life tenants and the Grant Foundation, Inc. (hereinafter sometimes referred to as the foundation), as the remainderman. 608 The foundation is a charitable organization to which gifts are deductible under section 2522(a), I.R.C. 1954. 1Petitioner's purpose in making each of 67 the transfers in trust was to provide life incomes for relatives, employees, and friends, and to transfer the principal assets outright to the foundation upon the deaths of the respective income beneficiaries.In each of these trusts the Connecticut Bank & Trust Co. (hereinafter referred to as the Connecticut Bank) was appointed trustee, and in each of the trusts, except the two created on May 8, 1956, and June 18, 1956, Albert E. Kelly (hereinafter referred to as Kelly) was appointed a cotrustee.Kelly was not related to petitioner but was employed on a full-time basis as petitioner's personal financial adviser from September 1951 through 1964 at a salary between $ 21,875 and $ 24,500 per annum, and in addition acted as an independent financial consultant to W. T. Grant Co. for consulting fees which ranged during the years 1956 through 1964 between $ 2,500 and $ 5,000 per year.The sole trustee of the trusts created on May 8, 1956, and June 18, 1956, was the Connecticut Bank.With the exception of the trust created on June 22, 1961, which named as the life beneficiary Beth Bradshaw, each trust agreement with respect to gifts in trust for a life beneficiary or beneficiaries and the charitable 68 remainder to the foundation, executed by petitioner during the years 1956 through 1962, provided in part as follows:Fourth: The Trustees shall have the following powers and discretions, in addition to any conferred by law:1. To retain the securities transferred hereunder and any additional securities or property which may be added to the trust, without liability for any decrease in value.2. To sell or exchange any property comprising the trust fund and the Income Reserve Fund and, without being restricted to property authorized by the laws of the State of Connecticut or of any other jurisdiction for trust investment, to invest said funds in any kind of property whatsoever, real or personal, whether or not productive of income, and without regard to the proportion that such property, or property of a similar character held, may bear to the entire trust fund; provided, however, that no sale, exchange, pledge or other disposition of any stock or securities of W. T. GRANT COMPANY, or its successor, at any time held by the Trustees shall be made without the written consent of at least two-thirds of the authorized number of Trustees of the GRANT FOUNDATION (INCORPORATED). The Trustees may 69 invest the Income Reserve Fund, in whole or in part, in shares of any Common Trust Fund maintained by the Corporate Trustee.The Trustees hereunder shall be under no obligation or duty to inquire into the business or affairs of said W. T. Grant Company or its successor, or to 609 inquire into the advisability of holding or disposing of any of the stock or securities of said company or its successor.3. To vote in person or by proxy, or to refrain from voting, upon securities held by it, and in such connection to delegate their discretionary powers.4. To exercise options, conversion privileges or rights to subscribe for additional securities and to make payments therefor.5. To consent to or participate in dissolutions, reorganizations, consolidations, mergers, sales, leases, mortgages, transfers or other changes affecting securities held by them and in such connection to delegate their discretionary powers and to pay assessments, subscriptions and other charges.6. To retain any property acquired in connection with the foregoing provisions, whether or not such property shall be authorized by the laws of the State of Connecticut or any other jurisdiction for trust investment.7. To register 70 any property in the name of their nominee or in their own names or to hold said property unregistered or in such other form that title shall pass by delivery, but without thereby increasing or decreasing their liability as Trustees.Fifth: No person or corporation dealing with the Trustees shall be required to investigate the Trustees' authority for entering into any transaction or to see to the application of the proceeds of any transaction.Sixth: If securities are purchased or received at a premium or at a price in excess of the call or redemption price or the amount payable at maturity or on liquidation the Trustees may, in their discretion, but shall not be required to, use any part of the income from such securities to amortize or restore to principal such premium or excess.Dividends and distributions received by the Trustees shall be treated as follows:1. All dividends paid in cash, whether ordinary or extraordinary and including dividends of wasting asset corporations and capital gains distributions of regulated investment companies, shall be income.2. Every dividend paid in stock of the declaring corporation, of the same class as the stock on which the dividend is declared, 71 which is in an amount not exceeding 5% of the shares on which the dividend is declared, and every dividend paid in stock of the declaring corporation, of a class different from the class on which the dividend is declared, which has a fair market value on the date of payment not exceeding 5% of the fair market value on such date of the stock on which the dividend is declared, shall be income.3. Every other dividend or distribution paid by a corporation in shares of its own stock shall be principal.4. All dividends paid in property of the declaring corporation (including stock or other securities of any other corporation) or in its bonds, to the extent that they represent or are charged against earnings of the declaring corporation, regardless of when earned, shall be income.5. Notwithstanding the foregoing, any distribution made by a corporation in whole or partial liquidation, or representing a substantial part of its total assets, shall be principal.The Trustees shall have discretion to resolve any questions of fact or of law arising in connection with the application of the foregoing, and as to the allocation of any property between principal and income as to which no express provision 72 is made in this Agreement, and their decision shall be binding upon all interested parties.610 Dividends declared but upaid on securities transferred by the Donor to the Trustees, and having a record date subsequent to the date of this Agreement, shall belong to the trust and shall be income.Seventh: The donor reserves the right to remove, without cause, any Trustee at any time acting hereunder, by instrument in writing delivered to such Trustee. After the death of the Donor the Trustees of The Grant Foundation (Incorporated), by vote of a majority of the authorized number of such Trustees, are authorized to remove any individual or corporate Trustee in like manner.Any Trustee at any time acting hereunder may resign by written notice to the Donor, given by registered mail or delivered personally, and after the death of the Donor, by such notice given to the co-Trustee then acting and to The Grant Foundation (Incorporated).In the event of the removal, death or resignation of any Trustee, either during the lifetime of the Donor or after his death, the Trustees of The Grant Foundation (Incorporated), by vote of a majority of the authorized number of such Trustees, are authorized to appoint 73 a successor Trustee, who may not be the Donor, by instrument in writing delivered to such successor.Any successor Trustee appointed as herein provided upon executing an acknowledged acceptance of the trusteeship shall be vested without further act on the part of any one with all the estates, rights, titles, powers, duties, immunities and discretions herein granted to the Trustees named.Any Trustee who resigns or is removed shall be entitled to reimbursement from the trust fund for all expenses incurred by such Trustee in connection with the settlement of his accounts and the transfer and delivery of the trust assets to a successor.Eighth: In the event of a disagreement between the corporate Trustee and the individual Trustee in respect to the exercise of any power or discretion conferred upon the Trustees under the provisions of this Agreement, the decision of the individual Trustee shall control.The trust agreements were drafted by petitioner's counsel and the provisions of subparagraphs 2 and 3 of paragraph Sixth of the agreements were placed in the trust agreements in accordance with the custom of the law firm of which petitioner's counsel was a member to make specific provision 74 with respect to the allocation between income beneficiaries and remaindermen of dividends paid in stock of the issuing corporation in all trust agreements which they prepared. When the trust agreements were given to petitioner for him to read and execute, his counsel did not specifically discuss these provisions with him.The trust agreement of June 22, 1961, under which Beth Bradshaw was the life beneficiary and the foundation was the remainderman, contained the following paragraph with respect to dividends paid by the corporation in its own stock:Sixth: Premiums on securities purchased by the Trustees shall be amortized.Every dividend paid by a corporation in its own stock received by the Trustees, shall be principal.Dividends declared but unpaid on securities transferred by the Donor to the Trustees, and having a record date subsequent to the date of this Agreement, shall belong to the trust and shall be income.611 On January 3, 1963, and January 2, 1964, petitioner created two trusts with individual life beneficiaries and the remainder to the foundation which contained the following provision with respect to dividends paid in stock of the issuing corporation:All ordinary dividends 75 paid in cash shall be income, but any distributions made by a corporation in whole or partial liquidation, or representing a substantial part of its total assets, and capital gains distributions of regulated investment companies, shall be principal.Every dividend paid in the stock of the declaring corporation shall be principal, except that any dividend paid in stock of the declaring corporation, of the same class as the stock on which the dividend is declared, which is in an amount not exceeding 5% of the shares on which the dividend is declared, and any dividend paid in stock of the declaring corporation, of a class different from the class on which the dividend is declared, which has a fair market value on the date of payment not exceeding 5% of the fair market value on such date of the stock on which the dividend is declared, and which stock dividends are paid wholly out of earnings of the corporation for the year in which declared, shall be income.On January 3, 1963, and January 2, 1964, petitioner transferred additional stock of W. T. Grant Co. to a number of the various trusts he had created between September 23, 1958, and February 1, 1961, the certificates for which were transmitted 76 to the trustee with a letter which stated in part as follows:The shares delivered to you herewith are to be held and administered, as segregated parts of said trusts, subject to all of the terms of the respective trust agreements, except that the provisions of the trust agreements that certain stock dividends, extraordinary cash dividends, and capital gains distributions of regulated investment companies, shall be income, shall not apply to the segregated parts constituting the additions hereby made to the trusts. The provisions in the trust agreements that such distributions shall be income were included in the trust agreements anticipating that any distributions made in accordance therewith in fact would be made out of current corporate earnings, and the allocation of such amounts to trust income would not result in a dilution of trust principal any more than if such provisions had not been included in the trust agreements.The life beneficiaries of six of the trusts created by petitioner, two created on September 23, 1958, three on February 29, 1960, and one on January 3, 1963, had died at the time of the trial of this case and the trust principal of each of these six trusts consisting 77 of the full number of shares of common stock of W. T. Grant Co. transferred by petitioner at the time the trust was created or by subsequent additions including any shares received as a result of a stock split in May 1960, had been paid over to the foundation in accordance with the terms of the trust agreements. The aggregate fair market value of the shares transferred to these six trusts as of the date such shares were transferred by petitioner to the trusts was $ 428,060, and the aggregate fair market value of these shares when transferred to the foundation on the deaths of the life beneficiaries was $ 476,386.612 W. T. Grant Co. is a Delaware corporation, incorporated in 1937, which is engaged in the business of operating a chain of general merchandise stores. This corporation is a successor to a Delaware corporation of the same name incorporated in 1927 which was the successor of a Massachusetts corporation of the same name incorporated in 1906. The Massachusetts corporation was organized by petitioner and three other unrelated individuals, each of whom owned a one-fourth interest. The first store operated by this corporation was opened on December 6, 1906, at Lynn, Massachusetts. 78 Subsequent to the organization of the Massachusetts corporation and prior to 1923, petitioner purchased the common stock of the other three organizers of the Massachusetts corporation so that by 1923 he or trusts created by him owned all of the common stock of that company. After 1923 shares of common stock of the original W. T. Grant Co. or its Delaware successor were sold to the public and in 1928 the common stock of the first Delaware corporation was listed on the New York Stock Exchange.No stock dividend has ever been paid by W. T. Grant Co., the Delaware corporation incorporated in 1937, and as of the date of the trial of this case that company had no present plans to declare any stock dividend.The only stock dividend declared by either of the predecessors of the present W. T. Grant Co. was in 1923 when, by the mechanics of a stock dividend, the common stock was split 10 for 1, and in 1929 when the common stock was doubled by a 100-percent stock dividend. Immediately following the stock dividend of 10 for 1, the then outstanding common stock was split 3 1/3 for 1.On September 18, 1945, the common stock of W. T. Grant Co. was split 2 for 1, and the par value per share was reduced 79 from $ 10 to $ 5, and on May 13, 1960, the common stock of W. T. Grant Co. was split 2 for 1 and the par value per share was reduced from $ 5 to $ 2.50. On May 13, 1966, the common stock of W. T. Grant Co. was split 2 for 1, and the par value per share was reduced from $ 2.50 to $ 1.25.Cash dividends have been paid by W. T. Grant Co. and its predecessor corporations on its common stock every year since 1907 and through the years the annual dividends have been increased steadily to the point where in 1966 such dividends were approximately 27 1/2 times the dividends in 1907.During the period 1956 through 1966 petitioner was chairman of the board of directors of W. T. Grant Co. In June of 1966 petitioner had become 90 years old. He was made honorary chairman of the board, and Edward Staley was made chairman. The board of directors of the W. T. Grant Co. consisted of 14 members from 1956 until February 1964 when it was increased to 18 members. No member of the board of directors and no executive officer of W. T. Grant Co. ever in office 613 has been a relative of petitioner. Until 1953 petitioner was actively engaged in the management of the affairs of W. T. Grant Co. although for several 80 years prior to 1953 he had not been involved in the day-to-day administration of the affairs of the company. From 1953 until 1959 petitioner was kept informed of the activities, policies, and procedures of the W. T. Grant Co. but took no active part in formulating such policies or procedures. In 1953 petitioner was 77 years old and suffered a stroke in that year.In September 1959 Edward Staley became vice chairman of the board of directors of W. T. Grant Co. and since that time petitioner has not participated in the managing and directing of W. T. Grant Co. He has not attended any directors or stockholders meetings or visited the executive offices of the company since 1959. Since 1959 he has attended about four courtesy luncheons with officers of W. T. Grant Co. Petitioner has not received or been paid an officer's salary by W. T. Grant Co. since 1932.In 1958 petitioner owned outright 2 1/2 percent of the outstanding shares of the common stock of W. T. Grant Co. and in 1965 owned outright 1 percent of such shares. In 1965 petitioner was cotrustee of a trust holding 2 1/2 percent of the outstanding shares of common stock of W. T. Grant Co. and 4.2 percent of such stock was in 81 trusts over which petitioner had a power of revocation. In 1959 the total of the amount of common stock held outright by petitioner or by trusts of which he was a trustee or trusts over which he had a power of revocation was 19.2 percent. The following schedule shows the total number of shares of common stock issued and outstanding as of January 31 of the years indicated, the number of stockholders of record as of such date, the number of shares of common stock of W. T. Grant Co. beneficially owned by petitioner as of March of each such year, the number of shares owned by the foundation as of March of each year, and the largest number of shares owned by the third largest shareholder on the quarterly dividend record date:Number ofNumber of sharesNumber ofsharesYearoutstanding,stockholdersbeneficiallyJanuary 31of record,owned byJanuary 31petitioneras of March19562,463,533 ($ 5 par)5,929647,812 (26%)19572,482,943 ($ 5 par)6,018634,012 (25.6%)19582,498,268 ($ 5 par)6,991586,412 (23.6%)19592,514,823 ($ 5 par)7,742573,412 (23%)19602,858,493 ($ 5 par)11,634524,912 (18%)19615,789,126 ($ 2.50 par)12,914954,824 (16.5%)19625,846,111 ($ 2.50 par)13,854874,724 (14.9%)19635,890,151 ($ 2.50 par)15,902821,724 (14%)19645,941,081 ($ 2.50 par)16,480815,524 (13.8%)19656,014,681 ($ 2.50 par)15,771842,624 (14.1%)Largest numberNumber ofof shares ownedshares ownedby thirdYearby the GrantlargestFoundation asshareholder onof Marcha quarterlydividendrecord book1956290,216 (12%)101,4241957290,216 (11.7%)127,3301958290,216 (11.7%)161,3171959290,216 (12%)191,7121960290,216 (10%)330,5751961616,768 (10.8%)379,4801962616,768 (10.5%)363,0301963634,462 (10.8%)349,4701964642,162 (10.8%)362,3901965647,162 (10.8%)669,84382 614 As of March of each of the years 1958 through 1964, the total number of shares of common stock of W. T. Grant held in trust by the Connecticut Bank and Kelly was 107,500, 123,500, 163,500, 419,000, 517,200, 571,970, and 592,070, respectively. For the years 1958, 1959, and 1960, the shares so held had a par value of $ 5 per share, and for the remaining 4 years they had a par value of $ 2.50 per share.On December 14, 1942, petitioner transferred a total of 146,833 shares of common stock ($ 10 par value) of W. T. Grant Co. to the Connecticut Bank and Howland S. Davis as trustees of 14 trusts created by agreements of that date under which the life beneficiaries were various individuals and the remainderman was the foundation. Each of these trust agreements provided that the donor reserved the right to remove the corporate trustee at any time without cause, that after the death of the donor, the trustees of the foundation were authorized to remove any individual or corporate trustee, that in the event of the death or resignation of any individual or corporate trustee during the lifetime of the donor, the donor may appoint a successor trustee, and that in the event of the death, resignation, 83 or removal of such a trustee after the death of the donor, the trustees of the foundation were authorized to appoint a successor trustee. The trust instruments also provided that in the event of a disagreement between the corporate trustee and the individual trustee in respect to the exercise of any power or discretion conferred upon the trustees, the decision of the individual trustee shall control.Howland S. Davis was a director of W. T. Grant Co. from 1924 and was a business associate of petitioner prior to 1924. Other than petitioner, Howland S. Davis had the longest period of continuous service on the board of directors of W. T. Grant Co., and he was also a trustee of the foundation from 1938 until 1964.As of March of each of the years 1956 through 1965, the total number of shares of common stock of W. T. Grant held in the trusts created by petitioner on December 14, 1942, of which the Connecticut Bank and Howland S. Davis were trustees, were 253,334 shares ($ 5 par value) for each of the years 1956 through 1960, 506,668 shares ($ 2.50 par value) for the years 1961 and 1962, and 492,004 shares ($ 2.50 par value) for the years 1963, 1964, and 1965.As of 1963 certain of the trusts 84 created on December 14, 1942, terminated by reason of the death of the individual life beneficiary and the shares of common stock of the W. T. Grant Co. held by those trusts at the time of termination were transferred to the foundation in accordance with the terms of the trust agreements.Between 90 and 91 percent of the outstanding common stock of W. T. Grant Co. is voted at each annual meeting. The common stock does not have cumulative voting rights. As of the date of the trial of 615 this case approximately 57 percent of the common stock of W. T. Grant Co. was held by the public and the remaining 43 percent was held by petitioner, trusts created by him, and the foundation. The shares of common stock of W. T. Grant Co. held by petitioner, the trusts created by him, and the foundation are always voted at the annual stockholders meetings.The Grant Foundation was incorporated by petitioner as a nonprofit charitable corporation on October 29, 1936. Petitioner was chairman of the board of trustees of the foundation during the years 1956 through 1964. The board of trustees of the foundation consists of nine trustees. Under the bylaws of the foundation not more than two trustees of the 85 foundation may be officers or employees of W. T. Grant Co. and not more than two trustees may be directors of W. T. Grant Co. Section 4 of article 8 of the bylaws of the foundation provides that no common stock of W. T. Grant Co. or of any successor thereof shall be sold or disposed of by the corporation except upon the concurring vote of at least two-thirds of the entire board.On May 8, 1958, the board of trustees adopted a "Revised Statement on Grant Foundation-Grant Company Relations," which was based on an earlier report dated September 8, 1954. The statement provided in part as follows:III. FOUNDATION-HELD STOCK * * 2. It is recommended that the Grant Foundation hold intact the W. T. Grant Company common stock it owns unless unusual circumstances or changing conditions make it desirable to do otherwise. It is particularly recommended that the Grant Foundation will not sell Grant Company common stock for the purpose of diversifying the holdings of the Foundation. The objective of this policy is to provide that the sale of Grant stock by the Foundation will not result in placing the control of the Company in the hands of parties who might not be interested in the welfare of 86 the Grant Company and its people.IV. COMPANY ACTIVITY IN THE FOUNDATION1. It is recommended that the Foundation Trustees will not elect as Foundation Officers or appoint to the Foundation Staff any active Grant Company officers or employees. The above recommendation does not apply to Mr. Grant. The objective of this policy is to assure that active Grant Company Officers or employees who are Foundation Trustees will not be in a dominant position in the Foundation and to prevent interlocking of the paid employees of the Grant Company and the Grant Foundation.Petitioner resigned as chairman of the board of trustees of the foundation on December 7, 1965. The foundation does not have and never has had an officer or trustee who was related to petitioner. Since 1956 petitioner has not actively participated in the affairs of the foundation. In 1956 he attended three meetings of the board of trustees of the foundation and in each of the years 1957, 1958, and 1959 he attended 616 only one such meeting, and he has not attended any meetings since May 14, 1959.During their existence, the foundation and the trustees of any trusts created by petitioner have executed the proxies solicited by the 87 management of the W. T. Grant Co. for the annual meetings of the corporation. During the period from 1937 to 1965, no motions were sought to be included in proxy statements of W. T. Grant Co. by minority stockholders and no nominations for membership to the board of directors of W. T. Grant Co. were made in opposition to the management nominees.The Connecticut Bank is a bank and trust company with its principal office at Hartford, Conn. It is one of the principal trust companies in the State of Connecticut. Petitioner does not own and never has owned any stock of the Connecticut Bank and is not and never has been an officer or director of that bank.Each of the trusts created by petitioner to which stock of W. T. Grant Co. was transferred provided that the laws of the State of Connecticut govern all questions pertaining to the validity, construction, and administration of the trust.In the case of all the trusts created by petitioner of which the Connecticut Bank is cotrustee with an individual, the bank holds the stock certificates for the stock transferred to the trust, keeps the trust records, and collects and disburses the trust income. Discretionary decisions are made by the 88 Connecticut Bank and submitted to the individual cotrustee for his approval. There has never been any difference of opinion between the Connecticut Bank and the individual cotrustee concerning any action recommended by the bank, and there has been very little occasion for the individual cotrustee to perform any administrative functions. All of the trusts created by petitioner of which the Connecticut Bank is a trustee hold stock of W. T. Grant Co.In 1945 the W. T. Grant Co. issued 150,000 shares of 3 3/4-percent cumulative preferred stock ($ 100 par value). The preferred stock was sold to the public through underwriters commencing in August 1945. Approximately 90 percent of the preferred stock is owned by the public and the remaining 10 percent by petitioner, trusts created by him, or the foundation. There are approximately 680 preferred stockholders.In 1962 the W. T. Grant Co. issued $ 35 million of 4 3/4-percent sinking fund debentures due January 1, 1987, and on June 1, 1965, $ 35 million of 4-percent convertible subordinated debentures due June 1, 1990.The prospectus with respect to the issue in 1945 of the 3 3/4-percent cumulative preferred stock contains the following provision 89 with respect to common stock dividend rights:617 COMMON STOCK, PAR VALUE $ 10 PER SHAREDividend rights: Subject to the prior rights of the holders of Cumulative Preferred Stock as hereinabove set forth, and the restrictions hereinafter set forth, holders of Common Stock are entitled to such dividends as shall be declared by the Board of Directors out of the assets or funds of the Company legally available therefor.So long as any of the Cumulative Preferred Stock shall remain outstanding, the Company shall not (1) declare or pay any dividends on any stock ranking junior to the Cumulative Preferred Stock as to dividends or assets nor purchase or redeem any stock ranking junior to the Cumulative Preferred Stock as to dividends or assets, if dividends on the Cumulative Preferred Stock or any sinking fund or stock purchase fund payment with respect to any series of Cumulative Preferred Stock shall be in arrears, nor (2) declare or pay any dividend (other than a stock dividend payable in stock of a class ranking junior to the Cumulative Preferred Stock as to dividends and assets) on any stock ranking junior to the Cumulative Preferred Stock as to dividends or assets, nor purchase or redeem 90 any stock ranking junior to the Cumulative Preferred Stock as to dividends or assets, if the aggregate amount expended after January 31, 1945 for dividends on or before the purchase or redemption of shares of any class of stock ranking junior to the Cumulative Preferred Stock as to dividends or assets exceeds an amount equal to the aggregate of (a) the consolidated net earnings of the Company and its subsidiaries earned after January 31, 1945, as determined in accordance with generally accepted accounting practice, (b) $ 5,000,000, and (c) the net proceeds from the sale after January 31, 1945 of any shares of any class of stock ranking junior to the Cumulative Perferred Stock as to dividends and assets.The prospectus issued January 24, 1962, with respect to the 4 3/4-percent sinking fund debentures due January 1, 1987, contains the following provision with respect to dividends:RESTRICTIONS AS TO DIVIDENDS AND CERTAIN OTHER PAYMENTSThe Indenture will prohibit the payment of dividends on stock of the Company (other than its 3 3/4 percent Cumulative Preferred Stock), except dividends payable in stock of the Company, or the purchase, redemption or other acquisition or retirement for value 91 of any such stock (other than Common Stock to be held for the Company's Deferred Contingent Compensation Plan) by the Company or the purchase or other acquisition for value of any such stock by a Restricted Subsidiary if, upon giving effect thereto, the aggregate amount (including dividends paid on the 3 3/4 percent Cumulative Preferred Stock of the Company) expended for such purposes subsequent to January 31, 1965 shall exceed an amount equal to the sum of (a) Consolidated Net Income (as defined) of the Company and its Restricted Subsidiaries earned subsequent to January 31, 1965, (b) the net proceeds of the sale of stock of the Company after January 31, 1965 (other than Common Stock held for the Company's Deferred Contingent Compensation Plan), (c) the net proceeds of the sale after January 31, 1965 of any indebtedness of the Company (including the Debentures) which has been converted into stock of the Company, and (d) $ 20,000,000. The Indenture does not restrict (i) the payment of any dividend within 60 days after the date of declaration thereof, if at said date the declaration complied with the provisions of the Indenture, or (ii) the retirement of stock of any class in exchange 92 for, or out of the proceeds of the substantially concurrent sale of, other shares of the 618 Company's stock or the retirement of stock (other than Common Stock) by exchange for, or out of the proceeds of the substantially concurrent sale of, Funded Indebtedness (as defined); no effect is to be given to such transactions in any calculations made in accordance with the preceding sentence. (Sections 6.04 and 1.01)The prospectus issued June 23, 1965, with respect to the sale of the 4-percent convertible subordinated debentures due June 1, 1990, contains the following provisions with respect to dividends:RESTRICTIONS AS TO DIVIDENDS AND CERTAIN OTHER PAYMENTSThe Company is not to (a) pay any dividend (other than those payable on the 3 3/4 percent Cumulative Preferred Stock of the Company or payable in shares of its stock), or (b) make or permit any Restricted Subsidiary to make any payment for the purchase, redemption or retirement of its stock (other than Common Stock to be held for the Company's Deferred Contingent Compensation Plan or stock retired by exchange for, or out of the proceeds of the substantially concurrent sale of, other stock or subordinated indebtedness of the Company), 93 or (c) make, or permit any Restricted Subsidiary to make, any investment in or advance to any Non-restricted Subsidiary after January 31, 1961 which will cause the then outstanding aggregate amount thereof to exceed $ 10,000,000, if, upon giving effect thereto, the sum of the aggregate amount expended as in (a) and (b) above (plus Preferred Stock dividend payments) and such investments and advances in excess of $ 10,000,000 in the aggregate then outstanding as in (c) above, exceeds Consolidated Net Income (as defined) of the Company and its Restricted Subsidiaries for the period subsequent to January 31, 1961 plus (i) $ 15,000,000, and (ii) the aggregate consideration received by the Company after that date with respect to the issue or sale of any of its capital stock (other than Common Stock held for the Company's Deferred Contingent Compensation Plan). (Section 4.07)On January 31, 1959, the total earnings of W. T. Grant Co. retained in the business amounted to approximately $ 82 million. On January 31, 1965, the total funds of W. T. Grant Co. retained in the business amounted to approximately $ 111 million. The New York Stock Exchange company manuals in effect for the period August 94 15, 1955, through June 15, 1966, contain a statement that many companies find it preferable at times to pay dividends in stock rather than in cash and in order to guard against possible misconception by the shareowners of the effect of stock dividends on their equity and on their relation to current earnings, the exchange had adopted certain standards of disclosure and accounting treatment which was stated in part to be as follows:EXCHANGE LISTING POLICYThe Exchange, in authorizing the listing of additional shares to be distributed pursuant to a stock dividend (or a stock split-up, whether or not effected through the technique of a stock dividend) representing less than 25 percent of the number of shares outstanding prior to such distribution will require that, in respect 619 of each such additional share so distributed, there be transferred from earned surplus to the permanent capitalization of the company (represented by the capital stock and capital surplus account) an amount equal to the fair value of such shares. While it is impracticable to define "fair value" 95 exactly, it should closely approximate the current share market price adjusted to reflect issuance of the additional shares.Applicability of Exchange Policy: This policy does not apply to distributions representing 100 percent or more of the number of shares outstanding prior to the distribution. As to distributions of 25 percent or more, but less than 100 percent, the Exchange will require capitalization at fair value only when, in the opinion of the Exchange, such distributions assume the character of stock dividends through repetition under circumstances not consistent with the true intent and purpose of stock split-ups.Reference is made to Section A 14 of this Manual, entitled Stock Split-Ups, for a statement of the Exchange's policy in relation to split-ups.Notice to Stockholders with Distribution: A notice should be sent to stockholders with the distribution advising them of the amount capitalized per share, the aggregate amount thereof, the relation of such aggregate amount to current undistributed earnings, the account or accounts to which such aggregate has been charged and credited, the reason for paying the stock dividend and that sale of the dividend shares would reduce 96 their proportionate equity in the company.On his gift tax return for each of the calendar years 1956, 1957, 1958, and 1960 through 1964, petitioner reported as gifts the fair market value of the common stock of W. T. Grant Co. transferred by him in trust as of the date of the transfer, such fair market value being computed by taking the average of the high and low prices at which the stock was sold in transactions on the New York Stock Exchange on the respective dates.From the value of gifts as so reported petitioner deducted the values on the respective dates of the transfers of the remainder interest to the foundation in such gifts by use of the tables for calculating trust remainder interests contained in the Gift Tax Regulations, the calculation being made on the basis of the fair market value of the stock transferred to the trusts computed as stated heretofore.Except for minor adjustments not here in issue the deficiencies determined by respondent resulted from the method used by respondent in calculating the amounts of the deductions for the value of the gifts by petitioner to the foundation as remainderman of the various transfers in trust made by petitioner. Respondent calculated 97 such deductions in accordance with the tables in the Gift Tax Regulations for valuing trust remainder interests, but for the purpose of this calculation he took as the value per share of common stock of the W. T. Grant Co. on the various dates of the transfers the fair market value per share of such stock on the valuation date as reported by petitioner minus the per-share amount of accumulated earnings and profits on or about 620 the valuation date divided by the number of shares of common stock outstanding on that date. 298 99 At the trial the parties stipulated the amount of charitable deduction allowable for the trust created by petitioner under the trust agreement dated June 22, 1961, and the amounts of the charitable deductions allowable for transfers to existing trusts made by petitioner by instruments dated January 3, 1963, and January 2, 1964.OPINIONSection 2522(a) provides that in computing taxable gifts for the calendar year, there shall be allowed as a deduction in the case of a citizen or resident, the amounts of all gifts made during such year to or for the use of a corporation or foundation organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes. Section 25.2522(a)-2(a), Gift Tax Regs., 3101 provides 621 that if a trust is created or property is transferred for both a charitable and private purpose, 100 deduction may be taken of the value of the charitable beneficial interest only insofar as that interest is presently ascertainable and severable from the noncharitable interest. The present value of a remainder interest or other deferred payment is to be determined in accordance with the rules stated in section 25.2512-5, Gift Tax Regs. Section 25.2512-5(a) provides that the fair market value of life estates, remainders, and reversions is their present value, determined in accordance with the provisions of that section. The section lists tables for use in determining the present value of a life estate for one individual or two or more individuals in order that the value of the life estate and reversion may be computed. These regulations (sec. 25.2512-5(d)) provide 102 that if the interest to be valued is a remainder interest subject to a life estate, the value of the interest should be obtained by multiplying the value of the property at the date of the gift by the appropriate figure contained in the tables set forth therein.Therefore, under these regulations, if the remainder interest in the trusts to which petitioner transferred the W. T. Grant Co. stock passed absolutely to the foundation without a more than negligible possibility that the charitable transfer would not become effective, the petitioner's method of valuation is in accordance with the regulations. Under the provisions of section 25.2522(a)-2(b), Gift Tax Regs., set forth in footnote 3, if the transfer for charitable purposes is dependent on some happening of a precedent event in order that it might become effective, no deduction is allowable unless the possibility that the charitable transfer will not become effective is so remote as to be negligible and the deduction is not allowable to the extent that the donee or trustee is empowered to divert the property or fund to a use which would have caused the deduction not to be allowable if such use had been the use for which the fund 103 was given.In the instant case respondent does not precisely state under what portion of these regulations he takes the position that the fair market value of the stock as of the date of the gift should be reduced by the per-share amount of accumulated earnings as of that date to determine the value to which to apply the figures contained in the actuarial tables in determining the amount of the charitable deductions. He argues that there existed at the date of such transfer of stock to the various trusts the possibility that stock dividends of less than 5 percent 622 of the outstanding stock would be declared by W. T. Grant Co. in such quantities that all the accumulated earnings of the company as of the date of the transfer of the stock would be absorbed by such dividends and that this possibility is not so remote as to be negligible. He also argues that because of the provisions in the various trusts with respect to the stock dividends of less than 5 percent going to the income beneficiary, the beneficial interest in the stock transferred to the charity is not presently ascertainable except to the extent of the value as he has determined it. In addition, he argues that the control 104 by the donor over the W. T. Grant Co. was such that the donor in effect retained the power to dilute the charitable gift by having W. T. Grant Co. declare a series of stock dividends in an amount of 5 percent or less until all of the accumulated earnings of W. T. Grant Co. which existed at the dates of the various transfers of stock to the trusts would have been diverted to the life beneficiaries by the setover to capital in accordance with the provisions of the New York Stock Exchange and Delaware law, which capital would go to the life beneficiaries prior to the time of the receipt by the charity of the trust corpus.The reason that respondent gives for not disallowing the charitable deduction for the transfer to the foundation in its entirety is that the requirement of the New York Stock Exchange that accumulated earnings of a corporation be set aside when stock dividends of 25 percent or less of the value of the outstanding stock are declared would prohibit any invasion of the trust corpus in excess of that portion represented by accumulated earnings of the W. T. Grant Co. at the respective dates of transfers of stock to the trusts. Respondent points out that the law of Delaware105 under which W. T. Grant Co. is incorporated prohibits the declaration of dividends, including stock dividends, as distinguished from stock splits or exchanges, except to the extent of the accumulated earnings of the company issuing such stock dividends. 4 Del. Code Ann. tit. 8, sec. 170. 4106 623 Petitioner and respondent both discuss various laws dealing with the allocation of stock dividends between income and corpus of a trust when the trust provides for a life beneficiary and remainderman, in the absence of a provision in the trust instrument with respect to such allocation. Both parties agree, and the case law is clear, that where there is a provision as to the allocation, as here, the allocation is to be in accordance with the provision of the trust instrument, and 107 allocation rules absent such a provision are of relevance only insofar as they indicate the underlying problem occasioned by the declaration of stock dividends with respect to stock which is held in a trust which has a life beneficiary and a remainderman.The parties are agreed that under the Massachusetts rule, a stock dividend issued in stock of the declaring corporation goes to capital of the trust fund, but cash dividends are always income for the trust. Hyde v. Holmes, 198 Mass. 287">198 Mass. 287, 84 N.E. 318">84 N.E. 318 (1908). The parties are likewise agreed that under the Pennsylvania rule, stock dividends go to the income beneficiary except to the extent that it is necessary to allocate a portion thereof to the principal of the trust to keep the shares of sock transferred to the trust at the book value which they had at the time they were transferred to the trust, or stated another way, this rule holds that a life beneficiary is entitled to the net income of the corporation accrued after the stock is acquired by the trust whether paid by stock or cash dividends, except to the extent that the stock which forms a part of the principal of the trust would, by the dividend declared, be reduced below its 108 book value as of the date the stock was transferred to the trust. See the discussion of this rule and its development in Cunningham's Estate, 395 Pa. 1">395 Pa. 1, 149 A. 2d 72 (1959).The Massachusetts common law rule has been adopted in the Uniform Principal and Income Act which has been adopted by a number of States including Connecticut which adopted this Act in 1939. It has been recognized that the Massachusetts rule as now adopted by the Uniform Principal and Income Act is unfair in some instances to the life beneficiary. However, this rule has the advantage of simplicity, whereas the Pennsylvania rule is difficult of application. See Gibbons v. Mahon, 136 U.S. 549">136 U.S. 549, 564-567 (1890), and Bogert, Trusts & Trustees, sec. 845 (2d ed.).Some States have in recent years modified by statute the rule of the Uniform Principal and Income Act by adopting specific legislation which provides that small stock dividends, usually limited to 4 to 6 percent of the value of the stock with respect to which they are issued, shall be considered as income of a trust and all other stock dividends as principal. In explaining the problem created by issuance of stock dividends, Bogert, Trusts & Trustees, sec. 845, 109 p. 480 (2d ed.), states:The problem is, What disposition must be made of the new stock after the stock dividend in order that justice may be done to the two parties interested under 624 the trust, the income and remaindermen beneficiaries. If one assumes that a trustee was given one share of stock having a par value of $ 100 in a corporation which then had a capitalization of $ 10,000 and a surplus of $ 5,000, he held the stock for ten years during which time the corporation accumulated additional surplus to the amount of $ 20,000, and then it declared a stock dividend of 100%, the trustee who originally held one share with a book value of $ 150 would then hold two shares with a combined book value of $ 350 (200 shares having an interest in corporate capital and surplus totalling $ 35,000 would make the book value of one share $ 175). If the one new share received is added to trust capital, the book value of that account will increase from $ 150 to $ 350, as far as the interest in this stock is concerned, but the income beneficiary will have lost all chance to receive a cash dividend out of the $ 10,000 of accumulated profits which were transferred from the surplus to the capital account; 110 and if the one new share is awarded by the trustee to the income account it will receive a benefit worth $ 175 and the trust capital account will retain the one old share now having a book value of $ 175 instead of its original book value of $ 150. [n49.5] [Footnote omitted.]Petitioner points out, and it is apparent, that a corporation may declare cash dividends in an amount sufficient to absorb not only earnings and profits accumulated after the creation of a trust but the accumulated earnings and profits which existed at the time the trust was created, and under the Delaware statute which is quoted in footnote 4, this would be legal. Therefore, there is a possibility that the earned surplus existing when the stock is transferred to the trust, which forms a part of the book value of the stock and reasonably might be assumed at least to affect the fair market value of the stock, will be reduced or entirely absorbed by payment of cash dividends which would be trust income to which the income beneficiary of the trust is entitled.Respondent argues that this is not a fair comparison since a stock dividend by its nature, if not retained by the owner of the shares with respect to which 111 it is declared, causes a change in the respective ownership by stockholders in the corporation, whereas a cash dividend does not. Respondent cites Eisner v. Macomber, 252 U.S. 189">252 U.S. 189, 211-212 (1920), with particular reference to the statement therein at page 212 that:But if a shareholder sells dividend stock he necessarily disposes of a part of his capital interest, just as if he should sell a part of his old stock, either before or after the dividend. What he retains no longer entitles him to the same proportion of future dividends as before the sale. His part in the control of the company likewise is diminished. * * The question in Eisner v. Macomber, supra, was the constitutionality of a statute providing that stock dividends were includable in the income of a taxpayer subject to income tax. The issue in the present case is not whether stock dividends are income but whether permitting stock dividends of 5 percent or less of the value of the stock of a corporation to go to the life beneficiary of a trust causes there to exist a possibility which is more than negligible that the transfer to the charitable 625 remainderman will not become effective, or that because of this provision 112 the donee or trustee is empowered to divert the property or fund to a noncharitable use. In considering the question in this case it must be approached from the standpoint not of what are properly increases in capital of the corporation but whether provision for considering small stock dividends as income would cause a diversion of the corpus of the trust to noncharitable uses. The corporation may accumulate earnings after the creation of the trust and these earnings do not belong to the shareholders as distinguished from the corporation in which they hold stock unless or until dividends are declared. As stated in Gibbons v. Mahon, supra (p. 558):Money earned by a corporation remains the property of the corporation, and does not become the property of the stockholders, unless and until it is distributed among them by the corporation. The corporation may treat it and deal with it either as profits of its business, or as an addition to its capital. Acting in good faith and for the best interests of all concerned, the corporation may distribute its earnings at once to the stockholders as income; or it may reserve part of the earnings of a prosperous year to make up for a possible 113 lack of profits in future years; or it may retain portions of its earnings and allow them to accumulate, and then invest them in its own works and plant, so as to secure and increase the permanent value of its property.Which of these courses shall be pursued is to be determined by the directors, with due regard to the condition of the company's property and affairs as a whole; and, unless in case of fraud or bad faith on their part, their discretion in this respect cannot be controlled by the courts, * * It, therefore, is apparent that whenever stock is transferred to a trust which has a life income beneficiary and a remainderman, the action of the corporate directors in accumulating income or distributing it will have a pronounced effect on whether the trust corpus increases or decreases in value. The accumulated earnings of the corporation may be eliminated by losses sustained by the corporation after the date of the transfer of the stock to the trust. When stock in a corporation is transferred to a trust and is held for a number of years until the death of a life beneficiary, that stock is unlikely to have the actual dollar value at the date the remainderman receives it that 114 it had at the date of its transfer. If the corporation is successful and its earnings are high and it does not distribute its total earnings in dividends, the stock will have a higher book value and is very likely to have a higher fair market value when it is received by the remainderman than when it was transferred to the trust. If the corporation sustains losses, thereby absorbing any earned surplus which it had as of the time of the stock was transferred to the trust, and perhaps causing a deficit, the stock will have a lower book value and may well have a lower fair market value when the remainderman receives it than it had when it was transferred to the trust even though the life beneficiary will have received less income than in the instance of a successful corporation.626 However, the regulations provide for valuing stock at its fair market value on the date of transfer for the purpose of determining the gift tax and provide tables to be used for determining the value of the remainder interest.Considering the nature of stock it might be argued that when the gift of stock is made to a trust, the income of which is to be paid to a noncharitable beneficiary for that individual's 115 life with the remainder to go to a charitable beneficiary, the remainder interest is not ascertainable with reasonable certainty if it is assumed that the trust will hold the stock transferred to it. Not only does the dividend policy of the corporation and its earnings ability in the years subsequent to the transfer affect the value of the stock, but such value may also be affected by the nature of the assets in which its capital or any earnings it has accumulated are invested, and whether these assets appreciate or depreciate in value. Likewise, whether stock dividends are all considered part of the corpus of the trust or some part of them are considered as income will affect this value. There is no difference in the situation where small stock dividends are to be treated as income to go to the life beneficiary under the provisions of the trust instrument and where they are to be so treated by State law insofar as the effect on the value of the remainderman's interest in the trust is concerned.New York is one of the States which recently provided by statute (N.Y. Pers. Prop. Law sec. 27-e(2)) that stock dividends of 6 percent or less made to a trustee shall be income. If no provision 116 is made in a trust governed by this law of New York as to the treatment of stock dividends paid to a trustee, the income of which is to be paid to an individual for life and the remainder to a charity, the treatment of such dividends under New York law would be substantially the same as the treatment under the trust instruments here involved.While respondent places great reliance on the law of Connecticut providing that all stock dividends are capital, he does not suggest what the difference would be if this were a New York trust created after the enactment of the statute heretofore referred to from the situation here where the provision as to small stock dividends being income is in the trust instrument.All of the argument made by respondent is based on the rights of a stockholder and proceeds under the philosophy that when a share of stock is issued to such stockholder as a stock dividend and accumulated earnings of the corporation are capitalized, the stockholder has no more after the issuance of the dividend than prior thereto. Prior to the issuance of the dividend, the stockholder owned the same proportionate interest in the corporation which had the same assets in capital and 117 surplus that it has after the stock dividend is declared with a larger percentage of such assets designated on its books as capital.627 This argument overlooks the fact that where stock is transferred to a trust, the trustee and not the remainderman of the trust or the life beneficiary of the trust is the stockholder. The remainderman does not have all rights of a stockholder. One of the substantial rights which he does not have, even if the trust were required to retain the stock, is the right to participate in distributions of income by the corporation so long as the life beneficiary lives. It is because of the bundle of rights comprising a stockholder's interest being equitably divided between a life beneficiary and a remainderman that the problem of what is capital and what is income is created. Where stock is held by a corporation in its treasury, it is an asset owned by the corporation which forms a part of the corporate assets in which each stockholder has an equitable interest just as does any other asset. If such treasury stock is distributed as a dividend and a stockholder receiving such a dividend disposes of it by sale, his proportionate right to share in future corporate 118 dividends and in the corporate management is diluted as much as it is by the sale of stock declared as a stock dividend. However, the Connecticut courts consider a distribution of treasury stock as a dividend which is income to be paid over to the life beneficiary of the trust. Greene v. Bissell, 79 Conn. 547">79 Conn. 547, 65 Atl. 1056 (1907).Viewed in the light of the remainderman having only a future interest in the trust corpus and the specific number of shares of stock transferred as constituting that corpus, the corpus of the trust is not impaired as long as the trustee holds that number of shares, shares received in exchange for such shares, or as a split of such shares, or the money received upon the sale of those shares or the other assets purchased with the money received upon the sale of those shares. It is not necessary that any increments that might be viewed as the fruit of the original shares transferred to the trust as distinguished from replacement of corpus be considered as a part of the principal of the trust to go to the remainderman to reach the conclusion that the remainder interest can be computed with reasonable certainty and is not subject to divestment or to be partially 119 diverted by either the trustees or the donor.We conclude that the provision in the trust instruments here involved with respect to stock dividends of 5 percent or less being trust income does not cause any more uncertainty as to the value of the charitable remainders of the various trusts than exists in any situation in which the transfer to such a trust is of stock.Respondent argues that because of the control that petitioner had over the W. T. Grant Co., he had the power to divert the trust principal from the remainderman to the life beneficiary. Many of the cases cited by the parties with respect to invasion of corpus of a trust involve estate tax questions, but the regulations with respect to charitable gifts 628 are substantially the same as those involving charitable bequests so that the principles announced in cases involving estate tax would be applicable in a gift tax case. See Estate of Simon Guggenheim, 1 T.C. 845 (1943).Respondent cites and relies on such cases as Commissioner v. Sternberger's Estate, 348 U.S. 187">348 U.S. 187 (1955), which involved a charitable bequest which would take effect only if the decedent's daughter who was 27 years old at the time of decedent's death died without 120 descendants surviving her, and Henslee v. Union Planters Bank, 335 U.S. 595 (1949), which involved the power of invasion of the trust principal for the benefit of the life beneficiary which invasion was held not to be limited to an ascertainable standard.The present case does not fit the pattern of these cases or any of the other cases cited by either party. Even if the donor and the trustees in combination with the foundation might possibly be considered as able to control the issuance of stock dividends by W. T. Grant Co., which is extremely doubtful, the fact remains that the foundation is the remainderman of the trusts with an interest adverse to the life beneficiary. Even in cases involving discretion over the trust corpus by trustees who are also the life beneficiaries of the trusts, the remainder interests of which are given to charity, we have held that the gift to charity is ascertainable in the absence of any showing that the trustees will violate their trust for their own benefit as income beneficiaries. William D. O'Brien, 46 T.C. 583">46 T.C. 583, 595 (1966).In the instant case, in order for the corpus of the trust to be diverted, it would have to be assumed that the management 121 of W. T. Grant Co. would declare stock dividends in small amounts on so regular a basis as to absorb not only earnings accumulated after the creation of the trusts here involved but also the accumulated earnings existing at the time the trusts were created, and that the trustees of the trusts would cooperate in such an erosion of trust corpus by holding the W. T. Grant Co. stock after such a policy was adopted by the directors of that company. In either case the assumption would be that fiduciaries would be unfaithful to the trust placed in them. There is no evidence, whatsover, in this case to support such a conclusion. The evidence is to the contrary.It is to be noted here that in order to sell the W. T. Grant Co. stock, the trustees would have to obtain the consent of two-thirds of the directors of the foundation, the remainderman of the trusts.On the facts of this case we conclude that any possibility that the charitable transfer will not become effective is so remote as to be negligible. In reaching this conclusion we have considered the admonishment of the Court in Henslee v. Union Planters Bank, supra at 599, that "What common experience might regard as remote in the 629 generality 122 of cases may nonetheless be beyond the realm of precise prediction in the single instance." We have also considered whether the uncertainty here is "appreciably greater than the general uncertainty that attends human affairs." Ithaca Trust Co. v. United States, 279 U.S. 151">279 U.S. 151 (1929). As we have pointed out, there is no more likelihood that the accumulated earnings of the W. T. Grant Co. at the date the stock was transferred to the trusts would be diverted to the life beneficiaries than there is in any case where stock is transferred to an otherwise similar trust which contains no specific provisions as to what constitutes income.We have recited a number of facts, mostly stipulated, pertaining to a few years after the last year here in issue, but in doing so have not considered them with respect to "what actually happened" (see Ithaca Trust Co. v. United States, supra), but only as they might bear on "the estimate of probable events" as they existed at the date of each transfer to the trusts here involved. Lincoln Rochester Trust Co. v. McGowan, 217 F. 2d 287, 293 (C.A. 2, 1954).In view of our conclusion, it is unnecessary to consider respondent's contention that gifts for the years 123 1956 through 1958 may be recomputed in computing the gift tax for later years or petitioner's contention that the provisions of the trusts created in 1963 and 1964 differ sufficiently from the earlier ones as to require in any event the full allowance of the charitable deduction for gifts to those trusts.We hold that petitioner's method of computing the charitable deductions for the years here involved is proper, but because of certain stipulated adjustments,Decision will be entered under Rule 50. Footnotes1. All references are to the Internal Revenue Code of 1954.↩2. In a letter from the director, Tax Rulings Division, to petitioner's attorney, dated Sept. 17, 1964, the following explanation of this adjustment was given with respect to three of the trusts, gifts to which are here in issue: In any event, our study clearly indicates that, under the trust agreements being considered, the distribution of stock dividends of five percent or less as income is not limited to a single stock dividend during any calendar year. Additionally, we find nothing which would prohibit the W. T. Grant Company from initiating a policy of paying small stock dividends semiannually, or even quarterly, in which event stock dividends to noncharitable income beneficiaries could aggregate five, ten, or even twenty percent per annum. The fact that the W. T. Grant Company has never paid stock dividends in the past is not significant in view of current business trends. However, we have reached the conclusion that the operation of article Sixth 2 of the trust agreements cannot result in dilution of the interest of the charitable remaindermen below a value based on the per share fair market value of the common stock, on the date of transfer, less the per share amount of the accumulated earnings and profits of the corporation at that time. Accordingly, it is held that deduction, under section 2522(a) of the 1954 Code, may be allowed in this case to the extent of the value of the charitable remainder interests computed by applying the actuarial factors shown below to the fair market value of each share transferred as of the date of transfer ($ 51.8125) less the per share amount of accumulated earnings and profits as of that date (approximately $ 29.8125) or approximately $ 22.00. * The present worth of $ 1.00 due at the death of the survivor of two persons aged 49 and 23 years is $ 0.21195. * Assuming that the fair market value per share, less accumulated earnings and profits attributable thereto on the date of transfer, is correctly valued at $ 22.00, the amount to be allowed as a charitable deduction in this case may be computed as follows:MARIAN GRANT HENRY TRUST$ 22.00 X 6,000 X 0.21195$ 27,977.40The deleted portions of the letter contained similar computations for the other two trusts.↩3. Sec. 25.2522(a)-2. Transfers not exclusively for charitable, etc., purposes.(a) Remainders and similar interests. If a trust is created or property is transferred for both a charitable and a private purpose, deduction may be taken of the value of the charitable beneficial interest only insofar as that interest is presently ascertainable, and hence severable from the noncharitable interest. The present value of a remainder or other deferred payment to be made for a charitable purpose is to be determined in accordance with the rules stated in Sec. 25.2512-5. * (b) Transfers subject to a condition or a power. If, as of the date of the gift, a transfer for charitable purposes is dependent upon the performance of some act or the happening of a precedent event in order that it might become effective, no deduction is allowable unless the possibility that the charitable transfer will not become effective is so remote as to be negligible. If an estate or interest passes to or is vested in charity on the date of the gift and the estate or interest would be defeated by the performance of some act or the happening of some event, the occurrence of which appeared to have been highly improbable on the date of the gift, the deduction is allowable. If the donee or trustee is empowered to divert the property or fund, in whole or in part, to a use or purpose which would have rendered it, to the extent that it is subject to such power, not deductible had it been directly so given by the donor, deduction will be limited to that portion of the property or fund which is exempt from the exercise of the power. * *4. Sec. 170. Dividends; payment; wasting asset corporations.(a) The directors of every corporation created under this chapter, subject to any restrictions contained in its certificate of incorporation, may declare and pay dividends upon the shares of its capital stock either (1) out of its net assets in excess of its capital as computed in accordance with the provisions of sections 154 and 242-244 of this title, or (2) in case there shall be no such excess, out of its net profits for the fiscal year then current and/or the preceding fiscal year. If the capital of the corporation computed as aforesaid shall have been diminished by depreciation in the value of its property, or by losses, or otherwise, to an amount less than the aggregate amount of the capital represented by the issued and outstanding stock of all classes having a preference upon the distribution of assets, the directors of such corporation shall not declare and pay out of such net profits any dividends upon any shares of any classes of its capital stock until the deficiency in the amount of capital represented by the issued and outstanding stock of all classes having a preference upon the distribution of assets shall have been repaired.(b) Subject to any restrictions contained in its certificate of incorporation, the directors of any corporation engaged in the exploitation of wasting assets may determine the net profits derived from the exploitation of such wasting assets without taking into consideration the depletion of such assets resulting from lapse of time or from necessary consumption of such assets incidental to their exploitation.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623573/	THE NEW YORK TRUST COMPANY, AS TRUSTEE UNDER TRUST INDENTURE, DATED DECEMBER 24, 1921, BY AND BETWEEN CONRAD HENRY MATTHIESSEN AND SAID THE NEW YORK TRUST COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.New York Trust Co. v. CommissionerDocket No. 28250.United States Board of Tax Appeals27 B.T.A. 1127; 1933 BTA LEXIS 1240; April 10, 1933, Promulgated 1240 1. Under the circumstances herein, held that petitioner has not shown that certain stock was not acquired by gift after December 31, 1920, within the meaning of section 202(a)(2) of the Revenue Act of 1921. The basis to be used in determining gain or loss upon the sale thereof by the trustee is the cost of such stock to the grantor. 2. Section 202(a)(2) of the Revenue Act of 1921 is constitutional. Taft v. Bowers,278 U.S. 470">278 U.S. 470. 3. Held, petitioner is not entitled to have its tax computed under section 206 of the Revenue Act of 1921, since the property was not held for more than two years. Russell D. Morrill, Esq., and Henry Mannix, Esq., for the petitioner. Brooks Fullerton, Esq., for the respondent. MCMAHON 1127 This is a proceeding for the redetermination of a deficiency in income tax for the year 1922 in the amount of $238,275.95. This Board held that this proceeding should be dismissed for lack of jurisdiction (New York Trust Co., Trustee,20 B.T.A. 162">20 B.T.A. 162), and it was dismissed. The United States Circuit Court of Appeals for the Second Circuit reversed the order of the Board1241 (New York Trust Co. v. Commissioner, 54 Fed.(2d) 463). Certiorari was denied by the United States Supreme Court, 285 U.S. 556">285 U.S. 556. The cause was remanded to the Board for such further proceeding as should be had. The following errors are alleged: (1) The respondent has erroneously determined petitioner's gross income for the year 1922 in that 1128 he has incorrectly computed the profit realized in that year upon the sale of 6,000 shares of the common stock of the Corn Products Refining Company, such profit having been computed by using as a basis the cost of said stock to petitioner's grantor pursuant to the provisions of section 202(a)(2) of the Revenue Act of 1921, instead of its fair market value on the date it was acquired by petitioner; (2) in so far as section 202(a)(2) of the Revenue Act of 1921 purports to authorize respondent to tax to petitioner an alleged profit upon the sale of such stock, computed by using as a basis the cost of said stock to petitioner's grantor, said section is unconstitutional and void; (3) in the event the Board finds that section 202(a)(2) of the Revenue Act of 1921 is constitutional and that the basis used1242 by respondent in computing the profit was correct, then respondent erred in computing the tax upon said profit at the full normal and surtax rates instead of at the rate of 12 1/2 per cent in accordance with section 206 of the Revenue Act of 1921. FINDINGS OF FACT. The petitioner is a corporation, organized under the banking law of the State of New York, and its principal office is at 100 Broadway, New York City. On April 27, 1906, Conrad Henry Matthiessen acquired 6,000 shares of the common stock of the Corn Products Refining Company at a cost of $141,375, which cost exceeded the value of such shares on March 1, 1913. By an irrevocable indenture dated December 24, 1921, Conrad Henry Matthiessen transferred the 6,000 shares of common stock of the Corn Products Refining Company to the petitioner in trust to collect the income and dividends therefrom and accumulate the same until such time as his son, Erard A. Matthiessen, should attain the age of 21 years, at which time petitioner was directed to pay over all such accumulated income to such son. Thereafter and until Erard A. Matthiessen should attain the age of 25 years, petitioner was directed to pay the income of the1243 fund to him currently, and upon his reaching such age, to pay over the principal to him. In the event that Erard A. Matthiessen should die before reaching the age of 25 years, it was provided that petitioner should pay over the principal in equal shares to two other sons of the grantor. On December 24, 1921, the 6,000 shares of common stock of the Corn Products Refining Company had a fair market value of $96.25 per share, or a total fair market value of $577,500. During the year 1922, the petitioner sold the 6,000 shares of the common stock of the Corn Products Refining Company above referred to, receiving therefor the net amount of $603,385. Petitioner filed 1129 a Federal income tax return for the calendar year 1922, wherein it reported a profit of $87,385 on the sale. In computing the profit realized by petitioner upon this sale, the respondent used as a basis the cost of such stock to Conrad Henry Matthiessen instead of its fair market value as of the date it was acquired by the petitioner. As shown by the notice of deficiency, the respondent treated the transaction whereby Conrad Henry Matthiessen transferred the stock in trust as a gift and computed the profit1244 under article 1562 of Regulations 62, which article deals with property acquired by gift after December 31, 1920. Erard Matthiessen had not reached the age of 21 during the year 1922. OPINION. MCMAHON: We must first determine the proper basis for the computation of gain or loss upon the sale by the petitioner in 1922 of 6,000 shares of common stock of the Corn Products Refining Company which were acquired by petitioner as trustee in 1921. The respondent has held that subdivision (2) of section 202(a) of the Revenue Act of 1921 1 is here applicable and that the proper basis to be used is the cost of such stock to the donor. 1245 The respondent has held that the irrevocable indenture dated December 24, 1921, accomplished a gift of the 6,000 shares of stock in question. There is no evidence to show that it did not accomplish a gift. On the contrary, it appears that Conrad Henry Matthiessen parted with all dominion over the subject matter. A gift may be made by a transfer in trust where, as here, the grantor relinquishes all dominion over the subject matter. Murray Guggenheim,24 B.T.A. 1181">24 B.T.A. 1181, affirmed by the Supreme Court in Burnet v. Guggenheim,288 U.S. 280">288 U.S. 280, which reversed the United States Circuit Court of Appeals decision in Guggenheim v. Commissioner, 58 Fed.(2d) 188. See also Bok v. McCaughn, 42 Fed.(2d) 616. The petitioner, however, contends that subdivision (2) of section 202(a), in referring to property "acquired by gift after December 31, 1920," means property acquired by the taxpayer, that the trustee is the taxpayer herein involved, and that since the trustee did not acquire the property 1130 by gift, but as trustee, subdivision (2) of section 202(a) does not apply here. This contention is not well founded. 1246 In Security Trust Co. et al., Trustees,25 B.T.A. 29">25 B.T.A. 29, 38, we stated: * * Here the testator actually created the trust by his will. The trust, not the trustees, is the taxpayer. The trustees are only one of the component parts of the taxpayer. They hold legal title to and possession of the property and act for the taxpayer. They never acquired a beneficial interest in the trust property - that goes to the cestuis que trustent, who are also a part of the trust. * * * Upon the record before us we can not hold that under subdivision (2) of section 202(a) the property in question was not "acquired by gift after December 31, 1920." This view is, we believe, in accord with the purpose of the section of the revenue act in question. The Ways and Means Committee report and the Finance Committee report upon the Revenue Act of 1921 contain the following discussion of subdivision (2) of section 202(a): * * * An essential change, however, is made in the treatment of property acquired by gift. No explicit rule is found in the present statute for determining the gain derived or the loss sustained on the sale of property acquired by gift; but the Bureau of Internal1247 Revenue holds that under existing law the proper basis is the fair market price or value of such property at the time of its acquisition. This rule has been the source of serious evasion and abuse. Taxpayers having property which has come to be worth far more than it cost to give such property to wives or relatives by whom it may be sold without realizing a gain unless the selling price is in excess of the value of the property at the time of the gift. The proposed bill in paragraph (2) of subdivision (a) provides a new and just rule, namely, that in the case of property acquired by gift after December 31, 1920, the basis for computing gain or loss shall be the same as the property would have in the hands of the donor or the last preceding owner by whom it was not acquired by gift. * * In Rice v. Eisner, 16 Fed.(2d) 358, the following appears: The act of 1921 was apparently passed for quite another reason, that is, in the future to prevent donors from escaping the high taxes prevailing by giving property to their wives or children. As the latter would be allowed on any subsequent sales to subtract the value of the gift when they received it, and as a1248 gift was not a sale as regards the donor, all increment escaped taxation which had accrued during the ownership of the donors. As to earlier gifts the rule remained as it had been in practice applied before the act of 1921 was passed. Francis Francis, Guardian,15 B.T.A. 1332">15 B.T.A. 1332, cited by petitioner, is distinguishable from the instant proceeding. In that case there was clearly no gift of the property involved after December 31, 1920, so as to render section 202(a)(2) of the Revenue Act of 1921 applicable. The taxpayers there acquired the property "pursuant to a vested legal right and this right had been theirs since long before the adoption of the Sixteenth Amendment in 1913." 1131 Bankers Trust Co., Trustee,24 B.T.A. 10">24 B.T.A. 10, cited by petitioner, is also distinguishable. There the beneficiaries, under the indenture, "took absolutely nothing until the grantor's death, and even then would receive nothing in case their deaths occurred prior to his. The final reversionary interest was to the grantor's estate." We there held that there was no gift inter vivos.Subdivision (2) of section 202(a) of the Revenue Act of 1921 provides that1249 the basis of the property shall be the same as that which it would have in the hands of the donor. The stock herein involved was acquired by the donor in 1906 at a cost of $141,375, which amount exceeded the value of such stock on March 1, 1913. Under subdivision (b) of section 202 of the Revenue Act of 1921, set forth in the margin, 2 the basis in the donor's hands would be the cost to him. We hold, therefore, that the basis to be used in the computation of gain derived by the petitioner upon the sale of the stock in question is $141,375. 1250 The contention of the petitioner that section 202(a)(2) is unconstitutional is without merit. Taft v. Bowers,278 U.S. 470">278 U.S. 470, and Cooper v. United States,280 U.S. 409">280 U.S. 409. The petitioner also contends that in the event the Board finds that section 202(a)(2) of the Revenue Act of 1921 is constitutional and that the basis used by respondent in computing the profit is correct, then respondent erred in computing the tax upon such property at the full normal and surtax rates instead of at the rate of 12 1/2 per cent in accordance with section 206 of the Revenue Act of 1921. 31132 However, following the decisions in Magdaline McKinney,16 B.T.A. 804">16 B.T.A. 804; William Kempton Johnson,17 B.T.A 611; affd., Johnson v. Commissioner, 52 Fed.(2d) 726; and Sydney M. Shoenberg,19 B.T.A. 399">19 B.T.A. 399; affd., Shoenberg v. Burnet, 55 Fed.(2d) 543, we hold that petitioner is not entitled to have its tax computed under section 206 of the Revenue Act of 1921, since the property in question was not held by the taxpayer for more than two years. 1251 Reviewed by the Board. Decision will be entered for the respondent.Footnotes1. SEC. 202. (a) That the basis for ascertaining the gain derived or loss sustained from a sale or other disposition of property, real, personal, or mixed, acquired after February 28, 1913, shall be the cost of such property; except that - * * * (2) In the case of such property, acquired by gift after December 31, 1920, the basis shall be the same as that which it would have in the hands of the donor or the last preceding owner by whom it was not acquired by gift. If the facts necessary to determine such basis are unknown to the donee, the Commissioner shall, if possible, obtain such facts from such donor or last preceding owner, or any other person cognizant thereof. If the Commissioner finds it impossible to obtain such facts, the basis shall be the value of such property, as found by the Commissioner as of the date or approximate date at which, according to the best information the Commissioner is able to obtain, such property was acquired by such donor or last preceding owner. * * * ↩2. SEC. 202. (b) The basis for ascertaining the gain derived or loss sustained from the sale or other disposition of property, real, personal, or mixed, acquired before March 1, 1913, shall be the same as that provided by subdivision (a); but - (1) If its fair market price or value as of March 1, 1913, is in excess of such basis, the gain to be included in the gross income shall be the excess of the amount realized therefor over such fair market price or value; (2) If its fair market price or value as of March 1, 1913, is lower than such basis, the deductible loss is the excess of the fair market price or value as of March 1, 1913, over the amount realized therefor; and (3) If the amount realized therefor is more than such basis but not more than its fair market price or value as of March 1, 1913, or less than such basis but not less than such fair market price or value, no gain shall be included in and no loss deducted from the gross income. ↩3. SEC. 206. (a) That for the purpose of this title: * * * (6) The term "capital assets" as used in this section means property acquired and held by the taxpayer for profit or investment for more than two years (whether or not connected with his trade or business), * * * (b) In the case of any taxpayer (other than a corporation) who for any taxable year derives a capital net gain, there shall (at the election of the taxpayer) be levied, collected and paid, in lieu of the taxes imposed by sections 210 and 211 of this title, a tax determined as follows: A partial tax shall first be computed upon the basis of the ordinary net income at the rates and in the manner provided in sections 210 and 211, and the total tax shall be this amount plus 12 1/2 per centum of the capital net gain; but if the taxpayer elects to be taxed under this section the total tax shall in no such case be less than 12 1/2 per centum of the total net income. * * * ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623503/	MOODY-WARREN COMMERCIAL COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Moody-Warren Commercial Co. v. CommissionerDocket No. 62495.United States Board of Tax Appeals29 B.T.A. 887; 1934 BTA LEXIS 1474; January 23, 1934, Promulgated 1474 Petitioner undertook to inventory feeder lambs on hand at the end of the taxable year on the so-called "farm-price method" and deduct from the gross income the difference between the cost of lambs and the estimated farm-price thereof. Held, that the inventory method used did not truly reflect income for the year in question and that petitioner, even if entitled to use the farm-price method, failed to comply with the plain requirements of article 106(2)(b) of Regulations 74. Thomas J. Warren, Esq., for the petitioner. James K. Polk, Esq., for the respondent. LANSDON 887 The respondent has determined a deficiency in income tax for the year 1929 in the amount of $1,877.84. The only issue is whether feeder lambs bought in one year to be fattened for market in the next may be inventoried by the farm-price method at December 31 of the year in which purchased. The facts have been established by a stipulation and by oral evidence of witnesses called by each of the parties. FINDINGS OF FACT. The petitioner is a corporation, with its principal office at Fort Collins, Colorado, where it is engaged in the mercantile and trading business as1475 a dealer in farm implements, grains, seeds, and general farm supplies. In the late summer or early fall of each year it buys large numbers of lambs which it fattens for market by feeding until about March or April of the succeeding year, when they are sold. Its annual turnover in the mercantile business is about $1,500,000 and in its sheep-feeding operations about $100,000. During the taxable year petitioner owned two farms of 80 and 53 acres, respectively, located in Larimer County. Such farms were worked by share-crop farmers and were known as the Dunlop and Paige farms, respectively. In the taxable year it acquired 8,562 lambs weighing 571,446 pounds at a cost of $70,526.77 and in the 888 same year incurred additional costs for feed and miscellaneous expenses in connection therewith, for which it expended $17,528.29, making a total cost of such lambs at December 31, 1929, of $88,006.68. If the lambs had been sold on December 31, 1929, the cost of marketing would have been $3,844.53. The lambs so acquired were placed on the Dunlop farm and the Paige farm, on feed lots in Fort Collins, and in feeding yards at Cozad, Nebraska, in lots of 1,253, 1,524, 1,753, and 4,032, 1476 respectively. Between the dates at which the lambs were purchased and December 31, 1929, market prices declined about $3 per 100 pounds. At December 31, 1929, an inventory of such lambs alleged to have been taken on the so-called farm-price method showed an estimated farm price value as of that date in the amount of $72,722.55. Petitioner keeps its books and makes its income tax returns on a calendar year basis. Uniformly and for many years prior to 1929, it reported the results of its lamb-feeding operations on the basis of total accumulated cost at date of sales compared with the total realizations from such sales. This method of reporting income from such operations is the usual practice of all feeders in Colorado. In 1929 the petitioner changed its method of accounting and alleges that it inventoried its lambs on feed at December 31 of that year by the so-called farm-price method. This inventory was not taken by actual count and weight, but was based on an estimated increase in weight of each lamb per month of about 7 pounds, beginning 30 days after being placed on feed. This formula for determining the weight of lambs on feed at any given time was developed in feeding1477 experiments conducted by the Animal Husbandry Department of the Colorado Agriculture College at Fort Collins. Upon such estimated increase petitioner determined that its lambs in question weighed 638,154 pounds on December 31, 1929, to which it applied a fair market price as of that date of 12 cents per pound, with a resulting value of $76,567.08, which it reduced by the cost of marketing in the amount of $3,844.53 and thereby arrived at a farm value of $72,722.55, which was $15,284.13 less than accumulated cost at that date. At the date of sale in 1930 petitioner marketed 8,271 lambs that weighed 856,812 pounds. The difference between purchase and sales represents lambs that died during the feeding season. In its income tax return for 1929, petitioner reduced its gross income in the amount of $15,254.13 alleged to represent a loss in its feeding operations. Upon audit of the return the Commissioner held that the business of the petitioner is not one in which the farm-price method of inventory is applicable, disallowed the loss so claimed, made other minor adjustments not in controversy, and determined the deficiency under review. 889 OPINION. LANSDON: The petitioner1478 claims that its income in the taxable year should be reduced by an amount which it alleges represents a loss sustained in its sheep-feeding operations. The loss claimed is the difference between the cost of feeder lambs purchased some months prior to December 31, 1929, plus feeding costs, and the alleged farm-price value of such lambs at that date. In support of its contention it relies on article 106(2)(b) of Regulations 74 which, so far as material here, is as follows: Because of the difficulty of ascertaining actual cost of live stock and other farm products, farmers who render their returns upon an inventory basis may at their option value their inventories for the current taxable year according to the "farm-price method," which provides for the valuation of inventories at market price less cost of marketing. If the use of the "farm-price method" of valuing inventories for any taxable year involves a change in method of valuing inventories from that employed in prior years, the opening inventory for the taxable year in which the change is made should be brought in at the same value as the closing inventory for the preceding taxable year. If such valuation of the opening inventory1479 for the taxable year in which the change is made results in an abnormally large income for that year, there may be submitted with the return for such taxable year an adjustment statement for the preceding year based on the "farm-price method" of valuing inventories, upon the amount of which adjustments the tax, if any be due, shall be assessed and paid at the rate of tax in effect for such preceding year. If an adjustment for the preceding year is not, in the opinion of the Commissioner, sufficient clearly to reflect income, adjustment sheets for prior years may be accepted or required. The respondent has disallowed the deduction claimed on the authority of section 22(c) of the Revenue Act of 1928, and in his notice of deficiency sets out his reasons therefor as follows: (1) The attempt to compute an inventory at the end of the year 1929 does not conform as nearly as may be to the best accounting practice in the trade or business and as clearly reflecting the income. (2) Throughout Colorado, taxpayers, who are lamb feeders, reporting income on a calendar year basis, invariably defer expenses and report profits or losses at the time when the transaction is completed. Thus1480 on lambs purchased in 1929, fed and sold in 1930, the income of 1930 contains the entire transaction. This custom has been that of your own company for a number of years without complaint or notice of a desire to change. (3) No weight was taken of the lambs on December 31, 1929, and the Bureau considers the methods used by your company to approximate the value of the lambs at that date are purely estimates and can not be accepted as accurate. Feeder lambs are purchased and sold on basis of price per pound and the absence of an actual weight on December 31, 1929 precludes the taking of an accurate inventory at that time. (4) The number of lambs which died before and after December 31, 1929 can not be determined which further tends to show that the inventory is not accurate. 890 (5) The method of arriving at market value December 31, 1929 is not in accordance with the farm price method as prescribed by articles 106(2)(b) of Regulations 74. The first four reasons stated by the respondent are fully sustained by the record. The method used by the petitioner in 1929 does not correctly reflect income for that year, since it involves the use of an estimate obtained by1481 applying a formula to the weight of lambs purchased some three months before the end of the year. The inventory in question was not taken by count or weight and its result is no more than an approximation of the weight of the lambs on hand at December 31, 1929. On the other hand, the method of reporting results from lamb-feeding operations used by the petitioner in prior years and generally by all lamb feeders in Colorado, Wyoming, and New Mexico involves neither formulas nor estimates because the accumulated cost of the lambs is a fact of record in the books of the feeder and the amount realized is exactly known. Precise results are obtainable by the simple process of comparing accumulated costs with the known sales price and the difference is either gain or loss determined by a method in which error is avoidable and the determination of true income is certain and accurate. It was therefore wholly within the discretion of the Commissioner to reject the method of the petitioner and prescribe one that truly reflects income, as provided in section 41 of the Revenue Act of 1928. 11482 Even if the petitioner is entitled to use the farm-price method of inventorying lambs on hand at December 31 of the taxable year, which for reasons to be discussed later is at the best extremely doubtful, it has not conformed with the express terms of article 106(2)(b) of Regulations 74. Its action was a change in method from previous practices, and it has ignored the requirement that the opening inventory of the year in which such change is made must be brought in at the same value as the closing inventory of the preceding taxable year. In our opinion this alone is sufficient answer to the petitioner's contention and completely supports the action of the respondent in disallowing the deduction here claimed. The regulation under consideration was promulgated because of the difficulty of ascertaining the actual cost of livestock or other 891 farm products in the hands of a farmer at the end of any taxable year. Farmers may, of course, purchase livestock and record the cost thereof, but in many instances all the animals on hand at the end of the year have been bred on the farm, fed with the products thereof, and the necessary work, unchargeable into a cost account, has1483 been done by the farmer or his family without other labor expense. In such conditions the determination of actual cost is so much more than merely difficult that it is practically impossible, and so the farm-price method of inventory valuation is authorized. There is no such situation here. The petitioner knows the exact cost of its lambs at December 31 and asks for the privilege of setting such cost against an estimated farm-price value for the purpose of determining a deductible loss resulting from a decline in market price. The farmer who uses the farm-price method does not offset the result obtained against cost because cost is ignored or is impossible of ascertainment. The farm-price value that he determines simply goes into his total inventory as an element in the computation of income at the end of the year. The use of the farm-price method for valuing inventories is expressly restricted to farmers. In the circumstances herein it is not clear that the petitioner falls within that classification. It is a corporation engaged in the general mercantile business and certainly to the extent of its operations therein it is a merchant. Only a relatively small number of the1484 lambs in question were fed on land owned by it and there is no evidence that any of the products of either of the small farms which it owned were used in its feeding operations. Such farms were operated by share-croppers and the nature of their products is left wholly to our imagination. The bulk of petitioner's lambs were fed in rented yards located in or near Fort Collins and Cozad, Nebraska. In these circumstances it would appear that petitioner is not a grower of lambs, but a merchant or dealer in such animals. The fact that the stock in trade of a dealer in animals is fed and may increase in value while on feed is not proof that the dealer is a farmer. Thousands of dealers in poultry, sheep, and other meat animals buy their stock in trade and feed for awhile in coops or yards and then slaughter or sell on the markets, but such activities are far removed from tilling the soil, either in person or by proxy of renters or share-croppers. It may be conceded that to the extent of its operations of its two small farms by share-croppers, the petitioner is a farmer, but there is no evidence that connects its extremely limited farming interests with its very extensive operations1485 as a dealer in lambs. 892 In his brief petitioner cites, discusses, and relies on our decisions in , and . In our opinion neither is in point here. In each case the petitioner inventoried livestock on hand at the end of the taxable year by the usual method and the only controversy related to an adjustment of inventory to conform to decline in market price, and neither used nor sought to use the farm-price method. It is obvious, therefore, that those decisions have no bearing on the issue here. In our opinion the petitioner has failed to show error in the determination of the Commissioner or to prove that its own procedure correctly determines income. The determination of the respondent is affirmed. . Decision will be entered for the respondent.Footnotes1. SEC. 41. GENERAL RULE. The net income shall be computed upon the basis of the taxpayer's annual accounting period (fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed, or if the method employed does not clearly reflect the income, the computation shall be made in accordance with such method as in the opinion of the Commissioner does clearly reflect the income. If the taxpayer's annual accounting period is other than a fiscal year as defined in section 48 or if the taxpayer has no annual accounting period or does not keep books, the net income shall be computed on the basis of the calendar year. (For use of inventories, see section 22(c).) ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623504/	HERBERT B. COPELAND and ELAINE COPELAND, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentCopeland v. CommissionerDocket No. 1642-78.United States Tax CourtT.C. Memo 1980-476; 1980 Tax Ct. Memo LEXIS 107; 41 T.C.M. (CCH) 253; T.C.M. (RIA) 80476; October 23, 1980, Filed Theodore W. Hirsh,James N.108 Schuth and Harold Altscher, for the petitioners. R. Dale Eggleston, for the respondent. GOFFEMEMORANDUM FINDINGS OF FACT AND OPINION GOFFE, Judge: The Commissioner, in his statutory notice, determined a deficiency of $1,537 in petitioners' Federal income tax for their taxable year 1975. The issue is whether petitioners' operation of their beach cottage (hereinafter the cottage) for that year was an "activity * * not engaged in for profit" within the meaning of section 183(a), Internal Revenue Code of 1954. 1FINDINGS OF FACT Some of the facts have been stipulated. The stipulation of facts, together with the exhibits attached thereto, are incorporated herein by this reference. The petitioners filed their joint Federal income tax return for the taxable year 1975 with the Internal Revenue Service Center at Philadelphia, Pennsylvania. At the time they filed their petition in this proceeding, they resided in Baltimore, Maryland. From approximately 1954 through 1966, petitioners vacationed at seaside resorts in Ocean City, Maryland, 109 and Rehoboth, Delaware, about once every two years. Their stays at Rehoboth never exceeded a weekend; those at Ocean City were for up to two weeks. Petitioners vacationed for more frequently at Caribbean resorts during these years. While vacationing at Ocean City in the mid-1950's, Petitioner Herbert Copeland (hereinafter Dr. Copeland) rented a cottage from one Ray Jarvis, a real estate agent. Jarvis suggested to Dr. Copeland that the latter might be interested in purchasing an ocean-front block of property in Ocean City for $40,000. Dr. Copeland had been in practice for only a few years at the time and was unable to afford the land; however, his interest in ocean-front property was stimulated, and he watched the value of the lot rise, over the years, from $40,000 to what he claimed was about $6 million. By the mid-1960's, when his financial position had sufficiently improved, Dr. Copeland began looking for an ocean-front lot that he could afford, that would appreciate in value, that would generate current income, and that he and his family could use for personal recreational purposes. Various relators showed petitioners properties in South Bethany and Rehoboth, Delaware, 110 but the area they became most interested in was Ocean Village, a small beach-front community in Southern Delaware which was in the early stages of development. The houses being constructed there were designed by architects and were thus more attractive, in petitioners' view, than the usual "box-type" beach house prevalent in tourist meccas such as Ocean City. In 1966, petitioners considered purchasing a lot in Ocean Village but eventually concluded that the asking price of $12,700 was too high. After further searching they returned to Ocean Village in 1967 and discovered that the lot's price had risen to $15,500. This substantial appreciation convinced petitioners that the lot was an excellent investment. Accordingly, in 1967 they acquired the property and had a cottage built upon it. In terms of his investment criteria, Dr. Copeland felt that the lot and cottage were more expensive than he would have liked, but (as he had been assured by local real estate agents) would rent well and would appreciate in value beyond his initial investment expectations. The cottage is a single dwelling frame structure of modern design on an ocean-front lot. It is fully air conditioned, provided111 with baseboard heat and a fireplace. It is not insulated and is uninhabitable from November through March. The cottage is nicely decorated and the petitioners are constantly upgrading its furnishings. Every year after 1967, petitioners have listed their cottage with an agent for rental to third persons for the period from the last week in June through Labor Day. They have never attempted to rent the cottage for any other period. Petitioners have never either personally, by friends, or by family, used the cottage during the time it has been listed for rental. In addition to listing the property with real estate agents, Dr. Copeland himself solicits rental.The prime rental season in Ocean Village is from the last week in June through Labor Day. Prior to and following this time, properties are rented, but for only one-half to two-thirds of the prime season rates. Dr. Copeland estimated that prior to the last week in June, no more than five or six of the 71 houses in Ocean Village are rented. Lifeguards are on duty at the beach in front of the cottage only during the prime rental season. Petitioners have little trouble renting the cottage in July and August; they do have trouble112 finding tenants for the last week in June and the week prior to Labor Day. Petitioners do not attempt to rent the cottage during the off-season because the lower rentals available at that time would, in their view, not justify the increased wear and tear, and because, in their opinion, off-season tenants generally are of lower quality and hence inflict more damage on the premises. Petitioners and their friends and relatives do spend time each year at the cottage during the off-season. Petitioners first visit the cottage for a weekend in April to "open" it. They remove the wooden storm "doors" and "windows" which protect the glass doors and windows during the winter. Various furnishings are taken out of storage and replaced, and the cottage is generally cleaned up.To ready the cottage for the rental season, much further work must be done for which there is insufficient time on opening weekend. Hence, petitioners return to the cottage on one or two weekends, and for a full week in June, prior to the prime rental season. The purpose of these visits is to ready the cottage for rental, to get it in the best possible condition for the tenants. After the prime season, petitioners visit113 the cottage on one or more weekends during September and October and for a full week in September to perform similar cleaning, maintenance, and repair tasks, and finally to close the cottage for the winter. Petitioners work up to six or seven hours a day performing these chores, but on the average spend from three to five hours per day. On three of the weekends petitioners spend at the cottage each year, they are accompanied by one of their children. Dr. Copeland's brother-in-law has used the cottage about three times since petitioners acquired it, and his mother-in-law stays with petitioners there about two weekends per year. On one or two weekends a year, petitioners lend the cottage to a friend or relative. The children and mother-in-law are expected to work when they stay at the cottage. Petitioners hire third parties to perform major maintenance tasks such as painting the whole cottage or draining the water pipes. However, the minor chores, in the aggregate, require much more time than do the major ones. While staying at the cottage, petitioners and family play as well as work. They enjoy sitting and sunbathing on the sundeck, swimming, and surf fishing. The water114 temperature at the cottage in early June is 60 to 61 degrees; by mid-June it is about 65, rising to 68 by the end of that month. Dr. Copeland finds the water too cold to swim in until late June; according to him, people who swim earlier than that (e.g., in May or February) are "polar bears." The water temperature in September is in the 70's which he finds comfortable. In his view September has the best weather of the year there. The water temperature drops back into the 60's in October. Although the weather and water temperatures in September are good, rentals are difficult to make because beach cottages are primarily rented to families and younger children return to school after Labor Day. Dr. Copeland is a physician; he and his wife reported the following amounts of adjusted gross income for their taxable years 1968 through 1975: AdjustedTaxable YearGross Income1968$ 66,199196976,144197068,396197179,435197282,735197399,090197495,700197568,384The following schedule shows the petitioners' items of gross income and deduction attributable to the cottage for their taxable years 1968 through 1975: ITEM1968196919701971Rental Income$ 2,099$ 1,513$ 2,313$ 2,077Expenses: Depreciation ofImprovements to land2,8472,5282,2511,951Taxes114171174175Interest1,5921,5391,4821,423Depreciation ofFurnishings1,6491,235901675All other1,0638971,1321,280TOTAL EXPENSES7,2656,3705,9405,504Net Income (loss)(5,166)(4,857)(3,427)10% Personal Use 2000550Loss Reported per Return$ (5,166)$ (4,857)$ (3,627)$ (2,877)115 ITEM1972197319741975Rental Income$ 2,199$ 3,350$ 2,925$ 1,735Expenses: Depreciation ofImprovements to land1,6901,4651,3221,198Taxes159154151147Interest1,3591,3951,1151,143Depreciation ofFurnishings9471,164810672All other1,8892,1441,8462,005TOTAL EXPENSES6,0446,3225,2445,165Net Income (loss)(3,845(2,972)(2,319)(3,430)10% Personal Use 2604214185201Loss Resported per Return$ (3,241)$ (2,758)$ (2,134)$ (3,229)116 As a result of petitioners' use of the cottage each year prior to and subsequent to the period that it is held for rental to third parties, an Internal Revenue Service agent, in connection with an audit of petitioners' 1969 return, proposed that they be charged with 10 percent of the expenses of the cottage, representing personal use. Since then, in preparing their Federal income tax returns, petitioners have reduced their expenses for the property by 10 percent in order to comply with the recommendation.The cottage had an initial cost for land and improveents (exclusive of furnishings) of $38,275. It was appraised in March 1979 at $135,000 by a local real estate firm. Respondent, in his statutory notice, determined that petitioners' operation of the cottage was an activity not engaged in for profit and accordingly disallowed all of their deductions attributable to the cottage in excess of their rental income therefrom, and further disallowed an investment tax credit they claimed for some furnishings they purchased for the cottage. OPINION We are called on to decide whether petitioners' ownership and operation of their cottage was an activity engaged in for profit during117 1975. Should we find in the affirmative, we must then determine the percentage of the depreciation and operating expenses of the cottage which is properly attributable to petitioners' personal use thereof. The pertinent part of section 183 of the Internal Revenue Code of 1954 provides: (b) DEDUCTIONS ALLOWABLE.--In the case of an activity not engaged in for profit * , there shall be allowed-- (1) the deductions * * allowable * * * for the taxable year without regard to whether or not such activity is engaged in for profit, and (2) a deduction equal to the amount of the deductions which would be allowable under this chapter for the taxable year only if such activity were engaged in for profit, but only to the extent that the gross income derived from such activity for the taxable year exceeds the deductions allowable by reason of paragraph (1). (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 * * * 212. The standard for determining whether an individual118 is carrying on a trade or business so that his expenses are deductible under section 162, or whether he is engaged in activities for the production of income or for the management, conservation, or maintenance of property held for the production of income so that his expenses are deductible under section 212, is: did the individual engage in the activity with the predominant purpose and intention of making a profit? Allen v. Commissioner,72 T.C. 28">72 T.C. 28, 33 (1979). Although a reasonable expectation of profit is not required, the facts and circumstances must indicate that the taxpayer entered into or continued the activity with the objective of making a profit. In determining whether an activity is engaged in for profit, greater weight is given to objective facts than to the taxpayer's mere statement of intent.Sec. 1.183-2(a), Income Tax Regs.Section 1.183-2(b), Income Tax Regs., lists some of the relevant factors to be considered in determining whether an activity is engaged in for profit. The list is not exclusive and no one factor is determinative. Rather, all facts and circumstances with respect to the activity are to be considered. Sec. 1.183(b), Income Tax119 Regs. Based upon this standard, we conclude that petitioners purchased and rented their cottage with the expectation of making a profit. Before explaining why we decide for petitioner, we feel constrained to discuss respondent's essential arguments. Respondent contends that petitioners' vacations in Ocean City and Rehoboth constitute a prior history of enjoyment of the same activity presently alleged to be engaged in for profit, which he correctly points out tends to show a non-profit motive. Johnson v. Commissioner,59 T.C. 791">59 T.C. 791, 815 (1973), affd. 495 F.2d 1079">495 F.2d 1079 (6th Cir. 1974).However, the record shows that petitioners' trips to these resort areas prior to 1967 were infrequent, occurring about once every two years, and that they primarily vacationed on Carribean islands. Thus, there is little, if any, "prior history" in this case. Compare these facts with those of Johnson, where petitioners vacationed on "numerous occasions" at the same resort island on which their private beach cottage was later located. 59 T.C. at 800. More aptly, respondent points to the petitioners' substantial losses each year from current operations. It120 is true that unexplained, continued losses may indicate the lack of a profit motive. Sec. 1.183-2(b)(6), Income Tax Regs. But it is obvious from the record that Dr. Copeland was interested as much in long-term appreciation as in current income. Section 1.183-2(b)(4) provides that: [the] term "profit" encompasses appreciation in the value of assets, such as land, used in the activity. Thus, the taxpayer may intend * * that, even if no profit from current operations is derived, an overall profit will result when appreciation in the value of land used in the activity is realized since income from the activity together with the appreciation of land will exceed expenses of operation. * * . Dr. Copeland did not purchase the land until he was certain of its potential for appreciation, as evidenced by its rise in value between 1966 and 1967. And it has appreciated very substantially since then. In this connection respondent asserts that petitioners' costs of carrying the property were not subsidized through the rental process because the rental income never exceeded expenses other than for interest, property taxes, and depreciation of improvements to the land. There is insufficient121 evidence in the record to determine whether the rental activity did or did not subsidize the carrying costs. Even if petitioners were holding the cottage purely for appreciation in value, they would still have needed to incur a significant amount of maintenance expense, which should properly be allocated to carrying, and not rental, costs. It may well be that the rentals received, less costs actually attributable thereto, did indeed offset carrying costs. Respondent maintains that petitioners did not carry on their rental enterprise in a businesslike manner, indicating an absence of profit motive. Sec. 1.183-2(b)(1), Income Tax Regs. He notes that petitioners, in the face of repeated losses, continued to rent the cottage only during the prime rental season. Yet, Dr. Copeland's decision not to rent in the off-season was clearly business related.He felt that the cottage would be even less profitable if it were rented during this time, due to increased wear and tear from lower-quality tenants and to the significantly lower rentals. Also, petitioners listed the cottage for rental with a real estate agency and Dr. Copeland himself solicited rentals. Petitioners did not use the122 cottage at any time during the period which they considered best for renting, and kept the cottage nicely furnished in order to attract the quality of tenant they desired. We find that petitioners conducted their rental operations in a business-like manner. The fact that the taxpayer devotes much of his personal time and effort to an activity may indicate that it is engaged in for profit. Sec. 1.183-2(b)(3), Income Tax Regs. Respondent argues that petitioners did not spend much time in operating their rental property. The record is replete, however, with testimony about the numerous and tedious maintenance tasks petitioners performed to ready the cottage for rental. The fact that major repairs were done by third parties did not make the petitioners' efforts any less laborious or essential. Respondent points to the personal use of the cottage made by petitioners and their family and friends, and to the fact that such personal use was one of Dr. Copeland's motives in acquiring the property, as indicating the lack of a profit motive. It is true that "[the] presence of personal motives in [the] carrying on of an activity may indicate that the activity is not engaged in for123 profit, especially where there are recreational or personal elements involved." Sec. 1.183-2(b)(9), Income Tax Regs. The same regulation goes on to state: It is not, however, necessary that an activity be engaged in with the exclusive intention of deriving a profit * * . An activity will not be treated as not engaged in for profit merely because the taxpayer has purposes or motivations other than solely to make a profit. * * We acknowledge that one of petitioners' purposes in acquiring the cottage was to have a facility which they could use personally, and that they did make some recreational use of it. However, the nature and quantity of their personal use was not sufficient to characterize the activity as not engaged in for profit. First, petitioners and their family used the cottage only for two full weeks and several weekends each year. They spent much of their time there performing essential maintenance. Use by their friends was sporadic and infrequent. Second, and most important, neither they nor their friends made any use whatsoever of the property during the prime rental season, when it was held out exclusively for rental to third parties. Petitioners made a legitimate, 124 rationally-based business decision not to rent the cottage at other times. Due to the cold water temperatures prior to late June, the start of grade school after Labor Day, and the sharply reduced market rentals, we find it quite likely that petitioners would have received relatively few rentals while suffering increased wear and tear to the cottage during the off-season. We do not feel that their decision can be attributed simply to a desire to make the facility available for their own use. Finally, it is true, as respondent notes, that Dr. Copeland's substantial income from outside sources tends to negate a profit motive. Sec. 1.183-2(b)(8), Income Tax Regs.Nevertheless, the factors favoring the opposite conclusion convince us of petitioners' bona fide intent to make a profit. Petitioners searched at length for beach-front property which would appreciate in value, purchasing their lot only after learning of a substantial increase in its selling price over a one-year period. They were also assured by local real estate agents that the cottage would generate current income, thus satisfying another investment objective. Once acquired, the petitioners operated the cottage125 in a business-like manner, listing it for rental with agents, soliciting rentals themselves, and holding the property out for rental for the entire prime season. It is true that petitioners suffered repeated losses from current operations, yet it is also true that the property continued to appreciate in value and that petitioners' personal use thereof was minimal. As we said in Allen v. Commissioner,72 T.C. 28">72 T.C. 28, 36 (1979): Although the petitioners have sustained substantial current losses, they still hope, in the long run, to realize a profit because the fair market value of the lodge has appreciated * * . The appreciation in value may, or may not in fact, offset the aggregate operating losses, but the prospect of realizing a profit on the sale of the lodge was bona fide when Mr. Allen decided to invest in the lodge and is sufficient to explain his willingness to continue to sustain operating losses. * * We conclude that petitioners acquired and oprated their cottage with the objective of making a profit. We next consider what portion of the petitioners' depreciation and operating expenses attributable to the cottage should be charged to their personal*126 use. This inquiry is purely factual, sec. 1.183-1(d)(3)(ii), Income Tax Regs., and under all of the facts and circumstances appearing of record, we find the ten percent figure which petitioners have been using to be reasonable. The 60 percent figure that respondent argues for is clearly unjustifiable. As noted above, petitioners' personal use was ancillary to their maintenance activities, which consumed much of their time spent at the cottage. And it would be hardly fair to charge them with, as personal use, other time in the offseason when the cottage was unoccupied due to their business decision to rent only during the prime season. Petitioners of course are fully entitled to deductions allowable without regard to whether the activity giving rise to them is profit motivated, e.g., interest (section 163) and taxes (section 164).The investment tax credit which petitioners claimed for 1975 must be reduced by ten percent to reflect personal use. Decision will be entered under Rule 155.Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended.↩2. The parties stipulated to all figures contained in this chart as well as to the assertions in the paragraph following it. Apparently, the personal use amounts for 1971-72 were based upon total expenses, whereas the ones for 1973-75 were based upon "all other" expenses. However, the record contained a copy of petitioners' 1975 return from which it appears that the figures for depreciation in the chart ($1,198 and $672) result from a separate 10 percent reduction in total depreciation expenses. Thus, at least for 1975, petitioners reduced all expenses except taxes and interest (which are deductible independently of their connection with a profit-oriented activity) to reflect personal use. It is possible that a similar procedure was followed for 1973 and 1974, and that the reductions for 1971 and 1972 were excessive. As none of these latter four years is before us, we express no opinion as to these matters.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623505/	ESTATE OF LAURA NELSON KIRKWOOD, DECEASED, IRWIN R. KIRKWOOD, EXECUTOR, JOHN E. WILSON, EXECUTOR OF ESTATE OF IRWIN R. KIRKWOOD, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Kirkwood v. CommissionerDocket No. 40845.United States Board of Tax Appeals23 B.T.A. 955; 1931 BTA LEXIS 1790; June 30, 1931, Promulgated 1790 1. Decedent created a trust fund, the income from which was used for the purpose of maintaining the Nelson Memorial Chapel, wherein the decedent's remains and the remains of her immediate family were interred. Held that such trust fund is not an allowable deduction in computing decedent's net estate under section 303(a)(3) of the Revenue Act of 1926. 2. The value of a life estate given by decedent to her husband should be computed on the basis of his life expectancy at the time of decedent's death, rather than on the actual facts which subsequently developed. 3. The inclusion by respondent of the value of decedent's homestead in her gross estate approved. 4. additional income taxes paid by decedent's estate for taxes due for the period just prior to decedent's death constitute an allowable deduction in determining the value of decedent's net estate. 5. In determining whether there has been a "transfer' within the meaning of the Federal taxing statutes imposing a tax on the transfer of a decedent's net estate, the state law in question is inapplicable. Phil D. Morelock, Esq., for the petitioner. Arthur Carnduff, Esq., for the respondent. 1791 MORRIS 956 This proceeding is for the redetermination of a deficiency in estate tax proposed against the estate of Laura Nelson Kirkwood in the amount of $15,299.14, $14,297.84 of which amount is contested by petitioner. The petition alleges that respondent erred in the following particulars: (a) The respondent has failed to allow as a deduction from the gross estate $105,000 provided in item 7 of the will of Mrs. Kirkwood for the purpose of maintaining the Nelson Memorial Chapel in Mt. Washington Cemetery. (b) The respondent has determined the factor used for determining the value of the estate of the life beneficiary Irwin R. Kirkwood as .44935 and has computed tax on this fractional part of the estate after passing to the life beneficiary upon the death of Mrs. Kirkwood, whereas Mr. Kirkwood died during the year 1927 and enjoyed the benefits of the estate of Mrs. Kirkwood less than two years. It is alleged that the factor to be used in determining the value of the estate of the life beneficiary in the estate of Mrs. Kirkwood should be based on actual facts as disclosed later rather than upon the theoretical basis of mortality tables. (c) The respondent1792 has erroneously reduced the amount of the property identified as previously taxed within the five-year period provided by law from $60,412.50 to $33,266.14. (d) The value of Oak Hall, the residence of the deceased, which passed to her husband, Irwin R. Kirkwood upon her death, was by him relinquished to the city of Kansas City, in the amount of $250,000, has been erroneously included in the gross estate by the respondent. (e) The respondent has failed to allow as a deduction against the gross estate $27,170.16 additional income tax paid as the result of changes in the income-tax return of Mrs. Kirkwood from January 1, 1926, to February 27, 1926. (f) The respondent is in error in including as a part of the gross estate the part thereof passing to Irwin R. Kirkwood, inasmuch as under Missouri law the husband's part of the estate of the deceased wife vests at the time of marriage. 957 FINDINGS OF FACT. The petitioner is the executor of the estate of Irwin R. Kirkwood, the said Irwin R. Kirkwood having been, prior to his death, the executor of the estate of Laura Nelson Kirkwood. For many years prior to his death, William Rockhill Nelson was the editor and publisher1793 of the Kansas City Star. Said William Rockhill Nelson died April 13, 1915, and his will was probated in the Probate Court of Jackson County at Kansas City, Mo., February term, 1915. It provided in part as follows: First: I give and devise my homestead, being Lot six (6), of Rockhill, an addition in and to Kansas City, Missouri, to my wife, Ida H. Nelson, for and during her life and after her death to my daughter, Laura Nelson Kirkwood, for life with full power to dispose of the same in fee simple. Said real estate may be by my wife and daughter, or the survivor of them, sold and conveyed absolutely in fee simple at any time for such price as they, or the survivor of them, may think proper, but if said real estate is not conveyed by deed by my wife and daughter, or the survivor of them, or specifically devised by the last will and testament of the survivor of them, then said real estate shall after their deaths become and be a part of the trust estate hereinafter mentioned. Second: I give and bequeath to my wife, all articles of household use and ornament, including furniture, rugs, statuary, pictures, books, works of art and silverware, and all jewelry and pleasure vehicles1794 owned by me. Third: I bequeath and devise all the rest, residue and remainder of my property, real, personal and mixed, of which I may die seized or possessed, or over which I may have testamentary control, or to which I may in any way be entitled at the time of my decease, of whatsoever the same may consist and wheresoever situate, to my wife, Ida. H. Nelson, and to my daughter, Laura Nelson Kirkwood, as trustees and to the successors of them and each of them in trust for the following purposes: * * Upon the death of his wife and daughter or their failure or inability to continue to serve as trustees, Nelson designated "University Trustees" as their successors, and he specifically set forth the duties of such trustees, the manner of filling vacancies, the management of the trust corpus and the disposition of a portion thereof upon the death of his wife and daughter, and provided that the net income and rents from the remainder were to be "used and expended for the purchase of works and reproductions of works of the fine arts, such as paintings, engravings, sculpture, tapestries and rare books, the purpose being to procure in this manner works or reproductions of works of fine1795 arts which will contribute to the delectation and enjoyment of the public generally, but are not usually provided for by public fund. I direct that the university trustees in the purchase of such works of the fine arts shall select works or reproductions of the works of artists who have been dead at least thirty years at the time of the purchase of the same." 958 Ida H. Nelson died October 6, 1921, and her will was probated in the Probate Court of Jackson County at Kansas City, Mo., October 17, 1921. Her will provided as follows: * * * Item 2: I give and bequeath to my daughter, Laura Nelson Kirkwood, all articles of household use and ornament, including furniture, rugs, statuary, pictures, books, bric-a-brac, works of art and silverware and all pleasure vehicles owned by me. Item 3: I give and bequeath to my daughter, Laura Nelson Kirkwood, for the term of her life all sums due or owing to me at the time of my death by the trustees under the will of William Rockhill Nelson, and after her death the sum or sums so bequeathed or the investments therefrom shall become a part of my residuary estate and be used for the purposes thereof herein stated, and any portion thereof1796 not required for said purpose shall be expended by the trustee herein named for the purchase of works and reproduction of works of the fine arts referred to in the will of William Rockhill Nelson. * * Item 13: All the rest, residue and remainder of my property, real, personal and mixed, of which I may die seized or possessed or over which I may have testamentary control or to which I may be entitled at the time of my death, of whatsoever the same may consist and wheresoever situate, I bequeath and devise to the New England National Bank, located at Kansas City, Missouri, as trustee and to its successor and successors in trust for the following uses and purposes: * * * Items 4 to 12, inclusive, covered specific bequests of cash. The trust created by item 13 was for the purpose of "erecting a building in Kansas City, Missouri, to be used for art purposes and to bear the name of William Rockhill Nelson followed by the words Gallery of Art or other suitable words." Laura Nelson Kirkwood, whose estate is the petitioner herein, died February 27, 1926, and her will was probated in the Probate Court of Jackson County at Kansas City, Mo., March 3, 1926. Her will provided in part1797 as follows: * * ITEM II I direct that my remains be placed and interred in the Nelson Memorial Chapel in Mount Washington Cemetery hereinafter mentioned. ITEM III I give and bequeath the portrait of my father, William Rockhill Nelson, deceased, which is included in my possession in my residence, known as "Oak Hall," the homestead of my father at the time of his death, to the University Trustees, to be appointed under and pursuant to the provisions of the Last Will and Testament of my father, to be placed with and made a part of the collection of works and reproductions of the works of fine arts, to be acquired by such trustees under said Will. * * * 959 ITEM V In the event my husband, Irwin R. Kirkwood, shall not survive my death, I direct my executor to have the furnishings, ornaments and other contents of my said residence viewed by at least two experts for the purpose of determining and selecting therefrom all works and reproductions of works of the fine arts. Such selections shall be tendered by my executor to the University Trustees aforesaid as a gift by me to be added to the collection of works and reproductions of works of fine arts to be acquired1798 under my father's will as aforesaid. In the event such gift shall not be accepted for the purpose by said University Trustees then such selections shall be treated and disposed of as a part of my residuary estate as hereinafter provided, in Item IX. * * * ITEM VII I give, devise and bequeath to Fred C. Vincent, Earl McCollum, John E. Wilson and New England National Bank and Trust Company in Kansas City, and their successors to be named as hereinafter provided, in continued trust: (1) The sum of One Hundred and Five Thousand Dollars ($105,000.00); and (2) Lot One (1) in Block Twelve (12) in Mount Washington Cemetery, as said lot is marked, designated and described on the sub-division or plat of a part of the Northwest Quarter (1/4) of Section Five (5) Township Forty-nine (49) Range Thirty-two (32), known as "Lot 1, Block 12, Mount Washington," said plat being on file in the office of the Recorder of Deeds of Jackson County. Missouri, at Independence, with the Memorial Chapel, known as the Nelson Memorial Chapel, thereon, together with all rights, privileges and appurtenances thereunto pertaining or belonging to me in connection therewith for the following uses and upon1799 the conditions following to-wit: (a) In addition to the remains of my father, William Rockhill Nelson, and my mother, Ida H. Nelson, now in the said Chapel, my remains and the remains of my husband, Irwin R. Kirkwood, shall be placed and kept therein. (b) No other remains or interments than those specified shall ever be placed or made in said Chapel or in or upon the said lot. (2) The said trustees shall invest and reinvest the trust fund as they deem to be the best interest of the trust, and after paying all expenses of the trust, including one hundred and fifty dollars ($150.00) per annum to each of the Trustees, shall out of the income and returns from the trust estate and with so much of the principal sum as they may consider necessary, pay: First, the sum of two hundred and fifty dollars ($250) per annum for the purpose of supplying and beautifying the interior of the Chapel with flowers and particularly on March 7th and 18th and November 29th of each year, and next the expense and cost of maintaining, protecting, caring for and keeping in condition the said lot and Chapel and its contents, renewing and rebuilding, when necessary, said Chapel, and constructing and maintaining, 1800 when deemed necessary, the roadways giving access to and about said lot, and to fencing, beautifying or making of other improvements deemed advisable by the trustees, so far and so long as such trust fund shall suffice and exist. In the event and when and as any trustee aforesaid or his successor, shall die, or cease for any reason to act, or if any of the above mentioned trustees, or his successor, shall fail, for any reason, to qualify as such, a successor to serve as trustee in his place and stead shall be named and appointed by the remaining trustees or trustee. 960 In the event the trust shall for any reason fail or cease then the trust fund remaining shall be treated and pass as a part of my residuary estate as hereinafter provided in Item IX. ITEM VIII Under and pursuant to the provisions of the Last Will and Testament of my father, William Rockhill Nelson, now deceased, I am invested with the power to specifically devise by my Last Will and Testament the property, which was described in my father's said Last Will and Testament as his homestead, being Block Six (6), Amended Plat of Rockhill, an Addition in and to Kansas City, Missouri, and I now, pursuant1801 to the right and power vested in me, specifically give and devise said property, viz: Block Six (6), Amended Plat of Rockhill, an Addition in and to Kansas City, Missouri, to my said Husband, Irwin R. Kirkwood, if he shall survive my death, for and during his life, with full power to sell and convey the same, after first, however, causing the residence, "Oak Hall", to be razed, and in the event of such sale the proceeds thereof shall be treated and disposed of as a part of my residuary estate as provided in Item IX hereof. Upon my said husband's death, if said property shall not have been sold by him, it shall pass to the trustees and become a part of the trust estate as specified in Item IX hereof. ITEM IX I give, devise and bequeath all of the rest, residue and remainder of the property and estate, real, personal and mixed, wheresoever situate, which I may own or be in any manner entitled to, in law or in equity, whether in possession or expectancy, at the time of my death, to my said husband, Irwin R. Kirkwood, if he shall survive my death, in trust for the following uses and purposes and upon the conditions following, to-wit: My said Trustee shall have full power to sell1802 at public or private sale, lease, dedicate and dispose of such trust estate or any portion thereof for such price and upon such terms and conditions as he shall see fit and to that end may execute all necessary contracts of sale, conveyances, leases or other instruments, and to invest and reinvest all funds realized from the sale of any property belonging to the estate in such property or securities and in such manner as he may deem prudent. He shall, out of the rents and income from the estate, pay all expenses of maintaining the properties of the estate and the insurance, taxes, assessments, cost of repairs and any and all other expenses connected therewith. The rents, returns and income from the trust estate after the payment of costs and expenses aforesaid shall go and belong to my said husband in his individual right. My said trustee shall have full right, power and authority to sell and convert into cash any and all of the said trust estate at any time and contribute and pay over the same in such amounts and under such conditions as he may see fit toward providing a site for or the cost of construction of a building in Kansas City, Missouri, to bear the name of William1803 Rockhill Nelson, followed by the words "Gallery of Art" or other suitable words, to be used for the purpose of housing and caring for pictures, paintings, sculpture, rare books, tapestries and works of the fine arts to be purchased pursuant to the provisions of the said Last Will of my deceased father, William Rockhill Nelson. My said trustee is authorized and empowered to use any remaining funds to acquire and purchase such pictures, paintings and works of art 961 as may be approved of by at least two (2) experts to be designated by him to be added to and to become a part of the collection aforesaid and housed in the said building so to be erected. Upon the death of my said trustee all of the trust estate then remaining shall go to and vest in the persons hereinafter named as trustees, to be held, managed and disposed of as hereinafter provided. If my husband, Irwin R. Kirkwood, shall not survive my death, then, said Block Six (6), Amended Plat of Rockhill, and all the rest, residue and remainder of the property and estate, real, personal, and mixed, wheresoever situate, which I may own or be in any manner entitled to, in law or in equity, whether in possession or expectancy, 1804 at the time of my death, shall go to and vest in Fred C. Vincent, John E. Wilson and New England National Bank and Trust Company in Kansas City, or the survivors or survivor at the time of them, in trust; or, in the event my said husband shall survive me and shall assume the duties of the trust as aforesaid all of the trust estate remaining at the time of his death, together with said Block Six (6), Amended Plat of Rockhill or such part thereof as he shall not have sold or disposed of, shall go to and vest in said Fred C. Vincent, John E. Wilson and New England National Bank and Trust Company in Kansas City, or the survivors or survivor at that time of them, in trust, for the following uses and purposes and upon the conditions following, to-wit: All of the furnishings, ornaments and other contents of the said residence "Oak Hall" not sold under the conditions hereinbefore mentioned by my executor, shall be sold by said trustees, (which term shall include the survivors or survivor of them) to or through dealers, merchants or persons, strangers to me, doing business or living more than Two Hundred Fifty (250) miles from Kansas City, Missouri, and the sum or sums realized therefrom shall1805 be placed in the trust estate; and said residence "Oak Hall" shall be forthwith razed by said trustees. At any time there may be idle funds belonging to the trust estate the trustees shall have the right to invest the same in bonds of the United States or general obligation bonds of the State of Missouri, State of Kansas or of Kansas City, Missouri, the interest and income therefrom to become and be a part of the trust estate. Said trustees shall manage and control the trust estate and may convert the same into cash in such manner as they deem proper, and to that end they shall have full right and power to sell and convey the same and to execute any and all deeds, conveyances and other instruments that may be necessary, and expend so much of said trust fund as they shall deem proper, first, to the payment of costs, charges and expenses of the trust estate and the properties a part thereof, and, next, toward providing a site for or construction of a building in Kansas City, Missouri, to bear the name of William Rockhill Nelson, followed by the words, "Gallery of Art" or other suitable words, to be used for the purpose of housing and caring for pictures, paintings, sculpture, rare1806 books, tapestries, and works of the fine arts to be purchased pursuant to the provisions of the said Last Will of my deceased father, William Rockhill Nelson, and any funds not so expended for a site for or the construction of a building as aforesaid shall be used and expended by the trustees for pictures, paintings and works of art, to be approved by at least two (2) experts to be designated by them, to be added to and to become a part of the collection aforesaid and housed in the said building so to be erected. I appoint my said husband, Irwin R. Kirkwood, if he shall survive my death, or John E. Wilson, if my said husband shall not survive my death, as 962 executor of this, my Last Will and Testament, and request that such executor be allowed to serve without bond and that he be not required to file an inventory or appraisement of any portion of my estate. * * The Nelson Memorial Chapel referred to in item seven of the decedent's will was erected in Mount Washington Cemetery during her lifetime. The chapel is a very costly and ornate structure of granite and marble, located on an elevation with flights of steps leading up to it. The entrance opens into a reception1807 space in the building which affords accommodations to visitors, spectators, and members of the public who come there and pay their respects or attend the burials. On a level lower than the entrance room is the space in which the caskets, containing the remains of the Nelsons and the Kirkwoods, are located. The only funds available for the upkeep of the chapel and grounds are the funds placed in trust under the will of Laura Nelson Kirkwood. In maintaining the chapel and in administering the trust fund providing for such maintenance, the trustees have kept the grounds and grass cut, the trees trimmed and in good order, the building repaired, and made renewals in various portions of the structure. A caretaker is employed who at all times looks after the tract, places flowers in the chapel, and attends to visits by members of the public. These visits are encouraged by the trustees as many people in and about Kansas City feel that William Rockhill Nelson was possibly the greatest man that Kansas City ever had, and the chapel, wherein his remains and the remains of his immediate family are interred, is considered a sort of shrine to his memory. Flowers are often placed in the chapel1808 by persons unknown to the trustees. In 1929 the Memorial Day service by the American Legion Post, which was quite a public function, was held in the chapel. "Oak Hall," the homestead of William Rockhill Nelson, referred to in the first paragraph of his will, was a tract of land of approximately twenty-two acres improved by a large stone residence and other appurtenances. Originally the stone dwelling was of moderate size, but from time to time Nelson had torn away portions of the building in order to make large additions thereto, which resulted in any number of wings. The decedent, Laura Nelson Kirkwood, employed architects to determine the value of the grounds and building for an art center. The building was found to be impractical for use as an art gallery, and it was necessary to locate the site for a new building. Prior to her death Laura Nelson Kirkwood had established the location of the art gallery on the tract to her own satisfaction. The homestead "Oak Hall" was not disposed of by either Ida H. Nelson nor Laura Nelson Kirkwood during their respective lives except as set forth in their respective wills. 963 Under date of January 28, 1927, Irwin R. Kirkwood1809 conveyed "Oak Hall" by deed to Kansas City, Mo. This conveyance was formally accepted by the municipality of Kansas City by ordinance. After Mr. Kirkwood's death the building was razed as promptly as possible and the plans for the art gallery provided for under Mrs. Nelson's will were enlarged to include the larger bequests. Irwin R. Kirkwood died August 29, 1927, or one year, six months, and two days after the death of his late wife, Laura Nelson Kirkwood, the decedent herein. At some time after August 1, 1926, after the purchase of the Kansas City Star, insurance of something over $600,000 was taken out upon his life, the greater portion being for the benefit of the said Kansas City Star and a smaller portion for his personal estate. There was some difficulty in consummating these policies, resulting finally in the insurance company advancing his age by five years, that is, he was actually 48 years of age and his age was advanced for insurance purposes to 53. Under the will of Laura Nelson Kirkwood, her husband, Irwin R. Kirkwood was given a certain life tenancy. The respondent, according to tables of mortality and expectancy, has computed the value of said life1810 estate passing to Irwin R. Kirkwood by multiplying the value of the net estate as determined by the respondent by .55065. In the net estate is included by the respondent the $105,000 provided in Item VII of the will of Mrs. Kirkwood for the benefit, maintenance and suitable upkeep of the Nelson Memoraial Chapel at Mount Washington Cemetery, and the value fixed by the respondent on "Oak Hall," being block six (6), amended plat of Rockhill, an addition in and to Kansas City, Mo., which was $250,000, and he reduced the value of the contents thereof of property previously taxed within five years from $60,412.50 to $33,266.14. Under date of June 4, 1928, the executor of the estate of Laura Nelson Kirkwood paid on behalf of said estate additional income taxes to the collector of internal revenue for the sixth district of Missouri in the sum of $25,406.01, and interest of $1,764.15, a total of $27,170.16. The additional income tax was for the period from January 1, 1926, to date of Mrs. Kirkwood's death February 27, 1926. Respondent has not allowed said payment of income tax as a deduction from the gross estate, but did allow as a deduction the amount of Federal income tax as originally1811 returned and paid by the estate, to wit, $3,166.53. OPINION. MORRIS: The first issue presented by the pleadings is whether the $105,000 trust fund established under the will of Laura Nelson Kirkwood constitutes an allowable deduction from her gross estate. The 964 deductibility of this trust fund depends upon the interpretation of section 303(a)(3) of the Revenue Act of 1926, which provides as follows: SEC. 303. For the purpose of the tax the value of the net estate shall be determined - (a) In the case of a resident, by deducting from the value of the gross estate - * * (3) The amount of all bequests, legacies, devises, or transfers, to or for the use of the United States, any State, Territory, any political subdivision thereof, or the District of Columbia, for exclusively public purposes, or to or for the use of any corporation organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, including the encouragement of art and the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private stockholder or individual, or to a trustee or trustees,1812 or a fraternal society, order or association operating under the lodge system, but only if such contributions or gifts are to be used by such trustee or trustees, or by such fraternal society, order, or association, exclusively for religious, charitable, scientific, literary, or educational purposes, or for the prevention of cruelty to children or animals. The amount of the deduction under this paragraph for any transfer shall not exceed the value of the transferred property required to be included in the gross estate. [Italics supplied.] By Item VII of her will Laura Nelson Kirkwood devised in continued trust to named trustees the Nelson Memorial Chapel in Mount Washington Cemetery and the sum of $105,000 for the upkeep and maintenance of the chapel and grounds. Since the devise was to trustees it would appear that petitioner should be governed by that portion of the above quoted section which refers to bequests, legacies, devises, or transfers "to a trustee or trustees." Petitioner, however, contends that, because of William Rockhill Nelson's charities and the esteem in which he was held by his fellow men, his place of burial is a sort of shrine where the public pays homage1813 to his memory. It is asserted that the shrines of great men are a moral inspiration to the people as a whole, that they are of great literary and educational value; therefore, the petitioner argues that since this chapel is for the use of the people of the State as a whole, it is for the use of the State, because in a broad sense the people of the State constitute the body politic, and that since this bequest was for the use of the State, it is deductible under section 303(a)(3) of the 1926 Act. The weakness of this argument lies in the fact that the trust fund was created for purely personal reasons, namely, the care and maintenance of the last resting place of the decedent and her immediate family. The State, nor indeed the people therein, had no interest in the trust fund, nor did it or they have any voice in or control 965 over the chapel or the activities of the trustees. The public visited the chapel, and even though such visits were encouraged, we are satisfied that the trustees, in the exercise of their discretion, could have excluded the public therefrom at any time. We can not agree with the petitioner's contention, therefore, that the chapel was maintained1814 under the trust, exclusively for public purposes; rather, we believe that it was the personal wishes of the decedent which were being carried out by the trustees. If in the course of performing the duties imposed by the trust instrument, the public was directly or indirectly benefited, we can not see how this benefit in any way changed the character of the trust or the uses for which it was created. It is our opinion, therefore, that the $105,000 trust fund is not a proper deduction within the meaning of section 303(a)(3) of the Revenue Act of 1926. Petitioner cites in support of his contention the decision of the court in , wherein it was held that the cost of a mausoleum was deductible from the decedent's gross estate. In that case the deduction was allowed upon the ground that the cost of the mausoleum was a part of the "reasonable interment expenses." No such question is raised in the present proceeding and the cases are, therefore, distinguishable. The decedent by item nine of her will gave her residuary estate to her husband in trust, and at the same time made him the sole beneficiary of the income from the trust1815 estate. She provided that upon the death of her husband the remainder of the trust estate should vest in three designated trustees who were to use the trust estate to provide a site for or construct a building in Kansas City, Mo., to bear the name of William Rockhill Nelson followed by the words "Gallery of Art," which said building was to be used to house and care for works of the find arts which were to be purchased under the last will and testament of her father. The trustees were to use any excess of the trust fund for the purchase of additional works of the fine arts. Her husband, as trustee, was given full power and authority during his lifetime to use any and all of the trust estate for the same purposes. Concededly, under the provisions of decedent's will her husband received a life tenancy in her residuary estate, and we are satisfied that the remainder of the residuary estate after his death was given in trust for "charitable, scientific, literary or educational purposes." This brings us to the second issue, namely, whether respondent erred in using the factor .55065 to determine the value of Irwin R. Kirkwood's interest in the estate of his wife, when the facts show1816 that he died within one year, six months, and two days of the decedent. In other words, we are asked to hold that Kirkwood's 966 actual life should control the valuation of his life estate, rather than his estimated life as shown by well known tables of mortality. In our opinion a lengthy discussion of this issue would serve no useful purpose, in view of the opinion of Mr. Justice Holmes in . In that case one Edwin C. Stewart died testate appointing his wife and the Ithaca Trust Company, executors, and the Ithaca Trust Company, trustee, of the trust created by his will. He gave the residue of his estate to his wife for life, and after her death there were bequests in trust for admitted charities. The wife died six months after the decedent. The opinion of Mr. Justice Holmes in part is as follows: * * The question is whether the amount of the diminution, that is, the length of the postponement, is to be determined by the event as it turned out, of the widow's death within six months, or by mortality tables showing the probabilities as they stood on the day when the testator died. The first impression1817 is that it is absurd to resort to statistical probabilities when you know the fact. But this is due to inaccurate thinking. The estate so far as may be is settled as of the date of the testator's death. See . The tax is on the act of the testator not on the receipt of property by the legatees. ; and passim; ; . Therefore the value of the thing to be taxed must be estimated as of the time when the act is done. But the value of property at a given time depends upon the relative intensity of the social desire for it at that time, expressed in the money that it would bring in the market. See . Like all values, as the word is used by the law, it depends largely on more or less certain prophecies of the future; and the value is no less real at that time if later the prophecy turns out false than1818 when it comes out true. See . . Tempting as it is to correct uncertain probabilities by the now certain fact, we are of opinion that it cannot be done, but that the value of the wife's life interest must be estimated by the mortuary tables. * * * The above quoted portion of the Supreme Court's decision is, in our opinion, determinative as to this issue. We hold, therefore, that the value of Irwin R. Kirkwood's life interest in his wife's estate should be determined upon the basis of his theoretical life as estimated by mortuary tables rather than on the facts as they subsequently occurred. The third issue is whether respondent erred in determining the deduction under section 303(a)(2) for property previously taxed to another estate within a period of five years. Petitioner assets that he is entitled to deduct the full value of the contents of "Oak Hall," having a stipulated value of $60,412.50, instead of $33,266.14 as allowed by respondent, which figure is the product of $60,412.50 X .55065. By item two of the will of William Rockhill Nelson his1819 967 wife received "all articles of household use and ornament, including furniture, rugs, statutory, pictures, books, works of art and silverware, and all jewelry and pleasure vehicles" owned by Nelson. Ida H. Nelson, by item two of her will, used practically the same language in giving the property to her daughter, Laura Nelson Kirkwood, adding the term "bric-a-brac" and omitting the term "jewelry." Mrs. Nelson died October 6, 1921, and her daughter died February 27, 1926, or less than five years after her mother. We are satisfied from the above facts that the contents of "Oak Hall" passed under and pursuant to the second paragraph of the will of Mrs. Nelson, and were taxed as a part of her net estate less than five years prior to the death of Laura Nelson Kirkwood. Section 303(a)(2) of the Revenue Act of 1926 provides that for the purpose of the tax the value of the net estate of the decedent shall be determined by deducting from the gross estate: (2) An amount equal to the value of any property (A) forming a part of the gross estate situated in the United States of any person who died within five years prior to the death of the decedent, or (B) transferred to the1820 decedent by gift within five years prior to his death, where such property can be identified as having been received by the decedent from such donor by gift or from such prior decedent by gift, bequest, devise, or inheritance, or which can be identified as having been acquired in exchange for property so received. This deduction shall be allowed only where a gift tax imposed under the Revenue Act of 1924, or an estate tax imposed under this or any prior Act of Congress was paid by or on behalf of the donor or the estate of such prior decedent as the case may be, and only in the amount of the value placed by the Commissioner on such property in determining the value of the gift or the gross estate of such prior decedent, and only to the extent that the value of such property is included in the decedent's gross estate and not deducted under paragraph (1) or (3) of this subdivision. The only difference between the parties is on the amount of the deduction under the above quoted provision. The respondent contends that the value deductible under the above provision is $33,266.14, the value of the life estate in the decedent's husband, as the balance thereof was deducted under paragraph1821 3 of the above subdivision, and if $60,412.50 were deducted as property previously taxed, the estate would get a deduction of $87,558.86. The statute specifically provides for the deduction of the value of property previously taxed within five years in the amount of the value placed by the Commissioner on such property in determining the value of the gross estate of such prior decedent, but only to the extent that the value of such property is included in the decedent's gross estate and not deducted under paragraph (1) or (3) of the subdivision. The deduction for the value of the contents of "Oak Hall," therefore, should be allowed to the extent of the value thereof included in the prior decedent's estate and in the present decedent's 968 gross estate, reduced by the value of such property deducted under section 303(a)(3). The next issue relates to the inclusion in decedent's gross estate of $250,000, the stipulated value of the homestead, "Oak Hall," exclusive of the contents thereof. Petitioner contends that as Irwin R. Kirkwood relinquished the property by deed to the municipality of Kansas City on January 28, 1927, less than one year after decedent's death, and1822 that as he died approximately a year and a half after the decedent, that the factor .55065 used by respondent was excessive. Under William Rockhill Nelson's will the homestead "Oak Hall" realty, as distinguished from personalty, was given to Ida H. Nelson for life, and upon her death to Laura Nelson Kirkwood for life with full power to dispose of same in fee simple. Upon the death of her mother Laura Nelson Kirkwood received the realty from her father with full power to convey the fee simple title thereto, and at this point it should be noted that Ida H. Nelson made no mention of the homestead in her will. The decedent's will gave a life tenancy in "Oak Hall" to her husband, together with a power to sell and convey the same, in which event the proceeds thereof were to be included in her residuary estate. As the husband was also given a life tenancy in decedent's residuary estate, it is obvious that Kirkwood had a life tenancy in the homestead. Since the homestead passed under decedent's will, and was not a part of a prior taxed estate, the respondent correctly included the stipulated value thereof in decedent's gross estate. The fifth issue relates to the deductibility of1823 additional income taxes paid by the estate under date of June 4, 1928, for the period January 1, 1926, to February 27, 1926, the date of decedent's death. This payment by the estate amounted to $27,170.16, $25,406.01 thereof being the principal amount of said income taxes, and $1,764.15 thereof being interest. Originally the estate had returned and paid income taxes of $3,166.53, which amount respondent allowed as a deduction from decedent's gross estate. Petitioner contends that under these facts he is entitled to deduct the additional income taxes from the said gross estate. This issue has been before the Board in two prior cases, in both of which we held that income taxes for a period prior to the decedent's death were allowable deductions in determining the value of decedent's net estate. , and , modified in other particulars at . Since the opinions in these cases support the petitioner's contention, our decision as to this issue is for the petitioner. 1824 The sixth and final issue is whether respondent erred in including as a part of decedent's gross estate, the part thereof passing to Irwin 969 R. Kirkwood, since under the laws of the State of Missouri the husband's part of his wife's estate vests at the time of marriage. Petitioner cites in support of the proposition that that part of decedent's estate passing to Kirkwood should be execluded under Missouri law, the decisions of the Federal District Court in , and . The decisions in those cases support petitioner's contention, but in (certiorari denied, ), the District Court was reversed, and the Circuit Court of Appeals, after an exhaustive examination of the decisions of the United States Supreme Court and the leading case by the Missouri Supreme Court - , held that the state law was inapplicable, and that there was a transfer within the meaning of the Federal taxing statute. Accordingly, we hold the respondent as to this issue. 1825 Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623506/	APPEALS OF M. C. STOCKBRIDGE, MRS. M. C. STOCKBRIDGE, MRS. ALICE D. HENDERSON, EXECUTRIX, S. H. HENDERSON, JR., MRS. S. H. HENDERSON, JR.Stockbridge v. CommissionerDocket Nos. 1866, 1867, 1875, 1916, 1917.United States Board of Tax Appeals2 B.T.A. 327; 1925 BTA LEXIS 2461; July 11, 1925, Decided Submitted May 20, 1925. 2461 1. Accelerated depreciation allowed. 2. Reserve for unaccrued liability disallowed. Lee I. Park, Esq., for the Commissioner. IVINS327 Before IVINS and MORRIS. These appeals were heard together upon the pleadings and a deposition, from which the Board makes the following FINDINGS OF FACT. The taxpayers, during the fiscal year ended June 30, 1919, were copartners engaged in business in Shreveport, La., under the name of Henderson Cotton Oil Co. In the return of the partnership for the fiscal year ended June 30, 1919, a deduction was taken from income in the amount of $22,000, representing estimated liability of the partnership for oil sold not meeting the standard required by chemical analysis. No claims had then been presented by purchasers. The partnership at first entered the estimates on its books at $15,000, $6,000, and $9,000, respectively, but subsequent to June 30, 1919, and before the closing of the books, reduced the respective estimates to $10,000, $5,000, and $7,000. After the close of the fiscal year, claims were presented by purchasers and settled as follows through payments by the partnership: July 25, 1919$9,844.01Sept. 25, 19191,888.98April 30, 19206,710.0018,442.992462 The balance, $3,557.01, was included in the income of the fiscal year ended June 30, 1920. In its tax return the partnership deducted depreciation in the amount of $19,786.87. The Commissioner disallowed $9,570.05 on the ground that it was depreciation applicable to the prior fiscal year but not then taken by the partnership. A reasonable allowance for depreciation applicable to the fiscal year ended June 30, 1919, is $29,698.73, due to the continuous day and night operation of the partnership plant. 328 The Commissioner determined deficiencies in the following amounts: M. C. Stockbridge$870.79Mrs. M. C. Stockbridge870.79Mrs. Alice D. Henderson, Executrix (not stated). S. H. Henderson, Jr748.57Mrs. S. H. Henderson, Jr748.57From these determinations the taxpayers, respectively, duly filed their appeals to this Board. DECISION. The deficiencies should be computed in accordance with the following opinion. Final determination of the Board will be settled on 10 days' notice, in accordance with Rule 50. OPINION. IVINS: We are satisfied by evidence submitted by the taxpayers, and uncontroverted, that depreciation should be*2463 allowed the partnership for the fiscal year ended June 30, 1919, in the amount of $29,698.73. The item of $22,000 was not a proper deduction for the fiscal year in question. At the end of that year it represented not an accrued liability but a reserve. During the fiscal year in question claims existed only in contemplation, not in fact. They did not arise and so accrue until after the close of the fiscal year. ; ; ; .	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623509/	MARK MARION AKINS, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentAkins v. CommissionerDocket No. 10765-92United States Tax CourtT.C. Memo 1993-256; 1993 Tax Ct. Memo LEXIS 260; 65 T.C.M. (CCH) 2937; June 10, 1993, Filed Decision will be entered under Rule 155. 260 For Mark Marion Akins, pro se. For respondent: David Delduco. GOLDBERGGOLDBERGMEMORANDUM OPINION GOLDBERG, Special Trial Judge: This case was heard pursuant to section 7443A(b)(3) and Rules 180, 181, and 182. All section references are to the Internal Revenue Code in effect for the years in issue. All Rule references are to the Tax Court Rules of Practice and Procedure. Respondent determined deficiencies in petitioner's Federal income tax for tax years 1987, 1988, and 1989 in the following amounts: Additions to TaxSection SectionSectionSection Section Tax Defic 6651(a)(1)6653(a)(1)(A)6653(a)(1)(B)6653(a)(1)6654(a) Yeariency1987$ 1,544$ 386.00$ 77.201- - 19884,4061,101.50- - 220.30$ 281.5219895,8551,405.50- - - 378.20After concessions, the issues for decision are: (1) Whether petitioner is 261 required to file tax returns and pay income tax for the years in question; (2) whether petitioner is liable for additions to tax for negligence for 1987 and 1988; (3) whether petitioner is liable for additions to tax for failure to file a timely return for 1987, 1988, and 1989; and (4) whether petitioner is liable for additions to tax for failure to pay estimated tax for 1988 and 1989. Some of the facts have been stipulated and are so found. The stipulation of facts and attached exhibits are incorporated by this reference. Petitioner resided in Dunwoody, Georgia, when he filed his petition. Petitioner formerly worked in Washington, D.C., for the Metropolitan Area Transit Authority in an administrative position. On May 11, 1982, he was attempting to enter his car in a parking lot when he was robbed and stabbed in the heart. He died, was resuscitated, and underwent surgery to repair his heart. Since that day, petitioner has suffered from post-traumatic stress syndrome to the extent that he is no longer able to work or engage in his former activities. Among his many afflictions, his memory was impaired, he has constant ringing in his ears, and he lives in incessant fear of another262 attack. For tax years 1983 through 1986, petitioner continued to file income tax returns and pay taxes, as he had always done in the past. For tax years 1987 through 1989, he had tax returns prepared by his accountant, but he has not filed them nor paid his taxes for those years. Petitioner agrees that respondent correctly determined his income tax liabilities. He has not filed his tax returns nor paid his taxes because he feels, as a result of the assault, that the Federal Government is directly responsible for his sufferings, due to negligent enforcement of the criminal laws in Washington, D.C.Petitioner testified that the juvenile who attacked him had committed seven crimes and bail violations within a short period, and had been released on bail shortly before the attack. He contends that this information was not made available to the judge before the assailant's release. According to petitioner, the assailant was apprehended but was never prosecuted, or even charged, for his attempt on petitioner's life. Petitioner now asks us to relieve him of his Federal income tax liability until such time as he feels he has recouped the costs of the attack, such as enormous medical263 expenses and lost wages. He believes that such a holding on our part would be analogous to a tort recovery and would deter negligence by Federal employees. The Court is sincerely sympathetic to petitioner for all the sufferings he has endured. We have no jurisdiction, however, to grant him an offset against his tax liabilities on that account. For example, see . His grievances against the policies of the Government or against the tax system as a whole do not excuse him from paying taxes on his income. . Respondent's determination as to petitioner's income tax deficiencies for tax years 1987, 1988, and 1989 is upheld. For 1987, 1988, and 1989, respondent also determined that petitioner is liable for the addition to tax imposed by section 6551(a)(1). Section 6651(a)(1) imposes an addition to tax for failure to file a timely return, unless it is shown that such failure is due to reasonable cause and not to willful neglect. The amount of the addition is 5 percent of the amount required to be shown as tax on the return if the failure264 is for not more than 1 month, with an additional 5 percent for each additional month, up to a maximum of 25 percent in the aggregate. To avoid the imposition of the addition to tax, the taxpayer must show that his failure to file was due to reasonable cause and not to willful neglect. Sec. 301.6651-1(c)(1), Proced. & Admin. Regs. Illness or incapacity may constitute reasonable cause if the taxpayer establishes that he was so ill that he was unable to file. See . Petitioner bears the burden of proof that this addition to tax does not apply. Rule 142(a); . Petitioner believes that his disability, post-traumatic stress syndrome, is of physical origin, though its symptoms are those of emotional illness. The regulations explaining the term "reasonable cause" state that: "If the taxpayer exercised ordinary business care and prudence and was nevertheless unable to file the return within the prescribed time, then the delay is due to a reasonable cause." Sec. 301.6651-1(c)(1), Proced. and Admin. Regs. Hence, to establish a defense265 of emotional illness as reasonable cause for failure to file, the taxpayer must show that he was incapacitated to the extent that he was unable to exercise ordinary business care and prudence during the period. ; . Cf. . In cases where physical illness is claimed as a defense to the penalty for failure to file a timely return, the taxpayer must establish that he was continuously incapacitated. . The fact that petitioner arranged to have his accountant prepare income tax returns for the years in question indicates to us that his physical and emotional problems did not prevent him from exercising ordinary business care and prudence. Compare (holding that filing returns 5 weeks after contact by special agent negates defense of ill health). By the same token, petitioner filed income tax returns266 for 4 tax years after the attack and then made a conscious decision not to file. Petitioner, in effect, concedes that his nonfiling was intentional. We hold that petitioner is liable for the addition to tax for failure to file a timely return for tax years 1987, 1988, and 1989. Respondent determined that petitioner is liable for the additions to tax for negligence or intentional disregard of rules or regulations for tax years 1987 and 1988. For tax year 1987, the additions to tax for negligence are imposed by section 6653(a)(1)(A) and (B); for tax year 1988, the applicable provision is 6653(a)(1). Negligence under section 6653 means lack of due care or failure to do what a reasonable and ordinarily prudent person would do under the circumstances. . Petitioner has the burden of proving that respondent's determination of the additions to tax is erroneous. Rule 142(a); . We find, under the circumstances of this case, that petitioner was negligent. Delinquent filing of a return, involving disregard of a known legal duty, 267 constitutes negligence. , affd. ; . In addition, petitioner has no legal basis to claim that he should not be required to pay income taxes. For tax years 1987 and 1988, respondent determined additions to tax under section 6654(a) for underpayment of estimated tax. Generally, section 6654(a) imposes an addition to tax where prepayments of tax, either through withholding or estimated quarterly tax payments during the course of the year, do not equal the percentage of total liability required under the statute. However, the addition is not imposed if the taxpayer can show that one of several statutory exceptions applies. Sec. 6654(e); ; . Petitioner has not shown that any of these exceptions applies. Therefore, he is liable for the 6654(a) addition to tax for tax years 1988 and 1989. Decision will be entered under Rule 155. Footnotes1. 50 percent of the interest on the portion of the deficiency attributable to negligence or intentional disregard of rules or regulations.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623510/	CAR-RON ASPHALT PAVING CO., INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentCar-Ron Asphalt Paving Co. v. CommissionerDocket No. 7341-81.United States Tax CourtT.C. Memo 1983-548; 1983 Tax Ct. Memo LEXIS 240; 46 T.C.M. (CCH) 1314; T.C.M. (RIA) 83548; September 7, 1983. Michael J. Occhionero, for the petitioner. David D. Dahl, for the respondent. SHIELDSMEMORANDUM FINDINGS OF FACT AND OPINION SHIELDS, Judge: The respondent determined that there are deficiencies in the income tax due from the petitioner for the years 1974 and 1975 in the respective amounts of $961.68 and $42,090.00. The deficiencies resulted from the disallowance by the respondent of deductions claimed by the petitioner, a paving subcontractor, for certain payments made for the benefit of an employee of one of the petitioner's general contractors. The payments were made by the petitioner in order to obtain subcontracts. The only issue for our decision is whether or not the payments are deductible under section 162. 1241 FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulation of facts together with the exhibits attached thereto are incorporated herein by reference. Car-Ron Asphalt Paving Co., Inc. is an Ohio corporation which had its principal office in Solon, Ohio, at the time its petition was filed. It was organized in 1968 by Raymond LaMarca and Michael Cohen, each of whom own 50 percent of its common stock. LaMarca has served as its president and Cohen has served as its vice president since its organization. The petitioner is in the paving business. Its work consists primarily of paving parking lots for factories, hospitals, shopping centers, schools, gas stations and occasionally driveways for private residences. Beginning in the latter part of 1974 and continuing through 1975 into 1976, the petitioner did the paving on two subcontracts it had with Forest City Enterprises, Inc. The subcontracts were on a job known as Rolling Acres Mall. Forest City Enterprises, Inc. was the general contractor for the construction of the mall and Nicholas Festa, its executive vice president, was responsible for obtaining, by competitive bids, all of the subcontracts242 on the job. Petitioner submitted bids through Festa for the paving and in the fall or winter of 1974 obtained the two paving contracts in the total amount of approximately $1,000,000. Although the contracts were supposedly obtained with the competitive bids, they were actually negotiated by LaMarca and Festa. In fact, in order to obtain the subcontracts LaMarca agreed to have the petitioner pay for certain services and materials being used in the construction of a personal residence for Festa. In accordance with the understanding between LaMarca and Festa the petitioner issued 32 checks in 1975 to various parties who had furnished services or materials toward the construction of Festa's residence. These checks totaled $75,757.13. In addition to these checks, and for the same reason, the petitioner installed in 1975 an asphalt driveway at Festa's residence. The cost of the driveway was $11,929.92. The checks and the cost of the driveway were deducted on the petitioner's 1975 return as subcontractor's expense. In 1976, and again for the same reason, the petitioner made payments of $3,500 and $872 toward the construction of the residence of Festa. On petitioner's 1976 return243 the $3,500 payment was deducted as subcontractor's expense while the $872 payment was deducted as professional consulting expense. The petitioner did at least 20 paving jobs each year. During 1973 through 1976 it had gross receipts as follows: YearGross Receipts1973$841,602.1719741,115,844.8219752,090,622.0019761,398,661.00For each of the years 1977 through 1980 the petitioner had gross receipts in excess of $2,500,000. For the year 1981 its gross receipts were approximately $4,000,000. During the years of its existence and up to the date of the trial the petitioner had done at least 25 but not more than 50 jobs for Forest City Enterprises including the job at Rolling Acres. The paving contracts on all of the jobs with Forest City other than Rolling Acres were obtained by competitive bids except about four or five. These four or five were obtained through Festa in the same manner as the contracts on Rolling Acres. These four or five contracts amounted to about $200,000 to $300,000. Almost all of the business done by the petitioner with the parties other than Forest City was done on competitive bids. None of the jobs done for others244 were obtained through the payment of kickbacks as in the case of Rolling Acres. During his investigation, respondent's agent determined that in addition to the petitioner three or four other subcontractors on the Rolling Acres job made payments to Festa in order to obtain their subcontracts. During his investigation the agent was aware of section [4232.7]328 of the Internal Revenue Manual, Techniques Handbook for Specialized Industries--Construction, which reads in part as follows: (1) In the examination of taxpayers engaged in the construction industry, particular attention should be given to items that have been charged to job costs or expense accounts. Special emphasis should be given to the following items: (a) Kickbacks and payoffs are common in the construction industry and such payments are often made against public policy. The following ways that taxpayers make these payments may be helpful in disclosing unallowable deductions. * * * 4 Kickbacks may be made in the form of free work, such as blacktopping a driveway, construction of a home or commercial building at a bargain price. This might be done for persons responsible for obtaining the contract. [Internal245 Revenue Manual, vol. I, pt. IV - Audit, ch. 4200, sec. [4232.7]328, at 7269-24 (CCH).] On or about July 1, 1983, Nicholas C. Festa pleaded guilty in the United States District Court for the Northern District of Ohio, Eastern Division, No. CR80-45, to having failed to include in his income tax return for 1973 "additional taxable income in the amount of $26,500 which was earned from commissions and kickbacks he solicited from contractors of his employer." At the same time and in the same action Festa also pleaded guilty to having failed to include in his 1975 income tax return "additional taxable income in the amount of $326,940.75, which was earned from commissions and kickbacks he solicited from contractors of his employer." Upon the entry of the guilty pleas the Court, at the request of the United States Attorney, dismissed similar charges against Festa with respect to his income tax returns for 1976 and 1977. No employee, officer, or other individual connected with Forest City Enterprises was aware during 1975 or 1976 that the petitioner was making payments to or for the benefit of Festa. At the time of the trial, Mr. LaMarca the president of petitioner had no direct knowledge246 of the payment of any kickbacks in the paving industry in the locality of petitioner's activities other than those made by the petitioner to Festa but he had heard through general gossip that such payments were made and he had read in a local newspaper that Festa had been indicted for failing to pay income tax on kickbacks paid to him by four or five subcontractors at Rolling Acres other than the petitioner. OPINION The parties have stipulated that the payments made by the petitioner to Festa in order to obtain the subcontracts on the Rolling Acres Mall were not at that time and under those circumstances illegal under any Ohio law or under the law of the United States in the sense that such payments did not subject the petitioner as the payor of such payments to any criminal penalty or to the loss of a license of any privilege to engage in its trade or business. The respondent contends that nevertheless the payments are not deductible under section 162 because the petitioner has not established that the payments were ordinary and necessary. On the other hand, the petitioner contends that the payments were both ordinary and necessary and therefore are deductible under section247 162. Section 162(a) provides that "[t]here 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." It has long been established that in order to be deductible under this section the expenditure must be both ordinary and necessary. . Ordinary as used in section 162 refers to "transactions * * of common or frequent occurrence in the type of business involved." . In other words it is "the kind of transaction out of which the [payment] arose and its normalcy in the particular business which are crucial and controlling." . In , affd. we stated that "[t]o be ordinary within the meaning of section 162, expenditures must be common in the taxpayer's dealings or of frequent occurrence in the type of business in which the taxpayer is engaged." Again in ,248 revd. on other grounds , we concluded that commercial bribes paid by the taxpayer to a purchasing agent of the taxpayer's principal customer were not deductible because the taxpayer had failed to establish by reliable evidence that other similar arrangements or practices were common or ordinary in his industry. We are forced to the same conclusion in this case. All of the evidence clearly establishes that five or six subcontractors on the construction of the Rolling Acres Mall paid kickbacks to the same employee of the general contractor on the job and that the employee involved was indicted and pleaded guilty for failing to pay income tax on the kickbacks. This evidence does not in any way establish that the payment of kickbacks is common or ordinary in the construction business generally or in the paving business in particular. In fact, Mr. LaMarca's own testimony tends to establish the contrary. He testified that the petitioner had never paid kickbacks to anyone other than Festa and only to Festa with respect to Rolling Acres Mall and our or five other jobs which amounted to only $200,000 to $300,000 in gross receipts. These five or249 six instances in which kickbacks were paid by the petitioner occurred over a period of 13 years, accounted for only five or six jobs out of approximately 260 jobs and resulted in not more than $1,300,000 in gross receipts. We conclude therefore that the petitioner has failed to establish that the payments made to Festa were ordinary within the meaning of section 162. ;2In reaching this conclusion we have been unable to attach any significance to the comment appearing in the Internal Revenue Manual that "[k]ickbacks and payoffs are common in the construction industry." When considered in context it is apparent that this comment refers only to a method sometimes used by taxpayers in the construction business to claim unallowable deductions. It does not, as contended by the petitioner, constitute an acknowledgement by the respondent that the payment250 of kickbacks and payoffs are ordinary in the construction business. We are also not convinced by this record that the payments made by the petitioner to Festa were necessary to the business of the petitioner. Here again Mr. LaMarca testified that the petitioner's business had grown steadily from its organization in 1968 through 1981. His testimony and the returns of the petitioner establish that for each of the eight years, 1974 through 1981, the gross receipts of the petitioner exceeded $1,000,000. For six of the eight years the gross receipts exceeded $2,000,000. None of the growth and obvious success prior to the latter part of 1974 can be attributed to kickbacks. All of the growth and success in obtaining business after that date was accomplished by the petitioner without making kickbacks to anyone other than Festa. Yet the business produced as a result of the payments made to Festa amounted at the most to only $1,300,000 as contrasted to the many millions which were not attributable to any kickback. Furthermore, from the minimum of 25 jobs which the petitioner obtained from Forest City only five or six were attributed by the petitioner to the kickbacks paid to Festa. 251 Consequently, petitioner must have received at least 19 or 20 contracts from Forest City without the payment of any kickback. As pointed out above, Mr. LaMarca also testified that these five or six contracts represented all of the kickbacks paid by the petitioner on the approximately 260 jobs petitioner had performed during the 13 years of its existence. The other 254 or 255 jobs must have been obtained without such payments. We conclude therefore that the petitioner has also failed to establish that the payment of the kickbacks to Festa was necessary to its business. To reflect the foregoing, Decision will be entered for the respondent.Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as amended, in effect during the years in issue.↩2. See also , on appeal (6th Cir. Mar. 21, 1983), involving another subcontractor on the Rolling Acres Mall.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623511/	Burr Oaks Corporation, et al., 1 Petitioners, v. Commissioner of Internal Revenue, RespondentBurr Oaks Corp. v. CommissionerDocket Nos. 4771-62, 4772-62, 1581-63, 1583-63United States Tax Court43 T.C. 635; 1965 U.S. Tax Ct. LEXIS 129; 43 T.C. No. 51; February 11, 1965, Filed February 11, 1965, Filed 129 Decisions will be entered under Rule 50. Three individuals acquired a tract of undeveloped land in 1957 for $ 100,000. They decided to subdivide and improve the land, and sell lots therefrom. They incorporated petitioner in 1959 and transferred the land to it. In return, each received what purported to be a 2-year, 6-percent promissory note in the principal amount of $ 110,000. The land was not worth more than $ 165,000 when so transferred. At approximately the same time, the wives or brothers of the three individuals transferred a total of $ 4,500 cash to petitioner and received common stock in petitioner. Although the wives and brothers were petitioner's only shareholders of record, they had nothing at all to do with petitioner's business, which was dominated and controlled by the three individuals. Petitioner was undercapitalized. Its prospects were speculative. Petitioner made certain distributions to the three individuals during 1959 with regard to their promissory notes. The notes, however, were not paid in full at their maturity date, but were extended. A portion of the principal balance on each of the notes was outstanding as of the trial herein. Held, 130 the transfer of the land to petitioner is an equity contribution, and the purported promissory notes are in the nature of preferred stock. Held, further, the transfer of the land and the transfer of the cash were part of an integrated transaction immediately after which the transferors were "in control" of petitioner. That transaction is therefore governed by section 351. Held, further, petitioner has a substituted basis for the land. Held, further, the distributions received by the three individuals during 1959 are essentially equivalent to dividends. Thomas J. Donnelly, Jr., Samuel J. Recht, Herbert Morse, for the petitioners.Denis J. Conlon, for the respondent. Fay, Judge. FAY635 Respondent, pursuant to a statutory notice of deficiency, determined deficiencies in the income tax of petitioner Burr Oaks Corp. for its taxable years ended September 30, 1958, 1959, and 1960, in the respective amounts of $ 15,067.26, $ 52,595.26, and $ 16,602.61. With regard to the various individual petitioners, respondent determined the following deficiencies in their respective income taxes:TaxableDocketPetitionersyearDeficiencyNo.endedDec. 31 --4772-62A. Aaron and Rosella Elkind1958$ 499.32195935,520.4919601,778.901581-63Harold A. and Fannie G. Watkins195930,386.551583-63Maurice and Esther Leah Ritz195937,702.90636 Petitioner Burr Oaks Corp. will hereinafter be referred to as the petitioner, and petitioners A. Aaron Elkind, Harold A. Watkins, and Maurice Ritz will hereinafter sometimes be referred to respectively as Elkind, Watkins, and Ritz, or as the individual petitioners.The only question133 2 remaining to be determined insofar as petitioner is concerned is its correct basis in certain unimproved real estate transferred to it by Elkind, Watkins, and Ritz. In order to make this determination, we must first decide whether the transfer by Elkind, Watkins, and Ritz to petitioner constituted a valid sale or a contribution to capital. In the event we find it to be the latter, we must further determine whether it constitutes a transfer to a controlled corporation within the meaning of section 351. 3134 Insofar as petitioners Elkind, Watkins, and Ritz are concerned, we must determine whether certain amounts received by them during 1959 from petitioner were taxable as ordinary income, rather than as long-term capital gain. 4FINDINGS OF FACTSome of the facts have been stipulated, and the stipulation of facts, together with the exhibits attached thereto, is incorporated herein by this reference.Petitioner is a corporation formed under the laws of the State of Wisconsin. It maintains its books of account and files its Federal income tax returns on the basis of an accrual method of accounting and a fiscal year ended September 30. It filed its Federal income tax returns for its fiscal years ended September 30, 1958 through 1960, with the district director of internal revenue at Milwaukee, Wis.A. Aaron and Rosella Elkind were, at all times relevant135 hereto, husband and wife. They filed joint Federal income tax returns for 1958, 1959, and 1960, prepared on the basis of a calendar year and the cash method of accounting, with the district director of internal revenue at Milwaukee, Wis.Harold A. and Fannie G. Watkins were, at all times relevant hereto, husband and wife. They filed a joint Federal income tax return for 1959, prepared on the basis of a calendar year and the cash method of accounting, with the district director of internal revenue, Milwaukee, Wis.637 Maurice and Esther Leah Ritz were, at all times relevant hereto, husband and wife. They filed a joint Federal income tax return for 1959, prepared on the basis of a calendar year and the cash method of accounting, with the district director of internal revenue at Milwaukee, Wis.Elkind, at all times relevant hereto, has been engaged in various aspects of real estate development, with primary emphasis on the development of tracts of one-family houses. These various endeavors were generally conducted through corporations in which Elkind or members of his family were majority stockholders. Elkind also has made a number of investments in real estate, including 136 raw land as well as improved property producing rental income.Ritz, at all times relevant hereto, was a certified public accountant and the senior partner of an accounting firm of which Elkind was a client. Ritz had made various investments in improved and unimproved real estate prior to the years in issue herein, primarily as a result of opportunities which he came across in connection with his accounting practice.At all times relevant hereto, Watkins was the president and principal stockholder of a corporation engaged in the manufacture and sale of slippers and other types of casual footwear. Watkins, also, had made several investments in real property over the years, primarily in improved properties producing rental income.Elkind, Watkins, and Ritz have, at least upon one occasion other than that involved herein, jointly invested in a relatively large tract of unimproved real estate. Thus, on June 4, 1953, they purchased for the sum of $ 70,124.15 a tract of undeveloped land located just outside the city of Madison, Wis. These individuals held that property (hereinafter referred to as the Gay Farm) jointly until April 20, 1954, at which time it was sold to one of Elkind's137 development corporations for the sum of $ 149,650.79. That corporation subdivided the property into 353 lots, constructed one-family homes thereon, and made substantial profits totaling approximately $ 500,000 upon their sale.In the fall of 1954 Elkind came across the opportunity to purchase a similar piece of property, this time a tract of land of approximately 70 acres, also located near the outskirts of the city of Madison and theretofore used as a golf course. This property will hereinafter sometimes be referred to as the Burr Oaks property.Elkind, in December of the same year, contacted Ritz and Watkins in regard to their participation with him in the purchase of that land. Watkins and Ritz agreed to join him in the acquisition upon the understanding that each of them would obtain a one-third interest therein. On December 7 of that year, Elkind tendered to the owner 638 of said property a written offer to purchase the property for the sum of $ 100,000. The offer provided that $ 10,000 of the purchase price was payable at the time of acceptance, $ 10,000 on February 15, 1955, $ 5,000 on April 1, 1955, with payments of $ 5,000 due quarterly thereafter until the final138 balance was paid. The offer was accepted on December 8, 1954.From the time they acquired the Burr Oaks property through the summer of 1957 Elkind, Watkins, and Ritz attempted to develop said property as a shopping center site or as an industrial park. In furtherance of this plan, they purchased in 1955 an additional 80 feet of frontage on an adjoining thoroughfare for the purpose of providing better access to the Burr Oaks property in the event of its commercial development. This 80 feet of frontage will hereinafter be referred to as the Brinkman property. Their efforts to develop the Burr Oaks property for commercial purposes, however, proved fruitless.Sometime during 1957 Elkind became convinced that their plans to develop the Burr Oaks property as a shopping center or an industrial park would not materialize. Contemplating that one of his corporations might purchase the property for purposes of subdivision or development, Elkind requested two of his business associates to investigate the zoning and platting possibilities of the Burr Oaks property. On March 11, 1957, a petition was filed with the City Council of Madison, Wis., to change the zoning of the Burr Oaks property139 from residential A (single-family dwellings) to residential A2 and B (two-family and four-family dwellings) and commercial A and B.Elkind then proposed to Watkins and Ritz that the three of them sell the Burr Oaks property to one of Elkind's real estate corporations, as they had done with the Gay Farm property. Watkins and Ritz, recalling the substantial profits made by Elkind's corporation after they had sold the Gay Farm property to it, rejected this proposal. Ritz suggested that the three of them transfer the Burr Oaks property to a corporation which they would form for the purpose of subdividing, developing, and selling the property; that the shareholders thereof would be comprised of his two brothers and the wives of Watkins and Elkind; and that in return for the transfer of the land, the corporation would issue promissory notes to Elkind, Watkins, and Ritz. It was agreed that they would follow Ritz' suggestions.On September 9, 1957, the City Council of Madison approved a preliminary plat incorporating the zoning proposed for the property in the aforementioned petition filed on March 11, 1957. The land as platted contained 89 lots zoned for single-family dwellings (residential140 639 A); 65 lots zoned for four-family apartments (residential B); 110 lots zoned for multiple-family apartments (residential C); 1 site zoned for commercial use; and 1 site zoned for a school. This zoning received final approval from the Madison City Council on November 25, 1957.Petitioner was incorporated on October 8, 1957, for the purpose of (1) acquiring the Burr Oaks property from Elkind, Watkins, and Ritz; (2) developing and subdividing said property; and (3) selling improved lots therefrom to customers. At the time petitioner was formed, the Burr Oaks property was completely unimproved. Elkind, Watkins, and Ritz were aware of a local ordinance pursuant to which owners of unimproved land could request the city of Madison to make improvements thereon such as streets, sewers, water, and sidewalks. The city would make these improvements and assess the costs incurred in connection therewith against the property. However, it was realized that the cost of some of the improvements to be made, such as grading and supplying crushed stone, would have to be borne directly by the developers. The total cost of such improvements, as estimated by petitioner, was in the amount 141 of $ 107,243.33.It was determined by Ritz, Watkins, and Elkind that petitioner's initial capital would be $ 4,500.Petitioner issued a total of 450 shares of its common stock to a group composed of Elkind's wife, Watkins' wife, and Ritz' brothers, Philip and Erwin, for an aggregate consideration of $ 4,500. Elkind's wife received 150 shares of the stock; Watkins' wife also received 150 shares; and Philip and Erwin Ritz each received 75 shares. The record does not indicate the exact date when this stock was issued. Philip and Erwin Ritz paid for their stock by their respective checks, each in the amount of $ 750 and dated October 9, 1957. Watkins' wife paid for her stock by a check in the amount of $ 1,500 dated October 14, 1957. Each of the above-mentioned four persons received from petitioner a receipt dated November 1, 1957, evidencing their payment for the stock. At all times relevant hereto, petitioner's stockholders of record and officers and directors were as follows:NumberShareholderof sharesOfficersPosition heldDirectorsheldRosella ElkindWatkinsPresident.Watkins.(Elkind's wife)150Philip M. RitzVice president.Ritz.Fannie G. WatkinsRosella ElkindSecretary-treasurer.Elkind.(Watkins' wife)150Fannie G. Watkins.Philip M. RitzPhilip M. Ritz.(Ritz' brother)75Rosella Elkind.Erwin M. Ritz(Ritz' brother)75142 640 Petitioner's articles of incorporation, at all times relevant hereto, provided:(c) Any stock that is hereafter issued by the corporation may be sold to such persons and at such prices but not less than such prices as may be determined by the majority of the Board of Directors, and without first offering any part of said stock to the then present holders of stock in the corporation.On November 1, 1957, Elkind, Watkins, and Ritz transferred their respective interests in the Burr Oaks property to petitioner. In consideration for this transfer, petitioner assumed the remaining unpaid balance for the property, namely $ 30,000, and issued to each of Elkind, Watkins, and Ritz what purported on the face thereof to be a promissory note in the principal amount of $ 110,000. Each of the notes recited that it bore interest at the rate of 6 percent and that it was payable 2 years after the making thereof. The $ 30,000 obligation for the Burr Oaks property to its original owner, assumed by petitioner from Elkind, Watkins, and Ritz, was entered on petitioner's books under an account captioned "Mortgage Payable." An additional account was set up under the title "Land Contract Payable" 143 in the amount of $ 330,000 to represent the alleged promissory notes. At the time Elkind, Watkins, and Ritz transferred the Burr Oaks property to petitioner, the fair market value of said property was substantially less than $ 360,000. The property was not worth more than $ 165,000 at that time.Although at the time Elkind, Watkins, and Ritz transferred their interests in said property to petitioner they hoped that petitioner's business would be successful, petitioner's prospects were uncertain. The nature of their investment can best be described by the term "speculative."Shortly after its incorporation, petitioner found that it did not have sufficient funds on hand with which to commence operations. Therefore, on November 30, 1957, it borrowed $ 15,000 from Elkind. On February 28, 1958, Elkind loaned petitioner an additional $ 10,000. These loans, together with interest thereon in the amount of $ 1,859.78, were repaid on June 30, 1959.None of petitioner's stockholders of record, namely Watkins' and Elkind's respective wives and Ritz' brothers, took any active interest in the management of petitioner. In fact, none of them had any real idea of the nature of petitioner's 144 business, other than some vague notion that it was engaged in "real estate" in some way or other.Watkins and Ritz hired Albert McGinnes to manage petitioner. His work included the supervision of the platting, development, and subdivision of the land, as well as taking charge of advertising and sales. McGinnes had known and worked for Elkind and his various 641 corporations for approximately 15 years prior to that time as a lawyer and real estate broker and in various other capacities. McGinnes, moreover, was the person who first interested Elkind in purchasing the Burr Oaks property and checked into the zoning and platting possibilities for the land. During the years in issue, McGinnes continued to work for various Elkind interests.Ritz' accounting firm, Ritz, Holman & Co., kept petitioner's books and took care of its accounting work. McGinnes was required to account to Ritz, Holman & Co. for the funds which he took in and disbursed in connection with his operation of petitioner's business.Upon a number of occasions, petitioner transferred various lots or parcels of property to Elkind, Watkins, and Ritz, either at no cost or at a price less than the amount for which such145 lots could have been sold to third parties. Thus, by deed dated November 3, 1958, petitioner conveyed to Elkind, Watkins, and Ritz a strip of commercial property, 70 feet by 120 feet, located in the southeast corner of the Burr Oaks property. This property was contiguous with another piece of commercial property, the Brinkman property, which Elkind, Watkins, and Ritz had purchased when they were contemplating using Burr Oaks for a shopping center. Nothing was paid to petitioner in consideration for this transfer. The deed by which the transfer was effected purported on its face to correct an erroneous conveyance of the land to petitioner in the first place.On November 14, 1958, petitioner sold five lots at a price of $ 3,000 per lot to the Leo Building Corp., which was owned and controlled by Elkind and an associate of his. On the same date petitioner sold an additional five lots for the same price to Carsons, Inc., a corporation owned by Watkins. Petitioner, on May 20, 1960, sold five more lots at $ 3,000 per lot to M & L Investment, Inc., a corporation in which Ritz owned a substantial interest. Each of the lots involved in these transfers was zoned residential B to accommodate146 four-family apartments. The evidence indicates that, at the time they were sold after having been platted, subdivided, and improved, each of these lots could have been sold to outsiders for $ 500 to $ 1,000 more than was received from the above corporations. None of petitioner's shareholders of record (Philip and Erwin Ritz, Elkind's wife, or Watkins' wife) was consulted with regard to, or knew of, any of these transfers. Nor was any such transfer authorized by a meeting of petitioner's board of directors.Although McGinnes was in charge of petitioner's day-to-day operations, Elkind, Watkins, and Ritz controlled and dominated petitioner's affairs.642 During its taxable years 1958 through 1963, inclusive, petitioner had gross receipts in the following amounts as a result of its subdivision and sale of the Burr Oaks property:Taxable year endedGross salesSept. 30 --of lots1958$ 86,0951959177,2001960118,625196168,250196249,400196313,900Total513,470As had been contemplated by Elkind, Watkins, and Ritz at the time of petitioner's incorporation, improvements to the Burr Oaks property, such as streets, sewers, water, and sidewalks, were made147 by the city of Madison. The city was to recover the cost of these improvements by special assessments against the lots, which assessments were generally payable over a period of 5 to 8 years. To the extent that installments of the special assessments came due prior to the sale of the lots, they were paid by petitioner and added to the price of the lots. To the extent the assessments had not been paid prior to the sale of the lots, they were assumed by the purchaser. Certain costs incurred in connection with the subdivision and improvement of the Burr Oaks property were borne directly by petitioner. These costs included the following: (1) The cost of installing a sewer along one of the streets in the subdivision; (2) a surveying fee running from $ 25 to $ 40 per lot; and (3) the costs of grading and supplying crushed stone. The cost of improvements incurred by petitioner in subdividing the Burr Oaks property, including the special assessments paid by it, totaled $ 107,243.33.In addition to the foregoing costs, petitioner during its taxable years ended September 30, 1958, through September 30, 1963, incurred the following operating expenses in connection with its subdivision 148 and sale of the Burr Oaks property:Taxable year endedSept. 30 --Amount1958$ 21,281.61195922,077.74196020,217.49196120,650.46196221,182.44196315,500.14In the latter part of 1959 Elkind, Watkins, and Ritz surrendered to petitioner the original "promissory notes" which they had received from petitioner in connection with their transfer of the Burr Oaks property. In return for the surrender of the notes, each of the individual 643 petitioners received from petitioner a distribution of $ 23,000 in cash and a promissory note dated November 1, 1959, in the principal amount of $ 87,000. The new notes recited (1) that they were payable 1 year after the making thereof and (2) that they bore interest at the rate of 6 percent per annum. Later that same year, petitioner paid an additional $ 8,000 apiece to Elkind, Watkins, and Ritz. Petitioner at that time, in exchange for each of their notes in the principal amount of $ 87,000, issued to each of them a new promissory note in the principal amount of $ 79,000.On December 29, 1959, petitioner purported to repay the outstanding balance on these "new promissory notes." At the close of business on that date149 petitioner had a bank balance of $ 5,398.88. The record does not clearly indicate how petitioner purported to repay these notes. However, the record does clearly indicate that petitioner urgently needed as working capital the $ 237,000 which it claims to have used to repay the three promissory notes. Therefore, immediately after those notes were "repaid," Elkind, Watkins, and Ritz each "loaned" $ 79,000 to petitioner, and petitioner, in turn, issued to each of the individual petitioners a "new" 1-year promissory note dated December 31, 1959, in the principal amount of $ 79,000. This transaction did not represent a repayment of the alleged "promissory notes." It was merely an extension of the purported maturity date. The individual petitioners never had any intention of enforcing their "notes" against petitioner.In addition to the foregoing, petitioner made the following distributions to each of the individual petitioners with regard to the "promissory notes":Amountpaid to each ofDate ofthe individualdistributionpetitionersAug 31, 1960$ 8,000Jan. 31, 196115,000Dec. 31, 196110,000There was an aggregate balance of $ 138,000 outstanding upon 150 the three "notes" at the time of the trial in this proceeding, or a total of $ 46,000 due upon each of said notes.Petitioner has not distributed any of its earnings to any of the shareholders of record.Elkind, Watkins, and Ritz treated their transfer of the Burr Oaks property to petitioner in November 1957 as a sale. Petitioner did likewise and set up on its books a cost of $ 360,000 for said property. Elkind, Watkins, and Ritz, however, did not report any gain with regard to this alleged sale until 1959 when petitioner purportedly paid in full the promissory notes which it had issued to them in connection with said transfer. In their respective income tax returns for 1959, 644 each of them reported long-term capital gain in the amount of $ 85,729.06 as a result of their transfer of the Burr Oaks property to petitioner in 1957.Respondent, pursuant to separate notices of deficiency issued to Elkind, Watkins, and Ritz with respect to their taxable year ended December 31, 1959, determined that --the gain realized from the sale of * * * [the Burr Oaks property] in the total amount of $ 85,729.06 is taxable as ordinary income rather than as long-term capital gains reported151 on your income tax return. * Pursuant to a statutory notice of deficiency issued to petitioner with respect to its taxable years 1958 through 1960, respondent increased petitioner's taxable income for said years by an aggregate amount totaling $ 192,686.98. This increase was based on respondent's determination that petitioner had understated its income for those years by claiming too high a basis or cost in the land sold by it in that period. The notice of deficiency indicates that, in making his determination, respondent treated petitioner as having a basis of $ 100,000 in the Burr Oaks property, rather than a basis of $ 360,000, as petitioner had claimed.OPINIONThere are two issues to be determined in this case. These are (1) petitioner's correct basis in the Burr Oaks property and (2) the proper tax treatment of the amounts received by Elkind, Watkins, and Ritz from petitioner during 1959. In order to resolve these issues, we must classify, for tax purposes, the transaction wherein each of the individual petitioners in November 1957 (1) transferred his respective interest in the Burr Oaks property to petitioner and (2) in return therefor received an instrument purporting152 to be a promissory note in the principal amount of $ 110,000.It is contended by Elkind, Watkins, and Ritz (1) that their transfer of the Burr Oaks property to petitioner constitutes the sale or exchange of a capital asset held in excess of 6 months; (2) that the promissory note received by each of them in return therefor represents a valid indebtedness incurred by petitioner; and (3) that the gain realized by them in connection with said transfer is properly reportable in 1959 when they allege that petitioner "paid in full" the "promissory notes" which had been issued to them. 5153 645 It is contended by petitioner that it purchased the Burr Oaks property from Elkind, Watkins, and Ritz at a cost of $ 360,000 and that such cost is its correct basis in said property.The plethora of arguments advanced by respondent in his opening statement and on brief indicates to us that the Government had some difficulty in formulating a suitable rationale under which to classify the transfer of the Burr Oaks property to petitioner. It would serve no purpose to set forth at this point the various contentions made by respondent since we believe that the transaction was not a sale, but an equity contribution. 6154 It is true that Elkind, Watkins, and Ritz attempted to cast their transfer of the Burr Oaks property to petitioner in the form of a sale. It is also true that, from a standpoint of form, the alleged promissory notes issued to the individual petitioners are clear evidences of indebtedness. However, it has often been noted in connection with similar issues, the substance of the transaction, rather than its form, is the controlling factor in the determination of the proper tax treatment to be accorded thereto. Sherwood Memorial Gardens, Inc., 42 T.C. 211 (1964), on appeal (C.A. 7, Aug. 10, 1964); 1432 Broadway Corporation, 4 T.C. 1158">4 T.C. 1158 (1945), affd. 160 F. 2d 885 (C.A. 2, 1947). Whether a transaction such as the one we are now confronted with is in substance, as well as in form, a sale is essentially 646 a question of fact. Gooding Amusement Co., 23 T.C. 408 (1954), affd. 236 F. 2d 159 (C.A. 6, 1956), certiorari denied 352 U.S. 1031">352 U.S. 1031 (1957).As we view the creditable evidence presently before us, the transfer155 of the Burr Oaks property to petitioner is so lacking in the essential characteristics of a sale and is replete with so many of the elements normally found in an equity contribution (cf. Emanuel N. ( Manny) Kolkey, 27 T.C. 37">27 T.C. 37 (1956), affd. 254 F. 2d 51 (C.A. 7, 1958), and Bruce v. Knox, 180 F. Supp. 907 (D. Minn. 1960)) that it appears to us as nothing more than a shabby attempt to withdraw from petitioner, at capital gains rates, the developer's profit normally inherent in the subdivision and sale of raw acreage such as the Burr Oaks property.This Court has been required upon numerous occasions to determine the true nature of alleged sales or transfers of assets to corporations. In the Kolkey case, we listed the following questions as among the relevant criteria for making such a determination:Was the capital and credit structure of the new corporation realistic? What was the business purpose, if any, of organizing the new corporation? Were the noteholders the actual promoters and entrepreneurs of the new adventure? Did the noteholders bear the principal risks of loss attendant156 upon the adventure? Were payments of "principal and interest" on the notes subordinated to dividends and to the claims of creditors? Did the noteholders have substantial control over the business operations; and if so, was such control reserved to them as an integral part of the plan under which the notes were issued? Was the "price" of the properties, for which the notes were issued, disproportionate to the fair market value of such properties? Did the noteholders, when default of the notes occurred, attempt to enforce the obligations? [Emanuel N. ( Manny) Kolkey, supra at 59.]We have set forth in our Findings of Fact, with some degree of specificity, the various factors which cause us to conclude that the transfer of the Burr Oaks property to petitioner was an equity contribution, rather than a sale. We set forth below some of the more significant factors which led us to this conclusion.In the first place, petitioner, from the start of its existence, was not only undercapitalized, but, in fact, had no significant capitalization at all. Cf. Hoguet Real Estate Corporation, 30 T.C. 580">30 T.C. 580, 598 (1958). Thus, 157 petitioner was organized in October with a paid-in capital of $ 4,500. Shortly thereafter, when Elkind, Watkins, and Ritz transferred the Burr Oaks property to petitioner, its books of account reflected liabilities of $ 360,000. In addition, it was contemplated from the very outset of petitioner's existence that although the city of Madison would initially pay the major portion of the cost of improving the Burr Oaks property, petitioner would, nevertheless, be required to incur substantial development costs. Petitioner estimated that these costs would be in excess of $ 100,000.Another factor indicating that petitioner was undercapitalized and did not have sufficient funds with which to commence business 647 is that on November 30, 1957, less than 2 months after it was formed, it borrowed $ 15,000 from Elkind. On February 28, 1958, it borrowed an additional $ 10,000 from Elkind.Moreover, the land transferred to petitioner by Elkind, Watkins, and Ritz was its only asset of significance and, without it, petitioner could not have engaged in business. See and compare Edward G. Janeway, 2 T.C. 197 (1943), affd. 147 F. 2d 602158 (C.A. 2, 1945); Aqualane Shores, Inc., 30 T.C. 519">30 T.C. 519 (1958), affd. 269 F. 2d 116 (C.A. 5, 1959). It was at all times contemplated by Elkind, Watkins, and Ritz that the land would remain at the risk of petitioner's business.It is generally recognized that one of the crucial factors in determining whether the transfer of property to a thinly capitalized corporation constitutes a bona fide sale, rather than a mere contribution to capital, is the anticipated source of payment to the transferor. Gilbert v. Commissioner, 262 F.2d 512">262 F. 2d 512, 514 (C.A. 2, 1959), affirming a Memorandum Opinion of this Court, certiorari denied 359 U.S. 1002">359 U.S. 1002 (1959). If payment to the transferor is dependent solely upon the success of an untried, undercapitalized business, the prospects of which are uncertain, the transfer of property raises a strong inference that it is, in fact, an equity contribution. But cf. Miller's Estate v. Commissioner, 239 F. 2d 729, 733 (C.A. 9, 1956), reversing 24 T.C. 923">24 T.C. 923 (1955); Sheldon Tauber, 24 T.C. 179">24 T.C. 179, 181-182 (1955);159 and Ainslie Perrault, 25 T.C. 439 (1955), affirmed per curiam 244 F. 2d 408 (C.A. 10, 1957), where repayment of the notes involved was dependent upon the continued success of an established business with a good earnings record and excellent future prospects.At the time of the transfer of the Burr Oaks property to petitioner, its business prospects can only be described as speculative and uncertain. 7 Elkind, Watkins, and Ritz realized that the only way petitioner could raise the $ 100,000 needed by it for improvements would be from sales of lots. It is obvious that the only hope that Elkind, Watkins, and Ritz had of obtaining repayment of the so-called promissory notes depended upon the successful development and sale of the lots in the Burr Oaks property.160 Despite the fact that the respective interests of Elkind, Watkins, and Ritz in petitioner were represented by what purported on their face to be promissory notes in the principal amount of $ 110,000, the evidence before us indicates that it was the intent of all concerned with the affairs of petitioner that these instruments would give Elkind, 648 Watkins, and Ritz a continuing interest in petitioner's business. The instruments issued by petitioner to Elkind, Watkins, and Ritz recited that they were to mature in 2 years from the date of issuance. However, after a review of the entire record, we believe that it was understood that no payment would be made on the notes, or would ever be demanded by Elkind, Watkins, and Ritz, which in any way would weaken or undermine petitioner's business. See Charter Wire, Inc. v. United States, 309 F. 2d 878, 881 (C.A. 7, 1962). It is true that petitioner during 1959 paid $ 31,000 apiece to Elkind, Watkins, and Ritz with respect to their so-called promissory notes. 8 However, petitioner's history with regard to making payments on the alleged promissory notes indicates that the payments thereon came only161 from gains derived through the sale of lots. Moreover, the fact that there was outstanding a substantial principal balance ($ 46,000) on each of the notes issued to the individual petitioners even as late as the time of the trial herein indicates that the alleged notes were intended to give the individual petitioners a continuing equity interest in petitioner. See Charter Wire, Inc. v. United States, supra at 881.162 The evidence clearly indicates that although Elkind, Watkins, and Ritz were not stockholders of record in petitioner, nevertheless, they completely dominated and controlled petitioner's affairs. Watkins was petitioner's president. Petitioner's board of directors consisted of Elkind, his wife, Ritz, his brother Philip, Watkins, and Watkins' wife. McGinnes, the man who ran petitioner's day-to-day affairs, had been employed by Elkind in one capacity or another for a period of at least 15 years. His activities were generally supervised by Ritz' accounting firm. After listening to his testimony and that of Elkind, Watkins, and Ritz, we are convinced that McGinnes operated petitioner in accordance with their wishes.Petitioner's shareholders of record consisted of Ritz' brothers Philip and Erwin, Elkind's wife, and Watkins' wife. They knew and understood little, if anything, of the nature of petitioner's business. Moreover, after listening to the testimony at the trial, it was obvious to us that they were subject to the control of Elkind, Watkins, and Ritz.By virtue of the provision in petitioner's articles of incorporation regarding the issuance of additional shares of common stock163 at such prices as a majority of the board of directors should determine, Elkind, 649 Watkins, and Ritz were in a position to appropriate to themselves (through the issuance of additional common stock at whatever price they chose) substantially all of the profits that petitioner might realize after repaying its purported indebtedness to them.The record also indicates that in transferring the Burr Oaks property to petitioner, Elkind, Watkins, and Ritz assigned a highly inflated value to said property. 9 Cf. Emanuel N. (Manny) Kolkey, supra at 61. The transfer of the Burr Oaks property to petitioner seems to us an integral part of a plan devised by Ritz whereby Ritz, Watkins, and Elkind could obtain an assured participation in the fruits of the development and subdivision of said property. See Bruce v. Knox, supra at 912. Watkins and Ritz both admitted that petitioner was formed in order to allow them to receive some part of the development profits. The inflation of the "sales price" to petitioner served to extend the period during which Elkind, Watkins, and Ritz could participate in petitioner's business as "creditors" and increased164 the amount which they could withdraw as "principal" if the venture proved successful.These are some of the factors which led us to conclude that the promissory notes received by Elkind, Watkins, and Ritz did not represent a true indebtedness. The purported promissory notes issued to the individual petitioners in our opinion constitute preferred stock. 10 See 1432 Broadway Corporation, supra at 1166; Foresun, Inc., 41 T.C. 706">41 T.C. 706, 717 (1964),165 on appeal (C.A. 6, Apr. 20, 1964); and Sherwood Memorial Gardens, Inc., supra at 230.Having decided that for tax purposes the so-called promissory notes issued to Elkind, Watkins, and Ritz constitute an equity interest in petitioner, we must now determine whether the transfer of the Burr Oaks property is governed by section 351.Section 351 deals with transfers of property to a corporation controlled by the transferor or transferors. 166 In pertinent part that section provides:(a) * * No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities 650 in such corporation and immediately after the exchange such person or persons are in control (as defined in section 368(c)) of the corporation. * Section 368(c) defines "control" for purposes of section 351 as meaning "ownership of stock possessing at least 80 percent of the total combined voting power of all classes of stock entitled to vote and at least 80 percent of the total number of shares of all other classes of stock of the corporation."In contending that section 351 does not govern the transfer of the Burr Oaks property, petitioner has presented three arguments. Two of these arguments (that the transaction was a sale and that no stock or securities were issued to the transferors of the property) have been previously considered and resolved adversely to petitioner. The third argument presented is that Elkind, Watkins, and Ritz, who transferred the Burr Oaks property to petitioner, were not, immediately after that transaction, in control of that corporation within167 the meaning of the term "control" as defined in section 368(c). Thus, it is contended that even if the promissory notes held by Elkind, Watkins, and Ritz constituted stock, that stock did not carry with it any voting rights. Petitioner further points out (1) that pursuant to its bylaws the right to vote was reserved exclusively to the shareholders of record, namely, Elkind's wife, Watkins' wife, and Ritz' two brothers, and (2) that, for the above reason, the transferors of the Burr Oaks property (Elkind, Watkins, and Ritz) failed to comply with the control requirements set forth in section 368(c) because they did not possess "ownership of stock possessing at least 80 percent of the total combined voting power of all classes of stock entitled to vote." There is a basic fallacy in petitioner's argument in that it is premised on the assumption that Elkind, Watkins, and Ritz were the only transferors of property to petitioner.As we view the transaction, Elkind, Watkins, and Ritz acted together with Elkind's wife, Watkins' wife, and Ritz' two brothers in forming petitioner. The record clearly indicates that each of them transferred property to petitioner. As we have previously found, 168 Elkind's wife, Watkins' wife, and Philip and Erwin Ritz transferred to petitioner a total of $ 4,500 shortly after its incorporation. It is settled law that money constitutes property for purposes of section 351. American Bantam Car Co., 11 T.C. 397">11 T.C. 397 (1948), affirmed per curiam 177 F. 2d 513 (C.A. 3, 1949), certiorari denied 339 U.S. 920">339 U.S. 920 (1950). In return therefor, petitioner issued to them an aggregate of 450 shares of its common stock. Shortly thereafter, Elkind, Watkins, and Ritz transferred to petitioner their respective interests in the Burr Oaks property and, in return, received what on its face purported to be promissory notes, but what we have previously determined to be preferred stock.651 Although Elkind, Watkins, and Ritz may not have received their preferred stock interests in petitioner at exactly the same time as the common stock was issued to Ritz' brothers and the respective wives of Elkind and Watkins, it seems clear that the transfers of cash and the Burr Oaks property to petitioner were integral parts of a unified transaction. Camp Wolters Enterprises v. Commissioner, 230 F.2d 555">230 F. 2d 555, 559169 (C.A. 5, 1956), affirming 22 T.C. 737">22 T.C. 737 (1954), certiorari denied 352 U.S. 826">352 U.S. 826 (1956). See also section 1.351-1(a)(1), Income Tax Regs., which provides:The phrase "immediately after the exchange" does not necessarily require simultaneous exchanges by two or more persons, but comprehends a situation where the rights of the parties have been previously defined and the execution of the agreement proceeds with an expedition consistent with orderly procedure. * On the basis of the record before us, it appears to us that Elkind, Watkins, and Ritz, together with Ritz' brothers, Elkind's wife, and Watkins' wife, were in control of petitioner, as defined in section 368 (c), immediately after their transfer of property to it. The fact that Elkind, Watkins, and Ritz received no common stock, which according to petitioner's articles of incorporation was the only class of stock entitled to vote, is of no significance; for there is no requirement in section 351 that each transferor receive voting stock for that section to be applicable. See Cyrus S. Eaton, 37 B.T.A. 715">37 B.T.A. 715 (1938), which involved the transfer170 of property by two persons to a controlled corporation. One transferor therein received only common stock and the other received only nonvoting preferred. In commenting upon the question of control, we stated: "Inasmuch as the transferors * * * owned all of the stock of the corporation, they have the necessary control required by the statute." 11 See also Gus Russell, Inc., 36 T.C. 965">36 T.C. 965 (1961).Since the nonrecognition provisions of section 351 apply to the transfer of the Burr Oaks property to petitioner, petitioner's basis in said property is limited to $ 100,000, which is a carryover basis from the transferors. Sec. 362(a)(1). 12171 Insofar as the distributions made by petitioner during 1959 to Elkind, Watkins, and Ritz are concerned, we have previously found that, to the extent they purported to be a repayment of the "promissory 652 notes," they were a sham. The net effect of the various payments by petitioner and exchanges of notes was that petitioner distributed $ 31,000 apiece to Elkind, Watkins, and Ritz in 1959. To this extent, the distributions resemble a redemption of stock in that the respective interests of these three individuals in petitioner were proportionately lessened. However, we are unable to find that said distributions fit within any of the paragraphs of section 302(b). Therefore, the $ 31,000 distributed by petitioner to Watkins, Elkind, and Ritz is governed by section 302(d) and to the extent of petitioner's earnings and profits is to be treated as a dividend. 13Decisions will be entered172 under Rule 50. Footnotes1. Proceedings of the following petitioners are consolidated herewith: A. Aaron Elkind and Rosella Elkind, docket No. 4772-62; Harold A. Watkins and Fannie G. Watkins, docket No. 1581-63; and Maurice Ritz and Esther Leah Ritz, docket No. 1583-63.↩2. Respondent has conceded that certain costs incurred by petitioner should be allowed as current costs of sales rather than be allocated to several years as they were treated in the notice of deficiency. Petitioner has conceded that certain gains from the sale of lots, which it reported as received during its taxable year 1960, were properly reportable during its taxable year 1959. Petitioner's only contention with regard to those sales is that its basis for the lots sold should be higher than that determined by respondent.↩3. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954, as it existed during the taxable years in issue.↩4. All other issues raised by the individual petitioners in their pleadings have been settled pursuant to agreement between the parties or have been conceded or abandoned.↩5. Passing over for the moment the validity of the first two parts of the individual petitioners' argument, we believe it appropriate to point out that the third part of their argument, namely, that the gain realized by them on the transfer of the Burr Oaks property was properly reportable in 1959, is incorrect. Watkins, Elkind, and Ritz at all times relevant hereto were cash basis taxpayers. When cash basis taxpayers sell property, they must include in income the fair market value of any property received in exchange therefor. This would include the fair market value of any notes received. See Pinellas Ice Co. v. Commissioner, 287 U.S. 462">287 U.S. 462 (1933). The individual petitioners have not advanced any of the arguments which would enable them to avoid the applicability of this general rule. Thus, they have made no argument that the "promissory notes" received by them were of indeterminate or unascertainable value or that the notes were not received by them in payment for the land. Cf. Robert J. Dial, 24 T.C. 117 (1955); Jay A. Williams, 28 T.C. 1000 (1957); and Schlemmer v. United States, 94 F. 2d 77 (C.A. 2, 1938). Nor do they contend (1) that the fair market value of the "notes" received by them was less than their respective bases in the land, cf. sec. 1.1001-1, Income Tax Regs., or (2) that the transfer was not a closed transaction, cf. Joseph Marcello, 43 T.C. 168">43 T.C. 168 (1964). There is nothing in the record to show that (1) they elected to report the gain realized by them at the time of the transfer on the installment method or (2) that they were entitled to report their gain on the deferred payment sale method. See sec. 1.453-4(b)(1) and (2) and sec. 1.453-6, Income Tax Regs.↩6. The statutory notices issued to the individual petitioners seem to be grounded on the theory that Elkind, Watkins, and Ritz were not entitled to report the sale of the Burr Oaks property as long-term capital gain since they were dealers. The deficiency notices did not raise any question with regard to the proper year for reporting the gain. In view of the fact that respondent, in the deficiency notice to petitioner-corporation, determined that petitioner's basis for the Burr Oaks property was the same as that of the transferors of the property, said statutory notice would seem to be based on the theory that the transfer was governed by sec. 351. This is undoubtedly what caused Elkind, Watkins, and Ritz to raise the following issue by way of amended petition: "In the alternative, in the event the basis of the * * [Burr Oaks property] in the hands of * * * [petitioner] is determined under section 351 of the Internal Revenue Code, respondent erred in failing to determine that petitioners had no taxable gain for the year 1959 as a result of the transfer of the said real estate to * * * [petitioner]."We have concluded that the transfer of the Burr Oaks property to petitioner was not a sale on the basis of the clear, uncontroverted facts in the record and without resort to the burden of proof. Nevertheless, we believe it appropriate to point out that the petitioners Elkind, Watkins, and Ritz, as well as the Burr Oaks Corp., have the burden of proof on this issue. For even if we were to regard the issue of whether the transfer of the property constitutes a bona fide sale as new matter insofar as Elkind, Watkins, and Ritz are concerned, they raised that question by way of their amended petition.↩7. It was argued on behalf of petitioner and Watkins, Elkind, and Ritz that at the time of the transfer of the property to petitioner a number of lots were ready for sale and that because of the money that could be derived therefrom petitioner did not need a great deal of capital at the time of its incorporation. However, there was no assurance that petitioner would be able to sell any of these lots right away. As matters actually developed, petitioner encountered difficulty in selling lots after it was formed, which caused it to borrow money from Elkind.↩8. On brief, it is argued on behalf of the various petitioners herein that the series of exchanges of notes that occurred at the end of December 1959 between Elkind, Watkins, and Ritz, on the one hand, and petitioner, on the other, constituted a repayment by petitioner of the "unpaid principal balance" in the amount of $ 79,000 on each of the alleged promissory notes, followed immediately by an advance of a similar amount by each of the individual petitioners. This alleged repayment by petitioner of an aggregate of $ 237,000 took place at a time when petitioner's liquid assets totaled less than $ 5,500. It is too much to ask this Court to believe that such an obvious sham constituted a repayment of the alleged notes. Cf. Arthur L. Kniffen, 39 T.C. 553">39 T.C. 553, 565-566↩ (1962).9. An expert witness introduced by petitioner testified that the Burr Oaks property was worth at least $ 360,000 when it was transferred to petitioner in November of 1957. However, we found the evidence presented by respondent's expert witness that the property had a fair market value of approximately $ 125,000 far more convincing, although not fully persuasive. On the basis of the evidence before us, we found the Burr Oaks property to have a fair market value of not more than $ 165,000 at the time of its transfer to petitioner.↩10. Although we have found the purported promissory notes to constitute equity interests in petitioner for tax purposes, we believe that the holders of those instruments occupied a preferred position vis-a-vis the holders of the common stock. In the first place, the purported promissory notes called for the payment of interest at 6 percent a year. This provision constituted a prior charge on the earnings of petitioner in favor of the holders of those instruments, not unlike a preferred dividend. Thus, we regard the purported promissory notes as preferred stock.↩11. This Court ultimately held that the nonrecognition provisions of sec. 112(b), I.R.C. 1939 (the predecessor of sec. 351), did not apply because the transferors failed to comply with the provisions of the "substantially proportionate" test which Congress deleted from the section when it was reenacted as sec. 351, I.R.C. 1954↩.12. SEC. 368. BASIS TO CORPORATIONS.(a) Property Acquired by Issuance of Stock or as Paid-In Surplus. -- If property was acquired on or after June 22, 1954, by a corporation -- (1) in connection with a transaction to which section 351↩ (relating to transfer of property to corporation controlled by transferor) applies, * * *then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain recognized to the transferor on such transfer.13. Petitioner's earnings and profits for the taxable years relevant hereto will be determined in the Rule 50 computation.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623513/	C. P. LATHROP & CO., INC., AND SOUTHERN SAND & GRAVEL CO., INC., PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.C. P. Lathrop & Co. v. CommissionerDocket No. 6603.United States Board of Tax Appeals5 B.T.A. 879; 1926 BTA LEXIS 2745; December 21, 1926, Promulgated 2745 1. Petitioners were affiliated during the calendar year 1920. 2. In view of the evidence in this proceeding, it is held that the Commissioner was not justified in reducing the allowance claimed by C. P. Lathrop & Co., Inc., for compensation paid to its officers. M. W. Cookerow, Esq., and J. McD. Wellford, Esq., for the petitioners. J. Harry Byrne, Esq., for the respondent. LITTLETON879 The Commissioner determined a deficiency in income and profits taxes of $3,093.30 against C. P. Lathrop & Co., Inc., for the calendar year 1920, and that company instituted this proceeding within sixty days after the mailing of the notice of deficiency. By consent of the parties the Southern Sand & Gravel Co., Inc., was made a petitioner to the proceeding. Petitioners claim that the Commissioner erred in holding that they were not affiliated within the meaning of section 240(b) of the Revenue Act of 1918, and in disallowing as a deduction $15,000 of a total of $50,500 paid as compensation for officers. FINDINGS OF FACT. Petitioners are Virginia corporations with principal office at Richmond. C. P. Lathrop & Co., Inc., was engaged in purchasing2746 and selling at wholesale and retail builders' supplies of all kinds except hardware. The business was commenced by C. P. Lathrop, Sr., about 1865, and for about thirty years prior to incorporation on April 8, 1920, the business was carried on in partnership with James D. Patton, Sr. During a period of several years prior to incorporation C. P. Lathrop, Jr., and C. B. Lathrop, sons of C. P. Lathrop, Sr., were also partners. The Southern Sand & Gravel Co., Inc., incorporated in 1911, was engaged in the production of sand and gravel and its product was sold exclusively by C. P. Lathrop & Co., Inc. The Southern Sand & Gravel Co., Inc., was separately incorporated for bookkeeping purposes, in order to segregate the costs of materials and expenses incurred. The entire production of the Southern Sand & Gravel Co., Inc., has always been sold by C. P. Lathrop & Co., Inc., and the 880 officers of the latter managed the affairs of the Southern Sand & Gravel Co., Inc., conducted its policies, purchased its supplies, and selected its employees. The officers of C. P. Lathrop & Co., Inc., were also officers of the Southern Sand & Gravel Co., Inc. The plant and land of the Southern2747 Sand & Gravel Co., Inc., were turned over to it by the Lathrop family, who were the principal owners of C. P. Lathrop & Co., Inc., for all of its capital stock. Twenty-five shares were later sold to James D. Patton, Sr., and 10 shares to J. D. Patton, Jr. To all intents and purposes the Sourthern Sand & Gravel Co., Inc., has always been conducted as a branch of C. P. Lathrop & Co., Inc. During the taxable year 1920 the common voting stock of these corporations was owned as follows: C. P. Lathrop & Co., Inc.Southern Sand & Gravel Co., Inc.Stockholders.No. of shares.Per cent.No. of shares.Per cent.C. P. Lathrop, Sr7503051 2/332.29C. P. Lathrop, Jr7503046 2/329.16C. B. Lathrop7503026 2/316.7Jas. D. Patton, Jr1004106.3C. N. Stutz753Edward McCurley502Branch Barksdale251Jas. D. Patton, Sr.2515.6Total2,500100160100Upon incorporation of C. P. Lathrop & Co., Inc., in April, 1920, C. P. Lathrop, Sr., his two sons, and Jas. D. Patton, Sr., turned over their partnership interests to the corporation for stock, the common stock being taken by the Lathrops and 650 shares2748 of preferred stock, being the total issued and outstanding preferred stock at that time, were issued to Jas. D. Patton, Sr. Shortly after incorporation certain shares of common stock of C. P. Lathrop & Co., Inc., were sold to Jas. D. Patton, Jr., C. N. Stutz, Edward McCurley, and Branch Barksdale, employees, for which they gave their notes and turned the stock back to the corporation to be held until the notes were paid. These notes were not paid during 1920. These individuals voted the stock during the time it was so held by the corporations. The stock in both companies, other than that issued to the Lathrops, was issued to the persons named on condition that if they should desire to relinquish it they would first offer to sell it to the Lathrops or to the corporation. 881 C. P. Lathrop, Sr., and his two sons were president, vice president, and treasurer, respectively, of both corporations. Jas. D. Patton, Jr., was made secretary of C. P. Lathrop & Co., Inc., some time during 1920. C. P. Lathrop, Sr., was the active head of the business and the prime mover in all of the affairs of both corporations. He personally indorsed all notes of the corporation for money borrowed. 2749 The gross business of C. P. Lathrop & Co., Inc., for 1920 was in excess of $800,000. At the date of incorporation C. P. Lathrop & Co., Inc., authorized a drawing account of $1,000 a month each for C. P. Lathrop, Sr., president, and C. P. Lathrop, Jr., vice president, and $300 a month for Jas. D. Patton, Jr., secretary. It was the avowed purpose of the corporation at the time to adjust the officers' salaries during the year to conform to the judgment of the directors as to the value of the services rendered to the corporation. During the year 1920 officers' salaries were determined, entered upon the books, and paid without regard to stockholdings, as follows: C. P. Lathrop, Sr., president$15,000C. P. Lathrop, Jr., vice president15,000C. B. Lathrop, treasurer15,000Jas. D. Patton, Jr., secretary5,500Total50,500This amount was claimed as a deduction by C. P. Lathrop & Co., Inc., in its return for 1920. The Commissioner disallowed $15,000 of the amount as a deduction. The Southern Sand & Gravel Co., Inc., paid salaries only to C. P. Lathrop, Sr., president, and C. P. Lathrop, Jr., vice president, in the amount of $5,000 each. It reported a loss2750 of approximately $6,000 for the year 1920. C. P. Lathrop, Jr., assisted his father generally in the management of the corporations and he was also the principal salesman of the business. C. B. Lathrop and Jas. D. Patton, Jr., in addition to their duties as treasurer and secretary, respectively, were engaged exclusively as salesmen of the company's product. The officers and salesmen of the corporation bore their own expenses without reimbursement, and considerable amounts were expended by them in promoting the interests of the corporation and in selling its product. C. B. Lathrop had been with the business since 1904; C. P. Lathrop, Jr., since 1905. Jas. D. Patton, Sr., who had been a partner for about 30 years, withdrew from active participation in the business shortly before incorporation. He was paid no salary by either corporation. Jas. D. Patton, Jr., had been with the business since 1910. Edward McCurley was bookkeeper and C. N. Stutz was employed in the lumber department. 882 The officers whose salaries are here in controversy devoted their entire time to the business. C. P. Lathrop & Co., Inc., reported a net income for 1920, after payment of officers' 2751 salaries, of $20,000. OPINION. LITTLETON: Upon consideration of the evidence submitted, we are of opinion that the stockholders of C. P. Lathrop & Co., Inc., owned or controlled all the stock of the Southern Sand & Gravel Co., Inc., during the calendar year 1920. In the deficiency notice mailed to C. P. Lathrop & Co., Inc., the Commissioner gave no reason for reducing the allowance for officer's salaries for 1920 from $50,500 to $35,500. Presumably, he thought that the total of the salaries paid by the corporation to its officers was unreasonable in amount. The Board is of the opinion from the evidence submitted in this proceeding that the Commissioner was not justified under the statute in reducing the deduction claimed by the corporation for compensation of its officers. The success of the business was due primarily to the services rendered by them; they devoted their entire time and efforts in the interest of the corporation. The entire responsibility of the management and the matter of profitableness of operations rested upon them. The greater portion of the corporation income was due to their efforts. They were put to considerable personal expense in selling the2752 corporation's product in the face of keen competition, for which they were not reimbursed by the corporation. The officers had been with the business for a number of years, were experienced and capable men in this line, and were well acquainted with the persons and concerns, both large and small, having need for the material which the corporation was selling. All of this resulted in the corporation being one of the largest builders' supplies concerns in its territory. There is no indication that the salaries paid constituted a distribution of profits in the guise of compensation; in fact the evidence is to the contrary. In view of these facts, the Board is of the opinion that the Commissioner was not justified in reducing the deduction claimed by the corporation for compensation of officers, and his action in this regard is reversed. Judgment will be entered on 15 days' notice, under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623515/	GARY N. TJOSSEM AND MARILYN E. TJOSSEM, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentTjossem v. CommissionerDocket No. 7747-91United States Tax CourtT.C. Memo 1991-626; 1991 Tax Ct. Memo LEXIS 674; 62 T.C.M. (CCH) 1555; T.C.M. (RIA) 91626; December 17, 1991, Filed 674 Leonard Thomas Bradt, for the petitioners. Cheryl M.D. Rees, for the respondent. COLVIN, Judge. COLVINMEMORANDUM FINDINGS OF FACT AND OPINION This case is before the Court on respondent's motion to dismiss for lack of jurisdiction and petitioners' cross-motion to dismiss for lack of jurisdiction. The sole issue is whether a notice of deficiency properly mailed by respondent to petitioners' "last known address" is rendered invalid because the notice was delivered by the Postal Service to a neighbor of petitioners. Respondent determined deficiencies in petitioners' Federal income tax for the taxable years 1986 and 1987 in amounts of $ 12,296 and $ 18,873, respectively. Respondent also determined additions to tax for the tax years 1986 and 1987 in the amounts of $ 615 and $ 944, respectively, under section 6653(a)(1)(A); amounts to be determined under section 6653(a)(1)(B); amounts to be determined under section 6621(c); and amounts of $ 3,074 and $ 4,718, respectively, under section 6661. All section references are to the Internal Revenue Code. All Rule references are to the Tax Court Rules of Practice and Procedure. FINDINGS OF FACT Some of the facts have been675 stipulated and are so found. Petitioners resided in Houston, Texas, when their petition was filed. Reference to petitioner in the singular is to Mr. Gary Tjossem. At all times relevant to this case, petitioners' address was 6131 Coral Ridge, Houston, Texas 77069. Petitioner frequently travels away from home, and his wife occasionally accompanies him. When petitioners are away from home, they usually let the mail accumulate in their mailbox and come home periodically to collect it. There have been times when petitioners made arrangements for someone to pick up the mail, but they normally do not do this. Petitioners never authorized or asked Mr. R. O. Brenner to receive mail for them. On February 2, 1990, respondent mailed by certified mail the notice of deficiency dated February 2, 1990, to petitioners at 6131 Coral Ridge, Houston, Texas 77069. The parties agree that the notice of deficiency was mailed to petitioners' last known address. Postal Service Form 3849-A, the Delivery Notice or Receipt, evidencing delivery of the notice of deficiency, was received and signed for by Mr. R. O. Brenner, who lived across the street from petitioners at 6134 Coral Ridge, Houston, Texas676 77069. Mr. Brenner is now deceased. Petitioner testified, as we discuss further below, that petitioners did not receive the notice of deficiency that was signed for and received by Mr. Brenner. On September 17, 1990, petitioner wrote to respondent regarding petitioner's receipt of notices of changes resulting from an examination of his 1986 and 1987 returns. Petitioner indicated that he was not in agreement with the proposed changes. Petitioner's letter did not attach the notice of changes or state when he received it. On December 18, 1990, petitioners wrote to respondent and enclosed copies of two requests for payment dated September 17, 1990, that they had received for 1986 and 1987. Petitioners stated they had no record of having received a 90-day letter, and they requested a copy of it and any record of delivery to them. The petition in this case was filed on April 26, 1991. Respondent moved to dismiss for lack of jurisdiction on the ground that the petition was untimely. Petitioners filed a cross-motion to dismiss for lack of jurisdiction on the ground that the notice was invalid. A hearing was held at Houston, Texas, on October 28, 1991. OPINION To maintain an action677 in this Court, there must be a valid notice of deficiency and a timely petition. ; . 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 . Petitioners were required to file their petition within 90 days after the notice of deficiency was mailed. Sec. 6213(a). The requirements for issuing a valid notice of deficiency are set forth in section 6212. Under section 6212(a), respondent is authorized to send a notice of deficiency to a taxpayer by certified or registered mail. It is well settled that a notice of deficiency is valid even if it is not received. ; ;678 , affd. without published opinion . Congress did not 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 taxpayer's "last known address." . Petitioners have not convinced us as to when they received the notice of deficiency. At trial, petitioner said little about his relationship with Mr. Brenner and offered no explanation for Mr. Brenner's failure to deliver the certified letter he had accepted for petitioners to them. Similarly, we note that petitioners did not call petitioner Marilyn Tjossem as a witness to testify as to whether she had ever received the deficiency notice from Mr. Brenner. We also note that petitioners did not call as a witness the Postal Service employee who delivered their mail and delivered respondent's notice, obtaining Mr. Brenner's signature thereon. Finally, 679 petitioner's December 18, 1990, letter to respondent shows that petitioner was aware that the September 17, 1990, requests for payment would have followed the issuance of a 90-day letter. Petitioners have failed to carry their burden of proving that they did not receive the deficiency notice because the U.S. Postal Service delivered it to Mr. Brenner. Petitioners would not prevail here even if they had convinced us otherwise of the facts surrounding their receipt of the notice of deficiency. Petitioners cite ; ; , affd. without published opinion , as providing an exception to the last known address rule of section 6212(b) when the U.S. Postal Service breaches its duty and misdelivers properly addressed mail to someone who is not an authorized agent and not at the address to which the mail is directed. The cases cited by petitioners are distinguishable because in each of them respondent was on notice 680 that the notice of deficiency was not delivered to petitioners and was returned by the post office to respondent. In addition, in those cases respondent's error in addressing the notice of deficiency contributed to the nondelivery of the deficiency notices. Petitioners also rely on , and , for the proposition that diversion of a deficiency notice by the U.S. Postal Service renders the notice invalid. In Mulder and McPartlin, respondent's file contained no return receipt for the deficiency notice sent to the taxpayers. Petitioners' reliance on Mulder and McPartlin is misplaced. We interpret these cases as holding that the presumption of delivery of a properly addressed notice of deficiency sent by certified mail may be overcome when no return receipt is received by the sender. Here, it was stipulated that respondent properly addressed the notice of deficiency to petitioners' last known address. Respondent received the return receipt and thus was not put on notice that the deficiency notice was not delivered681 to petitioners. Respondent argued that petitioners knew in September 1990, or at the latest December 1990, that a deficiency in tax had been determined for their 1986 and 1987 tax years, yet they did not file a petition with this Court until April 1991. In light of the foregoing, we need not reach this issue. It is not necessary that the taxpayer receive the notice of deficiency if the notice was, in fact, mailed to taxpayers' last known address, as it was here. Sec. 6212(b); (taxpayers failed to receive properly mailed deficiency notice); (properly addressed notice of deficiency was not received by the taxpayers due to post office error); . We conclude and hold that respondent has met the requirements of section 6212(b) for mailing a notice of deficiency to petitioners at their last known address, notwithstanding petitioners' failure to receive the notice of deficiency due to misdelivery by the U.S. Postal Service. The petition was filed beyond the *682 statutory 90-day period. Consequently, respondent's motion will be granted. Accordingly, An appropriate order will be entered.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623516/	OZARK MILLS, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Ozark Mills, Inc. v. CommissionerDocket No. 4377.United States Board of Tax Appeals6 B.T.A. 1179; 1927 BTA LEXIS 3311; April 30, 1927, Promulgated 3311 Petitioner's method of valuing raw cotton inventories on a cost basis by the use of perpetual inventories maintained by petitioner accepted in lieu of inventories submitted by the Commissioner or revised inventories on an average cost basis submitted by the petitioner. E. S. Parker, Jr., Esq., for the petitioner. Harold Allen, Esq., for the respondent. LITTLETON1180 The Commissioner determined deficiencies in income and profits tax for the fiscal year ending March 31, 1918, in the amount of $30,919.35, and for the fiscal year ending March 31, 1920, $15,678.33. The Commissioner determined no deficiency for the fiscal year ending March 31, 1919. The petitioner claims that the deficiency for the fiscal year ending March 31, 1918, is $6,034.77, and that for the fiscal year ending March 31, 1920, there has been an overpayment of $19,035.83. The principal controversy concerns the valuation of raw cotton which was in its inventories for the years involved. The fiscal year ending March 31, 1919, is considered only in so far as it is necessary in a determination of the deficiencies for the other years. There is no disagreement between the3312 parties as to the number of pounds of cotton on hand, in process or in finished goods at the beginning or end of any of the taxable years in question, nor is there any dispute that the actual cost of the cotton on hand at the end of each year was lower than replacement cost or market. FINDINGS OF FACT. Petitioner is a North Carolina corporation with principal office and place of business at Gastonia. Prior to and during a portion of the year 1917, petitioner was engaged in the manufacture of ordinary cotton yarn. In the year 1917 it made changes in its plant, installed new and additional machinery and began the manufacture of high-grade cotton yarn with what is known as an English process for use in the making of soft collars and silk goods. This meant a change from the manufacture of ordinary cotton yarn, requiring a low grade of cotton, to the manufacture of a higher grade of yarn, requiring a large percentage of high-grade cotton. At that time petitioner was one in a very few, if not the only mill in the South so conducting its manufacturing operations. As a part of petitioner's process cotton of many grades was mixed and used at the same time. Never less than ten bales3313 and usually about forty bales were opened at the same time and a certain quantity of cotton was taken from each bale and run through fifteen mixing machines. When the various grades of cotton became finished yarn, the cotton had been mixed thoroughly 2,948,000 times. The amount of high-priced and low-priced cotton used in the mixture of raw cotton that goes into the yarn depends upon the number of the yarns being manufactured at the time, that is, whether fine or coarse, and the kind of yarn being manufactured at any particular 1181 time depends upon market conditions. Because of this condition a supply of cotton of various grades is and was kept on hand sometimes for a period of two years. The keeping of cotton purchased from time to time on hand for a long period of time is further occasioned by the arrangement of petitioner's warehouse facilities. Its warehouse, having a capacity of fifteen hundred bales of cotton, a supply sufficient to run petitioner for six months, has but one opening on the platform alongside the railroad, and as cotton is purchased it is stored as far back in the warehouse as possible for convenience in storing so that the various grades of the3314 last cotton purchased are stored near the warehouse opening. In withdrawing cotton from the warehouse for manufacturing purposes, the cotton last purchased of the grade required is used first, leaving the cotton earlier purchased of the different grades in the rear of the warehouse. Petitioner uses from two hundred to two hundred and fifty bales per month. Prior to and during the taxable years when cotton was purchased petitioner made a record upon its books of account of the date of purchase, the number of pounds, from whom purchased, and the price paid per pound. After purchases were received there was attached to each bale a tag containing this information and petitioner made a record in its cotton book of the particular bales, grade, cost, date of purchase, etc., of cotton withdrawn from the warehouse for manufacturing purposes but in the storing and handling of the cotton some of the tags were detached and lost, and in some instances tags detached by employees when withdrawing cotton from the warehouse never reached the accounting office, consequently no record was made of such withdrawals until a check was made of the cotton book with a physical inventory. In the foregoing3315 manner a perpetual inventory was maintained from which it was possible to determine the cost of raw cotton on hand and the cost of cotton entering into the manufacturing process. No physical inventories were taken until March 31, 1920, for the purpose of ascertaining the total cotton on hand and, from the tags which might still be attached, the date of purchase and cost per pound of such cotton. The inventory at March 31, 1920, showed a difference (a decrease) from the perpetual inventory of approximately 48,500 pounds, which difference the petitioner priced by taking the average cost of cotton for the preceding year, and reduced the perpetual inventory by this amount, which resulting amount was used in its original returns as filed. The only other change in the inventories as used in its returns from that shown by the perpetual inventory, of which we have been advised, was at March 31, 1918, when the inventory as shown by the books was reduced $8,863.07 and explained as "reduction in value." 1182 In the revised inventories submitted to the Board, petitioner determined the cost per pound of raw cotton on hand at March 31, 1918, March 31, 1919, and March 31, 1920, on a3316 weighted average basis by taking into consideration the opening inventories of raw cotton and the purchases of raw cotton made during the year. The weighted average costs so obtained were as follows: March 31, 1918, 28.989 cents; March 31, 1919, 35.903 cents; and March 31, 1920, 53.118 cents. These costs were used in the petitioner's revised inventories in valuing raw cotton which entered into goods in process and finished goods on hand at the above inventory dates, as well as the raw cotton inventory. The revisions as contended for by the petitioner were not made in the inventory at April 1, 1917. The Commissioner, on the other hand, failing to find a physical inventory of cotton on hand at the end of each of the fiscal years mentioned taken at cost, proceeded to take from petitioner's books the most recent purchases to the extent of the number of pounds of cotton contained in the raw cotton inventory and used the cost of these purchases as the cost of the cotton on hand at each inventory date. To determine the cost of raw cotton in goods in process and in finished goods, the Commissioner used a weighted average cost per pound arrived at from sufficient recent purchases to3317 equal the opening inventory for each year. The weighted average costs so arrived at were as follows: April 1, 1917, 21.86 cents per pound, obtained from purchases made from October, 1916, through March, 1917; March 31, 1918, 38.57 cents per pound, obtained from purchases made from October, 1917, through March 31, 1918; March 31, 1919, 38.9 cents per pound, obtained from purchases made from September, 1918, through January, 1919 (no purchases being made in February and March, 1919); and March 31, 1920, 80.6 cents per pound, obtained from purchases made from December, 1919, through March, 1920. The Commissioner made no allowance for waste in manufacturing operations. During each of the fiscal years the actual waste in the number of pounds of raw cotton entering into the manufactured product was 30.69 per cent for the fiscal year ending March 31, 1918, 28.63 per cent for the fiscal year ending March 31, 1919, and 33.28 per cent for the fiscal year ending March 31, 1920. The average price received per pound for the waste was 22.65 cents, 30.21 cents, and 30.38 cents in each of the fiscal years in question. The method of calculating waste and the percentage of waste as shown by3318 the petitioner for the various years were accepted by the respondent at the hearing. Likewise, the petitioner conceded that the corrections which were made by the revenue agent in the raw cotton inventory on account of bales of cotton which had been opened but not yet put in process were correct. 1183 Petitioner included depreciation on tenement houses in administration expenses and claims that the Commissioner erred in including this depreciation in manufacturing costs. The Commissioner now admits that the rent received from these houses should be deducted from depreciation which he has included in manufacturing cost. Due to the slight difference between the parties on this point the petitioner accepts this adjustment and the parties are otherwise in accord as to manufacturing costs. The various items entering into the manufacturing costs (except the item for depreciation on tenement houses hereinbefore referred to) and the method by which cost of goods in process and cost of finished goods was determined, as shown by the petitioner were accepted by the respondent as being correct. OPINION. LITTLETON: The only question in controversy in this case is the basis3319 to be used in determining the cost per pound of raw cotton entering into the inventories of the petitioner for the taxable years ended March 31, 1918, and March 31, 1920. Since the revenue agent who made the investigation failed to find inventory records from which it was possible to identify specific purchases of the goods on hand at the various inventory dates, he applied that part of article 1582, Regulations 62, under subdivision (a) with respect to intermingled goods, which is quoted below: Goods taken in the inventory which have been so intermingled that they can not be identified with specific invoices will be deemed to be either (a) the goods most recently purchased or produced, and the cost thereof will be the actual cost of the goods purchased or produced during the period in which the quantity of goods in the inventory has been acquired, or * . The petitioner takes exception to the use of this method on the ground that it is inequitable, in its case, to apply a method which is based on a presumption that the goods on hand are those most recently purchased when the facts rebut any such presumption, and maintains that an average cost based on acquisitions of3320 raw cotton throughout each year and cost of raw cotton on hand at the beginning of each year, will furnish an inventory valuation with which its income can be more nearly reflected than that used by the Commissioner. Section 203, Revenue Act of 1918, provides: That whenever in the opinion of the Commissioner the use of inventories is necessary in order clearly to determine the income of any taxpayer, inventories shall be taken by such taxpayer upon such basis as the Commissioner, with the approval of the Secretary, may prescribe as conforming as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting the income. 1184 It will thus be seen that section 203 provides two tests to which each inventory must conform: (1) It must conform as nearly as may be to the best accounting practice in the trade or business, and (2) it must clearly reflect the income. The basis of valuation most commonly used by business concerns and which is accepted by good accounting authorities is: (a) Cost, or (b) cost or market, whichever is lower. Whether this taxpayer used the first or second basis is not definitely established in this case3321 and is not material since cost was always lower than market and, therefore, for the purpose of our determination we need only consider whether cost has been used in the raw cotton valuation by either of the bases contended for. First, we are of the opinion that the basis used by the Commissioner is erroneous for the reason that the presumption on which it is based is clearly rebutted by the evidence presented. In other words, we do not conceive that there is any conclusive presumption that the goods on hand at a particular inventory date are those most recently purchased, but that such a rule is applied only as a rule of convenience where competent evidence to the contrary is not shown. To adopt it in this case would be to disregard the fact that it was the petitioner's practice to use the last goods purchased first; that its storage facilities were such that it was impracticable to follow any practice other than the withdrawal of the later purchases first and further that in 1917 it changed from the manufacture of a product which required the use of a low grade of cotton to the manufacture of a product which required the use of a greater percentage of high-grade cotton, and, 3322 therefore, the tendency was to use more of the high-grade cotton which was being purchased rather than the low-grade cotton, a supply of which was on hand when the change was made. Since this method is not shown to represent cost and since the presumption on which it is based has been rebutted, it must be disregarded in this case. Secondly, does not method contended for by the petitioner in its revised inventories represent a cost valuation? It is what might be termed an average cost valuation in which the opening inventory and purchase of raw cotton during the year are considered to arrive at a weighted arithmetical average for a unit cost which is applied to the poundage on hand to determine the cost valuation. While this method in this case takes into consideration more factors than that employed by the Commissioner, we are not convinced that the petitioner's inventory so determined would be on a cost basis. Again this would seem to be another rule of convenience the application of which must be disregarded when a more nearly correct basis is available. For such a method to represent cost, so many factors, such as 1185 purchase, sale and use of cotton, must concur3323 in such an ideal manner, which we consider highly improbable of having happened in this case, that the basis can not be approved as representing a true cost valuation. More merit would attach to the taxpayer's method if we were dealing only with the fiscal year ended March 31, 1918, on account of its change in its manufacturing process for that year, but even here we are faced with the difficulty that only the closing inventory has been adjusted, which is not only contrary to good accounting practice, but also contrary to the principle of consistency which we have laid down on numerous occasions. Appeal of Thomas Shoe Co.,1 B.T.A. 124">1 B.T.A. 124; Appeal of George C. Peterson Co.,1 B.T.A. 690">1 B.T.A. 690; Appeal of Buss Co.,2 B.T.A. 266">2 B.T.A. 266, and other subsequent decisions. Finally, we are of the opinion that it is unnecessary to resort to either of the above arbitrary bases when a basis which more nearly reflects cost is available. The petitioner showed that it keeps a perpetual inventory in the form of a cotton book, in which it lists each bale of cotton purchased with the number of the vendor and that of the petitioner, the actual weight, price per3324 pound, and name of the vendor. When cotton is withdrawn for consumption, the bale used is checked off so that at the end of any period it would be possible to determine not only the number of pounds on hand, but also its actual cost. It would not be an average cost in any sense, but instead a true cost based on actual purchases of cotton not consumed, even if the cotton on hand had been purchased several years prior to the date on which the valuation is made. The following testimony by petitioner's bookkeeper which was given in answer to questions by petitioner's counsel, shows the method which was followed in keeping this cotton book and determining the inventory therefrom: Q. Mr. Gardiner, when cotton was purchased, what entries did you make on your mill books? A. On my mill books I made the entries from whom I buy the cotton, the total amount of pounds, the dollars and cents. That goes on the journal. Then I have a cotton book that I take and put each and every bale separate, and put on the number. It may start at 695 and run up to 745, run up fifty numbers. It has their number on its and my number, and then I put the actual weight of the cotton in the cotton book3325 and the price, and where it is bought from. Q. When you withdraw that cotton from the warehouse to be used, what entry do you then make on your cotton book? A. I take it out on my cotton book as being used, with a check mark; I put on the pounds and the tag and also the price, and put them all together. In a month's run, using maybe 275 bales, I have fifty bales of one price, five of another, a half dozen of another and so on. I sort them all out and get the different prices on the different piles and take an adding machine and run them 1186 up and multiply them by the prices paid for them and charge it out to cotton consumed. Q. At the close of the year, when you made your inventory, you said that the cotton was stacked in the warehouse where you could not readily get to it. Did you check that against your cotton book as to the actual bales on hand? A. I checked up the actual bales on my ledger. Q. I mean the numbers of the bales. A. No, I didn't. Q. How did you make up your inventory? A. Whenever it was so I could not get at it to count the cotton and get the tags, I took the pounds on the left-hand side, the pounds and the dollars and cents3326 it cost, and on the right-hand side the pounds and dollars and cents that had been consumed, and I took the difference and made an average price. Q. That was the way you took it? A. When I couldn't count it. Q. When you could count it? A. When we could count it, we did it exactly as we charged it out - run over and put the price on it and the pounds. Q. Was that book kept during the fiscal years of 1918, 1919 and 1920? A. Yes, sir. The cost so determined, barring inaccuracies, would not be an average price, as inaccurately referred to by the witness, but would be an actual cost. The physical count, to which he referred, is understood to be the physical inventory which was taken only at March 31, 1920, in so far as the years on appeal are concerned. The petitioner offers objection to this method on the ground that its cotton book contains inaccuracies in that tags are lost off the bales and, therefore, it is not possible to identify such specific bales used, and that tags are not always returned by the employees when the cotton is withdrawn and, therefore, no entry can be made in the cotton book. Again, we fail to see where the method advocated by the3327 petitioner would serve to correct either of these errors, as in both methods the number of pounds would be excessive by the same amount. Errors of both types would be corrected when a physical inventory is taken, but we do not have a physical inventory, except at the close of 1920, and, therefore, we must depend on the most reliable information available which seems to be the perpetual inventories maintained. These inventories are undoubtedly faulty, but they at least represent an attempt to arrive at a cost valuation, and, the percentage of error is small when we consider that from April 1, 1917, to March 31, 1920 - the latter date being the only time within the three years when a check was made of the cotton book with the physical inventory - a difference of approximately 100 bales was found when a physical inventory was taken and in that period approximately 6,000 bales were consumed, or a percentage of error of only 1.67 per cent. The following testimony by petitioner's bookkeeper on cross examination by respondent's counsel further indicates the accuracy of petitioner's cotton book: 1187 Q. The only time where you do not take the actual tag and actual price is where3328 the tag may be ripped off? A. Where the tag is ripped off and we cannot get to them. Q. Do you find any such discrepancy between the actual inventory and the book inventory as 48,000 pounds in any one year now? A. Not in any one year. There may be over a period of years. We find a discrepancy every year between what we ought to have and what we have in the records. Q. There is no such discrepancy in any one year now, is there? A. No, not in any one year. What your have reference to might run over a couple of years. I don't know. Mr. LITTLETON. When you can't find the tags, can you tell by the position of the bale when it was probably purchased? The WITNESS. No, Sir. We have no record of it. We just take what we have left and make up our stock accounts. Mr. LETTLETON. You keep a record as you purchase cotton? the WITNESS. Oh, yes. Mr. LITTLETON. Then when you check the bales that have tags on them, you can check that against the bales that have no tags? The WITNESS. When we get bales that are short, we are short just that much. That will go in the year's production. By Mr. ALLEN. Q. That doesn't happen to many bales now, does it? 3329 A. Not to very many bales lately. But we have it to happen to a few bales every year. We, therefore, are of the opinion that the petitioner's raw cotton inventories, for the years on appeal, should be valued by the use of the perpetual inventories which it maintains. Correction should, of course, be made on account of the difference in poundage found by the revenue agent and on account of the arbitrary reduction in value at March 31, 1918. Similarly, adjustment should be made to the physical inventory at March 31, 1920, where a difference of approximately 48,500 pounds is shown. We are of the opinion that a reasonably accurate method of adjusting this difference would be to consider that to this extent cotton was not properly recorded when withdrawn over the three-year period from April 1, 1917, to March 31, 1920, and reduce the closing inventories of each of the years on the basis of the poundage consumed in each year, pricing the cotton entering therein on the basis of the average cost for the respective grades during each of those years. This method would seem to be substantially in conformity with the alternative method suggested in article 1582, Regulations 62, which3330 was improperly disregarded by the revenue agent and which reads as follows: * * * Or (b) where the taxpayer maintains book inventories in accordance with a sound accounting system in which the respective inventory accounts are charged with the actual cost of the goods purchased or produced and credited with the value of goods used, transferred, or sold, calculated upon the basis of the actual cost of the goods acquired during the taxable year 1188 (including the inventory at the beginning of the year) the net value as shown by such inventory accounts will be deemed to be the cost of the goods on hand. As to the method which the petitioner used in determining the cost of cotton consumed, we have the following testimony from the petitioner's bookkeeper: Q. In arriving at the cost of cotton consumed, would you take it by the actual cotton or the average cost? A. Take it by the actual price in pounds. Q. Would that represent the actual cotton that went in, or your estimate of it? A. The actual cotton that went in. We have the cotton tag, and we take the number on it and the weight, and when the card comes back I put the weight on it and the price. In this3331 manner, the petitioner has a fairly accurate record of the cost of cotton which enters into consumption, barring the inaccuracies which we referred to under the raw cotton inventory. The petitioner showed further that the manufacture of cotton is a continuous process in which the cotton is placed in process and continues until the finished goods are obtained. We would not have the situation of goods in process on hand at an inventory date which had been placed in process several months or years prior thereto, but it would only be recently placed in process. We are, therefore, of the opinion that a reasonably accurate method of valuing the raw cotton which entered into such goods would be on the basis of the cost of raw cotton most recently placed in consumption prior to the respective inventory dates, sufficient to equal the poundage in such inventory. With respect to finished goods, we find that the total poundage on hand at each inventory date is very small as compared with the total production or total sales, representing in one instance less than one per cent of the total sales in pounds for the preceding twelve months. This would indicate that yarn is being produced as*3332 it is sold and that there is not on hand an appreciable accumulation which had been produced from cotton put in process long before the various inventory dates. We are, therefore, of the opinion that the same method should be followed in valuing raw cotton entering into finished goods as goods in process, viz., use the cost of raw cotton most recently placed in process prior to the various inventory dates sufficient to equal the total poundage in the finished goods inventory. A redetermination should, therefore, be made in accordance with the foregoing, taking into consideration the adjustments with respect to waste, depreciation of tenements, and the various items entering into manufacturing costs on which both parties are agreed. Judgment will be entered on 30 days' notice, under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623518/	SYDNEY R. WRIGHTINGTON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Wrightington v. CommissionerDocket No. 91371.United States Board of Tax Appeals38 B.T.A. 1230; 1938 BTA LEXIS 773; November 22, 1938, Promulgated 773 The fixed compensation of Town Counsel of Lexington, Massachusetts, is immune from Federal income tax. Sydney R. Wrightington, Esq., pro se. Paul E. Waring, Esq., for the respondent. STERNHAGEN 1230 OPINION. STERNHAGEN: The Commissioner determined deficiencies in petitioner's income tax of $4.83 for 1934 and $49.72 for 1935. The petitioner seeks to overcome these deficiencies by showing that income which he received as Town Counsel of Lexington, Massachusetts, is exempt from tax. The facts are contained entirely in a written stipulation. The amounts of petitioner's income which are brought in 1231 question are $850 received by him as salary in 1934 and $887.50 received by him as salary in 1935 from the municipality for general services as town counsel, such services being described in section 3 of the town bylaws as the drafting and approval of town documents and giving legal advice and opinions to town officers. Other amounts received by the petitioner for services incident to litigation he does not here put in issue. The question whether salary paid by a county, town, or other subdivision of a state to counsel regularly774 employed, as distinguished from amounts sporadically paid for specific services, is subject to Federal income tax has been considered in several cases, and until recently the decisions have held the salary to be exempt. ; ; ; ; ; ; ; . Recently, in , and , the Circuit Court of Appeals for the Third Circuit held that because New Jersey township attorneys were independent contractors they were not free from tax upon their fixed compensation. . The Board has recognized immunity in 775 ; ; and ; and denied it in . The Commissioner argues in this proceeding that , overruled these earlier decisions and puts an end to the immunity unless it can be shown not only that the services for which the compensation was received are essential to the preservation of the state government, but also that the Federal tax upon the individual operates as a burden upon the state. The Gerhardt case, however, was directed to the question of immunity of employees of the New York Port Authority, who were held not to be engaged in such governmental functions as were indispensable to the continued existence of the state. The functions there considered were in this respect quite different from those to which the services of the present town counsel were an incident. Such services covered the entire filed of existence and activity of the town, touching it at every point where the law might operate upon it. In every sense the petitioner776 was engaged in performing an inherent and traditional function of government. It is said, however, that the petitioner has not met the second test of immunity, in that he has not shown that the imposition of the Federal tax upon him operates to burden the state. If this means 1232 that he has not introduced primary evidence of an actual burden during the particular years in question, the statement is correct. It is difficult to believe, however, that the Gerhardt opinion must be read as requiring such a showing to support every claim of immunity which is made under the established doctrine that the Federal Government may not by taxation interfere with the free operation of the governmental functions of the states. . To read it as meaning this would logically lead to the conclusion that even the statutory compensation of the governor of the state may be taxed by the Federal Government unless evidence is introduced the preponderance of which shows that such tax operates in fact as an interference with the carrying on of the state's essential governmental functions or those which are indispensable to its existence as777 a state. Such a burden of proof would practically nullify the constitutional doctrine itself, for it is hard to conceive how the burden could be discharged by any individual officer or employee of a state. We are unable to conclude that the decision in the Gerhardt case may be carried so far. See . Since the petitioner was not an independent contractor, , and the compensation in question was received for services incident to the town's existence and governmental operations, the immunity from Federal tax is, in our opinion, established. Reviewed by the Board. Judgment will be entered under Rule 50.ARNOLD dissents. SMITH, DISNEY SMITH, dissenting: In Helvering v. Gerhardt,304 U.S. 405">304 U.S. 405, it was said: The basis upon which constitutional tax immunity of a state has been supported is the protection which it affords to the continued existence of the state. To attain that end it is not ordinarily necessary to confer on the state a competitive advantage over private persons in carrying on the operations of its government. There778 is no such necessity here, and the resulting impairment of the federal power to tax argues against the advantage. The state and national governments must co-exist. Each must be supported by taxation of those who are citizens of both. The mere fact that the economic burden of such taxes may be passed on to a state government and thus increase to some extent, here wholly conjectural, the expense of its operation, infringes no constitutional immunity. Such burdens are but normal incidents of the organization within the same territory of two governments, each possessed of the taxing power. It seems to me that the principle upon which the Gerhardt case was decided was that immunity from Federal income tax of the salary and wages of officers and employees of a state depends upon whether the imposition of the tax puts a substantial burden upon the state. Absent evidence of such burden the tax attaches. 1233 I think the opinion of the Supreme Court in the Gerhardt case overrules the principle of , and "a century of precedents," as stated by Mr. Justice Butler in his dissenting opinion. 779 In the instant proceeding there is no evidence that the imposition of the Federal income tax upon the petitioner's salary was a substantial burden upon the State of Massachusetts or the town of Lexington. DISNEY, dissenting: I think that in the light of , rehearing denied October 10, 1938, the question here presented requires our reexamination, and that, so reexamined, the answer is a denial of the immunity upheld by the majority opinion. The burden of taxation passed on to the state or subdivision by reason of taxation of this employee is theoretical, not actual. The tax is not discriminatory, and overrefinement of plausible, but unsound theory, instead of a weighing of reality, is in my opinion the basis of claim of immunity. , adopted what appeared to be a well balanced reciprocal treatment of state and national government, but which neglected the sound distinctions between taxation by a state and by the United States, made by Chief Justice Marshall in 780 , and reverted to and relied upon in ; and , has in turn been strained to apply to situations beyond its scope, until fact is made to subserve formula and, because of a certain symmetry in theory of reciprocal relations between nation and state, a class of immunity has been created which was with the idea of equality of taxation inhering in the income tax law and the Constitution. Too much emphasis, I think, has been placed upon the idea of separate sovereignties and the fear of encroachment of one upon the other in the tax field. The dichotomy in the governance of the citizen of the United States does not cut so deeply. Nation and state should not be treated as wholly independent sovereigns. They are interdependent, and nowhere more so than in the tax realm. The employee of the state is a citizen of the United States, subject to its laws. Realization of this interdependence and the pragmatic nature of income tax dictates that we should realize that there is in plain fact no burden upon the operation of state government because of*781 nondiscriminatory Federal income tax upon those who administer it in the indirect manner of the employee who is petitioner here. Though the function performed by him be essentially governmental, I think the burden upon state is essentially chimerical, not factual. OPPER agrees with this dissent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623519/	ESTATE OF RALPH A. BALAZS, Deceased, NOVICE M. BALAZS, Executrix, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentEstate of Balazs v. CommissionerDocket No. 1994-78United States Tax CourtT.C. Memo 1981-423; 1981 Tax Ct. Memo LEXIS 316; 42 T.C.M. (CCH) 632; T.C.M. (RIA) 81423; August 12, 1981. 316 A. Jeffrey Barash, for the petitioner. Thomas M. Cryan, for the respondent. WILBURMEMORANDUM FINDINGS OF FACT AND OPINION WILBUR Judge: Respondent determined a deficiency in petitioner's Federal estate tax of $ 74,617. The sole issue presented here for our decision is whether the petitioner is entitled to exclude from the gross estate any portion of the value of certain assets held jointly by the decedent and his wife. FINDINGS OF FACT Some of the facts have been stipulated. The stipulation of facts and the attached exhibits are incorporated herein by this reference. Ralph A. Balazs (hereinafter referred to as Ralph or the decedent) died on July 9, 1974. A Federal estate tax return was filed with the Internal Revenue Service at Jacksonville, Florida. Decedent's wife, Novice M. Balazs (hereinafter referred to as Novice) is the executrix of the estate and resided in Lighthouse Point, Florida at the time this suit was commenced. Ralph and Novice were married on September 29, 1959. This was not the first marriage for either party. Novice had received 317 a divorce from her former husband in 1956. She had three children: Priscilla, Sterling and Bonny. Ralph was a widower with no children. Prior to this marriage, Ralph owned one-half of the stock of Engineered Trusses, Inc., (hereinafter referred to as Engineered Trusses). He was employed by that company and paid a substantial salary. He was the part owner of a small piece of land on which the Engineered Trusses plant was located. Decedent's other real estate holdings included a farm in Maryland which was rented out and a farm in North Carolina which was sold in 1967 for a substantial sum of money, and other real properties in an unknown amount. In addition, Ralph received income from his 50 percent interest in the Balazs and Reynolds partnership and from Balisco Corporation (commissions and dividends). Notice's premarital property consisted in the main of family business ventures. She owned a one-third interest along with her two brothers in the McClellan's Firestone Dealer Store, Inc. (hereinafter referred to as the McClelland's Firestone), which included several properties adjacent to the store. She worked full-time in the store as a salesperson, drawing the same salary 318 as her brothers. She owned a new car and a home, both unencumbered. Shortly before their marriage, Novice went to her bank and closed her accounts. With the money she opened new accounts, title being taken jointly in the names of Novice and Ralph. No evidence was presented at trial as to the amounts in these accounts. In addition to their separate estates which they brought into their marriage, Novice and Ralph each received substantial sums subsequent thereto. Examining Novice's sources of funds first, we find that the majority of her receipts were at irregular intervals. She continued to work for McClellan's Firestone Store through 1961, earning $ 7,831.97 in 1959, $ 5,934.30 in 1960, and $ 3,250 in 1961. During 1964, Novice sold her interest in McClellan's Firestone Store to her brothers in exchange for $ 9,300 worth of stock in trade and a $ 7,000 installment note which was paid off in full as of February 28, 1969. Utilizing the stock in trade she received, Novice opened the Heritage Room Gift Shop. This venture resulted in losses of $ 3,411.26 and $ 4,517.37 for the years 1964 and 1965, respectively. On or about January 1, 1962, Novice, together with her two brothers, 319 formed a partnership known as McClellan's Real Estate. The partnership holdings included several large tracts of real estate, the sales of which provided the primary source of funds for distribution to Novice from the partnership. The distributions which were substantiated are as follows: YearDateAmountTotal1963November 30$ 98.00$ 98.001964May 9100.00100.001967Unspecified20,000.0020,000.001970April 6250.00250.001971September 81,000.00December 153,333.004,333.001972April 41,666.66May 1890,000.00May 3142,399.96September 20366.93Unspecified24,990.45159,424.001973April 61,000.00May 71,000.00June 61,000.00August 81,000.00September 111,000.00October 2381,736.71Unspecified1,000.2987,737.001974Unspecified20,528.0020,528.00$ 292,470.00In addition, the partnership generated varying amounts of income and losses, Novice's distributive share being as follows: Taxable YearIncome (Loss)a320 1962b 181.48 1963(431.08)1964(184.00)1965(46.57)1966(265.00)1967(305.49)1968(484.35)1969682.79 1970(1,152.00)1971219.00 Long-term capital gain7,829.00 1972(1,526.00)Long-term capital gain150,919.00 197388.00 Long-term capital gain83,526.00 1974(361.00)Novice and Ralph never made any contributions to the partnership out of any of their joint bank accounts. In 1973 Novice sold the home she had acquired from her former husband for a gain of $ 940. Sixty-four thousand dollars was realized on the sale. The gain was not recognized since the proceeds were invested in a new personal residence costing $ 64,421. Ralph's chief sources of income during these years were his salary from Engineered Trusses, income from the Balazs and Reynolds partnership, rental of a farm in Maryland and commissions from the Balisco Corporation. For the years 1959 through 1969, Ralph's income is shown as follows: Chart A Salary fromBalazs andCommissions andTaxableEngineeredReynoldsDirector's feesYearTrussesPartnershipfrom Balisco Corp.1959$ 20,582.00$ 1,752.27 196026,274.002,449.15 196116,694.002,906.52$ 1,440.00196218,870.003,189.00 1,440.00196312,194.003.191.00 1,440.00196412,428.503,184.00 19656,328.001,428.71 2,135.0019666,760.00(333.04)1,740.0019676,760.00(337.63)196817,200.001969Totals$ 144,090.50$ 17,429.98 $ 8,195.00321 Long-TermTaxableMaryland FarmInterestCapital GainsYearRental aIncome(Losses)Totals1959$ 469.00 $ 22,803.27 1960327.54 29,050.69 1961(143.87)20,896.65 1962( 60.00)23,439.001963(361.64)16,463.361964(586.00)15,026.501965(742.46)9,149.251966521.50 8,688.46 1967217.00 $ 352.57b $ 25,367.00 32,358.94 1968134.00c 34,075.00 51,409.00 1969d (1,674.00)(1,674.00)Totals($ 358.93)$ 486.57$ 57,768.00 $ 227,611.12 a Net rental income after expenses but before depreciation. b From the sale of Maryland farm. The amount realized on this sale was $ 96.900. c From the sale of 2,725 shares of stock in Engineered Trusses. The amount realized on this sale was $ 65,740. d From the sale of a cottage in Maryland. The amount realized on this sale was $ 11,550. During the course of their marriage, Ralph and Novice maintained several joint bank accounts and had on occasion purchased properties for investment (including real estate and securities) in their joint names. The income produced by their jointly owned assets is set forth below: Chart B Interest on JointCapital Gains fromTaxablePompano GulfSavings and LoanSale of JointlyYearServiceAccountsHeld Property1960($ 7,181.91)1961( 335.13)a322 a $ 2,025.511962a 2,882.001963a 2.843.001964a 2,968.001965a 3,512.041966850.6019671,496.611968790.0019692,546.00b $ 7,712.0019706,338.19c 6,377.0019712,934.00d 1,914.0019724,591.00e 3,416.0019738,052.00f (3,087.00)19745,432.00Totals($ 7,517.04)$ 47,260.95$ 16,332.00 YearDividendsAntique StoreTotals1960($ 7,181.91)19611,690.48 19622,882.00 1963g $ 194.003,037.00 1964g 2,135.005,103.00 19653,512.04 1966h 5,872.836,723.43 19671,496.61 1968790.00 196910,258.00 1970235.0012,950.19 1971592.00($ 777.00)4,663.00 19721,525,009,532.00 19731,873.006,838.00 19742,412.007,844.00 Totals$ 14,838.83($ 777.00)$ 70,137.84 During the years 1963 through 1965, $ 4,433.27 was reported as rental income, before depreciation but 323 after expenses, from the Engineered Trusses warehouse. During the years 1970 through 1972, the rental income from the warehouse was $ 9,075. Rental of the other Engineered Trusses property generated income of $ 143,621 for the 5-year period 1969-1974. There is no evidence as to whether the warehouse or other properties were owned by Ralph alone or by Novice and Ralph jointly. On the Federal estate tax return, petitioner listed on Schedule E various assets owned jointly by Ralph and Novice as of the date of his death. The alternative valuation date was elected. The petitioner excluded from the gross estate amounts deemed by it to be attributable to consideration furnished by Novice for the purchase of the respective asset. Respondent in his notice of deficiency determined that Novice had not provided any consideration for the purchase of any of the jointly held properties. The following is a listing of those properties, corresponding to their ordering on the estate tax return, together with the relevant details: JOINTLY HELD REAL PROPERTY Amount claimedas attributableParcelAlternateto co-tenant'sNumberDescriptionvaluationcontributionS. Side of N.E. 16th St. Westof Dixie Hgwy,1Pompano Beach, Fla.$ 56,437$ 28,2182Dixie Hgwy. & N.E. 16th St.Pompano Beach, Fla.181,12672,14431621 N. Dixie Hgwy., PompanoBeach, Fla.28,84314,42142511 N.E. 36th St.,Lighthouse Point, Fla.64,00064,0005Apt. 233, Tarleton TerraceCoop., Lighthouse Point, Fla.20,00010,0006Lot 15, Blk. 20, less West 5ft., Hillsboro Iles, Fla.35,00035,00074190 N. Federal Hgwy.,Lighthouse Point, Fla.125,000125,0008North Carolina Parcel No. 145,00022,5009North Carolina Parcel No. 245,00022,50010North Carolina Parcel No. 35,0002,50011Maryland Property--Not inissue herein30,000JOINTLY HELD STOCKS AND BONDS$ 71,017$ 35,508JOINTLY-OWNED BANK ACCOUNTS$ 101,878$ 50,939324 Amount determinedAmount includedby respondentParcelin gross estateincludable inAdjustmentNumberDescriptionper returngross estate(Increase)S. Side of N.E.16th St. West ofDixie Hgwy,1Pompano Beach, Fla.$ 28,219$ 56,437$ 28,2182Dixie Hgwy. & N.E.16th St. PompanoBeach, Fla.108,982181,12672,14431621 N. DixieHgwy., PompanoBeach, Fla.14,42228,84314,4214 2511 N.E. 36thSt., LighthousePoint, Fla.64,00064,0005Apt. 233, TarletonTerrace Coop.,Lighthouse Point, Fla.10,00020,00010,0006Lot 15, Blk. 20,less West 5 ft.,Hillsboro Iles, Fla.35,00035,00074190 N. FederalHgwy., LighthousePoint, Fla.125,000125,0008North CarolinaParcel No. 122,50045,00022,5009North CarolinaParcel No. 222,50045,00022,50010North CarolinaParcel No. 32,5005,0002,50011MarylandProperty--Not inissue herein30,00030,000$ 35,509$ 71,017$ 35,508$ 50,939$ 101,878$ 50,939$ 482,730The typical method of purchasing real estate was for the couple to make a down payment and then carry the mortgage for a short period of time after which the purchase price was paid off in full. They always took title jointly. Novice made all of the mortgage payments. The payments were generally made from their joint bank accounts. Parcel No. 1 was purchased 325 on May 13, 1968 for $ 28,000. A purchase and sales agreement had previously been entered into on February 13, 1968, at which time a cash deposit of $ 2,800 was made. At the May 13 closing an additional $ 5,200 was paid. The balance of $ 20,000 was financed by means of an installment note which was secured by a first mortgage signed by both Ralph and Novice. Monthly payments of $ 391.33 were made on the note from June 12, 1968 until October 4, 1969. The remaining balance on the note of $ 14,924.85 was paid off in full on November 20, 1969. With the single exception of the May 13, 1968 payment of $ 5,200, the parties have stipulated that all of the payments with respect to the acquisition of this property were made by means of checks drawn upon a joint checking account in the names of Novice and Ralph. Novice's signature appears on the checks. Parcel No. 2 was originally subdivided into seven separate units. Three of these units were purchased by the decedent for an unknown price prior to his marriage to Novice. The four remaining units were purchased jointly by Novice and Ralph during the course of their marriage. One of the seven units of Parcel No. 2 was the "Queens Systems," 326 purchased on January 26, 1962 for $ 16,000. Payment of the purchase price was accomplished by the assumption of a first mortgage in the amount of $ 6,882.61, the giving of a second mortgage in the amount of $ 4,500 executed by both Novice and Ralph, and a cash payment of $ 4,617.39. The first mortgage provided for monthly payments of $ 100 over an unknown period. This mortgage was eventually satisfied. The second mortgage required monthly payments of $ 136.00 and was satisfied in full as of April 30, 1965. The "Trucks Parcel," also one of the seven units of Parcel No. 2, was acquired on May 12, 1964 for $ 12,000. The purchase price was paid by means of a $ 6,000 cash payment and the giving of a first mortgage in the amount of $ 6,000, said mortgage being executed by both Notice and Ralph. Monthly payments of $ 182.54 over a 3-year period were required. This mortgage was satisfied in full as of May 8, 1967. The "Pure Oil Parcel," another of the seven original parcels, was purchased on April 24, 1968 for $ 16,000. The "Reynolds Property," the last of these seven parcels, was purchased on April 23, 1968. The documentation regarding the purchase price of the latter parcel and 327 the method of payment of both parcels was unavailable at the time of trial. Parcel No. 3 was purchased on or about February 24, 1969 for $ 14,500. The documentation concerning the method of payment of the purchase price is unavailable. Parcel No. 4 was the couple's personal residence. It was purchased by them on March 5, 1973 for $ 64,000. It was purchased contemporaneously with the sale of their prior home and from resources made available from that sale. Their prior home had been acquired by Novice during 1956 as part of her divorce settlement. After Novice's marriage to Ralph he moved into her home, although title remained in Novice's name alone. Maintenance and repairs, including the installation of a swimming pool, were paid for out of the couple's joint bank accounts. Two adjoining vacant lots were purchased jointly by Ralph and Novice from Novice's mother for $ 6,000 on February 28, 1969. A contract was entered into on February 6, 1973 to sell the house for $ 64,000. A $ 1,000 deposit was to be paid on that date, with $ 4,500 due at closing, and subject to the purchaser's ability to obtain a first mortgage in the amount of $ 58,500. This sale was eventually consummated 328 on April 11, 1973. After deducting the various expenses of sale, it generated cash in the amount of $ 58,676.72. Also on April 11, 1973, the vacant lots adjoining the home were sold for cash in the amount of $ 5,456.61. Parcel No. 5 was purchased on or about March 31, 1972 for $ 16,300. A deposit of $ 1,630 was paid on February 25, 1972 and the balance was paid in cash at the time of closing. Parcel No. 6 was purchased on May 5, 1972 for $ 37,000. Parcel No. 7 was purchased on February 1, 1974 for $ 133,000. Also, Parcel Nos. 8 and 9 (North Carolina parcels 1 and 2) were purchased for $ 17,100 and $ 17,500 on September 17, 1970 and June 28, 1967, respectively. Again, the documentation concerning the method of payment of these parcels was unavailable to the parties at the time of trial. Parcel No. 10 (North CarolinaParcel No. 3) was purchased on or about April 1, 1968 for $ 2,250. A $ 225 down payment was made on March 22, 1968 and the remaining balance of $ 2,025 was paid in cash at the time of closing. Novice and Ralph purchased stocks and bonds and held them in their joint names with right of survivorship. Those securities which were included in the gross estate are listed 329 below showing the date of acquisition and their cost: Date ofPurchaseDescriptionPurchasePrice$ 5,000 City of Winter Garden 6%Utility6/15/72$ 5,374.00Rev. Service due 9/1/87Accrued interest$ 5,000 Kansas City Special FacilityAirport11/18/715,100.00Rev. Bond 7.2% due 5/1/85Accrued interest$ 5,000 Harris Co. Water ControlDistrict4/5/715,443.04#119 Revenue Bonds 8% due 3/1/94Accrued interest$ 10,000 Dade Co. Port AuthorityRevenue1/6/7110,684.67Bond, Series B 8% due 1/1/80Accrued interest$ 5,000 Dade Co. Port Authority Sp. Rev.4/28/715,135.21Bond 7 3/8% due 1/1/93Accrued interest$ 5,000 Dade Co. Port Authority Sp.Rev.10/4/735,995.99Bonds Series B 8 5/8% due 1/1/90Accrued interest$ 10,000 Monroe Co. Bridge Rev. Bonds6/14/728,275.695 3/4% due 9/1/97Accrued interest$ 5,000 City of Winter Garden Utility6/15/725,358.00Rev. Bond Series 1971 6% due 9/1/88Accrued interest100 sh. Florida Steel2/16/723,350.50200 sh. Curtis Wright3/9/725,356.48200 sh. American Realty Trust12/13/711,746.00500 sh. Arlen Property Investors10/6/718,382.50200 sh. Carolina Power & Light11/6/734,152.74100 sh. John Hancock Investors1/14/712,500.00200 sh. Land Mark Banking6/10/71$ 3,237.508 sh. Narda MicrowaveUnknownUnknown400 sh. Pennzoil Offshore3/29/714,057.76400 sh. Southern Co.11/28/735,950.00200 sh. United Aircraft12/19/735,469.73200 sh. U.S. Leasing Real Estate12/17/705,000.00330 For purposes of the Federal estate tax return, petitioner deemed exactly one-half of the aggregate fair market value of these stocks and bonds as of the alternative valuation date to be excludable from the gross estate as being attributable to the wife's contributions. The respondent disagreed and required the entire alternative valuation to be included. The only documentary evidence presented at trial concerning the method of purchase of these items was a check for $ 10,000 signed by Novice and drawn on their joint checking account payable to a stock brokerage firm. Novice and Ralph maintained six savings accounts and two checking accounts in their joint names with the right of survivorship as of the date of Ralph's death. These accounts were included in the gross estate at value as of the alternative valuation date; however, one-half of the aggregate value of these accounts was excluded from the gross estate as being attributable to contributions by the surviving cotenant. The respondent determined in his notice of deficiency that no exclusion was allowable. The identification of these accounts is as follows: BankAccount Number 1Southern Federal Savings1006298-2& LoanAtlantic Federal Savings6-2293-3& LoanFirst Federal Savings & Loan15051-6-9of Broward161012-140988-850316-9PompanoChecking Acct.North CarolinaChecking Acct.331 Novice received significant income during the years of the marriage, including particularly large cash distributions from the McClellan Real Estate partnership beginning in the early 1970's. Novice opened the original joint accounts using funds of her own and major portions of the substantial sums she received during the marriage were deposited in the joint accounts. Some of these funds were used for down payments on real property acquired, and to amortize or liquidate mortgages on which the parties were jointly liable. At the date of Ralph's death at least the funds in the joint bank account were originally Novice's funds. Novice on occasion would help her husband in his business. For example, she would take over the bookkeeping functions when the full-time secretary was absent from the office, she went 332 to home shows, and as the vice-president and a member of the board of directors she attended most of the shareholders' and directors' meetings. When the company sought to obtain bank loans, Novice would sometimes co-sign the notes as a joint obligor or guarantor. At one point when Engineered Trusses had used up its line of credit with the banks, Novice and Ralph loaned the company the money it needed to conduct its operations. These funds were generally advanced from their joint bank accounts (including a loan for $ 12,000 on August 6, 1968), although at least once the money came from Novice's personal account. Finally, Novice and Ralph jointly acquired several parcels of land surrounding the company's plant, and leased them to the company. As previously stated, respondent in his statutory notice of deficiency disallowed any exclusions from the value of the property owned jointly by the decedent and his wife on account of his wife's contributions to the acquisition of the properties. Additionally, petitioner failed to report on its Federal estate tax return 200 shares of Banister Contingental stock which had been purchased by January 21, 1971 for $ 2,175.26 and which remained 333 in their joint names on the date of decedent's death. This stock had a fair market value of $ 875 as of the alternative valuation date (January 9, 1975). The parties have agreed that petitioner is entitled to additional deductions for expenses of administration. OPINION Decedent and his wife jointly acquired considerable assets during the course of their marriage. Some of these assets were still owned by them on the date of decedent's death. On its Federal estate tax return, petitioner excluded from gross estate a portion of the value of these assets as attributable to contributions to their purchase made by the wife. Respondent disallowed the claimed exclusions on the ground that the petitioner was unable to prove that the wife had made any contribution to the acquisition of the properties. Under the general rule of section 2033, the value of the gross estate includes the value of all property owned by the decedent at the time of his death, but only to the extent of the decedent's interest therein. Section 2040, 2335 however, provides a special rule of inclusion where the interest is held in a joint tenancy or tenancy by the entirety. In such a case, the value of the entire property 334 is included in the estate of the first joint tenant to die, except to the extent that the surviving tenant can show that he or she has contributed to the cost of the acquisition of the property. Thus a presumption is created by the statute that the deceased co-tenant was responsible for the entire cost of acquisition, and the burden of proof is placed on the estate to rebut this presumption by shwing that some portion of the consideration used to acquire the property originated with the surviving co-tenant. Foster v. Commissioner, 90 F.2d 486">90 F.2d 486, 488 (9th Cir. 1937), affd. per curiam 303 U.S. 618">303 U.S. 618 (1938), reh. denied 303 U.S. 667">303 U.S. 667 (1938), affg. a Memorandum Opinion of this Court. 336 The record is far from satisfactory, and this is understandable in view of the number of years involved, and the commingling of income and assets by a happily married couple.There are formidable difficulties of tracing with precision the flow of assets and income of a couple who were both engaged in successful independent investments and business ventures and who also cooperated extensively in common investment and business enterprises. In view of the unsatisfactory state of the record, it is incumbent on us to do the best we can with the material at hand, bearing in mind petitioner's burden of proof. Cf. Estate of Harris v. Commissioner, T.C. Momo. 1964-109. On the basis of the entire record before us, including but not limited to inferences from the documentary evidence before us corroborated by the testimony of Novice; the sources of income and assets and flow of funds we have documented in chart form in our findings of fact; and the testimony of Novice, whom we found to be a candid, forthright, and honest witness, we have decided: (1) petitioner is sustained as to the joint bank accounts; (2) we sustain the petitioner with respect to Parcels 1, 2 (Trucks and Pure Oil Parcels 337 only), 4, 5, and 10, and the respondent as to the remaining Parcels; and (3) we sustain the respondent as to the jointly held stocks and bonds. Joint Bank AccountsThere are admittedly some problems in determining whose funds the joint bank accounts contained. In some specific instances, there is a fair amount of certainty as to which spouse was responsible for deposits made into the accounts. For example, $ 5,872.93 deposited into the First Federal Savings & Loan of Boward account no. 15051-6-9 on February 6, 1966 corresponds in amount exactly to the liquidation distribution Ralph received from Balisco Corporation during 1966. On the other hand, sometimes the deposits were divided among several accounts so as not to exceed the maximum insurable limit. Thus following Novice's receipt of $ 90,000 distribution from McClellan's Real Estate on May 18, 1972, we find deposits totalling $ 59,000 being placed into five joint savings accounts on May 24, 1972. We feel that these evidentary gaps are overcome, however, by Novice's testimony concerning the financial customs of her family. We note that the original joint accounts were established by Novice with her own money at marriage. She 338 stated that it was the practice of her husband and herself to deposit all of their receipts either into a joint checking account or a joint savings account. When the balance in a particular checking account became too high in consideration of the fact that interest was not payable on checking account deposits, the excess funds would be transferred into a joint savings account. When funds were needed to purchase a particular asset, money would be withdrawn from the joint savings account and deposited into the joint checking account so that a check could be written to purchase the asset. Furthermore, whenever monies were received from their jointly held properties, these funds would also be deposited into one of the joint accounts. Despite some minor inconsistencies in other matters, we find Novice's testimony in this regard very forthright and convincing, supported in part by the documentary evidence presented.Respondent does not really challenge this account of their financial dealings. Real EstateAs to several parcels, petitioners have made a strong case. As indicated, Novice testified that the usual method of acquisition was to make a down payment from joint funds and jointly 339 execute a mortgage that was amortized and/or liquidated out of payments derived from the resources of joint accounts. Parcel No. 1. is typical. The purchase price of $ 28,000 was paid by two payments totalling $ 8,000 and a note and mortgage in the names of both Ralph and Novice for $ 20,000. Monthly payments were made until October 1968 when the entire note was paid off. The parties have stipulated that all of the payments--other than part of the down payment--were made from funds drawn from the joint checking account; and it is clear from the record as a whole that the down payment was from joint funds. We believe that of the units involved in parcel No. 2, the "Trucks Parcel" and the Pure Oil Parcel fall into the same category, as does parcel Nos. 5 and 10. We sustain the petitioner as to these items. As to the remaining units of Parcel No. 2, Parcel No. 3, and Parcels Nos. 6, 7, 8, and 9, the documentation concerning the method of payment was unavailable at the time of trial and there is simply an absence of any significant evidence other than general assertions by Novice. We are aware of the burden taxpayers face and sympathetic to the problems presented, but we believe 340 something more is required to find for the taxpayer as to these Parcels. Parcel No. 4, however, stands on a different footing. Petitioner contends that Novice was the sole source of consideration for the acquisition of Parcel No. 4, the couple's personal residence. This home was acquired on March 5, 1973 for $ 64,000. Their prior hme had been acquired by Novice during 1956 as part of a divorce settlement with her former husband. At all times following that date, title to the house remained in Novice alone. This property was expanded by the purchase of two adjoining vacant lots during 1969. Although the sale of this house was not consummated until April 11, 1973, we think it significant that a contract for its sale was entered into on February 6, 1973. The selling price was $ 64,000--precisely the cost of their new home. Thus it was known to the parties on March 5 that a substantial sum would be forthcoming should the February 6 contract be carried out. Furthermore, the actual cash ultimately generated on the sale, including $ 5,456.61 received for the sale, also on April 11, of the vacant lots was $ 64,133.33. Thus ample funds were in fact generated by the sale. We believe, 341 given the normal manner of their real estate dealings, the Balazs's contemplated that Novice's sale of her home generated the funds over a period of time sufficient to satisfy the purchase price of their new home It is of no consequence that the funds actually used to acquire the home may have initially come from the joint accounts pending replacement with the proceeds of the sale, as we find the two transactions to have been mutually dependent and the funds from the sale to have been ultimately used for the acquisition of the new residence. Hence it follows that Novice was responsible for the entire cost of acquisition with the exception of the amount contributed by her husband towards improvements to the home following their marriage. Therefore the value of pracel No. 4 is includable in the gross estate only to the extent of the actual expenditures by Ralph for the improvements, there having been no showing that the improvements themselves had appreciated in value prior to the date of death. Estate of Peters v. Commissioner, 46 T.C. 407">46 T.C. 407 (1966), affd. 386 F.2d 404">386 F.2d 404 (4th Cir. 1967). Jointly Held Stoks and BondsAs to the jointly held stocks and bonds, petitioner submitted virtually 342 no documentary evidence of any kind. Unlike the real estate acquired, she did not co-sign any notes that were periodically paid or finally liquidated from their joint accounts. While the evidence as to the real estate and joint bank accounts is fragmentary and contains gaps, it provides a fabric sewn together by specific testimony of Novice. Here the record contains little more than bare assertions by petitioner that half of the funds for the purchase of the securities were her own. We are simply unable to say on the record before us whether the securities were purchased by Ralph with his separate assets, by Novice with her separate funds, or by both together with joint funds. Recognizing the practical difficulties the statute imposes on happily married couples who quite naturally collect the economic fruits of their partnership in joint assets, we have traveled considerable ground in forming favorable inferences with respect to the real estate and joint bank accounts. On this record, it is simply not possible to do the same with regard to the securities. While on a different record we might reach a different result, here we know little more than that the securities (or some 343 unknown portion of them) may have been purchased by either spouse, or by both spouses together. This is insufficient and as to these items we sustain respondent. Income of Each SpouseAs indicated, the evidence with regard to some of the items on which we sustain petitioner is fragmentary. 3344 Nevertheless an analysis of the respective earnings of Ralph and Novice is consistent with our conclusions. During the years 1959 through 1969, Ralph's activities generated approximately $ 344,033.12. 4345 Although he had separate assets prior to his marriage to Novice, most if not all of these were converted into cash or other property prior to his death and are thus included in the total. Ralph alone accounted for none of the family's receipts after 1969. Yet the total cost of all of the jointly held assets in question here was $ 489,144.66, 5 or $ 125,111.54 more than is traceable to Ralph alone, 6 and $ 367,969.81 of this amount was expended after 1969. By contrast, Novice's cash flow reflected large increases after Ralph's ceased. As of 1969, Novice had collected only $ 45,585.64. Purchases up until this time amounted to $ 101,174.85. However, Novice could have provided one-half of the consideration because their jointly held properties had yielded $ 40,127.25 through that date. After 1969, when the bulk of the properties were purchased, both Novice's income and their joint income increased dramatically. During this latter period, Novice collected 346 $ 336,272 7 and jointly they collected at least $ 52,085.19. 8 Therefore, it is much more likely that Novice was the main source of funds for a substantial portion of their acquisitions. Finally, Novice had generated greater funds during the marriage ($ 381,857.64) than did her husband ($ 344,033.12). If one combines Novice's separate earnings and her one-half share of the couple's joint earnings, it is clear that Novice had the resources to supply far more than half of the consideration for all of the jointly held property that we have given her credit for. Our conclusion is also bolstered by the fact that Novice was of aid to her husband in his business. She not only performed sales work, she was also an officer and director of the concern. She additionally provided financial assistance at 347 a time when it appeared that the business might be in trouble and was in fact unable to garner sufficient bank loans to finance its operations. Thus to some degree at least she was responsible not only for her own contributions to the property but those of her husband as well. 9348 Respondent urges that even if Novice had sufficient funds to have made a contribution, she has not shown that she did not spend these funds instead on the family's living expenses, which he claims will not suffice as consideration since it would be unrelated to the cost of acquiring jointly-owned property. Fox v. Rothensies, 115 F.2d 42 (3d Cir. 1940). Respondent fails to see that this argument actually cuts against his own contentions. If during the years prior to 1970 the family had lived solely on the earnings of the wife, they would have had to live on $ 4,548.76 per year. Even if we add to this the money generated by their jointly held property, they would have had available only $ 8,561.49 each year. Their cash would have been spread very thin when one takes into account the fact that there were three children to support. It seems that Ralph must have used at least some of his money to support the family, thus reducing even further the amount he could have expended on the properties here in question. Thus the fact that Novice's earnings began to bloom only after her husband's earnings had trailed off is a further 349 indication of the lack of consistency in respondent's complete disallowance of any contribution claimed on behalf of Novice. Decision will be entered under Rule 155. Footnotes. Sidney Wasserman was the original counsel of record for the petitioner. Mr. Wasserman died prior to the trial of this case.↩a. On their 1962 joint Federal income tax return, Novice reported a loss↩ of $ 544. The parties have stipulated, however, that $ 181.48 of income was correct. b. On their 1963 joint Federal income tax return, Novice claimed a loss of $ 1,293. The parties have stipulated the correct loss to be $ 431.08. Apparently, Novice failed to take only her share of partnership losses ($ 431.08 X 3 = $ 1,293.24).↩a. Includes interest on loans made to Engineered Trusses, evidence at trial having shown that these loans were made from the Balazs' joint bank accounts. b. From the sale of two houses in North Carolina. combined amount realized on these sales was $ 54,000. ↩c. From the sale of a house in North Carolina and a lot in Pompano Beach, Fla. The combined amount realized on these sales was $ 43,000. ↩d. From sales of stock. The combined amount realized on these sales was $ 29,567. ↩e. Losses from stock sales amounted to $ 5,181. The combined amount realized on these sales was $ 22,241. There was also an $ 8,597 gain from the involuntary conversion of a warehouse. Sixty-seven thousand dollars was realized on the involuntary conversion. ↩f. From the sale of a single lot, the amount realized on the sale being $ 6,000. ↩g. Dividends from Balisco Corporation. These dividends were reported on the Federal income tax returns as attributable to jointly held assets, and we ignore a joint exhibit which lists them as income of Ralph alone. ↩h. Distribution in liquidation from Balisco Corporation. See footnote g, supra↩.1. The parties have stipulated that these accounts were in the joint names of Novice and Ralph Balazs, and that any other names appearing on the passbooks is the result of actions taken by Novice after Ralph's death. Due to this stipulation, we will ignore indications on the face of some of the passbooks that the funds contained therein were held in trust for Novice's children.↩2. All section references are to the Internal Revenue Code of 1954, as in effect for the years here in issue, unless otherwise indicated. Section 2040 (now section 2040(a)) provides: SEC. 2040. JOINT INTERESTS. The value of the gross estate shall include the value of all property to the extent of the interest therein held as joint tenants by the decedent and any other person, or as tenants by the entirety by the decedent nd spouse, or deposited, with any person carrying on the banking business, in their joint names and payable to either or the survivor, except such part thereof as may be shown to have originally belonged to such other person and never to have been received or acquired by the latter from the decedent for less than an adequate and full consideration in money or money's worth: Provided, That where such property or any part thereof, or part of the consideration with which such property was acquired, is shown to have been at any time acquired by such other person from the decedent for less than an adequate and full consideration in money or money's worth, there shall be excepted only such part of the value of such property as is proportionate to the consideration furnished by such other person: Provided further↩, That where any property has been acquired by gift, bequest, devise, or inheritance, as a tenancy by the entirety by the decedent and spouse, then to the extent of one-half of the value thereof, or, where so acquired by the decedent and any other person as joint tenants and their interests are not otherwise specified or fixed by law, then to the extent of the value of a fractional part to be determined by dividing the value of the property by the number of joint tenants.3. This approach we have taken is not novel to this Court in the joint tenancy area. Estate of Carpousis v. Commissioner, T.C. Memo. 1974-258; Estate of Bender v. Commissioner, a Memorandum Opinion of this Court dated April 23, 1947; accord, Estate ofHarris v. Commissioner, T.C. Memo 1964-109">T.C. Memo. 1964-109. Most of the cases denying an exclusion appear to be situations where there was a total failure of evidence as to any contribution by the surviving co-tenant, see, for example, Estate of Richards v. Commissioner, 20 T.C. 904">20 T.C. 904 (1953) affd. per curiam 221 F.2d 808">221 F.2d 808 (9th Cir. 1955); Estate of Blood v. Commissioner, 22 B.T.A. 1000">22 B.T.A. 1000 (1931). Many commentators have noted the inequity where the multitude of transactions as well as the period of time which has elapsed may make exacting proof through tracing an impossible task. See, Stephens, Maxfield & Lind, Federal Estate and Gift Taxation, par. 4.12 [8], p. 4-246 (4th ed. 1978); Riecker, "Joint Tenancy: The Estate Lawyer's Continuing Burden," 64 Mich. L. Rev. 801">64 Mich. L. Rev. 801, 811↩ (1966). For a look by a former head of the IRS Estate and Gift Tax unit at the inconsistent treatment and often ironic results occasioned by the statutory scheme, see Fisher, "Uncle Sam, the Indian Giver: More 'Human Drama in Death and Taxes'", 107 Trusts and Estates, 529 (1968). 4. This figure differs from the total appearing on Chart A since we have substituted the amount realized for the long-term capital gains, the former being a more accurate reflection of the proceeds generated by the sale available for reinvestment. This is particularly true here where the property sold was primarily premarital property. 5. This figure, and all others used herein to describe the costs of the various properties, do not reflect the cost of the Reynolds Property (part of parcel no. 2), acquired during 1968, as the purchase price is unknown. ↩6. The entire value of jointly held property is included in a decedent's gross estate unless the executor sumbits facts sufficient to show that property was not acquired entirely with consideration furnished by the decedent↩ * * *. [Sec. 20.2040-1(a), Estate Tax Regs. Emphasis supplied.]7. See footnote 4, supra↩. 8. This figure includes only the gain or loss element of the property sales in order to avoid counting the same dollars twice where the moneys have been reinvested. Were we to have used the amount realized instead, this figure would have been $ 257,561.19. We have thus construed the facts in the light most favorable to the respondent, in view of petitioner's burden.↩9. It has been held in several cases that the wife's participation in the family business created a relationship, be it founded in a partnership or an implied contract to share in the earnings, sufficient to be counted as a consideration in "money's worth" by the wife to the acquisition of the jointly held assets. Estate of Berkowitz v. Commissioner, 108 F.2d 319">108 F.2d 319 (3d Cir. 1939); Richardson v. Helvering, 80 F.2d 548 (D.C. Cir. 1935). We do not here consider whether the present case falls within the ambit of the cited cases, as we are not treating Novice's services as consideration, but merely as a factor in our conclusion that she did in fact supply her own separate funds in purchasing the properties. See also section 2040(c), which allows a limited exclusion where the spouse of the decedent materially participated in the business. This provision applies only to estates of decedents dying after December 31, 1978. Section 511(b), Revenue Act of 1978, 92 Stat. 2882.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623523/	Chaney & Hope, Inc., Petitioner v. Commissioner of Internal Revenue, RespondentChaney & Hope, Inc. v. CommissionerDocket No. 12431-78United States Tax Court80 T.C. 263; 1983 U.S. Tax Ct. LEXIS 124; 80 T.C. No. 6; January 24, 1983, Filed 124 Decision will be entered for the respondent for the fiscal years 1973 and 1974, and for the petitioner for the period ended July 31, 1975. Alps Corp. was one of a group of corporations involved in the construction business. The stock in all of these corporations was owned by the same individuals and the percentage of the stock ownership which each of these individuals had in one corporation was approximately the same percentage that he had in any of the other corporations. A majority interest in each of the corporations was held by one individual, H.H operated the corporations in the group in tandem with one another. Alps Corp. throughout its entire existence, never paid a dividend to its shareholders. During the fiscal years of Alps Corp. ended Sept. 30, 1973 and 1974 and the period Oct. 1, 1974, through July 31, 1975, here involved, the accumulated earnings of Alps Corp. were reflected almost entirely in quick assets, and such quick assets were utilized to obtain bonding on the construction work which a sister corporation, Addison, was seeking to undertake as a general contractor. In these same years, Alps Corp., itself, undertook no construction work as a general contractor. 125 Alps Corp., however, took on all of the management functions required by Addison, and it also submitted bids on almost all of the electrical subcontracting work on projects undertaken by Addison as general contractor, but performed none of these contracts. For rendering management services to Addison, Alps Corp. received a management fee which varied from 1 to 3 percent of the work Addison had under contract. The bonding company from whom Addison obtained bonding generally required a general contractor to maintain a minimum amount of liquid assets. Prior to the years in issue, Alps Corp., Addison, and the other corporations in the group entered into an indemnity agreement under which each would be liable to the bonding company for any loss suffered by the bonding company from the issuance of a bond to any of the other corporations in the group. The bonding company treated all of the corporations in the group as constituting a single entity for bonding purposes. On July 31, 1975, Alps Corp. was merged into Addison.Held: In each of the fiscal years 1973 and 1974, Alps Corp. accumulated its earnings in excess of its reasonable business needs and, therefore, in each of such126 years is subject to the accumulated earnings tax. The reasonable needs of its sister corporation are not reasonble business needs of Alps Corp.Held, further, 127 the liquid assets maintained by Alps Corp. would be of benefit in the expanded business to be conducted by Addison after Alps Corp. was merged into Addison, and under the circumstances here present, Alps Corp.'s accumulations for the reasonable needs of the merged corporations were for its own 128 reasonable business needs and Alps Corp. is not subject to the accumulated earnings tax for the period Oct. 1, 1974, through July 31, 1975. Robert L. Trimble and Thomas R. Helfand, for the petitioner.William P. Hardeman, for the respondent. Scott, Judge. SCOTT 264 Respondent determined liabilities of petitioner Chaney & Hope, Inc., as transferee based129 upon deficiencies in income tax of its transferor, Alps Corp., for its fiscal years ended September 30, 1973, September 30, 1974, and the period October 1, 1974, through July 31, 1975, in the respective amounts of $ 4,919.20, $ 5,138.38, and $ 6,876.93.The issue for decision is whether Alps Corp. was availed of during each of its fiscal years ended September 30, 1973 and 1974, and the period October 1, 1974, through July 31, 1975, 265 for the purpose of avoiding Federal income tax with respect to its shareholders, by permitting its earnings and profits to accumulate instead of being distributed, within the meaning of section 532. 1FINDINGS OF FACTSome of the facts have been stipulated and are found accordingly.Chaney & Hope, Inc. (petitioner), is a corporation duly organized under the laws of the State of Texas. At the time of the filing of its petition130 here, petitioner maintained its principal place of business in Addison, Tex.Petitioner is the successor to a group of several Texas corporations, the first of which was formed in 1958. Since that date, other corporations belonging to this group have at various times been formed, operated, and then subsequently merged into another member of the group. All of these corporations have been involved in and have engaged in the construction business. There was no parent-subsidiary relationship between these corporations. Rather, they were brother-sister corporations, a majority stock interest in each corporation being owned by the same individual, Grover Hope. Mr. Hope, Mr. Hope's children, and two other individuals, at least as of October 1, 1972, were the common shareholders in the three then-existing corporations. Mr. Hope has been the president and a director of each of the corporations in the group. Table I on page 266 sets forth the date of incorporation of each of these corporations and the various dates upon which each was merged into another in the group.The reason for Mr. Hope's formation and operation of several corporations, each of which was involved in or engaged in131 the construction business, was to employ what is known as a double-breasting technique. Mr. Hope's employment of this technique stemmed from his decision to seek construction work in areas of the country other than the Dallas, Tex., area. At one time or another, Mr. Hope's corporations have done construction work in each of the States comprising the 266 TABLE IAlps Corp.Chaney & Hope, Inc. 1(Incorporated 1/24/58)(Incorporated 10/23/61)(1) 5/16/72Merged intoAddison Machinery(2) 7/31/75Merged intoAddison Machinery;however, name of successorcorporation changed toChaney & Hope, Inc.TABLE IAddison Machinery Co., Inc.(Incorporated 2/20/62)(1) 5/16/72Addison Machinery Co., Inc.,successor by merger ofChaney & Hope, Inc.(2) 7/31/75Addison Machinery Co., Inc.,successor by merger ofAlps Corp., survivingcorporation is renamedChaney & Hope, Inc.132 267 southern half of the United States. Basically, this technique allows Mr. Hope, acting through his several corporations, to take best advantage of the particular union connections each corporation maintains in conducting its operations. For example, assuming that nonunion labor can be used on the project, the corporation which runs its operations on an open shop or nonunion basis would be the one in the group which would submit a bid to be the job's general contractor. Another example would be a situation where one of the corporations maintained a working relationship with a union whose members were permitted to perform a wide range of tasks on a project upon which they were employed. Since these workers can be employed to perform a wider variety of tasks, fewer total workers could be employed on the project. There would thus be a significant savings in labor costs using members of this union, as opposed to employing members of another union which is stricter in that it allows only workers possessing a specified job description or rating to perform certain tasks. Therefore, the corporation affiliated with the union which allows a contractor to employ its members to133 perform a wider variety of tasks would be the corporation in the group which would make a bid. Essentially, through his operation of several brother-sister corporations, Mr. Hope could choose to operate through the corporation whose setup would offer the most competitive advantages in light of the labor situation in the particular area where the prospective job was located. 2Mr. Hope, through his corporations, sought to be the 134 general contractor of large construction projects which generally required bonding. In the course of his involvement with a project, a contractor is required to furnish two types of bonds: (1) A bid bond and (2) a performance bond.In order to be in a position to submit a bid on a construction project in which he is interested, a contractor must first obtain a set of the plans from the owner of the proposed project. Only 268 upon obtaining the plans is the contractor able to make a reasonable estimate of his cost of construction and thus arrive at the amount which he will submit as his bid on the project. However, in order to obtain a set of the plans, the contractor is required to post a bid bond. One of the purposes of the bond, from the owner's standpoint, is to ensure that the contractor will return the plans if he is not selected to do the job. However, of chief importance to the owner is that the bond assures him that the contractor, if selected, will enter into a contract to do the job for the amount bid.Generally, a bid bond would be issued by a bonding company for an amount that would vary from 5 percent to 20 percent of the amount of the bid. By the issuance 135 of this bond, the bonding company is guaranteeing to the owner that the bonding company will pay to the owner the face amount of the bond if the contractor fails to provide a performance and payment bond and enter into a contract for the construction of the project if his bid is selected. Thus, the bonding company is also in effect guaranteeing to the owner that, if the contractor is awarded the job, the bonding company will issue the contractor a performance bond.The performance bond is the other bond a contractor is required to provide. This bond is a precondition to the owner's entering into a construction contract with the bidder. The bonding company, by issuing the performance bond, guarantees the owner that the contractor will complete the project at the contract price. Pursuant to this guarantee secured by the performance bond, if the contractor is unable to complete the contract, a new prime contractor would be employed by the owner or the bonding company to complete the project. If the amounts paid to the original contractor plus the amounts paid to the new prime contractor exceed the contract price, then the owner would be reimbursed by the bonding company for the amount136 spent in excess of the contract price.In order for a bonding company to be willing to issue a performance bond, a bonding company would usually require (1) that the company pay a premium or fee for the bond; (2) that the company maintain a substantial liquid financial position; and (3) that the company indemnify the bonding company for any loss. In examining a contractor's liquidity position, a bonding company normally would look at the 269 amount of the company's net quick assets (cash plus short-term receivables less current liabilities) in relation to the total contract price of all of the contracts on which a contractor is working, plus all of the contracts on which the contractor is bidding, in order to determine if a contractor has an acceptable liquid financial position. Generally, a bonding company would issue a performance bond only if the total contracts in progress, plus the total contracts bid on, did not exceed 10 times the lesser of the company's net liquid assets 3 or its net worth. As a result, the more net liquid assets a contractor has, the greater the total size of the projects he is in a position to undertake.137 The corporations in the group obtained bonding from the Travelers Indemnity Co. of Hartford, Conn. (Travelers). In its dealings with the corporations, Travelers treated them in substance as being one entity for bonding purposes. In September 1967, Travelers required the three corporations then in the group, Alps Corp., Chaney & Hope, Inc., and Addison Machinery Co., Inc. (Addison), to enter into a general agreement of indemnity. Under this agreement, each of the corporations agreed to indemnify Travelers for any losses suffered as a result of its issuance of a bond to any of the three corporations.Any one or more of the corporations could terminate the indemnity agreement upon giving at least 10 days' notice to Travelers. However, any such termination would not affect the corporation's liability as co-indemnitor on any construction work which Travelers had already bonded. The indemnity agreement provided, in pertinent part, as follows:This Agreement may be terminated by the Indemnitors, or any one or more of the parties so designated, upon written notice to the Company of not less than 10 days, but any such notice of termination shall not operate to modify, bar or discharge138 the liability of any party hereto, upon or by reason of any and all such obligations that may be then in force.270 Travelers, throughout its dealings with these corporations, strongly suggested that all the corporations be merged or combined into a single corporation. Travelers desired that this be done because it would be easier for Travelers to deal with a single corporation rather than two or three separate corporations. Travelers would have to examine only one set of books rather than three, and would have to proceed against only one corporation to obtain indemnity.Addison was in the business of heavy construction and usually worked on construction projects such as ammunition plants, firing ranges, roads, power systems, fuel depots, dams, municipal water supply and sewage systems, and lakeside recreational facilities, including shelter areas, bath houses, etc., for various departments of the Federal, State, and municipal Governments.Alps Corp. was incorporated to engage in the business of being a general contractor on large construction projects in a double-breasted capacity with the Chaney & Hope partnership. The corporation had also engaged in the business of being139 an electrical subcontractor. At one time, Alps Corp. did seek to do electrical subcontracting work for general contractors other than its sister corporations. However, prior to the first year here in issue all subcontracting work performed by Alps Corp. was on construction projects on which one of its sister corporations was the general contractor. Normally, a general contractor will require his subcontractor to furnish a performance bond on the subcontract work. However, such a performance bond was not required of Alps Corp. if it undertook to be the electrical subcontractor for any of its sister corporations because the indemnity agreement which had been entered into in 1967 made such a bond superfluous.In 1970, Alps Corp. had begun work as the general contractor on a project involving the construction of a water plant at Fort Leonardwood, Mo., for the U.S. Army Corps of Engineers. Construction of the project was completed sometime during 1971. However, Alps Corp. never received a letter of completion from the Army Corps of Engineers. Even after completion of construction, a general contractor is usually liable for a 1-year period on a warranty he gives the owner on the 140 work done. The warranty period normally begins upon the owner's giving a letter of completion to the general contractor. 271 However, owners, at times, delay giving the contractor a letter of completion. Alps Corp. never received a completion letter for the Fort Leonardwood project. Final payment for that project was received in August 1975, after Alps Corp.'s merger into Addison.By the beginning of the first year here in issue, Alps Corp. had taken over the general office management function of Addison, its sister corporation. As noted previously, on May 16, 1972, Chaney & Hope, Inc., merged into Addison, although Addison subsequently did business using the name Chaney & Hope. This management function which Alps Corp. undertook involved maintaining all books and records, handling all correspondence on jobs, making out payrolls, reviewing and making payments on the invoices submitted by various suppliers and subcontractors, and also submitting various reports to Government agencies for its sister corporation. The administrative personnel and the top management who performed these management functions were paid by Alps Corp. out of its own funds. All persons performing141 management work for the two corporations were therefore employed by Alps. In return for handling the management function of Addison, Alps Corp. was paid a management fee based upon the percentage of work Addison had in progress. The fee varied from 1 to 3 percent of the work Addison had in progress.Alps Corp. undertook this management function because, although the two corporations were separate, they both had the same common shareholders and thus there was no need to maintain separate teams of management and administrative personnel.In addition, Alps Corp. also furnished bids on almost all of the electrical subcontracting work involved in projects of which Addison was the general contractor. Alps Corp., during the years in issue, never did any actual electrical subcontracting work. However, the bids which Alps Corp. made were of great use to Addison for purposes of evaluating the bids submitted by other electrical subcontractors. Alps Corp.'s bid provided a standard against which Addison could compare the bids it had received from other subcontractors. Because of their specialization in electrical work, local subcontractors were often able to perform the work for less than142 it would have cost either Addison or Alps Corp. to do the job. On occasions 272 when Alps Corp.'s bid was the lowest initially submitted, Addison was able to go back and negotiate to have a local electrical contractor do the work for a lesser amount than had originally been bid. Alps Corp., during the years in issue, had only two employees who worked up its bids on electrical subcontracting work. At that time, all the work these employees did concerning electrical subcontracting was in connection with making out bids on the electrical subcontracting work to be done on projects on which Addison was the general contractor.During the period in issue, the construction industry was in a slump as a result of the economy's being in a recession. The quantity of construction work available during this period was not as large as previously and there was increased competition for the available jobs.Beginning at least as of October 1, 1972, the outstanding shares of Addison and Alps Corp. were held by the following individuals in the amounts indicated:Number of shares ownedStockholderAddisonAlps Corp.Grover Hope127 (63.5%)710 (71.0%)Byron Whitmarsh42 (21.0%)210 (21.0%)Ray Cook16 ( 8.0%)80 ( 8.0%)Hope's three children15 ( 7.5%)0 Total shares outstanding200 (100%)1,000 (100%)143 On the July 31, 1975, date of the merger of Alps Corp. into Addison, the shares in the two corporations were held by the following individuals in the amounts indicated:Number of shares ownedStockholderAddisonAlps Corp.Grover Hope9,713 (63.5%)710 (71.0%)Byron Whitmarsh3,214 (21.0%)210 (21.0%)Ray Cook1,224 ( 8.0%)80 ( 8.0%)Hope's three children1,149 ( 7.5%)0 Total shares outstanding15,300 (100%)1,000 (100%)Immediately after the merger of Alps Corp. and Addison on July 31, 1975, the outstanding shares in the corporation were held by the following individuals in the amounts indicated: 273 StockholderNumber of shares ownedGrover Hope17,737 (66.7%)Byron Whitmarsh5,586 (21.0%)Ray Cook2,128 ( 8.0%)Hope's three children1,149 ( 4.3%)Total shares outstanding26,600 ( 100%)For the period from October 1, 1967, through July 31, 1975, Alps Corp. had the following amounts of taxable income in the fiscal years indicated:FYEAmount9/30/68$ 25,753.839/30/6928,111.459/30/7024,866.749/30/7120,796.969/30/7224,285.599/30/7324,845.009/30/7423,955.007/31/7532,355.24Alps Corp. 144 had no nontaxable income in any of these fiscal years.No cash dividends were paid by Alps Corp. during its entire existence.The following table sets forth the net worth and the net quick assets of Addison and Alps Corp. as well as the combined total net quick assets of both corporations and the volume of work under contract during the period from February 1, 1972, through January 31, 1978:Addison --Chaney & HopeAlps Corp.TotalsFYEWork underJan. 31 --Net worthNet quickNet worthNet quickNet quickconstruction1973$ 387,358$ 374,513$ 225,718$ 225,693$ 600,206$ 5,743,4441974251,211349,219246,085246,062595,2814,221,6641975375,275230,815276,291276,267507,0826,361,0261976631,2951,148,371Merged into C&H1,148,3717,858,9451977690,809859,549859,5494,745,7221978782,901657,345657,3459,533,572At the end of its fiscal years 1973 and 1974, Alps Corp. had current assets and current liabilities as follows: 274 CurrentCurrentRatio of current assetsassetsliabilitiesto current liabilities1973$ 284,014$ 46,3976.32 to 11974312,89755,1785.67 to 1145 A portion of these current assets which consisted of accounts receivable from its sister corporation, Addison, and from Beltwood, another corporation in which Mr. Hope owned stock, were as follows:AmountCompany19731974Addison$ 12,706.53$ 12,706.53Beltwood1,520.000 Total14,226.5312,706.53The Schedule L -- Balance Sheets included in the U.S. corporation income tax return filed by Alps Corp. for its fiscal year ended September 30, 1973, disclosed the assets and liabilities and stockholders equity at the beginning and end of the year as shown on pages 276-277. The Schedule M-2 -- Analysis of Unappropriated Retained Earnings per Books, indicated the following:1 Balance at beginningof year$ 206,2892 Net income per books17,8883 Other increases(itemize)4 Total of lines1, 2, and 3224,1775 Distributions: (a) Cash(b) Stock(c) Property6 Other decreases (itemize)7 Total of lines 5 and 68 Balance at end of year(line 4 less 7)224,177The Schedule L -- Balance Sheets included in the U.S. corporation income tax return filed by Alps Corp. for its taxable year ended146 September 30, 1974, disclosed the assets and liabilities and stockholders equity at the beginning and at the end of the year as shown on pages 278-279. The Schedule M-2 -- Analysis of Unappropriated Retained Earnings Per Books, included in the return, showed the following: 275 1 Balance at beginningof year$ 224,1772 Net income per books18,6853 Other increases(itemize)4 Total of lines1, 2, and 3242,8625 Distributions: (a) Cash(b) Stock(c) Property6 Other decreases (itemize)43See statement 37 Total of lines 5 and 6438 Balance at end of year(lines 4 less 7)242,819The Schedule M-2 -- Analysis of Unappropriated Retained Earnings Per Books, included in the return for the period October 1, 1974, through July 31, 1975, showed the following:1 Balance at beginningof year$ 242,819.002 Net income per books32,355.243 Other increases(itemize)-0.534 Total of lines1, 2, and 3275,173.715 Distributions: (a) Cash(b) Stock(c) Property6 Other decreases (itemize)275,173.71See statement 57 Total of lines 5 and 6275,173.718 Balance at end of year(line 4 less 7)147 The merger of Alps Corp. into Addison took place on July 31, 1975, and petitioner thereupon succeeded to all the assets and liabilities of Alps Corp. As of July 31, 1975, there was an account receivable from Grover Hope to Alps Corp. for $ 47,000. This account receivable was attributable to a short-term advance which Alps Corp. had made to Mr. Hope on July 21, 1975, which was repaid to petitioner, as the successor to Alps Corp. on January 31, 1976.Respondent sent notification to petitioner by certified mail on January 26, 1978, pursuant to section 534(b), that an adjustment based on accumulated taxable income as defined in section 535 and a resulting tax under section 531 was to be included in the proposed notice of deficiency. 4148 Respondent in his notice of deficiency to petitioner, as transferee and successor in merger to Alps Corp., transferor, gave the following explanation:It is determined that you were formed or availed of for the purpose of avoiding the income tax with respect to your shareholders by permitting 276 Schedule L -- BALANCE SHEETSBeginning of taxable yearASSETS(A) Amount(B) Total1 Cash85,3942 Trade notes and accounts receivable(a) Less allowance for bad debts3 Inventories4 Gov't obligations: (a) U.S. and instrumentalities(b) State, subdivisions thereof, etc5 Other current assets (attach schedule)162,5886 Loans to stockholders7 Mortgage and real estate loans8 Other investments (attach schedule)9 Buildings and other fixed depreciable assets242(a) Less accumulated depreciation2182410 Depletable assets(a) Less accumulated depletion11 Land (net of any amortization)12 Intangible assets (amortizable only)(a) Less accumulated amortization13 Other assets (attach schedule)14 Total assets248,006LIABILITIES AND STOCKHOLDERS' EQUITY15 Accounts payable20,78716 Mtges., notes, bonds payable in less than 1 yr17 Other current liabilities (attach schedule)6,00618 Loans from stockholders19 Mtges., notes, bonds payable in 1 yr. or more20 Other liabilities (attach schedule)21 Capital stock: (a) Preferred stock(b) Common stock10,00010,00022 Paid-in or capital surplus (attach reconciliation)4,92423 Retained earnings -- Appropriated (attach sch.)24 Retained earnings -- Unappropriated206,28925 Less cost of treasury stock26 Total liabilities and stockholders' equity248,006149 278 Schedule L -- BALANCE SHEETSEnd of taxable yearASSETS(C) Amount(D) Total1 Cash269,7882 Trade notes and accounts receivable14,226(a) Less allowance for bad debts14,2263 Inventories4 Gov't obligations: (a) U.S. and instrumentalities(b) State, subdivisions thereof, etc5 Other current assets (attach schedule)6 Loans to stockholders7 Mortgage and real estate loans8 Other investments (attach schedule)9 Buildings and other fixed depreciable assets242(a) Less accumulated depreciation2182410 Depletable assets(a) Less accumulated depletion11 Land (net of any amortization)12 Intangible assets (amortizable only)(a) Less accumulated amortization13 Other assets (attach schedule)14 Total assets284,038LIABILITIES AND STOCKHOLDERS' EQUITY15 Accounts payable39,44016 Mtges., notes, bonds payable in less than 1 yr17 Other current liabilities (attach schedule)5,49718 Loans from stockholders19 Mtges., notes, bonds payable in 1 yr. or more20 Other liabilities (attach schedule)21 Capital stock: (a) Preferred stock(b) Common stock10,00010,00022 Paid-in or capital surplus (attach reconciliation)4,92423 Retained earnings -- Appropriated (attach sch.)24 Retained earnings -- Unappropriated224,17725 Less cost of treasury stock26 Total liabilities and stockholders' equity284,038150 Schedule L -- BALANCE SHEETSBeginning of taxable yearASSETS(A) Amount(B) Total1 Cash269,7882 Trade notes and accounts receivable14,226(a) Less allowance for bad debts14,2263 Inventories4 Gov't obligations: (a) U.S. and instrumentalities(b) State, subdivisions thereof, etc5 Other current assets (attach schedule)6 Loans to stockholders7 Mortgage and real estate loans8 Other investments (attach schedule)9 Buildings and other fixed depreciable assets242(a) Less accumulated depreciation2182410 Depletable assets(a) Less accumulated depletion11 Land (net of any amortization)12 Intangible assets (amortizable only)(a) Less accumulated amortization13 Other assets (attach schedule)14 Total assets284,038LIABILITIES AND STOCKHOLDERS' EQUITY15 Accounts payable39,44016 Mtges., notes, bonds payable in less than 1 yr17 Other current liabilities (attach schedule)5,49718 Loans from stockholders19 Mtges., notes, bonds payable in 1 yr. or more20 Other liabilities (attach schedule)21 Capital stock: (a) Preferred stock(b) Common stock10,00010,00022 Paid-in or capital surplus (attach reconciliation)4,92423 Retained earnings -- Appropriated (attach sch.)24 Retained earnings -- Unappropriated224,17725 Less cost of treasury stock26 Total liabilities and stockholders' equity284,038151 Schedule L -- BALANCE SHEETSEnd of taxable yearASSETS(C) Amount(D) Total1 Cash300,1902 Trade notes and accounts receivable12,707(a) Less allowance for bad debts12,7073 Inventories4 Gov't obligations: (a) U.S. and instrumentalities(b) State, subdivisions thereof, etc5 Other current assets (attach schedule)6 Loans to stockholders7 Mortgage and real estate loans8 Other investments (attach schedule)9 Buildings and other fixed depreciable assets242(a) Less accumulated depreciation2182410 Depletable assets(a) Less accumulated depletion11 Land (net of any amortization)12 Intangible assets (amortizable only)(a) Less accumulated amortization13 Other assets (attach schedule)14 Total assets312,921LIABILITIES AND STOCKHOLDERS' EQUITY15 Accounts payable52,50816Mtges., notes, bonds payable in less than 1 yr17Other current liabilities (attach schedule)2,67018Loans from stockholders19 Mtges., notes, bonds payable in 1 yr. or more20 Other liabilities (attach schedule)21 Capital stock: (a) Preferred stock(b) Common stock10,00010,00022 Paid-in or capital surplus (attach reconciliation)4,92423 Retained earnings -- Appropriated (attach sch.)24 Retained earnings -- Unappropriated242,81925 Less cost of treasury stock26 Total liabilities and stockholders' equity312,921152 280 earnings and profits to accumulate instead of being divided or distributed during the taxable years ended September 30, 1973, September 30, 1974, and taxable year October 1, 1974 to July 31, 1975. Accordingly, the accumulated earnings tax provided by section 531, of the Internal Revenue Code is being asserted for those years as computed below:730974097507Taxable Income$ 24,845.00$ 23,955.00$ 32,355.24Less: Taxes Paid6,957.005,270.007,348.21Accumulated Taxable Income17,888.0018,685.0025,007.03Percentage27.5%27.5%27.5%Section 531 Tax$ 4,919.20$ 5,138.38$ 6,876.93Notification was sent to you by certified mail on January 26, 1978, pursuant to section 534(b) of the Internal Revenue Code, but no statement in response thereto was filed by you in accordance with the provisions of section 534(c).OPINIONSection 532(a) provides that every corporation formed or availed of for the purpose of avoiding income tax with respect to its shareholders, by permitting earnings and profits to accumulate instead of being distributed, shall be subject to the accumulated earnings tax imposed by section 531. Section 533(a) 5 provides that153 the accumulation of earnings and profits beyond the reasonable needs of the business is determinative of the purpose to avoid income tax with respect to its shareholders, unless the corporation proves to the contrary by a preponderance of the evidence.Section 535(a) 6 defines "accumulated taxable income" (the recomputed income of the corporation against which tax under section 531 is imposed) as the taxable income of the corporation, 281 as adjusted in section 535(b), less the dividends-paid deduction (as defined in section 561) 154 and the accumulated earnings credit (as defined in section 535(c)). Insofar as here relevant, this accumulated earnings credit is the amount of the corporation's earnings and profits which are retained for the reasonable needs of the business. Where a taxpayer can show that all its current earnings were accumulated for the reasonable needs of the business, there is no accumulated earnings tax since the accumulated credit eliminates the amount against which the tax is imposed. See, e.g., Magic Mart, Inc. v. Commissioner, 51 T.C. 775">51 T.C. 775, 799 (1969); Faber Cement Block Co. v. Commissioner, 50 T.C. 317">50 T.C. 317, 336 (1968); John P. Scripps Newspapers v. Commissioner, 44 T.C. 453">44 T.C. 453, 474 (1965). Whether a taxpayer's accumulation of earnings and profits is in excess of its reasonable needs is a factual question. Helvering v. National Grocery Co., 304 U.S. 282">304 U.S. 282 (1938). In this regard, we recognize that the accumulated earnings tax is a penalty tax and for that reason should be strictly construed. Ivan Allen Co. v. United States, 422 U.S. 617">422 U.S. 617, 626 (1975).155 Respondent does not argue that Alps Corp. was formed for the purpose of avoiding income tax with respect to its shareholders, only that it was availed of for that purpose during each of the years here in issue. Consequently, the arguments of the parties center on the amount necessary to meet the reasonable needs of the business of Alps Corp. Section 537 7 provides that for the purpose of the accumulated earnings tax, the term "reasonable needs of the business" includes the reasonably anticipated needs of the business. Also, the determination of the reasonable needs of the business is based on the facts which exist at the end of the corporation's156 taxable year, and "subsequent events shall not be used for the purpose of showing that the retention of earnings or profits was unreasonable at the close of the taxable year if all the elements of reasonable anticipation are present at the close of 282 such taxable year." Sec. 1.537-1(b)(2), Income Tax Regs. Once we determine the amount necessary to satisfy the needs of the business, we will not simply compare this amount with petitioners' total accumulated earnings and profits, but will look to the amount of accumulated earnings and profits which are reflected in the net liquid assets of Alps Corp. Ivan Allen Co. v. United States, supra at 628; Smoot Sand and Gravel Corp. v. Commissioner, 274 F.2d 495">274 F.2d 495, 501 (4th Cir. 1960), affg. a Memorandum Opinion of this Court; Montgomery Co. v. Commissioner, 54 T.C. 986">54 T.C. 986, 1008 (1970). As the Supreme Court stated in Ivan Allen Co. v. United States, supra at 628: "The question, therefore, is not how much capital of all sorts, but how much in the way of quick or liquid assets, it is reasonable to keep on hand for the 157 business."Alps Corp. in its fiscal years 1973 and 1974, and in its short taxable year ending July 31, 1975, had taxable income of $ 24,845, $ 23,955, and $ 32,355.24, respectively. The balance sheets included in Alps Corp.'s income tax returns disclose that its accumulated earnings were reflected in net quick assets well in excess of $ 200,000 in each of these years.Respondent contends that Alps Corp. was accumulating its earnings and profits in the form of liquid assets for the benefit of the business of its sister corporation, Addison. Petitioner, on the other hand, argues that earnings were not accumulated beyond the reasonable needs of the business158 of Alps Corp. Petitioner advances four grounds justifying the accumulations of Alps Corp. as being within its reasonable business needs: (1) Alps Corp. continued to be in the construction business, and, therefore, had to maintain its bonding capability by retaining a large amount of quick assets; (2) Alps Corp. was under a contractual obligation imposed by the 1967 indemnity agreement with Travelers to maintain a large amount of quick assets; (3) Alps Corp.'s business of furnishing management services to Addison required it to maintain a large amount of quick assets, since Addison's ability to receive bonding was dependent upon the total net quick assets maintained by both corporations; and (4) as to the last year in issue, since Alps Corp.'s merger into Addison could be reasonably anticipated and did take place at the end of such year, Alps Corp. was entitled to make accumulations for the business needs of the combined entities.283 Accumulations made in order to satisfy the business needs of a brother or sister corporation cannot generally be considered as accumulations to meet reasonable business needs. The business of the sister corporation is not the business of the corporation. 159 Factories Investment Corp. v. Commissioner, 39 T.C. 908">39 T.C. 908 (1963), affd. 328 F.2d 781">328 F.2d 781 (2d Cir. 1964); Latchis Theaters of Keene, Inc. v. Commissioner, 1054">19 T.C. 1054 (1953), affd. 214 F.2d 834">214 F.2d 834 (1st Cir. 1954). The fact that the two corporations are owned and effectively controlled by the same individuals does not justify accumulation of earnings by one corporation in order to meet the needs of a sister corporation. To allow accumulations to be made for the needs of a sister corporation would frustrate the major purpose of the accumulated earnings tax, which is to force earnings out of a corporation to its individual shareholders so that they can be taxed a second time at graduated individual income tax rates. Factories Investment Corp. v. Commissioner, supra at 916-917; Latchis Theaters of Keene, Inc. v. Commissioner, supra at 1065-1066. See also Inland Terminals, Inc. v. United States, 477 F.2d 836">477 F.2d 836, 840 (4th Cir. 1973). See further, sec. 1.537-3(b), Income Tax Regs.8160 The first ground advanced by petitioner as justifying Alps Corp.'s retention of its earnings, is that the accumulations were needed for Alps Corp.'s own construction business. Petitioner contends that Alps Corp. was still engaged in the business of being a general contractor. Throughout the years here in issue, petitioner maintains that Alps Corp. was available to serve as a general contractor on construction 284 projects in a double-breasted capacity with its sister corporation, Addison. Since it might reasonably have anticipated bidding and subsequently receiving contracts to serve as the general contractor of a project, petitioner maintains that Alps Corp. had to maintain its bonding capability by retaining a large amount of liquid assets.The record shows that Alps Corp., during the years in issue, was not engaged in the construction of any projects as a general contractor. Nevertheless, for accumulated earnings tax purposes, the reasonable needs of the business encompass not only accumulations to meet present needs, but also accumulations to meet anticipated future needs. Sec. 1.537-1(b), Income Tax Regs. However, the evidence presented indicates that Alps Corp. accumulated161 its earnings to increase the bonding capacity of its sister corporation, Addison. Alps Corp. was incorporated to serve as a general contractor on large construction projects in a double-breasted capacity first with Mr. Hope's partnership and later with various sister corporations. From the time of its formation through the years in issue, Alps Corp. never sought work as a general contractor independent of either the Chaney & Hope partnership or its sister corporations. Mr. Hope, the common controlling shareholder, operated all of the corporations in the group in conjunction with one another. The table included in our findings, setting forth the net worth and net quick assets of Alps Corp. and its sister corporation, Addison, as well as the combined net quick assets of both corporations and the total work under construction, shows that the substantial liquid assets maintained by Alps Corp. were utilized to obtain bonding for Addison. All of the work under construction during the years in issue was work for which Addison had received contracts as general contractor. Although Mr. Hope and another officer of Alps Corp. testified at trial, neither gave any testimony of any work which162 Alps Corp. had under construction as a general contractor. Also, neither witness gave any testimony concerning projects upon which Alps Corp. was seeking to be the general contractor. We are certain that these witnesses would have so testified if such had been the case. On the basis of the record presented, we conclude that any possibility of Alps Corp.'s bidding or receiving a contract to be the general contractor on a project as of the years here in 285 issue was uncertain and indefinite. Because of this lack of specificity and definiteness, we cannot accept petitioner's contention that the accumulations were made by Alps Corp. to serve its own business needs as a general contractor.Petitioner next asserts that Alps Corp., during the years here in issue, was engaged in the construction business as a subcontractor, so that the accumulations were necessary for Alps Corp.'s subcontracting business. We do not accept this second contention of petitioner's. The officer who ran Alps Corp.'s day-to-day operations testified at trial. His testimony in effect was that, while at one time the corporation did seek electrical subcontracting work, by the years in issue, Alps Corp. 163 was not actually engaged in the business of being an electrical subcontractor. Alps Corp. did submit bids on the electrical subcontracting work involved in projects upon which Addison was the general contractor. However, it never did any actual electrical subcontracting work. Alps Corp.'s making of the bids was essentially a part of the management services which it rendered to Addison. The electrical subcontracting bids submitted by Alps Corp. were used by Addison to evaluate the bids submitted by other electrical subcontractors. In making a bid, Alps Corp. did not seriously entertain any hopes of actually receiving a subcontract which would require it to perform actual electrical subcontracting work. Indeed, in the several instances when Alps Corp. was initially low bidder, Addison went back and negotiated to have another one of the bidders perform the subcontract work. Thus, Alps Corp.'s accumulations cannot be justified on the ground that such accumulations were necessary for an electrical subcontracting business.Petitioner asserts that the accumulations were necessary for Alps Corp.'s business since Alps Corp. had possible contingent liability on the Fort Leonardwood project164 which it had completed in 1971. The warranty on the work done on this project was apparently still in effect at least as of the first year in issue.We have recognized that a contingent liability is a reasonable need for which a business may provide, if the likelihood of its occurrence would appear to a prudent businessman. Bremerton Sun Publishing Co. v. Commissioner, 44 T.C. 566">44 T.C. 566, 586 (1965). However, in order for such contingent liability to be 286 a reasonable need for which accumulations may be made, the likelihood of its occurrence must be more than merely a remote possibility. J. Gordon Turnbull, Inc. v. Commissioner, 41 T.C. 358">41 T.C. 358, 374-375 (1963), affd. 373 F.2d 87">373 F.2d 87 (5th Cir. 1967).Petitioner has not convinced us that the potential liability of Alps Corp. on its warranty was more than a remote possibility. Alps Corp. had completed the water plant at Fort Leonardwood in 1971. At the trial, neither of the officers who testified brought to our attention any special problems Alps Corp. might anticipate in connection with the work done on the water plant. In fact, the officer who ran165 day-to-day operations of Alps Corp. testified that he had never experienced any warranty liability in excess of $ 30,000 to $ 40,000. Thus, we conclude that any potential liability from the 1971 project was too remote a possibility to justify more than a small fraction, if that, of the accumulation of earnings made here.The second ground advanced by petitioner for Alps Corp.'s accumulation of its earnings is that the corporation was a party to an indemnity agreement with the bonding company under which it was contractually obligated to maintain a large amount of quick assets. In our view, the mere expedient of entering into a contract cannot, for accumulated earnings tax purposes, justify the retention of earnings by a corporation to meet the needs of its sister corporation. It is clear that Alps Corp. only undertook general contracting work in a standby capacity to its sister corporations. Although in earlier years it had actually undertaken some jobs as a general contractor, the inference that we derive from the record is that the volume of work Alps Corp. had as a general contractor never approached the volume of work undertaken by its sister corporations. Thus, the benefits166 derived by Alps Corp. in entering into the indemnity agreement were only minimal in comparison to the benefits derived by its sister corporations. Alps Corp.'s entry into the indemnity agreement, as well as its accumulations in the years in issue, were primarily for the benefit of its sister corporations. Thus, we do not view its contractual obligation under the agreement to be a business purpose of Alps Corp. justifying the accumulation of its earnings.The third ground advanced by petitioner is somewhat related to the previous. Alps Corp., during the years in issue, was engaged in the business of furnishing management 287 services to Addison. Petitioner asserts that it was necessary for Alps Corp. to maintain a large amount of liquid assets, since Addison's ability to undertake construction work was dependent upon whether it could receive bonding, which in turn depended upon the total amount of net quick assets maintained by both corporations. Addison was the sole customer of Alps Corp.'s management services. Petitioner points out that the more work Addison had under contract, the larger the management fees it would pay to Alps Corp. since the fee was based on a percentage167 of the total volume of work Addison had.Alps Corp. did not make any actual loans of its funds to Addison. Rather, its liquid assets were accumulated and pledged with respect to any dealings its sister corporation had with the bonding company. However, if Addison ever needed funds, we do not doubt that Alps Corp. would have furnished the funds by way of a loan to its sister corporation.One of the grounds listed by the regulations as a factor which may indicate that earnings are accumulated for reasonable needs of the business is the need to provide for loans to suppliers or customers, if necessary, in order to maintain the business of the corporation. Sec. 1.537-2(b)(5), Income Tax Regs. On the other hand, the regulations list accumulations for the purpose of making loans to a brother-sister corporation as a factor which may indicate that earnings are being accumulated beyond the reasonable needs of the business. Sec. 1.537-2(c)(3), Income Tax Regs. Obviously, even though a sister corporation is involved, to the extent that the contemplated loan does not exceed that which would have been furnished to a similar but unaffiliated customer, accumulations for such purpose should168 be considered as for the reasonable needs of the business. Further, in our view, where the benefits to be derived from such course of conduct substantially outweigh the detriments, accumulations for such purpose may be considered as a reasonable business need.There can thus be a conflict in the application of the two factors listed in the regulations cited above, one of which indicates that the accumulation was for reasonable business needs, while the other indicates to the contrary. In such instance, one inquiry to be made concerns the existence of sound reasons why the sister corporation could not provide for 288 its own needs. Factories Investment Corp. v. Commissioner, supra at 917-918. 9 Here, although Addison did have work under contract almost up to the combined bonding capacity of both itself and Alps Corp., the record indicates that Addison had other avenues by which it could have obtained bonding without relying on the liquid assets of Alps Corp. At the trial, a former employee of the bonding company testified that if a contractor did not initially meet the minimum requirements, there were several means by which he could still satisfy169 the bonding company. One of these alternatives was to bring in another party in a joint venture. Such other party's financial assets would then be added toward meeting the requirements of the bonding company. This witness also acknowledged that if the shareholder of a corporation was an individual of substantial means, such shareholder could also either pledge his own individual assets or become a co-indemnitor of any liability which the corporation might have to the bonding company. Mr. Hope, the majority shareholder in Addison, was an individual of substantial means. We find that petitioner has not shown that Addison would have been unable to conduct its general contracting business without Alps Corp.'s accumulating and making its funds available to Addison for bonding purposes. Although Addison was the sole customer of Alps Corp.'s management services, we conclude that a stronger showing of business need on Alps Corp.'s part is required where the accumulations have been made to satisfy the needs of a sister corporation. The business of Addison is not the business of Alps Corp. While Alps Corp.'s business of furnishing management services is related to the general contracting170 business carried on by Addison, in order to show a reasonable business need for accumulation of earnings, petitioner must show some reasonable relationship of the funds furnished to Addison to profits to be received by the maintenance of the business relationship with the sister corporation. Here, Alps Corp.'s accumulation for the purpose of providing funds to a sister corporation which is also its customer has not been shown in the record to be necessary. Although the record shows that under the indemnity agreement Alps Corp.'s assets 289 were pledged for bonds for Addison, there is no showing that Addison would have been unable to conduct its business as it did without this indemnity agreement. There is no showing that other arrangements could not have been made by Addison to obtain the necessary bonding. Even more important is the fact that by permitting the tying up of its capital in order to provide bonding for Addison, Alps Corp. curtailed its own ability to seek profitable endeavors of its own. In our view, an unrelated corporation would not have so limited its own activities for a small profit from management fees. Although Alps Corp. derived a profit from furnishing171 management services to Addison, and, during the period here involved, this was its only source of income except for collections on construction work completed in prior years, the record shows the management fee charged was only in an amount which allowed a small net profit after the deduction of the salaries and wages of the personnel Alps Corp. employed to provide these management and administrative services. An unrelated corporation would obviously not have entered into a similar arrangement of pledging its assets for the benefit of such a customer, as it would have been contrary to its business interests. It would have used its assets in a manner more productive of profits from its own business operations. Moreover, this arrangement was carried on over the entire time Alps Corp. was in existence and did not consist of just a few isolated incidents. On this record, petitioner has totally failed to show a need for Alps Corp. to accumulate earnings in the years here in issue to derive management fee income from services rendered to Addison.172 The taxpayer in Factories Investment Corp. v. Commissioner, supra, made an argument similar to this argument made by petitioner. That taxpayer contended that it needed the accumulation to make loans to its sister corporation, the tenant of its building, which provided its sole source of income. In that case, we pointed out that the taxpayer had failed to show the need of its sister corporation for such loans or that it could not have rented its building to another tenant. Petitioner in this case has likewise failed to show that its own business interests required the accumulation.In effect, Alps Corp. was used during the period here involved for accumulating earnings and profits for no business 290 purpose of its own but merely as a means of accumulating earnings and profits to avoid tax to its shareholders. We find that the accumulations were not justified because Alps Corp. furnished management services to its sister corporation. The accumulations made were not necessary for the reasonable business needs of Alps Corp.Petitioner's last contention is that as of the last period in issue, the period October 1, 1974, through July 31, 1975, 173 Alps Corp. was entitled to accumulate its earnings for the business needs of Addison since its merger into Addison was anticipated and did take place as of the end of such year. A corporation may accumulate its earnings for the purpose of acquiring a business enterprise through the purchase of such other enterprise's stock or assets. Such acquisition of another enterprise is merely one means by which the corporation may expand its business. Sec. 1.537-2(b)(1) and -2(b)(2), Income Tax Regs. Section 1.537-3(a), Income Tax Regs., further states that the business of a corporation is not only the business which it has previously carried on but includes any line of business which it may undertake.In the present case, it was not contemplated that Alps Corp. would acquire Addison as a subsidiary. Rather, it was planned that the two corporations would be merged into a single entity. Clearly, here the liquid assets maintained by Alps Corp. could be of benefit in the general contracting business to be carried on after the merger. The greater the assets of a construction contracting business, the larger the projects on which it can submit bids on other than a joint venture basis. The combined174 net quick assets of both Addison and Alps Corp. about 6 months prior to the merger represented less than 10 percent of the volume of the work in progress. Approximately 6 months after the merger, the combined entity had net quick assets representing only 14.6 percent of the work in progress. We have held that a corporation might reasonably accumulate its earnings to meet the needs of a future subsidiary at least as of the year in which acquisition of the subsidiary became reasonably certain. 10 It seems clear that if the earnings of Alps Corp. were accumulated to provide for bona fide business 291 expansion and pursuant thereto Addison was merged into Alps Corp., then such accumulation would be reasonable. We do not believe, at least under the circumstances of this case, that the issue should turn on which way the merger went. We conclude here that Alps Corp. could accumulate its earnings for the period October 1, 1974, through July 31, 1975, in order to meet the reasonably anticipated future needs of the expanded business to be conducted by its successor. Though it was to be merged into Addison, Alps Corp. would in substance continue on as part of the combined entity. 175 We find that Alps Corp. was not subject to the accumulated earnings tax for the period October 1, 1974, through July 31, 1975.However, prior to such year, the merger could not reasonably be said to be definite, since Mr. Hope had for many years resisted the bonding company's suggestion to combine all his corporations into a single entity. We find that Alps Corp. in each of its fiscal years 1973 and 1974, had allowed its earnings to accumulate far beyond its reasonable business needs. We note that petitioner has not submitted any specific estimates of the amount of capital it would need to carry out its actual business operations. Since Alps Corp., during the years in issue, was essentially an auxiliary corporation providing only management and administrative services to its sister corporation, we conclude that any operating needs would be minimal and could have been satisfied currently out of the fees it*176 received from Addison. Since petitioner has failed to carry its burden of proof to show the contrary, the accumulation of earnings beyond the reasonable business needs of Alps Corp. is determinative as establishing that one of the purposes was the avoidance of income tax on its shareholders. Sec. 533(a). See United States v. Donruss Co., 393 U.S. 297">393 U.S. 297, 301 (1969). We find that Alps Corp. is subject to the accumulated earnings tax in each of its fiscal years 1973 and 1974, but is not subject to this tax for the period October 1, 1974, through July 31, 1975.Decision will be entered for the respondent for the fiscal years 1973 and 1974, and for the petitioner for the period ended July 31, 1975. Footnotes1. Unless otherwise indicated, all statutory references are to the Internal Revenue Code of 1954 as amended and in effect during the years here in issue.↩1. Prior to incorporation, Chaney & Hope had been operated as a partnership. The partnership had been engaged in the construction business prior to the incorporation of Alps Corp., which was formed to serve in a double-breasted operation with the partnership.↩2. Mr. Hope in effect testified that, while a contractor's enrollment with a particular union would not legally obligate him to use that union's members on most of his projects, as a practical matter, a contractor engaged in doing large projects was constrained to do so. He explained that the work undertaken by his corporations involved projects which could last as long as 2 or 3 years. Thus, he stated, if a contractor doing this type of work breached his commitment to a union by not using its members on a particular project, the union would find out and make trouble for the contractor.↩3. One reason for requiring a contractor to have this minimum level of liquidity is to ensure that he has sufficient operating funds with which to complete the work he will have under the contract. Construction contracts often permit the owner to retain a percentage of the payments owed the contractor until the project is completed, the purpose of such withholding being to ensure that the work is done to the owner's satisfaction. As a result, a contractor may have most of his profits withheld from him until completion and, during this period of time, the contractor's only readily available source of operating funds would be his own liquid assets.↩4. The parties stipulated that petitioner and respondent had previously entered an agreement under which petitioner became, and is, a transferee at law within the meaning of sec. 6901; and, as such, is liable for the deficiency, if any, in income taxes due from its transferor for the taxable years ended Sept. 30, 1973 and 1974, and the period Oct. 1, 1974, through July 31, 1975, plus interest thereon as provided by law.↩5. Sec. 533(a) provides as follows:SEC. 533. EVIDENCE OF PURPOSE TO AVOID INCOME TAX.(a) Unreasonable Accumulation Determinative of Purpose. -- For purposes of section 532, the fact that the earnings and profits of a corporation are permitted to accumulate beyond the reasonable needs of the business shall be determinative of the purpose to avoid the income tax with respect to shareholders, unless the corporation by the preponderance of the evidence shall prove to the contrary.↩6. Sec. 535(a) provides as follows:SEC. 535. ACCUMULATED TAXABLE INCOME.(a) Definition. -- For purposes of this subtitle, the term "accumulated taxable income" means the taxable income, adjusted in the manner provided in subsection (b), minus the sum of the dividends paid deduction (as defined in section 561) and the accumulated earnings credit (as defined in subsection (c)).↩7. Sec. 537 reads in part as follows:SEC. 537. REASONABLE NEEDS OF THE BUSINESS.(a) General Rule. -- For purposes of this part, the term "reasonable needs of the business" includes -- (1) the reasonably anticipated needs of the business,(2) the section 303 redemption needs of the business, and(3) the excess business holdings redemption needs of the business.↩8. While a corporation may not accumulate its earnings for the business needs of a sister corporation, it is recognized in certain instances that a parent corporation may properly accumulate its earnings for the needs of a subsidiary. In such instances, the business of the subsidiary is considered to be in effect the business of the parent corporation. Sec. 1.537-3(b), Income Tax Regs. The rules promulgated in this regulation merely reflect views enunciated by Congress in the accompanying legislative history to the Internal Revenue Code of 1954. S. Rept. 1622, 83d Cong., 2d Sess. 69-70 (1954).The Fourth Circuit Court of Appeals has extended the principles enunciated in the regulation one step further by holding that it is also permissible for a subsidiary to accumulate its earnings for the business needs of its parent corporation. Inland Terminals, Inc. v. United States, 477 F.2d 836">477 F.2d 836↩ (4th Cir. 1973). However, the Court of Appeals in its opinion made clear that a situation where brother-sister corporations were involved was completely distinguishable from one involving parent-subsidiary corporations. The Court expressed the view that one of the major purposes of the accumulated earnings tax would be frustrated if it was held to be permissible for a corporation to accumulate its earnings by reference to the business needs of its sister corporation.9. See also 31 West 53dStreet Corp. v. Commissioner, T.C. Memo. 1974-32↩.10. See Suwanee Lumber Manufacturing Co. v. Commissioner, T.C. Memo. 1979-477↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623524/	PEDRO M. RAMOS AND LOURDES RAMOS, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentRamos v. CommissionerDocket No. 13817-78.United States Tax CourtT.C. Memo 1981-473; 1981 Tax Ct. Memo LEXIS 269; 42 T.C.M. (CCH) 924; T.C.M. (RIA) 81473; August 31, 1981. Luis Medina, for the petitioners. Marion L. Westen , for the respondent. HALL MEMORANDUM FINDINGS OF FACT AND OPINION HALL, Judge: Respondent determined a $ 40,874.47 deficiency in petitioners' 1974 income tax, plus a $ 10,228.87 addition to tax under section 6651(a)1 for failure timely to file a tax return and a $ 2,043.72 addition to tax under section 6653(a) for disregard of rules and regulations. The issues for determination are: (1) Whether petitioners are entitled to a $ 6,370 business loss resulting from the seizure of a fishing boat by Bahamian authorities; (2) Whether petitioners are entitled to a $ 10,000 embezzlement loss relating to a rice deal in Greece; (3) Whether petitioners are entitled to a $ 21,000 business loss relating to a joint venture involving commodity transactions; (4) Whether petitioners are entitled to a $ 15,000 business272 loss relating to the attempted establishment of a blood bank in Paraguay; (5) Whether petitioners are entitled to a $ 26,063.70 business loss relating to the production of a Las Vegas floor show; (6) Whether petitioners are entitled to deductions for certain miscellaneous items in amounts greater than those previously allowed by respondent; and (7) Whether petitioners are liable for additions to the tax under section 6651(a) for failure timely to file their 1974 joint tax return and section 6653(a) for disregard of rules and regulations. FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. Pedro M. ("petitioner") and Lourdes Ramos, 2 husband and wife, resided in Miami, Florida, when they filed their petition. Petitioner completed his medical studies at Havana University in 1956. As a result of Cuba's political situation, petitioner came to the United States in 1959. Thereafter petitioner accepted an intern position in Iowa, followed by a general surgery residency at Mt. Sinai Hospital in Miami. Since completing his residency in 1963, 273 petitioner has resided in Florida. Petitioner became an American citizen in 1964. In addition to his medical practice, petitioner has participated in numerous business ventures. Through the years petitioner has been involved in a kitchen cabinet business, the commodities industry, commercial fishing, commercial blood banks, an exporting business, a travel agency and a hospital construction business. Seizure of the "Viola"In 1971 and 1972 petitioner purchased two fishing vessels, the Pescador and the Viola. Petitioner used these vessels to enter into a joint venture with a fellow Cuban emigre. Their arrangement provided that petitioner would contribute the use of the vessels in exchange for one-half of the fishing profits. After two unprofitable years, petitioner terminated the joint venture arrangement and sold the Pescador. In 1974 petitioner used the Viola to enter into a new joint venture with Ruben Santana. The terms of this joint venture were similar to the prior one in that petitioner agreed to let Santana use the boat in exchange for one-half of the fishing profits. Sometime in 1974 Bahamian authorities seized the Viola for fishing in the territorial waters274 of the Bahamas. 3 Shortly after the seizure, petitioner approached his friend, Richard Cabrera, for advice. Cabrera, a seasoned fisherman who had prior encounters with Bahamian authorities, volunteered to go to the Bahamas and investigate the situation. 4 Upon his return, Cabrera reported to petitioner that the Viola had been dismantled and was in generally poor condition. Cabrera advised petitioner that the Viola could not be returned to Miami under her own power but would have to be towed back to Miami. Based on Cabrera's advice and experience, petitioner believed that the boat's state of disrepair coupled with the potential legal costs and impediments in obtaining the vessel warranted its abandonment. Petitioner's adjusted basis in the Viola at the time of abandonment was $ 6,370. $ 10,000 Embezzlement LossIn 1973 petitioner met Ricardo Ferrera while traveling from New York to275 Miami. During their conversation, Ferrera and petitioner discovered their mutual interest in the commodities business. Subsequently, Ferrera visited petitioner and outlined a rice venture he was currently undertaking in Greece. Ferrera suggested that petitioner participate in the venture and eventually approached petitioner for a $ 10,000 loan. Ferrera indicated that he intended to use the funds to defray traveling expenses. Petitioner loaned the money to Ferrera on the condition that if the venture were successful petitioner would receive one-half of the profits and, if not successful, Ferrera would personally repay the funds. A friend of petitioner's delivered $ 10,000 in cash to Ferrera on petitioner's behalf. In March 1974 petitioner received a $ 10,000 check drawn on the account of Ricardo and Carolyn Ferrera at Franklin National Bank, New York. Petitioner deposited the check into his account with Southeast National Bank of Coral Way in Miami. Shortly thereafter petitioner's bank notified him that the Ferrera check had been dishonored because the account on which it had been drawn was closed. Petitioner attempted to telephone Ferrera in New York but was informed that276 his telephone number had been disconnected. To date, petitioner has not heard from Ferrera. Petitioner claimed a $ 10,000 deduction for a "business embezzlement loss" on his 1974 income tax return. Respondent disallowed the deduction because of petitioner's failure to establish his entitlement to the deduction. The Noval ArrangementIn 1973 petitioner met Jose Noval, a Cuban expatriate involved in the exporting and importing of commodities, for the purpose of collaborating on a transaction involving the sale of South American rice to a United States corporation. Petitioner and Noval traveled to New York to consummate the deal but failed to do so due to unforeseen complications. After this aborted business venture, petitioner and Noval became good friends. In 1973 and 1974 petitioner paid Noval $ 21,000 to finance Noval's attempt to orchestrate commodity deals. Pursuant to their arrangement, petitioner would receive the first $ 21,000 of profits derived from the deals arranged by Noval and the two of them would split any additional profits. This arrangement was not memorialized in writing. Noval maintained no books or records of any of his expenditures nor did277 he supply petitioner with any reports or accountings of the funds. No commodity deals were ever consummated. No partnership returns were filed on behalf of the arrangement between Noval and petitioner. To date, Noval has returned none of the $ 21,000 to petitioner. On his 1974 tax return petitioner claimed a $ 21,000 "business abandonment loss" relating to the arrangement with Noval. Respondent disallowed the entire deduction for lack of substantiation. Paraguayan Blood BankIn 1969 petitioner formed ABD Plasma and Serum Corporation, a plasma center or blood bank, located in Miami, Florida. Between 1970 and 1972 petitioner and others attempted to establish a similar operation in Nicaragua. A blood bank, Centro Americana De Plasmapheresis, opened in Nicaragua in 1972 with petitioner as a 14 percent shareholder. Petitioner played a central role in the operations of the Nicaraguan corporation. In 1973 petitioner sold his interest in ABD Plasma and Serum Corporation at a profit. As a result of the profitability of the blood banks, petitioner desired to open a new facility in 1974. In searching for a location for this new venture, petitioner looked for a country similar278 to Nicaragua with respect to the general health of the donor population and in which no other commercial blood bank had yet been established. Petitioner researched the situation and identified three potential markets. Only one of these prospects, Paraguay, had no commercial plasma centers. Having decided on Paraguay as the location for this venture, petitioner contacted a friend, Frank Condon, who traveled frequently to Paraguay. Petitioner requested Condon to arrange a meeting between petitioner and Paraguayan officials. Sometime in August 1974 petitioner, his wife, Condon, Fausto Alvarez 5 and two other associates traveled to Paraguay via Argentina. Once in Paragury, petitioner and his entourage met with a Paraguayan lawyer named "Chapel", 6 the Minister of Health and a Paraguayan financier. Subsequently, Condon and Alvarez made several trips to Paraguay in furtherance of the project. Eventually, petitioner obtained permission from the Paraguayan government to establish a blood bank in that country. Unfortunately, however, petitioner could not arrange for local financing of the project nor could be afford to finance it himself. Despite the inability to immediately finance279 the operation, petitioner retained a one-year option to proceed with the project. Petitioner subsequently let the option lapse due to the continued lack of financing. Petitioner never established a blood bank in Paraguay. On his 1974 tax return, petitioner claimed a $ 15,000 "business abandonment loss" with respect to his abortive attempt to establish a blood bank in Paraguay. 7 In his statutory notice, respondent disallowed the entire $ 15,000 deduction. Theatrical ProductionOn his 1974 tax return, petitioner claimed a "business abandonment loss" of $ 26,063.70 relating to the production of a Las Vegas floor show. Respondent280 disallowed the entire deduction due to lack of substantiation. Miscellaneous ExpensesOn his 1974 return, petitioner claimed and respondent allowed the following deductions: ItemClaimed DeductionAllowed DeductionTelex, Telephone$ 8,082.64$ 5,713.07and TelegraphAuto Expenses2,304.651,152.83Travel and Entertainment5,540.00Interest19,868.0018,376.93Miscellaneous561.85Additions to the TaxDuring 1974 petitioner maintained inadequate books and records. Petitioner signed his 1974 tax return on September 24, 1976, and subsequently filed it with the Internal Revenue Service. In his statutory notice, respondent asserted additions to the tax under section 6651(a) for failure timely to file the tax return and under section 6653(a) for disregard of rules and regulations. OPINION In addition to his medical practice, petitioner participated in a number of financial ventures during 1974. Respondent challenges several of the deductions claimed by petitioner with respect to those ventures. Seizure of the "Viola"In 1974 petitioner and Ruben Santana, a fisherman, entered into a business arrangement whereby petitioner281 allowed Santana to use his fishing vessel (the "Viola") in exchange for one-half of the fishing profits. During one of the Viola's fishing expeditions in 1974, it was seized by Bahamian authorities for fishing in the territorial waters of the Bahamas. The boat was dismantled during its dockage in the Bahamas and left in a state of disrepair. Based on the advice and experience of Robert Cabrera, a seasoned fisherman and friend who had prior encounters with Bahamian authorities, petitioner decided to abandon the Viola rather than incur the legal costs necessary to secure repossession of the vessel, the towing fees required to return it to Miami and the cost of refurbishing it. On his 1974 tax return, petitioner claimed a "business casualty loss" equal to his adjusted basis in the Viola, i.e., $ 6,370. In his statutory notice, respondent stated The deduction of $ 6,370.00 claimed as a business casualty loss--confiscation of a boat is disallowed because you have not established that you are entitled to such a deduction. Therefore, your taxable income is increased in the amount of $ 6,370.00 for the year 1974. In his trial memorandum filed at the call of the calendar, respondent282 indicated two bases for disallowing petitioner's claimed loss. The first involved lack of substantiation and the second relied upon section 162(f). 8 This was the first time respondent had raised section 162(f) as a basis for the disallowance. On brief, respondent's only argument against petitioner's deduction related to section 162(f) and the regulations thereunder. For the reasons stated below, we hold for petitioner on this issue. At the threshold, we reject respondent's attempt in this case to use section 162(f) to disallow petitioner's claimed loss. Throughout this proceeding petitioner has consistently looked to section 165 as the source of his deduction and respondent has consistently challenged the deduction under that section. Respondent now requests this Court to apply section 162(f) to disallow a deduction taken under a different section of the Internal Revenue Code. Section 162(f), however, does not sweep so broadly. By its terms, section 162(f) only disallows those expenses that the otherwise283 allowable under section 162(a). Consequently, even disregarding respondent's delay in raising section 162(f), 9 it would appear that section 162(f) would have no bearing on petitioner's claimed deduction under section 165. Cf. R.R. Hensler, Inc. v. Commissioner, 73 T.C. 168">73 T.C. 168 (1979) (deduction under section 162 allowed regardless of deductibility under section 165). Section 165(a) allows a deduction for "any loss sustained during the taxable year and not compensated for by insurance or otherwise." In the case of an individual, the deduction is limited to losses incurred in the taxpayer's trade or business or in any transaction entered into for profit, and to certain casualty losses. Sec. 165(c). Petitioner bears the burden of proving he has sustained a deductible loss. Rule 142(a), Tax Court Rules of Practice and Procedure.10 Although the record is284 less than ideal on this point, we believe petitioner has sustained his burden. We do not view respondent's position on brief as seriously challenging these facts and we find them supportive of petitioner's entitlement to a business loss deduction. Losses arising from the seizure (or confiscation) of business property are generally deductible absent a showing that such deductions will frustrate a sharply defined national of state policy. See Holt v. Commissioner, 69 T.C. 75 (1977), affd. per curiam 611 F. 2d 1160 (5th Cir. 1980); Fuller v. Commissioner, 20 T.C. 308">20 T.C. 308 (1953), affd. 213 F. 2d 102 (10th Cir. 1954). 11 In this case, neither party has raised nor addressed whether the allowance of petitioner's loss will contravene a sharply defined national policy and, accordingly, we do not address this aspect. Moreover, petitioner's pragmatic decision to abandon the vessel rather than pursue285 its return does not preclude the deduction. See Hills v. Commissioner, 76 T.C. 484 (1981), on appeal (5th Cir. 1981). In sum, we conclude that petitioner sustained a $ 6,370 loss in 1974 relating to his fishing enterprise. $ 10,000 Embezzlement LossOn his 1974 tax return, petitioner claimed a $ 10,000 "business embezzlement loss" relating to petitioner's dealings with Ricardo Ferrera. On brief, petitioner has apparently abandoned the embezzlement argument and now asserts that the $ 10,000 represents a business bad debt deduction in 1974. 12 Respondent challenges the deduction due to petitioner's failure to prove the worthlessness of Ferrera's obligation and, we agree. 286 In general, section 166 permits taxpayers to deduct bad debts that become worthless within the taxable year. The determination of the worthlessness of a debt depends on the facts and circumstances in each case. Sec. 1.166-2(a), Income Tax Regs.; Estate of Pachella v. Commissioner, 37 T.C. 347">37 T.C. 347, 353 (1961), affd. 310 F. 2d 815 (3d Cir. 1962). Furthermore, the date of worthlessness is fixed by identifiable events which form the basis of reasonable grounds for abandoning any hopes of recovery. Id. at 353. Petitioner bears the burden of proof on this issue. Rule 142(a). 13The facts presented by petitioner do not adequately support his conclusion that the Ferrera debt was worthless in 1974. The record reveals that petitioner received a $ 10,000 check from Ferrera287 which was subsequently dishonored due to the closing of Ferrera's account and that petitioner's attempts to telephone Ferrera proved futile because the latter's telephone had been disconnected. We find these facts to be inconclusive of the debt's worthlessness. First, the reason why Ferrera's check was dishonored, i.e., the closing of his account, does not necessarily reflect adversely on Ferrera's ability to repay the loan. Second, although petitioner failed to reach Ferrera by telephone, petitioner's testimony at trial reveals that at least two of his friends were also acquaintances of Ferrera. There is no evidence in the record that petitioner enlisted the help of his friends or anyone else to locate Ferrera. Furthermore, there is no evidence of other efforts made by petitioner to contact Ferrera. Given the amount of money involved, it is surprising that petitioner would so easily give up on locating him. At trial, petitioner testified that he pursued no legal action against Ferrera because (1) he did not know where Ferrera lived, (2) he would have to institute legal proceedings in a foreign forum (New York), (3) the expense of hiring a lawyer would probably exceed any288 recovery and (4) Ferrera might not have the money to repay. Some of these statements are pure speculation and are uncorroborated. There is no evidence in the record of the nature and extent of petitioner's effort to contact Ferrera besides telephoning a disconnected number nor is there any evidence of petitioner contacting an attorney regarding his legal rights and the cost of asserting them. In sum, petitioner has presented insufficient evidence from which we can formulate an independent opinion as to the collectibility of the Ferrera debt. See Estate of Pachella v. Commissioner, supra at 353. The Noval ArrangementOn his 1974 tax return, petitioner claimed a $ 21,000 "business abandonment loss" relating to an arrangement between himself and Jose Noval, a commodities dealer, whereby petitioner supplied funds to finance Noval's attempt to put together commodity deals. Petitioner contends that the arrangement constituted a joint venture and that the $ 21,000 represented his investment in it. Petitioner further contends that the joint venture was a complete failure and, as a consequence, he sustained a $ 21,000 business loss. On the other hand, respondent289 questions the nature of the arrangement between petitioner and Noval and, in any event, asserts that petitioner has failed to sustain his burden of proof with respect to this deduction. Although the nature of the arrangement is not entirely clear from the evidence presented, 14 we will assume for purposes of this opinion that petitioner's characterization is correct. Nonetheless, we conclude that he has failed to establish his entitlement to the loss in 1974. Section 165 provides that: (a) General Rule.--There shall be allowed as a deduction any loss sustained during the taxable year and not compensated for by insurance or otherwise. (b) Amount of Deduction.--For purposes of subsection (a), the basis for determining the amount of the deduction for any loss shall be the adjusted basis provided in section 1011 for determining the loss from the sale of other disposition of property. 290 Petitioner must prove the amount of his loss and that it occurred during the taxable year in which the deduction is claimed. Rule 142(a). The sole basis for petitioner's claimed deduction is the unsupported representation made by Noval that the venture failed. Noval failed to maintain any records or accountings of how he expended the $ 21,000. At trial, Noval provided no details as to his expenditures; instead his testimony was vague and inconsistent. 15 Under these circumstances, Noval's bald assertion that the entire venture was a flop simply will not suffice to sustain petitioner's burden of proving that all, or any part, of the $ 21,000 was expended and, hence, lost. Moreover, even if we were satisfied that the entire $ 21,000 was expended and lost, the record is completely devoid of evidence pinpointing the taxable year in which such loss was sustained. Paraguayan291 Blood BankThis issue relates to the deductibility of certain legal and travel expenses pertaining to petitioner's abortive attempt to establish a blood bank in Paraguay. Petitioner claims that he is entitled to a $ 15,000 business loss for amounts expended before the planned venture was abandoned. Respondent, on the other hand, contends that petitioner has failed to substantiate his entitlement to this deduction and we agree. Initially, we recognize that the deductibility of preliminary or investigatory expenditures relating to prospective businesses often raises thorny issues as to whether the taxpayer is currently engaged in the trade or business, whether such expenditures were incurred in that trade or business, or whether such expenditures were incurred in a transaction entered into for profit. Sections 162(a), 165(c)(1) and 165(c)(2). See O'Donnell v. Commissioner, 62 T.C. 781">62 T.C. 781, 785-786 (1974), affd. without published order (7th Cir., July 23, 1975); Seed v. Commissioner, 52 T.C. 880">52 T.C. 880 (1969); Frank v. Commissioner, 20 T.C. 511 (1953).292 16 Under any of the above theories, the taxpayer must still prove the amount expended on the prospective business. Rule 142(a). Because petitioner has failed to prove the amount expended on the Paraguayan blood bank project, we need not address the question of which of the aforementioned Code provisions, if any, are applicable.17In support of his claimed deduction, petitioner introduced two cancelled checks drawn on his expense account with Southeast National Bank of Coral Way. The first check, dated December 3, 1974, is for $ 7,000 and made payable to S. Hompanera, Inc. The second check, dated December 17, 1974, is for $ 8,000 and made payable to293 "Cash." 18 Petitioner testified that the $ 7,000 check was given to Frank Condon, a friend of petitioner's who frequently traveled to Paraguay, to pay for the legal fees associated with the Paraguay project. There is, however, no explanation in the record as to the relationship between the Paraguayan lawyer referred to by petitioner as "Chapel" 19 and the payee of the check "S. Hompanera, Inc." Furthermore, there is no bill or other evidence indicating the amount of the legal fee incurred in the Paraguay project. Petitioner's failure to demonstrate how a check payable to "S. Hompanera, Inc." satisfied a fee charged by a lawyer named "Chapel" or that the amount of such check equals the legal fee charged by the Paraguayan lawyer, simply leaves too great an evidentiary gap for us to fill with speculation. With respect to the $ 8,000 check, petitioner testified that the proceeds were used to294 reimburse Fausto Alvarez, his accountant and business associate for expenses incurred in traveling to Paraguay. Although Alvarez testified that petitioner reimbursed him for his expenses, his testimony did not reveal how much those expenses were nor did he testify that he received an $ 8,000 payment from petitioner at any time. Alvarez's failure to mention receipt of the $ 8,000 coupled with the cash nature of the check makes us hesitant to attribute the funds to the Paraguay project. Furthermore, the expenses for which petitioner purportedly reimbursed Alvarez are not delineated or documented. Alvarez testified that he merely told petitioner how much he spent and was reimbursed for that amount. Under these circumstances we simply cannot find that petitioner had sustained his burden of proving that the $ 8,000 was expended on the Paraguay project. In addition to the two cancelled checks, petitioner also introduced a credit care receipt for a Paraguayan hotel bill, a hotel bill for a Sheraton Hotel in Argentina, and two airline tickets representing a round-trip from Miami to Paraguay in Alvarez's name. 20 We do not believe that these additional items aid petitioner's cause. 295 First, the credit card receipt for the hotel in Paraguay is in Alvarez's name and reflects the currency of Paraguay. Even if we presume the hotel bill relates to one of Alvarez's travels on behalf of the Paraguay project and that petitioner reimbursed him for that expense, we do not know the amount of the bill. Petitioner introduced no evidence as to the exchange rate for translating Paraguayan currency into United States dollars. Second, the hotel bill for the Buenos Aires-Sheraton Hotel reflects the charges incurred by Mr. and Mrs. Alvarez, Mr. and Mrs. Condon and Garcia Ciro, a business associate of petitioner's, during a 10-day period from August 4 through August 11, 1974. At trial petitioner testified that he, Alvarez, Condon and two associates including Ciro traveled to Paraguay via Argentina. Even assuming petitioner paid for the travel expenses of the entire group, we do not believe the expenses reflected in the Sheraton Hotel bill were primarily related to the Paraguay project. 21 No evidence was introduced explaining why the group needed to stay in Argentina for 10 days when the purpose of the trip was to investigate the prospects of forming a blood bank in Paraguay. 296 We surmise that the trip was not all business. 22 Third, the connection between the airline tickets and the Paraguay project is similarly attenuated. 23In sum, the evidence presented does not adequately substantiate petitioner's claimed expenditures relating to the Paraguay project. Even if we were to find that petitioner was in the trade or business of operating blood banks, see note 17, supra, and that he expended $ 15,000 on the Paraguay project, we would still be unable to permit petitioner's deduction for 1974. The record is devoid297 of any evidence as to when the project was abandoned. The project began sometime in August 1974. Subsequently, Condon and Alvarez visited Paraguay several times, evidently to obtain a permit and to obtain local financing. The record does not reveal the time frame of these subsequent trips nor of the financing negotiations. Petitioner did, however, obtain a permit to operate the blood bank. The rights associated with petitioner's permit required him to establish the business within one year or else forfeit the permit. It was only after the expiration of the one-year period that petitioner abandoned the Paraguay project. In light of these facts, petitioner's abandonment could not have occurred in 1974 and, consequently, he is not entitled to a section 165(c) loss in that year. 24Theatrical ProductionPetitioner claimed a $ 26,063.70 "business abandonment loss" on his 1974 tax return. In support of this deduction, petitioner testified298 that he invested this amount in the production of a Las Vegas floor show. According to petitioner, he transferred approximately $ 26,000 to Julio Diaz, a Mexican political figure, in 1974 for the purpose of financing a theatrical production to be choreographed by petitioner's friend, Robert Hulideros, a Cuban-born choreographer then living in Mexico. Petitioner further testified that Diaz disappeared with $ 15,000 after spending the difference on the production. No show was ever produced nor has petitioner heard from Diaz. Based on these events, petitioner contends that he suffered a business loss under section 165. Respondent maintains that petitioner has failed to meet his burden of proving that any deductible loss was sustained in 1974, and we agree.Section 165(a) provides that there shall be allowed as a deduction any loss sustained during the taxable year and not compensated for by insurance or otherwise. The loss must be evidenced by closed and completed transactions and fixed by identifiable events occurring in such taxable year. Sec. 1.165-1(d)(1), Income Tax Regs.299 Petitioner bears the burden of proving all elements of his claimed loss. Rule 142(a). In the present case, all we have is petitioner's vague and unsubstantiated testimony that he suffered a loss financing a theatrical production. Petitioner introduced none of the books or records of the production nor other documentary evidence indicating whether such a venture was ever undertaken and, if so, what amounts were expended. Petitioner produced two witnesses, Jose Espinales and Fausto Alverez to corroborate petitioner's testimony that he transferred approximately $ 26,000 to Diaz in 1974. At trial, petitioner testified that he requested a Nicaraguan corporation, Centro Americana de Plasmapheresis, in which he was a shareholder to transmit approximately $ 26,000 of his dividends directly to Diaz. Espinales, an accountant for the Nicaraguan corporation, testified that he transmitted approximately $ 26,000 on petitioner's behalf in 1974 to the account of J. Diaz. We find Espinales' testimony incredible. Espinales' testimony at trial was inconsistent with an affidavit signed on May 2, 1979, in which he stated that the transfer in question was sent to the order of "the City of Mexico300 D.F." Furthermore, after observing Espinales' demeanor at trial, we find his specific recall of this $ 26,000 to be suspicious. This is especially so in light of the passage of six years and the multitude of accounting entries and money transfers Espinales handled in his position with the Nicaraguan corporation. 25 Espinales offered no records, advices, receipts or other documentary evidence supporting his testimony. Alvarez, petitioner's personal accountant and controller of Centro Americana de Plasmapheresis, testified that he instructed Espinales to transmit the $ 26,000 to Diaz on petitioner's behalf. Alverez's testimony discloses none of the details surrounding the transfer nor did he present any documentary evidence regarding it. It general, we attach little, if any, weight to Alvarez's testimony. Even assuming funds were transferred to Diaz, the transfer alone would not substantiate the amount and timing of petitioner's loss. Moreover, the transfer in question did not necessarily have to relate to the theatrical production. In light301 of the absence of any credible corroborative evidence of the theatrical production, the amount involved, or the nature and timing of the expenditures, we find that petitioner's vague testimony is not sufficient enough to carry his burden on this issue. Miscellaneous ExpensesThe following table represents miscellaneous deductions claimed by petitioner on his 1974 tax return and the amount of those deductions allowed by respondent: ItemClaimed DeductionAllowed DeductionTelex, Telephoneand Telegraph$ 8,082.64$ 5,713.07Auto Expenses2,304.651,152.83Travel and Entertainment5,540.000Interest19,868.0018,376.93Miscellaneous561.850At trial, petitioner introduced partial and summary worksheets prepared by his accountant to substantiate the claimed deductions. These worksheets, by themselves, are not sufficient to sustain petitioner's burden of proof. Rule 142(a). Without some documentation or testimony supporting the worksheets we cannot say that the amounts reflected have been expended by petitioner or that they have been expended for a deductible purpose. Under the circumstances, we cannot find that petitioner is entitled302 to greater deductions than those previously allowed by respondent. Furthermore, with respect to the $ 5,540 travel and entertainment deduction, petitioner has presented no evidence indicating his compliance with the specific substantiation requirements of section 274(d). See sec. 1.274-5, Income Tax Regs.Additions to the TaxIn his notice of deficiency, respondent asserted additions to the tax under section 6651(a) for petitioner's failure timely to file his tax return and under section 6653(a) for disregard of rules and regulations. Petitioner bears the burden of proof on both of these issues. See Bixby v. Commissioner, 58 T.C. 757">58 T.C. 757, 791 (1972) (section 6653(a)); Fischer v. Commissioner, 50 T.C. 164">50 T.C. 164, 177 (1968) (section 6651(a)). Petitioner filed his 1974 tax return in September 1976 well past the due date of April 15, 1975. The record contains no evidence of the granting of any filing extensions; nor has petitioner introduced any evidence that his failure to file timely was due to reasonable cause. See Fischer v. Commissioner, supra at 177.303 Consequently, petitioner is liable for the addition to tax under section 6651(a).Section 6653(a) provides for an addition to tax of 5 percent of the "underpayment" where any part of such underpayment is due to negligence or intentional disregard of rules and regulations. We have held that the negligence penalty may be assessed in addition to the failure to timely file penalty, Robinson's Dairy, Inc. v. Commissioner, 35 T.C. 601">35 T.C. 601, 609 (1961), affd. 302 F. 2d 42 (10th Cir. 1962), provided it has not been established that respondent relied solely on the circumstances of unaggravated late filing without reasonable cause to apply the negligence penalty. 26In the present case we have been repeatedly confronted with the inadequacy of petitioner's books and records. This lax attitude on petitioner's behalf is in direct*304 conflict with the mandate of section 6001 and the regulations thereunder. Petitioner has offered no evidence explaining the inadequacy of his records and, accordingly, we find him liable for the negligence penalty under section 6653(a). See Gilman v. Commissioner, 72 T.C. 730">72 T.C. 730, 751 (1979). To reflect the foregoing, Decision will be entered under Rule 155. Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as in effect during the year in issue.↩2. Lourdes Ramos is a petitioner solely by virtue of having filed a joint return with her husband.↩3. As captain of the boat, Santana was placed in jail. ↩4. Previously, Cabrera experienced the seizure of one of his boats by Bahamian officials. Cabrera hired a Bahamian lawyer and eventually secured the release of his vessel, but by that time it had been dismantled beyond use.↩5. Fausto Alvarez is petitioner's accountant and business associate. ↩6. At trial, petitioner could not recall the exact spelling of the lawyer's name.↩7. On his return, petitioner specifically listed $ 8,000 as his loss from the blood bank venture. The additional $ 7,000 was included in petitioner's claimed abandonment loss relating to his commodities business. At trial and on brief, petitioner asserts that the $ 7,000 should now be included with the claimed blood bank loss and not with the loss derived from his commodities business.↩8. Section 162(f) provides: No deduction shall be allowed under subsection (a) for any fine or similar penalty paid to a government for the violation of any law.↩9. Of course, by raising this issue for the first time in his trial memorandum filed at the call of the calendar, respondent would bear the burden of proof. Rule 142(a), Tax Court Rules of Practice and Procedure.↩10. Unless otherwise indicated, any reference to "Rules" shall be deemed to refer to the Tax Court Rules of Practice and Procedure.↩11. See also Lafayette Extended Care, Inc. v. Commissioner, T.C. Memo. 1978-233 (1978); Howse v. Commissioner, T.C. Memo. 1974-225↩ (1974).12. Even assuming petitioner has not abandoned his embezzlement theory, the record will not support a finding that Ferrera embezzled the $ 10,000. Petitioner specifically testified that he lent Ferrera the $ 10,000. Nowhere in the record is there a scintilla of evidence that Ferrera misappropriated the funds.↩13. Regardless of whether the debt owing to petitioner is a business or nonbusiness debt, petitioner must still prove its worthlessness. Consequently, we do not reach the merits of petitioner's assertion on brief that the debt is business-related.↩14. At one point in his testimony Noval refers to the $ 21,000 as a personal loan. This is inconsistent with other references in the record to the $ 21,000 as an investment in the joint venture.↩15. For example, on direct examination Noval testified that the funds were used to defray traveling and telephone expenses. Yet on cross-examination he admitted that a portion of the funds were used by Alper, Inc., his wholly-owned corporation, to purchase commodities and to ward off bankruptcy.↩16. See also Bick v. Commissioner, T.C. Memo. 1978-390↩ (1978). 17. Petitioner's position on his tax return and on brief presupposes that any expenditure relating to the Paraguayan blood bank project would be deductible under section 165(c)(1). It is arguable, however, that petitioner's activities with the blood bank in Miami and Nicaragua do not suffice to qualify him as being in the trade or business of operating blood banks. See O'Donnell v. Commissioner, 62 T.C. 781">62 T.C. 781, 785-786↩ (1974).18. Both checks were signed by Coralia Verials, presumably an employee of petitioner's. The $ 7,000 check was endorsed by S. Hompanera, Inc. for deposit only in the Bank of Miami. The $ 8,000 check was endorsed "Coralia Verials--Cashed for Pedro M. Ramos." ↩19. See note 6, supra↩.20. According to the tickets, Alvarez left Miami on August 3, 1974, and returned on August 12, 1974. ↩21. The Sheraton Hotel bill presents a further problem of being quoted in Argentinian currency. Again, petitioner offered no evidence of the applicable exchange rate. ↩22. We find it strange that none of the bills presented reflect petitioner's presence with the group. ↩23. In comparing the departure and arrival dates on the airline tickets with the Sheraton Hotel bill, it appears that all of Alvarez's time was spent in Argentina. Furthermore, there is no evidence that petitioner reimbursed Alvarez for the airline tickets.↩24. Petitioner has never asserted that his expenditures are currently deductible under section 162(a). See note 17, supra↩. Accordingly, his entitlement to a 1974 deduction hinges on his proving the claimed loss occurred in 1974.25. At trial, Espinales denied having any prior discussions concerning his testimony with petitioner or petitioner's attorney.↩26. See Estate of Haseltine v. Commissioner, T.C. Memo. 1976-278↩ (1976). In this case, respondent relied on petitioner's failure to maintain adequate books and records to support his assertion of the negligence penalty.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623528/	Matson Navigation Company, Petitioner v. Commissioner of Internal Revenue, Respondent; Alexander and Baldwin, Inc., Petitioner v. Commissioner of Internal Revenue, RespondentMatson Navigation Co. v. CommissionerDocket Nos. 1625-74, 1626-74United States Tax Court67 T.C. 938; 1977 U.S. Tax Ct. LEXIS 139; March 16, 1977, Filed 139 Rule 121, Tax Court Rules of Practice and Procedure. -- P moved for summary judgment, asserting that its depreciation deductions for the taxable years 1965 through 1969 were allowable in accordance with Rev. Procs. 62-21, 2 C.B. 418">1962-2 C.B. 418, and 65-13, 1 C.B. 759">1965-1 C.B. 759, or in the alternative, that if adjustments are to be made in its depreciation deductions, the Court can and should decide in accordance with such revenue procedures the amount of such adjustments. Held, motion granted in part and denied in part; Rev. Procs. 62-21, 65-13, and 68-27, 2 C.B. 911">1968-2 C.B. 911, interpreted and applied. Hart H. Spiegel and Robert C. Livsey, for the petitioners.Vernon R. Balmes, for the respondent. Simpson, Judge. SIMPSON939 OPINIONThe petitioners have made a timely motion for partial summary judgment pursuant to Rule 121, Tax Court Rules of Practice and Procedure. The issues raised by this motion are: (1) Whether Matson Navigation Co. (Matson) can justify its claimed depreciation deductions for its water transportation equipment for the taxable years 1965 through 1969 on the basis of Rev. Proc. 62-21, 2 C.B. 418">1962-2 C.B. 418, 1141 as modified by Rev. Proc. 65-13, 1 C.B. 759">1965-1 C.B. 759; (2) whether, if Matson cannot justify its claimed depreciation deductions for such years on the basis of such revenue procedures, it may continue to claim depreciation at a rate previously accepted by the Internal Revenue Service on audit; and (3) whether, if Matson's depreciation is to be adjusted to a rate lower than that previously approved for it, the Commissioner is barred from making any adjustment in excess of that allowed by the minimal adjustment rule of Rev. Proc. 65-13. An extensive stipulation of facts with exhibits was submitted, and the parties have filed briefs in support of their positions.The Commissioner determined deficiencies in income taxes for the calendar years 1965 through 1969 in the following amounts:YearDeficiency1965$ 885,04119662,899,3081967189,50519681,152,8251969819,747142 The deficiencies resulted from the disallowance of depreciation deductions claimed by Matson on some of its vessels and from certain other adjustments not before us on this motion. 940 The petitioners filed timely petitions with this Court, seeking a redetermination of such deficiencies. Alexander & Baldwin, Inc., is involved in this proceeding solely because it filed consolidated returns with Matson for the taxable years 1968 and 1969, and Matson will be referred to as the petitioner.In disallowing a portion of Matson's claimed depreciation deductions, the Commissioner made adjustments to the useful lives and salvage values claimed with respect to certain of its vessels. Matson's main contention is that the class lives used by it in computing the claimed depreciation deductions on its water transportation equipment were justified on the basis of the reserve ratio test of Rev. Proc. 62-21, as modified by Rev. Proc. 65-13, and that therefore the Commissioner is precluded from disturbing its depreciation deductions. In the alternative, Matson argues that, pursuant to Rev. Proc. 62-21,143 it is entitled to depreciation deductions based on the class life previously justified on audit. Finally, Matson contends that even if this Court finds that its depreciation deductions were not justified, and does not accept its alternative contention regarding use of the class life previously justified on audit, the Commissioner is nonetheless barred by the minimal adjustment rule of Rev. Proc. 65-13 from making any adjustments to its depreciation deductions.Matson was audited by the IRS for the calendar years 1962, 1963, and 1964. As a result of such audit, the examining agent proposed adjustments to the depreciation deductions claimed by Matson on three of its vessels, the Californian, the Hawaiian, and the Citizen, by extending their useful lives from 10 to 15 years. Matson filed a protest taking exception to the proposed adjustments to its depreciation deductions on the three vessels and requested a hearing with the Appellate Division. The Appellate Division, after review of the agent's adjustments to the depreciation deductions on the three vessels for the years 1962, 1963, and 1964 and after several conferences with144 Matson, advised Matson that there was no deficiency. The appellate conferee's report concluded that the taxpayer's arguments in justification of the depreciation claimed, without regard to the application of Rev. Procs. 62-21 and 65-13, had considerable merit. Additionally, the report stated that Matson had satisfied the guideline form of the 941 reserve ratio test outlined in Rev. Procs. 62-21 and 65-13, and that therefore its depreciation deductions were justified.The dispute over Matson's depreciation deductions for the taxable years 1962, 1963, and 1964 arose in the context of a modernization program begun by it in 1958. In such year, upon the recommendation of its research department, Matson began a program of conversion to carry containerized cargo; this program involved the overhaul of its fleet, adapting its vessels so that they could carry the containers. 2 Prior to 1960, Matson had modified seven of its vessels to carry containers on deck. In 1960, the Citizen was converted to a full container ship, carrying containers in the holds as well as on deck. In such year, Matson also purchased two vessels (the Californian and the Hawaiian) which it converted145 to combination bulk cargo carriers and container ships; another vessel, the Fisherman, was converted to an auto carrier and renamed the Motorist. In 1963, Matson acquired the Legislator and converted it to an auto carrier, which could also carry containers on deck. In such year, the Motorist was further adapted to carry containers on deck.Matson's modernization program continued during the years at issue. In 1964, Matson exchanged the Packer and the Retailer for the Queen and the Monarch, which were converted146 into full container vessels and put into service in 1965. The conversion consisted of adding a midbody, removing the intermediate ship decks in the hold, and installing cell guides and cell structures so that the ship was able to carry cargo containers in the hold. The crews' quarters and bridge were relocated on the deck. In 1967, the Planter and the Craftsman were converted into full container vessels and renamed the Trader and the Banker. The amounts expended by Matson for the purchase, conversion, and improvement of its vessels, as of the end of each of the years 1964 through 1969, were as follows: 942 PurchaseOtherDatepriceConversionsimprovementsTotal cost 112/31/64$ 20,937,179$ 33,895,081$ 1,789,832$ 56,622,09212/31/6521,408,12650,029,4351,853,14773,290,70812/31/6621,408,12650,029,4352,156,46273,594,02312/31/6725,055,10957,539,0932,190,64884,784,85012/31/6825,055,10957,539,0932,566,01185,160,21312/31/6924,247,82257,539,0933,322,45785,109,372Net increase from12/31/64 to12/31/693,310,64323,644,0121,532,62528,487,280147 Matson computed its depreciation deductions on its vessels for the taxable years 1965 through 1969 on the straight-line basis for its books of account and financial statements. For tax purposes, it computed such deductions on the straight-line basis for assets acquired before 1963, and on a combination of the straight-line or the double-declining-balance method for assets acquired in 1963 and thereafter. Matson used individual item accounts for depreciating its water transportation equipment and claimed useful lives for the years 1964 through 1969 as follows:Matson's estimatedVesseluseful life in yearsSS Lurline12SS Hawaiian Rancher20SS Hawaiian Farmer20SS Hawaiian Motorist10SS Hawaiian Merchant20SS Hawaiian Builder20SS Hawaiian Citizen10SS Hawaiian Refiner20Californian10SS Hawaiian10SS Hawaiian Legislator10SS Hawaiian Queen10SS Hawaiian Monarch10Pacific Trader21(ex SS Hawaiian Planter)Pacific Banker21(ex SS HawaiianCraftsman)SS Hawaiian Princess18Barge Islander15Tug Sevier18Tug Doyle18In his notices of deficiency, the Commissioner made the following adjustments: (1) The useful lives of the Motorist148 and the Legislator were increased from 10 to 18 years, and the salvage value redetermined; (2) the cost to convert the Monarch and the Queen was extended from 10 to 18 years; (3) the remaining useful lives of the Banker and the Trader were extended from 6 to 18 years as of 1967, the year of major conversion; and (4) the salvage values of the Craftsman, the 943 Planter, the Lurline, the Rancher, the Farmer, the Merchant, the Builder, and the Refiner were redetermined.The class life correctly computed for Matson's vessels, barges, tugs, and similar water transportation equipment (collectively referred to as vessels), described in guideline class group 1, sec. 2(h), Part I, Rev. Proc. 62-21, for each of the years 1957 through 1969, was as follows:Computed classYearlife in years195718.52195815.65195916.24196016.70196115.21196213.83196313.34196413.11196512.96196612.14196711.82196811.16196910.65A guideline life of 18 years is specified for vessels in such group by such revenue procedure.The actual reserve ratio for Matson's vessels, 149 and the lower limit of the appropriate reserve ratio range (computed using the tabular form of the reserve ratio test prescribed in Part III, Rev. Proc. 62-21), for each of the taxable years 1964 through 1969 were as follows:ActualYearreserve ratioLower limit196461.1044.26196551.8745.69196662.3044.67196763.0145.12196871.5845.11196978.2348.04Under the guideline form of the reserve ratio test announced in Rev. Proc. 65-13, including the transitional allowances, Matson's actual reserve ratio was within the upper limit of the appropriate reserve ratio range (computed using an extended life equal to 120 percent of the class test life).The petitioner asks us to decide, in effect, that based upon Rev. Procs. 62-21 and 65-13, it is entitled to judgment as a matter of law. Rule 121, Tax Court Rules of Practice and Procedure; Julius E. Hoeme, 63 T.C. 18">63 T.C. 18, 20 (1974); James T. Shiosaki, 61 T.C. 861">61 T.C. 861, 862-863 (1974). The Commissioner has not questioned the propriety of the petitioner's motion for 944 150 summary judgment but has disputed the petitioner's interpretation of the provisions of those revenue procedures. Thus, the parties have, in effect, agreed that the above revenue procedures are controlling, and we have treated the relevant provisions of such revenue procedures as dispositive of the issues before us. However, we wish to make clear that in so doing, we are not passing upon whether such revenue procedures represent a reasonable interpretation or application of the law.Section 167(a) of the Internal Revenue Code of 1954 allows as a deduction "a reasonable allowance for the exhaustion, wear and tear (including a reasonable allowance for obsolescence) * * of property used in the trade or business." The reasonableness of a taxpayer's depreciation deduction is a question of fact. Connecticut Light & Power Co. v. United States, 368 F.2d 233">368 F.2d 233, 242 (Ct. Cl. 1966); cf. Suil J. Moss, 38 T.C. 605">38 T.C. 605, 608 (1962); M. Pauline Casey, 38 T.C. 357">38 T.C. 357, 381 (1962). In 1953, the IRS announced that it would propose adjustments to a taxpayer's depreciation deduction only where there was a "clear and151 convincing basis for a change" (Rev. Rul. 90, 1953-1 C.B. 43); yet, the reasonableness of claimed depreciation deductions continued to be the source of controversy between taxpayers and the IRS. The IRS issued Rev. Proc. 62-21, which was designed to provide taxpayers with a greater degree of certainty in determining the amount of their depreciation deductions, and to provide greater uniformity in the audit of such deductions, thereby eliminating needless controversy. Rev. Proc. 62-21 at 429.The revenue procedure constituted a comprehensive reform of the standards and procedures used in determining allowable depreciation. Part I, Rev. Proc. 62-21, provided guideline lives for approximately 75 broad categories of assets; the guideline lives were based on industry-wide experience as to the useful lives of assets in each such class. Part II provided a detailed description of the procedures to be used in examining a taxpayer's depreciation deductions on audit; more importantly, Part II provided that the depreciation 152 deduction (including useful life and salvage value) claimed by a taxpayer would not be disturbed if certain conditions were satisfied. Part III contained the reserve ratio tables and the adjustment table for class lives. See Pacific Fruit Express Co., 60 T.C. 640">60 T.C. 640, 643945 (1973); Vernon Keith Graves, 48 T.C. 7">48 T.C. 7, 12 (1967), affd. per curiam 400 F.2d 528">400 F.2d 528 (9th Cir. 1968).A taxpayer, who prior to the issuance of Rev. Proc. 62-21 was depreciating his assets in item accounts, was permitted to regroup his assets into accounts corresponding to the guideline classes, but was not required to do so. The taxpayer also was permitted to regroup his assets annually, solely for purposes of applying the tests of the revenue procedure (Rev. Proc. 62-21 at 430), as Matson has done in the case before us. Taxpayers were not compelled to use the guideline life for a guideline class, but were permitted to use a life longer or shorter than the guideline life, where appropriate. Moreover, a taxpayer who established a life consistent153 with the guideline life was not automatically protected from audit adjustments; rather, the taxpayer also was required to demonstrate that the life used was consistent with his actual retirement or replacement practices. The reserve ratio test provided an objective means of demonstrating that the taxpayer's actual retirement and replacement practices justified the life used or a proposed change in the life used. Rev. Proc. 62-21 at 429 n. 2. Application of the revenue procedure was not mandatory; rather, the taxpayer was given the option of having his depreciation deductions examined under the provisions of Rev. Proc. 62-21, or of having his accounts examined under previously established procedures.If a taxpayer elects to have his depreciation deduction examined under the provisions of Rev. Proc. 62-21, as the petitioner has done in the case before us, the first step is to determine the class life used by the taxpayer. In the case of a taxpayer depreciating assets in item accounts, the assets are first regrouped in classes corresponding to the prescribed154 guideline classes; the class life for each class is then determined by computing the weighted average of the lives used for the item accounts coming within the guideline class. Rev. Proc. 62-21 at 434. The next step is to compute the taxpayer's actual reserve ratio, that is, the ratio of the depreciation reserves for the assets in a guideline class to the basis of such assets. The tables in Part III, Rev. Proc. 62-21, establish the theoretically appropriate reserve ratio for the assets in a guideline class, taking into account the method of depreciation used by the taxpayer and the rate of growth of 946 his accounts for a guideline class. The tables also establish appropriate reserve ratio ranges, prescribing acceptable upper and lower limits. Rev. Proc. 62-21 at 440-442. The upper limit of the appropriate reserve ratio range includes a 20-percent tolerance, and the lower limit, a 10-percent tolerance. Thus, the actual reserve ratio for a taxpayer who is in fact replacing his assets at a rate 20 percent slower than is consistent with the life used 155 will nonetheless fall within the upper limit of the appropriate reserve ratio range. Likewise, a taxpayer may be replacing assets at a rate 10 percent faster than is consistent with the life used, yet his actual reserve ratio will not fall below the lower limit of the appropriate reserve ratio range. Answer 28, Rev. Proc. 62-21 at 470-471. In essence, the reserve ratio test provides an objective, yet not rigid, means of determining whether the taxpayer's actual retirement and replacement practices are consistent with the rate at which assets are being depreciated for tax purposes.Part II, Rev. Proc. 62-21, provides detailed procedures to be followed in examining depreciation deductions. Section 2 of Part II provides the standards to be applied where the class life used by the taxpayer is equal to or longer than the guideline life for a guideline class, whereas section 3 applies where the class life used by the taxpayer is shorter than the guideline life for a guideline class. In the case before us, the parties have stipulated the correctly computed class life for each of the years in issue and 156 also have stipulated that such class life is shorter than the applicable guideline life; hence, section 3 is applicable. Subsection .02 of section 3 applies where the class life used by the taxpayer is equal to or longer than the class life used in the immediately preceding taxable year, while subsection .03 of section 3 applies where the class life used by the taxpayer is shorter than the class life used for the preceding taxable year. As the parties have also stipulated that the class life used by the petitioner for each of the taxable years 1965 through 1969 is shorter than the class life used for each of the preceding taxable years, section 3.03 is the proper provision to be applied in examining the petitioner's depreciation deductions.Section 3.03, Part II, Rev. Proc. 62-21 at 432, provides:.03 Class life shorter than life used in preceding year. -- Where the class life used by a taxpayer is shorter than the guideline life for a guideline class 947 and is also shorter than the class life used by the taxpayer in the immediately preceding taxable year, the depreciation deduction claimed by the taxpayer will not be disturbed if157 either paragraph (a) or (b) of this subsection applies.(a) Class life justified by prior retirement and replacement practices. -- The depreciation deduction will not be disturbed if the taxpayer's prior retirement and replacement practices indicate that such shorter class life is justified, as demonstrated by the following factors:(1) the taxpayer's reserve ratio for the guideline class for the taxable year immediately preceding the taxable year under examination was below the lower limit of the appropriate reserve ratio range; and(2) the taxpayer has used approximately the same class life as the life used in such immediately preceding year for a period of years equal to at least one-half of the class life used in such preceding year; and(3) the shorter class life used in the taxable year under examination is not shorter than can be justified on the basis of the Adjustment Table for Class Lives.(b) Class life justified by other factors. -- The depreciation deduction will not be disturbed if the class life used by the taxpayer is justified for the taxable year under examination on the basis of all the facts and circumstances * * [Fn. refs. omitted; emphasis supplied.] 158 In its opening brief, the petitioner asserts as its main contention that the fact that its reserve ratio falls within the upper limit of the appropriate reserve ratio range (utilizing the transitional allowance of Rev. Proc. 65-13) demonstrates that its retirement and replacement practices are consistent with the class life used by it. However, such argument ignores the provisions of section 3.03. Under that provision, the fact that the petitioner's reserve ratio falls below the upper limit of the reserve ratio range is irrelevant: The provision clearly states that a taxpayer seeking to justify a class life which is shorter than the class life used by the taxpayer in the immediately preceding taxable year must demonstrate that his actual reserve ratio for the immediately preceding taxable year was below the lower limit of the appropriate reserve ratio range. In effect, a taxpayer can justify a class life shorter than that used in the preceding taxable year if the reserve ratio indicates that he has been depreciating assets too slowly. Such is not the case before us, as the petitioner's actual reserve ratio did not fall below the159 lower limit of the appropriate reserve ratio range (computed in accordance with Rev. Proc. 62-21) for any of the taxable years 1964 through 1968. Accordingly, we find that the petitioner has failed to 948 demonstrate that the class lives used by it for the taxable years 1965 through 1969 were justified by its prior retirement or replacement practices, pursuant to section 3.03(a), Part II, Rev. Proc. 62-21. The issue of whether the class lives used by the petitioner are justified on the basis of all the facts and circumstances, pursuant to section 3.03(b), is not before us on this motion. 3160 The petitioner contends, in the alternative, that it is entitled to depreciation deductions for each of the years at issue, based upon the class life of 13.11 years, which was accepted by the IRS on audit of its 1964 return. Section 3.05, Part II, Rev. Proc. 62-21 at 433, provides in part:.05 Subsequent use of class life previously justified. -- Where the class life used by a taxpayer was examined by the Internal Revenue Service and was accepted by reason of subsection .02, .03, or .04 of this section, or where such class life was accepted on audit by the Internal Revenue Service under presently established procedures for examining depreciation (whether before or after the effective date of this Revenue Procedure), the depreciation deduction claimed by the taxpayer for the assets in that class in any subsequent taxable year based on that class life will not be disturbed if the taxpayer's retirement and replacement practices for that class are consistent with the class life being used. This consistency may be demonstrated either by the reserve ratio test set forth in section 5 of this Part or by all the facts and circumstances.In further161 support of its argument that it is entitled to continue to use the class life previously justified by it, Matson also relies on section 6.03, Part II, Rev. Proc. 62-21 at 437. Such section sets forth rules for lengthening a shorter than guideline class life and provides that the class life used by the taxpayer may be lengthened in accordance with the adjustment table for class lives, or to the shortest life previously justified for the class.949 Although the Commissioner maintained earlier in these proceedings that the class life used by Matson was not accepted on audit for the taxable years 1962, 1963, and 1964, he has since abandoned that position, and now agrees that a class life of 13.11 years was accepted for 1964. 4 However, he argues that Matson may not rely upon its previously justified class life, because of his announcement in Rev. Proc. 68-27, 2 C.B. 911">1968-2 C.B. 911, 912, that --In situations in which the relative proportions of the different types of assets in an account are in fact substantially altered by subsequent additions, retirements, or replacements to the account, a previously162 justified shorter than guideline class life holds no significance and section 3.05, Part II, of Revenue Procedure 62-21 is not applicable.The Commissioner argues that during the 5-year period at issue, Matson made major changes in the relative proportions of the different types of assets, and that although a class life of 13.11 years may have been appropriate based on assets in existence as of December 31, 1964, it is not justified for the years at issue. In support of his contentions, the Commissioner points out that as of December 31, 1964, Matson's total investment in its vessels was approximately $ 56.6 million, whereas by December 31, 1969, its investment had increased by approximately 50 percent, to $ 85 million. Of the $ 28.5 million expended, only $ 3.3 million was for the purchase of additional assets, whereas $ 23.6 million was expended for major modifications or conversions of existing vessels. He asserts that such facts show that Matson did not spend money merely replacing old assets; rather, it spent substantial sums in converting previously unsuitable or inadequate vessels and thereby caused a shift in the relative proportions163 of types of assets in the class.Rev. Proc. 68-27 further provides that whether there has been a substantial alteration in the relative proportions of the different types of assets in an account is a question of fact to be determined in accordance with the principle enunciated in 950 example 2 of section 1.167(b)-1(b), Income Tax Regs., which provides in relevant part:In the case of classified or composite accounts, the classified or composite rate is generally computed by determining the amount of one year's depreciation for each item or each group of similar items, and by dividing the total depreciation thus obtained by the total cost or other basis of the 164 assets. The average rate so obtained is to be used as long as subsequent additions, retirements, or replacements do not substantially alter the relative proportions of different types of assets in the account. * Once the proper rate of depreciation for such an account has been established, the taxpayer is entitled to continue using such rate unless some change in circumstances requires an adjustment in such rate. For example, a taxpayer who demonstrates that assets in an account would be obsolete before the end of the useful life on which the rate originally was based may be entitled to change to a higher rate of depreciation. Cf. Morganton Full Fashioned Hosiery Co., 14 T.C. 695">14 T.C. 695, 702-704 (1950); Hoyt B. Wooten, 12 T.C. 659">12 T.C. 659, 665 (1949), affd. per curiam 181 F.2d 502">181 F.2d 502 (6th Cir. 1950). On the other hand, the taxpayer is not entitled to continue using the same rate if the useful life on which that rate was based has been extended.Although the petitioner vigorously argues that retroactive application of Rev. Proc. 68-27 is inequitable, it cites no165 legal authority in support of this argument and, in fact, has conceded on brief that "We do not suggest that respondent was without authority to modify his previous Rev. Procs. 62-21 and 65-13." The petitioner does maintain that Rev. Proc. 68-27 relates only to the application of section 3.05, Part II, Rev. Proc. 62-21. It does not apply, the petitioner asserts, to the rules for lengthening the class life prescribed in section 6.03, Part II, Rev. Proc. 62-21, and there is no justification for extending it beyond its literal terms. Thus, the petitioner contends that although it may not be entitled to rely on its previously justified class life, the Commissioner is nevertheless precluded from a lengthening adjustment which would extend the class life beyond that previously justified. However, such an interpretation of Rev. Proc. 68-27 appears to be unwarranted. Its restriction on the use of a previously determined class life appears to be equally applicable for the purpose of section 3.05 and for the purpose of section166 6.03, and 951 it seems clear that the Commissioner intended for the restriction to be applicable for both purposes.The petitioner argues further that in any event, the conditions of Rev. Proc. 68-27 are satisfied in this case. The petitioner points out that throughout the period in issue it had 14 freighters, and that the basic structure (the hulls and the propulsion machinery) remained unchanged. The petitioner asserts that although the cost of its modernization program was great, the type of asset was not substantially altered. By this argument, the petitioner is in effect maintaining that modification did not alter the physical useful life of its vessels. However, such argument is not in point; the question is whether conversion to containerized cargo so affected the economic usefulness of its vessels as to constitute a substantial alteration of the types of assets within the class. Cf. Massey Motors, Inc. v. United States, 364 U.S. 92">364 U.S. 92 (1960).The only evidence before us as to the economic useful lives of the converted vessels consists of the petitioner's assertions, which are vigorously disputed167 by the Commissioner. The petitioner, as the moving party, has the burden of proving that there is no dispute about the facts of the case. James T. Shiosaki, 61 T.C. 861">61 T.C. 861, 863 (1974). Since we are unable to determine from the record before us whether there has been a substantial alteration in the petitioner's vessel account, within the meaning of Rev. Proc. 68-27, we find that as to the taxable years 1965, 1966, and 1967, there is a material issue of fact (sec. 1.167(b)-1(b), example (2), Income Tax Regs.), which precludes our granting its motion for summary judgment with respect to the use of the class life approved by the Commissioner for 1964. Rule 121, Tax Court Rules of Practice and Procedure. However, it is clear from the record that no substantial alterations in the vessel account took place during the taxable years 1968 and 1969, as no modifications or conversions were undertaken during such years. Therefore, we agree with the petitioner that, under section 3.05, Part II, Rev. Proc. 62-21, it may continue to use, for the taxable years 1968 and 1969, whatever168 class life ultimately is determined to be justified for the taxable year 1967, provided its reserve ratios for 1968 and 1969, computed on the basis of such class life, fall within acceptable limits.952 Matson's final contention is that the minimal adjustment rule of Rev. Proc. 65-13 precludes any adjustment to its depreciation deductions for the taxable years 1965 through 1969, notwithstanding the fact that such deductions are not justified under any provision of Rev. Procs. 62-21 and 65-13, or that at least, such rule limits the adjustments that can be made. Rev. Proc. 65-13 added three new measures to the depreciation guidelines and rules of Rev. Proc. 62-21. A new method, called the guideline form of the reserve ratio test, was announced as an optional alternative to the tabular form of the reserve ratio test prescribed in Rev. Proc. 62-21; the purpose of such new method was to provide the taxpayer with a means of computing a reserve ratio upper limit based upon his individual circumstances. Rev. Proc. 65-13 at 761.169 A transitional allowance rule was announced, which raised the reserve ratio upper limit for the transitional period. 5Rev. Proc. 65-13 at 767. A minimal adjustment rule also was prescribed, which was designed to minimize the lengthening of a class life in cases where the reserve ratio test is not met. Rev. Proc. 65-13 at 768.Section 7, Part II, Rev. Proc. 65-13, provides rules to be applied where the class life used by a taxpayer for a guideline class is shorter than the class life used by the taxpayer for the immediately preceding taxable year, or the class life previously170 justified. Section 7.03, which is applicable to the case before us, provides at pages 771-772:.03 If the shortened class life is shorter than the guideline life for the guideline class, the depreciation deduction for such class will not be disturbed if factors (1), (2), and (3) of section 3.03(a) of Part II of Revenue Procedure 62-21 are present. For purposes of this section, if the taxpayer uses the guideline form, "the lower limit of the appropriate reserve ratio range" shall equal a reserve ratio upper limit computed under the guideline form using an extended life equal to 90 percent of the test life.The effect of such provision is to continue the rules of Rev. Proc. 62-21 with respect to automatic justification of a shortened class life. The taxpayer may rely upon either the tabular form of the reserve ratio test, computed in accordance 953 with Rev. Proc. 62-21, or the guideline form of Rev. Proc. 65-13.The record before us clearly demonstrates that the taxpayer's actual reserve ratio never fell below171 the lower limit of the appropriate reserve ratio range, using the tabular form prescribed in Rev. Proc. 62-21, and the petitioner does not contend that its actual reserve ratio fell below the upper limit of the guideline form computed using an extended life equal to 90 percent of the test life, 6 as prescribed in Rev. Proc. 65-13. Accordingly, the petitioner has failed to demonstrate that its class lives for the taxable years 1965 through 1969 were justified on the basis of section 7.03, Part II, Rev. Proc. 65-13. However, the petitioner argues that the Commissioner is nonetheless precluded from making any adjustments to its depreciation deductions by virtue of the minimal adjustment rule of Rev. Proc. 65-13.172 Section 7.04, Part II, Rev. Proc. 65-13 at 772, provides in part:.04 If neither section 7.02 nor 7.03 of this Part applies and if the shortened class life cannot be justified on the basis of all the facts and circumstances, the class life shall be lengthened as provided in section 4, 5, or 6 of this Part, whichever is appropriate * * The petitioner argues that neither section 5 nor section 6 is applicable, and we agree. Section 4, the minimal adjustment rule, provides limitations on adjustments by the IRS. Section 4.01 provides that under the minimal adjustment rule, class lives will not be lengthened by more than 10 percent in any taxable year. Section 4.02 provides rules for lengthening the class life. Section 4.02(a) gives the rule to be applied where the actual reserve ratio exceeds the transitional upper limit by 10 or more percentage points, whereas section 4.02(b) provides the rule to be applied where the excess is less than 10 percentage points. Rev. Proc. 65-13 at 768. The petitioner contends that since its actual reserve ratio never exceeded the transitional upper limit, neither 173 the rule of (a) nor of (b) is applicable, and therefore, the Commissioner is precluded from making any adjustments to its depreciation deductions.954 Section 7, Part II, Rev. Proc. 65-13, makes clear that a taxpayer seeking to use the reserve ratio test to justify a class life which is both shorter than the guideline life and shorter than the class life previously justified must continue to do so on the basis of the three-part test of section 3.03, Part II, Rev. Proc. 62-21. Such section 7 also provides that if its conditions are not satisfied, the class life shall be lengthened. The requirement for an adjustment would be nullified if we were to adopt the interpretation urged by the petitioner. Considering the scheme of the revenue procedures and all the provisions thereof, it seems clear that some adjustment in the depreciation deductions is required if the conditions of section 3.03, Part II, Rev. Proc. 62-21, and section 7, Part II, Rev. Proc. 65-13, are not satisfied, and therefore, we reject the petitioner's174 proposed interpretations.On the other hand, we can perceive no reason, nor has the Commissioner given one, why the general provisions of the minimal adjustment rule should not be applied in the case before us. Under that provision, the class life shall not be lengthened more than 10 percent in any taxable year, and in any event, shall not be lengthened beyond the shortest life which can be justified under all the facts and circumstances. Accordingly, if the petitioner is unable to demonstrate that it is entitled to continue using a class life of 13.11 years under section 3.05, Part II, Rev. Proc. 62-21, as modified by Rev. Proc. 68-27, its class life for the taxable year 1965 may be lengthened by the Commissioner in accordance with the procedure outlined in section 4.02(a), Part II, Rev. Proc. 65-13. The class life so adjusted may also be used for the taxable year 1966. See sec. 4.03, Part II, Rev. Proc. 65-13 at 768-769. For the taxable year 1967, the petitioner may use the same class life as it used for 1966 if175 it can demonstrate as a matter of fact that there was no substantial change in the relative proportions of the assets in the class in that year. If the petitioner cannot establish such fact, then it will be necessary to make an additional adjustment in the class life used by it in accordance with section 4.02(a), Part II, Rev. Proc. 65-13.In conclusion, the petitioner is not entitled to a summary judgment that under Rev. Procs. 62-21 and 65-13, no adjustment is to be made in the depreciation claimed by it for the years 1965 through 1969. Nor is the petitioner entitled to 955 a summary judgment that for such years it is entitled to use the class life of 13.11 years which had been approved for its use in 1964. The petitioner is free to establish that on the basis of all the facts and circumstances, the depreciation claimed by it was allowable under section 167(a) of the Internal Revenue Code of 1954. Alternatively, under section 3.05, Part II, Rev. Proc. 62-21, as modified by Rev. Proc. 68-27, the petitioner may establish as a matter of fact that there*176 has been no substantial alteration in the relative proportions of the assets in its depreciation account and that therefore it is entitled to use the class life of 13.11 years for the taxable years 1965 through 1969. If it does not establish that there has been no such alteration in the account, then the Commissioner may make adjustments in the depreciation account for the taxable years 1965, 1966, and 1967 in accordance with sections 4.02 and 4.03, Part II, Rev. Proc. 65-13. For the taxable years 1968 and 1969, no further adjustment is required, provided the petitioner continues to meet the reserve ratio test in accordance with section 3.05, Part II, Rev. Proc. 62-21. Accordingly, the petitioner's motion for summary judgment will be granted in part and denied in part.An appropriate order will be issued. Footnotes1. All references to Rev. Procs. 62-21 and 65-13↩ are to the pages in the Cumulative Bulletins where such revenue procedures are published.2. Containerization involves the application of trucking industry methods to shipping. A modified truck trailer, called a container, which may be lifted off the trailer chassis, is loaded at the shipper's warehouse, sealed, and sent via truck or railroad flatcar to the container yard at dockside for loading aboard ship. When the vessel arrives at its destination, the process is reversed. Containerization eliminates damage and pilferage and substantially reduces vessel port time.↩1. These figures do not reflect allowances for depreciation.↩3. The Commissioner argued on brief that Matson had not used approximately the same class life for a period of years equal to at least half a replacement cycle, as required by sec. 3.03(a)(2). The fact that a taxpayer's reserve ratio falls below the lower limit of the appropriate reserve ratio range is not meaningful for purposes of justifying a shorter than guideline class life unless: (1) The guideline class has a history equal in years to the guideline life for that class; and (2) the taxpayer has used approximately the same class life for a substantial period of years. Rev. Proc. 62-21↩ at 432 nn. 5 and 6. Since the taxpayer's reserve ratio never fell below the appropriate lower limit, as required by sec. 3.03(a)(1), we find it unnecessary to reach this issue.4. According to the appellate conferee's computations, the class life justified for 1964 was 13.22 years. However, such computations were in error, and the depreciation deductions claimed by the petitioner in fact resulted in a correctly computed class life in 1964 of 13.11 years, as stipulated by the parties.↩5. The transitional period for a guideline class begins with the fourth taxable year to which Rev. Proc. 62-21 applies (1965 for most taxpayers) and continues for a period equal to the guideline life for that class. Rev. Proc. 65-13↩ at 767.6. The effect of this formula is to provide a guideline form reserve ratio lower limit, with a 10-percent tolerance similar to that contained in the reserve ratio tables of Rev. Proc. 62-21↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623529/	Henry Cartan and Barbara Sesnon Cartan, et al., 1 Petitioners, v. Commissioner of Internal Revenue, RespondentCartan v. CommissionerDocket Nos. 56818, 56819, 56821United States Tax Court30 T.C. 308; 1958 U.S. Tax Ct. LEXIS 191; 9 Oil & Gas Rep. 833; May 16, 1958, Filed 191 Decisions will be entered under Rule 50. 1. Petitioners deposited $ 45,000 pursuant to an agreement to prevent wasteful depletion of gas pressure and consequent reduction in the amount of oil recoverable from a producing field. Held, this expenditure should be allocated over a term of years.2. Held, no portion of the $ 45,000 expended represents the cost of a future interest in minerals.3. Held, entertainment and travel expenses incurred by petitioner W. T. Sesnon, Jr., are deductible in part.4. Held, expenses incurred by W. T. Sesnon, Jr., for food and lodging while away from home in connection with the affairs of the American Red Cross are deductible as charitable contributions. Everett S. Layman, Esq., and Arthur J. Lempert, Esq., for the petitioners.Leslie T. Jones, Esq., for the respondent. Van Fossan, Judge. VAN FOSSAN 309 The respondent determined deficiencies in petitioners' income tax as follows:DocketNo.Petitioner1949195056818Henry and Barbara Sesnon Cartan$ 9,018.270 56819W. T., Jr., and Jacqueline K. Sesnon10,797.28$ 351.9456821Porter and Helen F. Sesnon7,210.010 There are three issues. First, is the sum of $ 45,000, expended by the petitioners in the year 1949 192 to prevent the depletion of gas pressure and consequent reduction in the amount of oil recoverable from a producing field, an expenditure recoverable over a term of years or may it be deducted in the year expended under section 23 (a) of the Internal Revenue Code of 1939? Second, does $ 4,500 (10 per cent of $ 45,000) represent the nondepreciable cost of an interest in minerals? Third, are certain travel and entertainment expenses claimed in Docket No. 56819 deductible expenditures?Another issue in Docket No. 56819 concerning the deductibility of a bad debt was settled prior to trial.FINDINGS OF FACT.Most of the facts are stipulated, the stipulations being incorporated herein by this reference.Henry Cartan and Barbara Sesnon Cartan are husband and wife, computing their income on the cash basis of accounting. They reside in San Francisco, California, and filed joint income tax returns for the years 1949 and following with the collector of internal revenue at San Francisco.W. T. Sesnon, Jr., and Jacqueline K. Sesnon are husband and wife, computing their income on the cash basis of accounting. They reside in Beverly Hills, California, and filed joint income tax returns for the years 193 1949 and following with the collector of internal revenue at Los Angeles.Porter Sesnon and Helen Sesnon are husband and wife, computing their income on the cash basis of accounting. They reside in San Francisco, California, and filed joint income tax returns for the years 1949 and following with the collector of internal revenue at San Francisco.Porter Sesnon, W. T. Sesnon, Jr., and Barbara Sesnon Cartan are brothers and sister and, for convenience, are hereinafter referred to as petitioners.310 The Aliso Canyon Oil Field in the county of Los Angeles contains a productive area known as the Sesnon Zone. This zone contains a reservoir of gas and oil in solution, herein usually called the "oil belt," pressure-connected with a reservoir of gas therein usually called the "gas cap." Pressure exerted by the gas cap on the oil belt is the dominant oil recovery mechanism in the Sesnon Zone but pressure of gas in solution is also used to drive the oil to the well bore. Production of gas from the gas cap or production of excessive quantities of gas (either of gas escaping from solution in oil or of gas-cap gas), in relation to the oil recovered from such production, would wastefully decrease 194 the reservoir pressure in the Sesnon Zone, resulting in leaving millions of barrels of oil in place, unrecovered and unrecoverable under any presently known commercial method.In 1949 it was estimated by engineers of the petitioners and other oil producers that 1,150 surface acres overlay the Sesnon Zone. Approximately 800 of these acres were owned in 1949 by the petitioners as tenants in common, Porter Sesnon, W. T. Sesnon, Jr., and Barbara Sesnon Cartan each owning an undivided third. Some of the lands owned by the petitioners were under lease to Tide Water Associated Oil Company (hereinafter referred to as Tide Water) in 1949, and some were under lease to Standard Oil Company of California (hereinafter referred to as Standard).A small portion of the surface acreage overlying or in 1949 believed to overlie the Sesnon Zone was owned by Jane Cato Marquis and Lewis F. Marquis. This portion is hereinafter usually referred to as the Marquis property.In 1949, in order to prevent waste by reason of production at excessive gas-oil ratios from wells drilled on the Marquis property, and loss of reservoir pressure by reason of wells on the Marquis property producing excessive quantities of 195 gas in relation to the oil produced therefrom, i. e., at excessive gas-oil ratios, and the consequent loss of recoverable oil, Standard and Tide Water, together with the petitioners, entered into negotiations with the owners of the Marquis property. It was proposed by the petitioners that to prevent waste in the Sesnon Zone, Standard and Tide Water should lease or otherwise acquire the Marquis property and thus make it impossible for any outside parties to drill into the Sesnon Zone from the Marquis lands.Standard and Tide Water at the outset refused to consummate the proposed lease unless petitioners would pay 15 per cent of the annual rental, which the petitioners declined to do. The petitioners countered with a proposal that each of the three petitioners would pay a lump sum of $ 15,000 or a total sum of $ 45,000, which was 15 per cent of $ 300,000, the aggregate of the rental for the first 20 years. The petitioners were willing to do this only in order to facilitate the transaction 311 and thus conserve their properties and prevent any loss of income to them due to possible wasteful operation of the Marquis property.On November 14, 1949, Tide Water and Standard executed a lease 196 for the Marquis property with Jane Cato Marquis and Lewis F. Marquis. This lease commenced on January 1, 1950, and extended for 40 years, but lessees were entitled to quitclaim the lease after December 31, 1969. Rent was payable by annual installments of $ 15,000. Petitioners were referred to in the lease as "neighboring producers."The lease provided that the oil companies might obtain from the neighboring producers a contribution to the annual rent due the lessors. Provisions of the lease made it unnecessary for the lessees to develop the leased property or utilize it for any purpose. The lease recognized that hydrocarbons were being extracted from lands owned by the lessees and the neighboring producers and that this might or would drain oil and gas from the leased premises. The lessees and the neighboring producers were released from liability for such detrimental results to the leased property. The lessor was entitled to royalties on oil, gas, and gasoline extracted or produced from the leased property. Royalties were payable only when the amount exceeded the annual rent. The terms of the lease inured to the benefit of the neighboring producers.On or before November 14, 197 1949, Standard and Tide Water, as first parties, and petitioners, as second parties, executed an agreement providing in part as follows:Whereas, a certain instrument entitled Lease and Agreement and herein sometimes referred to as "lease and agreement" of even date herewith, is about to be executed between JANE CATO MARQUIS and LEWIS F. MARQUIS, her husband, as Lessor, and First Party herein as Lessee, relating to certain property therein described in the City of Los Angeles, County of Los Angeles, State of California, in which lease and agreement Second Party is named as among the "neighboring producers" and as one of the owners of lands in the general area of the lands leased under said lease and agreement; andWhereas, the said lease and agreement further provides that the said Lessee therein may obtain from said neighboring producers or from some or all of them or from others a sum or sums, either as a consideration for the execution of said lease and agreement by said Lessee or as a payment on account of or a contribution to the Fifteen Thousand Dollars ($ 15,000.00) annual rental payable thereunder by the said Lessee to the said Lessor; andWhereas, Second Party herein desires 198 to deposit with Tide Water Associated Oil Company the sum of Forty-five Thousand Dollars ($ 45,000.00) with which the latter shall make payments as hereinafter provided;Now, Therefore, in consideration of the premises and of the agreements hereinafter contained, the parties hereto agree as follows: * * Article 2. It is understood and agreed that this agreement shall become effective only if and when said lease and agreement is executed; and that if for any reason said lease and agreement is not executed, this agreement shall be wholly void.312 Article 3. Immediately upon execution of this agreement and of said lease and agreement, Second Party agrees to deposit with Tide Water Associated Oil Company the sum of Forty-five Thousand Dollars ($ 45,000) for the purposes and subject to the provisions of this Article 3.On or before the 31st day of March, 1950, and on or before the 31st day of March of each calendar year thereafter up to and including March 31, 1969, or for such portion of such period as said lease and agreement is in effect, said Tide Water Associated Oil Company shall withdraw from said deposit the sum of Twenty-Two Hundred and Fifty Dollars ($ 2,250) and, subject to the 199 right to defer disbursal thereof to permit compliance with Article 24 of said lease and agreement without risk to Tide Water Associated Oil Company, shall disburse the same as follows: A. To the Lessor or to the depositary for Lessor provided for in said lease and agreement, Tide Water Associated Oil Company shall pay a sum equal to (1) Fifteen per cent (15%) of the annual rental due Lessor under said lease and agreement for the calendar year in which such withdrawal from said deposit is made (which annual rental shall be the sum of Fifteen Thousand Dollars ($ 15,000) or such lesser sum to which such rental has been reduced in accordance with the provisions of Article 24 of said lease and agreement); minus(2) Such sum, not in excess of fifteen per cent (15%) of the annual rental as aforesaid due Lessor under said lease and agreement for said calendar year, as shall equal fifteen per cent (15%) of the amount, if any, which but for the provisions of Article 24 and/or the first sentence of Article 10 of said lease and agreement would have been payable to the Lessor pursuant to the provisions of Articles 7, 8 and 9 thereof for production during the preceding calendar year.B. To Second 200 Party hereunder, Tide Water Associated Oil Company shall pay the balance, if any, of said Twenty-Two Hundred and Fifty Dollars ($ 2,250.00).Following the March 31, 1969 withdrawal, or upon the sooner termination of the obligation of First Party to pay said annual rental, any balance on hand shall be paid promptly without interest by Tide Water Associated Oil Company to Second Party.* * * Article 4. Save and excepting for the releases expressly made under said lease and agreement by Lessor therein to Second Party and successors, it is agreed that Second Party has no rights, claims or interest in, to or under said lease and agreement. Second Party shall have no obligation, responsibilities or liabilities thereunder of any kind or nature whatsoever.As between the parties hereto, it is understood and agreed that First Party hereto, as Lessee in said lease and agreement, is the sole judge as to what, if any, operations Lessee will conduct under said lease and agreement, and as to the nature, extent and duration of such operation; provided, however, that if at any time during the continuance of said lease and agreement oil or gas is found in any well or wells drilled by First Party on 201 land subject thereto, First Party, if, whenever and so long as, it operates such well or wells and produces oil or gas therefrom, shall conduct such operations in accordance with good oil field practice and at rates not substantially greater, proportionate to potential production and with due allowance for any substantial difference in conditions between the properties involved, than the rates of production by said Tide Water Associated Oil Company and said Standard Oil Company of 313 California on the producing properties in the same field now held by them respectively under leases from Second Party.The petitioners, concurrently with the execution of the agreement and in the calendar year 1949, paid to Tide Water as a deposit the sum of $ 45,000 in accordance with the terms of the agreement. Of this $ 45,000 Porter Sesnon paid $ 15,000, W. T. Sesnon, Jr., paid $ 15,000, and Barbara Sesnon Cartan paid $ 15,000. These payments, aggregating $ 45,000, were made in order to prevent impairment of income-producing property owned by the petitioners.In each of the joint returns filed by petitioners for the year 1949 each petitioner claimed a deduction for the payment of $ 15,000 as an ordinary 202 and necessary expense incurred for the conservation or protection of income-producing property.At the time of the hearing no payments had been made to the petitioners, or any one of them, pursuant to article 3 of their agreement with Tide Water and Standard.Facts Applicable to Docket No. 56819 Only.The business activities of petitioner W. T. Sesnon, Jr. (hereinafter referred to as Sesnon), included real estate as well as oil interests.For many years Sesnon was head of the Los Angeles chapter of the Red Cross and a member of the National Board of Governors of the American Red Cross. The fulfillment of these offices required him to make at least four trips a year to Chicago.Sesnon, during the years 1949 and 1950, was a member of the following clubs to which he paid the amounts indicated:1949ClubDuesOtherTotalpaymentsBeverly Hills Club11$ 505.02Bohemian Club$ 108.00$ 89.41197.41California Club288.00585.04873.04Chicago Club11319.20Los Angeles Country Club324.8036.48361.28Pacific Union Club2 316.8021.36338.16Total payments to all clubs 2,594.111950Beverly Hills Club11$ 528.90Bohemian Club$ 108.00$ 528.01636.01California Club288.00497.14785.14Chicago Club11238.04Los Angeles Country Club331.20208.17539.37Pacific Union Club2 316.8094.79411.59Total payments to all clubs 3,139.051 Not 203 sufficient information to segregate.2 At least.314 The Beverly Hills Club is a restaurant club in Beverly Hills, near Sesnon's home. During 1949 and 1950 Sesnon used the club for social purposes, as well as to entertain his attorney, and engineers and geologists with whom he discussed business affairs.The Bohemian Club is located in San Francisco. The club also has an establishment called Bohemian Grove. During 1949 and 1950 Sesnon used these facilities when he was in San Francisco solely to entertain people in related business activities, primarily the oil business. These guests included engineers and geologists.Sesnon joined the California Club in Los Angeles because his business associates congregated there almost daily. He took no social guests to the club but entertained there only persons who were associated with his business activities.Sesnon joined the Chicago Club primarily because his Red Cross activities required him to make at least four trips a year to that city. He needed a place in which to stay when in Chicago and to entertain such people as he met there for other business reasons. He made no social use of the club. He was reimbursed by the Red Cross for rail and 204 airline tickets but did not apply for any incidental expenses.Upon recommendation of the president of an oil company, Sesnon joined the Los Angeles Country Club. His primary purpose was association with people in allied businesses of which there were many in this particular club. He never played golf at that or any other club. He had a large social party at the country club during 1949 or 1950. The cost of this party was not included in the above list of expenses.The Pacific Union Club is located in San Francisco. Sesnon used its facilities in 1949 and 1950 for the same purposes as the Bohemian Club -- the entertainment of business associates when he was in San Francisco.Some of the expenditures to the clubs were made for the economic benefit of the entire Sesnon family, and Sesnon was reimbursed a proportionate share by his brother and sister for expenditures made in line with their joint activities.In November 1949 Sesnon made the following unreimbursed expenditures in connection with activities carried on in his office:Telephone and telegraph$ 91.51Entertainment40.00Total unreimbursed expenditures 131.51During 1950 Sesnon drew checks in the amounts, on the dates, and to the 205 persons indicated as follows:DateDrawn to --AmountJune 21Porter Sesnon$ 150.00December 6Adelson Brothers111.79December 18Porter Sesnon29.52December 22H. K. Williamson100.00December 27United Vulcanizing Co237.61December 27W. D. Crandall40.67December 22Cash250.00Total 919.59315 The $ 150 payment on June 21 was to reimburse Porter Sesnon for paying a guest card fee at the Bohemian Grove. The guest was brought from the East in connection with activities in the operation of their business.The check drawn to Adelson Brothers on December 6 represented a gift of a bottle of liquor to each member of the drilling crew in the Aliso Canyon oil field. This was not an uncommon gesture in the oil business and tended to secure the cooperation of the drilling crews.The $ 100 check drawn on December 22 was a gift to H. K. Williamson, an associate in the real estate business.The payment of $ 237.61 to United Vulcanizing Company was for tires on a car utilized in Sesnon's business.The $ 250 item on December 22 was a cash withdrawal covering expenses of a trip to San Francisco, during which Sesnon spent most of his time discussing his various operations in different parts of the country with his brother, 206 sister, attorney, and other people.The above checks totaling $ 919.59 were charged to the "Travel and Misc. Exp." account in Sesnon's general ledger for 1950. By a closing entry in Sesnon's general ledger dated December 31, 1950, the sum of $ 118.11 was subtracted from this account and charged to the "Cleaning oil and other Engineering Exp." account of the general ledger. No identification was made of the items of $ 40.67 and $ 29.52.On his Federal income tax returns Sesnon claimed $ 2,821.36 in 1949 and $ 3,421.48 in 1950 for travel and entertainment expenses. On brief these amounts were reduced to $ 2,158.35 and $ 3,328.42, respectively.Sesnon's travel and entertainment expenses for the years 1949 and 1950 are deductible in part.OPINION.The primary issue is whether the sum of $ 15,000 expended by each of the three petitioners to prevent the wasteful depletion of gas pressure and consequent reduction in the amount of oil recoverable from a producing field is deductible in the year 1949 or must be prorated over a term of years.Petitioners entered into a contractual agreement with Tide Water Associated Oil Company and Standard Oil Company of California on November 14, 1949. This 207 agreement recited the fact that Tide Water and Standard were about to enter into a lease with Jane Cato Marquis and Lewis F. Marquis, neighboring landowners. The agreement was to become effective only when the lease between Tide Water, Standard, and the Marquises was executed. The lease was executed on the same day -- November 14, 1949.316 Pursuant to their agreement with Tide Water and Standard, petitioners deposited $ 45,000 with Tide Water. The contract refers to the item as a deposit. Tide Water was to withdraw $ 2,250 from this deposit each year to pay 15 per cent of the annual rent of the Marquis lease for a period of 20 years.The cumulative result of these arrangements was that petitioners secured protection for at least 20 years against the wasteful operation of oil or gas wells on the Marquis property. The petitioners were anxious to achieve this goal because it was thought that a portion of the gas cap of the Sesnon field extended underneath the Marquis property. If this gas cap were wastefully depleted, the pressure necessary to drive oil to well bores on the petitioners' property might be exhausted to such an extent that large quantities of oil lying beneath petitioners' 208 property would be unrecoverable.Petitioners contend that the deposit of $ 45,000 with Tide Water was an ordinary and necessary expense for the conservation of property held for production of income and thus was deductible in 1949 under the provisions of section 23 (a) (2) of the Internal Revenue Code of 1939. 2 All petitioners kept their accounts on the cash basis.The parties have agreed that the deposit was an ordinary and necessary expense and deductible as such, the only disagreement being as to the time of deduction. We have little difficulty in determining that its intended purpose was to conserve and protect petitioners' property. However, not every expenditure which may be so characterized results in a deduction in the year of payment. In our opinion the present 209 item is of such a nature that income will best be reflected if the deposit is deducted over a period of years.Petitioners, by contractual agreement, acquired the benefit of an arrangement whereby the wasteful depletion of the gas pressure necessary to extract oil from their lands was prevented for at least 20 years. It does not matter that petitioners might eventually have achieved the same result through litigation. The fact is that they chose to achieve their ends by contract.The contract provides inter alia that petitioners agreed to deposit $ 45,000 with Tide Water. From this deposit Tide Water was annually to withdraw $ 2,250 to make payment of 15 per cent of the rental due under the terms of the lease between Tide Water and Standard and the Marquises.317 There was no intention that the money all be expended in the year of payment. It was to be held by Tide Water and paid out in annual installments over a 20-year period.If petitioners had each year paid $ 2,250 to conserve and protect their property, there is no question that the sums would have been deductible only in the years actually paid. 3 Petitioners may not, by depositing with Tide Water an amount equal to the total 210 of these payments for 20 years, claim a deduction for all 20 years in the year of deposit.Petitioners are party to a contract the essence of which is to award them a benefit over a period of years. Normally the payments under the contract should be deducted over those years. Stewart Title Guaranty Co., 20 T. C. 630 (1953).If, as an alternative, petitioners' deposit is considered as an advance payment of rent, the result is the same.To prevent waste in the Sesnon Zone it was proposed by the petitioners that Standard and Tide Water lease or otherwise acquire the Marquis property and thus make it impossible for any outside parties to drill into the zone from the Marquis lands. Standard and Tide Water at the outset refused to consummate the proposed lease unless petitioners would pay 15 per cent of the annual rental, which petitioners declined to do.The petitioners countered with a proposal that each of the petitioners pay a lump sum of $ 15,000, a total of $ 45,000, which was 15 per cent of $ 300,000, the aggregate of the rental for the first 20 years. This proposal was reduced to a written agreement.As noted above, by the terms of the agreement 211 Tide Water was each year to withdraw $ 2,250 from the $ 45,000 deposit to pay 15 per cent of the annual lease rental. If the annual rental was reduced in accord with provisions contained in the lease a proportional repayment was to be made to petitioners; similarly, if any balance remained in the deposit at the time the lease was terminated it was to be repaid to petitioners without interest.Clearly, it may reasonably be argued that petitioners intended that their deposit of $ 45,000 should constitute an advance payment of the share of the rental which Tide Water and Standard demanded they contribute.It has long been held that such advance payments may not be deducted as a business expense in the year paid but must be apportioned as an expense over the entire term of the lease. Baton Coal Co. v. Commissioner, 51 F. 2d 469 (C. A. 3, 1931); Galatoire Bros. v. Lines, 23 F.2d 676">23 F.2d 676 (C. A. 5, 1928).318 Although petitioners were not parties to the lease, they were referred to in its provisions, they benefited by its accomplishment, and it recognized the right of the oil companies to obtain contributions to the leasehold rental from petitioners.After considering all the evidence and arguments, 212 we are convinced that whether we view petitioners' deposit as an allocable nonbusiness expense under section 23 (a) (2) or advance payment of rent, or otherwise characterize it, it must be regarded as an expenditure which is directly apportionable to the years in which the lease is in effect, and income will best be reflected if deductions for the expenditure are allocated over these years.The lease commenced January 1, 1950. It was subject to quitclaim at the end of 20 years. It follows that the sum of $ 45,000 expended by petitioners to secure the benefits of the lease should be deducted over the fixed 20-year period beginning January 1, 1950. Cf. Sigmund Spitzer, 23 B. T. A. 776 (1931).Petitioners cite several cases in which ordinary and necessary expenses incurred for the conservation of income-producing property were declared deductible in the year paid. Alleghany Corporation, 28 T. C. 298 (1957); Ramsey v. White, an unreported case, 56-1 U. S. T. C. 9190, 51 A. F. T. R. 1762 (S. D.Ill., 1955); Brown-Forman Distillers Corp. v. United States, 132 F. Supp. 711 (Ct. Cl., 1955); L. B. Reakirt, 29 B. T. A. 1296 (1934), affd. 84 F. 2d 996 (C. A. 6, 1936); and Bliss v. Commissioner, 57 F. 2d 984213 (C. A. 5, 1932), overruled by Jones' Estate v. Commissioner, 127 F. 2d 231 (C. A. 5, 1942). All of these cases primarily involve costs of litigation and related expenses and thus may be distinguished on the facts.We cannot, however, sustain respondent's contention that $ 4,500 (10 per cent of the sum deposited with Tide Water) should be regarded as representing petitioners' interest in oil which might be produced from the Marquis property and is thus subject to depletion rather than deductible as expense. 4214 319 At the time petitioners signed the agreement with Tide Water and Standard it was theoretically possible that petitioners might recoup their entire $ 45,000 expenditure if Tide Water and Standard immediately developed and operated wells on the Marquis property and by royalty payments reduced or eliminated rental due the Marquises.This provision for reimbursement must be regarded as ancillary to the main purpose of the contract 215 which was the prevention of the depletion of the gas cap providing pressure for the operation of wells on petitioners' property. Merely because petitioners may be reimbursed for their expenditure at a future date is not cause to deny the allocation of the entire consideration over the life of the contract. Cf. Alleghany Corporation, supra, and Burnet v. Hutchinson Coal Co., 64 F. 2d 275 (C. A. 4, 1933).At the time of this hearing no such reimbursements had been made to the petitioners. If reimbursements are made in the future they may be appropriately treated at that time.We hold that one-twentieth of the total deposit of $ 45,000 should be deducted in each taxable year, beginning January 1, 1950.The last issue is whether certain "travel and entertainment expenses" incurred by W. T. Sesnon, Jr., are deductible.Sesnon asserts that the sum of $ 2,158.35 expended in 1949 and the sum of $ 3,288.42 expended in 1950 are deductible for the respective years under section 23 (a) as ordinary and necessary expenses incurred in carrying on a business, 5216 or as ordinary and necessary expenses incurred in the management of property held for the production of income. 6Sesnon further asserts that if the sums of $ 319.20 and $ 238.04 paid to the Chicago Club in the years 1949 and 1950, respectively, are not deductible under section 23 (a), they are, in the alternative, deductible as charitable contributions under section 23 (o). 7217 320 Sesnon's business activities included both oil and real estate interests.During 1949 and 1950 he was a member of several clubs variously located in Los Angeles, Beverly Hills, San Francisco, and Chicago. A schedule of his expenditures at each of these clubs for the years in question is set forth in the facts.Entertainment expenses may be deducted from gross income only insofar as they are ordinary and necessary in carrying on a trade or business. Sec. 23 (a) (1) (A). 8 Whether 218 or not a particular expenditure is a business expense turns on the facts of the case and the burden of proof is on the petitioner to show that such expenditures were primarily business rather than personal expenses.Club dues may be deductible if certain tests are satisfied. Deductibility depends upon the use made of the club during each taxable year.The Bohemian Club and the Pacific Union Club are in San Francisco. These clubs were used by Sesnon to entertain business associates, including engineers and geologists. Sesnon testified that since he did not reside in San Francisco he had no opportunity to use the clubs for social purposes during the years in question. In the usual situation the cost of the taxpayer's own meals and personal entertainment is not deductible. Richard A. Sutter, 21 T. C. 170 (1953). However, expenditures for board and lodging while away from home in the pursuit of a trade or business may be deducted.9 Sesnon is therefore entitled to a deduction for his own meals while he was in San Francisco, as well as those of his business guests. All of the expenses incurred by Sesnon at the two clubs in San Francisco during the years 1949 and 1950, 219 including dues, are deductible. Charles S. Guggenheimer, 18 T. C. 81 (1952).The Los Angeles Country Club and the California Club are in Los Angeles. The Beverly Hills Club is located in Beverly Hills.Sesnon joined the Los Angeles Country Club upon recommendation of the president of an oil company primarily for the purpose of associating with people in allied businesses. He never played golf at that or any other club. The cost of a large social party held at the country club in 1949 or 1950 was excluded from the claimed list of disbursements. To the best of Sesnon's recollection, none of the items included in the list of disbursements was spent in the entertainment of purely social guests.This being a local club, and because of the lack of positive proof by petitioner of his personal expenses, one-half only of the payments is allowed. Richard A. Sutter, supra.321 Sesnon joined the California Club because his business associates congregated there almost daily. He testified that he took no social guests to the club but entertained people there who were associated with his business activities.We are convinced that Sesnon originally joined the club 220 solely for business reasons. However, since petitioner's personal expenses in his use of the club are not segregated or proved, one-half only of the payments to the club is allowed as a deduction. Richard A. Sutter, supra.The Beverly Hills Club was near Sesnon's home and was used for social as well as business purposes. Sesnon testified that more than one-half of his entertaining there was for business reasons. As stated above, generally a taxpayer is not entitled to a deduction for amounts spent in a local club on meals and entertainment for himself or his dependents. Richard A. Sutter, supra.The amount paid to the Beverly Hills Club as dues is not in evidence. However, being convinced that part of the petitioner's use of the club was for purely business reasons, a deduction of $ 100 for each of the years 1949 and 1950 is allowed. Cohan v. Commissioner, 39 F. 2d 540 (C. A. 2, 1930).For many years, fulfillment of his obligations as a member of the National Board of Governors of the American Red Cross required Sesnon to make at least four trips a year to Chicago.Sesnon urges that amounts paid to the Chicago Club are deductible as entertainment expenses or, because of his Red 221 Cross activities, as charitable contributions. The National Red Cross reimbursed Sesnon for railroad and airplane tickets. He testified that his duties with the Red Cross were the primary reason for joining the club. He further testified that he joined because he needed a place to stay and entertain such people as he met for business purposes. No proof was offered as to what connection these people in Chicago might have with his business. No segregation of dues paid was made. In the state of the record no deduction for business entertainment expenses or dues is allowable as such.Respondent, however, ruled in 1955 that --a taxpayer who gives his services gratuitously to an association, contributions to which are deductible under the provisions of section 23 (o) of the Code, and who incurs unreimbursed traveling expenses, including the cost of meals and lodging, while away from home in connection with the affairs of the association and at its direction, may deduct the amount of such unreimbursed expenses in computing his net income subject to the limitation provided by section 23 (o) of the Code. [Rev. Rul. 55-4, 1955-1 C. B. 291, 292.]It is conceded that contributions to the 222 American National Red Cross are deductible under section 23 (o).We hold that a portion of Sesnon's expenditures at the Chicago Club in each of the years 1949 and 1950 may be deducted as a charitable 322 contribution under section 23 (o). However, since it is impossible on the record to make a precise determination, we hold 50 per cent of the payments he made to the Chicago Club in 1949 and 1950 to be deductible in the respective years. Cohan v. Commissioner, supra.In November 1949 Sesnon made unreimbursed expenditures totaling $ 131.51 in connection with activities carried on in his office. No explanation of these expenditures was made; they are therefore disallowed.In 1950 Sesnon charged seven checks totaling $ 919.59 to the "Travel and Misc. Exp." account in his general ledger. Of this total the two following items are deductible in full: $ 150 to reimburse Porter Sesnon for paying a business guest's expenses at Bohemian Grove and $ 111.79 representing a gift of a bottle of liquor to each member of a drilling crew in the Aliso Canyon oil field. Because of the lack of proof or segregation as to the specific use of the sum of $ 250 claimed to cover a business trip to San Francisco223 to confer with the members of his family, only one-half of the sum is allowed. Two hundred thirty-seven dollars and sixty-one cents was expended for tires for a car utilized in Sesnon's business. We are not informed whether the car was used exclusively for business purposes or partly for personal ends. Accordingly, we hold only one-half of this expenditure is deductible. Cohan v. Commissioner, supra.Items of $ 29.52 and $ 40.67 were unexplained and are therefore disallowed. Sesnon failed to show how or why a gift of $ 100 to H. K. Williamson was of assistance to him in his business undertakings. The amount is disallowed.It is stipulated that by means of a closing entry in Sesnon's general journal dated December 31, 1950, the sum of $ 118.11 was subtracted from the "Travel and Misc. Exp." account and charged to another account. Since we are not told to which of the items in the account this reduction applies, it will be charged against the total of the items allowed as deductions.Decisions will be entered under Rule 50. Footnotes1. Proceedings of the following petitioners are consolidated herewith: W. T. Sesnon, Jr., and Jacqueline K. Sesnon, Docket No. 56819; and Porter Sesnon and Helen Sesnon, Docket No. 56821.↩2. SEC. 23. DEDUCTIONS FROM GROSS INCOME.In computing net income there shall be allowed as deductions:(a) Expenses. -- * * * (2) Non-trade or non-business expenses. -- In the case of an individual, all the ordinary and necessary expenses paid or incurred during the taxable year for the production or collection of income, or for the management, conservation, or maintenance of property held for the production of income.↩3. Sec. 23 (a) (2), supra↩, footnote 2.4. SEC. 23. DEDUCTIONS FROM GROSS INCOME.In computing net income there shall be allowed as deductions: * * (m) Depletion. -- In the case of mines, oil and gas wells, other natural deposits, and timber, a reasonable allowance for depletion and for depreciation of improvements, according to the peculiar conditions in each case; such reasonable allowance in all cases to be made under rules and regulations to be prescribed by the Commissioner, with the approval of the Secretary. In any case in which it is ascertained as a result of operations or of development work that the recoverable units are greater or less than the prior estimate thereof, then such prior estimate (but not the basis for depletion) shall be revised and the allowance under this subsection for subsequent taxable years shall be based upon such revised estimate. In the case of leases the deductions shall be equitably apportioned between the lessor and lessee. In the case of property held by one person for life with remainder to another person, the deduction shall be computed as if the life tenant were the absolute owner of the property and shall be allowed to the life tenant. In the case of property held in trust the allowable deduction shall be apportioned between the income beneficiaries and the trustee in accordance with the pertinent provisions of the instrument creating the trust, or, in the absence of such provisions, on the basis of the trust income allocable to each.5. 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.↩6. Sec. 23 (a) (2), supra↩, footnote 2.7. SEC. 23. DEDUCTIONS FROM GROSS INCOME.(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;↩8. Footnote 5, supra↩.9. Sec. 23 (a) (1) (A), supra↩, footnote 5.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623530/	JOHN SINGLE, JR., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentSingle v. CommissionerDocket No. 35048-87.United States Tax CourtT.C. Memo 1988-549; 1988 Tax Ct. Memo LEXIS 578; 56 T.C.M. (CCH) 762; T.C.M. (RIA) 88549; November 30, 1988; As amended December 7, 1988 578 P and his wife jointly filed state income tax returns for 1983. When the jointly payable refund checks arrived at P's home in 1984, P and his wife were undergoing marital discord. P's wife withheld the state refund checks and failed to turn any proceeds over to P. In 1985, P's wife obtained a court order requiring P's credit union to accept P's wife's signature on the checks. The court designated the funds as emergency financial relief to P's wife in 1985. P also omitted dividend income from his 1984 return. Held: P did not constructively receive income from the state refund checks in 1984 since he did not receive the funds and did not authorize his wife to withhold the funds. Further held, that P is liable for negligence for failure to report dividend income. James B. Lewis, and Edwin Lubin, specially recognized, for the petitioner. William R. Davis, Jr., for the respondent. PANUTHOSMEMORANDUM FINDINGS OF FACT AND OPINION PANUTHOS, Special Trial Judge: This case was heard pursuant to the provisions of section 7443A(b) of the Code and Rules 180, 181 and 182. 1FINDINGS OF FACT In his notice of deficiency, dated July 22, 1987, respondent determined a deficiency of $ 1,422 in petitioner's 1984 Federal income tax, and additions to tax under section 6653(a) in the amount of $ 46 2 and section 6653(a)(2) in the580 amount of 50 percent of the interest due on the deficiency. After concessions, the issues remaining for decision are: (1) Whether refunds of two checks in payment of state income tax refunds mailed to petitioner and his wife as joint payees were constructively received, in whole or in part, by petitioner and thus includible in income; and (2) Whether petitioner is subject to the addition to tax under section 6653(a)(1) and (2) for failing to report dividends received. 3Some of the facts have been stipulated and are so found. The stipulation of facts and attached exhibits are incorporated herein by this reference. At the time of filing the petition herein, petitioner resided at Yorktown Heights, New York. In August 1984, petitioner, an employee of I.B.M. Corporation, and his wife, Suzanne Single, jointly filed their Federal, New York State and Minnesota State income tax returns. 581 The state income tax returns reflected refunds due of $ 2,552 and $ 876, respectively. Sometime in August 1984, hostility arose between petitioner and Suzanne Single. Petitioner and his wife remained in the marital residence; however, they resided in different quarters. In October 1984, Suzanne Single commenced litigation against petitioner in the Family Court of the State of New York for the County of Westchester. Also, in October 1984, refund checks from petitioner's and Suzanne Single's 1983 tax overpayment from New York and Minnesota were delivered to the family residence. The refund checks were payable to petitioner and Suzanne Single, jointly. Petitioner never received physical possession of the checks and was apparently unaware that they had been delivered to the residence. Suzanne Single took physical custody of the two refund checks, but did not immediately cash them. At some point, petitioner contacted New York state authorities to determine why he had not received his refund check. He was advised that the refund had been sent to his residence. At that time, he realized that his wife had received the checks without his knowledge. Arguments ensued between petitioner582 and his wife concerning the disposition of the checks. On September 13, 1985, petitioner moved out of the marital residence and Suzanne Single immediately filed an application for emergency family relief. On October 1, 1985, the Family Court ordered the I.B.M. Credit Union to accept Suzanne Single's signature as endorsement on the state refund checks which were payable to petitioner and his wife jointly. The funds were designated by the court as emergency financial relief to Suzanne Single. Pursuant to the order of the Family Court, Suzanne Single cashed the two refund checks. OPINION A taxpayer who reports income under the cash method must report income for the taxable year when actually or constructively received. Section 1.451-2(a), Income Tax Regs.Income * * * is constructively received by [a taxpayer] in the taxable year during which it is credited to his account, set apart for him, or otherwise made available so that he may draw upon it at any time, or so that he could have drawn upon it during the taxable year * * * Section 1.451-2(a), Income Tax Regs. Additionally, for income to be constructively received, the taxpayer must have control over its disposition, 583 and the income must not be subject to substantial limitations or restrictions. Section 1.451-2(a), Income Tax Regs.Petitioner argues that this case is comparable to Alsop v. Commissioner,290 F.2d 726">290 F.2d 726 (2d Cir. 1961). In Alsop, the court held that royalties embezzled by a literary agent of the taxpayer, an author, were not income until recovered from the agent years later. Alsop involved a crime by which the funds were, in essence, stolen from the taxpayer and a judgement was obtained against the agent. While there was no theft of the refund checks here, Suzanne Single did withhold the funds from petitioner in 1984. Under the laws of New York, neither a husband nor a wife may exclude the other from enjoyment or benefits of jointly held property. (N.Y. Gen. Oblig. Law § 3-301 (McKinney 1963)); Bour v. Commissioner,23 T.C. 237">23 T.C. 237, 240 (1954). Thus, while each spouse had a right to the refund checks, Suzanne Single's actions made it impossible for petitioner to have access to any portion of the funds in 1984. In Wiener v. Commissioner,T.C. Memo 1971-56">T.C. Memo. 1971-56, the taxpayer's wife received a refund584 check payable to the taxpayer and his wife jointly. The wife cashed the check signing the taxpayer's name and the taxpayer did not receive any of the proceeds. We found in that case that the taxpayer constructively received the proceeds since the taxpayer authorized his wife to endorse his name on the check and retain the proceeds. Based on this record, we do not believe that petitioner should be charged with having received income from the refund checks in 1984. Application of the doctrine of constructive receipt should be applied sparingly. Thomas v. Commissioner,44 B.T.A. 735">44 B.T.A. 735, 738 (1941); Roach v. Commissioner,20 B.T.A. 919">20 B.T.A. 919, 924-925 (1930). 4 While petitioner had some expectation of the receipt of state income tax refunds, the timing was not certain. In fact, petitioner contacted New York State authorities after the refund check was due to ascertain why he had not yet received the funds. After this inquiry, he realized that his wife had received the refund checks. During 1984, Suzanne Single did not turn over any portion of the refund checks to petitioner. Petitioner did not authorize his wife to retain, withhold or cash the checks. 585 Cf. Wiener v. Commissioner, supra.Suzanne Single did eventually obtain authority to cash the checks from the Family Court. However, this occurred in 1985, a year not before us. Accordingly, we find that petitioner did not constructively receive the state income tax refunds in 1984. The final issue is whether petitioner is liable for the additions to tax for negligence or intentional disregard of rules and regulations under section 6653(a)(1) and (2). Petitioner bears the burden of proving that he is not liable for the additions to tax. Bixby v. Commissioner,58 T.C. 757">58 T.C. 757, 791-792 (1972); Enoch v. Commissioner,57 T.C. 781">57 T.C. 781, 802-803. For purposes of section 6653(a)(1) and (2), negligence is defined as the lack of due care or the failure to do what a reasonable and ordinarily prudent person would do under the circumstances. Neely v. Commissioner,85 T.C. 934">85 T.C. 934, 947 (1985). Petitioner conceded that he received dividends, and that the dividend income was omitted from his return. In light of petitioner's failure to explain his omission, 586 he failed to carry his burden. Respondent's addition to tax for negligence will be sustained. Decision will be entered under Rule 155.Footnotes1. All section references are to the Internal Revenue Code, as amended and in effect during the year in issue, unless otherwise indicated. All rule references are to the Tax Court Rules of Practice and Procedure.↩2. In his trial memorandum, respondent conceded $ 31.00 of the section 6653(a)(1) addition and thus claimed that the amount in dispute was $ 15.↩3. Petitioner conceded that he received dividends from I.B.M. Corporation in 1984 that he did not report on his 1984 Federal income tax return.↩4. See also Davis v. Commissioner,T.C. Memo. 1978-12↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623531/	BRUCE P. JOHNSON AND WILDA L. JOHNSON, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentJOHNSON v. COMMISSIONERDocket No. 19207-81.United States Tax CourtT.C. Memo 1984-599; 1984 Tax Ct. Memo LEXIS 73; 49 T.C.M. (CCH) 91; T.C.M. (RIA) 84599; November 19, 1984. Bruce P. Johnson, pro se. Elaine T. Moriwaki, for the respondent. GOFFE MEMORANDUM FINDINGS75 OF FACT AND OPINION GOFFE: Judge: The Commissioner determined a deficiency in petitioners' Federal income tax for the taxable year 1979 in the amount of $480. The issue for decision is whether petitioners may deduct the cost of an unfinished aircraft as a capital loss, casualty loss, trade or business loss, abandonment loss, or bad debt loss. FINDINGS OF FACT Some of the facts have been stipulated. The stipulation of facts and accompanying exhibits are so found and incorporated herein by reference. Petitioners Bruce P. and Wilda L. Johnson, husband and wife, were residents of Long Beach, California, at the time the petition in this case was filed. Petitioners timely filed a joint Federal income tax return for the taxable year 1979 with the Internal Revenue Service Center at Los Angeles, California. Petitioner Bruce P. Johnson (Mr. Johnson) has been a licensed pilot since approximately 1958, but has been employed during that period as a pipe-fitter. In 1973, Mr. Johnson began buying parts to build a custom aircraft (Model Bede 5) according to plans furnished by Bede Aircraft, Inc. (Bede). Such purchases continued until 1975. Mr. Johnson made all but one76 purchase of aircraft parts from Kibler-Bede Aircraft, Inc., the local authorized dealer for Bede. Mr. Johnson paid $4,685.68 for parts and $95.63 for transporting the parts to him. The drive system, engine, long wings and electrical system, which cost a total of $1,203.50 (included in the $4,685.68 figure), were paid for, but never received. Mr. Johnson also maintained a journal of amounts paid for miscellaneous expenses such as electric drills, screwdriver sets, file sets, drill bit sets, "C" clamps, paint, spatulas and "x-acto" knives. As each stage of construction was completed, Mr. Johnson was required to obtain approval of the construction from the Federal Aviation Administration (FAA) before proceeding to the next phase of construction. On July 31, 1974, the FAA approved the construction of the wings, the wing stabilizers, and the vertical and horizontal tail stabilizers. Bede filed a petition in Federal bankruptcy during 1979 in Wichita, Kansas.A court-ordered auction of all Bede assets, including the inventory of aircraft parts, was set for June 18 and 19, 1979. Petitioners filed a claim against Bede Aircraft, Inc. in the bankruptcy matter as a part of a77 group or class of creditors. The bankruptcy case of Bede Aircraft, Inc. was still open as of July 21, 1983. Petitioners have not sold, exchanged or otherwise disposed of the partially constructed aircraft. Further, the cost of the parts necessary to complete construction of the aircraft plus the cost of the present structure would exceed the potential sales price.Petitioners have never sold any other aircraft although, prior to 1958, Mr. Johnson worked for Douglas Aircraft Company, which sold aircraft. Petitioners have never constructed any other aircraft although Mr. Johnson has worked on the construction of aircraft in his capacity as an employee. Mr. Johnson planned to fly the aircraft himself once it was completed and before it was sold. Petitioners deducted $4,000 as a long-term capital loss on their joint Federal income tax return for the taxable year 1979. On July 1, 1981, the Commissioner issued a statutory notice of deficiency to petitioners for the taxable year 1979. The Commissioner disallowed the entire capital loss claimed by petitioners on the basis that petitioners did not establish that the amount claimed on their return was "(a) a loss (b) which78 is allowed as an adjustment to your Income [sic] and (c) sustained by you." OPINION The issue for decision in whether petitioners may deduct the cost of an unfinished aircraft as a capital loss, casualty loss, trade or business loss, abandonment loss, or bad debt loss. Deductions are a matter of legislative grance, and taxpayers must satisfy the specific requirements of the deductions they claim. Deputy v. du Pont,308 U.S. 488">308 U.S. 488 (1940); New Colonial Ice Co. v. Helvering,292 U.S. 435">292 U.S. 435 (1934). Respondent's determinations are presumptively correct and petitioners bear the burden of proving their entitlement to the deductions they claim. Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933); Rule 142(a). 1Petitioners claimed the cost of the unfinished aircraft as a long-term capital loss on their return. Petitioners argue that they have sustained either a capital loss or a casualty loss in the amount of $4,00079 because they cannot obtain the parts necessary to complete the aircraft at a reasonable cost. Petitioners contend that the loss occurred when it became apparent, as a result of Bede's bankruptcy filing in 1979, that they would be unable to complete the aircraft at a cost allowing for profit upon sale. Respondent contends that petitioners have sustained no deductible loss on the basis that: (1) there was no capital loss in the taxable year 1979; (2) there was no casualty within the meaning of section 165(c)(3) during the taxable year 1979; (3) petitioners' construction of the aircraft did not constitute a trade or business; (4) the aircraft project was not abandoned during the taxable year 1979; and (5) the fact that Bede filed for bankruptcy in 1979 is insufficient basis for a bad debt deduction under section 166(d)(1)(B). Petitioners' primary argument is that the loss is deductible as a long-term capital loss. Such capital losses are deductible by an individual under section 1211(b) when they result from the sale or exchange of business, income-producing or investment property. Losses from sales of personal property are not deductible. 80 Wrightsman v. United States,428 F.2d 1316">428 F.2d 1316 (Ct. Cl. 1970). Even if we were to assume that the aircraft was either investment property or business property, there has been no sale or exchange, and hence no capital loss. Sec. 1211(b). In the alternative, petitioners argue that the loss occurred as the result of a casualty, which is defined, under section 165(c)(3) as: losses of property not connected with a trade or business, if such losses arise from fire, storm, shipwreck, or other casualty, or from theft. * * * Petitioners have failed to present any evidence of a casualty of the sort listed under section 165(c)(3). An economic detriment, in and of itself, is not a casualty. Billman v. Commissioner,73 T.C. 139">73 T.C. 139 (1979). Implicit in petitioners' arguments is a contention that this loss is deductible as a trade or business loss under section 165(c)(1). "Trade or business" has been defined as extensive activity over a period of time for the purpose of producing income. Fischer v. Commissioner,50 T.C. 164">50 T.C. 164, 171 (1968). We are unable to find that the building of one, incomplete aircraft over the course of six years constitutes81 a trade or business under section 165(c)(1), despite Mr. Johnson's apparent ability to eventually complete the aircraft if he finds it both feasible and economical to do so.2A third type of loss deductible by an individual under section 165 is an abandonment loss, evidenced by a closed and completed transaction, and fixed by identifiable events. Sec. 1.165-1(b), Income Tax Regs. Petitioners must establish an intent to abandon, coupled with an act of abandonment ascertainable from the facts and circumstances of the case. Massey-Ferguson, Inc. v. Commissioner,59 T.C. 220">59 T.C. 220 (1972).Mere non-use of the asset is insufficient to constitute an abandonment. Burke v. Commissioner,32 T.C. 775">32 T.C. 775 (1959), affd. 283 F.2d 487">283 F.2d 487 (9th Cir. 1960), nor has an abandonment occurred based upon a claimed loss of value when the taxpayer has neither abandoned nor intends to abandon the asset. 82 A.J. Industries, Inc. v. United States,503 F.2d 660">503 F.2d 660 (9th Cir. 1974). Petitioners presented no evidence of an abandonment in the taxable year 1979. Finally, when an individual pays for goods, but does not receive them, the individual may have a bad debt deductible under section 166(d)(1)(B): where any nonbusiness debt becomes worthless within the taxable year, the loss resulting therefrom shall be considered a loss from the sale or exchange, during the taxable year, of a capital asset held for not more than 1 year. The bad debt must, however, be shown to be totally worthless in the year for which the bad debt is claimed. Sec. 166(d)(1)(A). The fact that the debtor has filed a peition in bankruptcy establishes the likelihood that some part of the debt is worthless, section 1.166-2(c), Income Tax Regs., but not that the entire debt is worthless. Teitelbaum v. Commissioner,294 F.2d 541">294 F.2d 541 (7th Cir. 1961), affg. a Memorandum Opinion of this Court. Petitioners' claim was still pending as of July 21, 1983, and thus the debt did not become worthless within the taxable year 1979. The fact that this debt was not deductible for the taxable year*83 1979 does not preclude a deduction in a later taxable year should the requirements of section 166 be met. While we are sympathetic to petitioners' inability to either recover the funds paid to Bede for which they received no parts, or to reasonably complete their aircraft, petitioners have failed to present sufficient evidence to support allowance of a deduction under section 165 or section 166 for the taxable year 1979. Petitioners here, therefore, failed to meet their burden of proof under Rule 142(a). The Commissioner's determination to disallow the deduction for the incomplete aircraft is sustained. Decision will be entered for the respondent.Footnotes1. All section references are to the Internal Revenue Code of 1954, and attendant regulations as amended and in effect for the relevant years, and all rule references are to this Court's Rules of Practice and Procedure.↩2. Neither party contend that the facts reflect a "transaction entered into for profit" under section 165(c)(2)↩ or an activity "not engaged in for profit" under section 183.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623533/	R. M. SMITH, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentSmith, Inc. v. CommissionerDocket No. 478-74.United States Tax CourtT.C. Memo 1977-23; 1977 Tax Ct. Memo LEXIS 422; 36 T.C.M. (CCH) 97; T.C.M. (RIA) 770023; January 31, 1977, Filed 422 Held: Values of patents on various types of lawn and garden equipment and packaging devices determined. Held,further: Petitioner failed to prove that the failure of petitioner's liquidated subsidiary corporation to report depreciation recapture on its final return was not due to negligence or intentional disregard of rules and regulations. Imposition of addition to tax under sec. 6653(a), I.R.C. 1954, upheld. 423 Kenneth P. Simon, for the petitioner. Joseph M. Abele, for the respondent. DRENNENMEMORANDUM FINDINGS OF FACT AND OPINION DRENNEN, Judge: Respondent424 determined deficiencies in petitioner's corporate income taxes and a liability against petitioner as a transferee of assets of Gilmour Manufacturing Co. for a deficiency in its corporate income tax and an addition to tax as follows: Deficiencies TYECorporate income Aug 31,tax deficienciesTotal1970$68,123.58197196,606.94$164,730.52Transferee LiabilityAddition to tax PeriodDeficiency1 under sec. 6653(a) TotalJuly 1, 1969to Mar. 31, 1970$124,329.85$6,216.51$130,546.36Due to concessions made by both parties at trial and on brief with regard to both the determined transferee liability and income tax deficiencies, the only issues remaining for decision are: (1) Whether deductions claimed by petitioner with respect to depreciation and amortization for its taxable years ending August 31, 1970, and August 31, 1971, were overstated because petitioner's basis in depreciable property determined under section 334(b)(2) was overstated. (2) Whether Gilmour Manufacturing Co., transferor425 of assets to petitioner, was liable for an addition to tax under section 6653(a) for the period July 1, 1969, to March 31, 1970. 2FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. The stipulation of facts together with associated exhibits are incorporated herein by this reference. Petitioner is a corporation organized under the laws of the Commonwealth of Pennsylvania. Its principal office and place of business at the time of filing the petition herein was 926 North Center Street, Somerset, Pa. It filed its Federal income tax returns for its fiscal years ended August 31, 1970, and August 31, 1971, with the Office of the Internal Revenue Service at Philadelphia, Pa. Prior to the purchase of the stock of Gilmour Manufacturing Co., described below, petitioner was engaged in the business of real estate development. Petitioner filed its income tax returns under the name Morrison Enterprises, Inc., until June 26, 1970, when its name was changed to R.M. Smith, Inc., and its principal place426 of business was designated as 926 North Center Street, Somerset, Pa. Gilmour Manufacturing Co. (Gilmour Co. or Gilmour) was also a Pennsylvania corporation with its place of business located in Somerset, Pa. Robert A. Gilmour (R.A. Gilmour) operated Gilmour Co. as a proprietorship from 1948 to 1968, when it was incorporated. Thereafter R. A. Gilmour was the sole shareholder and president of Gilmour Co., which was engaged in the business of manufacturing lawn and garden supplies including such items as hose nozzles, lawn sprinklers, and sprayers. Robert M. Smith (Smith) was a certified public accountant maintaining a full-time accounting practice in Johnstown, Pa., prior to December 1970. Smith acquired a controlling interest in the stock of petitioner sometime during 1968 and has been, since at least that time, the president and chief executive officer of petitioner. In connection with his accounting practice, Smith also served as accountant for R. A. Gilmour as well as Gilmour Co. from 1945 through January 1970. On January 20, 1970, R. A. Gilmour and Smith, both acting in their capacities as chief executive officers of their respective corporations, entered into a handwritten427 memorandum agreement for the sale of substantially all of the operating assets of Gilmour Co. and purchase thereof by petitioner on February 1, 1970, for an aggregate purchase price of $3,500,000. A short time subsequent to this agreement, at the insistence of R. A. Gilmour, the agreement for the sale of assets was altered to a sale of stock of Gilmour Co. by R. A. Gilmour to petitioner. The terms of the stock purchase were essentially the same as had been agreed upon in the initial agreement with the following modifications: The purchase price for the Gilmour Co. stock was increased by $280,550 to a total amount of $3,780,550 to cover the value of certain nonoperating assets owned by Gilmour Co. which were not included in the list of assets bargained for. At the closing of the sale, those nonoperating assets owned by Gilmour Co. which had not been included in the original sale of assets agreement, were to be sold by petitioner to R. A. Gilmour for their book and fair market values aggregating $280,550. Those assets were the land and building where Gilmour Co. maintained its offices and plant and which had a book and fair market value of $192,836.10, certain nonoperating machinery428 and equipment valued at $71,758,57, and an airplane hangar valued at $15,955.33. The parties additionally agreed that the above-described building and real estate would be leased back to petitioner for an annual rental of $36,000. The effective date of the stock purchase transaction was not altered by the above modification, i.e., it remained February 1, 1970. However, after being advised by counsel that the necessary documentation could not be prepared by February 1, 1970, the parties agreed that closing would occur at the convenience of their respective counsel but the transaction would be effective as of February 1, 1970. The sale was finally consummated on March 24, 1970, at which time all the stock of Gilmour Co. was transferred to petitioner. Contemporaneously therewith, Smith caused Gilmour Co. to sell its real estate to R. A. Gilmour for $192,836.10, and the airplane hangar and miscellaneous machinery and equipment for $86,713.90. R. A. Gilmour then leased the real estate to petitioner for a term of 10 years effective February 1, 1970, at an annual rental of $36,000. The petitioner and R. A. Gilmour also executed an employment agreement hiring the latter as an independent429 contractor consultant at an annual compensation of $25,000 for a period of 5 years effective as of February 1, 1970. Between Smith and R. A. Gilmour, the sale and purchase of stock was treated by the parties as if it were consummated on January 31, 1970, as initially contemplated in the memorandum agreement for the sale of assets: R. A. Gilmour's salary as president of Gilmour Co. ceased as an officer on January 31, 1970, and he was thereafter paid by petitioner a lesser amount pursuant to the abovedescribed consulting agreement dated March 24, 1970. Petitioner paid R. A. Gilmour rent for the real estate occupied by the business pursuant to a lease dated March 24, 1970, and made effective February 1, 1970, in the amount of $3,000 each for the months of February and March 1970. R. A. Gilmour maintained control of Gilmour Co.'s bank account and paid all liabilities accrued as of February 1, 1970. Smith opened a new bank account into which all receipts of Gilmour Co. were deposited after January 31, 1970. Immediately upon closing of the stock purchase transaction on or about March 24, 1970, petitioner began the liquidation of Gilmour Co., which was completed by March 31, 1970. 430 The fair market values and, where pertinent herein, the useful lives of the tangible assets received by petitioner upon liquidation of Gilmour Co. have been stipulated as follows: AssetsValueUseful lifeAutomobile equipment$ 14,010.005 years S/LDies15,322.007 years S/LFurniture & fixtures12,552.006 years S/LMachinery & equipment542,865.0010 years S/LPrinting plates2,065.004 years S/LInventory360,238.00Accounts receivable554,767.00(Total)($1,501.819.00)Real estate sold toGilmour192,836.10Machinery & equipmentand airplane hangar87,713.90(Total)($280,550.00)(Total)($1,782,369.00)On liquidation of Gilmour Co., petitioner also received cash of $126,114.52 and a receivable of $58,550 for 1969 estimated Federal tax payments. Petitioner assumed liabilities of Gilmour Co. in the amount of $159,451.93. The remaining assets which petitioner received upon liquidation of Gilmour Co. were intangible assets and included 3 a number of patents for hose nozzles, spraying devices, and sprinklers, an invention for packing nozzles for sale, a trademark (Hosemaster), and the right to use the Gilmour name. 431 4On its tax returns for the years at issue petitioner claimed deductions for amortization with respect to the patents and invention based upon an aggregate amount of basis for said assets of $1,833,392.53. Respondent, in notices of deficiency for the taxable years at issue herein, determined that only one patent had an amortizable basis and that the amount thereof was $10,000; respondent assigned no value to, recognized no tax basis in, and allowed no amortization for the remaining patents or the invention. 5432 The depreciation and amortization deductions claimed by petitioner on its returns and the amounts allowed by respondent with respect to the fiscal years involved herein, are as follows: Fiscal year endedFiscal year endedAugust 31, 1970August 31, 1971ClaimedAllowedClaimedAllowedDepreciation - automotive$32,116.66$19,291.15$78,298.68$45,700.53equipment, machineryand equipment, dies,molds, furniture andfixtures, printingplates, Hosemasterglobe and pylonAmortization of patents65,797.30245.10157,913.52588.23Totals$97,913.96$19,536.25$236,212.20$46,288.76Less: Depreciation andAmortization allowed19,536.2546,288.76Adjustment (amountsdisallowed)$78,377.71$189,923.44The various patents and invention with which we are concerned herein and the products with which they are associated are as follows: U.S. Patent NumberAssociated Product1 D 194,014Pistol-grip nozzle2 3,045,927Jet Speed nozzle3 RE 26,013, et al.Thum Trol nozzle4 3,191,869, et al.Sprayer5 3,207,443Dual barrel spray head6 3,498,543Wave sprinklerInventionNozzle package433 A brief description of the products covered by the above patents, in layman's language, is as follows: Patent #1 (D 194,014) - Pistol-grip nozzle.--This patent protects the design of a pistol-grip hose nozzle manufactured by Gilmour Co., the distinctive features of which include a flared handle and easy-to-grip control. Patents #2 (3,045,927 et als.) - Jet speed nozzle.--This patent was a mechanical patent protecting the manufacture of a rotary-type nozzle. The distinctive characteristic of this nozzle is that it can be completely opened or closed, so as to control the pattern of water spray, by turning the barrel of the nozzle only one-half turn, i.e., 180 degrees. Patents #3 (RE 26,013 et als.) - Thum-Trol Nozzle.--These mechanical patents protect the manufacture of a barrel-type nozzle which controls the flow of water by a thumb activator, i.e., a slide which looks and operates very much like a slide found on a flashlight. Patents #4 (3,191,869 et als.) - Sprayer.--These patents deal with the spray-head mechanism of spraying devices used primarily in dispensing fertilizers, insecticides, weed killers, or disinfectants. The device controls the amount434 of the liquid fertilizer or insecticide held in a plastic container attached to the sprayer which is drawn from the container through a plastic tube into the spray head and dispensed therefrom together with the water flowing from the attached hose. Patent #5 (3,207,443) - Dual-Barrel Spray Head.--The product manufactured under this patent is advertised as a dual-barrel acid-cleaning gun. This device is similar to the sprayer covered by Patent #4 except that it has two conduit barrels and two separate spray heads which permits cleaning an aluminum trailer, for instance, with a mixture of the secondary liquid (acid) and water, and then by adjusting the controls, rinsing it off with water alone. Patent #6 (3,498,543) - Wave Sprinkler.--The product manufactured under this patent is an oscillating or wavetype lawn sprinkler. But instead of a rigid bar spray head, this device has a flexible tubular bar head which permits adjustment of both the length and width of the water pattern. Invention - Nozzle package.--This invention, which was not patented at the time of the liquidation of Gilmour Co., provided a method of affixing a nozzle (or similar device) to a display435 card by means of a plastic button rivet driven through a hole in the nozzle handle and through a hole in the card. This permits a potential purchaser to remove the nozzle from the card to examine it and return it to the card without damage to the card. The more conventional methods of affixing the product to the card by means of tape, wire fasteners, or a plastic covering do not possess this feature. In attempts to establish the proper fair market values for the above-described intangible assets, petitioner presented the testimony of its president, R. M. Smith, and, as its expert witness, Murray V. Johnston; respondent presented the testimony of one expert witness, James P. Burns, Esq. R. M. Smith has had no experience in valuing patents of any type. Smith had no experience in the business of manufacturing or selling nozzles, lawn sprinklers, or sprayers prior to petitioner's acquisition of Gilmour Co., except in connection with his rendering of accounting services to Gilmour Co., R. A. Gilmour, and A. W. Francis Co. (another manufacturer of lawn and garden supplies). Smith has never testified in any proceeding as an expert on the valuation of patents. In December of 1970, 436 in order to allocate the amount of petitioner's adjusted basis in its Gilmour Co. stock to the assets received from the liquidation of Gilmour Co. for the purpose of establishing the respective bases of said assets pursuant to section 334(b)(2), R. M. Smith prepared a schedule of the patents and invention owned by Gilmour Co. on February 1, 1970. On this schedule Smith recorded what he determined to be the fair market values of said patents and invention as of February 1, 1970; the aggregate amount of these values was $2,542,505. However, Smith determined that the available amount of petitioner's adjusted basis 6 in its Gilmour Co. stock, after determining the fair market values of the tangible assets petitioner received on liquidation and allocating a corresponding amount of the adjusted basis to said assets, was less than the amount he had determined constituted the fair market values of the patents and invention. As a result Smith reduced pro rata the amounts allocated to the patents and invention to an aggregate amount of $1,833,392.53. These reduced amounts shown as "value allocated" on the schedule reproduced in the margin, 7438 were recorded on petitioner's books and records437 and used by petitioner as bases for purposes of computing deductions claimed for amortization on its returns for the years at issue. In making his determination of the fair market values of the patents and the invention Smith took into consideration the nature of the patent, the selling price of the related manufactured item, and the value to petitioner as he saw it at that time. The technique used by Smith in determining the contested values of most of the items was essentially as follows: Smith first determined what he characterized as a patent's "value per unit" manufactured. He computed this value in most cases by comparing the net selling price of the item manufactured under the particular patent with the net selling price received from the sale of a different model of the same or a similar type item. For instance, patent #6 (3,498,543) pertained to "wave sprinkler" - Model #3,000 had a net selling price of $7.28. Gilmour Co. also manufactured and sold another wave sprinkler, Model #2,800 (apparently not protected by patent) for a net selling price of $5.25. The difference in the net selling prices received for these items is approximately $2.00; Smith determined that this amount was the unit value of products manufactured under patent #6. However, different methods were used in at least two instances: Smith determined a unit value for patent #1 of $.015 by talking to petitioner's employees and estimating a value per unit to petitioner. In determining a value for the invention owned by Gilmour Co., Smith calculated a unit value of $.006 based upon savings of labor cost per item sold resulting from the use of the card packaging invention. After determining a unit value for the particular patent under valuation, Smith multiplied this unit value by the estimated annual sales of the item manufactured to compute an amount characterized as "value per year." Smith estimated the sales for each product manufactured under patent based upon his general knowledge of Gilmour Co.'s sales history 8 and upon information gathered from his discussions with, presumably, key employees about their predictions as to future sales. Smith's computatations were then completed by multiplying the "value per year" by the number of years the particular patent would continue legally enforceable. 9Petitioner called Murray V. Johnston to testify as an expert witness with regard to the valuation of the patents and invention. Johnston is a self-employed financial consultant and financial appraiser. He began offering consulting services in 1961 and was certified as439 a member of the American Society of Appraisers in 1963 and offered appraisal services thereafter. During the vast majority of Johnston's professional career, from 1928 until 1961, he was an employee of Gulf Oil Corp. During the last 6 years of his association with Gulf he was employed as general credit manager. During Johnston's employment with Gulf he had experience in determining values of intangible assets; this was in connection with appraisals of various businesses that Gulf, at one time or another, was considering acquiring. However, this experience was limited in scope to determining the value of goodwill. During Johnston's period of employment with Gulf, he had no experience in examining and determining the value of patents. Johnston testified that his sole experience with regard to patent valuation has been in connection with his work as a financial appraiser and that since 1963 he has appraised 15 different patents. He has had no previous experience in connection with a transaction involving either the transfer or sale of patents; nor has he ever previously testified as an expert witness in establishing patent values. Johnston's general approach in determining the440 values of the patents and invention of Gilmour Co. included obtaining and studying the financial reports of Gilmour Co., going to the company's plant and observing the manufacturing process, viewing the company's patented products, and considering Gilmour Co.'s past sales history 10 and Smith's opinion as to future sales. The method used by Johnston to make his evaluations was to estimate the earnings petitioner could realize from royalties if it were to grant exclusive unlimited licenses for the use of the patents for their remaining legal lives as of March 31, 1970. Computations were made using estimated dollar amount of sales of the item covered by the patent for the year 1970, projecting estimated future sales during the life of the patent by applying an estimated annual growth rate (usually 12-1/2 percent compounded per annum) to the preceding year's sales, and then determining the estimated average annual sales during the remaining life of the patent. This was multiplied by the percentage royalty Johnston thought was justified (7-1/2 to 10 percent) to obtain the estimated royalty income value per year. The latter was multiplied by the number of remaining years in the life441 of the patent to get a gross royalty value of the patent. The gross value was then reduced to present (1970) value by applying what is commonly referred to as "Hoskhold's formula."11With respect to the nozzle packaging invention, which was not patented in 1970, 12 Johnston arrived at a value for this "know how" or invention by determining that this method of packaging would save petitioner $5.20 per thousand units packaged over petitioner's cost of packaging its products under its prior method, 442 and then multiplying the number of packages that would be used over the next 10 years by $5.20 per thousand to arrive at a gross value of the invention, which was then reduced to 1970 value by applying Hoskhold's formula. Johnston determined estimated sales by applying an estimated 12-1/2-percent compounded annual growth rate to the 1970 sales which presumably utilized the package. Since the package was not patented in 1970 Johnston assumed that the value of the package would last 10 years before being replaced by a better method of packaging nozzles and other garden products. At trial respondent called as its sole expert witness James P. Burns, Burns is an attorney specializing in the field of patent law; he is currently the senior partner of a Washington D.C. law firm which limits its practice to patent, trademark, and unfair competition law. Burns has had about 50 years of experience in the area of patent law beginning in the early 1920's with his work as a patent examiner in the United States Patent Office. During his career Burns has served as president of the American Patent Law Association and many professional committees443 including an advisory committee to the Secretary of Commerce with respect to patents. Burns' experience with respect to patents includes determining fair market values of patents, patent infringements including the assessment of damages arising therefrom, licensing of patents, and advising clients with respect to proper royalty rates to be received or paid upon the sale, licensing, or acquisition of patents. In determining the fair market values of the Gilmour Co. patents Burns took into consideration: The scope of the patent; the prosecution history of the matter being patented to determine whether any part thereof was already in the public domain or was anticipatory or whether any patent claim was given up as a condition precedent to the grant of a new patent; what, if any, competitive products can be marketed royalty-free; and the potential market including the range and magnitude for the patented products and the price range at which the product sells.Burns utilized the same computational formula for determining fair market value of the patents as was used by Johnston, except that the gross values determined were not reduced to current cash values. Burns usually used Johnston's444 estimated sales for 1970 but, for reasons stated in his appraisal reports including consideration of the abovementioned factors, Burns used a significantly lower estimated compounded annual growth rate of sales to arrive at estimated annual sales of the patented products, and also a lower percentage royalty (usually 3 percent) to determine the royalty value of the patents. With respect to the wave sprinkler (Patent No. 3,498,543), Burns concluded that the design or mechanical improvements covered by the Gilmour patent were pre-empted by a Jepson patent which did not expire until 1977, so this gave the Gilmour patent a negative value for 7 years (to cover the royalty that would have to be paid to Jepson if the sprinkler was marketed), thus reducing the overall value of the patent. With respect to the dual barrel spray head (Patent No. 3,207,443) Burns concluded that it provided nothing new and assigned only a nuisance value to it.And with regard to the nozzle card package, Burns concluded that the patent, when issued in 1972, was invalid and assigned it only a nominal value for going concern "know how." The appraised values of the various patents and invention determined by the three445 appraisers who testified as to the values of the patents were as follows: Smith Pat. No.ItemJohnstonBurnsSmithreducedD 194,014Pistol-grip$1,136,000$202,246$202,500$145,000nozzle3,045,927Jet Speed18,0007,0003,3253,000nozzleRE 26,013Thum Trol59,00014,745123,95990,000et als.nozzle3,191,869Sprayer366,000127,6561,421,8751,025,000et als.3,207,443Dual Spray-10,0005,00076,00055,000head3,498,543Wave Sprink-278,00068,000510,000365,000lerInventionCard package130,00010,000204,000150,000Total$1,997,000$434,647$2,542,50513$1,833,392.53Gilmour Co. operated a successful business operation. In each of its taxable years since at least 1964 through its liquidation on March 31, 1970, Gilmour Co. operated at a profit. After its liquidation, petitioner uninterruptedly continued the business operation of Gilmour as a division of R. M. Smith, Inc., and continued to use the trade446 names of Gilmour and Gilmour Co.Petitioner acquired a substantial customer list from Gilmour and continued to use substantially the same sales representatives for its products as had Gilmour Co. prior to its liquidation. Prior to the stock acquisition by petitioner, Gilmour Co. sold its products under the trademark of "Hosemaster." Upon the liquidation of Gilmour Co. petitioner acquired the "Hosemaster" trademark and has, to a certain extent, continued its use. The "Hosemaster" trademark is displayed prominently on petitioner's sales catalogues, and on its sales display packages for pistol-grip, jet-speed, and thum-trol nozzles as well as the display packages for the various sprinklers marketed by petitioner. In addition, the trademark "Hosemaster" is displayed on a globe which is attached to the top of a large pylon that stands outside petitioner's manufacturing plant and can be seen from the Pennsylvania turnpike. The corporate income tax return of Gilmour Co. for the period July 1, 1969 to March 31, 1970, was prepared by Robert M. Smith. Said return did not report any income from the recapture of depreciation and investment credit previously taken by Gilmour Co. with respect447 to certain assets owned by it which were distributed to petitioner upon liquidation.Petitioner has conceded that Gilmour Co. should have reported income from the recapture of depreciation and investment credit on its final return. Smith has had an extensive background in a tax and accounting practice. Smith began work as an accountant with the Pittsburg office of Haskins & Sells in December 1938. From July 1941 through March 14, 1948, Smith practiced public accounting with the firm of Davies-Silverstone & Co. in Johnstown, Pa.Smith became a certified public accountant in the State of Pennsylvania in 1945. In his accounting practice Smith represented clients in over 100 cases with the Internal Revenue Service at various levels. And as a CPA and tax practitioner, Smith was cognizant of the depreciation and investment credit recapture provisions of the Internal Revenue Code. A depreciation recapture issue was involved in one of the cases in which Smith represented a client before the Internal Revenue Service. Smith testified that he hastily prepared the income tax return of Gilmour Co. for the period ended March 31, 1970. ULTIMATE FINDINGS OF FACT The fair market values448 of the patents and invention received by petitioner in liquidation of Gilmour Co. were as follows: Pat. No.ItemFMV1 D 194,014Pistol-grip nozzle$355,0002 3,045,927Jet speed nozzle11,0003 RE 26,013 et als.Thum Trol nozzle25,0004 3,191,869 et als.Sprayer220,0005 3,207,443Dual sprayhead9,0006 3,498,543Wave sprinkler125,000InventionCard package115,000Total$860,000Upon the liquidation of Gilmour Co. petitioner received valuable intangible assets including a trademark, goodwill, and going concern value. Petitioner failed to prove that the underpayment of tax by Gilmour Co. for the taxable period beginning July 1, 1969, and ending March 31, 1970, was not due to negligence or intentional disregard of rules and regulations. The following findings of fact are made to reflect concessions of the parties on certain issues: 1. Gilmour Co. is entitled to deductions for rent expense of $6,000 and a consultant fee of $4,000 paid to Robert A. Gilmour during the period ending March 31, 1970. 14449 2. Gilmour Mfg. Co. is not entitled to a deduction for depreciation in the amount of $646.87 for the period ended March 31, 1970. 3. Depreciation in the amount of $189,950.16 for the period ended March 31, 1970, should have been recaptured by Gilmour Mfg. Co. under section 1245 as gain taxable as ordinary income upon the liquidation of said company. 4. Gilmour Mfg. Co. should have recaptured investment credit in the amount of $13,596.34 for the period ended March 31, 1970, upon the liquidation of Gilmour Mfg. Co. as there was a disposition of section 38 property within the meaning of section 47. 5. Petitioner is entitled to deductions of $6,515.73 and $5,572.71 for "interest expense - others" in the fiscal years ended August 31, 1970, and August 31, 1971, respectively. 6. Petitioner is entitled to deductions of $5,962.69 and $7,863.31 for "interest expense - stockholders" in the fiscal years ended August 31, 1970, and August 31, 1971, respectively. 7. Petitioner did not have dividend income of $280,550 from Gilmour Mfg. Co. on or about March 24, 1970. 8. Petititioner is not entitled to a dividend received deduction of $238,467.50 for the year 1970 as set450 forth in the notice of deficiency, as respondent conceded that petitioner did not have dividend income of $280,550. 9. Gilmour Mfg. Co. did not have a gain on sale of machinery and equipment, building and landscaping, and airplane hangar in the amount of $12,360.42 in 1970. OPINION We must decide two questions herein: (1) Whether petitioner overstated deductions for depreciation or amortization of patents and an invention claimed on its corporate tax returns for fiscal years ended August 31, 1970 and August 31, 1971; and (2) whether Gilmour Co. is liable for an addition to tax under section 6653(a) for the taxable period July 1, 1969 to March 31, 1970.Effective February 1, 1970, petitioner purchased all of the stock of Gilmour Co. from R. A. Gilmour and soon thereafter began the liquidation of Gilmour Co., which was completed on March 31, 1970. Petitioner paid $3,500,000 for all the stock of Gilmour Co., plus the fair market value of certain nonoperating assets of Gilmour Co. which were immediately sold to R. A. Gilmour at the same fair market value. Upon the liquidation of Gilmour Co. petitioner allocated the $3,500,000 purchase price of the stock among the assets received451 by petitioner as a result of the liquidation of Gilmour Co. Petitioner allocated to the tangible assets received, and to the inventory and accounts receivable, a total of $1,615,400.19, and the balance of the purchase price, or $1,884,599.81, to certain patents and an invention owned by Gilmour Co. at the time of the liquidation. Petitioner allocated nothing to intangibles such as goodwill, tradename, and going concern value. On its income tax returns for the periods ending August 31, 1970 and 1971, petitioner claimed deductions for amortization of the patents and invention, using as a tax basis the values allocated thereto as above indicated. Upon audit of those returns respondent determined that petitioner had a tax basis of only $10,000 in one of the patents and no basis in the others and disallowed all but a small amount of the patent amortization deductions claimed by petitioner.The parties have stipulated the values of the tangible assets, accounts receivable and inventories received by petitioner on the liquidation of Gilmour Co., which total $1,501,819. Hence, the principal issue remaining for our determination is the fair market value of the patents and invention, and452 if that together with the stipulated value of the tangible assets, accounts receivable, and inventories is less than the purchase price of the stock, whether the balance should be allocated to goodwill and other nondepreciable intangible assets or to the depreciable and amortizable assets. Petitioner also failed to include in the final return of Gilmour Co. recapture of depreciation mandated by law, and the secondary issue remaining for our decision is whether the underpayment of tax resulting therefrom was due to negligence or intentional disregard of rules and regulations so as to make the addition to tax imposed by section 6653(a) applicable.Section 167(a) 15 provides that there shall be allowed as a depreciation deduction a reasonable allowance for the exhaustion, including obsolescence, of property used in a trade or business. For purposes of this case, as is indicated in the regulations, see sec. 1.167(a)-1, Income Tax Regs., the amount of the allowable deduction for depreciation is computed with respect to the basis and useful life of each particular asset. Gilmour Co. was liquidated tax free in accordance with section 332 and it is uncontested that petitioner's basis453 in the assets thus received is governed by section 334(b)(2). Under section 334(b)(2) 16 the basis of the property received in liquidation by petitioner is petitioner's adjusted basis in the Gilmour Co. stock with certain adjustments thereto as prescribed in the regulations. Under section 1.334-1(c), Income Tax Regs., the aggregate basis in the assets received by petitioner is the cost of the Gilmour Co. stock reduced by the amount of cash received and increased by the liabilities assumed or subject to which the property was received. 17 After the prescribed adjustments are made to the adjusted basis, said aggregate basis is then allocated among the various assets received in the liquidation (except cash and its equivalent) both tangible and intangible, ordinarily in proportion to the net fair market values of such assets on the date received, see sec. 1.334-1(c)(4)(viii), 454 Income Tax Regs., and as such constitutes the individual basis for each asset in the hands of the petitioner. 455 Petitioner now contends that the aggregate fair market value of the patents and invention as of March 31, 1970, was $1,997,000, Johnston's aggregate appraisal figure. Upon petitioner's argument, the portion of petitioner's adjusted basis in the Gilmour Co. stock, as finally adjusted, which was not allocated to the tangible assets is allocable to the patents and invention in proportion to their respective fair market values. Furthermore, petitioner apparently contends that after the aggregate basis has been allocated to the tangible assets and to the patents and invention under section 334(b)(2), if any amount thereof remains it should be reallocated pro rata among all of the assets both tangible and intangible in accordance with their respective fair market values.Respondent now contends, based on the testimony and valuation report of his expert witness, James Burns, that the aggregate fair market value of the patents and invention, as of March 31, 1970, did not exceed $434,647, that petitioner received additional valuable intangible assets from the Gilmour Co. liquidation including a trademark and goodwill, and that the remaining part of the stock purchase price should be allocated456 under section 334(b)(2) to these nondepreciable intangible assets. Respondent proposes that, for purposes of allocating the basis to the assets received from Gilmour Co., we should adopt a so-called "residual appraisal method," i.e., basis is allocated to depreciable assets according to their respective values and the remaining or residual amount of basis is allocated to nondepreciable assets. We agree with respondent that petitioner improperly overvalued and allocated an excessive amount as basis to the depreciable intangibles received in liquidation and in fact received valuable nondepreciable intangible assets to which a portion of the available amount of basis should have been allocated pursuant to section 334(b)(2) and the regulations thereunder. We also agree with petitioner, however, that respondent's allocation of only $10,000 of that basis to the patents and invention was arbitrary and unreasonable and that the presumption of correctness which normally attaches to respondent's determination is not applicable with regard to this issue. This leaves us with the burden of determining the value of these patents and the invention, which at best is a will-o-the-wisp exercise, 457 from the evidence presented during the trial of this case, without support of a burden-of-proof rule. We have described in some detail in our findings of fact the approaches taken by the three witnesses in determining the values of these assets, the mechanics used to carry out those approaches, and the amount of the values so computed. While the testimony and appraisal reports of those witnesses were helpful, after a careful review of all of the evidence presented herein, we have concluded that the parties have overstated their cases, and, as a result, have exaggerated their appraisals. Consequently, in making our determination, we have not sustained either of the parties' valuations because we believe the answer lies somewhere between the two extremes and have made our findings accordingly. At the outset we note that the opinion evidence submitted was somewhat less than exemplary. Our basic criticism of the evaluation reports concerns the data upon which the reports are based and from which the conclusions contained therein were necessarily drawn; they seen to us unduly speculative. We recognize that the process of making determinations of value is by its nature speculative458 and that the subject matter concerned herein, patents, which by their nature are unique, serves to exacerbate the uncertainties inherent in an evaluation determination (see Simmons Company,8 B.T.A. 631">8 B.T.A. 631, affd. 33 F.2d 75">33 F.2d 75 (1st Cir. 1929), cert. denied 280 U.S. 588">280 U.S. 588 (1929)). Nevertheless, conjecture should be kept to a minimum by establishing, where possible, a firm factual foundation from which necessary projections can be made with some degree of confidence. In this case both parties' experts made their evaluations of the patents on the basis of projected future earnings. These projections, which theoretically represent a consideration of the reasonable prospects for the future, were, in turn, based upon the earnings history of Gilmour Co. for the 5-year period immediately preceding March 31, 1970. However, the historical earnings figures used by the experts 18 as the basis for their projections were in fact estimates made by R. M. Smith and did not represent actual historical data in which earnings or sales from products were segregated to reflect those amounts related to specific patents. Moreover, the figures from which Smith made459 his estimates did not even reflect a distinction between sales of nonpatented products from those manufactured under patent. There was testimony at trial to the effect that production records of Gilmour Co. do exist and are and were available. We do not know how informative such records might be nor what time periods they may reflect but it is clear that no such records were resorted to in compiling the valuation reports submitted herein. 19460 By our criticism we do not mean to cast aspersion on either of the parties' expert witnesses. Clearly, Burns, respondent's expert, is an attorney of great stature in his field and a review of his accomplishments and professional contributions is indicative of this fact. Moreover, Burns' experience in advising clients as to the fair market values of various patents evidence his competency to testify as an expert witness in this proceeding. Petitioner's expert, Johnston, although not possessing much experience in evaluating patents, is a senior member of the American Society of Appraisers and testified as an expert herein without objection from respondent. Furthermore, the methods used by these experts to evaluate the patents, which methods were essentially the same, represented appropriate means by which to determine fair market values--attempts to determine at what price the patents would change hands between a willing buyer and seller. See Bendix Engineering Works, Inc.,23 B.T.A. 1049">23 B.T.A. 1049 (1931); Nice Ball Bearing Co.,5 B.T.A. 484">5 B.T.A. 484 (1926); Harry W. Bockhoff,3 B.T.A. 560">3 B.T.A. 560 (1926). However, we find the method used by petitioner's461 president, R.M. Smith, to evaluate the patents wholly unacceptable, having no apparent relation to what a willing buyer and seller might agree upon at arm's length. At first blush it may seem incongruous to ignore the testimony of the individual who negotiated the purchase of Gilmour stock on behalf of petitioner. However, the transaction which Smith negotiated was a lump-sum purchase of stock of a profitable ongoing business, payable in installments. Such experience does not necessarily indicate Smith's capability of accurately determining the fair market values of the patents. It should be clear, however, that our refusal to give weight to Smith's testimony with respect to the valuation of the patents is not predicated upon a finding that he is incompetent to give such testimony. Rather, our decision was made after reviewing his testimony as to the method he used to determine such values. The method Smith used was described earlier in our fact findings and further discussion thereof is unwarranted except to say that generally it consisted of comparing the net sales price of the product manufactured under the particular patent being evaluated with the net sales price of a similar462 product which is either manufactured under another patent or without patent protection. From this comparison, Smith determined the sales price differential and treated this amount, called "unit value," as the royalty petitioner would receive if the patent were licensed. We fail to see any logical relationship between differences in prices of items manufactured and sold by petitioner and the royalty amount another manufacturer would pay to obtain the right to manufacture and sell a patented item. 20Furthermore, as sole owner of petitioner, it was very much to Smith's advantage to allocate the largest part of the basis available to those patents which had the shortest remaining lives for amortization deduction purposes. To illustrate, we note that on the final return of Gilmour Co. for the period July 1, 1969 to March 31, 1970, gross profit on sales was reported as $959,609.14 and taxable income was reported as $303,053.04, whereas on the return of petitioner463 for the period September 1, 1970 through August 31, 1971, gross profit on sales from the Gilmour division was reported to be $1,012,102.82, operating expenses of that division, including an amortization deduction of $157,913.52, were reported as $993,933.06, and net operating income was reported as $18,169.76.We are also curious to know why Smith did not give us some information concerning Gilmour's breakdown of his $3,500,000 original asking price for the operating assets of Gilmour Co.; and in fact why Gilmour was not called as a witness. Under the circumstances we can give little weight to Smith's valuation of the patents and invention. Johnston determined an aggregate fair market value for the six patents under examination of $1,867,000. In determining the values of the patents, generally Johnston used royalty rates of 10 and sometimes 7-1/2 percent and projected future sales over the remaining lives of the patents based on an assumed annual sales increase of 12-1/2 percent. Burns determined an aggregate gross fair market value for the patents of $424,647. Burns assigned only a nominal value to some of the patents and to others he applied a 3-percent royalty rate to the464 average of sales during the lives of the patents assuming a 6 - 6-1/2-percent annual compounded growth rate. Neither of the parties has brought to our attention, nor have we discovered, an established royalty rate or range thereof applicable to lawn and garden supplies or equipment. However, it seems to us rather clear that the rates chosen by Johnston were excessively high. None of the patents under evaluation were basic, conferring a monopoly of commercial importance. Rather, each of the patents contained claims which were improvements to the existing art and in most cases rather narrow. Garden City Feeder Co.,35 B.T.A. 770">35 B.T.A. 770, 780 (1937); Keystone Steel & Wire Co.,16 B.T.A. 617">16 B.T.A. 617, 621 (1929); Cheatham Electric Switching Device Co.,1 B.T.A. 984">1 B.T.A. 984, 988 (1925). At trial Johnston cited an example in which a 10-percent royalty was paid for the rights to a patented invention. However, the example chosen involved a very sophisticated invention in the electronics industry the sales of which yielded a 40-percent net profit before taxes. Obviously, petitioner's patents, design and mechanical, relating to hose nozzles and sprayers, do465 not compare favorably with such highly sophisticated electronic devices. 21However, the royalty rates applied by Burns were too low. In most instances weighing heavily in his selection of appropriate rates was his opinion that the validity of a number of the patents was open to serious question. We believe this was an erroneous guide for choosing an appropriate royalty rate. In cases wherein the value of patents was sought to be determined courts have generally reacted negatively to evidence or opinions of their invalidity in the absence of evidence of infringement litigation. In the case of B.F. Sturtevant Co. v. United States,18 F. Supp. 28">18 F. Supp. 28, 33-34 (D. Mass. 1937), the court refused to receive evidence, similar to that cited by Burns as support for his opinion, as to the validity of patents, on the grounds that such466 evidence was immaterial. In Joseph H. Adams,23 B.T.A. 71">23 B.T.A. 71, 103 (1931), we rejected a similar attack on certain patent applications indicating that " * * we must accept the patents as valid * * " and that a " * * collateral attack may not be made in this proceeding upon the action of the Patent Office * * ." And in Syracuse Food Products Corporation,21 B.T.A. 865">21 B.T.A. 865, 885 (1930), we rejected one expert's valuation as too low because it was based upon his opinion that the patents under consideration therein were invalid. We explained: "We have no reason to believe that the question of doubtful validity would have been present in the mind of a prospective purchaser of these patents to any greater degree than might be reasonably anticipated in any ordinary case of a purchase and sale of patents." Cf. Zouri Drawn Metals Co.,8 B.T.A. 853">8 B.T.A. 853, 855 (1927); and Van Kannel Revolving Door Co.,11 B.T.A. 1209">11 B.T.A. 1209, 1213 (1928). With respect to the projections made by the expert witnesses of the average estimated future sales attributable to the patents, once again Johnston was overly optimistic and Burns unduly pessimistic. As467 pointed out in our earlier criticism, the so-called historical sales figures of patented products were somewhat suspect and that must be taken into account in determining a reasonable estimate. Additionally, we think unrealistic an assumption that sales of patented products such as these will grow by 12-1/2 percent each year over the patents' remaining lives as Johnston has assumed. Although Gilmour Co.'s average growth rate for all sales was 11-1/2 to 12-1/2 percent during the 5-year period immediately preceding March 31, 1970, i.e., 1965-1969, we believe it more reasonable to presume that the sales of inexpensive items covered only by improvement patents would be more likely to decline towards the end of the patents' legal lives, especially where, as here, fierce competition exists and is likely to increase, and that this fact should not be overlooked in making a valuation determination. Also Johnston's projection gave no recognition to the effect Gilmour Co.'s tradename, "Hosemaster" and its place in the market might have had on sales of the patented items. On the other hand, Burns, in his valuations simply rejects the sales figures used by Johnston and arbitrarily selected468 much lower amounts. Even though we have criticized the source of the sales figures Johnston used, there was credible testimony at trial supporting the fact that Gilmour enjoyed substantial sales of its patented products.And it is clear that Gilmour Co. had considerable overall sales and was a profitable enterprise; Burns' determination did not give sufficient weight to these facts. Burns was correct in focusing attention to the competition that petitioner would face in marketing its patented products. Nevertheless, the fact is that the competition which Burns cited had existed prior to March 31, 1970, and yet Gilmour still enjoyed considerable sales success. Consequently, we believe Burns overemphasized the effect of petitioner's competition. We also believe that the effect upon Burns' opinion as to the validity of the various patents was pervasive in his evaluations and have taken this into consideration. There is one other factor which we believe has some unquantifiable degree of significance in evaluating these patents: The fair market values determined by Burns were gross amounts, 22 i.e., not reduced to current cash values, and yet respondent, while using the method of469 projecting estimated earnings over the lives of the patents to establish accurate values, a method which is meaningless unless the gross amounts are reduced to current values, urges us to sustain these gross amounts. We believe implicit in this situation is the fact that respondent recognizes the potential for error in his determination and that such error has been resolved in his favor. After giving careful consideration to testimony received, the valuation reports submitted, and the parties' arguments on brief, we have done the best we could to make a reasonable determination of the fair market value of the patents as of March 31, 1970, and, using the same approach used by Johnston and Burns, have computed an aggregate amount of $745,000, delineated as follows: Patent No.1 Pistol-grip nozzle$355,0002 Jet-speed nozzle11,0003 Thum-Trol nozzle25,0004 Sprayer220,0005 Dual-barrel spray head9,0006 Wave sprinkler125,000$745,000470 We do not understand respondent to contest the use of the respective remaining legal lives of the above patents, as of March 31, 1970, as their useful lives for purposes of amortization by petitioner and accordingly we so hold. To this point our discussion has not encompassed the valuation of the "carded nozzle packaging invention" received by petitioner from Gilmour Co. We have delayed such discussion until now because we believe that, by the nature of the subject matter, this asset should be considered separately from the patents. In the context of this proceeding the value of certain property is sought, as of March 31, 1970. Necessarily, the property rights under consideration must be examined as of that date. Under the facts herein, prior to its liquidation, Gilmour Co. did not possess any statutory patent rights with respect to the carded nozzle packaging process.Rather, as of March 31, 1970, Gilmour possessed and transferred to petitioner only a right, recognized under common law, to make, use, sell, and otherwise enjoy this invention. See Patterson v. Kentucky,97 U.S. 501">97 U.S. 501, 507 (1878). Therefore, we proceed to examine the evidence with respect to471 the value of this carded nozzle packaging invention with the understanding that as of March 31, 1970, the property right received by petitioner was the above-described common law inventor's right. Johnston determined that the fair market value of this invention was $130,000. He computed this amount on the basis of the expected labor cost savings to be realized over a 10-year period in packaging pistol-grip nozzles, and reduced the amount of the estimated savings to current cash value as of March 31, 1970. Burns determined a nominal value of $10,000 for this invention for the most part due to the numerous competitive packaging methods. Reasonably anticipated labor cost savings resulting from the implementation of a patented invention have been found to be an appropriate basis for determining a value for such an invention. Westclox Co. v. United States,37 F. 2d 191 (Ct. Cl. 1930). However, as that case points out the savings from which the value is determined is the amount of savings the petitioner will realize in comparison with the costs incurred by its competitors under the methods they use to package their products. See Westclox v. United States,supra at p. 195;472 cf. Keystone Steel & Wire Co.,supra at p. 621. Petitioner's valuation of this invention was not based upon comparative cost savings nor may it be safely assumed that petitioner's competitors used petitioner's old method for packaging their products or that they incurred the same labor costs as did petitioner. Nevertheless, we are of the opinion that this carded nozzle package developed by Gilmour Co. had inherent value to petitioner as of March 31, 1970.Not only did it save petitioner labor costs but it had a marketing appeal. By use of this device petitioner's products could be displayed on the sales floor in a manner that would permit potential customers to remove the product from the card to examine it and then to replace it without damage to the card. The competitive packages which employed either staples or plasticized coverings did not have this advantage.In 1970 Gilmour Co. had the going concern "know how" to utilize this device and whether it obtained a patent on the device or not would relate more to the length of time petitioner could enjoy the marketing advantage than its value to petitioner in 1970. Taking all factors into consideration, we find473 that the fair market value of the carded nozzle packaging invention as of March 31, 1970, was $125,000. Consideration of the proper period over which petitioner's basis in the invention may be amortized is a bit more complicated than that necessary with respect to the patents discussed supra, although neither party makes specific reference to this factor on brief. We recognize that it has been held that a patent application has no definite period of useful life and is not the proper subject of exhaustion, Hershey Manufacturing Co.,14 B.T.A. 867">14 B.T.A. 867, 873 (1928), affd. 43 F. 2d 298 (10th Cir. 1930), and that it can be argued that the life of a common-law inventor's property right is likewise indeterminable. However, we believe the carded nozzle invention had a limited life probably shorter than the life of most patents.As of 1970 we would accept Johnston's estimate of 10 years and hold that petitioner is entitled to a deduction for amortization of the value we have allocated to the invention based on a 10-year life. We make no determination with respect to the rate of amortization that would be applicable if the invention is patented. Having determined474 that the aggregate fair market value of the patents and invention received by petitioner from Gilmour Co. was $860,000 as of March 31, 1970, one further question remains with respect to the proper allocation of basis under section 334(b)(2). As discussed supra, section 334(b)(2) and the regulations thereunder require an allocation of petitioner's adjusted basis in the Gilmour Co. stock among all of the assets petitioner received in liquidation in accordance with their respective fair market values. As a result of the parties' stipulation and their respective concessions as to the tax liability of Gilmour Co. asserted against petitioner herein as transferee, the parties may compute the correct amount of petitioner's adjusted basis in the Gilmour Co. stock under the Rule 155 computations. The parties have stipulated the fair market values of all the tangible assets received by petitioner, and we have determined the fair market values of the patents and invention received. However, the sum of the fair market value of these assets clearly will be less than the amount of the adjusted basis when finally calculated and a controversy exists as to what this amount represents and475 as to how it is to be treated in this proceeding. Respondent contends that upon the liquidation of Gilmour Co. petitioner received valuable assets, in addition to the tangible assets and the patents and invention already enumerated, namely a trademark and goodwill. Respondent argues that the residual amount of petitioner's adjusted basis in the Gilmour stock not absorbed by the value of the patents and invention, the value of the tangible assets, and the amount of cash received in the liquidation is attributable to the value of said intangible assets in accordance with the so-called residual method of valuing goodwill. Petitioner vigorously contests respondent's position. Petitioner argues that although a trademark and certain assets, which have been recognized in the past as indicia of goodwill, were received from Gilmour, those assets were of nominal value only. And, although petitioner steadfastly maintains that we should sustain its asserted valuation of the patents and invention, petitioner belatedly argued that if we should decide that the fair market values of the patents and invention were of lesser amounts than petitioner has claimed, nevertheless, the value of the476 trademark and goodwill should not be determined under the residual method. Rather, petitioner urges, as best we can understand it, that a specific determination of the fair market value of the trademark and goodwill must be made, which petitioner maintains would leave a portion of petitioner's adjusted basis in Gilmour Co. stock to be reallocated among all of the liquidated assets in proportion to their respective fair market values. Notwithstanding its argument to the contrary, we find that upon the liquidation of Gilmour Co. petitioner received intangible assets of substantial value to which it erroneously failed to assign any portion of its basis, as adjusted, in the Gilmour stock. Consequently, we have no doubt that the amount of depreciation and amortization claimed by petitioner for the tax years in question was excessive. Furthermore, we hold that under the facts of this case the aggregate value of the previously unaccounted for intangible assets is to be determined under the residual method of valuation as argued by respondent. Not only do we find that the residual method of valuing those intangible assets is appropriate under the circumstances of this case, but we also477 believe that the evidence justifies the value that will be allocated to those assets under such method. As noted in our findings of fact, petitioner received in the liquidation an on-going profitable business that had been marketing lawn and garden equipment for a number of years under the name "Gilmour Manufacturing Co." and the tradename "Hosemaster." After the liquidation petitioner continued the same business in the same markets identifying its products by the names "Gilmour Manufacturing Co." and "Hosemaster." Despite Smith's testimony to the contrary, we believe it is obvious that those names and the products identified therewith were well and favorably known to the users of lawn and garden equipment and promoted sales of these products. It matters not whether petitioner sold its products through jobbers or direct to the consumers--the fact that sales to consumers were promoted by these names and the position of Gilmour Co. in the market would filter through the jobbers to constitute a valuable asset, goodwill, of Gilmour Co. which petitioner acquired and used.The fact that petitioner retained most of the customers of Gilmour Co. bolsters that conclusion, even though those478 customers were jobbers for the most part. Gilmour Co.'s marketing program for its products included the use of sales representatives in numerous States, in Canada, in Venezuela, and one representative for other countries.These representatives were responsible for ensuring that petitioner's products were carried by various jobbers and hundreds of retail outlets throughout the United States and elsewhere. To attribute the success of Gilmour to the patented products and ignore the effect of good management and a good marketing program is erroneous. As we commented in Cheatham Electric Switching Device Co.,1 B.T.A. 984">1 B.T.A. 984, 988 (1925): We are unable upon consideration of the evidence in this appeal to agree with the taxpayer that its earnings are and were attributable entirely to its patents. No one of its patents covered a basic principle, and other manufacturers were, and are, free to use the same principle used by Cheatham, so long as the devices manufactured by them do not infringe upon the Cheatham device. Other devices capable of performing the same service, but not infringing upon the Cheatham device, were produced, marketed, and placed in operation, and we479 therefore conclude that the taxpayer's earnings were not only due to the patents it owned, but largely to good management and the ability of its salesmen to market its product in the face of competition. See also Auto Specialties Manufacturing Co.,9 B.T.A. 455">9 B.T.A. 455, 458 (1927). Although the trademark, goodwill, and going-concern value acquired by petitioner are separately identifiable assets, they are all nondepreciable. Clarke v. Haberle Crystal Springs Brewing Co.,280 U.S. 384">280 U.S. 384 (1930); Norwich Pharmacalco.,30 B.T.A. 326">30 B.T.A. 326 (1934); Northern Natural Gas Co. v. United States,470 F. 2d 1107 (8th Cir. 1973), cert. denied 412 U.S. 939">412 U.S. 939 (1973); and sec. 1.167(a)-3, Income Tax Regs. Consequently, in the context of this case where we are seeking assets' fair market value for purposes of a section 334(b)(2) allocation, we see no need to determine separate values for these assets. Petitioner's argument that this case does not present an appropriate occasion to value these assets under the residual method is erroneous. Indeed, the facts of this case present the exact situation wherein the residual valuation method480 has been held to be applicable. Jack Daniel Distillery v. United States,379 F. 2d 569, 579 (Ct. Cl. 1967). In general terms, section 334(b)(2) attempts to equate a corporate acquisition of stock followed by a liquidation of the subsidiary with an outright acquisition of the underlying assets of such a corporation. Boise Cascade Corp. v. United States,288 F. Supp. 770">288 F. Supp. 770 (D. Idaho 1968), affd. per curiam 429 F. 2d 426 (9th Cir. 1970). Cf. Argus, Inc.,45 T.C. 63">45 T.C. 63 (1965); and Cabax Mills,59 T.C. 401">59 T.C. 401 (1972).23 The petitioner's basis as adjusted in the Gilmour Co. stock is the best evidence of the fair market value of the assets acquired.24This aggregate fair market value is fractionalized under the regulations, see sec. 1.334-1(c)(4)(viii), Income Tax Regs., and allocated among all of the assets acquired in liquidation. Since we have found that petitioner received the valuable nondepreciable intangible assets enumerated above and since the petitioner's basis, as adjusted, in the Gilmour Co. stock and the fair market values of all other assets acquired in the liquidation have been or may now be determined, 481 we hold that the value of the nondepreciable intangibles is to be determined under the residual valuation method. Jack Daniel Distillery v. United States,supra;Philadelphia Steel & Iron Corp. v. Commissioner,344 F. 2d 964 (3d Cir. 1965), affg. per curiam a Memorandum Opinion of this Court; Copperhead Coal Company v. Commissioner,272 F. 2d 45 (6th Cir. 1959), affg. a Memorandum Opinion of this Court; Florida Publishing Co.,64 T.C. 269">64 T.C. 269 (1975), on appeal (5th Cir. Aug. 21, 1975); see Saline Motor Co.,22 B.T.A. 874">22 B.T.A. 874 (1931); see Bittker & Eustice, Federal Income Taxation of Corporations and Shareholders, par. 11.45 at 11-44 (3d Ed. 1971). The final issue for decision is whether Gilmour Co. is liable for the addition to tax under section 6653(a) for the taxable period July 1, 1967 to March 31, 1970. The final corporate tax return for Gilmour Co. failed to include the income realized under section 1245, from recapture of the depreciation previously taken with482 respect to certain assets which were distributed to petitioner in the liquidation of Gilmour Co. R. M. Smith prepared and filed Gilmour Co.'s final return; Smith signed the return in his capacity as president of Gilmour Co. and also signed the name of his accounting firm, Smith & Martin, as preparer. Respondent determined that the failure of Gilmour Co. to report the income from depreciation recapture was due to negligence or intentional disregard of rules and regulations. Section 6653(a)25 imposes an addition to tax in an amount equal to 5 percent of the underpayment if any part thereof is due to negligence or intentional disregard of rules and regulations. The taxpayer has the burden of proving that the assertion of the section 6653(a) addition to tax is erroneous. David Courtney,28 T.C. 658">28 T.C. 658, 669 (1957). Petitioner makes two arguments against imposing the section 6653(a) addition to tax: (1) Since the recapture provisions do not normally apply to nontaxable transactions such as a section 332 liquidation, applying normal tax reasoning one would conclude that section 1245 was inapplicable under the facts at bar because such a tax would be borne by a corporate483 owner who did not receive the benefit of the deduction; (2) as a CAP, Smith was sufficiently aware of Internal Revenue Service procedures to know that the final tax return of Gilmour as well as petitioner's initial return filed subsequent to the Gilmour liquidation would both be audited as a matter of course so that technical compliance with all provisions would be expected.Petitioner's arguments are without merit. Smith carried on a full-time accounting practice through April 15, 1970, and in his capacity as a CPA had experience with the recapture provisions of the Code. He had prepared the returns for Gilmour Co. on which the accelerated depreciation was claimed. Furthermore, 484 the only evidence offered to explain the failure to report the depreciation recapture on Gilmour Co.'s final return was Smith's testimony that the return was hastily prepared. Gilmour Co. cannot thus escape responsibility for its duty to file accurate tax returns. See Vern W. Bailey,21 T.C. 678">21 T.C. 678, 687 (1954).Under the facts of this case such a statement itself may prove negligence. 26 See Marcello v. Commissioner,380 F. 2d 499, 506 (5th Cir. 1967), affg. in part and remanding in part a Memorandum Opinion of this Court. At any rate, petitioner has clearly failed to meet its burden of proof on this issue. See David Courtney,supra, and Gavin S. Millar, 67 T.C. (Jan. 10, 1977), and we hold for respondent on this issue. Decision will be entered under Rule 155. Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended, unless otherwise stated.↩2. Petitioner conceded the deficiency in corporate income tax of Gilmour Manufacturing Co. and that it was liable for the deficiency as transferee.↩3. The question as to whether petitioner received goodwill from Gilmour Co. upon its liquidation is discussed infra.↩ It should be noted, however, that petitioner has taken the position on its returns, at trial, and on brief that it received no goodwill from Gilmour Co. 4. The total cost for the intangible assets reflected on Gilmour Co.'s books was $10,000 which it had paid for a patent.↩5. Respondent, since trial, has taken the position that the aggregate value of the patents and invention for purposes of amortization is no more than $434,647. See discussion infra.↩ Respondent's theory is that the excess of the purchase price of the stock over the stipulated values of the tangible assets and the values he allocates to the patents received by petitioner on liquidation of Gilmour Co. should be allocated to "residual goodwill." Petitioner takes the position that the excess of the purchase price of the stock over the stipulated value of the tangible assets should be allocated to the patents or other depreciable assets, that the trademark and Gilmour name had no value, and that the Gilmour Co. had no goodwill of value to petitioner.6. Under sec. 334(b)(2) and the pertinent regulations the total combined amount of a parent's basis in all of the assets received from the subsidiary in liquidation is the parent's adjusted basis, as further adjusted, in the stock of the subsidiary. ↩7. GILMOUR MANUFACTURING COMPANYPATENTSJanuary 31, 1970PERIODVALUEPATENT #DESCRIPTIONISSUEEXPIRESCATALOG #PER UNIT1. Des 194,014Hose nozzle11-6-6211-6-76562,563.01-1/2all nozzlesfor sprayers2. 3,045,927Spray nozzle7-24-627-24-79520.01Des 189,411Spray nozzle12-6-6012-6-74520.005666,308Spray nozzle7-9-637-9-83See #(Canadian)(jet speed3,045,927nozzle)above3. RE 26,013Hose nozzle1-8-631-8-80TT 65.25(thum trol)Des 202,686Hose nozzle10-26-6510-26-79TT 65(thum trol)4. 3,191,869Spraying de-6-29-656-29-823621.25(2,754,152vice havingalso pro-restrictedtects #362)oriface &expansionchamberconstruction3,112,884Spraying de-12-3-6312-3-80not beingvicemfg'd3,090,564Spraying de-5-21-635-21-80484 pro-1.252,788,245 vice with di-tected by2,788,244 lution controlthis patent5. 3,207,443Dual spray9-21-659-21-8262,62S1.50head having vent62SHcontrol means6. 3,498,543Wave sprink-3-3-703-3-873000 plus2.00lerothers laterInventionCarded nozzlenonenoneall nozzles.006packaging(Machine)Total↩Est. SalesValueRemainingTotal$ ValuePer YearPer YearLife Yrs.$ ValueAllocated1. Des 194,0142000M30,0006-8/12202,500145,000.002. 3,045,927350003509-4/123,3253,000.00Des 189,411350001754-8/12846392.53666,308(Canadian)3. RE 26,01350M10,0009-9/12123,95990,000.00Des 202,6864. 3,191,86950M62,50012-3/12776,042560,000.00(2,754,152also pro-tects #3623,112,8843,090,56450M62,50010-4/12645,833465,000.002,788,2452,788,2445. 3,207,4434M4,50012-6/1276,00055,000.006. 3,498,54315M30,00016-11/12510,000365,000.00Invention2000M12,00017204,000150,000.00Total212,0252,542,5051,833,392.538. There is no evidence refining or explaining what is included in the vague notion of Gilmour Co.'s "sales history." It appears that records of actual total sales of all products manufactured by Gilmour Co. for at least a 5-year period were avail1ble and may have been used by Smith. It is not clear whether complete production and sales records for each product manufactured under patent were available but it is clear that no such records were used by Smith in making his valuation.↩9. Smith used a 17-year useful life as the factor in computing the value for the card-packaging invention. This figure was presumably used because at the time of the stock purchase Smith contemplated patenting this invention; in fact a patent was obtained in 1972.↩10. The records of Gilmour Co.'s sales used by Johnston were those of total sales of all products, both patented and nonpatented; he used no records which identified sales of individual products manufactured, see fn.8, p.18, supra↩. None of the records of Gilmour Co. were offered in evidence. 11. Hoskhold's formula is a sinking fund method of valuation by which the taxpayer receives an assumed specified rate of interest on his capital (the present worth of estimated future earnings), and the capital is returned to the taxpayer by annual payments to a sinking fund accumulated at 4 percent interest, compounded annually. Hoskhold, Engineer's Valuing Assistant, 2d Ed. London, 1905.↩12. A patent was issued on the package in 1972.↩13. This includes $392.53 for the value of Design Patent 189,411↩ - Spray Nozzle, about which we have no evidence and neither Johnston nor Burns appeaised.14. Since respondent appears to have conceded all issues which were dependent upon whether the transaction between Smith and Gilmour was effective as of January 31, 1970, or March 31, 1970, we find no need for us to determine the effective date.↩15. 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.↩16. SEC. 334. * * * (b) Liquidation of Subsidiary.-- * * *(2) Exception.--If property is received by a corporation in a distribution in complete liquidation of another corporation (within the meaning of section 332(b)), and if-- (A) the distribution is pursuant to a plan of liquidation adopted-- (i) on or after June 22, 1954, and (ii) not more than 2 years after the date of the transaction described in subparagraph (B) (or, in the case of a series of transactions, the date of the last such transaction); and (B) stock of the distributing corporation possessing at least 80 percent of the total combined voting power of all classes of stock entitled to vote, and at least 80 percent of the total number of shares of all other classes of stock (except nonvoting stock which is limited and preferred as to dividends), was acquired by the distributee by purchase (as defined in paragraph (3) during a 12-month period beginning with the earlier of, (i) the date of the first acquisition by purchase of such stock, or (ii) if any of such stock was acquired in an acquisition which is a purchase within the meaning of the second sentence of paragraph (3), the date on which the distributee is first considered under section 318(a) as owning stock owned by the corporation from which such acquisition was made, then the basis of the property in the hands of the distributee shall be the adjusted basis of the stock with respect to which the distribution was made. For purposes of the preceding sentence, under regulations prescribed by the Secretary or his delegate, proper adjustment in the adjusted basis of any stock shall be made for any distribution made to the distributee with respect to such stock before the adoption of the plan of liquidation, for any money received, for any liabilities assumed or subject to which the property was received, and for other items. ↩17. Sec. 1.334-1(c)(4)(v), Income Tax Regs.↩, specifies the adjustments which are to be made to the petitioner's adjusted basis of the subsidiary's stock which include, in addition to those for cash and liabilities indicated in the text above, certain adjustments on account of the earnings and profits, or deficit thereof, realized by Gilmour during the period beginning February 1, 1970 through March 31, 1970. We received no evidence in this respect but any necessary adjustment can be made by the parties in the Rule 155 computation.18. Although Burns did not actually use the same figures as Johnston in making his determinations, the figures that he did use were not the result of independent research. The sales figures used by Burns in his calculations were the result of his rejection of the figures used by Johnston as unrealistic, followed by Burns' rather arbitrary selection of other amounts. ↩19. Although respondent, on brief, challenges the credibility of Johnston's evaluation on this basis, he cannot escape some responsibility for the lack of reliable data when, as it appears herein, he made no effort through means of discovery, to acquire Gilmour's production records. This is not a situation where respondent can rely upon the burden which falls on petitioner because respondent's determinations are presumptively correct.↩20. As indicated in our findings, see p. 15, supra.↩Smith used a different method to evaluate two of the patents. However, it is quite obvious that such method was no better than that rejected in the text above.21. We note that in Sec. 9 of the consulting agreement between petitioner and Gilmour it was provided that if Gilmour developed any product which may be patented, "he shall offer the same to the Company for a royalty equal to one and one-half per cent of the net sales by the Company of such patentable products over the life of the patent."↩22. Burns did indicate in his valuation report that reduced to terms of current cash value as of March 31, 1970, his aggregate determined fair market value of the patents and invention would be approximately $350,000.↩23. See also Moss American, Inc.,T.C. Memo. 1974-252↩. 24. Moss American, Inc.,supra.↩25. SEC. 6653. FAILURE TO PAY TAX. (a) Negligence or Intentional Disregard of Rules and Regulations With Respect to Income or Gift Taxes.--If any part of any underpayment (as defined in subsection (c)(1)) of any tax imposed by subtitle A or by chapter 12 of subtitle B e8relating to income taxes and gift taxes) is due to negligence or intentional disregard of rules and regulations (but without intent to defraud), there shall be added to the tax an amount equal to 5 percent of the underpayment.↩26. See also James J. Arditto,T.C. Memo. 1971-210↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623534/	ADA ORTHOPEDIC, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentAda Orthopedic, Inc. v. CommissionerDocket No. 14112-93RUnited States Tax CourtT.C. Memo 1994-606; 1994 Tax Ct. Memo LEXIS 614; 68 T.C.M. (CCH) 1392; December 12, 1994, Filed 614 Decision will be entered for respondent. For petitioner: Clarke L. Randall and James W. Bruce. For respondent: C. Glenn McLoughlin. RAUMRAUMMEMORANDUM OPINION RAUM, Judge: This case involves the revocation of a prior favorable determination regarding the qualification of petitioner's defined benefit pension plan under section 401(a)1 for the plan year ending June 30, 1986, and all subsequent years. The revocation letter was based on a determination that the pension plan was not managed for the exclusive benefit of the employees as required by section 401(a)(2). The case is before us on a petition for a declaratory judgment under section 7476 and Rule 217. The parties filed a joint stipulation as to the completeness and correctness of the administrative record, and submitted the case for determination under Rule 122. 615 Petitioner, Ada Orthopedic, Inc., is a professional corporation organized and existing under the laws of the State of Oklahoma. Petitioner had its principal place of business in Ada, Oklahoma, at the time of the filing of its petition. On November 30, 1978, petitioner adopted the Ada Orthopedic Inc. Defined Benefit Pension Plan (the Plan) to be a qualified plan under section 401(a). On June 29, 1983, petitioner amended the Plan, effective July 1, 1983, (First Amendment) to comply with the provisions of the Tax Equity and Fiscal Responsibility Act of 1982, Pub. L. 97-248, 96 Stat. 324. On December 31, 1986, petitioner again amended the Plan, effective July 1, 1984, (Second Amendment) to comply with the provisions of the Tax Reform Act of 1984, Pub. L. 98-369, 98 Stat. 494, and the provisions of the Retirement Equity Act of 1984, Pub. L. 98-397, 98 Stat. 1426. On September 18, 1987, the District Director for the district in which the petitioner is located issued a favorable determination letter to petitioner regarding the Plan. The determination letter found that the Plan satisfied the qualification requirements of section 401(a). The September 18, 1987, determination letter616 specifically stated: Continued qualification of the plan will depend on its effect in operation under its present form. (See section 1.401-1(b)(3) of the Income Tax Regulations.) The status of the plan in operation will be reviewed periodically.An examination of the Plan's plan year ended June 30, 1986, was commenced on April 6, 1989. On August 1, 1990, the examination was expanded to include the plan years ended June 30, 1987, June 30, 1988, and June 30, 1989. On April 8, 1993, a final revocation letter was issued to petitioner, determining that the Plan failed to meet the section 401(a) requirements for the plan year ended June 30, 1986, and all subsequent years. The final revocation letter also retroactively revoked the September 18, 1987, favorable determination letter. Prior to filing the petition in this case, petitioner exhausted the administrative remedies within the Internal Revenue Service in accordance with section 7476(b)(3). Petitioner has complied with the requirements of the regulations issued under section 7476(b)(2) with respect to the notice to other interested parties. The Plan's trustees for the plan years at issue were Dr. Jack B. Howard and Robert617 D. McDougal. Dr. Howard is the sole shareholder of petitioner and was, during all periods at issue, a participant in the Plan. The Plan had six participants during the plan year ended June 30, 1986, eight participants during the plan year ended June 30, 1987, and seven participants during the plan years ended June 30, 1988, and June 30, 1989. The terms of the Plan allowed loans to participants, subject to specific requirements. The applicable provisions under the First Amendment (effective from July 1, 1983, to June 30, 1984) governing such loans were found at paragraph 3.5. The applicable provisions under the Second Amendment (effective from July 1, 1984) governing such loans were found at paragraph 15.16. On July 14, 1983, Dr. Howard borrowed $ 50,000 from the Plan. The record contains no evidence of either a promissory note signed by Dr. Howard documenting the loan or of a security agreement for the loan as required by Plan section 3.5(c) (as then in effect). There is no evidence in the record that Dr. Howard made written application for the loan to the Plan as required by Plan section 3.5(a) (as then in effect). For these reasons, the July 14, 1983, loan to Dr. Howard618 violated the Plan participant loan provisions. Dr. Howard repaid the July 14, 1983, unsecured loan in four unequal payments, with the last payment occurring on January 17, 1986. Between October 24, 1985, and March 10, 1986, Dr. Howard borrowed an additional $ 26,150 from the Plan. 2 There is no evidence in the record that Dr. Howard signed promissory notes for the loans or gave the Plan any security for the loans, as required by Plan section 15.16(b). There is no evidence in the record that a repayment period of 5 years or less was included in the terms of the loan, as required by Plan section 15.16(a) (for loans made after August 13, 1982). Dr. Howard made the following payments on these later loans: Payment DateAmount3/14/86$ 4,00012/8/86$ 7,500Dr. Howard made no additional payments of principal or interest on these later loans between December 1986 and April 1991. For these reasons, the loans made to Dr. Howard between October 24, 1985, and March 10, 1986, violated the Plan participant loan provisions. 619 For the first time, on January 10, 1992, Dr. Howard executed a promissory note to the Plan covering his liability for the later loans. The promissory note was in the amount of $ 20,335.88 and bore interest at a rate of 10 percent per annum. The promissory note was payable within 5 years and was secured by Dr. Howard's pledge (with spousal consent) of his vested pension benefit. On September 15, 1984, Gary P. Freeland, a plan participant, borrowed $ 10,000 from the Plan. Mr. Freeland signed a promissory note documenting the loan, but did not give the Plan any security for the loan, as required by Plan section 15.16(b). The loan was payable on demand, or no later than October 15, 1990, a repayment period (6 years) that violated the 5-year requirement of Plan section 15.16(a) (for loans made after August 13, 1982). Mr. Freeland made no payments of principal or interest on the $ 10,000 loan from the Plan. For the reasons outlined above, the September 15, 1984, loan to Mr. Freeland violated the Plan participant loan provisions. On March 22, 1985, Delores McDonald, a plan participant, borrowed $ 5,000 from the Plan. Ms. McDonald signed a promissory note documenting the loan, but620 did not give the Plan any security for the loan, as required by Plan section 15.16(b). The loan was payable on demand or no later than March 22, 1990. Ms. McDonald made regular payments of principal and interest on the $ 5,000 loan from the Plan. The March 22, 1985, loan to Ms. McDonald violated the Plan participant loan provisions (then in effect), since Ms. McDonald failed to provide any security for repayment of the loan. During the period from October 7, 1983, through March 8, 1988, the Plan also made a significant number of loans to individuals who were not plan participants. On October 7, 1983, the Plan loaned $ 35,000 to Lynwood Read. Mr. Read is a friend of Mr. McDougal, one of the Plan trustees, but has no personal or professional relationship with Dr. Howard. Mr. Read signed a promissory note documenting the $ 35,000 loan, but did not give the Plan any security for the loan. The loan was payable in installments through June 30, 1988. Mr. Read made no payments of principal or interest on the $ 35,000 loan. There is no evidence in the record that the Plan took any action to enforce the terms of Mr. Read's installment note. Contrary to the terms of Mr. Read's promissory621 note, there was an oral agreement between Dr. Howard and Mr. Read that no payments would be due on the note until Mr. Read sold certain Nevada investment property. On June 3, 1985, the Plan loaned $ 5,000 to William H. Lee. Mr. Lee is Dr. Howard's cousin and has been involved with Dr. and Mrs. Howard in numerous financial dealings over the years. Although Mr. Lee claims to have signed a promissory note documenting the $ 5,000 loan, the Plan was unable to supply a copy of the note. The $ 5,000 loan to Mr. Lee was payable on demand and Mr. Lee did not give the Plan any security for the loan. Mr. Lee made no payments of principal or interest on the $ 5,000 loan. On November 27, 1985, the Plan loaned $ 32,500 to I. J. Newlin, Jr. Mr. Newlin is Dr. Howard's uncle and has been involved with Dr. and Mrs. Howard in numerous financial dealings over the years. Although Mr. Newlin claims to have signed a promissory note documenting the $ 32,500 loan, the Plan was unable to supply a copy of the note. The $ 32,500 loan to Mr. Newlin was payable on demand. Mr. Newlin did not give the Plan any security for the loan. Mr. Newlin made no payments of principal or interest on the $ 32,500 622 loan. Despite Mr. Newlin's failure to make any payments on the foregoing loan, the Plan loaned an additional $ 60,000 to him and his wife on March 8, 1988. Mr. and Mrs. Newlin signed a promissory note documenting the $ 60,000 loan. The $ 60,000 loan to the Newlins was payable on demand and the Newlins did not give the Plan any security for the loan. Petitioner provided the funds for the Newlins' $ 60,000 loan by making a $ 60,000 contribution to the Plan on March 8, 1988. The Plan immediately disbursed the funds on March 8, 1988, to the Newlins. The Newlins made no payments of principal or interest on the $ 60,000 loan. Mr. Newlin is now dead, and the Plan has supplied no supporting documentation showing that claims were filed against Mr. Newlin's estate. On July 20, 1979, the Plan purchased a 2-acre undeveloped tract of real estate in Wagoner County, Oklahoma, from Financial Analysts, Inc. On August 12, 1980, the Plan purchased another one-half acre undeveloped tract of real estate in Wagoner County, Oklahoma, from Financial Analysts, Inc. The deeds to the two properties indicate that the Plan paid an aggregate of $ 23,402 for the properties, but the Plan's books reflected623 an aggregate cost of $ 18,000 for the properties. The Plan did not obtain warranty deeds for the properties, warranting the transfer of fee simple title to the properties, free and clear of encumbrances. Instead, the Plan obtained only quitclaim deeds conveying whatever right, title, and interest Financial Analysts, Inc., had in the properties. The Plan did not record its interests in either of the two properties under the quitclaim deeds by filing the deeds with the Wagoner County Clerk. There is no evidence in the record that the Plan took any action (by obtaining a title opinion or a title insurance policy) to confirm that it was obtaining fee simple title to the properties, free and clear of encumbrances, or that it received any marketable interest whatsoever. At the time the Plan acquired the Wagoner County properties, there was a preexisting $ 164,000 purchase money mortgage covering the two tracts, as well as adjoining tracts owned by other unrelated parties. Financial Analysts, Inc., executed the mortgage when it acquired the entire 80-acre property, including the Plan's two tracts. In June 1988, the $ 164,000 purchase money mortgage was foreclosed on the entire 80-acre624 property, including the two tracts owned by the Plan. The mortgage holders obtained the property through the foreclosure and extinguished the rights in the property of all named defendants (including Financial Analysts, Inc.) and all others claiming rights in the property through those defendants. The Plan was not named a party to the foreclosure proceeding, since the quitclaim deeds from Financial Analysts, Inc., had not been filed with the Wagoner County Clerk. However, the Plan's investment in the Wagoner County property became worthless following the foreclosure. As the lawyer for the Plan wrote in a letter to Dr. Howard dated February 6, 1990, "At this point, there does not appear to be any chance of recovering the investment made in the above [referenced] property, and it is my opinion that you should no longer consider it to be an asset of the pension trust." In the late 1970s the Plan acquired three loose diamonds which were valued in 1979 as follows: .57 Carat (VS2-F)$ 1,710.50 Carat (VS1-F)$ 1,8002.03 Carat (SI-J)$ 12,180The Plan maintained the two small diamonds in a safe deposit box at Citizens Bank & Trust Co., Ada, Oklahoma. In a letter dated625 July 7, 1989, Dr. Howard told the examiner that the larger diamond was being held at the Financial Analysts, Inc., office for possible sale in the future. In an August 21, 1989, letter, the Plan's counsel told Dr. Howard that neither Financial Analysts, Inc., nor its owner, Frank Goins, could be located. There is no evidence as to when the Plan consigned the large diamond to Financial Analysts, Inc. There is no evidence the Plan took any action to monitor the whereabouts of the large diamond or the marketing efforts of Financial Analysts, Inc. The whereabouts of the large diamond is unknown, and, as the Plan's lawyer wrote in a letter to the IRS dated February 28, 1991, "it appears that * * * [Financial Analysts, Inc.] has embezzled or otherwise converted this Plan asset." There is no evidence in the record that the Plan sought to guard against the loss of the large diamond by insuring it or otherwise protecting its investment. In 1983, the Plan purchased a 16.5-percent interest in the Sandy Creek Partnership I (the partnership), a general partnership in the business of promoting, showing, training and breeding purebred Arabian horses. The partnership's principal place of business626 is Route 6, Box 328, Ada, Oklahoma 74820. J & L Farms, another entity wholly owned by Dr. and Mrs. Howard, is also located at Route 6, Box 328, Ada, Oklahoma 74820. Dr. and Mrs. Howard owned a 16.5-percent interest in the partnership. Dr. Howard's uncle, I. J. Newlin, and Mr. Newlin's wife owned a 33-percent interest in the partnership. The Plan made the following capital contributions to the partnership between 1983 and 1989: 1983$ 13,5001984$ 13,5001985$ 18,0001986$ 3,5001987$ 3,5591988$ 1,5001989$ 900Total$ 54,459The financial projections provided by the Plan for the partnership forecasted losses in the first 4-5 years, with a large capital gain in the final year of projection. 3 While such a device is typically used to shelter ordinary income from income taxes, no reason was given, and none appears to exist, why trust fund assets believed to be exempt from Federal taxation would be invested in a loss generating partnership. The only reasonable explanation for this Plan investment would appear to be a decision to use the Plan assets as a source of capital for an enterprise otherwise dominated by Dr. and Mrs. Howard and Mr. and Mrs. 627 Newlin. The only operating assets owned by the partnership were a number of horses purchased in 1983 for $ 60,000. The Plan received no distributions, in cash or in kind, from the partnership from 1986 through 1989, and there is no evidence the Plan received any distributions at any time prior to 1986. There is no evidence the partnership generated any gross income at any time. The partnership consistently had a negative cash flow from operations since its commencement in 1983. On 628 August 29, 1986, the Plan disbursed $ 1,500 to Betsy Jackson, who was not a plan participant. The Plan provided no explanation for this payment, and there is no evidence the $ 1,500 was repaid to the Plan. On August 30, 1986, and October 1, 1986, the Plan disbursed $ 8,000 and $ 4,000, respectively, to J & L Farms, an entity owned by Dr. and Mrs. Howard. 4 The Plan provided no explanation for these payments, and there is no evidence the $ 12,000 was repaid to the Plan. The Commissioner determined that the administration of the Plan violated the exclusive benefit rule of section 401(a). Following that determination the qualified status of the Plan was revoked as to the plan year ending June 30, 1986, and all years thereafter. Section 401(a) provides in part: (a) REQUIREMENTS FOR QUALIFICATION. -- A trust created or organized in the United States and forming part of a stock bonus, 629 pension, or profit-sharing plan of an employer for the exclusive benefit of his employees or their beneficiaries shall constitute a qualified trust under this section -- * * * (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 * * Section 1.401-1(b)(3), Income Tax Regs., states: All of the surrounding and attendant circumstances and the details of the plan will be indicative of whether it is a bona fide stock bonus, pension, or profit-sharing plan for the exclusive benefit of employees in general. The law is concerned not only with the form of a plan but also with its effects in operation. * See also Winger's Dept. Store, Inc. v. Commissioner, 82 T.C. 869">82 T.C. 869, 876 (1984); Quality Brands, Inc. v. Commissioner, 67 T.C. 167">67 T.C. 167, 174 (1976). In the present case there is no question that630 the Plan's documents were in proper form, the question is whether the operation of the Plan was such that the exclusive benefit rule of section 401(a) was violated. We must decide whether the investment practices of the Plan were so antithetical to the Plan purpose as to violate the exclusive benefit rule. The Internal Revenue Code and the income tax regulations do not specifically describe what types of investments will meet the exclusive benefit rule. Section 1.401-1(b)(5)(i), Income Tax Regs., states in part: No specific limitations are provided in section 401(a) with respect to investments which may be made by the trustees of a trust qualifying under section 401(a). Generally, the contributions may be used by the trustees to purchase any investments permitted by the trust agreement to the extent allowed by local law. * * However, Rev. Rul. 69-494, 2 C.B. 88">1969-2 C.B. 88, sets forth four criteria in respect of employer security investments for compliance with the statute. These are (1) the cost must not exceed fair market value at the time of purchase; (2) a fair return commensurate with the prevailing rate must be provided; (3) 631 sufficient liquidity must be maintained to permit distributions in accordance with the terms of the plan; and (4) the safeguards and diversity that a prudent investor would adhere to must be present. The reasoning of Rev. Rul. 69-494 has been extended to investments not involving employer securities. See Rev. Rul. 73-532, 2 C.B. 128">1973-2 C.B. 128. Although this Court has held that these conditions are not necessarily binding, Winger's Dept. Store, Inc. v. Commissioner, supra at 882; Shelby U.S. Distribs. v. Commissioner, 71 T.C. 874">71 T.C. 874, 882 (1979), they are nevertheless persuasive guidelines as to the congressionally intended requirements. Cf. Central Motor Co. v. United States, 583 F.2d 470">583 F.2d 470, 490 (10th Cir. 1978), revg. in part and affg. on this issue 454 F. Supp. 54">454 F. Supp. 54 (D. N.M. 1976). Prior decisions dealing with the exclusive benefit rule and plan disqualification were discussed in Winger's Dept. Store, Inc. v. Commissioner, supra.No bright line test632 was stated in Winger's or the other cases where exclusive benefit rule violations were found, Central Motor Co. v. United States, supra, Ma-Tran Corp. v. Commissioner, 70 T.C. 158">70 T.C. 158 (1978), Feroleto Steel Co. v. Commissioner, 69 T.C. 97">69 T.C. 97 (1977). It is clear that each case must be decided on its own facts. In Winger's Dept. Store, Inc. v. Commissioner, supra at 887, the decision was "based on a totality of the transgressions". See also Feroleto Steel Co. v. Commissioner, supra at 113 ("In these circumstances, we hold that the exclusive benefit rule has not been followed."). Our examination of the facts of this case leaves no doubt that the Plan was not managed for the exclusive benefit of the employees. While the detailed facts of this case are not identical with those in Winger's, the ultimate thrust of Winger's is equally applicable here. The plans in both cases were not managed for the exclusive benefit of the employees, in violation of section 401(a). All of the investments described above showed an633 indifference towards the continued well-being of the plan participants. The Plan was needlessly subjected to an increased risk of loss because of the poor way that its assets were managed. The Plan made substantial unsecured loans both to plan participants and to non-participants. Each of the participant loans violated the terms of the Plan in effect at the time of the loan transaction. The fact that all of the loans were unsecured is significant. We note that in Winger's Dept. Store, Inc. v. Commissioner, supra at 882-883, and Central Motor Co. v. United States, supra at 491, the lack of adequate security for the loans made was noted as evidence of exclusive benefit rule violations, while in Shelby U.S. Distribs. v. Commissioner, supra at 884, the fact that the loans were secured was noted as evidence against an exclusive benefit rule violation. In our opinion, the lending of a large portion 5 of the Plan's assets through unsecured loans, the making of participant loans in violation of the terms of the Plan, the failure to pursue delinquent payments owed the Plan, and the634 oral agreement between Dr. Howard and Mr. Read combine to prove the Plan was not managed for the exclusive benefit of the employees, but for the equal or greater benefit of those who borrowed from the Plan. The Plan was used as a personal bank by Dr. Howard, his family, and selected others, for loans that were made without regard to risk or in at least one case prior repayment history. These facts alone would support the Commissioner's disqualification of the Plan. These do not, however, represent the full extent of the Plan's violations. 635 The Plan's investment in the Wagoner County land, the management of the large diamond, and the investment in the partnership further support our finding as to violations of the exclusive benefit rule. The Plan purchased quitclaim deeds without investigating the state of the title in the land or obtaining title insurance. The use of Plan assets for such an investment is so far removed from any reasonable standard of management that the trustees should have known that they were putting the Plan's assets at risk. Subsequent events only proved what should have been clear from the beginning; these misguided land purchases conferred a benefit on the seller at the expense of the Plan participants. The large diamond was entrusted to Financial Analysts, Inc., for possible sale. By turning a physical asset over to a third party and then failing to monitor that asset or protect its value through insurance or any other means, the Plan needlessly subjected itself to an unnecessary risk of loss. This is but another example of how the Plan was not managed for the exclusive benefit of the employees, but was managed in a way that substantial benefits were sure to accrue outside of the Plan. 636 6The Plan investment in the partnership is, perhaps, the most troubling of the exclusive benefit rule violations. As noted above, the financial projections included in the record 7 forecasted a series of losses before significant capital gains were to be realized through the sale of horses. In our opinion, the investment of qualified plan assets in such a tax shelter is clearly improper. We agree with the Commissioner's assertion that the Plan investment in the partnership served only as a source of capital to an enterprise otherwise controlled by Dr. Howard, Mr. Newlin, and their respective spouses. Such a use of funds to benefit a Plan participant who is also a trustee and the sole shareholder of the Plan sponsor is a clear violation of the exclusive benefit rule. 637 The Commissioner's examination discovered three other transactions which violated the exclusive benefit rule. These were the August 29, 1986, payment to Betsy Jackson and the payments on August 30 and October 1, 1986, to J & L Farms. There is no evidence that these payments were loans or that the amounts have been repaid. We hardly need to pause to state that unexplained payments to third parties (one of which is controlled by a Plan trustee who is the sole shareholder of the Plan sponsor) violate the Code's mandate that the Plan's funds be used for the exclusive benefit of the employees. Having described the way in which the Plan assets were managed and how the benefits of the Plan's investments could have, or did, accrue to those outside the Plan, we are convinced the exclusive benefit rule of section 401(a) was violated. We are also convinced that the extent of those violations supports the Commissioner's determination that the Plan's qualified status should be revoked. The petitioner makes several arguments against such determination, with which we deal below. Petitioner first argues that the loans made to Dr. Howard between October 24, 1985, and March 10, 1986, and the638 two disbursements to J & L Farms should not be aggregated with the other transactions described above in order to find the exclusive benefit rule was violated. Petitioner's reasoning is that these transactions were determined to be prohibited transactions under section 4975, and are adequately dealt with through the applicable excise taxes. We disagree. This same argument was made to and rejected by this Court in Winger's Dept. Store, Inc. v. Commissioner, 82 T.C. at 887: Nor do we believe that the excise tax sanction in section 4975 was intended to preempt the sanction of disqualification under the exclusive benefit rule in the case now before us. We are not herein dealing with any isolated prohibited transaction described in section 4975. Rather, our decision that petitioner's trust did not operate for the exclusive benefit of employees is based on a totality of the transgressions that occurred and pervaded the entire operations of the trust. The fact that some of those transgressions are described specifically in section 4975 and made subject to an excise tax is merely fortuitous. [Fn. ref. omitted.]Petitioner quoted this language639 in its opening brief, but offered no reason why our treatment of the prohibited transactions in the present case should differ from the treatment given in Winger's. Petitioner argues that the prohibited transactions in the present case were not as pervasive as those found in Winger's. However, this record here does reveal numerous prohibited transactions that constituted violations of the exclusive benefit rule. It is not a matter of critical importance as to which case had a greater number of such violations. The point is that there were a significant number of such violations in both cases. Petitioner next argues that the Plan's non-loan investments (the land purchases, the loose diamonds, and the partnership) do not violate the exclusive benefit rule. Petitioner contends that a finding that these investments were exclusive benefit rule violations is based upon an improper use of hindsight. It relies upon DeBruyne v. Equitable Life Assurance Society of the United States, 720 F. Supp. 1342">720 F. Supp. 1342 (N.D. Ill. 1989), affd. 920 F.2d 457">920 F.2d 457 (7th Cir. 1990), where plan trustees were found not to have violated the fiduciary 640 duties established by the Employee Retirement Income Security Act of 1974 (ERISA), Pub. L. 93-406, 88 Stat. 829, by failing to anticipate the stock market crash of 1987. Petitioner fails to grasp the Commissioner's argument and, in turn, the basis for the conclusion that we reach today. The exclusive benefit rule was violated not because of the ultimate results of the non-loan investments. The exclusive benefit rule was violated either upon making the investments or upon their mismanagement. The exclusive benefit rule was violated the moment the Plan purchased the land investments without investigating the titles or obtaining title insurance. The Plan undoubtedly paid more for a quitclaim deed than it would have paid had it known of the pre-existing mortgage. Similarly, the exclusive benefit rule was violated when the Plan invested in the partnership in order to provide capital for Dr. Howard and Mr. Newlin. It is irrelevant for purposes of this determination what the outcomes of those investments were. With respect to the loose diamond, the exclusive benefit rule was violated because of the poor way that asset was supervised, apart from any other possible grounds for finding641 a violation. Petitioner's reliance on DeBruyne v. Equitable Life Assurance Society of the United States, supra, is misplaced. There the Court was asked to look at the results of otherwise reasonable investments. Here we need not even look at the results of the investments at issue, since it is sufficient to examine the wisdom of making the investments at all. Petitioner's third argument is that the Plan's investments, viewed in their totality, do not merit disqualification. Petitioner argues that the extent of the violations in the present case does not reach the level of violations found in Central Motor Co. v. United States, 583 F.2d 470">583 F.2d 470 (10th Cir. 1978), Feroleto Steel Co. v. Commissioner, 69 T.C. 97">69 T.C. 97 (1977), Ma-Tran Corp. v. Commissioner, 70 T.C. 158">70 T.C. 158 (1978), and Winger's Dept. Store, Inc. v. Commissioner, 82 T.C. 869">82 T.C. 869 (1984). We disagree. Our review of the record in this case makes it clear to us that the Plan's assets were managed first for the benefit of Dr. Howard, his family, and certain others, rather than for 642 the benefit of the Plan participants as a whole. The argument can also be made that certain Plan assets, the land investments and the large loose diamond, were so mismanaged that they benefited no one. This means only that they were not managed for the benefit of the employees. We refuse to engage in the numbers game the petitioner and the Commissioner invite us to play regarding the percentage of the Plan assets involved in exclusive benefit rule violations. Part of our reason for doing so is the difficulty, mentioned above at note 5, of establishing the amount of the Plan's total (remaining) investments. Without determining an actual percentage, it is clear to us that a majority of the Plan's assets were invested in ways that violated the exclusive benefit rule. Also, and perhaps more important, our decision is based on a determination that the entire investment philosophy of the Plan was aimed not at providing benefits for the employees, but at making capital available to Dr. Howard and his relatives, and certain others. The manipulation of pension plan assets by a trustee, who is also the sole shareholder of the plan sponsor, is a clear example of an exclusive benefit rule643 violation. Finally, petitioner has advanced several arguments relating to the steps taken by the Commissioner in revoking the qualified status of the Plan. First, in its reply brief petitioner has raised an entirely new issue based upon its allegation in the reply brief that the record "is void of any fact showing that the Secretary of the Treasury timely notified the Secretary of Labor prior to issuing, to Petitioner, a preliminary notice of intent to disqualify" the Plan as required by section 103 of the Reorganization Plan No. 4 of 1978, 43 Fed. Reg. 47113, 1 C.B. 480">1979-1 C.B. 480. The Commissioner moved to strike the portions of petitioner's reply brief relating to this new issue, pointing out that this new issue involved factual materials not contained in the stipulated administrative record and that five separate exhibits attached to the motion provided evidence that there was in fact consultation between the IRS and the Department of Labor, sufficient to satisfy the requirements of section 103 of the Reorganization Plan No. 4 of 1978. We granted the motion to strike, and accordingly do not regard this new issue as properly before us. Indeed, 644 in its response to the motion to strike petitioner indicated that it had no objection to striking those portions of its reply brief "addressing the three 'new' legal issues" relating to the "coordination aspects of Section 103 of the Reorganization Plan". However, it continues to argue certain other matters regarding the steps taken by the Commissioner in disqualifying the Plan. First, petitioner contends that the IRS exceeded its authority either by applying Rev. Rul. 69-494, 2 C.B. 88">1969-2 C.B. 88, as if it had the force of law or by disqualifying the Plan for violations of ERISA section 404, something that, petitioner alleges, the Commissioner cannot do. Section 404(a)(1)(B) of ERISA requires a plan fiduciary to discharge his duties "with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims". 88 Stat. 877. The Commissioner's interpretation of section 401(a)(2) in Rev. Rul. 69-494 dictates that investments be made645 using the safeguards "a prudent investor would adhere to". 2 C.B. 88">1969-2 C.B. 88. The overlap between the requirements of the Internal Revenue Code (as interpreted by the Commissioner) and ERISA are obvious. This overlap was explicitly recognized by Congress when it enacted ERISA. As the conference committee report accompanying ERISA stated: Under the Internal Revenue Code, qualified retirement plans must be for the exclusive benefit of the employees and their beneficiaries. Following this requirement, the Internal Revenue Service has developed general rules that govern the investment of plan assets, including a requirement that cost must not exceed fair market value at the time of purchase, there must be a fair return commensurate with the prevailing rate, sufficient liquidity must be maintained to permit distributions, and the safeguards and diversity that a prudent investor would adhere to must be present. The conferees intend that to the extent that a fiduciary meets the prudent man rule of the labor provisions, he will be deemed to meet these aspects of the exclusive benefit requirements under the Internal Revenue Code.H. Conf. 646 Rept. 93-1280, at 302 (1974), 3 C.B. 415">1974-3 C.B. 415, 463. It is clear that a violation of the prudent investor standard of ERISA can simultaneously act as a violation of the exclusive benefit rule of the Code. Contrary to the position taken in petitioner's reply brief, the Commissioner did not disqualify the Plan for violating the prudent investor requirement of ERISA section 404(a)(1)(B). The Commissioner disqualified the Plan for violations of the exclusive benefit rule of section 401(a). To do so the Commissioner was required to determine what it means to use trust funds for the exclusive benefit of the employees as required by section 401(a)(2). As noted above, the Commissioner has already offered an interpretation of the exclusive benefit rule in Rev. Rul. 69-494. While we have not conferred upon Rev. Rul. 69-494 the force of law, Shelby U.S. Distribs., Inc. v. Commissioner, 71 T.C. at 882; Winger's Dept. Store, Inc. v. Commissioner, 82 T.C. at 882, we do regard it as setting forth relevant standards to be647 considered, and we note the Tenth Circuit's conclusion that the ruling is of some evidentiary value in interpreting the statute. Central Motor v. United States, 583 F.2d at 490. Therefore, while our decision could be seen as applying a requirement of prudence, we have not taken these admittedly imprudent transactions 8 as conclusively determinative of the issue. We view them merely as evidence of the fact that the Plan was not managed for the exclusive benefit of the employees. In Shelby U.S. Distribs., Inc. v. Commissioner, supra at 884, in deciding that Rev. Rul. 69-494 had648 not acquired the force of law, it was stated "In Feroleto and Central Motor, the trusts lost their exemption because of their investment practices, but in each case, the conclusion is justifiable without subjecting the trust to a rule of prudence". However, in distinguishing Central Motor, the Shelby court went on to say "In Central Motor, although the district court referred to a rule of prudence and a requirement of diversification, the loan was unwise and improper, irrespective of such requirements". Id.Similarly, in Winger's Dept. Store, Inc., supra, after determining that Rev. Rul. 69-494 did not acquire the force of law following the passage of ERISA, we upheld the Commissioner's disqualification of the plan at issue. We noted several factors in upholding the disqualification; among those factors were the failure of the participant loans to follow the plan prescriptions, the risk created by investing a major portion of the trust assets in unsecured loans to one individual, and the fact that the remaining trust assets were not profitably invested. Winger's Dept. Store, Inc. v. Commissioner, supra at 882-883.649 The cases above show that disqualification is proper where the investments were "unwise and improper" or risky and unprofitable. Without stating so, these cases looked at the prudence of the plan investments for evidence of exclusive benefit rule violations. That evidence was sufficient to support disqualification without granting conclusive legal status to Rev. Rul. 69-494. While violations of the prudent investor requirement of Rev. Rul. 69-494 will not lead to automatic disqualification, such violations may properly be considered as evidence of exclusive benefit rule violations. Petitioner argues that we should not consider the prudence of the Plan's investments at all. Petitioner states: The test is to determine whether the trust's investment policies effectively make the plan serve the employer's interests or selected employees' interests to the point where the plan is no longer operated according to the exclusive benefit rule. The relevant inquiry is, therefore, unconcerned with policies or practices which, though imprudent, do not serve the interests of either the employer650 or selected employees. [Fn. ref. omitted.][Pet. Reply Brief at p.6.] Petitioner relies upon a passage from Winger's Dept. Store, Inc. v. Commissioner, supra at 878, where it was stated: Notwithstanding the statutory and regulatory failure to deal specifically with the application of the exclusive benefit rule in the context of trust investments, it is obvious that an investment policy, if not otherwise checked, effectively could make the plan serve the employer's interests or selected employees' interests to the point where the plan is no longer operated in accordance with the exclusive benefit rule embodied in section 401(a). * We reject petitioner's proposed standard. We find it is inconsistent with the cases described above, where we refused to treat the Commissioner's rule of prudence as conclusive, but where we considered the prudence of the plan investments in determining whether the exclusive benefit rule was violated. We find petitioner's interpretation of the above quoted passage to be unduly narrow. While using plan assets to benefit either the employer or selected employees would serve as evidence of an exclusive651 benefit rule violation, we think that Winger's did not intend to set forth an exclusive standard for judging violations. Having concluded that it is proper to consider the evidence of the imprudent investments made by the Plan, we are convinced that the primary purpose of benefiting employees or their beneficiaries was not maintained with respect to the Plan's investments. See Winger's Dept. Store, Inc. v. Commissioner, supra at 880; Feroleto Steel Co. v. Commissioner, 69 T.C. at 107. The investments made by the Plan violated the exclusive benefit rule of section 401(a). The Commissioner properly revoked the qualified status of the Plan. Decision will be entered for respondent. Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the years at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩2. These loans were determined by the Key District Office to be prohibited transactions within the meaning of sec. 4975(c).↩3. The projections made part of the record were for Sandy Creek General Partnership II, while the Plan invested in Sandy Creek Partnership I. No explanation for this discrepancy was given, and there is no suggestion that the projections for the other partnership would be materially different. In a letter dated Dec. 9, 1989, the Commissioner's agent requested that the petitioner provide an executed copy of the Sandy Creek General Partnership - I partnership agreement. There is no evidence the petitioner complied with this request.↩4. These disbursements were determined by the Key District Office to be prohibited transactions within the meaning of sec. 4975(c).↩5. The exact percentage of Plan assets loaned to individuals is difficult, if not impossible, to calculate. This is because, as already discussed, specific Plan assets appear to be lost forever (the large diamond and the land investment). Also, the value of the partnership investment would appear to be significantly less than the carrying value included on the Plan's final balance sheet. If these investments were removed from the Plan's balance sheet (as we believe they should be), then the amount of total assets will decrease, and the percentage of total assets represented by these loans will increase.↩6. We do not mean to imply that the mere theft or embezzlement of a plan asset, without more, constitutes a violation of the exclusive benefit rule requirement.↩7. See supra↩ note 3.8. Petitioner admitted the unsecured loans made to Plan participants and to third parties failed to meet the standard of prudence contained in Rev. Rul. 69-494, 2 C.B. 88">1969-2 C.B. 88↩, and Employee Retirement Income Security Act of 1974, Pub. L. 93-406, 88 Stat. 877-878. [Petitioner's brief at p.20.]	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623535/	LEO SCHWARTZ, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. JULIUS RICH, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Schwartz v. CommissionerDocket Nos. 8473, 8697.United States Board of Tax Appeals7 B.T.A. 223; 1927 BTA LEXIS 3226; June 8, 1927, Promulgated 3226 1. The 25 per cent reduction provided by Title XII, Revenue Act of 1924, is applicable literally to the tax payable in 1924 shown on returns for 1923, and does not reduce the 1924 tax payable in 1925 of an individual partner whose 1924 taxable income is made up in part of a share of partnership income for a fiscal year beginning in 1923. 2. In arriving at the "earned income" of a partner there shall be included in the partner's share of the distributable profits of the partnership the salary received from the partnership, and not in excess of 20 per centum of such share of the profits may be considered as earned income. M. D. Cohen, C.P.A., for the petitioners. D. D. Shepard, Esq., for the respondent. SMITH224 These are proceedings for the redetermination of deficiencies in income tax for the year 1924 in the amount of $104.78 in the case of Leo Schwartz, and of $63.82 in the case of Julius Rich. The cases were consolidated for the purpose of decision. Each petitioner alleges error on the part of the Commissioner (1) in failing to give him a credit of the 25 per cent reduction in tax provided by Title XII of the Revenue Act of 19243227 on such part of his taxable net income for 1924 as is taxable at 1923 rates, and (2) in computing each petitioner's earned income credit on the minimum amount of $5,000. FINDINGS OF FACT. The petitioners are members of the partnership of Rich, Schwartz & Joseph of Nashville, Tenn. The firm is a dealer in ladies' ready-to-wear. It has been in existence for many years. During the year 1924 the partnership was composed of three members, the two petitioners and Arthur J. Joseph. For many years the partnership books have been kept upon a fiscal year basis ending June 30. The partners have made individual income-tax returns upon the basis of the calendar year. The share of the profits of the partnership for the fiscal year ended June 30, 1924, credited to each of the petitioners was $4,404.04. All of this income was reported in each petitioner's individual income-tax return for the calendar year 1924, but each showed that one-half of his share of the partnership profits, or $2,202.02, was taxable at rates for the calendar year 1923, and that the other one-half, or $2,202.02, was taxable at rates for the calendar year 1924. Each petitioner showed on his return the total tax3228 on the $2,202.02 falling within the calendar year 1923 at the original 1923 rates and claimed a deduction from the total tax of 25 per cent of the amount thereof under the provisions of Title XII of the Revenue Act of 1924. The amount of the credit thus claimed in the case of Leo Schwartz was $62.28 and in the case of Julius Rich $55.07. The respondent has disallowed these credits in the computation of deficiencies. In the computation of the net income of the partnership for the purpose of determining the distributable shares of net income the partnership first deducted from gross income salaries payable to the partners in the aggregate amount of $24,000. For many years it had been the practice of the partnership to deduct from gross income salaries for the partners in the determination of the net income. Prior to July 1, 1920, the salary paid to each partner was $5,000. This salary allowance was based upon an oral agreement between the partners. On July 3, 1920, the partners entered into a written agreement which was to continue for a period of 5 1/2 years from July 1, 1920, which declared in part: 225 (2) Said partnership shall commence as of the date of July 1st, 3229 1920, and shall continue for the term of five and one-half (5 1/2) hears from date, thereby ending December 31st, 1925. (3) As of July 1st, 1920, each of the three partners had a one-third interest in the stock in trade, money, assets, credits, and things belonging to and owing to said firm, and of all such matters as are generally included in annual accounts. (4) Each of the three partners shall be paid a salary of Eight Thousand ($8000.00) dollars per annum, which shall be charged to the expense of carrying on and conducting the business; and before a division of profits; the net profits of the business shall accrue to each of the three partners in equal parts. * * * (8) As a material consideration for the execution of this contract said Julius Rich and Arthur J. Joseph hereby agree that during each year for the full term of this contract they will have charged to their respective stock accounts. on the books of the firm, the aggregate sum of Thirty Five Hundred ($3500.00) Dollars, as follows: Twelve Hundred and Fifty ($1250.00) Dollars of said amount to be charged to the stock account of Julius Rich, and Twenty-two Hundred and Fifty ($2250.00) Dollars to be charged to3230 the stock account of Arthur J. Joseph; and the aggregate amount of both items, is to be credited to the stock account of said Leo Schwartz, on the books of the firm. The first amounts so charged and credited shall be as of July 1st, 1921, and like amount for each succeeding year during the life of this contract. (9) Should either of the partners suffer from sickness at any time, which should incapacitate him from attending to the duties incumbent on him in said partnership, and should such sickness or disability prevent him from being at the store, then and in such case, and in consideration of the good fellowship and friendly feeling existing, it is mutually agreed that the full interest in the business of such invalided or sick partner, shall remain and be in full force and effect, regardless of the duration of such inability to attend to business, and the consequent absence from the store, during the full term of this partnership agreement. The earnings of the partnership for the fiscal year ended June 30, 1924, before the deduction of salaries for partners, was $37,212.12. Schwartz received $15,904.04; Rich, $11,154.04; and Joseph, $10,154.04. In their individual income-tax3231 returns for 1924 Leo Schwartz claimed as earned income $10,000 and Julius Rich either $8,000 or $6,750. The respondent determined deficiencies in each case upon the basis of an earned income of only $5,000. OPINION. SMITH: The decision on the first question involved in these proceedings is governed by the Board's decisions in , and . In accordance therewith the question must be resolved adversely to the petitioners. The second question relates to the "earned income" of each petitioner for the calendar year 1924. Each was a member of a partnership 226 which provided in its partnership agreement for the payment of salaries to members. Under the agreement each of the three partners was to receive a salary of $8,000 per year. By reason of the fact that Leo Schwartz rendered more valuable services to the partnership than those rendered by the other partners, the partnership agreement provided, as indicated in the findings of fact, that certain credits should be made to the account of Schwartz and deducted from the stock accounts of Rich and Joseph for the purpose of adequately3232 compensating him for services performed. So far as the record shows these credits were to be made to Schwartz even though the net result of the partnership operations was a loss in any year. Schwartz claims that his earned income for the year 1924 was $8,000 from the partnership and $3,500 additional from Rich and Joseph. Rich claims that his earned income for the year was $8,000. Section 218(a) of the Revenue Act of 1924 provides in part: Individuals carrying on business in partnership shall be liable for income tax only in their individual capacity. Subsection (c) of the same section provides: The net income of the partnership shall be computed in the same manner and on the same basis as provided in section 212 except that the deduction provided in paragraph (10) of subdivision (a) of section 214 shall not be allowed. Section 209 of the Act provides in part as follows: (a) For the purposes of this section - (1) The term "earned income" means wages, salaries, professional fees, and other amounts received as compensation for personal services actually rendered, but does not include that part of the compensation derived by the taxpayer for personal services rendered3233 by him to a corporation which represents a distribution of earnings or profits rather than a reasonable allowance as compensation for the personal services actually rendered. In the case of a taxpayer engaged in a trade or business in which both personal services and capital are material income producing factors, a reasonable allowance as compensation for the personal services actually rendered by the taxpayer, not in excess of 20 per centum of his share of the net profits of such trade or business, shall be considered as earned income. (2) The term "earned income deductions" means such deductions as are allowed by section 214 for the purpose of computing net income, and are properly allocable to or chargeable against earned income. (3) The term "earned net income" means the excess of the amount of the earned income over the sum of the earned income deductions. If the taxpayer's net income is not more than $5,000, his entire net income shall be considered to be earned net income, and if his net income is more than $5,000, his earned net income shall not be considered to be less than $5,000. In no case shall the earned net income be considered to be more than $10,000. 3234 * (c) In the case of the members of a partnership the proper part of each share of the net income which consists of earned income shall be determined 227 under rules and regulations to be prescribed by the Commissioner with the approval of the Secretary and shall be separately shown in the return of the partnership and shall be taxed to the member as provided in section 218. The only regulations which the respondent has promulgated relating to this section are articles 1661 and 1662 of Regulations 65. The former provides - * * The earned income credit will be allowed to the members of a partnership with respect to the share of the net income belonging to each which consists of earned income. There must be included in the return of the partnership a statement showing (1) the amount of earned income as defined in article 1662, and (2) the names of the members and the amounts of their respective shares of earned income. Article 1662 provides in part: The term "earned income" means wages, salaries, professional fees, and other amounts received as compensation for personal services actually rendered. In the case of a taxpayer engaged in a trade or business in3235 which both personal services and capital are material income-producing factors, a reasonable allowance in compensation for personal services actually rendered by the taxpayer shall be considered as earned income, but the total amount which shall be treated as the earned income of the taxpayer from such trade or business shall, in no case, exceed 20 per cent of his share of the net profits of such trade or business. Although subdivision (c) of section 209 of the taxing statute contemplates that the Commissioner shall make regulations for the purpose of determining the earned income of a partner, the application of the above quoted regulations to the case at bar is somewhat obscure. The fair inference to be drawn from them is that where partners are engaged in a trade or business in which both personal services and capital are material income-producing factors, the 20 per cent limitation on the share of the profits which may be considered earned income provided for by subsection (1) of paragraph (a) of section 209 of the taxing statute is applicable. That the Commissioner has so interpreted his regulations is clear from the fact that form 1065-A, upon which partnerships were required3236 to make returns for 1924, provides that any amounts paid as salaries to partners shall be included in the distributable net income and that they shall not be deducted from gross income in arriving at the net income. In Mimeograph 3283, C.B. IV-I, p. 14, Ruling No. IV-9-2045, it is stated: (c) In the case of a partnership which is engaged in a trade or business in which both capital and labor are material income-producing factors, each partner who renders services may consider as reasonable compensation for such services an amount not in excess of 20 per cent of his share of the net profits of the partnership. A member of the partnership who does not render services to the partnership may not consider any part of his share of the profits as earned income. 228 (e) Attention is called to the fact that in the forms for 1924, salaries paid to the individual members of a partnership are not to be deducted in computing the net profits of the partnership, and the members do not report the salaries received from the partnership in item 1, Form 1040, as salary, but include such salary in the profits from the partnership, which are reported in item 4, Form 1040. If the partnership3237 is engaged in a business in which capital is not a material income-producing factor, it will not be necessary for column 4 of item 13, Form 1065, to be filled in, since the 20 per cent limitation does not apply. An individual who is engaged in a trade or business on his own account should not deduct in Schedule A, Form 1040, any compensation paid to himself. All of the profits from the business should be reported in item 2, Form 1040. As above indicated the respondent has computed the deficiencies upon the basis that the last sentence of section 209(a)(1) of the taxing statute applies to each petitioner. This is objected to by the petitioners on the ground that it is the partnership which is engaged in a trade or business and not each petitioner and that a partnership is not a "taxpayer" within the meaning of the taxing statute. That a partnership is not a taxable entity is of course conceded. In , it was stated: This law [Revenue Act of 1913], therefore, ignores for taxing purposes the existence of a partnership. The law is so framed as to deal with the gains and profits of a partnership as if they were the gains and3238 profits of the individual partner. The paragraph above quoted so provides. The law looks through the fiction of a partnership and treats its profits and its earnings as those of the individual taxpayer. Unlike a corporation, a partnership has no legal existence aside from the members who compose it. The Congress, consequently, it would seem, ignored, for taxing purposes, a partnership's existence, and placed the individual partner's share in its gains and profits on the same footing as if his income had been received directly by him without the intervention of a partnership name. On appeal the above statement was approved, but with the following reservation, : * * We concur in and adopt the conclusion reached. However, the statement made in the opinion that a partnership has no legal existence, aside from the members who compose it, is too broad, as, for instance, in view of the Bankruptcy Act (Act July 1, 1898, c. 541, 30 Stat. 544 [Comp. St. § 9585 et seq.]), yet as applied to the particular portion of the statute and the question in hand it is correct, and with this explanation we approve the reasoning of the opinion. We think that the language3239 of section 209(a)(1) is applicable to each of these petitioners. Under the partnership agreement Leo Schwartz received in 1924, $3,500 more than his share of the partnership profits. This money was to compensate him in part for services performed to the partnership. It was charged to the stock accounts of the other two partners. It was payable without regard to profits or losses made or sustained 229 by the partnership. We think that the amount was "earned income" of Schwartz. In our opinion the respondent has correctly determined that the earned income of Rich for the year 1924 was the amount of $5,000. Judgment will be entered on 15 days' notice, under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623537/	LEE R. CHRONISTER and ROBERTA L. CHRONISTER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentChronister v. CommissionerDocket No. 8705-71.United States Tax CourtT.C. Memo 1973-237; 1973 Tax Ct. Memo LEXIS 49; 32 T.C.M. (CCH) 1108; T.C.M. (RIA) 73237; October 25, 1973, Filed Lee R. Chronister, pro se. Richard J. Shipley, for the respondent. SCOTT MEMORANDUM FINDINGS OF FACT AND OPINION SCOTT, Judge: Respondent determined a deficiency in petitioners' income tax for the calendar year 1968 in the amount of $2,751.08. The issue for decision is to what extent, if any, a payment of $19,384.65 made by the Alaska Mortgage Adjustment Agency to the Small Business Administration on behalf of petitioners in reduction of their home mortgage constitutes gross income to petitioners as a recovery for a previously deducted earthquake casualty loss. 2 FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. Petitioners, husband and wife, whose legal residence at the time the petition in this case was filed was Anchorage, Alaska, filed a joint Federal income tax return for the calendar year 1968 with the district director of internal revenue, Anchorage, Alaska. On March 27, 1964, a severe eathquake, commonly52 referred to as the "Good Friday" earthquake, occurred over a large part of Alaska. The earthquake caused substantial damage to petitioners' personal residence which was located in Anchorage, Alaska. Petitioners moved out of their home immediately after the earthquake until repairs could be made. Because of the extensive repairs which would be needed in order to make petitioners' home habitable, petitioners estimated that the value of the house immediately after the earthquake and prior to making any repairs was approximately $10,000. Subsequently, with funds received from a loan, as hereinafter outlined, petitioners made the repairs which were essential to enable them to move back into the house and have continued to make repairs 3 to the house since 1964. At the time of the trial of this case, there remained to be made certain repairs necessary to put petitioners' property back into a condition comparable to the condition it was in prior to the earthquake. Petitioners purchased their personal residence in 1963 at a cost of $41,900. They had made a $6,500 downpayment on the home at the time it was purchased and placed a first and a second mortgage on the home to cover the53 balance of the purchase price and some incidental expenses. Petitioners made some payments on the first and second mortgages and at the date of the earthquake the total amount due by petitioners on these two mortgages plus accrued interest was $35,416.62. In November 1964 petitioners obtained a loan from the Small Business Administration in the amount of $47,100 which they used to satisfy the existing mortgages on their home and spent the balance for repairs to their house. On August 19, 1964, Congress amended the Alaska Omnibus Act by Pub. L. 88-451, 78 Stat. 505, to provide assistance to the State for the reconstruction of the areas damaged by the earthquake. Section 57 of 4 Pub. L. 88-451 contained provisions authorizing grants for the purpose of enabling the State of Alaska to retire or adjust outstanding home mortgage obligations on one to four family homes which were severely damaged or destroyed in the "Good Friday" earthquake. On September 7, 1964, a special session of the Alaskan legislature enacted legislation to implement section 57 of the Alaska Omnibus Act (Chapter 1, SLA 1964, First Special Session). This legislation authorized the governor of the State54 of Alaska to establish an Alaska Mortgage Adjustment Plan for the implementation of section 57 of the Alaska Omnibus Act. Under the plan which was approved on behalf of the President of the United States on February 18, 1965, the Commissioner of Commerce of the State of Alaska was to administer the program through an agency entitled the "Alaska Mortgage Adjustment Agency." Petitioners made application to the Alaska Mortgage Adjustment Agency for relief and during 1968 that agency made a payment of $19,384.65 to the Small Business Administration to be applied in reduction of petitioners' home mortgage loans. The payment was made on petitioners' behalf because of the damage sustained by petitioners' residence during the 5 "Good Friday" earthquake and was applied by the Small Business Administration in accordance with the requirement of the State and Federal law to reduce the mortgages encumbering petitioners' property. Since the reduction of their mortgage by the payment made on their behalf by the Alaska Mortgage Adjustment Agency, petitioners have been able to and have borrowed additional sums to make further repairs to their home. In 1970 they borrowed $2,500 from the First55 National Bank of Alaska which they used to relevel their house. Since the earthquake petitioners have had continuing problems with the house due to settling and cracking and have claimed additional casualty losses or damages from these causes on certain of their Federal income tax returns for years subsequent to 1964. Section 190 of the regulations issued by the Alaska Mortgage Adjustment Agency provided as follows: Procedures and Criteria for determining fair market value The Agency shall determine, subject to review by the Commissioner on appeal as provided in Part XI of the Plan, pre-earthquake fair market value on the basis defined in item 9, Section 250 of these regulations, and shall compute the post earthquake value in the manner indicated by Sections 160 and 185 of these regulations. The Agency shall require such appraisals, 6 surveys, estimates, sworn statements, and other information to be furnished, in addition to the items specifically mentioned in the Plan, Supplemental Application, and these regulations, as the Agency deems appropriate to establish an adequate basis56 for the exercise of its judgment in the circumstances of each case. Item 9 of section 250 of these regulations provided as follows: 9. "Fair market value" means the amount that could reasonably be expected to be realized by a willing seller, under no extraordinary pressure or compulsion to sell, on a sale to a willing buyer under no extraordinary pressure or compulsion to buy. Section 160 of these regulations defined eligible costs of restoration as follows: (a) Eligible costs of restoration shall include the estimated or actual contractual costs of: 1. repairs or replacements to improvements on properties described in Section 130 of these regulations, needed to restore them to substantially the same usefulness and appearance as immediately before the earthquake; and 2. grading or other work to the lot itself, needed for continued occupancy and use of the property. (b) Where the improvements have been or will be moved to a different lot, costs under Section . 160(a) 2. of these57 regulations, shall include the value of the new lot minus the value, if any, of the old lot, plus moving costs. 7 (c) Where damage to the lot itself, or to the surrounding area, including underlying ground layers, is so extensive that further residential use of the lot is prohibited under State or local law or regulations, and the improvements are not to be moved to a different lot, the property shall be considered to be totally destroyed, and the cost of restoration shall be considered to be equal to the value of the property immediately before the earthquake. Section 185 of the regulations provided the method of determining the payments to be made by the Alaska Mortgage Adjustment Agency. Applying these criteria, the amount which was paid for petitioners was computed as follows: 1. Pre-earthquake fair market value$37,000.002. Physical damage (cost of restoration)25,500.003. Computed post-earthquake value (line 1 minus line 2)11,500.004. March 27, 1964, aggregate outstanding amounts of purchase money and improvements lien obligations.Philadelphia Savings Fund Soc.$28,424.785 3/4% interest 3-1-64 to 3-28-64122.58H. Henry & Barbara N. Roloff 6% interest 3-12-64 to 3-28-6418.27Total$35,416.62Less: Roloff-reduced contract balance any discounts at which lienors acquired the obligations3,503.975. Aggregate outstanding obligations$31,912.656. Adjusted outstanding obligations$31,912.657. Amount by which March 27, 1964 obligations are eligible for reduction (Line 6 minus Line 3)$20,412.658. Amount of principal required to be paid by or for lien debtor subsequent to March 27, 19641,000.00(a) Amount paid to principal since March 27, 1964$ 4,961.44(b) Excess (over $1,000) to be credited by lienor in further reduction of indebtedness (8(a) minus 8)3,961.449. Amount to be paid by Agency (Line 7 minus Line 8, but not to exceed $30,000)$19,412.6510. Amount by which each obligation is to be reduced by Agency payment in accordance with priorities under Alaska lawSmall Business Administration$19,384.65Alaska Title Guaranty Co.28.00TOTAL$19,412.6558 Petitioners had filed their original return for the calendar year 1963 prior to the "Good Friday" earthquake. On this return they had shown total salary and wages of $14,586.02, which they reduced by a loss computed on a rental of part of the building in which they had lived prior to the purchase of the home which was damaged by the earthquake at $788.80, leaving total income of $13,797.22. They claimed total deductions of $4,558.72 which, excepting $90 of Union dues, consisted of contributions; interest paid on their home mortgages, 9 to a credit union, to various stores, and to General Motors Acceptance Corporation; real estate, sales, State income taxes and personal property taxes; and medical and dental expense deductions. The State income taxes were shown at $407.71. After subtracting these claimed deductions petitioners showed income of $9,238.50, claimed five personal exemptions totaling $3,000 and showed taxable income of $6,238.50 with a tax due of $1,292.53. After the earthquake, petitioners heard various radio announcements stating that the Internal Revenue Service's assistance programs had individuals available to help persons who had sustained losses in the59 "Good Friday" earthquake properly fill out their income tax returns for the year 1963. Petitioners consulted with one of the persons assigned to this tax assistance program in the office of the district director of internal revenue and as a result of this consultation, on April 12, 1964, filed a form 1040, U.S. Individual Income Tax Return, entitled 10 "Amended Tax Return Casualty - Earthquake." 1 On this return the same income was reported and deductions and exemptions claimed as were claimed on the first tax return filed by petitioners for the calendar year 1963, except that petitioners claimed a loss of property by earthquake of $6,500. Petitioners 11 attached to their return the following explanation of this claimed loss: We previously submitted a return with refund due of $606.64 which should be subtracted from the amount claimed on this return. 1. Value of Home before disaster$41,9002. Value of Property after disaster-10,000(Would have to be moved to new lot and new basement and utilities constructed at cost of $12,000)3. Decrease in value of property31,9004. Adjusted basis of property31,9005. Loss sustained on property31,9006. Estimated insurance recoveryNone7. Value of furnishings before disaster8,0008. Value of furnishings after disasterapprox. 4,0009. Decrease in value of furnishingsapprox. 4,00010. Less insurance recoveryNone11. Casualty loss on furnishingsapprox. 4,000Loss on both home & furnishingsapprox. 35,90060 Note: It would be ridiculous to claim such a loss, as we could not possibly pay such a figure. I claimed only loss of down payment. Will claim additional loss in future year IF and WHEN we pay it. 61 Petitioners on their Federal income tax return for the calendar year 1964 reported income of $13,170.70 and deductions of $24,943.35, of which $21,100 consisted of claimed damage to home by earthquake of $19,900 and damage to furnishing of $1,200. Based on this claim petitioners showed no tax due for the year 1964. 12 Attached to their return for the calendar year 1964 petitioners had the following explanation: In September of 1963, we contracted to buy a house at $41,900…in March of 1964, it sustained $15,000 damage to the house…the soil of the lot compacted and dropped a foot so the house is now valued at $31,000. On the amended return submitted last year, I claimed $6,000 and no more (I don't know how I arrived at this figure, since we paid approximately $7,000 down). I couldn't conceive of obtaining a loan to repair the house. Nevertheless, we did obtain a loan of $15,000, which we have begun repaying. We also lost approximately $1,200.00 of our furnishings. Petitioners' 1963 and 1964 income tax returns were examined by respondent, and respondent determined the total amount of their casualty loss to be $22,050. Respondent further determined that the entire62 amount of the casualty loss was allowable in 1963 because petitioners had made a valid election to claim the loss in that year. As a result of carrying back the unused 1963 loss, respondent allowed a refund of $1,365.76 to petitioners for taxes paid for the year 1960. 2 13 Petitioners on their Federal income tax return for the calendar year 1968 included no amount of the payment made on their behalf by the Alaska Mortgage Adjustment Agency in their income. They attached the following explanation: Form 1099 Received From State of Alaska Mortgage Adjustment Agency as relief from earthquake of March 27, 1964. Casualty loss was allowed by IRS only to extent of cost of repair. No tax benefit received. Respondent in his notice of deficiency increased petitioners' income as reported for the calendar year 1968 by $10,236.37 with the following explanation: 63 It is determined that the amount of $19,384.65 paid to Small Business Administration on your behalf by the State of Alaska Mortgage Adjustment Agency constitutes gross income to the extent that such payment exceeds the recovery exclusion provided by Section 111 of the Internal Revenue Code. It is further determined that the recovery exclusion computed with respect to each payment was $10,236.37. Taxable income is accordingly increased by $10,236.37. OPINION Respondent in his brief takes the position that the mortgage adjustment payment made on petitioners' behalf in 1968 constitutes "compensation" for the casualty loss sustained by petitioners on their house from the "Good Friday" earthquake within the meaning 14 section 165(a), I.R.C. 1954. 3 Respondent then states that because this amount constitutes compensation for a casualty loss deductible under sections 165(c) and 165(h), the payment by the Alaska Mortgage Adjustment Agency constitutes income to petitioners to the extent determined in his notice of deficiency under the provisions of section 1.165-1(d) (2) (iii), Income Tax Regs.464 Respondent argues that the payment on petitioners' behalf by the Alaska Mortgage Adjustment Agency was not a gift and was in fact to compensate petitioners for eathquake damage to their home. We need not discuss further in this case this argument of respondent since petitioners point out in thier brief and stated at the trial that they recognize that the payment by 15 the Alaska Mortgage Adjustment Agency on their behalf was to compensate them for their casualty loss and they concede that this payment would properly be income to the extent that it exceeds the portion of their properly deductible casualty loss for which they received no tax benefit. It is petitioners' position that they were entitled to deduct a casualty loss because of the "Good Friday" earthquake of not less than $30,000, but that they received a tax benefit for less than $10,000 of this properly deductible casualty loss. Petitioners contend that their properly deductible casualty loss exceeded the amount of the $19,384.65 payment made on their behalf by the Alaska Mortgage Adjustment Agency by more than the $10,000 for which they received a tax benefit. Respondent's only answer to this argument of petitioners65 is to state that the amount of the casualty loss deduction is pertinent only for the purpose of computing the recovery exclusion under section 111 and that this Court has previously held that it is not permissible to reopen the year of the previous deduction in order to claim additional deductions or to make 16 corrections. First National Bank, 22 T.C. 209">22 T.C. 209 (1954), aff'd. 221 F.2d 959">221 F.2d 959 (C.A. 2, 1955), certiorari denied 350 U.S. 887">350 U.S. 887 (1955). Section 111 provides "Gross income does not include income attributable to the recovery during the taxable year of a bad debt, prior tax, or delinquency amount, to the extent of the amount of the recovery exclusion with respect to such debt, tax, or amount." Section 1.111-1(a), Income Tax Regs., provides, in part: The rule of exclusion so prescribed by statute applies equally with respect to all other losses, expenditures and accruals made the basis of deductions from gross income for prior taxable years, * * * Section 111(b) (4) defines recovery exclusion as the amount of deductions66 " * * allowed, on account of such bad debt, prior tax, or delinquency amount, which did not result in a reduction of the taxpayer's tax * *." Respondent in his determination as set forth in his notice of deficiency apparently computed the recovery exclusion at $10,236.37 and considered this amount to be taxable to petitioners instead of considering the amount of the recovery in excess of the recovery exclusion to be the amount taxable to petitioners. One of petitioners testified that petitioners received 17 a tax benefit on less than $10,000 of the amount they claimed as a deduction for their casualty loss. Therefore, apparently a proper computation of the amount includable in petitioners' income for the taxable year 1968, even under respondent's theory of the amount of "recovery exclusion" to which petitioners are entitled, would be the difference between the payment of $19,384.65 made on petitioners' behalf in 1968 and the amount of the recovery exclusion of $10,236.37. Petitioners, however, contend that respondent incorrectly limited the amount of their casualty loss to $22,050 in determining the excess of their casualty loss over the amount for which they received a67 tax benefit. We do not agree with respondent that the First National Bank case supports his position that petitioner is bound by the amount of $22,050 as the amount of deduction for their casualty loss. In that case the taxpayer had reported a loss on its corporate return for the year 1937 after having claimed deduction of $58,933.17 for bad debts on various notes and bonds. The Commissioner made no changes in the income, deductions, or tax of the taxpayer for the year 1937. In 1949, the taxpayer recovered a portion of the bad 18 debt that had been charged off in 1937. Respondent determined that the total amount of the recovery was taxable. In years prior to 1949 the taxpayer had made bad debt recoveries for the debts charged off in 1937 in excess of the loss claimed on its 1937 return. The taxpayer claimed that it had other deductions for the year 1937 which it could have claimed but did not since without claiming such deduction it had a net loss. The taxpayer wanted to relitigate the year 1937 and have this Court determine what the proper income for that year would be prior to the deduction of its bad debts. We held in the First National Bank case that the provisions of68 section 22(b) (12) (D), I.R.C. 1939, which are substantially similar to the provisions of section 111 of the 1954 Code, did not authorize relitigating the year in which the deduction on which a recovery was made had been claimed. In that case the taxpayer was contending that it had unclaimed 1937 deductions unrelated to the deduction of which a recovery was made which would decrease the net income prior to that deduction, thereby increasing the amount of the recovery exclusion. Petitioners in the instant case claimed on their returns in the two years 1963 and 1964 total deductions 19 for a casualty loss of $27,600, and in our view actually claimed a loss of at least $31,900 since apparently they would, in accordance with the statement made in their return for 1963, have continued in years subsequent to 1964 to claim the balance of what they considered to be their casualty loss to the extent needed to offset their income. However, when respondent determined that petitioners, having made an election to claim the deduction in 1963, were required to first carry the deduction back to years prior to 1963, apparently the amount of the loss became academic since petitioners had paid69 little tax in these prior years. 5 One of petitioners testified: In 1965, January, we returned to taxpayer assistance and asked for help in preparing our tax return. At that time, they permitted us to claim only part of the loss, $22,050. That was set by the IRS after our inspection. We were also told the loss 20 would have to be claimed in 1963 and carried back five years. 1963 was a year of low income, and 1962 and 1961 were years of almost no income, because we were in business for ourself, and we lost our shirts, so to speak. Therefore, not only did the IRS not permit us to claim the full amount of the loan [sic (apparently should be loss)], which was at least $10,000 greater as in the figure set by the IRS, but they instructed us to elect the loss in a low income year and carry it back to the years of no income. This resulted in our receiving a disasters tax refund in the amount of $1,365.76, a tax benefit on our loss of less than 10,000. * * * As we received no tax benefits on approximately $20,000 to the original $30,000 character [sic (apparently should be casualty)] loss * * * [it] is logical for the IRS to contend this $19,384.65 as income and propose70 a tax deficiency of $2700. We pointed out that IRS figures showed that the mortgage adjustment relieved us of our entire loss only because we were originally prevented from claiming the full loss. At this time, IRS figured our disaster tax refunded in 1964. They contended since we had no - had not paid a large amount of taxes in 1963 and prior years, that we could not expect a large refund. They said that our actual loss amount was immaterial, that the figures they imposed, $22,050, was large enough to give us the tax refund we could expect in ratio to the taxes we had paid. We must therefore decide the amount71 of casualty loss to be used in determining the exclusion from petitioners' gross income for the year 1968 because of petitioners not receiving a tax benefit from the deduction. Dobson v. Commissioner, 320 U.S. 489">320 U.S. 489 (1943). 21 The record is clear that petitioners had no recovery of any of their casualty loss in any year prior to 1968. The import of a number of our cases is that section 111 defining the term "recovery exclusion" does not limit the application of the tax benefit rule which was recognized by case law prior to the enactment into the Revenue laws of the provisions now contained in section 111. In Home Savings & Loan Co., 39 T.C. 368">39 T.C. 368 (1962), we held that a rebate received by a taxpayer of State property tax paid in prior years when it had been exempt from Federal income tax was not includable in its income. We pointed out that the entire amount of this refund of State tax exceeded the amount of a deduction or credit which had been allowed for prior taxable years since the taxpayer had not been subject to income tax for prior taxable years. In72 so holding we stated (39 T.C. at 369-370): He [respondent] determined the $59,114.98 to be an item of income to petitioner in 1956, grounding his argument on the broad general proposition that section 61(a) of the Internal Revenue Code of 1954 requires the inclusion in income of all items of income except those specifically excluded. Respondent points out that the sum in question does not fall within the exclusion provided by section 111 of the 1954 Code 22 for the recovery of "prior taxes." [footnote omitted] While we are inclined to agree, we find it unnecessary to pass upon this issue since we think petitioner falls squarely within the broader, more general rule relating to tax benefits which we have said is not limited by the provisions of section 111. Birmingham Terminal Co., 17 T.C. 1011">17 T.C. 1011 (1951). Relying on this rule, petitioner contends that since the payment of the State taxes in question did not give rise to any tax benefit when they were paid, it ought not be taxed on the recovery of those taxes. We agree. It our view that 73 one does not ordinarily acquire taxable income by a refund of taxes which he should never have had to pay. However, where the taxpayer has used the taxes paid to gain a tax deduction, the later recovery of such taxes is "for tax purposes, like a windfall and within the broad definition of taxable income." Perry v. United States, 160 F. Supp. 270">160 F. Supp. 270 (Ct. Cl. 1958).In the instant case petitioner did not deduct, nor in fact could it have deducted, the payment of State taxes during the years of its exemption. Yet it can make no difference in the application of the principle recognized in the Dobson case that petitioner did not actually deduct these taxes in the earlier years, as is contended by respondent. Cf. Birmingham Terminal Co., supra. In Birmingham Terminal Co., 17 T.C. 1011">17 T.C. 1011, 1013 (1951), referred to in the Home Savings and Loan case, respondent was contending that when the taxpayer received reimbursement by a railroad on account of retirement losses, which because of Interstate Commerce 23 Commission regulations it could not charge against the railroad using its facilities in prior years, it had received taxable income. In holding74 that this was not the fact, we pointed out that for the years in which the retirements were made the taxpayer's income tax returns did not show any income, that only part of the retirement losses were actually deducted by the taxpayer on its returns, that these produced no tax benefit and that the taxpayer would not have derived any tax benefit through any deduction of the remainder of the losses. We held that since the taxpayer would have received any tax benefits had it deducted all the not losses that it properly could have deducted, it received no income when it was reimbursed for those losses. In so holding we stated: Petitioner had no net income against which to offset the retirement losses when they occurred, and it can make no difference in the application of the principle recognized in these cases that it did not actually deduct all those losses in the earlier years, since it was entitled to take the deduction but would have derived no advantage had it done so. Again, in Louise Webber O'Brien, 22 T.C. 661">22 T.C. 661 (1954), we refused to adopt the restrictive view contended for by respondent in determining the application of the tax benefit rule. In accordance with75 the holdings 24 in these cases, we conclude that petitioners are correct in their position that in determining the extent to which, if any, the $19,384.65 amount paid on behalf of petitioners primarily to the Small Business Administration is taxable to them in 1968, we must start with a deduction of a proper amount of loss for the casualty sustained by petitioners in the 1964 "Good Friday" earthquake and then subtract the casualty loss for which petitioners received a tax benefit from the amount of the casualty loss sustained by petitioners. If the remainder exceeds the $19,384.65 recovery, no amount of the recovery is taxable to petitioners in 1968. If it does not, the excess of the $19,384.65 recovery over the portion of the casualty loss for which petitioners received no tax benefit is taxable income to petitioners in 1968. In our view petitioners originally claimed a casualty loss of at least $31,900. However, considering all the testimony in the record we have concluded that petitioners actually suffered a casualty loss in the "Good Friday" earthquake in the amount of $30,000 as they now claim. In reaching this conclusion we have considered not only petitioners' testimony, *76 25 but also the testimony of the director of the Alaska Mortgage Adjustment Agency as to how that Agency determined the payments to be made on mortgages during the year 1968 when it made the payment on behalf of petitioners. We recognize that petitioners did not pursue in a court proceeding the correctness of respondent's determination that they were entitled to only $22,050 as a casualty loss instead of the greater amount which they had claimed. However, apparently, if they accepted respondent's determination that they were bound by their election to claim the loss in 1963, they would have had no standing to contest his determination of the amount of the loss at that time since their taxes would not have been lessened by a greater loss. In our view, therefore, the deduction for the casualty loss to be used in determining whether petitioners are taxable on any portion of the $19,384.65 paid on their behalf by the Alaska Mortgage Adjustment Agency in 1968 is $30,000. Decision will be entered under Rule 50. Footnotes1. Sec. 165(h), I.R.C. 1954, as applicable in the year 1964, provided as follows: (h) Disaster Losses. - Notwithstanding the provisions of subsection (a), any loss (1) attributable to a disaster which occurs during the period following the close of the taxable year and on or before the time prescribed by law for filing the income tax return for the taxable year (determined without regard to any extension of time), and (2) occurring in an area subsequently determined by the President of the United States to warrant assistance by the Federal Government under sections 1855-1855g of title 42, at the election of the taxpayer, may be deducted for the taxable year immediately preceding the taxable year in which the disaster occurred. Such deduction shall not be in excess of so much of the loss as would have been deductible in the taxable year in which the casualty occurred. If an election is made under this subsection, the casualty resulting in the loss will be deemed to have occurred in the taxable year for which the deduction is claimed. The President of the United States determined Alaska to be a disaster area because of the earthquake of March 27, 1964. See Rev. Rul. 64-332, 2 C.B. 59">1964-2 C.B. 59↩. 2. The stipulation reads "an assessment of $1,365.76 was allowed for 1960." One of the petitioners testified that petitioners received "a disaster tax refund in the amount of $1,365.76" as a result of carrying back a loss to years prior to 1963, so we conclude that petitioners received a refund in this amount for 1960. ↩3. All references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated. ↩4. Sec. 1.165-1(d) (2) (iii), Income Tax Regs., provides as follows: (iii) If the taxpayer deducted a loss in accordance with the provisions of this paragraph and in a subsequent taxable year receives reimbursement for such loss, he does not recompute the tax for the taxable year in which the deduction was taken but includes the amount of such reimbursement in his gross income for the taxable year in which received, subject to the provisions of section 111↩, relating to recovery of amounts previously deducted. 5. The evidence is not in the record to show why on a carryback petitioners could absorb a loss of $22,050 and, apparently if petitioner's testimony is accurate, even an additional $10,000 without having available any carryover to 1964. However, it is obvious from the provisions of sections 172(c) and (d) which provide for the computation of net operating losses and section 172(b) (2) which provides for the carryback and carryover of net operating losses, that this could be the situation. In any event, this is a matter which can be resolved in a Rule 50 computation. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623539/	HENRY S. THOMPSON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Thompson v. CommissionerDocket No. 29374.United States Board of Tax Appeals18 B.T.A. 1142; 1930 BTA LEXIS 2508; February 14, 1930, Promulgated 2508 Deduction on account of bad debts disallowed upon the evidence. Howard W. Brown, Esq., for the petitioner. W. F. Gibbs, Esq., for the respondent. SMITH 1142 This proceeding is for the redetermination of a deficiency in income tax for the calendar year 1924 in the amount of $2,392.35. The petitioner alleges that the respondent erred in disallowing a deduction of $13,500 claimed in his return on account of bad debt losses. 1143 FINDINGS OF FACT. The petitioner resides at Fairhaven Hill, Concord, Mass. He graduated from Harvard College in 1899. Soon after his graduation he began helping his younger brother and sister in their education. At various times during the years 1900 to 1908, inclusive, he advanced small sums of money to defray their expenses while attending preparatory schools and colleges. The brother graduated from Harvard College in 1906. The sister graduated from Bryn Mawr College. The petitioner sometimes paid the tuition and other expenses incurred by his brother and sister as they became due. During, or at the close, of each school year the brother and sister gave the petitioner their personal notes for2509 the amount of the money advanced to them by the petitioner during the year. It was the understanding that these notes would be paid later out of their earnings. In September, 1908, the petitioner's sister gave him her personal note for $7,500, representing her total indebtedness at that time for money advanced by the petitioner for her education. In January, 1912, the petitioner's brother gave him a like note for $6,000. Neither the petitioner's brother nor his sister ever made any payments on these notes. They were both living at the close of the taxable year 1924. The brother was then 47 and the sister 50 years of age. They had been employed from time to time since their graduation from college, but their earnings had always been small and they had not accumulated any property of value. The petitioner had continued to give them financial assistance from time to time up to the year 1924. On account of the inability of the brother and sister to pay, the petitioner had never attempted to collect either of the notes. In his income-tax return for the calendar year 1924 the petitioner charged off the notes in question as bad debt losses, believing at that time that they were2510 and would remain uncollectible. OPINION. SMITH: The only question involved in this proceeding is the petitioner's right to deduct the amounts of $6,000 and $7,500 representing the notes of his brother and sister. Section 214(a)(7) of the Revenue Act of 1924 permits the deduction from gross income of debts ascertained to be worthless and charged off within the taxable year. In , the court stated that this section of the statute contemplated the deduction of bad debts within the year in which they were ascertained or reasonably should have been ascertained to be worthless and that "a taxpayer should not be permitted to close his eyes to 1144 the obvious, and to carry accounts on his books as good when in fact they are worthless, and then deduct them in a year subsequent to the one in which he must be presumed to have ascertained their worthlessness." The evidence, to our mind, does not show that the debts in question were of any less value in 1924 than in many of the prior years of their existence or that the petitioner had any more reasonable grounds for considering them uncollectible in the year 1924 than*2511 he had in prior years. There was no change in the financial condition of the debtors in the year 1924. They had never been able to pay the notes given by them and the petitioner had continued to give them financial assistance after their graduation from college. The petitioner submits that the worthlessness of the notes in 1924 was evidenced by the fact that his brother and sister had reached the ages of 47 and 50, respectively, without ever having been able to pay any part of their obligations. This fact does not, however, prove that the notes were any more uncollectible in 1924 than in prior years. Judgment will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623540/	Michael Cohen v. Commissioner. Herman M. Stein v. Commissioner.Cohen v. CommissionerDocket Nos. 205, 206.United States Tax Court1944 Tax Ct. Memo LEXIS 327; 3 T.C.M. (CCH) 236; T.C.M. (RIA) 44084; March 18, 1944327 A. Loeb Salkin, Esq., for the petitioners. Scott A. Dahlquist, Esq., for the respondent. SMITH Memorandum Findings of Fact and Opinion SMITH, Judge: These proceedings, consolidated for hearing, are for the redetermination of deficiencies in income tax for 1940 of $1,326.52 and $2,648.02, respectively. The question in issue is whether the petitioners are entitled to bad debt deductions in the computation of taxable net income for 1940 or did they sustain capital losses limited by the provisions of section 117 (d) I.R.C., as amended by section 212 of the Revenue Act of 1939. Findings of Fact The petitioners are individuals residing in New York, N. Y., with business address at 76 Ninth Avenue. They filed their income tax returns for the year 1940 with the collector of internal revenue for the second district of New York. In the income tax return filed by Michael Cohen a deduction was claimed on account of alleged bad debts in the amount of $3,546.86, which deduction was explained therein as follows: Bad Debt Advances (net) to Edwards Development Corporation on notes made on October 23, 1939, ascertained and written off as bad and uncollectible in 1940. Company was liquidated328 in 1940. Total advances made$4,666.67Less recoveries in liqui-dation1,119.81Net bad debt$3,546.86In the income tax return filed by Herman M. Stein a deduction was claimed on account of alleged bad debts in the amount of $7,093.72, which deduction was explained therein as follows: "Taxpayer advanced to Edwards Development Company $9,333.33. The taxpayer had a one-third interest in the stock of this Company, formed to acquire leasehold or royalty interests in Illinois. A leasehold was acquired and an oil drilling operation was commenced. This proved to be a dry hole, and in 1940 the property was abandoned by the Company as a total loss, and the Edward [s] Development Company dissolved. "The Company was able to repay only $2,239.61 of the taxpayer's loan, leaving the remainder of $7,093.72 a bad debt." These deductions were disallowed as bad debts by the respondent in the determination of the deficiencies and treated as short-term capital losses. During 1940 the income of both petitioners consisted of salaries received from the Davega-City Radio Co., Inc., directors' fees, dividends, and profits derived from the sale of securities. During 1938 Sidney Harris, 329 an attorney, who was an officer and director of various oil companies, discussed with petitioner Herman M. Stein the business possibilities in the oil fields of the State of Illinois, particularly in view of the development of new oil fields in Edwards County. At that time Harris was president of the Mammoth Producing & Refining Corporation, a company engaged in leasing and developing oil properties, and as part of the proposed plan it was suggested that if petitioner and his associates were willing to invest funds in such a venture the purchase of royalties could be made through that corporation. This plan was agreed to by Stein. On September 5, 1939, Sidney Harris, as president of the Mammoth Producing & Refining Corporation addressed a letter to Herman M. Stein confirming the arrangement theretofore reached. This letter stated that the two petitioners were to advance the sum of $15,000; that with this money royalty interests and/or royalty leases in Wabash and Edwards Counties, Ill., would be purchased and the interests therein were to be owned by Harris and the two petitioners in the following proportions: Sidney Harris, one-half interest, and Herman M. Stein and Michael Cohen330 two-thirds and one-third share, respectively, of the remaining one-half interest. It was further stated that all oil interests and/or oil leases would be purchased in the name of Harris and then transferred to the three members of the venture in accordance with their respective interests and that the liability of those participating in the venture would be limited to the original investment made therein and proceeds realized from the sale of royalties or oil would be used for the reimbursement of the money advanced by the petitioners before any distribution of the profits. On September 7, 1939, Herman M. Stein delivered to Sidney Harris his check for $15,000 made payable to Sylvester & Harris, the law firm of which Harris was a member, which check was deposited to a special account in a bank. This sum included $5,000 invested in the venture by Michael Cohen. Subsequently, Harris suggested to petitioner Stein that due to activity in the oil fields and the high prices of royalties it would be advisable to acquire a lease for drilling of oil wells instead of purchasing royalties and that such drilling could be done by Mammoth Producing & Refining Corporation. It was further suggested331 that on account of the personal liability which might be involved in such operations a corporation be formed by the petitioners. This was agreed to by the petitioners. Pursuant to the above arrangements between the parties, a corporation known as Edwards Development Corporation was duly organized under the laws of the State of Illinois on September 29, 1939, with an authorized capital of 100 shares without par value and in its certificate of incorporation it was specifically provided that the 100 shares of its capital stock were to be sold for an adequate consideration of $1,000. Thereafter the incorporators of the corporation duly held formal meetings for the purpose of completing the organization of the corporation a board of directors was duly elected and such board of directors duly held the usual organizational meetings and duly elected officers of the corporation. At the first meeting of Edwards Development Corporation, which was held on October 23, 1939, a resolution was duly adopted, which reads as follows: "RESOLVED, that in the opinion of the Board of Directors that the fair and reasonable value of the capital stock of this corporation at the present time is $10 per share332 and the proper officers of this corporation be and they hereby are directed to issue and sell one hundred shares of the capital stock thereof at such figure." Petitioner Herman M. Stein, on his own behalf and on behalf of his associates instructed Sidney Harris, as their attorney, to pay to Edwards Development Corporation the sum of $15,000 theretofore deposited with Sylvester & Harris and to cause the corporation to take appropriate action with respect to the issuance of its capital stock. The certificates were issued as follows: Michael Cohen33 1/3 sharesHerman M. Stein33 1/3 sharesFannie M. Stein16 2/3 sharesHerman M. Stein as Trus-tee under Declaration ofTrust dated Oct. 30, 193716 2/3 shares Sidney Harris was elected vice-president and secretary of the newly organized corporation. On October 27, 1939, and November 25, 1939, Fannie M. Stein paid to Herman M. Stein, her husband, the amounts of $100 and $66.67, respectively, for 16 2/3 shares; and on the same dates Herman M. Stein, as Trustee under Declaration of Trust dated October 30, 1937, paid to himself individually, the respective amounts of $100 and $66.67. The trust referred to was created by Herman333 M. Stein for the benefit of his son. These amounts were in payment for 16 2/3 shares of the capital stock of the Edwards Development Corporation acquired by the trust from Herman M. Stein. With the aforesaid funds received by Sidney Harris a lease was purchased jointly by the Mammoth Producing & Refining Corporation and the Edwards Development Corporation for the sum of approximately $8,500, each owning a 50 percent interest therein, and drilling was commenced. These operations proved a failure. No entries covering the aforesaid transactions were made on the books of the Edwards Development Corporation until some time subsequent to July 31, 1940, the accountant basing such book entries on information gained from minutes of the meetings of the board of directors and the stock certificate book. The aforesaid sum of $15,000 paid to petitioners by the Edwards Development Corporation was the only working capital of the corporation during its corporate existence. No notes or other evidences of indebtedness were given by Sidney Harris or the Edwards Development Corporation to petitioners of the aforesaid sum of $15,000, nor was there any understanding between them that any notes or other334 evidences of indebtedness were to be given. The board of directors of the Edwards Development Corporation did not assume any liability on behalf of the corporation with respect to loans from the petitioners, nor did they confirm any arrangement by the corporate officers obligating the corporation for such a loan. On September 9, 1940, the Edwards Development Corporation filed with the Secretary of State of the State of Illinois articles of dissolution and at about the same time a small amount of cash remaining in the corporate treasury was distributed to the petitioners. The monies paid to the Edwards Development Corporation by Michael Cohen and Herman M. Stein, and their associates, in the respective amounts of $5,000 and $10,000 represented an investment by them in the Edwards Development Corporation; the losses resulting from the liquidation of the corporation are capital losses subject to the limitations of section 117(d) of the Internal Revenue Code, as amended by section 212 of the Revenue Act of 1939. Opinion It is the contention of the petitioners herein that together they invested $1,000 in the capital stock of the Edwards Development Corporation and that they also loaned335 to it an amount of $14,000, Michael Cohen having loaned one-third of the amount and Herman M. Stein two-thirds. They contend that the loans in excess of the distributions of cash became worthless during the year 1940 and that they are entitled to deduct such amounts from gross income as debts which became worthless during the calendar year 1940. The respondent does not deny that the petitioners had losses in the amounts claimed by them. He argues, however, that Michael Cohen invested $5,000 in the stock of the Edwards Development Corporation and Herman M. Stein $10,000 and that upon the liquidation of the corporation in 1940 the investments became a total loss except for the small amount of cash received by each. We think that from the standpoint of substance the respondent's contention is correct. Clearly all monies advanced by the petitioners to the Edwards Development Corporation were at the risk of the business. The corporation had no assets besides the $15,000 that was paid into it by the petitioners. They knew at the time that the investments were made the monies would be lost if the oil well that was to be driven on the leased premises proved to be a dry hole. It did prove336 to be a dry hole. No differentiation can be made between the amounts invested in the stock of the corporation and the loans to the corporation. The facts in these proceedings are analogous to those in Edward G. Janeway, 2 T.C. 197">2 T.C. 197. In that case the taxpayers and others advanced money to a corporation receiving notes and corporate stock in direct proportion to the amount of money invested by the stockholders. The corporation had no assets or capital except the advances so made. We held that the taxpayers owned securities and that the loss resulting from the dissolution of the corporation was limited under the statute as a loss from the sale or exchange of capital assets. Likewise, in Joseph B. Thomas, 2 T.C. 193">2 T.C. 193, we held that monies advanced by a taxpayer to a corporation in 1938 and early in 1939 constituted a capital investment in and not a loan to the corporation and that since the investment became worthless in the tax year 1939 the loss thus sustained was a capital loss, the deductibility of which was limited by section 23 (g) (1) and (2) of the Revenue Act of 1938. The above cited cases are dispositive of the *337 present proceedings. Decisions will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623543/	D. H. BROWN, BY JAMES A. MITCHELL, GUARDIAN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Brown v. CommissionerDocket Nos. 5633, 5634.United States Board of Tax Appeals5 B.T.A. 209; 1926 BTA LEXIS 2920; October 27, 1926, Decided 2920 Held, on the evidence, that the debts were not shown to have been ascertained to be worthless during the taxable year involved. Frank M. Dixon, Esq., for the petitioner. W. Frank Gibbs, Esq., for the respondent. TRAMMEL 209 These are proceedings for the redetermination of deficiencies in income tax for 1918, 1919 and 1920, in the amounts of $2,730.13, $31.69 and $7,086.47, respectively. The deficiencies arise on account of the action of the Commissioner in disallowing as deductions bad debts and a loss on account of advances to a corporation of which petitioner's ward was the principal stockholder. FINDINGS OF FACT. The petitioner's ward, D. H. Brown, was adjudged insane in 1924, and the petitioner was duly appointed and qualified as his guardian and instituted these proceedings in that capacity. D. H. Brown is at this time incarcerated in an insane asylum. 210 For several years prior to 1918, D. H. Brown had been engaged in the coal brokerage business as an individual, under the name of D. H. Brown & Co., with offices in Birmingham, Ala. The business was that of middleman - bringing seller and buyer of coal together, 2921 and also buying and selling coal. Paul Lanier was employed as manager of the business. In April, 1918, a corporation known as the Ajax Coal & Mining Co. was organized with a capital stock of $10,000, of which Brown subscribed and paid for $9,000 in cash, and Lanier $1,000 in cash. Thus Brown became the owner of nine-tenths of the capital stock. That corporation acquired a small tract of mining property on which a wagon mine was then being operated, and acquired forth acres on which it owned the mineral rights and a lease on another forty acres with two or three years to run at the time of the organization of the corporation. The royalties required to be paid were unusually high, being considerably higher than any other royalties in that territory. The seam of coal acquired by the corporation had a slope of about 85 degrees. By reason of the pitch of the coal the timbering cost was at least 35 cents a ton above the average. The workings were spread over a distance of 3,000 feet, necessitating a long haul and abnormal handling charges. The miners were paid by the car, although the coal was sold by the ton, and no weighing device was installed to verify the weights. On account2922 of these circumstances, the corporation could not successfully operate the mine and could not compete with other concerns. In addition to the money paid out by Brown in acquiring the capital stock of the Ajax Co., in the latter part of 1918 and the first part of 1919, Brown advanced to that corporation a total of $35,000, and about the first of February, 1918, he received from that corporation notes in the amount of $35,000, payable to him, representing the money he had advanced. In addition to the above advances, Brown made further advances in 1921, 1922 and 1923, until, at the end of 1923, a total of $87,631.91 had been advanced. Of the $35,000 advanced up to February, 1919, $7,000 was repaid, leaving $28,000 of the advances unpaid. The books of D. H. Brown & Co. showed all the transactions in the coal brokerage business and some of the transactions of D. H. Brown personally, but did not contain a complete record of all of Brown's transactions. In 1918 the Ajax Co. lost from operations $17,793.98. In 1919 it made a profit of $3,419.19, and in 1920 a profit of $12,937.89. From 1921 to 1925, inclusive, it sustained losses, and in 1925 it was adjudged a bankrupt. 2923 Brown, in his income-tax return for 1918, took a deduction of $15,000 as a loss on account of advances made to the Ajax Co. In 211 his return for 1920 he claimed $15,976.70 as a deduction on account of bad debts, and $8,076.23 as a deduction on account of "losses and adjustments." The Commissioner conceded the deductibility of $6,239.04 of the total amount claimed. The debts sought to be deducted are as follows: George O. Berry$702.53Farmer's Cotton Oil & Trading Co.1,593.45Gulf & Ship Island Ry. Co4,110.92New Orleans Coal Co2,332.32Southern Railway Co450.90Southern Railway Co3,340.65Pratt Engineering Co2,500.00Atlanta & St. Andrews Bay Ry. Co1,448.55Gulf States Steel Co826.40W. M. Murray59.10W. H. Medlin153.63Gude & Co189.15Practically all of the above amounts represented indebtedness on account of coal shipped during 1920. The books of the taxpayer, while kept on the calendar year basis, were not actually closed until a few days before the 15th of March, 1921, being held open until the income-tax return was about ready to be filed. The facts and circumstances relating to the various acounts are as2924 follows: The taxpayer had general information that Berry was nearly insolvent and the chances of collection of his debt looked very doubtful. The account was paid in 1922. The coal for which the account was due was sold to Berry in December, 1920. He was written a letter for the first time asking for payment the latter part of January, 1921. The account of the Farmer's Cotton Oil & Trading Co. was for coal sold during December, 1920. A partial payment was made on the account January 17, 1921, another payment was made February 4, 1921, and another payment March 3, 1921, making a total amount paid on the account of $909.85, which was paid on or before March 3, 1921, leaving a balance of $1,593.45 unpaid when the income-tax return for 1921 was prepared. This company became financially involved in 1921 and either offered a creditors' settlement or went into bankruptcy in that year. The Gulf & Ship Island Railway Co. was indebted to the taxpayer for coal shipped over its line to a purchaser but which was confiscated and used by the company. The coal was shipped on November 30, 1920. It was confiscated shortly thereafter, before it reached its destination. The Gulf & Ship2925 Island Railway Co. was in existence 212 and operating its railroad up until about 1925, when the Illinois Central Railroad Co. purchased it. The greater part of this account was paid during 1921, some of it being paid later. The account of the New Orleans Coal Co. was for coal sold and shipped during November and December, 1920. The New Orleans Coal Co. was a large concern, to which the taxpayer shipped large quantities of coal. That company claimed that it never received the coal represented by the account and denied liability. The account against the Southern Railway Co., in the amount of $450.90, was for coal which the taxpayer claimed the railroad had confiscated. This the Railroad Company denied. The account was finally settled in May 1921. The account against the Southern Railway Co., in the amount of $3,340.65, was divided into two accounts, one for $3,278.25 for coal shipments, and the other for $62.40 for a claim of some nature. The account was paid in March, 1921. The account was charged off the books because it was sixty days past due and the taxpayer "had no way of telling whether the Southern would go into the hands of a receiver or not." The2926 Atlanta & St. Andrews Bay Railway Co. owed a balance of $1,448.55, on account of coal sold and shipped during the latter part of 1920, which represented confiscations of coal that had been taken off of other accounts and charged to the railroad. It was paid during 1921. The Gulf States Steel Co.'s account at the end of 1920 was $826.40. It denied liability for this coal upon the ground that it had never received it. This amount of coal never arrived at the plant of the Steel Company. It remained charged to that company until the taxpayer located the coal and determined where it went. It was finally charged to railroads that had confiscated it and was paid for by them. The account against W. M. Murray, in the amount of $59.10, was denied by Murray upon the ground that the coal shipped him was of an inferior quality. The taxpayer acknowledged this fact and made an allowance to Murray. The account of W. H. Medlin, in the amount of $153.63, represented the unpaid balance due on coal sold in October, 1920. The account had not been paid up to March, 1921, and at that time Medlin's affairs were in bad shape. Later, in 1921, he made a compromise settlement and the taxpayer2927 accepted $55 in settlement. The account against Gude & Co. was for coal sold the latter part of 1920 but which had not been paid for at the time the books were closed in March, 1921. 213 The Pratt Engineering Co. had not paid its account up to March, 1921. It was in bad financial condition and in 1921 made a settlement with its creditors and paid approximately 50 per cent. OPINION. TRAMMELL: The first question involved is whether the taxpayer, D. H. Brown, is entitled to a deduction in 1918 or 1919 with respect to advances made to the Ajax Co., and whether he is entitled to a loss with respect to his investment in the stock of that company. During 1918 and 1919 the Ajax Co. was a going concern. It had net profits during 1919 and 1920 and there is no evidence to show that it was not solvent. There is no evidence that the account due by that company on account of the advances was ascertained to be worthless either in 1918 or 1919. There is no evidence that Brown exercised bad judgment in his control of the corporation in acquiring the properties which the corporation operated. The royalties required to be paid were unusually high and the coal could not be2928 as economically mined and handled as other coal, but these facts did not establish the worthlessness of the debt due by that corporation or the worthlessness of the company's stock. With respect to the debts charged off before the closing of the books for 1920 in March, 1921, the evidence does not convince us that they were ascertained to be worthless during the taxable year 1920. Judgment will be entered for the Commissioner.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623544/	J. Rene Harris, Petitioner, v. Commissioner of Internal Revenue, RespondentHarris v. CommissionerDocket No. 36353United States Tax Court22 T.C. 1118; 1954 U.S. Tax Ct. LEXIS 110; August 31, 1954, Filed August 31, 1954, Filed 110 Decision will be entered for the respondent. During the taxable year petitioner was postmaster of the United States post office at Taylorsville, Kentucky. His compensation was in the form of an annual salary; and, subject to the direction of the Postmaster General and under the rules and regulations issued by him, petitioner performed the services required and necessary in the management of the said post office, and as a condition of or incident to his employment, made certain expenditures, for which he was not reimbursed by the Government. Held, that the business of the petitioner consisted of the performance of services by him as an employee within the meaning of section 22 (n) (1) of the Internal Revenue Code of 1939; and, as a consequence, he is not entitled under that section to deduct the expenses in question from his gross income in arriving at his adjusted gross income. J. Rene Harris, pro se.Michael J. Clare, Esq., for the respondent. 112 Turner, Judge. TURNER 1119 The respondent determined a deficiency in income tax against the petitioner for the year 1948 in the amount of $ 63.32. The question for determination is whether, within the meaning of section 22 (n) (1) of the Internal Revenue Code of 1939, petitioner was engaged in a trade or business which did not consist of the performance of services by him as an employee, and if so, whether certain expenditures made by him were attributable to the trade or business and were deductions which are allowable under section 23 of the 1939 Code.FINDINGS OF FACT.Petitioner is an unmarried individual and lives in the vicinity of Taylorsville, Kentucky. He filed his income tax return for 1948 with the collector of internal revenue for the district of Kentucky.During 1948 he was postmaster of a second class United States post office at Taylorsville. The post office was housed in a building which had been rented by petitioner for $ 780 a year, which rent was covered by and paid from an appropriation made by Congress. Working under petitioner were three clerks and four rural route carriers.When petitioner became postmaster in 1941, he purchased items of equipment113 and fixtures from his predecessor for use in the post office, as follows:Call boxes and general delivery window$ 15.00Front fixtures25.00Sorting table and four boxes10.00Cancelling table and stool10.00Parcel post case and routing case7.50Clock5.00Postmaster desk, stool, and chair2.50Stove25.00$ 100.00For his services as postmaster in 1948, petitioner received a salary of $ 3,606.25, which was his total compensation therefor.On his 1948 income tax return, petitioner reported $ 6,351.43 as his adjusted gross income. That amount was composed of two items: 1120 $ 3,052.68, described as net executor's fees; and $ 3,298.75, which was his salary of $ 3,606.25, minus $ 307.50, described as "Expenses in work," the details of which were shown in an attached schedule as follows:Gas, oil, etc., used in work$ 111.60Repairs to fixtures at post office26.50Premium -- Bond13.00Box rents, bulbs, floor sweep, incidentals156.40Total$ 307.50In arriving at his net income, petitioner deducted from his reported adjusted gross income as the standard deduction allowable, $ 635.14, which was 10 per cent of such reported adjusted gross114 income and less than $ 1,000, which otherwise would have been the amount of the standard deduction allowable.The expenditures for "Gas, oil, etc." were made to cover automobile expense incurred on trips between Taylorsville and Louisville, Kentucky, and around the routes covered by the rural carriers working out of the Taylorsville post office. The amount deducted was computed on a basis of 9 cents per mile for the trips made. The 9-cent rate was selected because that represented the allowance made by the Government to the rural mail carriers for automobile expense. The petitioner as postmaster at Taylorsville made his reports, both monthly and quarterly, to the district office, which was located in Louisville. He also filed his personal bond with, and made his remittances to, that office. The district officer was also the postmaster of the Louisville post office. Most of petitioner's trips to Louisville were for the purpose of conferring with, and reporting to, the district office and for the purchasing of supplies, such as stamps and postal cards. Petitioner was an active worker in the Red Cross and some of his trips were primarily in the interest thereof, and the transaction115 of business relating to his duties as postmaster was incidental. Petitioner was required to make periodic trips over the rural routes running from the Taylorsville post office, but it was also required that such trips be made at no expense to the Government. Without cost to him, he was privileged to make these trips with the route carriers.Included in the $ 26.50 deducted as amounts expended for repairs to fixtures at the post office, were $ 6 for stove pipe and $ 10 for a sorting case. Other amounts were expended for repairs to post office lockboxes. The sorting case was an upright structure, made of wood and containing pigeon holes for sorting mail. Up to and including 1948, the Government had not provided the post office at Taylorsville with sorting cases or similar facilities.1121 To qualify as postmaster, petitioner was required to make a personal bond in the principal amount of $ 13,000. The premium on the bond for 1948 was $ 13, and was paid by petitioner.Of the $ 156.40 deducted on the return as having been expended for box rents, bulbs, floor sweep, and incidentals, $ 24 represented the rental paid by petitioner for lockboxes. During 1948 and prior thereto, 116 the Government did not furnish the Taylorsville post office with lockboxes and the petitioner was required to furnish them at his own expense. Included also were $ 24 paid for electric light bulbs, $ 15 for floor sweep, $ 6 for laundering towels, and $ 32 for the building of a fire each morning in the post office stove during the winter months.As to none of the above expenditures was petitioner ever reimbursed by the Government.The respondent, in his determination, disallowed the deduction of $ 307.50 made on the return in arriving at adjusted gross income, the ground for the disallowance being that the expenditures in question were not deductible "in computing adjusted gross income under the provisions of Section 22 (n) of the Internal Revenue Code."OPINION.The primary question is whether petitioner's serving as postmaster of the Taylorsville post office was a trade or business carried on by him, which trade or business did "not consist of the performance of services as an employee" within the meaning of section 22 (n) (1) of the Internal Revenue Code of 1939. 1118 If it was such a trade or business, petitioner was within his rights in deducting from gross income, for purposes117 of arriving at adjusted gross income, all of the above expenditures attributable to such business which, under section 23 of the 1939 Code, would have been allowable deductions from gross income for the purpose of computing net income. If, on the other hand, the business of serving as such postmaster was a trade or business which did consist of the performance of services by him as an employee, not only is he not entitled to deduct the said expenditures from gross income, in arriving at adjusted gross income, but neither is he entitled to deduct the said expenditures under section 23, even though they were of such character as to be so deductible, the reason being that in making his return, he elected to take in lieu of 1122 those deductions, the standard deduction provided in section 23 (aa) (1) (A) of the 1939 Code, 2 and that election is thereafter irrevocably binding upon him under section 23 (aa) (3) (C).That the trade or business carried on by the petitioner did consist of the performance of services is, in our opinion, established by the facts, and we do not understand that he contends otherwise. It is his claim, however, that he was not an employee of the Government, that he rendered no services119 as such, and accordingly was not barred under section 22 (n) (1) from taking the deductions claimed, for the purposes of arriving at his adjusted gross income. He was not represented by counsel, but undertook to present his own case, and his interpretation of the law and application thereof to the facts are not as definite and clear as we would have liked. His contention that he was not an employee is based first on the proposition that section 851, chapter 23, Title 39, of the United States Code, which has to do with personnel of the postal service, "expressly excludes a second class postmaster" in defining the term "employee," and that Congress, in enacting the revenue laws, could not have intended that he, as such second class postmaster, should be regarded as an employee for the purposes here. In addition, there is some indication in the discussion in his brief that he considers his status to have been that of an independent contractor, or, at least, that it was comparable thereto. There is also some indication that he regarded himself as an officer of the United States Government, as distinguished from an employee, and, for that reason, that the services rendered by him as120 postmaster of the Taylorsville post office may not be said to have been rendered by him "as an employee," under section 22 (n) (1).Aside from the well established principle that a particular statute is to be construed and applied according to its own terms, intent, and purposes, the provisions of section 851 of the Postal Service Code, themselves, demonstrate that the definition therein of the term "employees" is limited to the particular purposes of that code and is of no significance or force in the instant case. By that section, it is provided that "The term 'employees' wherever used in this chapter 1123 shall include officers, supervisors, special-delivery messengers in offices of the first class, and all other employees paid from field appropriations of the postal service, other than postmasters, skilled-trades employees of the mail-equipment shops, job cleaners in the first- and second-class post offices, and employees who are paid on a fee or contract basis." By explicit language, the term "employees," as defined in the said section, was specifically limited to its use in chapter 23 of the Postal Service Code, which chapter has to do with the reclassification of the121 personnel of the postal service, and it is also to be noted, in passing, that some of the personnel whom the section itself identified as employees were included in the term "employees," as defined, while others so identified were excluded.It is our further conclusion on the facts that the petitioner was not an independent contractor. Certainly the post office operation itself was not his business, but that of the United States. He was, to say the least, a member of the salaried personnel of the Government. The performance of his duties was subject to rules and regulations prescribed by his superiors, and he did not have that freedom in the exercise of discretion and judgment in the conduct of the post office operations which is inherent in the status of an independent contractor. See Raymond E. Kershner, 14 T. C. 168, wherein it was concluded that the taxpayer's business was that of rendering services as an employee, and not as an independent contractor, and Irene L. Bell, 13 T.C. 344">13 T. C. 344, where it was found that the business of the taxpayer was that of an independent contractor, and not that of an employee. In 122 the Kershner case, we quoted from A. P. Dowell, Jr., 13 T. C. 845, to the effect that an independent contractor is usually one who contracts to do certain work according to his own methods and without being subject to the control of the employer, except as to the product or result of his work. That a postmaster of a United States post office in the performance of his duties as such does not enjoy such latitude or freedom from control and supervision, does not in our opinion require further elaboration.As to whether or not a Government officer, as distinguished from an employee and whose business likewise consists of the performance of services, would as a matter of law be permitted or denied the benefits of section 22 (n) (1) in arriving at his adjusted gross income, the respondent has not taken a position, but seeks disposition of the matter on the ground that, whereas an officer exercises "discretion and control," as distinguished from the performance of duties which are wholly prescribed under rules and regulations of the executive branch of the Government, the duties of the petitioner were ministerial in nature, and were accordingly those of123 an employee. Certainly there is nothing in section 22 (n) (1) itself to indicate that Congress, in 1124 enacting that section, had any thought or intent that the test, as to whether the salaried personnel of the Government, whose business was that of rendering personal services, would or would not be entitled to the benefits of that section, should be whether, strictly or technically speaking, they happened to be employees of the Government or officers.The concept of adjusted gross income was introduced into the Internal Revenue Code of 1939 as section 22 (n) by the Individual Income Tax Act of 1944, and some understanding of the meaning of its provisions and the intent of Congress with respect thereto is to be had from the reports of the congressional committees. In Senate Report No. 885, 78th Congress, 2d Session, the Committee on Finance said, in part:Fundamentally, the deductions thus permitted to be made from gross income in arriving at adjusted gross income are those which are necessary to make as nearly equivalent as practicable the concept of adjusted gross income, when that concept is applied to different types of taxpayers deriving their income from varying sources. 124 Such equivalence is necessary for equitable application of a mechanical tax table or a standard deduction which does not depend upon the source of income. For example, in the case of an individual merchant or store proprietor, gross income under the law is gross receipts less the cost of goods sold; it is necessary to reduce this amount by the amount of business expenses before it becomes comparable, for the purposes of such a tax table or the standard deduction, to the salary or wages of an employee in the usual case. * * At another place in the report, it was said:The only expenses in connection with his employment which are deductible by an employee electing the standard deduction, as distinguished from an individual entrepreneur, are those which he incurs for travel, meals, and lodging while away from home, or those for which he is reimbursed directly by a separate payment by his employer. Thus, for example, an employee who incurs expenses for his employer for which he is reimbursed or for which he receives a per diem remuneration, would include in his gross income the amount of the per diem or reimbursement but would be entitled to deduct the amounts paid out by him for125 expenses.From a reading of section 22 (n) (1), and in light of what was said in the portions of the committee report quoted above, we think it apparent that Congress in that section was making provision for the deduction from gross income, in arriving at adjusted gross income, of expenditures made in a trade or business, even though the trade or business might consist of the rendering of personal services, wherein the enterprise or business was not only the independent operation of the taxpayer but the expenditures, in addition to being such as would reasonably be required in those operations, would also be a substantial factor in earning and enhancing the profits anticipated from the enterprise, and that it intended to and did exclude therefrom a trade or business consisting of the performance of personal services where the services were controlled, supervised, or directed and rendered in the operations of another and the quantum of the earnings or profits, 1125 such as salaries or wages, was not so likely to be influenced by, or so directly dependent upon, such expenditures as might be made by the taxpayer as a condition of or incident to his employment.The position of postmaster, 126 whether of the first, second, or third class, is, and from as early as 1938 has been, a position "without term" in the classified civil service, section 31a, Title 39, of the United States Code, and while appointments are made by the President, by and with the advice and consent of the Senate, they are made by promotion from within the postal service, or by competitive examination in accordance with the civil service acts and rules. Secs. 31a and 31b, 39 U. S. C. The compensation for the services rendered is in the form of an annual salary fixed by the Postmaster General but within the ranges, as to amount, specified by statute. Broadly speaking, the business of the petitioner was that of managing the Taylorsville post office for the Government; it was that of performing the services required and necessary in supervising and directing the handling of the mail, parcel post, money orders, and the like to and from that post office; and while it was anticipated and expected that he would exercise sound personal discretion and judgment in the performance of his duties as such postmaster, his functioning was under the Postmaster General and the rules and regulations promulgated by him127 covering the operation of post offices, particularly post offices of the second class. He was required to keep records of the business done, in such form as the Postmaster General should direct, and at such times and in such form as should be prescribed, and he was required to render accounts "of all moneys received or charged by him or at his office, for postage, rent of boxes or other receptacles for mail matter," for the delivery of mail matter, "or for the performance of any other function connected with his office." The Postmaster General had the authority to require a certification of each account, to the effect that the statements in the account were true, that petitioner had not knowingly delivered, or permitted to be delivered, any mail on which the postage was at the time not paid, that the account exhibited truly and faithfully the entire receipts collected at his office, and which, by due diligence, could have been collected, and that the credits claimed were just and right. Secs. 41, 42, and 43, 39 U. S. C. In serving as postmaster of the Taylorsville post office, petitioner was required to report, and did report, regularly to the district officer in Louisville. As128 previously noted, the post office itself was not the petitioner's business, and the employees were not his employees, but those of the Government. His business with respect to the employees was that of supervising and directing them for and on account of the Government in the performance of their duties.On the basis and in the light of the considerations stated, it is our opinion, and we conclude, that the business of the petitioner 1126 in acting and serving as postmaster of the Taylorsville post office consisted of the rendering of services by him "as an employee" within the meaning of section 22 (n) (1), supra, and that such is the case, even if for other purposes he may with nicety be referred to as an officer of the Government rather than an employee. It is true that, as a condition of his employment, he was required to post a personal bond and personally pay the premium thereon, and was also required to provide lockboxes for use in the post office, so long as they were not furnished by the Government, and did make certain other expenditures as an incident to his employment for which he was not reimbursed, but those expenditures, in our opinion, were not such as 129 to change his status as postmaster from that of an employee within the meaning of the statute, to that of an independent contractor or entrepreneur, as was envisioned by Congress in enacting the law. In making such expenditures, he was in our opinion in a position no different from other employees who, as an incident to or condition of their employment, were required to supply their own tools, as in the case of certain mechanics, to pay union dues, to furnish their own uniforms, or to provide the use of an automobile, as was the situation in the case of Raymond E. Kershner, supra. Such expenditures may, of course, be deducted under section 23 of the Internal Revenue Code of 1939 for the purpose of computing net income, provided the taxpayer does not elect, as petitioner did in the instant case, to take in lieu thereof the standard deduction provided in section 23 (aa).In reaching the above conclusion, we are not unmindful of the fact that Congress, in certain revenue legislation, has seen fit to use the terms "officers" and "employees" in conjunction in referring to Federal and State personnel, whereas in section 22 (n) (1) of the 1939 Code reference130 is to an "employee" only. See section 22 (a) of the Internal Revenue Code of 1939, wherein gross income is defined as including income in the form of salaries, wages, or compensation derived from personal services as "an officer or employee" of a State or political subdivision, and section 201 (a) of the Revenue Act of 1917, wherein the compensation or fees of "officers and employees under the United States, or any State, Territory, or the District of Columbia" were exempted from taxation thereunder. The use of the terms in those statutes was for the particular purpose in the one case of specifically including in gross income the salaries, wages, or compensation of all individuals receiving salaries, wages, or other compensation for performing services for a State or political subdivision, whether they were denominated officers or employees; and in the other instance, that of excepting from taxation the compensation of all individuals who were performing services in connection with, or as a part of, the essential governmental functions of the Federal Government, a State, or a political subdivision thereof, and whether they 1127 might be termed officers or employees. See Metcalf & Eddy v. Mitchell, 269 U.S. 514">269 U.S. 514.131 We find in those provisions, however, no basis for assuming or concluding that such use of the term "officer" in conjunction with the term "employee" for the purposes indicated has anything to do with or is indicative of the meaning and intent of section 22 (n) (1).Decision will be entered for the respondent. Footnotes1. SEC. 22. GROSS INCOME.(n) Definition of "Adjusted Gross Income." -- As used in this chapter the term "adjusted gross income" means the gross income minus -- (1) Trade and business deductions. -- The deductions allowed by section 23↩ which are attributable to a trade or business carried on by the taxpayer, if such trade or business does not consist of the performance of services by the taxpayer as an employee;2. SEC. 23. DEDUCTIONS FROM GROSS INCOME.(aa) Optional Standard Deductions for Individuals. -- (1) Allowance. -- In the case of an individual, at his election a standard deduction as follows: (A) Adjusted Gross Income $ 5,000 or More. -- If his adjusted gross income is $ 5,000 or more, the standard deduction shall be $ 1,000 or an amount equal to 10 per centum of the adjusted gross income, whichever is the lesser, except that in the case of a separate return by a married individual, the standard deduction shall be $ 500. * * (3) Method and effect of election. -- * * *(C) If the taxpayer does not signify, in the manner provided by subparagraph (A) or (B), his election to take the standard deduction, it shall not be allowed. If he does so signify, such election shall be irrevocable.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623545/	Joseph S. LoParo v. Commissioner.Joseph S. LoParo v. CommissionerDocket No. 17398.United States Tax Court1949 Tax Ct. Memo LEXIS 84; 8 T.C.M. (CCH) 795; T.C.M. (RIA) 49214; September 1, 194984 Petitioner's income for the calendar years 1944 and 1945 determined by the net worth method, and the respondent's imposition of a 50 per cent addition to the tax for fraud in each taxable year sustained. Elmer J. Patton, Esq., 811 Hanna Bldg., Cleveland 15, Ohio, for the petitioner. Lawrence R. Bloomenthal, Esq., for the respondent. ARUNDELLMemorandum Findings of Fact and Opinion The Commissioner has determined the following deficiencies in income tax for the calendar years 1944 and 1945 and has imposed in each year a 50 per cent addition to the tax for fraud: AdditionYearDeficiencyto TaxTotal1944$10,263.84$5,131.92$15,395.7619455,303.212,651.617,954.82$23,350.58The petitioner in this proceeding alleges that the respondent erred in determining the amount of the deficiencies and in imposing in respect thereto additions to tax for fraud in each of the taxable years involved. Findings of Fact The petitioner, Joseph S. LoParo, is an individual who now resides at 1303 W. 110th Street, Cleveland, Ohio. His income tax returns for the calendar years 1944 and 1945 were filed with the collector of internal85 revenue for the 18th district of Ohio at Cleveland, Ohio. During the year 1944 the petitioner owned and operated the following business enterprises: NameBusinessLoParo Distributing Co.Orange drink distrib-utor for Bireley's Inc.Lubeck CasinoBar and restaurantMickey (Merry) MouseBar and restaurantCafeBarberton Tap RoomBarDuring 1945 petitioner sold the LoParo Distributing Company and the Barberton Tap Room. During the years in question, petitioner employed managers and other employees in each of his business establishments and engaged an accountant to maintain the business books and records and prepare his individual income tax returns. Petitioner's books and records were kept and his returns were filed on a cash receipts and disbursements basis. No inventories of goods sold were maintained although the tax returns for 1944 and 1945 showed the same opening and closing inventory figure of $200. In 1944 petitioner purchased over $5,000 worth of liquor which was not recorded on his books and which was not deducted by him in his tax return for that year. Petitioner included in his income for 1944 the amount of $1,040 from coin machines86 and additional income of $500 not reflected in his business records. In 1945 petitioner included in his income the amount of $2,600, representing an estimate of funds withdrawn by him from the business. This figure likewise was unsupported by his books and records. No improper deductions were found by the respondent in petitioner's tax returns for either 1944 or 1945. The petitioner's books and records did not accurately reflect his correct taxable income for the years in question. The respondent therefore recomputed the petitioner's income for each year by the so-called "net worth" method. In recomputing petitioner's income for 1944 and 1945 under the net worth method, respondent determined petitioner's assets and liabilities as of December 31, 1943, 1944, and 1945, in the following amounts: Assets194319441945Cash on Hand$10,000.00$ 5,000.00$ 2,000.00Cash in BanksCleveland Trust Co.Sav. #149981,505.122,115.222,134.03Sav. #2583401,000.002,111.27Sav. #2475680.0000Com'l. - Lubeck Cassino - Joe LoParo206.00137.595,426.78Morris Plan (Bank of Ohio)Sav. #180877.71100.661,309.22Com'l. - Jack McHugh & Joe LoParo87.531,245.481,073.68Com'l. - Josephine LoParo00890.70Central NationalSav. #P461010013,841.50Sav. #6938800475.75Com'l. - Josephine LoParo0092.98Com'l. - LoParo Dist. Co. - Joe LoParo2,362.454,657.570War Bonds - Series E2,812.502,850.002,550.00American Dist. Stk. - 10 shares01,100.001,100.00Inventories2,200.009,700.0014,200.00Automobiles1941 Chrysler1,268.501,268.501,268.501937 Nash00100.00Furniture - Fixtures - EquipmentJ. LoParo Dist. Co. (J. LoParo)7,461.507,461.500Lubeck Cassino (Rose Zingale)2,460.002,460.002,460.00Mickey Mouse (Josephine LoParo)3,965.003,965.003,965.00Barberton Tap Room (Josephine LoParo)09,664.000Real Estate10304 Lake Ave. (Rose Zingale)15,000.0015,000.0015,000.001722-6 Payne Ave (Joe & Santa Manzeo) 1/2 int.002,875.001704-8 E. 18 St. (Frank Kilbane)0015,750.00Total Assets$49,416.31$67,725.52$88,624.41LiabilitiesMortgagesPension Fund-Evan Church (Rose Zingale)$ 9,900.00$ 6,533.23$ 2,234.52Cleve. Trust (Joe & Santa Manzeo) 1/2001,070.61Roumanian Sav. & Loan (Frank Kilbane)006,773.62Loans and Chattel MortgagesMorris Plan - Bank of Ohio2,768.0000Depreciation Reserves: LoParo Dist. Co.6,294.086,992.460Lubeck Cassino1,620.002,161.002,210.00Mickey Mouse198.25594.75991.25Barberton Tap Room083.200Total Liabilities & Reserves$20,780.33$16,364.64$13,280.00Net Worth$28,635.98$51,360.88$75,344.41Net Worth - Previous Year$28,635.98$51,360.88Increase - Net Worth$22,724.90$23,983.5387 Petitioner is in complete agreement with the respondent's determination of liabilities and concurs in his determination of assets for each year with the exception of the amounts representing cash on hand as of December 31, 1943, 1944, and 1945, and the ownership of funds on deposit in 1944 and 1945 in savings account #25834 which was held in the joint names of the petitioner and his mother. The funds in savings account #25834 were solely owned by the petitioner's mother and did not at any time represent the property of the petitioner. In June, 1943, petitioner's father, Carmelo LoParo, was seriously ill and summoned to his home his entire family, including two sons who were then serving in the Armed Forces. In the presence of his assembled relatives he turned over to the petitioner, his eldest son, the sum of approximately $33,000 in cash. Petitioner had cash on hand in the amounts of $27,000 as of December 31, 1943; $17,000 as of December 31, 1944, and $6,000 as of December 31, 1945. Respondent determined that the petitioner's income tax returns for 1944 and 1945 understated his true income in the amount of $22,110.50 and $11,548.37, respectively. The respondent's determination88 was as follows: 19441945Net Worth (Increase)$22,724.90$23,983.53Personal, Family, Living Expenses3,600.003,600.00Income Taxes Paid800.00600.00Indicated Net Income$27,124.90$28,183.53Less: Non-taxable Income50% Long Term Capital Gain6,524.21Taxable Net Income$27,124.90$21,659.32Standard Deduction500.00500.00Adjusted Gross Income - Corrected$27,624.90$22,159.32Adjusted Gross Income - Reported5,514.4010,610.95Understatement of Income$22,110.50$11,548.37Petitioner admitted in his petition and reply understatements of income in his tax returns for 1944 and 1945 in the amounts of $10,245.36 1 and $2,765.80, 1 respectively; and deficiencies in tax of $3,855.89 for 1944 and $1,263.38 for 1945. A part of the deficiency due for each of the calendar years 1944 and 1945 is due to fraud with intent to evade tax. Opinion ARUNDELL, Judge: The first issue herein concerns the amount of petitioner's taxable income for the calendar years 194489 and 1945. In determining the deficiencies for each year, the respondent rejected the petitioner's books and recomputed his income under the so-called net worth system. Although the respondent concedes that the petitioner's tax returns were in accord with his books, except as to several items of income which were estimates of the petitioner, neither party herein contends that the books completely or accurately disclosed his correct income for either taxable year. The petitioner, in contesting the respondent's determination, has not introduced his business records in evidence, nor has he attempted to prove their adequacy. In fact, petitioner concedes understatements of income of $10,245.36 for 1944 and $2,765.80 for 1945, which he bases on the respondent's recomputation of net worth for each year with the exception of two items, namely, the amount of cash on hand as of December 31, 1943, 1944, and 1945, and the ownership of funds deposited in a joint savings account held in the names of the petitioner and his mother during 1944 and 1945. The parties are in agreement concerning the value of other assets and the amount of petitioner's liabilities in each year. Therefore, we are called90 upon to make a determination only in connection with the two elements of net worth upon which the parties have been unable to agree. Petitioner contends that, exclusive of funds on deposit in various bank accounts, he had cash on hand amounting to $32,100.31 as of December 31, 1943, $17,232.15 as of December 31, 1944, and $6,160.75 as of December 31, 1945, rather than $10,000, $5,000 and $2,000 as determined by the respondent as cash on hand on the same dates. The respondent's refusal to accept the petitioner's explanation that he received $33,000 in cash from his father in June of 1943 accounts in a large measure for the difference between the parties in respect to the figures representing cash on hand. However, we have found that petitioner's father, who was seriously ill during June, 1943, and who died shortly thereafter, called his entire family together at his home, including two sons in the Armed Forces, one of whom was serving overseas, and, in the presence of his assembled relatives, turned over to the petitioner the sum of approximately $33,000. The petitioner, two of his brothers, and a sister all testified in great detail as to the events of the meeting and particularly91 the father's giving of $33,000 to the petitioner. It is impossible to determine from the record with any degree of accuracy the total amount of cash available to the petitioner during 1943. However, there is evidence that the petitioner made substantial expenditures during 1943 for medical expenses, taxes, personal living expense, contributions, the purchase and improvement of properties, and payments on existing indebtedness which in our judgment certainly reduced his cash on hand at the end of 1943 to a figure less than $32,000. Having given full consideration to the petitioner's assets and expenditures during 1943 in so far as they are disclosed in the record before us, it is our judgment and we have so found as a fact that the petitioner had cash on hand as of December 31, 1943 of $27,000. From a similar analysis of the evidence of petitioner's financial affairs in the years 1944 and 1945, we have reached the conclusion that he had cash on hand as of December 31, 1944, and December 31, 1945, of $17,000 and $6,000, respectively. The second element of the petitioner's net worth which is in dispute is the ownership of the savings account which was held in the joint names of petitioner92 and his mother during 1944 and 1945 at the Cleveland Trust Company. All of the evidence presented is to the effect that the funds deposited in this account were the separate property of the petitioner's mother and that the account was opened by the mother in their joint names only to insure petitioner's receiving the money therein in the event of her death. Therefore, it is our opinion that the respondent erred in treating the amounts deposited in that account, namely, $1,000 in 1944 and $2,111.27 in 1945, as assets of the petitioner in those years. The remaining issue concerns the correctness of the respondent's imposition of a 50 per cent addition to the tax for fraud in each of the taxable years in question. It has been stated that in assessing income taxes the Government relies primarily upon a full and honest disclosure by the taxpayer of all the relevant facts in his annual return. . As a deterrent to tax evasion Congress enacted section 293(b) which provides for a 50 per cent addition to the tax if any part of any deficiency is due to fraud with intent to evade tax. However, to sustain the imposition of the so-called fraud93 penalty, the respondent must show by clear and convincing evidence that the taxpayer filed false and fraudulent returns with intent to evade tax. As it is seldom possible to establish fraud by direct evidence of the taxpayer's intention, we may consider the character of the transactions involved and the taxpayer's conduct as evidence of his intent. . In the instant proceeding we have found that the books and records maintained by the petitioner neither completely nor accurately disclosed his true taxable income for the years 1944 and 1945. Apparently for that reason the petitioner made no attempt to prove the adequacy of his books. On the contrary, the petitioner in challenging the proposed deficiency recomputed his income for each year under the net worth method. As a result of his own recomputation, an understatement of income for the year 1944 was disclosed in the amount of $10,200.94, which understatement is in itself approximately 200 per cent of the income disclosed in his 1944 return. For the year 1945, petitioner's own net worth statement discloses an understatement of $2,765.70, or 26 per cent of his reported income for that year. 94 The petitioner offers no explanation for the omission of this income from his books or his income tax returns. We have held in the past that, in the absence of any reasonable excuse, a taxpayer's failure to report substantial amounts of income unquestionably received constitutes sufficient evidence of a fraudulent intent to sustain the imposition of so-called fraud penalties. ; ; ; ; . The record demonstrates that the petitioner was an intelligent and experienced business man who maintained close personal contact with his several businesses. He had filed Federal income tax returns in prior years and we may assume that he was thoroughly acquainted with his duty to make correct returns of income. The amounts of income disclosed by the net worth statements submitted in evidence by petitioner considered alone show omissions from his returns for 1944 and 1945 of amounts much too large to be attributed to mere oversight or to the petitioner's poor bookkeeping practices. Our findings95 show omissions from gross income in larger amounts with a consequent greater deficiency for each of the years than petitioner concedes even though the income as determined by us is somewhat less than respondent has determined. In the absence of any reasonable explanation from the petitioner, these facts in our judgment constitute clear and convincing evidence of fraud. It is our opinion and we have so found as a fact that a part of the deficiency for each year is due to fraud with intent to evade tax. The respondent's imposition of the 50 per cent addition to tax for fraud in each year is sustained, adjusted in amount to reflect the deficiencies as they will appear as a result of the conclusions reached herein. Decision will be entered under Rule 50. Footnotes1. In a net worth statement offered in evidence by petitioner the understatements of income for 1944 and 1945 are shown as $10,200.94 and $2,765.70, respectively.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623549/	Estate of Philip Landau, Deceased, Herbert Landau and Sidney Landau, Executors, v. Commissioner of Internal Revenue, RespondentLandau v. CommissionerDocket No. 40824United States Tax Court21 T.C. 727; 1954 U.S. Tax Ct. LEXIS 293; February 18, 1954, Promulgated 293 Decision will be entered for the respondent. Deduction -- Loss -- Mortgage Pool -- Partnership, Corporation, or Trust. -- The petitioner has not shown that the mortgage pool was a trust rather than a partnership, as determined by the Commissioner, or rather than an association taxable as a corporation, or that it sustained a loss on the investment in the mortgage pool which was deductible in 1948 in an amount greater than that allowed by the Commissioner. Sidney B. Gambill, Esq., and Robert F. Banks, Esq., for the petitioner.Philip O. North, Esq., for the respondent. Murdock, Judge. MURDOCK 727 The Commissioner determined a deficiency of $ 218.39 in the income tax of Philip Landau for 1948. The only assignment of error is the action of the Commissioner in failing "to294 allow a deduction for an ordinary loss, allowable in full, for the year 1948 in the amount of $ 9,550, rather than a net capital loss in the amount of $ 288.10, allowed in the statutory notice of deficiency for said year."FINDINGS OF FACT.Philip Landau filed his Federal income tax return for 1948 with the collector of internal revenue for the twenty-third district of Pennsylvania. 728 Philip died in 1952 and Carrie, his wife, predeceased him in 1942.The Pennsylvania Legislature in 1925 authorized banks to assign, to their various trust estates, participation in a general trust fund of mortgages upon real estate securing bonds evidencing loans, but provided that no participant would have any individual ownership in any of the mortgages or bonds. The Bank of Pittsburgh National Association, hereafter called the bank, had such a pool of mortgages in 1930. The record does not show any agreement, document, rule, or regulation pertaining to its creation or operation except a copy of a certificate attached to each mortgage to show that it was held by the trust department of the bank for those "customers who have purchased participations therein" and a certificate showing the 295 participation of the holder in the pool of mortgages. The participation certificates were transferable. The law authorizing the pools was repealed in 1933 except as to existing pools.Philip and Carrie created a revocable trust on November 15, 1930, hereafter called the Landau trust, of which the bank was made trustee. Philip transferred $ 25,000 to the trust at that time and on April 17, 1931, transferred an additional $ 25,000 to it. The trustee was to invest the corpus in first mortgages upon real estate and pay the net income semiannually to the grantors, who reserved the right to withdraw any or all of the corpus upon notice. The bank used the entire corpus to acquire, for the trust, participating interests in its mortgage pool. The record shows no change of any kind in the trust after that time.A receiver was appointed for the bank in the latter part of 1931, and the Orphans' Court of Allegheny County, upon petition of a participant, appointed the Commonwealth Trust Company of Pittsburgh, hereafter called Commonwealth, successor trustee of the mortgage pool of the bank. Commonwealth took over all of the assets, files, and accounts of that pool on January 19, 1932. The296 assets consisted of first mortgages at that time, some of which were past due. $ 5,347,585.57 had been invested by the bank in about 450 mortgages upon behalf of about 400 participants in the pool.Commonwealth accepted no new investments in the pool by participants and made no new investments of pool funds but proceeded to liquidate the pool by distributing pro rata to the participants all money received by it in excess of expenses and other expenditures. No participant could withdraw anything from the pool except as distributions were made by Commonwealth. Liquidation of the pool was completed on April 9, 1948.Commonwealth never filed any income tax return for the pool. It filed accounts with the Orphans' Court showing all receipts and disbursements. Receipts of interest and rent on properties acquired by foreclosure were accounted for as income and the excess over expenses 729 charged against income was distributed as income. Receipts of principal and net proceeds from sales of real estate were accounted for as principal, and the excess thereof over expenses and expenditures charged against principal was distributed as principal. The accounts of Commonwealth were 297 approved by the Orphans' Court. Five were filed. The foreclosures and distributions were authorized by the Orphans' Court.The bank never distributed any principal to the Landau trust. The record does not show whether or not the bank ever filed an income tax return for the pool. Commonwealth made 50 distributions designated income and 34 designated principal during its trusteeship. It did not include gains from sales in the income distributions, deduct losses from income, or take depreciation into account in any way. Properties acquired by foreclosure were entered on its books at the amount due on the mortgage, plus foreclosure costs. No distribution was made in 1947 but it was known that a further distribution of an amount then unascertainable would be made later. The final distribution was made on April 9, 1948. It consisted of amounts designated as 1.445+ per cent of the original principal of each participant and amounts designated 1/2 per cent income.The total distributions from Commonwealth on the Landau trust participations were $ 40,472.58 designated principal and $ 14,928.82 designated income, or a total of $ 55,401.40, of which $ 773.84 was distributed in 1948.The298 record does not show how or whether Philip reported any of the distributions on his income tax returns or what information, if any, was available to him from Commonwealth in addition to that shown by the distributions and the accounts filed on behalf of the pool. His 1948 return is not in evidence.The Commissioner, in determining the deficiency for 1948, added $ 711.90 to income as "Loss from capital assets adjusted." He explained that adjustment as follows:(b) It is determined that your capital net loss was $ 288.10, which amount has required a reduction of $ 711.90 from the loss of $ 1,000.00 reported in your income tax return, said adjustment of $ 711.90, being explained in detail below.(1) Amount invested in mortgage pool$ 50,000.00(2) Total investments of all partners in mortgagepool5,347,585.00[sic] (3) Liquidation of the Bank of Pittsburgh mortgagepool9,550.00$ 9,550.00(4) Expenses in 1948, $ 31,190.93(5) $ 50,000.00 multiplied by $ 31,190.93 divided by5,347,585.57 equals291.64291.64(6) Unallowable loss$ 9,258.36(7) Capital loss carry-over eliminated8,546.46(8) Adjustment for 1948 as stated above$ 711.90299 730 The record contains no further explanation of items (3), (4), (6), or (7) of the above computation.All facts stipulated are incorporated herein by this reference.OPINION.The Commissioner, as shown by the notice of deficiency, referred to the participants in the mortgage pool as partners for tax purposes and apparently allowed the participant-partner to deduct for 1948 only his distributive share of the partnership expense for that year. Section 3797 defines a partnership to include "a syndicate, group, pool, joint venture or other unincorporated organization, through or by means of which any business, financial operation or venture is carried on and which is not, within the meaning of this title, a trust or estate or a corporation." It further provides that "A person shall be recognized as a partner for income tax purposes if he owns a capital interest in a partnership in which capital is a material income producing factor, whether or not such interest was derived by purchase or gift from any other person." A trust may be a partnership for tax purposes. Dolores Crabb, 41 B. T. A. 686, 696, affd. 119 F. 2d 772,300 on rehearing 121 F.2d 1015">121 F. 2d 1015, remanded 47 B. T. A. 916, affd. 136 F.2d 501">136 F. 2d 501. Here a financial operation, in which capital was the material income producing factor, was carried on by means of this pool. Those statutory provisions mentioned above support the theory of the Commissioner's determination that the participants were partners unless it appears that the pool was a corporation or a trust for tax purposes. If it was a partnership, losses would be deductible by the participant-partners annually, no such loss as the petitioner is claiming would be deductible in 1948 ( Heiner v. Mellon, 304 U.S. 271">304 U.S. 271), and the determination of the Commissioner would have to stand.The petitioner, in order to sustain its allegation of error and to obtain a favorable decision, must show that Philip sustained an income tax loss in 1948 of some larger amount due to the fact that he did not get back all of the original investment of $ 50,000 and, further, that the loss was not a capital loss. It must show that the pool was not a partnership for tax purposes but that some other theory of301 taxation was applicable under which the claimed loss would be deductible in 1948. Counsel for the petitioner, if they had any theory, supported by provisions of the revenue laws or other authority, which would lead step by step to the result sought by them, should have set it forth in their briefs for the benefit of their client and the guidance of the Court. Such a theory might explain what returns, if any, the pool was required to file; how and by whom its bad debts, losses from foreclosure, depreciation, and other deductions should have been reported currently; what the participants should have reported currently as a 731 result of the operation of the pool; and how the participants would be entitled, under a proper reporting by them and the pool, to take as a loss in 1948 the difference between the amount originally placed in the pool and some amount received by them from the pool. They have not set forth any theory of taxation, or references to statutory or other authority to support it, leading to the result they desire and the obvious inference is that they know of none. They are not aided by the fact that the Commissioner's briefs are similarly deficient, since the302 petitioner is the moving party.The cooperative undertaking, involving 400 participants joined together, could differentiate this pool from an ordinary trust. Morrissey v. Commissioner, 296 U.S. 344">296 U.S. 344. Furthermore, the pool had many of the characteristics of an association taxable as a corporation, and if it was not a partnership for tax purposes it might possibly have been an association taxable as a corporation, but the meager evidence does not justify an affirmative finding either that it was or was not an association. Morrissey v. Commissioner, supra;Title Insurance & Trust Co. v. Commissioner, 100 F.2d 482">100 F. 2d 482; Main-Hammond Land Trust, 17 T. C. 942, affd. 200 F.2d 308">200 F. 2d 308; Royalty Participation Trust, 20 T. C. 466. However, the petitioner argues that the pool was not taxable as a corporation because the petitioner recognizes that a loss to a stockholder on his investment resulting from the liquidation of the corporation is a capital loss deductible only to a limited extent and no advantage to the303 petitioner lies in that direction. Secs. 115 (c) and 117 (a) and (d), I. R. C.Arthur Letts, Jr., 30 B. T. A. 800, affd. 84 F.2d 760">84 F. 2d 760.The pool might possibly have been a trust for tax purposes, rather than a corporation or a partnership, but the record is inadequate to show that it was taxable as a trust so that the participants could delay deduction of their capital losses until 1948 when the liquidation was completed. The bank originated the pool and intended to continue to operate it. Commonwealth was merely substituted for the bank without any change in purpose or in the nature of the entity for tax purposes, so far as the record shows. Commonwealth voluntarily chose to liquidate the pool rather than to take in new participations and to make new investments. At least there is no evidence that it was required to limit its activities to the liquidation of the pool. Its powers, rather than the extent to which they were used, must control in this connection. Morrissey v. Commissioner, supra;Commissioner v. North American Bond Trust, 122 F. 2d 545, certiorari304 denied 314 U.S. 701">314 U.S. 701; Royalty Participation Trust, supra.The record does not show how the mortgage pool was created. No deed of trust or other document creating any trust has been introduced in evidence. Nor is there any evidence of any rules or regulations which might have been necessary in operating the pool. The bank, in the participation certificates 732 which it issued, stated that the mortgages were held "in trust for those of its customers who have purchased participations in said mortgages" and certificates attached to the mortgages themselves contained a somewhat similar statement. The record is not clear as to whether participation in the pool was limited to various trust estates of the bank or whether others could participate. However, the participants were the only ones who could benefit from the operation of the pool. They were entitled to receive all income and all capital distributions. The bank or its successor could and did change investments, but the record does not show how extensive their powers of management were. This record does not justify a finding that the pool was for income tax purposes305 a trust rather than a partnership as determined by the Commissioner or a corporation; that losses from bad debts and from the sale of foreclosed property would not be deductible currently by the participants, if it was a trust; or that the participants would be entitled to deduct, upon the final termination of the activity in which they were engaged, the difference between the amount originally invested in the pool and the total amount distributed as a return of capital.The petitioner argues that Philip could not make proper returns because the pool made none and failed to give him the necessary information, but, of course, any failure of the pool to make required tax returns does not give Philip any deduction to which, otherwise, he would not be entitled. The petitioner also argues that the Commissioner can not deny that a loss was sustained in 1948 because he "determined that Philip sustained an 'Unallowable loss' of '$ 9,258.36' with respect to his investment in the pool." The determination is somewhat puzzling, particularly in the absence from the record of Philip's return for 1948, but the words used by the Commissioner in the explanation can not be interpreted fairly to mean306 that although a loss of $ 9,258.36 was actually sustained in that year, nevertheless, for some undisclosed reason it is unallowable as a deduction in that year. Rather, he seems to be saying merely that the amount is unallowable as a loss in 1948. The question would still remain, however, of whether any loss sustained was deductible in 1948.The case of Mortgage Trust Certificate Pool, 42 B. T. A. 1238, which the petitioner cites, is in no way in point here because of distinguishing differences in the facts. There "Reading [the bank] commingled with its other trust funds the amounts received by it for mortgage trust certificates" and "did not administer as a separate trust fund the amounts paid in by certificate purchasers." Reading itself agreed to pay interest on the certificates which it issued and it retained the interest on the mortgages.The petitioner cites Adolph Klein, 15 T. C. 26, for the proposition that the alleged loss sustained by Philip in 1948 was an ordinary loss deductible in full and not a long-term capital loss. It has failed to 733 demonstrate, however, that the loss it is talking about was307 sustained and deductible in 1948. Klein, who had purchased participation interests in a mortgage pool, reported capital gains thereon in 1944 resulting entirely from distributions from the pool made and received in 1944. The Commissioner held that they were ordinary gains and the question presented for decision was whether they were ordinary or capital gains. The alleged gains were apparently computed in the same way that the petitioner here has computed its alleged loss, but the question of whether there was a gain and when it should have been reported was not raised. The case is not authority for holding that the alleged loss in this case was sustained or deductible in 1948, since the entire amounts involved there were distributions made to and returnable by the participants in the taxable year.Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4653916/	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/4623574/	WILLIAM FRANKLIN SMITH AND ALTA R. SMITH, 1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Smith v. Comm'rDocket No. 12400-93United States Tax CourtT.C. Memo 1995-304; 1995 Tax Ct. Memo LEXIS 304; 70 T.C.M. (CCH) 30; July 12, 1995, Filed 304 Decision will be entered for respondent. Alta R. Smith, pro se. For respondent: Julia L. Wahl. POWELLPOWELLMEMORANDUM OPINION POWELL, Special Trial Judge: This case was heard pursuant to the provisions of section 7443A(b)(3) and Rules 180, 181, and 182. 2 This case was submitted pursuant to Rule 122. Respondent determined a deficiency in petitioners' 1990 Federal income tax in the amount of $ 953. Petitioners resided in Apollo, Pennsylvania, at the time they filed the petition. The issue is whether military pay received by petitioner William Franklin Smith (petitioner) during the year at issue is "earned income" for purposes of the earned income tax credit (EITC). Sometime prior to 1990 petitioner retired from the U.S. Air Force and began receiving military retirement pay. In his retirement status, petitioner was subject to recall to active duty. 305 In 1990 petitioner received $ 9,264 of military retirement pay. No amounts were withheld for employment taxes or for Federal and State income taxes. The U.S. Air Force issued petitioner a Form W-2P, Statement for Recipients of Annuities, Pensions, Retired Pay, or IRA Payments, reflecting the payment. On their 1990 Federal income tax return petitioners reported the income as wages and claimed an EITC in the amount of $ 953. Respondent determined that the amount received by petitioner was a pension and did not constitute "earned income" within the meaning of section 32. An EITC is a refundable income tax credit based on a percentage of "earned income". It is intended "to provide tax relief to low-income working individuals with children and to improve incentives to work." S. Rept. 99-313 (1986), 1986-3 C.B. (Vol. 3) 1, 43. Section 32(c)(2)(A)(i) includes in earned income "wages, salaries, tips, and other employee compensation". However, section 32(c)(2)(B)(ii) provides an exception relevant here: "For purposes of subparagraph (A) * * * no amount received as a pension or annuity shall be taken into account". Although the Code does not define the term "pension", 306 Webster's Second New International Dictionary 1811 (1957), provides guidance. A pension is "A stated allowance or stipend made by a government or business organization, in consideration of past services or of the surrender of rights or emoluments, to one retired from service". Petitioners contend that, as petitioner was subject to recall by the military, the payments constitute reduced compensation for current services rather than a pension. Petitioners cite as authority for their position McCarty v. McCarty, 453 U.S. 210 (1981), and United States v. Tyler, 105 U.S. 244 (1881), which suggest that military retirement pay is compensation for current services. However, when directly confronted with the issue, the Supreme Court explicitly rejected the proposition, stating: "military retirement benefits are to be considered deferred pay for past services." Barker v. Kansas, 503 U.S. 594">503 U.S. 594, 605 (1992). (Emphasis added.) Petitioner received the military retirement pay as a pension, and as such it does not constitute "earned income" for purposes of section 32 and the EITC. Decision will be 307 entered for respondent. Footnotes1. Petitioner William Franklin Smith died after the petition was filed in this case and no administrator or other fiduciary, competent to represent the estate of petitioner William Franklin Smith, has been appointed. By Order dated February 2, 1995, this Court allowed the heirs of William Franklin Smith until March 6, 1995, to oppose respondent's motion to dismiss this case with respect to petitioner William Franklin Smith for lack of prosecution. The motion remains unopposed. Respondent's motion will be granted and this case as it pertains to petitioner William Franklin Smith will be dismissed, and a decision will be entered consistent with the decision entered with respect to petitioner Alta R. Smith.↩2. Section references are to the Internal Revenue Code in effect for the year in issue, and 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/4476162/	OPINION. Bruce, Judge: The questions presented for decision are (1) whether the amount petitioner received as compensation for services rendered by way of a bargain purchase of his employer’s stock should be measured by the difference between the option price and the market price on the day the option was authorized or by such difference on the day the option was exercised; and (2) whether stock purchased by the corporation and delivered to petitioner in amounts equivalent to dividends declared on the optioned shares after the option authorization but prior to its exercise represents compensation to petitioner in addition to the optioned shares. Section 22 (a), Internal Revenue Code, and Regulations 111, section 29.22 (a)-1. With respect to the first issue, petitioner admits that the stock option was by way of compensation for services, but contends in the main that the option was property and as property he received something at the time it was authorized in 1944. Therefore, he contends, the date of authorization is the proper date to use in measuring the difference or spread between the option and the market price. The petitioner relies upon certain language of the Supreme Court in its opinion in Commissioner v. Smith, 324 U. S. 177. In that case the contention by the taxpayer was that an option issued and delivered to the taxpayer constituted “property” and consequently was income realized by him at that time. The Court stated: In certain aspects an option may be spoken of as “property” in tbe hands of the option holder. Cf. Helvering v. San Joaquin Fruit & Investment Co., 297 U. S. 496, 498, 56 S. Ct. 569, 570, 80 L. Ed. 824; Shuster v. Helvering, 2 Cir., 121 F. 2d 643, 645. When the option price is less than the market price of the property for the purchase of which the option is given, it may have present value and may be found to be itself compensation for services rendered. But it is plain that in the circumstances of the present case, the option when given did not operate to transfer any of the shares of stock from the employer to the employee within the meaning of § 22 (a) and Art. 22 (a)-1. Cf. Palmer v. Commissioner, 302 U. S. 63, 71, 58 S. Ct. 67, 70, 82 L. Ed. 50. And as the option was not found to have any market value when given, it could not itself operate to compensate respondent. * * * We cannot see where petitioner gains support for his contention from the above-quoted language. Here the petitioner asks that we treat the option as property and hold it to have been received, not when issued and delivered, but when authorized in a prior year by corporate resolution. We do not agree. Even if it could be held that on July 27, 1944, when the directors authorized the issuance of the option, such action vested the petitioner with certain fixed rights to acquire the stock at the option price (and the facts do not justify the conclusion), such rights would necessarily have to be shown to have a definite value when acquired, as pointed out by the Court in Commissioner v. Smith, supra. Moreover, if such showing of value were made that property would constitute income then realized by petitioner in the amount of such value. Petitioner, however, is here contending that the date of authorization be used only for purposes of valuation, the income from the receipt of such property to be determined as realized upon the exercise of the rights m the following year after the issuance and delivery of the option to him. Petitioner appears to base his contention upon a claim that the corporation was legally obligated to issue him the option by reason of a definite agreement to do so whereby the corporation secured his services. As to this there is not only no evidence of such an agreement but its existence cannot be reconciled with the written contract of employment of petitioner which is set out in our findings. Upon the question of value of such option on July 27, 1944, the date petitioner contends it should be treated as issued and delivered, the record is silent. Petitioner appears to assume that such value is a mere matter of computation of the difference between the option price and the then market price of the stock. Such is manifestly not the case. In the first place the resolution of 1944 only authorized the present optioning of one half of the stock here involved, the remaining one half to be covered by an option to be issued one year later and then only when authorized by another corporate resolution. This second option was provided to be issued only if petitioner was then employed by the corporation, his services had been satisfactory, and he still possessed the stock issued him under the prior option. The corporate resolution forbade assignment of any of the options except to another officer or employee of the corporation and then only with the consent of the corporation. These restrictions were made a part of the regular option issued by provision on the face of the printed option form. An option carrying such conditions and restrictions, in our opinion, makes impossible a determination of market value. Harold H. Kuchman, 18 T. C. 154; Burnet v. Logan, 283 U. S. 404; Commissioner v. Carter, 170 F. 2d 911; Westover v. Smith, 173 F. 2d 90. We think it clear under the facts disclosed that petitioner possessed no option as to the stock here in question until the issuance and delivery to him of such option. The exact date this was done is not shown. We merely know that it was between September 27, 1945, when the secretary-treasurer of the corporation was authorized to issue the option, and October 3, 1945, when the option was exercised by petitioner. For all we are advised, both issuance and delivery may have been on the latter date. When petitioner exercised the option, the corporation parted with and petitioner received the stock at a price of $3 per share which then had a market value of $33,875 a share. Petitioner then realized compensation through a bargain purchase measured by the difference between the price paid and the then market value of the stock. With respect to the second issue, petitioner contends that these 360 shares should be. considered as a stock dividend and should be considered as included with the 2,000 shares he was to receive when he exercised the option. Petitioner’s counsel has conceded that this position falls on bis failure to be sustained on the first issue. It might, however, be noted that these 360 shares were in lieu of an authorized cash payment by way of adjustment for cash and stock dividends in undisclosed proportions to stockholders at a period prior to when petitioner attained that status. Payment in such circumstances compels us to the conclusion that it was additional compensation for services in the amount of the fair market value of the 360 shares of stock when issued to petitioner. Decision will be entered for the respondent.	01-04-2023	01-16-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623576/	Estate of Thomas E. Gannett, Ella J. Gannett, Administratrix, Petitioner, v. Commissioner of Internal Revenue, RespondentGannett v. CommissionerDocket No. 45409United States Tax Court24 T.C. 654; 1955 U.S. Tax Ct. LEXIS 141; July 14, 1955, Filed 141 Decision will be entered for the petitioner. Sole purpose of administration of decedent's estate subject to Louisiana community property law having been in connection with estate taxes, expenses of administration held deductible in full. Louis M. Jones, Esq., for the petitioner.James F. Hoge, Jr., Esq., for the respondent. Opper, Judge. OPPER654 OPINION.Respondent determined a deficiency in estate tax of $ 800.26, all of which is contested by petitioner. The only issue remaining in controversy is the deductibility in full of administration expenses where decedent was a member of a Louisiana marital community. All of the facts have been stipulated.The facts are found in accordance with the stipulation of the parties:1. Petitioner is administratrix of the Estate of Thomas E. Gannett. Petitioner filed a United States Estate Tax Return, Form 706, on September 15, 1949 with the Collector of Internal Revenue at New Orleans, Louisiana * * 2. The statutory notice of deficiency was mailed to Estate of Thomas E. Gannett, Mrs. Ella Jones Gannett, Administratrix, 100 Poydras Street, New Orleans, Louisiana, on September 10, 1952.3. The entire gross estate of142 Thomas E. Gannett in the amount of $ 120,670.79 represented his one-half community interest.4. The following expenses were incurred subsequent to the death of Thomas E. Gannett:Attorneys' fees$ 8,500.00R. H. Krutz -- Appraiser312.50H. J. Rosenmeier -- Appraiser312.50Louis M. Jones -- Notarial fees1,250.00Court costs173.33Newspaper notices76.25Premium -- Administratrix's bond (Louisiana)322.55Premium -- Administratrix's bond (Mississippi)5.00Wm. B. Jones & Company -- Accounting and tax services1,545.00Total$ 12,497.13655 5. The only purpose for the administration of the estate of Thomas E. Gannett was to pay state and federal inheritance taxes. The sole heir to the estate of Thomas E. Gannett was the surviving wife, Mrs. Ella Jones Gannett.In the notice of deficiency, respondent decreased deductions of the estate in the amount of $ 6,248.57, with the following explanation:Funeral and administration expensesReturnedDeterminedAttorneys' fees$ 8,500.00$ 4,250.00Miscellaneous administration expenses3,997.131,998.57Total$ 12,497.13$ 6,248.57It is held that only one-half of the amount of attorneys' 143 fees and miscellaneous administration expenses claimed on the return is deductible from decedent's gross estate, since the other one-half thereof is chargeable against the surviving spouse's share of the community property.Respondent having abandoned his claim respecting decedent's insurance, we have for consideration only the deductibility of the one-half of the administration expenses, consisting primarily of attorneys', accountants', and notarial fees, which respondent failed to allow. The total amount is not in dispute, but respondent presses his disallowance on the ground that the whole community estate was administered and hence that petitioner's share of the expenses was only one-half.Whatever may be the rule as to general administration expense where either the entire estate is the subject of administration, see , or the parties agree to an apportionment of the administration costs, see , the latter authority, which has several times been cited with approval, see e. g., ,144 requires that expenses peculiarly applicable to the decedent's estate be allocated entirely to it.Thus in the Lang case, supra, attorney's fees due "in connection with the settlement and adjustment of the tax liability of the Federal and state estate taxes" were held to be deductible in full: "We hold that the Board was in error in not permitting the full deduction of these items. It is immaterial that the expense was incurred in the course of the administration of the entire community estate. They were incurred solely for and on behalf of that portion of the community estate which was subject to decedent's disposition and which made up the 'estate' subject to tax by the state and federal governments. The portion of the community automatically distributed to the decedent's wife, and which is no part of the gross estate under the Revenue Act, was unconcerned with such tax liability and derived no benefit from the services rendered and expenses incurred."The present facts are even stronger. The parties have stipulated that "The only purpose for the administration of the estate * * was to pay state and federal inheritance taxes." And while it is true the 656 Lang145 case was decided under the community property law of the State of Washington, as we said in , "No contention is made by the parties that the Louisiana law on this point is different." And see , affd. .We conclude that the administration expense is, under the present facts, deductible in full.Decision will be entered for the petitioner.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623578/	Henry L. Watkins v. Commissioner. Walter A. Biesterfeldt v. Commissioner.Watkins v. CommissionerDocket Nos. 21387, 21388.United States Tax Court1950 Tax Ct. Memo LEXIS 176; 9 T.C.M. (CCH) 448; T.C.M. (RIA) 50135; June 12, 1950176 Wayne B. Wright, Esq., and Thomas F. McDonald, Esq., 780-812 Olive St., St. Louis 1, Mo., for the petitioners. Frank M. Cavanaugh, Esq., for the respondent. JOHNSONMemorandum Findings of Fact and Opinion JOHNSON, Judge: In these consolidated proceedings the Commissioner determined deficiencies in income tax for the year 1943 as follows: DocketNo.PetitionerDeficiency21387Henry L. Watkins$2,826.8121388Walter A. Biesterfeldt1,545.23The sole issue for decision is whether the Commissioner erred in his determination that the Ad Service Engraving Company, a corporation, upon its dissolution on October 31, 1943, in addition to its physical assets, had a good will value of $26,263, thus increasing the reported gain of petitioners, who were its only stockholders. Petitioners contend that the corporation had no good will, and if so, its value was greatly less than that determined by the Commissioner. Upon the hearing, other adjustments made by the Commissioner in his letters of deficiency were acquiesced in by petitioners. Findings of Fact Petitioners, Henry B. Watkins and Walter A. Biesterfeldt, are individuals residing in towns177 suburban to St. Louis, Missouri, and each filed a separate income tax return for the year ended December 31, 1943, with the collector of internal revenue for the first district of Missouri. The Ad Service Engraving Company, hereinafter called the company, was incorporated under the laws of Missouri on June 15, 1922, with an authorized capital of $10,000, consisting of 100 shares of common stock of the par value of $100 each. Petitioners and three other individuals, viz: Crowe, Deal and Schieli, were the original incorporators, and each subscribed and paid $2,000 for 20 shares of its capital stock. All five incorporators were skilled mechanics in the work of the company, being journeymen or shopmen, and all gave their full time thereto in different capacities so long as they were stockholders. The business of the company was making engraving plates upon orders for the individual needs of its customers. The photo engraving process consists basically of obtaining a photographic negative of a picture or drawing and printing that negative on to a sensitized copper, zinc, or brass plate and etching it. The surplus metal is then removed and the plate is mounted and proofed. An engraving178 plate is made in much the same way that a photographic print is made except the photograph is printed through the negative on to metal. The process consists of several basic steps and these steps are handled by separate departments within the photo engraving shop, requiring experts in each. The company continued in business in St. Louis until October 31, 1943, when it was dissolved by petitioners who then owned all of its stock, 1 Watkins owning 60 shares and Biesterfeldt 40 shares, and petitioners thereafter continued the business as a partnership. Prior to its dissolution, whenever stock of the company was sold, either Watkins or Biesterfeldt bought it, as they wanted to keep outsiders from buying into the company. Petitioners, by their service, experience, skill and ability contributed much to such success as the company179 achieved. Watkins, while a boy, attended night school while serving his apprenticeship. He later became a journeyman in copper etchings and was proficient therein, and he was also a good salesman and in later years devoted much of his time thereto. The company had two other salesmen. Biesterfeldt was president of the company during most of the company's existence. His duties were exclusively in the shop where he served as finisher and proofer and also as foreman and superintendent of the shop. The company's shop labor was performed by skilled employees, members of the St. Louis Photo Engraving Union, to which petitioners also belonged. Most shop workers remain for some time, while some are often changing. Some of the company's employees they had had for a number of years, one for twelve years. If one quits, he can be replaced through the union agency. There were about 15 photo engraving shops in St. Louis, the shop workers in the company's shop, which was average in size, being from ten to twelve. This did not include salesmen and other employees. The majority of the company's customers were secured by personal calls of the company's salesmen, and each salesman had his particular180 line of customers who would contact him when they wanted work done, and the customers did not often go to the shop, but placed their orders through the salesmen, but some orders did originate by telephone. Salesmen of a photo engraving business were generally paid 15 per cent of sales made by them, and this the company did at all times. The company had 50 to 75 accounts at the time of its dissolution, and all of its customers were in St. Louis. Its place of business was always the same, being premises rented on a monthly basis for no definite period and consisted of 5,500 square feet on the second floor of a six-story building which was reached by a freight elevator entrance. There was a name plate of the company at the entrance. Many landlords refused to take photo engravers as tenants, due to the nature of the business. To move a business of this kind would be expensive due to the heavy installations, plumbing wiring, etc. The company did very little advertising and depended largely upon the quality of its work and its salesmen to secure customers. Its books were kept and income tax returns made annually on a fiscal year basis from July 1 to June 30. The company's earnings, 181 dividends paid, etc., for each year of its existence were as follows: EarningsCapital stockYear ended(after taxes)DividendsBalance atoutstandingNet worth atJune 30(loss)paidend of yearat end of yearend of year1923$ 1,059.35$1,059.35$10,000.00$11,059.35192415,209.99$10,000.006,269.3410,000.0016,269.34192514,757.0716,500.004,526.4110,000.0014,526.41192610,915.077,000.008,441.4810,000.0018,441.4819275,536.648,000.005,978.1210,000.0015,978.121928(5,477.34)500.7810,000.0010,500.7819295,494.485,995.2610,000.0015,995.2619304,119.057,500.002,614.3110,000.0012,614.311931(6,059.41)(3,445.10)10,000.006,554.901932$ 775.63[2,669.47)$10,000.00$ 7,330.531933(3,896.02)(6,565.49)10,000.003,434.5119341,055.35(5,510.14)10,000.004,489.8619354,473.31(1,036.83)10,000.008,963.1719364,141.923,105.0910,000.0013,105.0919372,918.59$ 5,000.001,023.6810,000.0011,023.681938( 716.01)307.6710,000.0010,307.6719393,954.305,000.00( 738.03)10,000.009,261.9719404,875.184,000.00137.1510,000.0010,137.1519411,960.845,000.00(2,902.01)10,000.007,097.9919424,860.895,000.00(3,041.12)10,000.006,958.8819437,117.307,000.00(2,923.82)10,000.007,076.18Oct. 31, 19432,200.50( 723.32)10,000.009,276.68182 The company paid salaries to its officers for the period designated below as follows: Period endingW. A. Blester-Fred H. Schiele,H. L. Watkins,June 30Totalfeldt, presidentvice-presidentsecy. & treas.1939$10,800.00$3,600.00$3,600.00$3,600.00194012,600.004,200.004,200.004,200.00194110,800.003,600.003,600.003,600.00194210,800.003,600.003,600.003,600.0019438,700.003,600.001,500.003,600.00Oct. 31, 1943(4 mo. period)2,300.001,200.00(See note below)1,100.00Note: - When Schiele sold his stock, he was no longer with the company. His services had been unsatisfactory for some time and Biesterfeldt had been trying to buy his interest long prior thereto. A reasonable annual salary for each of the petitioners during the period above mentioned was $5,000 exclusive of dividends and selling expenses paid them. Since dissolution the business has been carried on by petitioners as a partnership under the same name, each owning the same proportionate interest therein. Since dissolution the volume of business has increased and in 1948 it was about twice as large as in 1943. This increase was183 due partly to the improvement of general business conditions and also the acquisition by the firm after 1943 of the services of petitioners' three sons who had been trained in the business and whose services were valuable. Petitioners each filed individual income tax returns for the calendar year 1943. The book value of all tangible assets and accounts receivable of the company transferred to the partnership on October 31, 1943, was $9,276.68. The Commissioner determined that in addition to this, the company then had a good will value of $26,263, by applying a formula of capitalized earnings. He arrived at this sum by capitalizing, on a 15 per cent basis, the annual earnings (averaged over a five and one-third year period from July 1, 1938, through October 31, 1943) which were in excess of $757.73 per year, i.e., 8 per cent of $9,471.58 (invested capital averaged over the same period). The company, upon its dissolution, in addition to its tangible assets, had a good will value of $10,000. Opinion We cannot agree with the petitioners that the company had no good will value at the time of its dissolution. A corporation which had been a going concern continuously for more than184 twenty years, which had weathered the years of the depression, and during a fifth of a century had with some degree of success been engaged in the same business, under the same name and at the same location, it would seem must have acquired some measure of that intangible asset which we call "good will." Neither can we sustain petitioners' contention that the success of the corporation was due solely to the skill, ability and other personal characteristics of petitioners themselves, and hence under the holding in D. K. MacDonald, 3 T.C. 720">3 T.C. 720 and other cited cases, no value attributable to good will attached to the assets of the corporation. The facts here are distinguishable from those in that line of cases. While the petitioners here did contribute much to the success of the corporation, it cannot be said that they were solely responsible therefor, others also played a prominent and necessary part therein. If the company's success was due solely to petitioners' ability and personality, their continued connection and services with the business would have been indispensable to its existence. We do not think the separation of the petitioners from the company would have185 meant its demise. It may not for awhile have done as well unless and until properly trained parties had taken over its management. That the company had a good will value is best evidenced by the fact that each time any of its stock was sold, after 1923, it brought a price in excess of the value of the company's physical or tangible assets. This difference in tangible values and the selling price of the stock we think evidences not only the existence of good will, but in some degree a measure of its value. While we differ with petitioners as to the existence of good will, we certainly differ with respondent's determination that its value was the sum of $26,263. His own witnesses condemn this figure as being excessive, and his attorneys do not defend it. In respondent's brief he says that the good will value was "not less than $15,000." One of the respondent's two witnesses concerning good will, both of whom qualified as experts upon this subject, testified that the good will value of the company upon its dissolution "was from $10,000 to $12,000," while the other witness gave two different figures, based upon two different computations, in one of which he determined the value to*186 be $12,410, and in the other $15,500. Under all the facts and circumstances, we think that the reasonable value of the good will of the company at the time of its dissolution was $10,000, which we have found, and so hold. Decisions will be entered under Rule 50. Footnotes1. Petitioner Watkins purchased Crowe's 20 shares on July 1, 1923, for slightly more than $2,000, and in 1934, upon Deal's death, Watkins bought from Deal's estate his 20 shares for $4,500. Petitioner Biesterfeldt purchased Schiell's 20 shares in December, 1942, for $4,500. There appears to have been no other sales of the company's stock than these.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623579/	WILLIAM DUNNEGAN AND JACQUELINE FISHER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentDunnegan v. CommissionerDocket No. 8428-94United States Tax CourtT.C. Memo 1995-167; 1995 Tax Ct. Memo LEXIS 159; 69 T.C.M. (CCH) 2391; April 11, 1995, Filed Decision will be entered under Rule 155. In 1985, P and his parents (Fs) acquired a rental property as tenants in common. As part of the purchase price, P and Fs incurred a $ 111,750 debt for which they were jointly and severally liable. On Aug. 30, 1988, P sold his principal residence for an adjusted sales price of $ 214,000. In Feb. 1990, P gave his interest in the rental property to Fs; P and Fs remained jointly and severally liable for the debt. On July 31, 1990, P repurchased the rental property for $ 215,000 as his new principal residence under sec. 1034(a), I.R.C. P agreed with Fs to assume the $ 101,125 balance remaining on the debt as part of the repurchase price. The lender was not advised of this "assumption" and did not release Fs from liability for the debt. Held: P may not include the $ 101,125 debt in the cost of the new residence under sec. 1034, I.R.C.Held, further, P is liable for an addition to tax for substantial understatement under sec. 6661(a), I.R.C.William Dunnegan, pro se. For respondent: Julia A. Roy. LAROLAROMEMORANDUM FINDINGS OF FACT AND OPINION LARO, Judge: This case is before the Court fully stipulated160 under Rule 122(a). 1 William Dunnegan and Jacqueline Fisher petitioned the Court to redetermine respondent's determination of a $ 38,264 deficiency in their 1988 Federal income tax and an $ 8,960 addition thereto under section 6661(a). Since Jacqueline Fisher is involved in this matter only because she filed a 1988 joint Federal income tax return with William Dunnegan, we use the term "petitioner" to refer solely to William Dunnegan. Following concessions, 2 the issues for decision are: 1. Whether exhibit 14-N is relevant to this proceeding. We hold that it is not. 161 2. Whether petitioner may compute deferred gain under section 1034 by including in the cost of his new residence a debt that he had incurred to purchase the same residence more than 4 years earlier; at all times relevant herein, petitioner was jointly and severally liable for the debt. We hold that he may not. 3. Whether petitioner is liable for an addition to tax for substantial understatement under section 6661(a). We hold that he is. FINDINGS OF FACT 3Petitioner is an attorney. He and Jacqueline Fisher are married individuals who resided in Ho Ho Kus, New Jersey, when they petitioned the Court. Petitioner and Jacqueline Fisher filed a joint Federal income tax return for the year in issue. On May 31, 1985, petitioner's parents (Parents) and petitioner purchased a one-family house located at 113 Sheridan Avenue, Ho Ho Kus, New Jersey (the Sheridan property). Petitioner and Parents acquired the Sheridan property as tenants162 in common; petitioner owned a one-half interest in the property after the purchase. The purchase price of the Sheridan property was $ 149,900, and petitioner and Parents: (1) Each paid approximately $ 20,000 cash and (2) obtained a 30-year loan (secured by a mortgage on the Sheridan property) of $ 111,750. Petitioner and Parents were jointly and severally liable on the debt. From July 1985 until on or about August 30, 1988, petitioner and Parents rented the Sheridan property. Petitioner reported one-half of each year's rental income and expenses on his 1985 through 1988 Schedules E, Supplemental Income Schedule. Petitioner sold his primary residence at 10 Marion Court, Ho Ho Kus, New Jersey (the Marion property) for $ 225,000 on August 30, 1988, and his selling expenses were $ 11,000. 4 Petitioner's adjusted basis in the Marion property was $ 102,000 at the time of the sale. Petitioner filed Form 2119, Sale of Your Home, as part of his 1988 joint Federal income tax return, stating that he was deferring the recognition of his $ 112,000 gain because he intended to buy a new residence within the prescribed replacement period under section 1034(a). 163 On August 30, 1988, petitioner moved into the Sheridan property under an oral agreement (between him and Parents) that he would pay all of the property's expenses as rent. A written lease was never executed. Petitioner claimed deductions for home mortgage interest of $ 12,124 and $ 9,468 on his 1989 and 1990 joint Federal income tax returns, respectively, with respect to the Sheridan property. On February 21, 1990, petitioner gave his interest in the Sheridan property to Parents. 5 Parents did not agree to assume petitioner's liability with respect to the debt that encumbered the property, and the lender was neither advised of, nor consented to, the transfer. On July 31, 1990, petitioner agreed in writing to repurchase the Sheridan property from Parents for its then fair market value of $ 215,000. Petitioner agreed in writing to: (1) Pay Parents $ 20,000 in cash, 6 (2) assume the $ 101,125 debt that encumbered the property on July 31, 1990, and (3) pay Parents $ 93,875, exclusive of interest at 7 percent per annum, in yearly installments of $ 6,000. Although the written agreement provided that petitioner would execute a $ 93,875 note in favor of Parents, a note was never 164 intended to be provided (and, in fact, was never provided) because petitioner and Parents believed that providing a note might cause the Commissioner to challenge Parent's installment sale treatment on the sale. 7 The Sheridan property was transferred from Parents to petitioner on the same date. The lender was neither advised of, nor consented to, the transfer. On September 15, 1990, the Sheridan property first appeared in a computerized multiple listing for sale; the asking price was $ 259,000. On March 27, 1991, the Sheridan property was sold to an unrelated buyer for $ 240,000. The net sales165 proceeds equaled $ 222,316.54. Petitioner received $ 188,316.54 of these proceeds in cash, and a 5-year note (secured by a mortgage on the property) in the principal amount of $ 34,000 was issued to Parents. The note provided for a balloon payment of $ 47,686 (inclusive of interest at 7 percent per annum) on March 27, 1996. Petitioner directed the buyers to issue the note to Parents in satisfaction of 5-2/3 years of payments under Parents' July 31, 1990, agreement with petitioner. Petitioner never made any other payments to Parents with respect to their agreement of July 31, 1990. Prior to effecting the agreement of July 31, 1990, petitioner read section 1034 and the regulations thereunder. He also consulted for approximately 3 to 5 minutes with a partner practicing in the tax department at the law firm of Shea & Gould, regarding the anticipated transaction and its effect under section 1034. 8 Two days after their consultation, the partner advised petitioner that he should experience no adverse tax consequences if he proceeded with the transaction as proposed. 166 OPINION 1. Admissibility of Exhibit 14-NRespondent objects to the admissibility of exhibit 14-N on the grounds of relevancy. Exhibit 14-N consists of numerous items of correspondence between petitioner and respondent's examination division pertaining primarily to the conduct of respondent's audit of petitioner's 1989, 1990, and 1991 taxable years and to petitioner's disagreement with certain of respondent's positions taken during the audit. All of this correspondence preceded respondent's issuance to petitioner of the subject notice of deficiency. We sustain respondent's objection. It is well settled that the Court will not look behind a notice of deficiency under the facts presented herein to review respondent's determination or to review her administrative policy or procedure for making a determination. Dellacroce v. Commissioner, 83 T.C. 269">83 T.C. 269, 280 (1984); Greenberg's Express, Inc. v. Commissioner, 62 T.C. 324">62 T.C. 324, 327 (1974). A trial in this Court is a proceeding de novo, Greenberg's Express, Inc. v. Commissioner, supra at 328, and, as such, the Court's determination of 167 a taxpayer's tax liability must be based on the merits of the case, rather than on a previous record developed at the administrative level. Accordingly, we have not relied on exhibit 14-N to find facts or to render our opinion. 92. Petitioner's Cost of Repurchasing the Sheridan PropertySection 1034 requires that the recognition of gain on the sale of a principal residence must be deferred in certain situations. Petitioner must prove that his sale of the Marion property is one of these situations. Robarts v. Commissioner, 103 T.C. 72">103 T.C. 72, 76 (1994); Thomas v. Commissioner, 92 T.C. 206">92 T.C. 206, 242 (1989); Shaw v. Commissioner, 69 T.C. 1034">69 T.C. 1034, 1038 (1978). Given the concessions168 by the parties, we focus on whether petitioner's repurchase of the Sheridan property was effective to defer the gain on his sale of the Marion property. Section 1034(a) allows an individual to defer the recognition of all or part of any gain realized on the sale of his or her principal residence if the individual purchases a new principal residence within the period beginning 2 years before the date of the sale and ending 2 years after that date. Section 1034(a) provides that the gain on such a sale is recognized only to the extent that the individual's adjusted sale price of the old residence exceeds his or her "cost of purchasing the new residence". The cost of purchasing the new residence under section 1034 is not always the same as the taxpayer's basis in the property. Section 1034(c)(2) provides that "In determining the taxpayer's cost of purchasing a residence, there shall be included only so much of his cost as is attributable to the acquisition * * during the [4-year] period specified in subsection (a)." See also sec. 1.1034- 1(b)(7), Income Tax Regs. 10 The regulations under section 1034 provide that the cost of purchasing a new residence "includes not only cash but169 also any indebtedness to which the property purchased is subject at the time of the purchase whether or not assumed by the taxpayer". Sec. 1.1034-1(c)(4)(i), Income Tax Regs. The regulations also provide that "The taxpayer's cost of purchasing the new residence includes only so much of such cost as is attributable to acquisition * * within the period of * * * in which the purchase and use of the new residence must be made in order to have gain on the sale of the old residence not recognized under this section." Sec. 1.1034- 1(c)(4)(ii), Income Tax Regs. It is on the language in section 1.1034-1(c)(4)(i), Income Tax Regs., that petitioner relies. Petitioner argues in his brief that he is allowed to include the $ 101,125 liability in his cost of repurchasing the new residence because the Sheridan property was subject to the liability at the time that he repurchased it. According to petitioner, section 1.1034-1(c)(4)(ii), Income Tax Regs., is irrelevant because subdivision (i) is the specific provision that controls the disposition of his case. Petitioner also contends that the fact that he was already liable for this debt is irrelevant. 170 We are unpersuaded by petitioner's argument. Contrary to petitioner's assertion, his cost of repurchasing the Sheridan property in 1990 does not include the $ 101,125 debt because none of that debt was "attributable to the acquisition * * during the * * * [4-year] period specified in subsection (a)." 11Sec. 1034(c)(2); see also Kern v. Granquist, 291 F.2d 29">291 F.2d 29 (9th Cir. 1961); Shaw v. Commissioner, supra at 1037-1038; sec. 1.1034-1(b)(7), Income Tax Regs. The Code and regulations are explicit: Only costs that were incurred by petitioner within the prescribed period before or after his sale of the Marion property are included in his cost of purchasing the new residence under section 1034. Although section 1.1034-1(c)(4)(i), Income Tax Regs., specifies that certain liabilities enter into the computation of the cost of purchasing the new residence under section 1034, those liabilities are limited by subdivision (ii) to liabilities that are incurred during the period described in section 1034(a). See Shaw v. Commissioner, supra at 1037-1038. 171 Petitioner did not incur any debt to the mortgagee within the 4-year statutory period. Petitioner and Parents became subject to joint and several liability to the mortgagee for the debt on the Sheridan property when the debt originated in 1985, which was well before the inception of the 4-year period. Their liability continued until after petitioner's repurchase of the property. Petitioner's liability for the debt was not extinguished (or otherwise lessened) by his gift to Parents on February 21, 1990. Under the law of the State of New Jersey, the governing law as provided in the loan document, a successor in interest (e.g., Parents) may assume a debt subject to a mortgage only by an express written covenant between the mortgagor and his or her successor. N.J. Stat. Ann. sec. 46:9-7.1 (1989). 12 Petitioner has not established such a covenant with respect to his gift. 172 With respect to the repurchase (and the gift), we find relevant the fact that the lender/mortgagee did not consent to the transfer. 13Under the law of the State of New Jersey, an agreement between a mortgagor and his or her transferee does not release the mortgagor from liability for a debt to the mortgagee. The mortgagee must release a mortgagor from liability. Absent such a release, the mortgagee retains his or her claim against the mortgagor and his or her security interest in the underlying property. Ramsey v. Hutchinson, 181 A. 52">181 A. 52, 53 (N.J. Sup. Ct. 1935), revd. on other grounds 187 A. 650">187 A. 650 (N.J. 1936); Hunt v. Gorenberg, 155 A. 881">155 A. 881, 883 (N.J. Sup. Ct. 1930); Palmer v. White, 46 A. 706">46 A. 706 (N.J. Sup. Ct. 1900); see also 29 New Jersey Practice (Cunningham & Tischler, Law of Mortgages) sec. 131, at 596-597 (1975).173 In sum, petitioner's liability to the mortgagee did not change when he gave the Sheridan property to Parents or when he repurchased it from them. Petitioner and Parents were jointly and severally liable to the mortgagee for 100 percent of the debt before and after the gift, and that liability continued after the repurchase (notwithstanding that petitioner agreed with Parents to "assume" the entire debt as part of the repurchase). The record does not establish that the mortgagee released petitioner's Parents from any portion of the debt by reason of his purported assumption. 14 See Hovis v. Commissioner, T.C. Memo. 1995-60. We hold that petitioner may not include any part of the $ 101,125 debt in his cost of the Sheridan property. 174 3. Addition to Tax Under Sec. 6661(a)Respondent determined that petitioner is liable for an addition to tax for a substantial understatement of income tax under section 6661(a). Section 6661(a) imposes an addition to tax equal to 25 percent of the amount attributable to a substantial understatement. 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). An understatement is 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). Respondent's determination of an addition to tax for substantial understatement is presumed to be correct, and petitioner bears the burden of proving it incorrect. Rule 142(a); Welch v. Helvering, 290 U.S. 111">290 U.S. 111, 115 (1933); Murphy v. Commissioner, 103 T.C. 111">103 T.C. 111, 119-120 (1994); Weis v. Commissioner, 94 T.C. 473">94 T.C. 473, 490 (1990). Petitioner argues in his brief that he is not liable for this addition to tax because he had substantial authority for175 his treatment, given that he read the applicable statute and regulations, and consulted with a tax professional, before consummating the transaction at hand. We disagree. A taxpayer has substantial authority for the treatment of an item only when the weight of the authorities supporting his or her position is substantial in relation to the weight of authorities supporting contrary positions. A taxpayer's belief that he or she has substantial authority is irrelevant to this determination. Sec. 1.6661-3(b)(1), Income Tax Regs.; see also Antonides v. Commissioner, 91 T.C. 686">91 T.C. 686, 702 (1988), affd. 893 F.2d 656">893 F.2d 656 (4th Cir. 1990). We do not find that petitioner had substantial authority for his position. Petitioner, who is an attorney, bases his tax treatment solely on section 1.1034-1(c)(4)(i), Income Tax Regs. We find his exclusive reliance on this section misplaced. It cannot properly be read in isolation from the Code and case law, or from other provisions of the regulations, including section 1.1034-1(c)(4)(ii), Income Tax Regs.We are also not persuaded by the fact that petitioner "consulted" for approximately 3 to 5 minutes176 with a tax professional in his firm. The opinion of counsel is not substantial authority, see sec. 1.6661-3(b) (2), Income Tax Regs. We reject petitioner's suggestion that he had substantial authority for his position merely because he fleetingly discussed it with a partner at his firm. We conclude that petitioner is liable under section 6661(a). See Murphy v. Commissioner, supra at 119-120. We have considered all arguments made by petitioner and, to the extent not discussed above, find them to be without merit. To reflect the foregoing, Decision will be entered under Rule 155. Footnotes1. Rule references are to the Tax Court Rules of Practice and Procedure. Unless otherwise indicated, section references are to the Internal Revenue Code in effect for the year in issue.↩2. Petitioner has never alleged that respondent erred with respect to her determination (included in the notice of deficiency) that his income must be increased by $ 7,424 to reflect a passive activity loss adjustment. We hold that petitioner has conceded this determination. Rule 34(b)(4); Jarvis v. Commissioner, 78 T.C. 646">78 T.C. 646, 658↩ n.19 (1982). Respondent conceded through stipulation that petitioner's gain on the subject transaction was $ 112,000, rather than the $ 113,000 amount included in her notice of deficiency.3. The stipulations and attached exhibits are incorporated herein by this reference.↩4. Thus, petitioner's "amount realized" and "adjusted sales price" were both $ 214,000. See sec. 1.1034-1(b)(3) and (4), Income Tax Regs.↩5. On or about Apr. 26, 1993, subsequent to the start of respondent's audit of the subject transfer, petitioner and Jacqueline Fisher filed Federal gift tax returns to report the transfer. Neither petitioner nor Ms. Fisher paid any gift tax on the transfer.↩6. Petitioner paid Parents $ 20,000 on Aug. 1, 1990.↩7. Petitioner also did not file a Form 1099-S, Proceeds From Real Estate Transactions, to report the sale.↩8. Petitioner was an employee of Shea & Gould during at least his 1990 taxable year.↩9. Exhibit 14-N, however, would have been of limited (if any) value to petitioner. Respondent did not stipulate to the truth of any fact contained therein, except to the extent that a fact was duplicative of any fact that she had otherwise stipulated.↩10. Sec. 1.1034- 1(b)(7) and (c)(4)(ii), Income Tax Regs., does not refer to this 4-year replacement period. The regulations under sec. 1034↩ do not reflect the fact that sec. 122 of the Economic Recovery Tax Act of 1981, Pub. L. 97-34, 95 Stat. 172, 197, generally set the replacement period at 4 years (i.e., 2 years before and 2 years after the date of sale) for old residences that are sold or exchanged after July 20, 1981.11. Petitioner devotes much time in his brief to hypothetical transactions that he states could have been consummated to reach the result that he desired. We are not persuaded by these hypothetical transactions. We focus on the facts of the transaction consummated by petitioner and give no consideration to the hypothetical facts of other transactions that petitioner may have structured to reach a given result.↩12. N.J. Stat. Ann. sec. 46:9-7.1 (1989) provides that: Whenever real estate situated in this State shall be sold and conveyed subject to an existing mortgage or is at the time of any such sale or conveyance subject to an existing mortgage, the purchaser shall not be deemed to have assumed the debt secured by such existing mortgage and the payment thereof by reason of the amount of any such mortgage being deducted from the purchase price or by being taken into consideration in adjusting the purchase price, nor for any other reason, unless the purchaser shall have assumed such mortgage debt and the payment thereof by an express agreement in writing signed by the purchaser['s] * * * acceptance of a deed containing a covenant to the effect that the grantee assumes such mortgage debt and the payment thereof↩. [Emphasis added.]13. There is no indication in the record that petitioner notified the lender of either transfer. It appears that the lender could have accelerated the balance of the note at the time of either transfer, charged an assumption fee, or increased the interest rate on the debt. According to the note and the underlying mortgage: If all or any part of the Property or an interest therein * * * is sold or transferred by Borrower without Lender's prior written consent, * * *, Lender may, at Lender's option, declare all the sums secured by this Mortgage to be immediately due and payable. Lender shall have waived such option to accelerate if, prior to the sale or transfer, Lender and the person to whom the Property is to be sold or transferred reach agreement in writing that the credit of such person is satisfactory to Lender and that the interest payable on the sums secured by this Mortgage shall be at such rate as Lender shall request and such person has paid to Lender such assumption fees as Lender shall request. If Lender has waived the option to accelerate provided in this paragraph 17, and if Borrower's successor in interest has executed a written assumption agreement accepted in writing by Lender, Lender may, but is not obligated to, release Borrower from all obligations under this mortgage.↩14. Petitioner does not argue that Parents had a right of contribution from petitioner following the "assumption" to the extent that Parents were required to pay any of the debt. The record leads us to conclude that the "assumption" was a device contrived by petitioner to inflate the "cost of purchasing the new residence" under section 1034(a)↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623580/	BRUCE W. AND BARBARA M. CLAUSSE, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentClausse v. CommissionerDocket No. 3383-94United States Tax CourtT.C. Memo 1995-198; 1995 Tax Ct. Memo LEXIS 198; 69 T.C.M. (CCH) 2546; May 4, 1995, Filed 198 Decision will be entered for respondent. Bruce W. and Barbara M. Clausse, pro se. For respondent: S. Mark BarnesCOUVILLIONCOUVILLIONMEMORANDUM OPINION COUVILLION, Special Trial Judge: This case was heard pursuant to section 7443A(b)(3) 1 and Rules 180, 181, and 182. Respondent determined a deficiency of $ 1,673 in petitioners' 1990 Federal income tax. The sole issue for decision is whether petitioners may exclude disability benefits received by Bruce W. Clausse (petitioner) from gross income under section 104(a)(1). Some of the facts were stipulated, and those facts, with the annexed exhibits, are so found and incorporated herein by reference. At the time the petition was filed, petitioners' legal residence was Ogden, Utah. Petitioner is a disabled deputy sheriff from the Sacramento County, California, Sheriff's Department199 (Department). In February 1976, petitioner was diagnosed with Chrohn's disease, which causes inflammation of the digestive system. The Worker's Compensation Board and the Department determined that petitioner's disability was sustained within the course and scope of his employment. Petitioner's disability entitled him to receive long-term disability benefits through a group insurance policy underwritten by Standard Insurance Company (Company). Since February 1976, petitioner has received disability income from this policy, which was purchased by Sacramento County (County). All premium payments on the policy were paid by the County. Apparently, there was either a negotiated agreement between the County and the Department or a statute that required the County to provide, at its expense, this disability insurance. The insurance policy of the Company provided for disability payments to be paid upon notification to the Company that an insured had become totally disabled as a result of injury or sickness. Total disability was defined, in pertinent part, as the "complete inability of the Member to engage in any employment or occupation". The policy did not require that the disability200 arise while in the course and scope of employment of the insured. The policy additionally stated: "Long Term Disability Insurance is not in lieu of and does not affect any requirement for coverage by workmen's compensation insurance." From February 18, 1976, to March 23, 1990, petitioner received workmen's compensation benefits, in addition to the above-described monthly disability insurance payments. When petitioner's workmen's compensation award was exhausted, March 23, 1990, he began receiving life pension benefits from the County. To date, petitioner continues to receive both the pension benefits and the disability insurance payments. 2201 During 1990, the year at issue, petitioner received $ 8,733.60 in disability insurance payments from the Company. The Company issued to petitioner an Internal Revenue Service (IRS) Form W-2P, Statement for Recipients of Annuities, Pensions, Retired Pay, or IRA Payments, and classified the payments as taxable income. 3 Petitioners reported the payments as nontaxable income on their 1990 Federal income tax return. It appears from the record that petitioners, in prior years, had reported these payments in this fashion and, in audits for prior years, the IRS agreed that these payments were not includable in gross income. In the notice of deficiency, respondent determined that the disability insurance payments were includable in gross income. 4202 The determinations of the Commissioner in a notice of deficiency are presumed correct, and the burden of proof is on the taxpayer to show that the determinations are incorrect. Rule 142(a); Welch v. Helvering, 290 U.S. 111">290 U.S. 111, 115 (1933). Petitioners contend that the disability insurance payments are excludable from gross income under section 104(a)(1) because the payments were received under a statute in the nature of a workmen's compensation act for a work-related injury. More specifically, petitioners contend that they were informed by the IRS that the benefits were excludable pursuant to Rev. Rul. 68-10, 1 C.B. 50">1968-1 C.B. 50, and the Public Safety Officers' Benefits Act of 1976, Pub. L. 94-430, sec. 2, 90 Stat. 1346. In the notice of deficiency, respondent determined that the disability insurance payments are not excludable from gross income under section 104(a)(1) because the payments were not paid under a workmen's compensation act or any statute in the nature of a workmen's compensation act. In general, gross income includes "all income from whatever source derived". Sec. 61(a). However, amounts received203 under a workmen's compensation act for personal injuries or sickness are excluded from gross income. Sec. 104(a)(1). Section 1.104-1(b), Income Tax Regs., provides in part as follows: "Section 104(a)(1) excludes from gross income amounts which are received by an employee under a workmen's compensation act * * * or under a statute in the nature of a workmen's compensation act which provides compensation to employees for personal injuries or sickness incurred in the course of employment. * * * Section 104(a)(1) * * * does not apply to amounts which are received as compensation for a nonoccupational injury or sickness". In order for petitioner's insurance disability payments to qualify for the exclusion under section 104(a)(1) and the cited regulation, it is necessary to first establish that the disability payments were received under either a workmen's compensation act or under a statute that is in the nature of a workmen's compensation act. Rutter v. Commissioner, 760 F.2d 466">760 F.2d 466, 468 (2d Cir. 1985), affg. per curiam T.C. Memo 1984-525">T.C. Memo. 1984-525; sec. 1.104-1(b), Income Tax Regs. After that, it is necessary to establish that the disability204 benefits were received for an injury sustained in the course of employment. Sec. 1.104-1(b), Income Tax Regs.Petitioners contend that, under Rev. Rul. 68-10, supra, and under the Public Safety Officers' Benefits Act of 1966, supra, the benefits petitioner received are excludable from gross income under section 104(a)(1). In Rev. Rul. 68-10, supra, the IRS took the position that benefits under Cal. Lab. Code sec. 4850 (West Supp. 1990) and Cal. Lab. Code sec. 4853 (West Supp. 1990) are excludable under section 104(a)(1). Cal. Lab. Code sec. 4850 (West 1990) provides generally that, if any sheriff, officer, or employee of a sheriff's office, who is a member of the California Public Employees' Retirement System or subject to the County Employees Retirement Law of 1937, is disabled, whether temporarily or permanently, by injury or illness arising out of and in the course of his or her duties, he or she shall become entitled, regardless of his or her period of service with the city or county, to a leave of absence while so disabled without loss of salary in lieu of temporary disability 205 payments, for the period of the disability, but not exceeding 1 year. Cal. Lab. Code sec. 4853 (West Supp. 1990) provides, in pertinent part, that, whenever such disability continues for a period beyond one year, such member shall thereafter be subject to disability indemnity during the remainder of the period of the disability or until the effective date of his retirement under the Public Employees' Retirement Act, supra. The Public Safety Officers' Benefits Act, supra, provides, generally, that, when it is determined that a public safety officer has become permanently and totally disabled as the direct result of a catastrophic injury in the line of duty, the Bureau shall make benefits payments to such officer. Petitioners presented no evidence to establish that the disability insurance payments to petitioner were paid pursuant to the Federal and State statutory provisions cited. On the contrary, in a joint exhibit stipulated into evidence, the Company stated that the payments to petitioner were not paid pursuant to either Cal. Lab. Code sec. 4850 (West Supp. 1990) or Cal. Lab. Code sec. 4853 (West Supp. 1990), but rather were paid by the Company as third party sick pay. 206 See supra note 3. Moreover, if the disability insurance payments were made pursuant to a statute considered to be in the nature of a workmen's compensation act, such statute would have to limit the disability benefits to job-related injuries. Rutter v. Commissioner, supra at 468; Take v. Commissioner, 82 T.C. 630">82 T.C. 630, 634 (1984), affd. 804 F.2d 553">804 F.2d 553 (9th Cir. 1986); Haar v. Commissioner, 78 T.C. 864">78 T.C. 864, 868 (1982), affd. per curiam 709 F.2d 1206">709 F.2d 1206 (8th Cir. 1983). Furthermore, a statute must also preclude an employee from filing an independent claim for workmen's compensation benefits to be in the nature of a workmen's compensation act. See Gallagher v. Commissioner, 75 T.C. 313">75 T.C. 313, 316-317 (1980); Blackburn v. Commissioner, 15 T.C. 336">15 T.C. 336 (1950). In the present case, the insurance policy, under which petitioner received his payments, provided for payments to be paid regardless of whether the injury or disability arose in the course and scope of employment. The disability benefits207 were not limited to only work-related injuries or injuries sustained in the course and scope of employment. Furthermore, petitioner was not precluded from filing an independent claim for workmen's compensation benefits. This is evidenced by the fact that petitioner received workmen's compensation benefits for a period of 14 years, while also receiving the disability insurance benefits from the Company. Additionally, the insurance policy itself provides that "Long Term Disability Insurance is not in lieu of and does not affect any requirement for coverage by workmen's compensation insurance." The Court holds that the disability insurance payments petitioner received during 1990 were not received under a workmen's compensation act or a statute in the nature of a workmen's compensation act. Accordingly, the Court holds that the disability benefits received by petitioner are not excludable from gross income under section 104(a)(1). Respondent is, therefore, sustained. The Court notes that it is sympathetic to the fact that petitioners were informed by the IRS during several audits for prior years that the disability payments were not includable in gross income. However, even though*208 respondent may have overlooked or accepted the tax treatment of the disability payments in previous years, respondent is not precluded from correcting that error in subsequent years with respect to the same taxpayers. Garrison v. Commissioner, T.C. Memo 1994-200">T.C. Memo. 1994-200. Decision will be entered for respondent.Footnotes1. Unless otherwise indicated, section references are to the Internal Revenue Code in effect for the year at issue. All Rule references are to the Tax Court Rules of Practice and Procedure.↩2. During the period of Aug. 1977 through Nov. 1986, the Company reduced petitioner's monthly insurance payments by the amount he was concurrently receiving as workmen's compensation. However, as the result of a class action lawsuit and a resulting settlement agreement, the Company reimbursed petitioner for the amounts deducted in prior years and increased petitioner's disability payments to the maximum amount, which amount he was receiving at the time of trial.↩3. It appears that the Company considered the benefits paid to petitioner as amounts paid through accident or health insurance for personal injuries or sickness other than in petitioner's status as an employee. Because the premiums were paid by petitioner's employer, such benefits were not excludable from gross income under sec. 104(a)(3).↩4. As a result of this determination, respondent also made computational adjustments to petitioner's itemized deductions for medical and dental expenses.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623582/	OAK KNOLL CELLAR, WILLIAM P. JAEGER, JR., TAX MATTERS PARTNER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentOak Knoll Cellar v. CommissionerDocket Nos. 11758-92, 4239-93United States Tax CourtT.C. Memo 1994-396; 1994 Tax Ct. Memo LEXIS 407; 68 T.C.M. (CCH) 412; 94-2 U.S. Tax Cas. (CCH) P47,958; August 18, 1994, Filed 407 For petitioner: R. Todd Luoma and Stephen T. Buehl. For respondent: Daniel J. Parent and Kathryn K. Vetter. DAWSONDAWSONMEMORANDUM OPINION DAWSON, Judge: These cases were consolidated for trial, briefing, and opinion. They have been reassigned to Special Trial Judge Stanley J. Goldberg pursuant to the provisions of section 7443A(b)(4) of the Internal Revenue Code (the Code) of 1986, as amended, and Rules 180, 181, and 183 of the Tax Court Rules of Practice and Procedure. The Court agrees with and adopts the opinion of the Special Trial Judge, which is set forth below. OPINION OF THE SPECIAL TRIAL JUDGE GOLDBERG, Special Trial Judge: This matter is before the Court on petitioner's Motion for An Award of Reasonable Litigation Costs under section 7430 and Rule 231. Petitioner does not seek any administrative costs he incurred in connection with the consolidated cases. Section references are to the Code in effect for the taxable years in issue; however, unless otherwise indicated, references to section 7430 are to the Code in effect at the time these cases were filed. 1 All Rule references are to the Tax Court Rules of Practice and Procedure. 408 Respondent, by notices of final partnership administrative adjustment (FPAA), determined adjustments to the income of Oak Knoll Cellar (the partnership) for its fiscal years ended June 30, 1988 (1988 year), and June 30, 1989 (1989 year), in the amounts of $ 3,240,963 and $ 169,412, respectively. The adjustments are attributable to respondent's termination of the partnership's election to use the last-in, first-out (LIFO) method of valuing inventory and recomputation of the value of the inventory using the first-in, first-out (FIFO) method; adjustments to the capitalization of inventory costs under section 263A; and adjustments made to the depreciation deductions the partnership claimed for certain caves used to store wine. The substantive issues in these cases were conceded by respondent shortly before trial. The issue for decision is whether William P. Jaeger, Jr. (petitioner), is entitled to an award of litigation costs. For purposes of petitioner's motion, respondent concedes that petitioner has substantially prevailed with respect to the amounts in controversy and that petitioner has exhausted the administrative remedies available to him. 2 We must decide whether respondent's409 position was substantially justified within the meaning of section 7430(c)(4)(A)(i). In accordance with Rule 232, the parties have submitted declarations and memoranda supporting their positions. We decide the motion for litigation costs based on petitioner's motion, respondent's objection, petitioner's reply to respondent's objection, and the declarations and exhibits provided by both parties. There are conflicts of facts presented by each party. Neither party requested a hearing, however, and we conclude that a hearing is not necessary for410 the proper consideration and disposition of this motion because the facts in dispute are not relevant to our conclusion. Rule 232(a)(3). The relevant facts, as drawn from the record and set out below, are not disputed. BackgroundIn GeneralThe partnership is a California limited partnership whose principal place of business at the time of the filing of the petitions was St. Helena, California. The partnership, formed in April 1976 to manufacture and sell premium Napa Valley wines, operates a winery located near St. Helena, California, and produces premium wines under the Rutherford Hill Winery label. Each year the partnership crushes several different varieties of grapes and produces several different varieties of wine from the resulting juices. Among the varieties of wine produced by the partnership are Cabernet Sauvignon, Sauvignon Blanc, Chardonnay, Zinfandel, and Merlot. The partnership did not own or operate any vineyards before July 1, 1988. Rather, the partnership purchased all of the grapes it used in the production of its wines. The grapes are of the same type, from the genus Vitis vinifera, and are all grown in Napa County, California. Grapevines are411 divided by variety, by location, and by ownership into blocks. Grapes are harvested when the partnership's winemaking team determines that the grapes on the vine are ripe; i.e.; have reached the desired sugar level. Identical grape varieties in different blocks located only a few miles distant from each other may reach the desired sugar level several weeks apart, depending on a variety of factors including soil, water content of the soil, age of the vines, size of the crop being ripened, and elevation and microclimate of the location of the block. From year to year, the sequence in which the grape varieties have been harvested has changed, depending on when each particular block of grapes reaches its desired sugar levels. The cost of the grapes, the production costs, and the aging periods vary for each type of wine. The removal of the skins and seeds from the grape juice generally occurs immediately or soon after crushing for white grapes or red grapes made into pink wine, and as much as several days to a week later for red grapes which are to be made into red wine. Some wines are fermented in steel tanks while others are fermented in redwood or oak barrels. White wines take412 about 6 to 12 months to age, and red wines take 12 to 24 months to age. White wines are aged an additional 3 to 6 months. Red wines are aged for an additional 1 to 2 years. The partnership sells wine in bulk as well as in bottled form. After the completion of the holding period in barrels or tanks, each wine variety that is not sold as bulk wine is bottled. Before bottling, the winemaking team decides what, if any, blending of different varieties is to occur. Some wine varieties, such as Chardonnay, usually are not blended before bottling. Other wine varieties, such as Cabernet Franc, are used almost exclusively as blending wines. Still other varieties, such as Cabernet Sauvignon and Merlot, are used for blending as well as being bottled as varietal wines. The partnership uses the specific-goods LIFO method, and two pools, i.e., wine and bottling costs, in accounting for inventory and cost of goods sold. In computing the value of inventory, the partnership uses an average cost per gallon to determine increments and decrements to the pool of wine gallons regardless of the varietal. During 1985 the partnership completed construction of some caves being built into a hillside413 to store and age wine (caves). The partnership depreciated the caves on its Form 1065, U.S. Partnership Return of Income (partnership return), using a 5-year useful life. The caves have electricity and consist of a series of tunnels and side caves. The floors, walls, and ceilings are a combination of concrete and shotcrete. Examination of the Partnership ReturnsThe 1988 ReturnRespondent's revenue agent Barbara Osborne (Osborne) started the examination of the partnership return for the 1988 year on December 6, 1990. During the audit of the 1988 year, Osborne toured the caves at the partnership's winery. She observed that the walls and floor of the caves were dry and that the partnership was in the process of digging a new cave and finishing an underground entertainment room at one end of the caves. In a summary report for the 1988 year (the summary report), Osborne proposed changing the partnership's method of accounting for inventory from the LIFO method to the FIFO method because she believed that the partnership had valued some of its inventory using the lower of cost or market method, contrary to the provisions of section 1.472-2(b), Income Tax Regs., which414 generally requires that inventory must be valued at cost regardless of market value when the LIFO method for valuing inventory is used on the tax return. In the alternative, in order to clearly reflect income under the specific-goods LIFO method, Osborne proposed changing the partnership's LIFO method to (1) accounting for each varietal as an item within the LIFO pool in the manner prescribed under the regulations for the dollar-value LIFO method, or (2) accounting for each varietal as a separate pool under the specific-goods LIFO method of valuing inventory. In the summary, Osborne further proposed adjustments to the costs required to be capitalized and included in inventory pursuant to section 263A on the ground that the partnership had not capitalized interest on its Cabernet wine and had not accounted for cumulative section 263A costs. She also proposed changing the useful life of the caves from 5 to 18 years on the ground that the caves were a building and not a special purpose structure within the meaning of section 1.48-1(e)(1), Income Tax Regs.The partnership replied to the summary report in a written response dated August 27, 1991. In its reply, the partnership asserted, 415 among other things, that it had not used market value for valuing inventory on its tax return but had used a market value reserve only for financial statement purposes. A closing conference for the 1988 year was held on August 27, 1991 (closing conference). That morning during a telephone conversation before the closing conference, Timothy Kelly (Kelly), who at the time apparently was the revenue agent in charge of respondent's Santa Rosa, California, office, informed Stephen Buehl (Buehl), the partnership's general counsel, that the revenue agents who were attending the closing conference might want to inspect the caves to resolve certain unagreed items, such as whether there was mold in the caves. Buehl responded that respondent's agents could inspect the caves at the end of the closing conference. Respondent's agents did not inspect the caves at that time, however, but agreed that, if necessary, a tour of the caves would be conducted sometime later following further research on the issues. During the closing conference Kelly advised the partnership's representatives that a technical advice request on the LIFO pooling issue had been submitted relating to an unrelated winery416 that also had elected a similar specific-goods grouping. Kelly advised the partnership's representatives further that advice relating to the LIFO pooling issue was being sought from respondent's Sacramento District Office. During a telephone conversation between Buehl and Kelly on September 5, 1991, Kelly advised Buehl, among other things, that the technical advice request had not been submitted and that respondent's Sacramento District Office did not agree with Osborne's proposed varietal-by-varietal approach for accounting for inventories. Instead, that office favored a time-of-production grouping approach, such as white wine and red wine, with possible further subdivisions of the red wine if different varieties of red wine were produced over significantly different periods of time. On October 31, 1991, the partnership filed an amended partnership return for the 1988 year, to correct, among other things, the value of its inventory resulting from deductions mistakenly taken for that year for wines with market values less than cost. Respondent issued the FPAA with respect to the partnership for the 1988 year on March 3, 1992. In that FPAA respondent changed the partnership's417 method of accounting for inventory from LIFO to FIFO, adjusted costs required to be capitalized and included in income under section 263A, and changed the useful life of the caves from 5 years to 18 years. The 1989 ReturnOsborne started the examination of the partnership return for the 1989 year sometime after she started the examination of the 1988 partnership return. As a result of additional information provided to her by the partnership during the examination of the 1989 year, Osborne determined that the partnership had made a number of errors in calculating the value of its inventory for earlier years, both in the partnership's favor and to its detriment. She concluded that the cumulative effect of those errors resulted in no material distortion of the partnership's income. Consequently, Osborne decided to accept the partnership's LIFO method for the 1989 year. On April 9, 1992, Osborne advised the partnership's accountant that she was dropping the FIFO issue for the 1989 year. Respondent issued the FPAA for the 1989 year on December 4, 1992. In that FPAA the only item adjusted was the depreciation deduction claimed for the caves. The Petitions and Answers418 Petitioner filed his petition for readjustment of partnership items under section 6226 for the 1988 year on June 1, 1992. Respondent filed her answer on July 24, 1992. In the answer respondent conceded that the partnership was not required to change its method of accounting for inventory from the LIFO to the FIFO method. Respondent, however, affirmatively alleged in the answer that the partnership should be required to use a separate pool for each wine varietal in accounting for the value of its inventory. Petitioner filed his reply to the answer on September 8, 1992. The Court issued a notice dated December 2, 1992, setting the 1988 year for trial at a session beginning on June 21, 1993. Respondent filed a motion for continuance dated February 11, 1993, unopposed by petitioner and subsequently granted, citing as grounds that on December 4, 1992, respondent had mailed to petitioner an FPAA for the 1989 year involving the same issues as were involved in the 1988 year, 3 that the intricate and complex calculation of the proposed inventory adjustment for the 1988 year directly affected the 1989 year, and that a continuance would permit the parties to consolidate the related cases, 419 narrow the issues for trial, and pursue settlement. Petitioner filed his petition for readjustment of partnership items under section 6226 for the 1989 year on March 1, 1993. Respondent filed her answer on April 15, 1993. The Court issued a notice dated April 14, 1993, setting the 1988 year for trial at a session beginning in San Francisco on September 20, 1993 (the September 20 trial session). Respondent filed a motion on June 1, 1993, unopposed by petitioner and subsequently granted, to consolidate for trial, briefing, and opinion the cases for the 1988 year and the 1989 year and to set the 1989 year for trial also at the September 20 trial session. Other Actions420 On October 30, 1992, representatives of the partnership met with one of respondent's Appeals officers, Dennis Gallagher (Gallagher), to discuss the issues raised for both the 1988 and the 1989 years. Sometime later, Gallagher sent the administrative file to one of respondent's revenue agents to review Osborne's calculations. During March 1993, representatives of the parties met to discuss two other cases then docketed in this Court relating to an unrelated winery and also set for trial at the September 20 trial session. Counsel for the parties in the instant cases also were counsel in those unrelated cases. The primary issue in the unrelated cases was whether a separate specific-goods LIFO pool was required for each variety of wine produced by that winery. During that meeting, other specific-goods LIFO groupings were suggested, including a grouping consisting of one pool for red wines and one pool for white wines. Additional information was requested by respondent's agents to determine whether such a grouping would clearly reflect the winery's income. As of August 27, 1993, respondent's agents had not received all the information that they believed they needed to complete 421 that determination. During May 1993, Gallagher contacted the partnership's counsel to arrange for an inspection of the caves. Because of conflicting schedules of the representatives for both parties, the tour of the caves originally could not be scheduled until July 9, 1993, and then had to be rescheduled for August 6, 1993, because of a change in respondent's counsel and further scheduling conflicts. On August 12, 1993, following that tour, Gallagher informed the partnership's counsel that respondent would concede the depreciation issue. On August 2, 1993, Gallagher indicated to the partnership's counsel that respondent would consider settling the LIFO inventory method issue by the partnership's creating a pool for red wine and a pool for white wine. That grouping method for the partnership's wine inventory was similar to the grouping method being proposed to settle the cases involving the unrelated winery. On August 20, 1993, petitioner served on respondent and mailed to the Court a motion for determination of burden of proof on the issues remaining for trial. In her response to that motion, filed August 31, 1993, respondent admitted that she had the burden of proof for such422 issues. On August 23, 1993, petitioner filed a motion for extension of time to submit an expert witness report or to permit expert witness to testify without a written report. In that motion petitioner alleged that he had engaged an expert witness to testify at trial relating to such matters as the validity of the partnership's specific-goods LIFO method of accounting for inventories and whether its method conforms with the requirements of the applicable Code and regulations provisions and clearly reflects income. Respondent opposed such motion in her reply filed August 31, 1993. At a meeting held on August 27, 1993, the parties' representatives discussed generally alternative inventory pooling arrangements for the partnership's wine, such as one pool for all wines, a pool for red wine and a pool for white wine, and a pool for each wine varietal. Thereafter, on September 2, 1993, petitioner submitted a settlement offer to respondent in which petitioner proposed the following: In order to settle the cases, petitioner is willing to do the following. Petitioner is willing to settle the LIFO issue along the lines of two specific items of (1) gallons of red wine and (2) gallons423 of white wine, rather than the current single item of gallons of wine. Petitioner [the partnership] will change its method of accounting, however, only on a prospective basis; i.e., commencing with the year July 1, 1993, ending June 30, 1994. As part of the offer resolving the LIFO issue, with respect to the § 263A issue, respondent must agree that there is no adjustment in tax liabilities for 1988 and 1989. This settlement proposal also presumes that respondent has conceded the depreciation issue involving the wine caves.At a conference held on September 8, 1993, to discuss petitioner's settlement offer, respondent agreed to concede the issues remaining for trial. Petitioner filed his motion for award of reasonable litigation costs with a memorandum and declarations in support of the motion on September 20, 1993. Petitioner filed supplemental declarations in support of his motion on October 22, 1993. Respondent filed her objection to petitioner's motion on November 19, 1993, to which petitioner filed a reply and second supplemental declarations on December 20, 1993. DiscussionUnder section 7430(a), a taxpayer in a civil tax proceeding may be awarded a judgment424 for reasonable litigation costs if that taxpayer is the "prevailing party". To be considered a prevailing party, the taxpayer must establish that the position of the United States in the proceeding was not substantially justified, the taxpayer has "substantially prevailed" with respect to either the amount in controversy or the most significant issue or set of issues presented, and he or she meets the net worth test as set forth in the Equal Access to Justice Act (EAJA), 28 U.S.C. section 2412(d). Sec. 7430(c)(4)(A). Furthermore, in order to be awarded litigation costs, the taxpayer must have exhausted the administrative remedies available to him or her within the Internal Revenue Service. Sec. 7430(b)(1). Moreover, the taxpayer may not be awarded litigation costs for any portion of the court proceedings which he or she has unreasonably protracted. Sec. 7430(b)(4). All of these requirements must be met. Polyco, Inc. v. Commissioner, 963">91 T.C. 963 (1988); Sher v. Commissioner, 89 T.C. 79">89 T.C. 79, 83 (1987), affd. 861 F.2d 131">861 F.2d 131 (5th Cir. 1988). The taxpayer bears425 the burden of proving that he or she is entitled to an award of litigation costs. Rule 232(e); Coastal Petroleum Refiners, Inc. v. Commissioner, 94 T.C. 685">94 T.C. 685, 688 (1990); Stieha v. Commissioner, 89 T.C. 784">89 T.C. 784, 790 (1987). We will consider first whether respondent's position was substantially justified within the meaning of section 7430 because a determination favorable to respondent on this issue renders the remaining questions moot. Petitioner contends that respondent was not substantially justified in the position she took with respect to each of the issues involved in the instant cases. Respondent contends, on the other hand, that she was reasonable at all times in the position she took regarding the issues involved in these cases. We agree with respondent. Whether the Commissioner's position is substantially justified turns on a finding of reasonableness, based upon all the facts and circumstances, as well as legal precedents relating to the cases. 4 See Pierce v. Underwood, 487 U.S. 552 (1988) (construing similar language in the Equal Access to Justice Act, 28 U.S.C. sec. 2412426 (1988)); Huffman v. Commissioner, 978 F.2d 1139">978 F.2d 1139, 1147 (9th Cir. 1992), affg. in part and revg. in part and remanding T.C. Memo. 1991-144; Berotolino v. Commissioner, 930 F.2d 759">930 F.2d 759 (9th Cir. 1991; Powers v. Commissioner, 100 T.C. 457">100 T.C. 457, 471 (1993). A position is substantially justified if the position is "justified to a degree that could satisfy a reasonable person." Pierce v. Underwood, supra at 565; see also Norgaard v. Commissioner, 939 F.2d 874">939 F.2d 874, 881 (9th Cir. 1991), affg. in part and revg. in part T.C. Memo 1989-390">T.C. Memo 1989-390. For a position to be substantially justified, there must be "substantial evidence" to support it. Pierce v. Underwood, supra at 564-565. 427 Furthermore, in deciding whether the Commissioner's position was substantially justified, the Court will consider not only the basis of the Commissioner's legal position, but also the manner in which the Commissioner maintained that position. Wasie v. Commissioner, 86 T.C. 962">86 T.C. 962, 969 (1986). The reasonableness of the Commissioner's position necessarily requires considering what the Commissioner knew at the time she took the position and the events that occurred afterwards. See Rutana v. Commissioner, 88 T.C. 1329">88 T.C. 1329, 1334 (1987); Don Casey Co. v. Commissioner, 87 T.C. 847">87 T.C. 847, 862 (1986); DeVenney v. Commissioner, 85 T.C. 927">85 T.C. 927, 930 (1985). The taxpayer need not show bad faith to establish that the Commissioner's position was not substantially justified for purposes of a motion for litigation costs under section 7430. Estate of Perry v. Commissioner, 931 F.2d 1044">931 F.2d 1044, 1046 (5th Cir. 1991); Powers v. Commissioner, supra.The legislative history of section 7430 sets forth the following guidelines for determining428 whether the Commissioner's conduct was unreasonable: The committee intends that the determination by the court on this issue is to be made on the basis of the facts and legal precedents relating to the case as revealed in the record. Other factors the committee believes might be taken into account in making this determination include, (1) whether the government used the costs and expenses of litigation against its position to extract concessions from the taxpayer that were not justified under the circumstances of the case, (2) whether the government pursued the litigation against the taxpayer for purposes of harassment or embarrassment, or out of political motivation, and (3) such other factors as the court finds relevant. * * * [H. Rept. 97-404, at 12 (1981).]Absent extenuating circumstances, the Commissioner's adoption of a position that is clearly inconsistent with the position taken in other similar cases demonstrates unreasonableness. Hubbard v. Commissioner, 89 T.C. 792">89 T.C. 792, 803 (1987). Moreover, the Commissioner's position may be unreasonable if the Commissioner failed to adequately investigate the case. Lennox v. Commissioner, 998 F.2d 244">998 F.2d 244, 248 (5th Cir. 1993),429 revg. and remanding T.C. Memo. 1992-382; Powers v. Commissioner, supra at 476. The fact that the Commissioner eventually concedes the case is not sufficient in itself to establish that a position is unreasonable. E.g., Estate of Merchant v. Commissioner, 947 F.2d 1390">947 F.2d 1390, 1395 (9th Cir. 1991), affg. T.C. Memo. 1990-160; Broad Ave. Laundry & Tailoring v. United States, 693 F.2d 1387">693 F.2d 1387, 1391-1392 (Fed. Cir. 1982); Powers v. Commissioner, supra at 471; Sokol v. Commissioner, 92 T.C. 760">92 T.C. 760, 767 (1989). However, the Commissioner's concession does remain a factor to be considered. Powers v. Commissioner, supra.Nonetheless, just as a concession does not make an otherwise unreasonable position reasonable, see Hanson v. Commissioner, 975 F.2d 1150">975 F.2d 1150, 1156-1157 (5th Cir. 1992), a concession does not make an otherwise reasonable position unreasonable, see Price v. Commissioner, 102 T.C. 660">102 T.C. 660, 664-665 (1994).430 Whenever there is a factual determination, the Commissioner is not obliged to concede the case until the necessary documentation to prove the taxpayer's contention is received. See Egan v. Commissioner, 91 T.C. 705">91 T.C. 705, 713 (1988); Bayer v. Commissioner, T.C. Memo. 1991-282. However, the Commissioner cannot escape an award of litigation costs simply because the issue presents a question of fact. Minahan v. Commissioner, 88 T.C. 492">88 T.C. 492, 500-502 (1987); Frisch v. Commissioner, 87 T.C. 838">87 T.C. 838 (1986). With these general principles in mind, we consider now the issues involved in the instant cases. The Applicable Position of the United StatesWe first must determine from which point we are to evaluate the position of the United States. Respondent's position as set forth in the answer for the 1988 year differs from her position in the FPAA for that year. Petitioner, relying on Sliwa v. Commissioner, 839 F.2d 602">839 F.2d 602, 605-607 (9th Cir. 1988), and Golsen v. Commissioner, 54 T.C. 742">54 T.C. 742 (1970), affd. 445 F.2d 985">445 F.2d 985 (10th Cir. 1971),431 argues that, because these cases are appealable to the Court of Appeals for the Ninth Circuit, we should review the position of the United States both before and after the commencement of litigation. Respondent, however, asserts that petitioner must prove that respondent's position in the proceedings in this Court was not substantially justified. We agree with respondent. Sliwa v. Commissioner, supra, which was decided under the 1982 version of section 7430 that contained no statutory definition for the phrase "position of the United States", is not applicable to the instant cases. Rather, because these cases were commenced after November 10, 1988, section 7430 as amended by the Technical and Miscellaneous Revenue Act of 1988 (TAMRA), Pub. L. 100-647, sec. 6239, 102 Stat. 3743, applies. See Huffman v. Commissioner, 978 F.2d 1139">978 F.2d 1139, 1144 (9th Cir. 1992), affg. in part and revg. in part T.C. Memo. 1991-144; Estate of Merchant v. Commissioner, supra at 1392 n.6. Section 7430(c)(7) as amended by TAMRA provides that in proceedings commenced after November 432 10, 1988, the position of the United States includes the position taken by the United States in a judicial proceeding and in an administrative proceeding as of the earlier of (1) the date of a taxpayer's receipt of the decision from respondent's Appeals Office or (2) the date of the notice of deficiency. In Huffman, the Court of Appeals for the Ninth Circuit agreed with this Court that, for proceedings commenced after November 10, 1988, section 7430 as amended requires a bifurcated analysis of "substantially justified" as to the position taken in the administrative proceeding and the position taken in the judicial proceeding. Huffman v. Commissioner, supra at 1146. Because petitioner is not seeking any costs for the administrative proceedings, our analysis is limited to the position taken by the United States in the judicial proceeding. For purposes of these cases, therefore, in order to recover his reasonable litigation costs petitioner must show that the position taken by the United States in the judicial proceeding was unreasonable. Sec. 7430(c)(7)(A). Generally, the position of the United States in a judicial proceeding is established433 initially in the Commissioner's answer. Huffman v. Commissioner, supra at 1148. Our analysis therefore is limited to the reasonableness of respondent's position asserted in the answer and of her subsequent conduct in maintaining that position. Respondent's Position Relating to Petitioner's LIFO Inventory MethodIn her answer for the 1988 year, respondent alleged that in accounting for the value of its inventory the partnership should be required to use a separate pool for each varietal of wine produced rather than using one pool for all of its wine. Petitioner contends that respondent had no legal or factual basis for challenging the specific-goods LIFO method the partnership used for valuing its inventory. Respondent, however, contends that it was reasonable for her to require the partnership to use more than one pool for its wine in accounting for inventory. A taxpayer's method of valuing its inventory constitutes a method of accounting; therefore, the treatment of inventories for tax purposes is governed by sections 446 and 471. Thor Power Tool Co. v. Commissioner, 439 U.S. 522">439 U.S. 522 (1979); Hamilton Indus. Inc. v. Commissioner, 97 T.C. 120">97 T.C. 120, 128 (1991);434 Rockwell International Corp. v. Commissioner, 77 T.C. 780">77 T.C. 780, 808 (1981), affd. per curiam 694 F.2d 60">694 F.2d 60 (3d Cir. 1982). Sections 446 and 471 grant the Commissioner broad discretion in matters of inventory accounting and give the Commissioner wide latitude to adjust a taxpayer's method of accounting for inventory so as to clearly reflect income. Thor Power Tool Co. v. Commissioner, supra at 532-533; see Commissioner v. Joseph E. Seagram & Sons, Inc., 394 F.2d 738">394 F.2d 738, 743 (2d Cir. 1968), revg. 46 T.C. 698">46 T.C. 698 (1966); Thomas v. Commissioner, 92 T.C. 206">92 T.C. 206, 220 (1989). Sections 446 and 471 have been interpreted as imposing a heavy burden of proof on a taxpayer disputing the Commissioner's determination on accounting matters. 5Thor Power Tool Co. v. Commissioner, supra.435 Section 446(a) requires that taxable income be computed by a taxpayer under the method of accounting it regularly uses in keeping its books. Section 446(b), however, provides that where the method of accounting regularly utilized by the taxpayer does not clearly reflect taxable income, the computation of taxable income shall be made under such method, as, in the Commissioner's opinion, does clearly reflect income. On the other hand, when a taxpayer demonstrates that the taxpayer's method of accounting does clearly reflect income, the Commissioner cannot require that taxpayer to change to a different method even if, in the Commissioner's view, the Commissioner's method more clearly reflects income. Molsen v. Commissioner, 85 T.C. 485">85 T.C. 485, 498 (1985). A taxpayer's accounting method clearly reflects income if it results in accurately reported taxable income under a recognized method of accounting. Wilkinson-Beane, Inc. v. Commissioner, 420 F.2d 352">420 F.2d 352, 354 (1st Cir. 1970), affg. T.C. Memo. 1969-79; RLC Indus., Co. v. Commissioner, 98 T.C. 457">98 T.C. 457, 490 (1992); see also Honeywell, Inc. and Subs. v. Commissioner, T.C. Memo. 1992-453.436 Whether a particular method of accounting clearly reflects income is a question of fact which must be decided on a case-by-case basis. Peninsula Steel Prods. & Equip. Co. v. Commissioner, 78 T.C. 1029">78 T.C. 1029, 1045 (1982); Coors v. Commissioner, 60 T.C. 368">60 T.C. 368, 394 (1973), affd. sub nom. Adolph Coors Co. v. Commissioner, 519 F.2d 1280 (10th Cir. 1975); see also Boecking v. Commissioner, T.C. Memo. 1993-497. For tax purposes, the requirement that a method of accounting clearly reflect income is paramount. Thor Power Tool Co. v. Commissioner, 439 U.S. at 538-544; see also Ford Motor Co. v. Commissioner, 102 T.C. 87">102 T.C. 87, 99 (1994); Thomas v. Commissioner, supra at 220. Even if a method of accounting comports with Generally Accepted Accounting Principles (GAAP), such method will not control for tax purposes if it does not clearly reflect income. Thor Power Tool Co. v. Commissioner, supra at 538-544; see also Hamilton Indus., Inc. v. Commissioner, supra at 128;437 UFE, Inc. v. Commissioner, 92 T.C. 1314">92 T.C. 1314, 1321 (1989); Sandor v. Commissioner, 62 T.C. 469">62 T.C. 469, 477 (1974), affd. per curiam 536 F.2d 874">536 F.2d 874 (9th Cir. 1976). However, if the taxpayer's method of accounting reflects a consistent application of GAAP, it will ordinarily be regarded as clearly reflecting income. Hallmark Cards, Inc. v. Commissioner, 90 T.C. 26">90 T.C. 26, 31 (1988); sec. 1.446-1(a)(2), Income Tax Regs. But see Thor Power Tool Co. v. Commissioner, supra at 539-540. The Commissioner's mere acquiescence in the treatment of an item in prior years does not preclude adjustment in later years. Menequzzo v. Commissioner, 43 T.C. 824">43 T.C. 824, 836 (1965); Massaglia v. Commissioner, 33 T.C. 379">33 T.C. 379, 386-387 (1959), affd. 286 F.2d 258">286 F.2d 258 (10th Cir. 1961). The Commissioner thus is not barred from requiring a taxpayer to change from an erroneously approved accounting method which does not clearly reflect income to an accounting method which does clearly reflect income. 438 Thomas v. Commissioner, supra at 225. Therefore, although the Commissioner's approval in prior audits of the taxpayer's accounting methods is given weight in determining whether the Commissioner is justified in changing the method used by a taxpayer, the Commissioner is not estopped from changing methods if that method does not clearly reflect income. Ezo Prod. Co. v. Commissioner, 37 T.C. 385">37 T.C. 385, 391 (1961); see also Thomas v. Commissioner, supra at 225-226. Section 471 provides that inventories shall be taken by a taxpayer on such basis as the Commissioner may prescribe whenever, in the Commissioner's opinion, the use of inventories is necessary in order to clearly determine the income of the taxpayer. When inventories are required, they must be maintained on a basis that conforms as nearly as possible to the best accounting practice in the trade or business and that most clearly reflects income. Sec. 471; see also W.C. & A.N. Miller Dev. Co. v. Commissioner, 81 T.C. 619">81 T.C. 619, 626 (1983); Fox Chevrolet, Inc. v. Commissioner, 76 T.C. 708">76 T.C. 708, 719-722 (1981);439 sec. 1.471-1, Income Tax Regs.Section 472 permits taxpayers to value inventories under the LIFO method, which deems closing inventory to consist of the earliest purchased goods. Sec. 472(b)(1). By matching the cost of the most recently purchased goods with current sales revenue, the LIFO method removes from current earnings any artificial profits attributable to inflationary increases in inventory costs. Amity Leather Prods. Co. v. Commissioner, 82 T.C. 726">82 T.C. 726, 732 (1984). Because section 472 expressly grants taxpayers the right to elect the LIFO method for purposes of inventorying their goods, the Commissioner's discretion as to an initial election of LIFO is more circumscribed than is generally the case as to changes of accounting method. See, e.g., John Wanamaker Philadelphia, Inc. v. United States, 175 Ct. Cl. 169">175 Ct. Cl. 169, 174-177, 359 F.2d 437">359 F.2d 437, 439-441 (1966); W.C. & A.N. Miller Dev. Co. v. Commissioner, supra at 626-627; Peninsula Steel Prods. & Equip. Co. v. Commissioner, supra at 1055. However, pursuant to section 1.472-3(d), Income440 Tax Regs., the Commissioner has discretion to examine a taxpayer's tax returns and books and records pertaining to the taxpayer's LIFO method in order to determine whether the taxpayer will be permitted to continue to use the LIFO method elected. The two principal methods of computing inventory under the LIFO method permitted by the regulations are the specific-goods method, a measure of inventory in terms of physical units of individual items, see secs. 1.472-1 and 1.472-2, Income Tax Regs., and the dollar-value method, a measure of inventory in terms of total dollars of pools of goods, see sec. 1.472-8, Income Tax Regs.; see also Hutzler Brothers Co. v. Commissioner, 8 T.C. 14">8 T.C. 14, 24-25 (1947). Under the specific-goods LIFO method, inventory is measured in terms of physical units of homogeneous items such as yards, gallons, or pounds. In computing a LIFO inventory under the specific-goods method, the quantity of items in a taxpayer's inventory at the end of the year is compared with the quantity of items of a like kind in its inventory at the beginning of the year to determine whether there has been an increase or decrease during the year. Fox Chevrolet, Inc. v. Commissioner, 72 T.C. 447">72 T.C. 447, 452 (1979);441 Wendle Ford Sales, Inc. v. Commissioner, 72 t.C. 447, 452 (1979); see also 1 Schneider, Federal Income Taxation of Inventories, sec. 12.01 at 12-2, sec. 12.04[1], at 12-31 (1994). Because the specific-goods LIFO method requires the matching of physical units, practically speaking, it is only used as a method for valuing inventories in those industries with inventories which contain a limited number of items with quantities that are easily measured in units. Wendle Ford Sales, Inc. v. Commissioner, supra.In the case of raw materials, section 1.472-1(d), Income Tax Regs., provides that raw material in the opening inventory must be compared with similar raw material in the closing inventory. There may be several types of raw materials, depending upon the character, quality, or price, and each type of raw material in the opening inventory must be compared with a similar type in the closing inventory.For goods-in-process and finished goods, section 1.472-3(a), Income Tax Regs., requires that the taxpayer's analysis of its beginning and ending inventories which is to be included with the taxpayer's application to use the LIFO convention should include a description442 of: goods in process, and finished goods, segregating the products (whether in process or finished goods) into natural groups on the basis of either (1) similarity in factory processes through which they pass, or (2) similarity of raw materials used, or (3) similarity in style, shape, or use of finished products. * * Thus, under the specific-goods LIFO method for valuing inventory, items may be grouped in the same pool only if they are similar. The regulations, however, provide limited guidance as to what items will be considered similar under the specific-goods LIFO method. As an illustration, in the case of raw materials, section 1.472-1, Income Tax Regs., provides in part the following: (e) In the cotton textile industry there may be different raw materials depending upon marked differences in length of staple, in color or grade of the cotton. But where different staple lengths or grades of cotton are being used at different times in the same mill to produce the same class of goods, such differences would not necessarily require the classification into different raw materials. (f) As to the pork packing industry a live hog is considered as being composed443 of various raw materials, different cuts of hog varying markedly in price and use. Generally a hog is processed into approximately 10 primal cuts and several miscellaneous articles. However, due to similarity in price and use, these may be grouped into fewer classifications, each group being classified as one raw material. [Emphasis added.]Thus, it appears that the appropriate scope of a specific-goods grouping is a complex question depending on the facts and circumstances of the particular taxpayer. We do not decide here whether petitioner's specific-goods LIFO grouping of all its wine inventory into one pool did or did not clearly reflect income. We must determine rather whether respondent acted reasonably in challenging petitioner's specific-goods LIFO grouping. We believe that she did. The parties have not cited, and the Court has not found, any published opinion which directly addresses the appropriateness of a taxpayer's grouping of items under the specific-goods LIFO method. The importance of the proper grouping of items under the specific-goods LIFO method appears implicit in the very nature of that method, however. It may be reasonable for the Commissioner444 to pursue litigation that may tend to clarify the law, even though such litigation will be burdensome and expensive for the taxpayer, and even though the Commissioner's chances of success may be marginal. See Hubbard v. Commissioner, 89 T.C. 792">89 T.C. 792, 804 (1987); Don Casey Co. v. Commissioner, 87 T.C. 847">87 T.C. 847, 862 (1986). The Commissioner may seek the reversal of precedent, or seek to carve out an exception to a well-established rule, but if she is unsuccessful, the taxpayer may be awarded litigation costs. See Don Casey Co. v. Commissioner, supra.But see Ashburn v. United States, 740 F.2d 843">740 F.2d 843, 850 (11th Cir. 1984) (costs may be denied where issues involved are not simple, routine, or clear cut). Nonetheless, the Commissioner generally is not subject to an award of litigation costs under section 7430 where the underlying issue presents a question of first impression. E.g., Stebco, Inc. v. United States, 939 F.2d 686">939 F.2d 686, 688 (9th Cir. 1990); Estate of Wall v. Commissioner, 102 T.C. 391">102 T.C. 391 (1994); Stieha v. Commissioner, 89 T.C. 784">89 T.C. 784, 791 (1987);445 see also Hoang Ha v. Schweiker, 707 F.2d 1104">707 F.2d 1104, 1106 (9th Cir. 1983). But see Oregon Environmental Council v. Kunzman, 817 F.2d 484">817 F.2d 484, 498 (9th Cir. 1987) ("Although the absence of adverse precedent on an issue is relevant to the determination of the 'substantially justified' question, it is not dispositive."). In the instant cases we cannot conclude from the record that the question of whether the partnership's pooling method clearly reflected its income is not an issue upon which reasonable arguments could be made. See, e.g., In re Petition of Hill, 775 F.2d 1037">775 F.2d 1037, 1042 (9th Cir. 1985). Furthermore, although there are no cases directly on point, when she filed her answer respondent had substantial legal precedents generally under the clear reflection of income theory to challenge the partnership's specific-goods LIFO method. See, e.g., secs. 446(b), 471(a); Thor Power Tool Co. v. Commissioner, 439 U.S. 522">439 U.S. 522 (1979); Thomas v. Commissioner, 92 T.C. 206">92 T.C. 206 (1989). Section 1.472-3(d), Income Tax Regs., moreover, gives the Commissioner446 specific authority to examine a taxpayer's records to determine whether that taxpayer may continue to use the LIFO method elected. There is no evidence that respondent's counsel inserted the pooling issue in the answer on a whim or for any improper purpose. At the time the answer was filed, respondent's counsel was in possession of Osborne's summary report in which, in the alternative, petitioner's specific-goods LIFO grouping was challenged under the clear reflection of income. From the foregoing, we cannot conclude that respondent's position was unworthy of belief. Petitioner has made no attempt to establish that the partnership's grouping of all its wine inventory into one pool clearly reflects its income. Instead, petitioner relies on a legal argument to establish that respondent's position was unreasonable. According to the partnership, it properly elected the specific-goods LIFO method and has consistently applied that method from the time of its election through the years in issue. The partnership asserts that its LIFO method is consistent with the accounting methods used in the wine industry and is consistent with GAAP. Accordingly, petitioner argues, because the partnership447 has consistently applied a LIFO method specifically authorized in the Code and the regulations, under the principles set forth in Hallmark Cards, Inc. v. Commissioner, 90 T.C. 26">90 T.C. 26, 31 (1988), and Orange & Rockland Utils. v. Commissioner, 86 T.C. 199">86 T.C. 199, 215 (1986), the partnership's LIFO method is deemed to clearly reflect income and respondent therefore cannot change that LIFO method. Therefore, petitioner asserts, respondent's position did not have any basis in law or fact and thus was unreasonable from the outset. We do not agree. Petitioner's argument totally ignores respondent's authority under section 1.472-3(d), Income Tax Regs., to determine during audit whether a taxpayer may continue to use the LIFO method it had elected. Moreover, in Ford Motor Co. v. Commissioner, 102 T.C. 87">102 T.C. 87 (1994), we recently addressed a similar argument. There the taxpayer argued that its accounting method for tax purposes of deducting the full amount of all future payments it was obligated to make under "structured settlements" with tort claimants conformed with a method of accounting authorized by the Code448 and the regulations and therefore clearly reflected income. We observed: Petitioner also relies on Hallmark Cards, Inc. v. Commissioner, 90 T.C. 26">90 T.C. 26 (1988). Petitioner contends that because the Code allows taxpayers to use an accrual method, the Commissioner has no authority to reject the method when it meets the all events tests for accrual. In furtherance of its contention, petitioner cites the following statement from Hallmark Cards: Respondent's broad authority to determine whether a taxpayer's accounting method clearly reflects income is limited, in that he may not reject, as not providing a clear reflection of income, a method of accounting employed by the taxpayer which is specifically authorized in the Code or regulations and has been applied on a consistent basis. [Hallmark Cards, Inc. v. Commissioner, 90 T.C. at 31; citation omitted.]We think that petitioner interprets the foregoing quote too broadly. As we read Hallmark Cards, we addressed only the question of whether the all events test had been met for the accrual of income by the taxpayer. * * the principle that a method specifically449 sanctioned in the Code or regulations cannot be rejected under section 446(b) is derived from Orange & Rockland Utilities, Inc. v. Commissioner, 86 T.C. 199">86 T.C. 199, 215 (1986). In that case, we held that the "cycle meter reading" method provided in the regulations and used by the taxpayer was a permissible method under section 446(c)(2). Orange & Rockland dealt with a specific method of accrual; it did not suggest that any method of accrual is to be protected from the Commissioner's scrutiny under section 446(b). Consequently, we do not think that Hallmark Cards stands for the proposition that no accrual method may be rejected under section 446(b) merely because section 446(c) permits an accrual method to be used. Indeed, in Estate of Ratliff v. Commissioner, 101 T.C. 276">101 T.C. 276, 281 (1993), we recently stated that Hallmark Cards stands for the proposition that "respondent does not have unbridled discretion under section 446 in that she cannot force a taxpayer to adopt another method of accounting if the taxpayer's method clearly reflects income." In short, we view Hallmark Cards as addressing only the issue of 450 whether the taxpayer satisfied the all events test. [Ford Motor Co. v. Commissioner, supra at 97-98; emphasis added.]Similarly, we do not believe that no LIFO method of valuing inventory may be rejected under section 446(b) merely because section 472 permits the use of a LIFO convention. Indeed, section 1.472-3(d), Income Tax Regs., specifically provides that "whether or not such method [the taxpayer's LIFO inventory method], once adopted, may be continued * * * will be determined by the Commissioner in connection with the examination of the taxpayer's income tax returns." Accordingly, we find that petitioner's reliance on Hallmark Cards and Orange & Rockland is not sufficient to establish that respondent's position on the LIFO issue had no basis in law or fact and therefore was unreasonable. As further support for his position, petitioner relies on a statement Kelly made to Buehl in September 1991 to the effect that respondent's Sacramento District Office did not agree with the varietal-by-varietal method proposed by Osborne. Petitioner contends that such statement further demonstrates that respondent's position in the answer for451 the 1988 year was not substantially justified. The Sacramento District Office, however, did not agree with the partnership's specific-goods LIFO method of using one pool for all the wines it produced, but instead allegedly, at that time, that office favored a time-of-production grouping, such as a pool for red wine and a pool for white wine. Respondent's representatives apparently did agree, however, that the partnership's specific-goods LIFO method for valuing inventory did not clearly reflect income. We do not agree with petitioner that a difference in opinion among respondent's representataives as to the appropriate composition of the specific-goods LIFO pools illustrates that the position respondent asserted in the answer was unreasonable. There is no evidence that, when she filed the answer, respondent adopted her position relating to the partnership's specific-goods LIFO grouping to extract concessions from petitioner that were not justified under the circumstances or for purposes of harassment or embarrassment, or out of political motivation. See H. Rept. 97-404, at 12 (1981). Nor is there any evidence that respondent's position in these cases was clearly inconsistent452 with the position she has taken in other similar cases. Cf. Hubbard v. Commissioner, 89 T.C. 792">89 T.C. 792, 803 (1987). Instead, the record shows that respondent's position on the partnership's specific-goods LIFO grouping was substantially the same as the position she was taking for at least one other winery. Petitioner's proposal to settle the cases on the same basis as that unrelated winery's settlement of the same issue -- of prospectively changing the partnership's specific-goods LIFO method to one pool for red wine and one pool for white wine -- further supports an inference that there was a reasonable basis for respondent at least to challenge petitioner's specific-goods LIFO method. In the instant cases, respondent's position was not contrary to any published decision. Nor could a reasonable person say that it lacked colorable justification. Furthermore, from the record here, we cannot conclude that respondent's position that a specific-goods LIFO grouping consisting of only one pool for all wine did not clearly reflect the partnership's income had no reasonable basis in fact or law. See Pierce v. Underwood, 487 U.S. at 565.453 Consequently, we find that petitioner has not shown that respondent's position was not substantially justified at the time she filed her answer. Alternatively, petitioner contends that even if the Court determines that respondent's position was substantially justified in the beginning, nonetheless respondent's position became unreasonable at some later point. Petitioner asserts that respondent's stated reasons for conceding the cases 6 are illogical or involve factors that were present from the time that respondent filed her answer. Petitioner suggests that these circumstances demonstrate that respondent's actions in her conduct of the cases, at a minimum, were unreasonable from the time she filed her answer. 454 For the reasons discussed above, petitioner has not persuaded us that when respondent filed the answer, and subsequently, her position that the partnership's specific-goods LIFO method did not clearly reflect income was unreasonable. Moreover, we are satisfied from this record that throughout the proceedings, respondent actively and diligently proceeded under that reasonable theory. In addition, the LIFO issue involved in these cases is far from simple and apparently a question of first impression. Under such circumstances, we cannot conclude that respondent's position was unreasonable for purposes of section 7430. See Minor v. United States, 797 F.2d 738">797 F.2d 738, 739 (9th Cir. 1986); Estate of Wall v. Commissioner, 102 T.C. at 394; see also Edwards v. McMahon, 834 F.2d 796">834 F.2d 796, 802-803 (9th Cir. 1987) (issue of first impression); Rawlings v. Heckler, 725 F.2d 1192">725 F.2d 1192, 1196 (9th Cir. 1984) (issues unsettled); Cornella v. Schweiker, 741 F.2d 170">741 F.2d 170, 171 (8th Cir. 1984) (issues were question of first impression in circuit; factual issues were 455 not simple). We fail to see why respondent's position should be determined unreasonable simply because she concluded that it was better to concede the cases rather than to litigate such a complex issue, especially in light of her concession that she would have the burden of proof on this issue. In addition, petitioner argues that respondent's concession of the cases was not timely. Petitioner asserts that, because respondent neither requested nor otherwise sought information from petitioner after the issuance of the FPAA, respondent had all of the information she needed to decide to concede the cases from the very beginning, and therefore she should not have waited until less than 2 weeks before trial to concede the cases. We do not agree. It appears from the record, however, that even though respondent may not have requested specific information from petitioner following the filing of the answer, additional information was requested from the unrelated winery to make the complex calculations needed to check the effect on income of various pooling methods. Presumably, that information would have aided respondent in the instant cases as well. We note further that settlement negotiations456 between respondent and petitioner continued into September of 1993. Under such circumstances, we cannot conclude that respondent took too long to concede the cases. Respondent's Position Relating to the Capitalization of Inventory CostsUnder section 263A and the regulations promulgated thereunder, a taxpayer generally must capitalize certain indirect costs allocable to the production of goods and include those costs in inventory. In the FPAA and in the answer for the 1988 year, respondent took the position that the costs the partnership was required to capitalize and include in inventory pursuant to section 263A had to be adjusted. Respondent notified petitioner on September 8, 1993, that she was conceding this issue. In his motion for determination of burden of proof, petitioner alleged that respondent had the burden of proof on the section 263A capitalization issue because the adjustments alleged under section 263A are sufficiently different when considering LIFO rather than FIFO and, consequently, the section 263A adjustments proposed in the answer constituted new matter. In her reply to that motion, respondent conceded that the section 263A adjustment was a new matter457 and therefore she had the burden of proof as to that issue. 7Respondent contends that her position that the partnership had failed to capitalize interest costs attributable to Cabernet Sauvignon and production costs for some varietals of wine that were in process for over 1 year was reasonable. Petitioner contends merely that the section 263A capitalization issue was tied to the LIFO inventory issue and therefore had no basis in law or fact because the LIF0 inventory issue had no basis in law or fact. Petitioner has the burden of proof on this issue. Rule 232(e); Coastal Petroleum Refiners, Inc. v. Commissioner, 94 T.C. 685">94 T.C. 685, 688 (1990). For the reasons stated above relating to the LIFO inventory issue, petitioner458 has not met his burden of proving that respondent's position on the section 263A capitalization issue was not substantially justified. Respondent's Position Relating to Depreciation of the CavesUnder section 168, the accelerated cost recovery system (ACRS) generally provides a depreciation deduction for new or used tangible depreciable property used in a trade or business or held for the production of income over statutory recovery periods based on the category of property involved. Most business machinery and equipment has a 5-year recovery period, whereas most real property placed in service before May 9, 1985, and after March 15, 1984, has an 18-year recovery period. On the partnership returns for 1988 and 1989, the partnership claimed depreciation deductions for the caves under ACRS on the basis of a 5-year recovery period. 8 In the FPAA and in the answer for both the 1988 and the 1989 years, respondent took the position that the caves are buildings (real property), not special purpose structures (equipment), for depreciation purposes and therefore should be depreciated using the applicable ACRS rates for buildings based on the year the caves were placed in service459 (in these cases using the rates for 18-year real property). Respondent notified petitioner on August 12, 1993, that she was conceding this issue. The applicable recovery period for the caves depends on whether they are classified as equipment, as460 petitioner alleged, or as a building, as respondent contended. Section 1.48-1(e)(1), Income Tax Regs., defines a building generally as a structure or edifice that encloses a space within its walls, is covered by a roof, and has as its purpose the furnishing of shelter or housing, or of working, office, parking, display, or sales space. That regulation provides further generally, however, that the term "building" does not include a structure which is essentially an item of machinery or equipment or a structure which houses property used as an integral part of manufacturing, production, or extraction, or of furnishing transportation, communications, electrical energy, gas, water, or sewage disposal services, if the use of the structure is so closely related to the use of that property that the structure clearly can be expected to be replaced when the property it initially houses is replaced. See, e.g., McManus v. United States, 863 F.2d 491 (7th Cir. 1988); Brown-Forman Distillers Corp. v. United States, 205 Ct. Cl. 402">205 Ct. Cl. 402, 499 F.2d 1263">499 F.2d 1263 (1974); Loda Poultry Co. v. Commissioner, 816">88 T.C. 816 (1987);461 Central Citrus Co. v. Commissioner, 58 T.C. 365">58 T.C. 365 (1972). Respondent contends that her position that the caves did not qualify as special purpose structures was reasonable on the basis of the information available to her when the answer was filed. Petitioner contends merely that respondent was dilatory in deciding to concede this issue. According to petitioner, respondent knew as early as August 1991 that a tour of the caves was needed to resolve certain factual matters pertaining to the caves, but that tour did not occur until August 6, 1993 -- 14 months after the answer was filed for the 1988 year. Respondent then immediately conceded the issue after the tour. Petitioner asserts that if respondent had acted in a diligent manner, the depreciation issue could have been conceded before the issuance of the FPAA for the 1988 year. Respondent counters that she was not dilatory in conceding this issue because her representatives toured the caves 4 months after she filed the answer for the 1989 year and she conceded the issue less than 1 week after that tour. Under the circumstances present in these cases, we do not believe that respondent waited an unreasonable462 period of time to concede the depreciation issue. On this record, petitioner has not established that the position of the United States was not substantially justified. This is not a situation where review of the administrative file would have shown that respondent's position was untenable. Cf. Bayer v. Commissioner, T.C. Memo. 1991-282; Leewaye v. Commissioner, T.C. Memo. 1988-129. At the time the answer was filed for the 1988 year, the information in the summary report relating to the caves supported respondent's position that the caves did not qualify as a special purpose structure. A tour of the caves was necessary before respondent had sufficient information to formulate her decision to concede the depreciation issue. We do not believe the 13-month delay from the time the answer for the 1988 year was filed until the issue was conceded to be unduly long under the circumstances present in the instant cases. During the months between the filing of the answer for the 1988 year and respondent's concession of the depreciation issue, the FPAA for the 1989 year, involving the identical depreciation issue, was issued463 and the petition and answer were filed in this Court as well as the motion to consolidate the cases. Respondent attempted to arrange for a tour of the caves within a month of the filing of the answer for the 1989 year. The tour could not be scheduled earlier than July 1993, however, because of scheduling conflicts involving counsel for both sides, and then had to be postponed until August 1993 because of a change in respondent's counsel. Respondent conceded the depreciation issue within 2 weeks of the tour of those caves. Furthermore, during the months between the filing of the answer and the concession of the depreciation issue, the parties were actively and diligently involved in discussions relating to the more complex LIFO inventory issue. That issue was not conceded until after the depreciation issue was conceded. There is no evidence that respondent delayed conceding the depreciation issue in an attempt to extract unjustified concessions from petitioner or for any other improper purpose. See Gantner v. Commissioner, 92 T.C. 192">92 T.C. 192, 197-198 (1989), affd. 905 F.2d 241">905 F.2d 241 (8th Cir. 1990); Sher v. Commissioner, 89 T.C. 79">89 T.C. 79, 84-85 (1987),464 affd. 861 F.2d 131">861 F.2d 131 (5th Cir. 1988); see also H. Rept. 97-404, at 12 (1981); cf. Frisch v. Commissioner, 87 T.C. 838">87 T.C. 838, 841 (1986); Williford v. Commissioner, T.C. Memo. 1994-135. Petitioner has presented no evidence which would show that respondent took her position on the depreciation issue for any reason other than because she thought her position was correct. See Vanderpol v. Commissioner, 91 T.C. 367">91 T.C. 367 (1988). Petitioner relies merely on respondent's ultimate concession of the issue to support his claim that respondent's position in the litigation was not substantially justified. However, respondent's concession of the cases in and of itself is not sufficient to establish that her position was unreasonable. Estate of Merchant v. Commissioner, 947 F.2d 1390">947 F.2d 1390, 1395 (9th Cir. 1991), affg. T.C. Memo. 1990-160; Price v. Commissioner, 102 T.C. at 662-663; Sokol v. Commissioner, 92 T.C. 760">92 T.C. 760, 767 (1989); Powers v. Commissioner, 100 T.C. at 471.*465 "Substantial justification for a position is not the same as a winning, legally correct argument on a position." Gantner v. Commissioner, supra at 198. Petitioner, moreover, has not shown that his attorneys incurred costs which they would not have incurred if the caves had been toured at an earlier date. See Brice v. Commissioner, T.C. Memo 1990-355">T.C. Memo. 1990-355, affd. without published opinion 940 F.2d 667">940 F.2d 667 (9th Cir. 1991). On this record, we conclude that respondent's position was not unreasonable. Accordingly, we conclude that petitioner does not satisfy the statutory definition of "prevailing party" for any issue involved in these cases and is not entitled to an award for litigation costs. Having concluded that petitioner is not the prevailing party within the meaning of section 7430, we need not decide whether petitioner satisfied the net worth requirements and whether the amounts of litigation costs sought by petitioner are reasonable. Accordingly, petitioners motion for litigation costs will be denied. To reflect the foregoing, Appropriate orders and decisions will be entered. Footnotes1. Because the proceedings in the instant cases were commenced after Nov. 10, 1988, sec. 7430, as amended by the Technical and Miscellaneous Revenue Act of 1988 (TAMRA), Pub. L. 100-647, sec. 6239, 102 Stat. 3743, applies.↩2. It is unclear from the record whether petitioner has satisfied the net worth requirement of sec. 7430(c)(4)(A)(iii) (see Rule 230(b)(6)). Respondent does not allege that petitioner unreasonably protracted the proceedings. See sec. 7430(b)(4). We therefore deem that issue also conceded. See Rule 151(e)(4) and (5); Petzoldt v. Commissioner, 92 T.C. 661">92 T.C. 661, 683 (1989); Money v. Commissioner, 89 T.C. 46">89 T.C. 46, 48↩ (1987).3. The change to the partnership's LIFO method of accounting for the 1988 year resulted in a decrease in partnership income for the 1989 year. According to respondent, she intended to treat both years consistently, but showed only the depreciation issue on the FPAA for the 1989 year pending resolution of the inventory issue for the 1988 year.↩4. For civil actions or proceedings commenced after Dec. 31, 1985, sec. 1551(d)(1) of the Tax Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2085, 2752, changed the language of sec. 7430 describing the position of the United States from "unreasonable" to "was not substantially justified." This and other courts, however, have held that the "substantially justified" standard is not a departure from the previous reasonableness standard. E.g., Sokol v. Commissioner, 92 T.C. 760">92 T.C. 760, 764↩ n.7 (1989).5. In the instant cases, respondent conceded that she had the burden of proof for the inventory valuation and sec. 263 capitalization issues initially raised in the answer for the 1988 year. The fact that respondent bears the burden of proof, however, does not nullify her authority under the clear reflection of income theory to challenge petitioner's grouping of items under the specific-goods LIFO method. Cf., e.g., Ferrill v. Commissioner, 684 F.2d 261">684 F.2d 261 (3d Cir. 1982), affg. per curiam T.C. Memo. 1979-501 (material distortion of income theory under sec. 446(b) raised in amendment to answer); Seligman v. Commissioner, 84 T.C. 191">84 T.C. 191, 198 (1985), affd. 796 F.2d 116">796 F.2d 116 (5th Cir. 1986) (the Commissioner may assert specific reasons for disallowance of deductions or credits in the notice of deficiency, in the answer, or in an amendment to the answer); German v. Commissioner, T.C. Memo. 1993-59↩ (clear reflection of income theory raised in amendment to answer).6. In her opposition to petitioner's motion for litigation costs, respondent gave the following reasons for her decision to concede the cases rather than settle on the basis proposed by petitioner: Respondent's decision to concede these cases was based on a number of factors. These include, inter alia↩, an unacceptable settlement proposal, the inability to anticipate the nature of the testimony of petitioner's expert and litigating hazards with respect to a very complicated issue.7. We make no decision here on the merits of petitioner's allegations and respondent's concession as to who would have had the burden of proof on such issue. But see Seagate Technology, Inc. & Consol. Subs. v. Commissioner, 149">102 T.C. 149↩ (1994).8. In the petition, petitioner alleges that the caves are special purpose structures that are designed specifically to provide for the aging of fine wine under unique, subterranean temperature and humidity conditions that maximize the quality of the wine. As such, petitioner alleges, the caves do not have the appearance of a building, nor do they function like a building, but rather they function like an item of machinery or equipment. Petitioner further alleges that the purpose of the caves is not to provide shelter or housing or to provide working, office, parking, display, or sales space and that the caves are not reasonably adaptable to, and could not economically be used for, any purpose other than their current use for the carefully controlled aging of fine wine.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623583/	GEORGE H. BELSHAW and ETHA S. BELSHAW, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentBelshaw v. CommissionerDocket No. 9706-80.United States Tax CourtT.C. Memo 1983-157; 1983 Tax Ct. Memo LEXIS 626; 45 T.C.M. (CCH) 1062; T.C.M. (RIA) 83157; March 23, 1983. William A. Cohan and Gloria T. Svanas, for the petitioners. Deborah A. Butler, for the respondent. FAYMEMORANDUM OPINION FAY, Judge: Respondent determined a deficiency of $17,436.90 and an addition to tax under section 6653(a) 1 of $871.85 in petitioners' 1977 Federal income tax. After concessions, the issues are (1) whether income reported by a "family trust" is taxable to petitioners, (2) whether628 expenses of establishing a "family trust" are deductible under section 212, (3) whether petitioners had certain unreported wage income in 1977, and (4) whether any part of the underpayment with respect to 1977 is due to negligence. Petitioners, George H. Belshaw and Etha S. Belshaw, were residents of Bozeman, Mont., when the petition was filed herein. During 1977 petitioner George H. Belshaw (petitioner) was a licensed physician in the State of Indiana. On March 17, 1977, petitioner established a trust entitled "George H. Belshaw Family Trust" utilizing materials he purchased from Educational Scientific Publishers (herein ESP) for $7,000. Petitioner transferred his medical building and personal residence (herein the property) to the trust. On April 1, 1977, petitioner entered into an agreement to practice medicine on behalf of the trust. Prior to that date, petitioner practiced medicine on behalf of his professional corporation, George H. Belshaw, M.D., Inc. (herein the medical corporation). Petitioners are their629 son, John E. Belshaw, were trustees of the trust in 1977. John resigned as trustee on April 15, 1977. Petitioners remained trustees through 1977. The trust instrument provides that upon termination, trust assets are to be distributed to the beneficiaries. Pursuant to the first meeting of the board of trustees in 1977, all 100 units of beneficial interest in the trust were issued to petitioner. Such units were cancelled and then reissued in equal shares to petitioners at the second meeting of the board of trustees in 1977. Thereafter, petitioners continued to be the sole beneficiaries of the trust. After creation of the trust, petitioners continued to use the property just as they had before, and petitioners exercised full control over the income generated by the property. There was no change in petitioner's medical practice subsequent to the formation of the trust. This case involves yet another attempt to escape taxation by transferring property to a "family trust." On numerous occasions this Court and the Courts of Appeals have considered similar such attempts and, without exception, the taxpayers' attempts to shift the incidence of taxation have been rejected. ,630 affg. a Memorandum Opinion of this Court; , affg. a Memorandum Opinion of this Court; , affg. a Memorandum Opinion of this Court; and cases cited therein at note 4. 2 This case presents nothing which requires a different result. Accordingly, we hold the income of the trust is taxable to petitioners. No further discussion of this issue is necessary. 3631 The second issue is whether petitioners are entitled to deduct the cost of the trust materials which petitioner purchased from ESP. Petitioners contend such expenditure is deductible under section 212(2) because the trust was created to shelter the property from claims of medical malpractice. However, the deduction under section 212(2) applies to expenditures for the protection or preservation of property itself, such as safeguarding or keeping it up, but not to expenditures for a taxpayer's retention of its ownership. ; . Petitioner created the trust herein merely in an attempt to insure that he would retain ownership of the property. Even if the trust somehow insulated the property from claims of medical malpractice, in no way did it preserve or protect the property itself. Thus, we hold that petitioners may not deduct the $7,000 paid to ESP for the trust materials. In his notice of deficiency, respondent determined that petitioners underreported by $3,200 petitioner's 1977 wages from the medical corporation. Since petitioners have offered no proof that respondent's632 determination is incorrect, we sustain such determination. 4; Rules 142(a) and 122(b). 5We also sustain respondent's assertion of an addition to tax under section 6653(a). Petitioners' underpayment in 1977 was primarily attributable to their entanglement in the "family trust" scheme. As the Ninth Circuit Court of Appeals stated in a similar context, "No reasonable person would have trusted this scheme to work." Moreover, petitioners' assertion on brief that they relied on the advice of their accountant is not supported by the record. See . Accordingly, we sustain633 respondent's assertion that petitioners are liable for an addition to tax under section 6653(a). To reflect the foregoing, Decision will be entered for respondent.Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954 as amended and in effect for the taxable year in issue.↩2. The courts rely on three theories: (1) the trust is not recognized for tax purposes since it lacks economic substance, (2) under assignment of income principles, the grantor is taxable on the income, and (3) the trust provisions violate the grantor trust rules under secs. 671-678. ↩3. In the stipulation of facts filed by the parties on July 26, 1982, petitioners concede they are taxable on the income of the trust. In their subsequent brief, however, petitioners argue they are not taxable on such income. Because our conclusion herein on this issue is consistent with petitioners' stipulation, it is unnecessary for us to determine whether petitioners are bound by such stipulation. See, e.g., .↩4. In the stipulation of facts, petitioners concede to such determination. On brief, however, they assert they did not underreport petitioner's 1977 wages from the medical corporation. Because our conclusion herein is consistent with petitioners' stipulation, it is unnecessary for us to determine whether petitioners are bound by such stipulation. See n. 3, supra.↩5. 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/4623584/	INTERNATIONAL BANDING MACHINE CO., PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.International Banding Machine Co. v. CommissionerDocket No. 13744.United States Board of Tax Appeals12 B.T.A. 1062; 1928 BTA LEXIS 3413; June 30, 1928, Promulgated 3413 The cash value of an application for a patent paid into the petitioner corporation in 1907 in exchange for shares of stock and cash determined. Isidor Wels, Esq., for the petitioner. LeRoy L. Hight, Esq., and J. M. Morawski, Esq., for the respondent. SMITH 1062 This is a proceeding for the redetermination of a deficiency in income and profits tax for 1921 in the amount of $8,377.44. All of the assignments of error stated in the petition were waived at the hearing except as follows: Disallowance of patents in an amount of $219,700 as part of taxpayer's invested capital for the year 1921. FINDINGS OF FACT. The petitioner was incorporated under the laws of the State of New York on November 9, 1907, with the expressed object of manufacturing machines for the purpose of affixing bands to cigars. The capitalization was $400,000, which consisted of $200,000 of preferred stock and $200,000 of common stock. Petitioner is a manufacturer of the only cigar-banding machine in existence. At the time of incorporation an application for patent was pending and the patent thereunder was issued in 1909. The patent is basic and was sustained3414 by the United States Circuit Court of Appeals, Second Circuit, in International Banding Machine Co. v. American Bander Co., 9 Fed.(2d) 606. Under this decision claims 22 and 99 in Wagner and Malocsay Patent No. 920698, issued May 4, 1909, were held valid and infringed and claim 97 not infringed. The credit for the idea expressed in the patent and for the development of the business of the petitioner is due entirely to Isidor Steiner, president of the petitioner. His father, William Steiner, was engaged in the lithographing business and specialized in the manufacture of cigar bands. The business was established in 1872 and was made a partnership in 1896 by the admission of the sons and Joseph Kopperl, a son-in-law of William Steiner, and the firm name became William Steiner Sons & Co. The Steiner firm prior to 1907 manufactured between 6,000,000 and 7,000,000 cigar bands a year and it had as its customers a large number of cigar manufacturers with whom Isidor Steiner conferred and from whom he learned there would be a ready market for a 1063 machine which would band cigars, as all cigars were at that time banded by hand. In about 1904, Isidor Steiner3415 had spoken to one Charles Wagner, who was a manufacturer of a lithographing machine which was used by the Steiners, about getting up a cigar-banding machine. When the company was formed in 1907, the machine that had been built at the instigation of Isidor Steiner was already operating successfully and there was simply a question of building it smaller. In 1907 the Steiner firm took over this machine into their own building and also took Malocsay, the inventor, with them and established a machine shop. They bought a lathe and some drill presses, a power saw and some milling machines. At that time the petitioner was without funds and, necessarily, all expenses in experimentation, development and building the machine had to be paid out by those interested in the project and particularly by members of the Steiner firm, who were the largest stockholders. Upon the organization of the petitioner it was agreed that $250,000 of the capital stock of the petitioner should be issued to Wagner and Malocsay upon their executing and delivering to the petitioner a proper assignment of all their right, title and interest in and to the application for patent already filed and to pay to them3416 the sum of $17,500 when the sum of $25,000 should have been realized from the sale of the treasury stock of the company. Of the required cash payment of $17,500 the sum of $2,500 was actually paid to Wagner and Malocsay. The patent application was duly assigned to the petitioner. Before March 1, 1913, the petitioner had finished 10 machines, making everything by hand, in the Steiner factory. The machines at that time had 600 or 700 parts. The Steiner firm had 5 or 6 men in its employ whose salaries were paid sometimes by the Steiner firm and sometimes by the individual members thereof. The 10 machines which had been built were actually in operation in various cigar factories on March 1, 1913, and were doing satisfactory work. Each machine was capable of banding between 30,000 and 42,000 cigars a day. The average worker could band only about 4,000 cigars a day by hand. The first machines built went into the Eisenlohr factories in Pennsylvania and Eisenlohr has continuously used the petitioner's machines since and at the present time has 42 in operation. These machines are never sold but are rented out on 5-year contracts. 3417 The patent subsequent to the one for which the $250,000 par value of stock was issued was granted to Malocsay, No. 1,261,832, under date of April 9, 1918, and one of the claims under this second patent was, in International Banding Machine Co. v. American Bander Co.,1064 supra, held valid and infringed. The following is quoted from said decision: The object of the invention of the first patent is said to provide a new and improved banding machine, designed for rapidly and accurately applying bands or labels to cigars and other articles and to wrap the same singly around the articles and secure their overlapping ends together, without danger of injury to the articles or to the bands or labels. The object of the second patent is said to provide a machine which will securely, accurately, and rapidly apply bands to cigars and other articles where an adhesive is used, and it is desired to return the cigars to the box whence they came without turning them in any way so that, if they happen to be dry, they will go back exactly as they came out, and thereby escape all injury. The second patent is said to be a patentable improvement over the first patent, 3418 and the machine is claimed to be a pioneer machine for banding boxed cigars. The first patent is a pioneer for banding cigars of any sort, particularly loose cigars. But the first patent did not band boxed cigars with sufficient rapidity for the trade. * * There were two occasions when stock of the petitioner corporation was sold. In 1910 the shares of stock were changed from $100 par value to $10 par value and in that year and in 1911 a total of a little over 430 shares of stock was sold to 20 or 30 purchasers through the medium of a broker on the basis of $10 for a unit of one share of preferred and one share of common stock, out of which the broker was to receive 25 per cent for his services. The broker, however, sold the preferred stock at par and kept the common stock for himself and because of this the further sale of stock was discontinued at that time. In 1915, in order to raise necessary capital to manufacture machines in quantities, the financial structure of the petitioner was recast so that the $200,000 of preferred stock and $200,000 of common stock were all turned into common stock of a par value of $10 each, and $100,000 of new preferred stock was issued, 3419 carrying 7 per cent dividends, with a provision that the preferred stock should share in the common stock dividends. Of this new issue of preferred stock $83,350 was sold at par in 1915. During the year 1921 the common stock paid dividends at the rate of 6 per cent and preferred stock at the rate of 13 per cent. The petitioner was in an experimental stage up to about 1917. Although certain cigar-banding machines had been placed in cigar factories for experimental purposes prior to that time the company received no rentals from the machines until 1917, during which year it received rentals of $1,850. In 1918 it received rentals of $10,707.50 and in 1921 $188,627.09 from 334 machines which it had in operation. In its income-tax return for 1921 the petitioner included in invested capital an amount, not shown by the evidence, representing the value or depreciated cost of patents. Of the amount claimed the Commissioner 1065 disallowed $219,700 in the computation of the deficiency determined for 1921. OPINION. SMITH: The only assignment of error stated in the petition which was not waived at the hearing is the disallowance by the respondent of patents in an amount3420 of $219,700 as part of petitioner's invested capital for the year 1921. The amount claimed in the return filed for 1921 is not in evidence. The deficiency notice sent to the petitioner by the respondent states: Since the cash value of patents acquired with stock has not been established, depreciation has been disallowed on all patents acquired for stock. Depreciation on patents acquired for cash is computed as follows: CostRateAllowanceClaimed$46,772.721/17$2,751.341920 addition2,377.001/17139.821921 addition849.251/3424.972,916.13$15,674.862,916.1312,758.73The Board assumes from this statement that the respondent disallowed the claim of the petitioner for the inclusion in invested capital of any amount in respect of the application for the patent paid in for $250,000 capital stock of the petitioner corporation in 1907. We are of the opinion that the application for the patent had some value at that time. The petitioner then had a model for a machine for the banding of loose cigars and the record indicates that the invention was basic. The petitioner paid $2,500 cash to the inventor for3421 the patent and a resolution was passed by the board of directors of the petitioner corporation in 1907 by which the officers were authorized to pay Wagner and Malocsay in addition to the stock to be issued to them the sum of $17,500 when the sum of $25,000 had been realized from the sale of treasury stock. Only $2,500 of this amount was paid, however. The balance of $15,000 the petitioner claims should be included in invested capital as representing a part of the value of the patent application. No attempt was made at the time to sell shares of stock of the petitioner corporation. At a later date an arrangement was made with a broker for the sale of one share of preferred stock and one share of common stock at a price to the purchaser of the par value of the preferred stock out of which the petitioner was to receive 75 per cent of the amount received by the broker. By reason of the fact that the broker was not living up to his agreement with the petitioner only 430 shares of stock were thus sold. We are of the opinion that the 1066 evidence in the record warrants the conclusion that the patent application had a value at the time paid in for stock of $25,000 and that the3422 patent application had the same value in 1909 when the patent was granted. Invested capital for 1921 should be computed accordingly. At the hearing of this proceeding the petitioner made various claims which are not covered by the petitioner or amendments thereto. The issues thus attempted to be raised can not be considered in accordance with numerous decisions of this Board. Dixie Mfg. Co.,1 B.T.A. 641">1 B.T.A. 641; W. P. Weaver,2 B.T.A. 709">2 B.T.A. 709; W. A. Roth,4 B.T.A. 834">4 B.T.A. 834; S. L. Fowler,6 B.T.A. 250">6 B.T.A. 250; Old Colony Railroad Co.,6 B.T.A. 1025">6 B.T.A. 1025; H. D. & J. K. Crosswell, Inc.,6 B.T.A. 1315">6 B.T.A. 1315. Judgment will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623585/	MOTTY EITINGON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. CHARLES EITINGON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. NAUM EITINGON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Eitingon v. CommissionerDocket Nos. 58854, 60163, 60610.United States Board of Tax Appeals27 B.T.A. 1341; 1933 BTA LEXIS 1205; April 28, 1933, Promulgated 1205 Interest paid on an open account by a resident individual to nonresident aliens, held income from sources in the United States within the meaning of section 119(a)(1) of the Revenue Act of 1928. I. Graff, Esq., for the respondent. MURDOCK 1341 OPINION. MURDOCK: The Commissioner determined a deficiency of $2,853.12 and a penalty of $713.28 in the income tax of Charles Eitingon for the calendar year 1928. At Docket No. 60163 the following is assigned as an error in the determination of the Commissioner: That the petitioner [Charles Eitingon] was liable for tax to the American Government upon an amount of interest of $44,359.98 received by him on an indebtedness on an open account from Motty Eitingon, an American citizen, the 1342 transaction out of which the said indebtedness for interest to the petitioner arose having been wholly consummated outside of the United States, the amount of interest in question having been paid to the petitioner outside of the United States and having no connection with American sources as defined by the law. The Commissioner determined a deficiency of $975.32 and a penalty of $243.83 in the income1206 tax of Naum Eitingon for the year 1928. At Docket No. 60610 the error assigned was the same as that above quoted from Docket No. 60163, except that the interest received was in the amount of $2,884.36 and was received by Naum Eitingon. The Commissioner determined a deficiency of $2,362.22 representing tax which Motty Eitingon should have withheld for 1928 from income paid to Charles Eitingon and Naum Eitingon, nonresident aliens, which income and tax he should have reported on a withholding return. The cases have been consolidated. When they came on for hearing there was no appearance for the petitioners, but counsel for the respondent filed a stipulation of facts which is as follows: 1. Petitioners Naum Eitingon and Charles Eitingon are and were during the calendar year 1928 non-resident alien individuals, being residents of the City of Lodz, Poland, and petitioner Motty Eitingon is and was during the calendar year 1928 an American citizen, a resident of the City, County and State of New York. 2. Petitioner Motty Eitingon paid an amount of interest in the sum of Two thousnad eight hundred eighty four and 36/100 ($2,884.36) Dollars on an indebtedness on an open account1207 to Naum Eitingon, of Lodz, Poland during the calendar year 1928, said indebtedness being unsecured by any collateral within the United States. 3. Petitioner Motty Eitingon paid an amount of interest in the sum of Forty four thousand three hundred fifty nine and 98/100 ($44,359.98) Dollars on an indebtedness on an open account to Charles Eitingon of Lodz, Poland, during the calendar year 1928, said indebtedness being unsecured by any collateral within the United States. 4. On or about November 6, 1930, Motty Eitingon executed and filed individual income tax returns for the calendar year 1928 on behalf of Charles Eitingon and Naum Eitingon. True photostat copies of said returns are attached hereto, marked Exhibits A and B, respectively, and made a part hereof. No other returns for said year were filed by Charles or Naum Eitingon, or by Motty Eitingon on behalf of Charles or Naum Eitingon. 5. Petitioner Motty Eitingon did not withhold tax on the interest so paid to petitioners Naum Eitingon and Charles Eitingon, non-resident aliens, and did not report such income and tax on a withholding return, not having regarded such interest as income from sources within the United States1208 as defined in Section 119(a)(1) of the Revenue Act of 1928. 6. The interest received by non-resident alien petitioners, Naum Eitingon and Charles Eitingon, from Motty Eitingon, an American citizen, was not included in returns for the said non-resident alien petitioners filed on their behalf for the calendar year 1928, treating such interest as income from sources without the United States as defined by Section 119(c)(1) of the Revenue Act of 1928. 1343 7. Respondent has treated the amounts of interest paid to Naum Eitingon and Charles Eitingon as income from sources within the United States and taxable by the American Government and seeks to hold petitioner Motty Eitingon liable for withholding tax thereon as on income from sources within the United States. 8. If said interest constitutes income to petitioners Naum Eitingon and Charles Eitingon from sources within the United States, then petitioner Motty Eitingon is liable as withholding agent for the amount of the deficiency determined against him as shown in the notice of deficiency. The income tax return filed on behalf of Charles Eitingon reported net income of $5,577.50, consisting entirely of dividends1209 on stock of domestic corporations, an exemption of $1,500 was claimed, and no tax was shown to be due. The Commissioner added to income, as shown on the return, $44,359.98, representing interest received from Motty Eitingon, and computed the deficiency and a delinquency penalty of 25 per cent for failing to file a return within the time prescribed by law. The income tax return filed on behalf of Naum Eitingon reported net income of $29,422.50, consisting entirely of dividends on stock of domestic corporations, an exemption of $1,500 was claimed and the only tax shown to be due was surtax in the amount of $833.80. The Commissioner added to income, as shown on the return, $2,884.36, representing interest received from Motty Eitingon, and computed the deficiency and a delinquency penalty of 25 per cent for failing to file a return within the time prescribed by law. The three petitioners are stockholders in Eitingon-Schild Company, Inc., an American corporation which has branches in many parts of the world. The open accounts above referred to originated in the course of business dealings between Motty Eitingon and the other two petitioners. 1210 No question has been raised in the petitions in regard to the penalties, and the proof which has been offered does not indicate that the Commissioner erred in this respect. Cf. Cantrell & Cochrane, Ltd.,19 B.T.A. 16">19 B.T.A. 16. The only question for our decision is whether or not the interest paid by Motty Eitingon to the two other petitioners was income from sources within the United States. If it was not, then there is no deficiency in any of the three cases, the penalty would have no tax to support it in the case of Charles Eitingon, and the penalty in the case of Naum Eitingon would be limited to 25 per cent of the surtax on $29,422.50. There is no showing that the transaction out of which the obligation for interest arose was consummated outside of the United States or that the interest in question was paid outside of the United States. Thus, the quoted assignment of error is not an accurate statement of the issue. 1344 The pertinent provisions of section 119 of the Revenue Act of 1928, under which the question must be decided, are as follows: (a) Gross income from sources in the United States. - The following items of gross income shall be treated as1211 income from sources within the United States: (1) INTEREST. - Interest on bonds, notes, or other interest-bearing obligations of residents, corporate or otherwise, not including - (A) interest on deposits with persons carrying on the banking business paid to persons not engaged in business within the United States and not having an office or place of business therein, or (B) interest received from a resident alien individual, a resident foreign corporation, or a domestic corporation, when it is shown to the satisfaction of the Commissioner that less than 20 per centum of the gross income of such resident payor or domestic corporation has been derived from sources within the United States, as determined under the provisions of this section, for the three-year period ending with the close of the taxable year of such payor preceding the payment of such interest, or for such part of such period as may be applicable, or (C) income derived by a foreign central bank of issue from bankers' acceptances. Subsection (c)(1) provides that interest other than that derived from sources within the United States, as provided in subsection (a)(1), shall be treated as income from sources without1212 the United States. Counsel for the petitioners argues that the rule of ejusdem generis should be applied in interpreting the phrase "other interest-bearing obligations" in section 119(a)(1). He would interpret this phrase to mean obligations similar to bonds and notes, that is, formal written agreements or acknowledgments of a liability to pay a certain sum. Even so, it might include the obligations here in question. We rejected a similar contention in Stockholms Enskilda Bank,25 B.T.A. 1328">25 B.T.A. 1328. See also British-American Tobacco Co., Ltd.,27 B.T.A. 226">27 B.T.A. 226. Although counsel for the petitioners has not attempted to refute the reasoning of the Board employed in the former case, nevertheless, what we there said on the subject was undoubtedly mere dicta and need not control us here. The rule of ejusdem generis has been evolved as an aid in the search for intent through a consideration of the words used by a writer. It should be used to resolve a doubt, not to create one. There are other valuable rules of interpretation. These frequently conflict one with the other and also with the rule of ejusdem generis. The problems of statutory interpretation1213 are seldom solved by rote. Sound judgment should be exercised to the end that the true intent of the legislators may be determined as accurately as is humanly possible. In United States v. First National Bank,190 Fed. 336, at page 343, the court said that the rule of ejusdem generis is not much in favor 1345 at the present time. The following was then appropriately quoted from Sutherland on Statutory Construction, sec. 279, as an accurate definition of the limits of the rule: In cases coming within the reach of the principle just illustrated, general words are read, not according to their natural and usual sense, but are restricted to persons and things of the same kind or genus as those just enumerated. They are construed according to the more explicit context. This rule can be used only as an aid in ascertaining the legislative intent, and not for the purpose of controlling the intention or of confining the operation of a statute within narrower limits than was intended by the lawmaker. It affords a mere suggestion to the judicial mind that, where it clearly appears that the lawmaker was thinking of a particular class of persons or objects, 1214 his words of more general description may not have been intended to embrace any other than those within the class. The suggestion is one of common sense. Other rules of construction are equally potent, especially the primary rule which suggests that the intent of the Legislature is to be found in the ordinary meaning of the words of the statute. The sense in which general words, or any words, are intended to be used, furnishes the rule of interpretation, and this is to be collected from the context; and a narrower or more extended meaning will be given, according as the intention is thus indicated. To deny any word or phrase its known and natural meaning in any instance, the court ought to be quite sure that they are following the legislative intention. Hence, though a general term follows specific words, it will not be restricted by them when the object of the act and the intention is that the general words shall be understood in their ordinary sense. The following quotation from United States v. Hartwell,6 Wall. 385">6 Wall. 385, 396, is apposite: When the words are general, and include various classes of persons, there is no authority which would justify a court1215 in restricting them to one class, and excluding others, where the purpose of the statute is alike applicable to all. The proper course in all cases is to adopt that sense of the words which best harmonizes with the context, and promotes in the fullest manner the policy and objects of the Legislature. The language used in section 119(a)(1) is broad if the words used are read according to their natural and usual sense. Thus read they would undoubtedly include the interest here in question. This interest was upon interest-bearing obligations of a resident. It was interest on deposits with a resident individual. It was earned and paid in the United States. The record does not disclose whether or not there was any writing or formal agreement evidencing the donor's obligation to pay interest and return the principal. The Commissioner's regulations and rulings indicate that he has always treated interest such as this as income from sources within the United States. See Regulations 45, article 91; Regulations 62, article 317; I.T. 1311, C.B.I-1, p. 224. Although we have studied the act and the legslative history of the section and its predecessors in earlier acts, no reason occurs1216 to us why Congress might have desired to 1346 relieve such income from tax. On the contrary, we would suppose that Congress had intended to tax it as income from sources within the United States in order to accomplish the object of the act. Cf. Burnet v. Brooks,288 U.S. 378">288 U.S. 378. There is nothing to indicate that the lawmakers were thinking only of interest of a particular class which would not include the interest in question. The words used should not be narrowly construed, as the petitioners urge, since there is no apparent reason for such a construction. The Commissioner did not err in holding that this interest is income from sources within the United States and subject to tax. Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623587/	Walter Bachrach v. Commissioner. Richard Uhlmann v. Commissioner. Alice U. Benjamin v. Commissioner.Bachrach v. CommissionerDocket Nos. 17025, 17083, 17084.United States Tax Court1949 Tax Ct. Memo LEXIS 212; 8 T.C.M. (CCH) 373; T.C.M. (RIA) 49092; April 22, 1949212 Morris Solomon, Esq., 231 So. La Salle St., Chicago, Ill., for the petitioners. Jackson L. Boughner, Esq., for the respondent. KERN Memorandum Findings of Fact and Opinion KERN, Judge: In these consolidated proceedings, respondent determined deficiencies in income tax of petitioners for the year 1944, as follows: Docket No.PetitionerDeficiency17025Walter Bachrach$155.0117083Richard Uhlmann489.5517084Alice U. Benjamin603.58 The deficiencies result from respondent's action in disallowing deductions claimed by petitioners, representing 50 per cent of losses said to have been sustained on the sale of Certificates of Indebtedness of the Standard Club in 1944, and the inclusion by respondent of 50 per cent of the sums received as long-term capital gains. It is the position of the respondent that the certificates were worthless upon their receipt in 1937 when petitioners exchanged second mortgage leasehold bonds of the Standard Club which they owned for such certificates as part of the 77B reorganization of the Standard Club commenced in 1934, and, consequently, petitioners made a "surrender" of rights rather than an exchange of213 securities under section 112 (b) (3). He also maintains that these bonds were worthless in 1934, and therefore petitioners' basis as to the certificates was zero when they were acquired. The first issue is whether the exchange of the bonds for the certificates, under the facts presented in these proceedings, constituted a "tax-free" reorganization, as defined in section 112 (g) of the 1936 Revenue Act, with a resultant non-recognition of gain or loss under section 112 (b) (3), and a consequent carrying over to the certificates of petitioners' basis as to the bonds, under section 113 (a) (6); and, secondly, whether the second mortgage leasehold bonds were worthless in 1934, the certificates of indebtedness issued therefor thereby having a basis of zero for the purposes of determining gain or loss. [The Facts] All of the facts have been stipulated and are hereby found accordingly. Only so much of the facts as are necessary to understand the problems involved will be recited. For the year 1944, petitioners, who were individuals residing in Chicago, Illinois, filed their income tax returns for the year involved with the collector for the first district of Illinois. Walter214 Bachrach acquired one $500 Standard Club second mortgage leasehold bond in 1928 at face value. Richard Uhlmann acquired two $1,000 bonds in 1927 at face value; and Alice U. Benjamin acquired six such bonds in the same year at face value. The bonds were issued by the Standard Club, a non-profit Illinois corporation which operated as a private club for its members. Its principal asset consisted of a spacious 10-story club building erected in 1925 upon property leased by the Club under three long-term leases. In 1925 the Club issued $1,000,000 of first mortgage leasehold bonds, and in 1927 it issued $1,000,000 of second mortgage leasehold bonds. The funds received from the sale of these bonds, together with initiation fees, were used in erecting the building and for furnishings and fixtures. The cost of the building was carried on its books at time of acquisition at $2,639,080.34, and the equipment and fixtures were carried at $314,850.25. In 1934 the reproduction cost of the club building, after deducting ordinary age depreciation, was $1,420,920. In 1934 the Club was in default with respect to the payment of rentals under the leases in the amount of $113,650. It was also delinquent215 in the payment of real estate taxes, including interest and penalties, of $100,000. There was also due on the first mortgage leasehold bonds the principal sum of $782,000 and matured interest of $109,740; and on the second mortgage leasehold bonds the principal sum of $1,000,000, and interest coupons of $125,000. Its other liabilities approximated $39,000. At the time it was possessed of its building, and furniture and fixtures, and current assets of approximately $100,000. Its balance sheet as of March 31, 1934, revealed assets totalling $3,130,021.07, and liabilities aggregating $2,370,264.62. As the Club was unable to meet its debts as they matured, in July of 1934 it filed proceedings in the District Court of the United States for the Northern District of Illinois, seeking to be reorganized under section 77B of the Bankruptcy Act. In its petition it recited that the lessors under the ground leases were amenable to amending such leases, agreeing to reduction in ground rent, provided that the Club could raise certain funds from contributors to meet delinquent taxes and otherwise satisfactorily recapitalize its debt structure. By orders of the court the Club was permitted to remain216 in possession of its property and operate it, which it did, uninterruptedly during and after the reorganization. In 1937, all provisions of the plan of reorganization having been complied with, the reorganization proceedings were terminated. Under the plan the old first mortgage leasehold bonds became and were exchangeable for new 15-year income leasehold bonds, with interest payable at variable rates dependent on the Club income available; and the old second mortgage leasehold bonds became and were exchangeable for new certificates of indebtedness due and payable without interest in 1949. As part of the plan, it was provided that the certificates of indebtedness would be retired, to the extent possible, out of monies left after payment of operating expenses of the Club, including ground rentals, taxes, and the amounts allocable to the purchase of the new first mortgage bonds and interest thereon, and for sinking-fund requirements. A sum slightly in excess of $81,000 was necessary to meet these obligations. In only one year, that ending March 31, 1944, was the income of the Club sufficient to permit the retirement of any certificates of indebtedness. The Club operated at a loss during217 the fiscal years ended March 31, 1933, 1934, and 1935; but thereafter, for every year, it operated at a profit. Its fixed assets, as well as the club equity (excess of assets over liabilities), remained substantially the same from 1934 to 1946, according to the Club's books. The club equity exceeded $750,000. There were no bid and asked quotations on second mortgage bonds or on the certificates of indebtedness at any time from 1934 to 1946. From 1938 to 1943 holders of about $65,000 worth of these certificates sold them at a rate of $2 per thousand. During 1944 the Club purchased on tenders pursuant to the terms of the plan of reorganization $194,500 par value of such certificates at a total cost of $4,064.34, including those owned by petitioners herein. Each petitioner claimed a deduction on his 1944 tax return of a long-term capital loss of 50 per cent, based upon the difference between the amount received on the sale of the certificates and the face amount of the certificates. In the statement attached to each notice of deficiency, respondent determined: "The deduction * * * claimed from gross income on your 1944 income tax return, representing 50% of a loss * * * alleged218 to have been sustained from the sale of certificates of indebtedness of The Standard Club, has been disallowed for the reason that it has been determined that the basis of the certificates in your hands was zero, and that they were worthless prior to the year 1944. * " [Opinion] We need not long be detained by the first issue, for respondent recognizes that if we follow , affirming , and , affirming a Tax Court Memorandum Opinion [, that issue must be decided adversely to him. Although respondent urges, without advancing any new arguments, that those cases were wrongly decided, we believe otherwise and shall continue to follow them in these proceedings. The principal area of difference between the parties then becomes whether the certificates of indebtedness which petitioners sold in 1944 had no basis for purposes of determining gain or loss, as respondent argues; or whether they retained the basis of the cost of the second mortgage bonds, which were exchanged in 1937 for the219 certificates, as petitioners urge. It is respondent's contention that in 1934 the second mortgage bonds became worthless when the Club filed its petition in bankruptcy, and that the certificates given in exchange therefor in 1937 were also worthless; and, therefore, they had no basis in the hands of petitioners. He argues that by the harsh terms of the lease amendments, later incorporated in the plan of reorganization, the lien of the second mortgage bondholders was extinguished, and they had no present equity. The securities had no prospective value, he maintains, because the Club income had to reach a virtually unattainable level before any portion thereof would be available for retirement of the certificates pursuant to the terms of the reorganization plan. In this argument, it is to be observed that respondent disregards the factor that any certificates not purchased or retired prior to August, 1949, were "to be and become the general obligation" of the Club. Moreover, he minimizes the book value and reproduction value of the Club's principal assets as elements in determining the question of the worthlessness of the securities. Petitioners, on the other hand, have stressed220 the facts that according to the Club's balance sheets its assets exceeded liabilities at all times material by over 3/4 of a million dollars, and that even if the building were to be valued at reproduction cost, after ordinary age depreciation, there was still an equity in the holders of the second mortgage leasehold bonds of approximately 70 cents on the dollar. Additionally, they assert that the Club at all times was a going concern and earned substantial profits every year from March 31, 1935, to March 31, 1947. Viewing the matter with practical and realistic objectiveness, cf. , we believe that petitioners have made a prima facie showing that the second mortgage bonds were not worthless in 1934, and that the certificates of indebtedness were not worthless upon receipt or at any other time prior to their sale in 1944, and such showing we deem sufficient to shift the burden of going forward to respondent. . The test generally applied in situations where the question of worthlessness of securities is involved was stated in , affd. (CCA-7), 221 : "The ultimate value of stock, and conversely its worthlessness, will depend not only on its current liquidating value, but also on what value it may acquire in the future through the foreseeable operations of the corporation. Both factors of value must be wiped out before we can definitely fix the loss. If the assets of the corporation exceed its liabilities, the stock has a liquidating value. If its assets are less than its liabilities but there is a reasonable hope and expectation that the assets will exceed the liabilities of the corporation in the future, its stock, while having no liquidating value, has a potential value and can not be said to be worthless. The loss of potential value, if it exists, can be established ordinarily with satisfaction only by some 'identifiable event' in the corporation's life which puts an end to such hope and expectation." See, e.g., ; ; , affd. (CCA-3), . The application of this test to the facts before us gives support to222 petitioners' views. As in the Edwards case, there were here produced balance sheets of the corporation, as well as other stipulated facts bearing upon the value of its principal assets, which we can, in the absence of any different showing, utilize in resolving the question of worthlessness that is presented. Cf. . These data reflect that assets substantially exceeded liabilities, and permit the conclusion that the second mortgage bonds were not only not worthless in 1934, but that there was a present liquidating, as well as potential, value; and, likewise, the conclusion that the certificates procured in 1937 were not worthless upon receipt. It is facts such as these which distinguish the present proceeding from ; certiorari denied, , cited by respondent. It was there found that liabilities exceeded assets by a substantial sum and the other attendant circumstances were such as to justify the ascertainment of worthlessness by the taxpayer, the statutory test then applicable. The reorganization of the Club under section 77B223 of the Bankruptcy Act, the strongest single element upon which respondent can rely, is not of itself sufficient to establish worthlessness. ; . This is particularly so where, as here, there is continuing profitable operation of the venture; cf. et seq., affirming CCA-3, ; the retention of the principal assets which induced and secured petitioners' original investment in the enterprise, cf. ; and a reduction in the fixed charges making possible the continued use of the assets securing petitioners' investment. It may further be observed that if petitioners had sought to claim that their bonds were worthless in 1934, respondent might well have argued that they were not, and that the deductions should have been disallowed. Cf. , affd. (CCA-3), . It is our conclusion that petitioners in these proceedings have made a prima facie showing sufficient to overcome*224 the presumptive correctness of respondent's determination. ; cf. , with , and . No significant contrary evidence having been adduced, respondent's determination is disapproved. Decisions will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623589/	Clifford J. Straehley and Oriel C. Straehley v. Commissioner. Clifford J. Straehley v. Commissioner.Straehley v. CommissionerDocket Nos. 41431, 50077, 50078.United States Tax CourtT.C. Memo 1955-116; 1955 Tax Ct. Memo LEXIS 224; 14 T.C.M. (CCH) 415; T.C.M. (RIA) 55116; May 6, 1955224 Upon the facts, held: 1. [Reconstruction of income: Net worth method.] Respondent was not justified in reconstructing petitioner's taxable net income by use of the net worth method. 2. Fraud penalties disallowed. Robert N. Gorman, Esq., 808 Traction Building, Cincinnati, Ohio, for the petitioners. Lyman G. Friedman, Esq., and R. G. deQuevedo, Esq., for the respondent. HARRON Memorandum Findings of Fact and Opinion HARRON, Judge: The Commissioner determined deficiencies in income tax and 50 per cent additions thereto for fraud under section 293(b) of the 1939 Code for the years 1946, 1948, 1949 and 1951, as follows: YearDeficiencySec. 293(b)1946$31,731.89$15,865.9519487,143.80 13,696.9019492,279.721,139.8619513,627.841,813.92The Commissioner determined the amounts of taxable net income by use of the increase in net worth and expenditures method. The income tax deficiencies225 result from such determinations of net income. The issues to be decided are as follows: (1) Whether it was proper for the respondent to resort to the net worth method. (2) If so, whether respondent correctly determined the petitioner's taxable net income for the years 1946, 1948, 1949, and 1951 by use of the net worth method. (3) Whether part of any deficiency is due to fraud with intent to evade tax. The returns were filed with the director for the first district of Ohio in Cincinnati. Findings of Fact Petitioners reside in Cincinnati, Ohio. Clifford J. Straehley filed an individual return for 1946. Joint returns were filed for 1948, 1949, and 1951. Oriel C. Straehley is involved only because joint returns were filed. The issues presented relate to transactions involving only Clifford J. Straehley. He is referred to hereinafter as the petitioner. Petitioner is a physician. He has practiced his profession in Cincinnati, Ohio, since 1920. He is a specialist in cardiology. Petitioner was born in 1896. He was graduated from Harvard University in 1916, and from the University of Cincinnati Medical School in 1920. He took a graduate course in medicine at Harvard University in226 1928. He studied in Europe during a part of each of the years 1927, 1929, 1930, 1932, and 1934. He has lectured at Good Samaritan and Bethesda Hospitals. During the years 1946 through 1951 petitioner maintained two residences one in Cincinnati, Ohio, and the other in Asheville, North Carolina. He spent approximately 60 per cent of his time in Cincinnati and 40 per cent in Asheville, making frequent trips between the two cities. Petitioner purchased his residence in Asheville in 1945. He did not practice medicine in Asheville. Petitioner maintained three checking accounts during the period in question; one at The Provident Savings & Trust Co. of Cincinnati, hereinafter referred to as the Provident Bank; one at the Atlas National Bank of Cincinnati; and one at Wachovia Bank & Trust Co. of Asheville, North Carolina. He did not have any savings account in any bank. Petitioner maintained a safe-deposit box in his own name at the Provident Bank prior to and during the years 1946 through 1951. Petitioner's wife had access to his box. In addition, petitioner had access to safe-deposit boxes at the Provident Bank rented in the name of Linton Securities Company, which represents a name227 used by the family in connection with security transactions, and resembles the name of a nominee. Petitioner kept in his safe-deposit box personal papers, insurance policies, stock certificates, municipal bonds, and cash. Petitioner did not keep any record at any time of the amounts of cash in his safedeposit box, the sources of such cash, or the disposition by him of cash withdrawn from the lock box. Petitioner's principal sources of taxable income during the period 1946 through 1951 were his medical practice, stock dividends, and gains from sales of stocks and municipal bonds. He also received nontaxable income during this period from inheritance and the proceeds from an insurance policy. Petitioner has employed the same person as an office nurse and bookkeeper since 1928. During the years involved, petitioner's records of income from and expenses of his medical practice consisted of a card file system and a cash book. Petitioner also used his checking account at the Provident Bank in connection with his medical practice. Petitioner's records of professional income and expenses were kept by his office nurse. The gross receipts and net income from petitioner's medical practice228 as shown by his books and reported in his returns for cash of the taxable years were as follows: Gross receiptsNet incomefromfromYearprofessionprofession1946$23,679.25$12,753.98194818,250.006,367.69194914,750.002,733.75195114,294.002,010.33 The gross and net income of petitioner's medical practice were correctly reported in the return filed for each of the taxable years. Petitioner owned corporate stocks as of December 31, 1945, (the starting point of respondent's net worth statement) which had a cost basis to him of $130,612.13. He made numerous purchases and sales of stocks in each of the years 1946 through 1951. The total cost, or basis, to petitioner of stocks owned by him as of December 31 of each of the years 1946 through 1951 was as follows: YearCost or basis1946$162,950.791947160,622.241948182,340.031949167,667.571950191,633.511951160,331.50The volume of petitioner's stock market transactions during the period 1946-1951, that is, the total amount of his purchases and sales of stock, exceeded $2,000,000. The following schedule 2 shows the cost of stocks purchased by petitioner229 in each of the years 1946-1950, and the amounts of the proceeds received by him from sales of stocks in each of the years 1946-1951: YearCostProceeds from Sales1946$199,337$ 223,929194771,86875,9981948138,208130,5341949140,085144,0151950334,425347,7941951250,896Totals$883,923$1,173,166Petitioner did not deposit the proceeds from the sales of stocks in any bank account, and he did not pay for purchases of stocks with checks drawn on any of his bank accounts. He did not keep a cash balance in any of the brokerage accounts. Any cash balances due petitioner from brokerage firms were remitted to him by checks. Petitioner ordinarily cashed checks received from brokers and placed the proceeds in his safe-deposit box. Petitioner usually paid for purchases of stocks with cashier's checks which he obtained for cash from the Provident Bank. All of the cashier's checks were made payable to him. He endorsed cashier's230 checks and gave them to brokers in payment for purchases of stocks. During the years 1946 through 1951, 3 the Provident Bank issued to petitioner 122 cashier's checks in the total amount of $492,875.73, with one exception which is not material. The following schedule shows the total amount of such checks which were issued to petitioner in each of the years 1946-1951, inclusive: Total amountYearNo. of checksof checks194636$151,840.6119472061,174.0419482097,872.3419491551,029.60195025111,256.851951619,702.29Totals122$492,875.73Of the 122 checks, 77 were endorsed by petitioner to brokerage firms; the total amount of the 77 checks was $312,551.65. The following schedule shows the total amounts of cashier's checks endorsed by petitioner and given to brokerage firms in each of the years 1946-1951: No. ofcashier's checksendorsed toYearbrokerage firmsTotal amount194621$ 78,059.6919471444,174.041948954,785.1519491450,555.4819501881,835.94195113,141.35Totals77$312,551.65231 Petitioner's records of his stock market transactions consisted of the broker's slip for each purchase or sale of stock. Petitioner did not keep any record of the source and amount of cash in his safe-deposit box at any time, and he did not keep any record of the source of the funds with which he purchased cashier's checks made payable to brokers. Petitioner reported in his returns, dividends from stocks in each of the taxable years in the amounts set forth below. The respondent accepted as correct the amounts so reported: Dividend incomeYearreported1946$ 7,305.13194812,501.15194914,181.94195115,185.26Petitioner reported in his returns, net long-term capital gain (or loss), and net short-term capital gain (or loss) from the sales of stocks in each of the years, 1946, 1948, 1949, and 1951, in the amounts shown below. The respondent accepted as substantially correct the amounts of gain or loss, so reported: YearLong-term gainShort-term gain1946$36,276.85[11,271.91)1948(4,427.18)( 2,454.26)19494,772.33( 767.79)195127,627.22( 5,440.47)Petitioner realized net long-term capital gain (or loss), 232 and net short-term capital gain (or loss) from the sales of stocks in each of the years 1946, 1948, and 1949, in the following amounts: YearLong-term gainShort-term gain1946$37,537.17[17,227.35)1948(5,219.31)( 2,454.26)19493,055.20874.881951(not established by record)The following schedule summarizes the adjusted gross income, non-business deductions, and net income as reported by petitioner in each of the taxable years: Adjusted gross income:1946 1948 1949 1951 Net income from medical practice$12,753.98$ 6,367.69$ 2,733.75$ 2,010.33Dividend income7,305.1312,501.1514,181.9415,185.26Interest income1,412.031,420.781,251.85Income from annuities81.2981.2981.2981.29Net income (or loss) from rents(117.33)(145.02)Net gain (or loss) from sale of capitalassets6,866.51(1,000.00)(1,000.00)8,373.14Total adjusted gross income as reported$27,006.91$19,244.83$17,272.74$26,901.87Nonbusiness deductions claimed in returns1,297.721,451.911,722.542,319.38Net income as reported$25,709.19$17,792.92$15,550.20$24,582.49233 The respondent determined the amounts of petitioner's taxable net income for each of the years 1946 through 1951 by use of the annual increase in net worth and expenditures method. As a result, he determined that petitioner's net income as reported in his returns for each of the years 1946, 1948, 1949, and 1951 was understated, and he determined deficiencies for those years. The respondent's net worth statement did not indicate that petitioner realized income in 1947 and 1950 in excess of the amounts reported in his returns for those years, and he has accepted as substantially correct the returns for 1947 and 1950. Those years are not before us. The chief reason for respondent's resorting to the net worth method was because all of petitioner's stock market transactions were in cash, and the respondent was unable to trace the source and disposition of the amounts of cash involved. The respondent's net worth statement, Ex. 1A, is incorporated herein by this reference. The respondent did not include among assets in the net worth statement as of the end of 1945-1949, any amount for municipal bonds. He did not include among assets at the end of 1945, or of any subsequent year, any234 amount for undeposited cash belonging to petitioner. As of December 31, 1945, the petitioner owned and possessed bonds of municipalities in Florida, Michigan, North Carolina, Ohio, and South Dakota. The total face amount of the bonds amounted to $126,000. The bonds were bearer bonds. The bonds were acquired by the petitioner at various times prior to December 31, 1945. He owned them at the end of 1945, and they were in his possession at that time. He kept them in a safety-deposit box. The bonds are listed in the following schedule. The bonds were sold to, or by, the Provident Bank, which has a bond department, during the years 1946, 1948, 1949, and 1950 for the total amount of $129,855.77. The following schedule sets forth the municipal bonds, the face values, the dates of sale, and the amounts received by petitioner: Date of SaleFace ValueBondReceivedMarch 29, 1946$ 5,000St. Augustine, Fla., 3% Ref.$ 5,361.67March 30, 19465,000Clearwater, Fla., 3 1/2% Ref.5,168.40April 9, 194610,000Ft. Lauderdale, Fla., 4% Ref.12,558.89June 10, 194610,000Miami, Fla., 3 1/2% Ref.11,579.58August 1, 19465,000Detroit, Mich., 4% Ref.5,679.17Nov. 20, 194610,000Asheville, N.C., 2-4% Ref.9,202.22Nov. 20, 194610,000St. Augustine, Fla., 3% Ref.10,315.83Feb. 4, 194812,000West Palm Beach, Fla., 3% Ref.11,343.00Feb. 16, 194820,000Ft. Pierce, Fla., 3-3 1/2% Ref.17,975.00March 9, 19486,000Village of Amherst, O., 3/4% Ref.6,375.00May 27, 19481,000Broward Co., Fla. S.D., Ref. 4%1,031.22Nov. 9, 194810,000Akron, O., 3% Ref.10,319.17July 8, 19495,000Escambia Co., Fla., 2 5/8% Ref.4,840.05Jan. 4, 19507,000Broward Co., S.D., 4% Ref.7,492.33Jan. 4, 19505,000Mobile, Ala., 3 1/2% Ref.5,126.46Jan. 24, 19505,000Ft. Lauderdale, Fla., 4% Ref.5,487.78Totals$126,000$129,855.77235 The bonds, with one exception, were purchased by the bank; the Village of Amherst bond was sold by the bank as agent for the petitioner. The bank paid for the bonds by cashier's checks which were made payable to the petitioner. In some instances the payments were made in cash to petitioner. Both the cashier's checks and the cash were charged to the bond department of the bank upon the bank's records. Petitioner did not report gain or loss from the sales of the municipal bonds in his returns for the years 1946, 1948, 1949, and 1950. Petitioner did not retain broker's slips for the sales of the municipal bonds. The records of the sales of the municipal bonds were kept by the bank. The petitioner's books and records clearly reflected his income, except for gains or losses from the sales of municipal bonds. The respondent was not justified in reconstructing the petitioner's taxable net income by use of the annual increase in net worth and expenditures method. No part of any deficiency for the years 1946, 1948, 1949, and 1951 is due to fraud with intent to evade tax. Opinion Respondent determined deficiencies for the years 1946, 1948, 1949, and 1951 by use of the annual increase236 in net worth and expenditures method. He reconstructed petitioner's taxable net income under this method for each of the years 1946 through 1951. However, the net worth statement did not indicate any unreported income in the years 1947 and 1950. Therefore, the respondent accepted petitioner's records for 1947 and 1950 as clearly and adequately reflecting his true income for those years; he accepted as substantially correct, also, the income tax returns which were filed for 1947 and 1950. Those years are not before us. Respondent also determined that part of the deficiency for each of the taxable years involved was due to fraud with intent to evade tax under section 293(b) of the 1939 Code. Petitioner contests respondent's resort to and use of the net worth method. He contends that he had and maintained books and records which clearly reflected his net income for the years in question, and that his returns for the years in dispute are substantially correct, as filed. He admits that there are certain errors in his returns for some of the taxable years, but he contends that such errors are not substantial and that they do not justify resort to the net worth method. He has given explanations237 for some of the errors and appears to be willing to endeavor to settle them with the respondent at the time recomputations are made under Rule 50. Petitioner's explanation of the discrepancies between the amounts of his net income as reported in his returns, and as determined by respondent is that he owned and possessed municipal bonds in the face amount of $126,000 at the end of 1945, that he sold bonds during the years 1946, 1948, 1949, and 1950. He contends that if the bonds of the above value had been included by respondent in the net worth statement, practically all of the allegedly unreported net income would be wiped out. The real controversy in these proceedings is whether, at the end of 1945, petitioner owned and possessed municipal bonds in the face amount of $126,000. The parties now agree that bonds in the total amount of $126,000 were purchased by the Provident Bank in 1946, 1948, 1949, and 1950. Respondent did not include any amount of municipal bonds in the net worth statement at the end of 1945, or of any other year. He now contends that petitioner has failed to establish ownership of bonds. The question to be decided is a question of fact. Respondent does not238 question the correctness of petitioner's records of income from his profession for the taxable years. He concedes that the amounts of professional income which were reported in the returns correspond to the records of income from petitioner's medical practice. He concedes that the amounts of petitioner's income, from dividends and other sources and from gains and losses from sales of stock, as reported in the returns for each of the taxable years, are substantially correct. But, the respondent claims that he could not trace the sources and the disposition of the amounts of cash involved in petitioner's stock transactions, which were substantial in amount, to any records kept by petitioner. He argues, also, that petitioner's standard of living, involving large expenditures, indicated that petitioner had income in the taxable years in excess of the amounts reported in the returns. He argues that use of the net worth method of determining taxable net income was justified because it seems to have revealed that there were substantial understatements of net income in the returns. Respondent recognizes that if the Court finds that municipal bonds were owned and sold by the petitioner in the239 amounts claimed, the basis for his use of the net worth method and the validity of his determination of taxable net income fall. We are satisfied from the entire record and have found that petitioner owned municipal bonds in the face amount of $126,000 at the end of 1945, and the petitioner sold the bonds to the Provident Bank in the years 1946, 1948, 1949, and 1950 for the sums set forth in the Findings of Fact, and received the proceeds of the sales. Furthermore, we are satisfied from all of the evidence that the records kept by the petitioner were adequate and clearly reflected his income, and that the amounts of petitioner's income reported in the returns for the taxable years were substantially correct, except for gains from the sales of municipal bonds, a point which is discussed hereafter. It is held, therefore, that respondent's resort to the increase in net worth method was not justified and was improper, and that his determinations of deficiencies based thereon are erroneous and cannot be sustained. See . The petitioner could have and should have kept and maintained better and clearer records of the existence of and his dealings240 in municipal bonds, particularly because all of his dealings in the bonds were cash transactions which did not clear through any of his bank accounts. His conduct was such as to give rise to doubts about his ownership and possession of the bonds, as well as about the sources of large amounts of cash which he used in the taxable years. The bonds were bearer bonds, and they were kept in safe-deposit boxes to which members of the Straehley family had access as well as petitioner. The situation, created by petitioner, was one which raised inferences which were adverse to petitioner. On the other hand, the petitioner gave testimony in this proceeding about his ownership and sales of the municipal bonds which stands unrefuted. Also, his testimony about his transactions in the bonds is corroborated by the testimony of a representative of the Provident Bank, by documentary evidence, and by cashier's checks of the Provident Bank bearing the dates and the amounts shown by the statements covering the bank's purchases. The cashier's checks were made payable to the petitioner. There is no evidence establishing that bonds in the above amount were owned at the end of 1945 by anyone other than the241 petitioner, or that anyone other than the petitioner owned or received the proceeds from the sales thereof. We cannot disregard the unimpeached, competent, relevant, and corroborated testimony of the petitioner. ; . Also, care and restraint must be exercised in approving and applying use of the net worth method of determining taxable income. . The petitioner had the burden of proving error in the respondent's determinations of the amounts of his taxable net income for the years in question. , aff'd ; . The respondent's determinations were prima facie correct. However, it is concluded that the evidence adduced by the petitioner overcomes the prima facie correctness of the respondent's determinations of the amounts of taxable net income. The respondent did not introduce evidence which rebutted petitioner's evidence, or discredited his testimony. The respondent242 had the burden of proving that part of each deficiency in tax, if any, was due to fraud with intent to evade tax. , certiorari denied . He failed to meet his burden of proof. It is held that no part of the deficiencies, if any, for the taxable years is due to fraud with intent to evade tax. The addition of 50 per cent penalties is reversed. The trial of this proceeding was upon issues arising out of respondent's determinations that petitioner realized income in the taxable years in the amounts shown by respondent's net worth statement. However, originally, the respondent determined a deficiency in income tax for 1948 without resort to a net worth statement; he disallowed several deductions taken in the return for 1948, and made other adjustments. Under the conclusions reached here, there remains the matter of disposing of the respondent's adjustments in the amount of net income reported for 1948, upon his audit of the return for that year. The petitioner is not at this time precluded from introducing evidence relating to those adjustments, if necessary, and upon appropriate motion, there can be243 a further hearing to receive additional evidence with respect to the year 1948. However, the parties may be able to resolve disputed items relating to the correct net income for 1948 by entering into and filing with the Court a written stipulation, effect to which can be given thereafter by the parties in their respective recomputations under Rule 50. Also, petitioner now concedes that there are deficiencies in tax for 1946, 1948, and 1949 because he failed to include in income in his returns capital gains from sales in those years of municipal bonds. Petitioner states that his failure was due to the erroneous belief that the bonds were tax-exempt with respect to gains as well as interest, i.e., that they were tax-exempt in every respect. His explanation is accepted in the absence of proof that such failure was due to fraudulent intent, with respect to which there is no clear and convincing evidence. Petitioner concedes, further, that errors were made in his returns in some of the amounts of capital gains and losses, from sales of stock which were reported in his returns. Such errors may have been made in the return for 1951, which is before us, as well as in the returns for other244 taxable years, although the record is not clear on this point. Under all of the circumstances, the parties should attempt to agree upon all of the adjustments to be made in taxable net income, as reported in the returns, for all of the taxable years under stipulations to be filed with the Court, and to be given effect by the parties in Rule 50 recomputations. Otherwise, an appropriate motion may be filed for further hearing with respect to petitioner's income as shown by his records and as reflected in his returns. Although respondent's use of the net worth method is not approved, it does not follow that there are no deficiencies in tax for all or some of the taxable years, as is explained above, and the parties will endeavor to agree upon the amounts of the deficiencies in their Rule 50 recomputations. See Decisions will be entered under Rule 50. Footnotes1. By amended answer, the Commissioner made claim for increase in the deficiency for 1948 from $2,739.46 to $7,143.80, and he also made claim for 50 per cent addition to the increased deficiency under section 293(b), 1939 Code.↩2. Figures for the years 1946-1950 are taken from Ex. 10. Figures for 1951 are not included in Ex. 10. Proceeds from sales in 1951 are taken from the income tax return, Ex. E.↩. Not disclosed by the record. ↩3. The Provident Bank issued 13 cashier's checks to petitioner in 1945 in the total amount of $47,839.07.↩. Individual return. ↩*. Joint returns.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623591/	Marvin Ansel Young and Glendora May Young, Petitioners v. Commissioner of Internal Revenue, Respondent; George C. Wallace and Mauzella Wallace, Petitioners v. Commissioner of Internal Revenue, RespondentYoung v. CommissionerDocket Nos. 3929-69, 3995-69United States Tax Court58 T.C. 629; 1972 U.S. Tax Ct. LEXIS 88; July 18, 1972, Filed 88 Decision in docket No. 3929-69 will be entered for the petitioners.Decision in docket No. 3995-69 will be entered for the respondent. George and Glendora were divorced in June 1963. Under the original decree Glendora was to receive the principal sum of $ 41,650 to be paid in installments over a period ending less than 10 years from the date of the decree. By December 1964, George had fallen behind in his payments and had been cited for contempt on several occasions. He still owed $ 38,050. To alleviate the problem, the parties entered into an "alimony agreement." They agreed that George would pay the balance ($ 38,050) in installments of $ 250 per month until the couple's minor child became emancipated or reached majority, then in installments of $ 400 per month. Under this arrangement the period for payment would last less than 10 years. Together the decree and the subsequent agreement called for installment payments to be paid over a period exceeding 10 years. Held, payments made in 1966 and 1967, when both the decree and the agreement were operative, are installment payments not includable in the former wife's gross income under sec. 71, I.R.C. 89 1954, and are not deductible by the former husband under sec. 215, I.R.C. 1954. Payments made pursuant to the original decree may not be tacked on to payments made after the signing of the subsequent agreement. Held, further, the former husband, by the terms of the agreement, does not have the right to extend the installment payments over a period in excess of 10 years. Although it was possible at the time of signing that the premature death of the minor child would prevent the increase in payments from $ 250 to $ 400 per month, this fact does not lead to the conclusion that, under the terms of the agreement, payments "may be paid" over a period lasting longer than 10 years. Sec. 71(c)(2), I.R.C. 1954. Robert F. Brandenburg, Jr., and Harry G. Foreman, for the petitioners in docket No. 3929-69.Raymond O. Burger, Gary F. Fuller, and Reid E. Robison, for the petitioners in docket No. 3995-69.Thomas J. Miller, for the respondent. Dawson, Judge. Simpson, J., concurring. Drennen, Tannenwald, and Goffe, JJ., agree with this concurring opinion. DAWSON629 In these consolidated cases the respondent determined the following Federal income tax deficiencies:PetitionersDocket No.YearDeficiencyMarvin Ansel Young and Glendora May Young3929-691966$ 574.541967497.41George C. Wallace and Mauzella Wallace3995-691966732.471967742.32Petitioners George C. Wallace and Mauzella Wallace have conceded one issue concerning their medical expense deduction for the year 630 1966. The only issue remaining for decision is whether $ 3,000 paid by George C. Wallace in 1966 and again in 1967 to his former wife, Glendora May Young, should be included in Glendora's92 gross income for those years under section 71, I.R.C. 1954, 1 and allowed as a deduction to George under section 215.FINDINGS OF FACTSome of the facts have been stipulated and are found accordingly.Petitioners Marvin Ansel Young and Glendora May Young (herein called Glendora) were residents of Norman, Okla., when they filed their petition with this Court. They filed joint Federal income tax returns for the years 1966 and 1967 with the district director of internal revenue at Oklahoma City, Okla. On these returns they did not include the $ 3,000 payments received from George C. Wallace as income.Petitioners George C. Wallace (herein called George) and Mauzella Wallace resided in Enid, Okla., when they filed their petition herein. In 1966 and 1967 they filed joint Federal income tax returns with the district director of internal revenue at Oklahoma City, Okla. On both returns93 they claimed a deduction for the amounts paid by George to Glendora in 1966 and 1967.George and Glendora were married on November 22, 1941. They had three children. One of the children, Darrell, was born on February 20, 1949.On June 25, 1963, Glendora obtained a divorce from George in an action filed with the District Court of Cleveland County, Okla. The decree of divorce awarded Glendora alimony in the amount of $ 41,650 to be paid in installments of $ 350 per month. Payment was to be completed in 119 installments. The decree reads as follows:Now on this 25th day of June, 1963, the same being one of the regular court days of this Court, the above styled and numbered cause comes on regularly for trial, Plaintiff appearing in person, and by counsel, Hugh P. Mabe, and Defendant appearing in person. All the evidence having been presented, and the Court being fully advised in the premises, finds that the thirty day waiting period required in such case has passed, and that the allegations contained in the petition of Plaintiff are true. The Defendant elected to stand on Plaintiff's evidence, and rested. That Plaintiff is a bona fide resident of the State of Oklahoma, and of94 Cleveland County; that there are three minor children, as alleged; that Defendant has been guilty of extreme mental cruelty, as alleged; that Plaintiff is a fit and proper person to be awarded the custody of said minor children; that One hundred fifty dollars ($ 150.00) per month per child is a reasonable amount for support of said minor children; that the properties accumulated 631 by the parties during said marriage, should be divided as prayed for; and that Plaintiff be awarded alimony in the amount of Forty-one thousand six hundred and fifty dollars ($ 41,650.00) to be paid to Plaintiff at the rate of $ 350.00 per month until fully paid out.It Is Therefore Ordered, Adjudged, and Decreed by the Court that the Plaintiff be awarded a Decree of Divorce from the Defendant, on the grounds of extreme mental cruelty, as aforesaid, and the bonds of matrimony heretofore existing between the parties be, and the same hereby are dissolved, set aside, and held for naught.It Is Further Ordered, Adjudged, and Decreed by the Court that Plaintiff be awarded the custody of the minor children of the parties, subject to the right of Defendant to visit with said minor children at reasonable95 and seasonable times.It Is Further Ordered, Adjudged, and Decreed by the Court that Defendant pay the sum of one hundred fifty dollars ($ 150.00) per month per child, for the support of said minor children of the parties, said sum to be paid through the Clerk of this Court, on or before the 1st day of each month, and continuing until further order of this Court.It Is Further Ordered, Adjudged, and Decreed by the Court that Plaintiff be awarded the home at 731 Oakbrook Drive, subject to the mortgage payments thereon, together with the household furnishings therein; that Plaintiff also be awarded the 1963 Oldsmobile 98 Sedan, subject to the mortgage payments thereon, and that Plaintiff be awarded one-half of the proceeds of a $ 9,000.00 note, aforementioned.It Is Further Ordered, Adjudged, and Decreed by the Court that Defendant pay to Plaintiff the sum of Forty-one thousand six hundred and fifty dollars ($ 41,650.00) alimony; that said sum should be paid to Plaintiff at the rate of $ 350.00 per month until the full amount has been paid, payable through the Clerk of this Court on or before the 15th day of each month, and continuing until further order of this Court.It Is Further96 Ordered, Adjudged and Decreed by the Court that insofar as the rights of the parties hereto to remarry are concerned, this Decree shall not become final, absolute, or take effect until after the expiration of six months from this date.George made the first monthly payment on July 15, 1963, and continued to comply with the terms of the decree until February of 1964 when he began falling behind. During 1964 he was twice cited for contempt and was adjudged guilty of contempt on May 6, 1964. Later, on September 28, 1964, he was purged of contempt, but he was again cited for contempt on November 13, 1964. He was scheduled for a jury trial on the second contempt citation on December 10, 1964.To alleviate the problem of alimony payment and to enable George to purge himself of contempt, the parties entered into an "alimony agreement" dated December 10, 1964, which was filed with and approved by the District Court of Cleveland County, Okla. Under the terms of the agreement, George was to pay the unpaid balance owing under the decree ($ 38,050) in installments of $ 250 -- rather than $ 350 -- 632 per month until such time as Darrell became emancipated or obtained majority; then97 the amount of the monthly payment was to be increased to $ 400 per month. Since Darrell would reach the age of 21 on February 20, 1970, it could be foreseen that payment under this agreement would be completed in less than 120 installments (approximately 118 installments). The "alimony agreement" reads as follows:This agreement made and entered into this 10th day of December, 1964, between plaintiff and defendant herein, and upon approval of the Court.There having been filed in the District Court of Cleveland County, State of Oklahoma, by the Plaintiff, a citation for contempt against the defendant, and the same being set for trial on December 10, 1964, and there having been an agreement reached between the parties concerning this matter, and with reference to the previous order of the Court dated June 25, 1963, it is therefore agreed by and between the parties, subject to the approval of the Court that:For and in consideration of the payment to plaintiff by defendant of the sum of $ 2,000.00, plaintiff waives any further right she may have under the decree of divorce dated June 25, 1963, with reference to the one-half interest of the proceeds of the $ 9,000.00 note, it being98 agreed that this is the remainder and residue of plaintiff's interest in said note.Plantiff, in further consideration of the above payment, hereby agrees that all alimony due and payable under the decree of divorce dated June 25, 1963, be extended pursuant to this agreement and she hereby requests the Court to purge defendant of his contempt as a result of the nonpayment of any alimony payments to date.Plaintiff further agrees that the decree of divorce dated June 25, 1963, may be modified with respect to the parties in that beginning on the 1st day of January, 1965, defendant shall pay to the plaintiff, the sum of $ 38,050.00 which amount represents the unpaid balance due on the alimony judgment to be paid at the rate of $ 250.00 per month beginning on the 1st day of January, 1965, until paid. Except that in the event that the minor child, Darrell Wallace, now residing with plaintiff becomes emancipated or obtains majority, then and in that event, defendant will continue to pay plaintiff the amount of $ 150.00 per month, which amount will be payment on the alimony judgment.It is further understood by the parties that this agreement in no way effects [sic] the order of the99 Court with respect to child support.In support of this agreement, the Court heard the testimony of the parties and finds that the matters and things contained herein are as stated, and it appearing to be the intention of the parties to consummate this agreement approves the same.Darrell Wallace joined the Armed Forces of the United States on or about January 22, 1969. Thus payment under the "alimony agreement" was completed even sooner than expected, i.e., in approximately 114 monthly installments.In 1968, when she learned that her former husband had been and was deducting his payments to her, Glendora filed a "Motion to Clarify Order" with the District Court of Cleveland County. In it she asked that the court find that the original decree required payment of the 633 principal sum ($ 41,650) over a period ending less than 10 years from the date of the decree.After hearing testimony and considering the parties' briefs, the District Court of Cleveland County found that it was without jurisdiction to change the original decree of divorce. The court's order, dated January 4, 1969, reads as follows:Now on the 24th day of September, 1968, there came on for hearing a100 Motion to Clarify Order filed by plaintiff, Glendora May Wallace, before the Honorable Elvin J. Brown, Judge of the District Court in and for Cleveland County, State of Oklahoma. Plaintiff appearing in person and by her attorney, Lester A. Reynolds; defendant appearing in person and by his attorney, Raymond O. Burger, and the Court after hearing the sworn testimony of witnesses, then took the matter under advisement and requested briefs from the parties involved.After hearing testimony and considering the parties' briefs, the as filed in this cause, the Court finds that it was without jurisdiction to change the Decree of Divorce of June 25, 1963, under which the parties' rights and responsibilities have continued to accrue; and the Court finds further, that although the defendant's obligation to pay plaintiff alimony the sum of $ 41,650.00 at the rate of $ 350.00 per month has continued unabated, the plaintiff is equitably estopped to cite the defendant for contempt of court for violation of the alimony payment ordered by such Decree of Divorce of June 25, 1963, so long as the defendant complies with the subsequent Alimony Agreement of December 10, 1964, although all other execution101 processes remain available to the plaintiff.It Is Hereby Ordered, Adjudged and Decreed by the Court that the Court was without jurisdiction to change the Decree of Divorce of June 25, 1963, and that the defendant's obligation thereunder to pay plaintiff alimony in the sum of $ 41,650.00 at the rate of $ 350.00 per month continues in full force and effect, but the plaintiff is ordered equitably estopped to cite defendant for contempt of court for failure to make such alimony payments, so long as defendant complies with the terms of the Alimony Agreement executed between the parties and approved by the Court December 10, 1964. Done in open court this 4th day of January, 1969.George took exception to the court's order and appealed to the Supreme Court of the State of Oklahoma. The Oklahoma Supreme Court reversed the lower court's decision on the ground that jurisdiction did exist upon the joint application of both parties; and therefore it remanded the case to the lower court with directions to grant a new trial. The Oklahoma Supreme Court did not express an opinion as to whether the lower court in fact exercised its jurisdiction to modify the decree. Wallace v. Wallace, 490 P. 2d 749 (Okla. 1971).102 Upon remand, the District Court of Cleveland County, after hearing the parties' arguments, wrote the following memorandum opinion:(1) The voluntary appearance of the parties and their consent for the Court to hear the matter conferred jurisdiction upon the Court to modify their 1963 Decree.634 (2) However, neither party requested the Court in any way, manner, method or detail, to modify that Decree, or its alimony award, notwithstanding [sic] any implication to the contrary from the ineptly worded "Alimony Agreement" of 12-10-64.(3) The parties appeared and asked that their agreement be approved only because of the financial pressures produced by repetitive contempt citations.(4) Defendant specifically agreed that his alimony obligation continued to accrue at the rate of $ 350.00 per month, but he acknowledged understanding that if the Court approved their Agreement, he would only have to pay $ 250.00 per month until his child support stopped, at which time he would start paying $ 400.00 per month, which was more than required under the 1963 Decree.(5) Plaintiff specifically stated that while she knew her alimony was accumulating at the rate of $ 350.00 per month, 103 she was agreeing to give up any right to coerce payment through contempt proceedings or execution of more than $ 250.00 per month until the child support stopped, when she could expect $ 400.00 per month toward retirement of the accrued and accruing alimony due her.Therefore, the Court concludes that it was not the intention of the parties or of the Court to modify the alimony award contained in the 1963 Divorce Decree of these parties, but that it was the announced intention of the parties and Order of the Court to estop the plaintiff from enforcing the collection through contempt of more than $ 250.00 per month until majority or emancipation of the child, when defendant would pay $ 400.00 per month. While this appears in retrospect to be a poor method of accomplishing the desired result, such is what happened.Lest anyone misunderstand and suspect one or the other of these attorneys of perpetrating a fraud on the Court or the other party, it is well to remember that neither of these are the original attorneys for either party. Only the parties and the trial judge maintain their original stations in this case, and the trial judge looks forward to the day when he can terminate104 his association with this matter.Counsel may draw a Journal Entry reflecting the conclusion of this Memoranda Opinion and preserving exceptions dated this 8th day of February, 1972.George made all payments called for under the "alimony agreement" from its inception to the date of the trial of these consolidated cases.OPINIONThe issue confronting us is whether payments made in the taxable years 1966 and 1967 by George to his former wife, Glendora, qualify as periodic alimony payments. If they do, they must be included in gross income by Glendora under section 71(a)2105 and are deductible by 635 George under section 215(a). 3 If they are not periodic but are installment payments, then George bears the burden of taxation. 4The respondent took inconsistent positions in his notices of deficiency, determining in Glendora's case that the payments were periodic and in George's case that the payments were installment payments. This action was taken as a defensive measure to protect Federal revenue. On brief, however, respondent has adopted a position that favors the former wife, i.e., the payments were properly106 excluded from income by Glendora and improperly deducted by George. Respondent contends that the payments in issue should be characterized by reference to the alimony agreement of December 10, 1964, the instrument pursuant to which the payments were made.The former wife's position is, of course, similar. She argues that the alimony payments made from June 25, 1963, until December 10, 1964, were made pursuant to the original divorce decree and were installment payments; that all payments made thereafter, including those made in the taxable years 1966 and 1967, were made pursuant to the subsequent alimony agreement and were likewise installment payments; and that payments made pursuant to the decree cannot be tacked on to payments made pursuant to the agreement so as to extend the period for payment past the 10-year limitation set forth in the statute 5 and regulations, thus making payments made pursuant to the agreement periodic.107 George's position is that the starting point for computing the 10-year period is the date of the divorce decree, that the agreement did not modify or supersede the original decree, and that therefore the 636 payments made or to be made after the signing of the subsequent agreement must be tacked on to those made before the agreement.Respondent and Glendora cite two cases as standing for the proposition that in a case such as this one, where there is first a divorce decree and then an amendatory agreement, all post-agreement payments must be considered as being paid pursuant to the agreement and only the agreement can be looked to in determining the character of the payments. The cases are Frank J. Loverin, 10 T.C. 406">10 T.C. 406 (1948), and Mary Louise Williams, T.C. Memo 1953-341">T.C. Memo. 1953-341. George distinguishes these cases on the ground that they involved agreements that completely superseded the terms of the divorce decree.6 In both cases the decree called for periodic alimony payments and the subsequent agreement substituted an installment payment arrangement. In Loverin, the parties agreed to accept payments under their agreement in lieu of any108 and all payments under the decree, and they exchanged general releases. Frank J. Loverin, supra at 407. In Williams, the former spouses likewise agreed to an installment arrangement in lieu of the periodic arrangement established by the decree. They also executed a satisfaction of judgment. Mary Louise Williams, supra.Here the original decree was not superseded or supplanted by the subsequent agreement. In fact, the trial judge who granted the original divorce decree and signed the later agreement wrote in the memorandum opinion in response to Glendora's "Motion to Clarify Order" that "it was not the intention of the parties or of the Court to modify the alimony award contained in the 1963 Divorce Decree of the parties * ." See also, Alan E. Ashcraft, Jr., 252 F. 2d 200 (C.A. 7, 1958), affirming 28 T.C. 356">28 T.C. 356 (1957).109 These two cases aside, it is also in the former husband's favor that both the decree and the subsequent agreement called for installment payments. The problem of combining periodic payments with installment payments does not appear herein. See and compare Furrow v. Commissioner, 292 F. 2d 604 (C.A. 10, 1961) (payments made pendente lite are periodic; they cannot be added to section 71(c)(1) installment payments). See also Ellert v. Commissioner, 311 F. 2d 707 (C.A. 6, 1962) (payments made under a temporary alimony agreement cannot be tacked on to later payments under a separation agreement that was incorporated in the divorce decree: "the payments made under the [temporary agreement] * * * were not in payment of any principal sum, nor were they even referred to in the separation agreement or in the divorce decree, and therefore may not be tacked on to 637 the payments provided for in paragraph 4 [of the separation agreement]"); and Estate of John M. Jarboe, 39 T.C. 690 (1963) (where this Court relied on Alan E. Ashcraft, Jr., supra, and Ellert v. Commissioner, supra).Still, we cannot agree110 with the former husband's conclusion that the 10-year period begins on the date of the divorce decree and runs until the conclusion of payments under the subsequent agreement. We view the realities of this case in the same way as the State court trial judge: The parties have caused a decree to be issued that calls for installment payments of $ 350 per month over a 119-month period. Eighteen months later they laid on top of that decree a bilateral agreement calling for installment payments of $ 250 per month (to be increased to $ 400 per month no later than x years and x months into the agreement). So, at the time of the payments in question, 1966 and 1967, the parties were operating under both the decree and the agreement. Under the decree, Glendora could compel George to pay her $ 250 per month. She could not compel him to pay the full $ 350 per month because she was equitably estopped from doing so. See Judge Brown's memorandum opinion set out in our Findings of Fact. Under the agreement, Glendora had a legal right to receive $ 250 per month, and $ 400 per month later. The decree will expire 119 months after the date of the first payment, July 15, 1963, i.e., June 15, 1973. 111 The agreement, on the other hand, will continue in existence until the principal sum of $ 38,050 is paid out, i.e., no later than October 1974. As George admits, the divorce decree has not been modified so as to extend its original life past the statutory 10-year period.Given this state of affairs, we know of no section of the Code or tax case that compels us to tack payments under the decree to payments under the agreement in order to create a figure in excess of 10 years or 120 months and thereby trigger the surprise metamorphosis of installment payments into periodic payments. Furthermore, common sense tells us that this area of the tax law, the area of alimony payments, does not need another camouflaged pitfall. Cf. Lemuel Alexander Carmichael, 14 T.C. 1356">14 T.C. 1356, 1365-1366 (1950). We hold that the payments made pursuant solely to the decree cannot be tacked onto the payments made after the signing of the agreement.George makes an alternative argument. Disregarding the preagreement payments and focusing on the "alimony agreement" alone, he argues that the period for payment exceeds the 10-year statutory period and therefore the payments qualify as periodic payments112 under section 71(c) (2). He admits that the occurrence of either of 638 the contingencies provided for under the agreement -- the minor child's reaching majority or becoming emancipated -- will cause payment of the $ 38,050 to be completed in less than 10 years. 7 Yet he contends that at the time the agreement was reached it was possible that the child would die prior to his reaching majority or becoming emancipated and the increase from $ 250 to $ 400 per month would never occur. Thus the principal sum may be paid over a period exceeding 10 years.Section 71(c)(2), which is quoted in footnote 5, provides that if the principal sum, by the terms of the agreement, is to be paid or may be paid over a period lasting more than 10 years, then the installment payments shall be treated as periodic payments for purposes of subsection (a). Concerning the phrase "may be paid" as it appears113 in subsection (c) (2), we said in Alice Grabowski, a case cited by the parties:The word "may" in the phrase "may be paid" relates to the decree and it is to be given its ordinary permissive meaning as distinguished from ability, possibility, or what is likely to occur. The question is whether the decree by its terms permits installment payments of the principal sum so that the husband would be complying with the terms of the decree if he extended the payments beyond the 10-year period. If he does not, then the installment payments are not includible in the wife's income, even though it appears uncertain whether the husband will, or will be able to, make the payments within the 10-year period. In deciding whether the principal sum "may be paid" within 10 years, the possibility of noncompliance with the terms of the decree is not recognized. Robert D. Stecker, * * * [31 T.C. 749">31 T.C. 749 (1959)]. In short, the issue is whether the decree grants Felix [the husband] the right to extend the installment payments on the principal sum of $ 23,500 beyond the 10-year period. [Alice Grabowski, T.C. Memo. 1962-43.]See generally, 5 Mertens, Law114 of Federal Income Taxation, sec. 31A.04, pp. 50-51.As we interpret the "alimony agreement," it requires George to complete his payments within a period of less than 10 years. Nowhere in the agreement is he permitted to extend the payments beyond the 10-year period. Even if the minor child had not become emancipated approximately 1 year before reaching majority, the agreement's principal sum still would have been paid out in less than 10 years. At the time he reached the age of 21, the amount of the monthly alimony payments was to have increased from $ 250 to $ 400; at that rate, the entire principal sum ($ 38,050) will be paid out in approximately 639 118 installments. Accordingly, we conclude that George does not have and never has had the right to extend his payments over a period exceeding 10 years.Our decision in William D. Price, Jr., 49 T.C. 676">49 T.C. 676 (1968), does not compel us to reach a different conclusion. In that case the agreement provided for installment payments of a principal sum over a less-than-10-year period. It further provided that if the wife was later given custody of the children, the period for payment was to be extended. The principal115 sum due, however, would not be reduced under any circumstances. We held for the Commissioner on the ground that the husband had failed to show that by the terms of the agreement the principal sum "may be paid" over a period exceeding 10 years. The husband had not shown the ages of the children or any other facts that would show that if custody were given to the wife, the less-than-10-year period over which payment would otherwise be made would be extended beyond 10 years. The negative inference to be drawn from the case is that if the possibility or contingency 8 (i.e., the wife being given custody of the children) had been properly shown, the petitioner-husband would have succeeded in bringing his case within the "may be paid" phrase of subsection (c) (2). It is important to note, however, that the possibility that was discussed in Price was expressly provided for in the agreement. And, as we stated in both Price and Robert D. Stecker, supra, it is the terms of the decree, instrument, or agreement which control. In the instant case the possibility that the child might die prematurely was not mentioned in the agreement. The only possibility that was116 included in the 1964 agreement was the possibility (actually, the likelihood) that the child would reach majority or become emancipated and the payments would be increased thereby. Moreover, the possibility of the child's premature death is one step further removed than the possibility involved in the Price case. In Price, if the wife were to be given custody, then the period for payment would be extended beyond 10 years. Here, if the child reaches majority or is emancipated, then the payment period will not exceed 10 years. Thus the possibility at this level works to Glendora's advantage. George is attempting to extend the payment period by pointing out a contingency at the next level: If the child dies before reaching majority or becoming emancipated, then the first level possibility will never occur and, consequently, the payment period will be extended.117 640 In view of our interpretation of the "alimony agreement," we hold that the period for payment under the agreement does not exceed 10 years.Decision in docket No. 3929-69 will be entered for the petitioners.Decision in docket No. 3995-69 will be entered for the respondent. SIMPSONSimpson, J., concurring: I agree with the result reached by the majority, but my reasons for so concluding are somewhat different.The purpose of sections 71 and 215 is to permit the husband and wife to enter into arrangements that will shift the tax burden with respect to alimony payments to the wife. See H. Rept. No. 2333, to accompany the Revenue Act of 1942, 77th Cong., 2d Sess., p. 46; see also 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, the tax burden with respect to alimony payments is not shifted unless the intent to do so is clearly manifested in the instrument under which the payments are made. See Commissioner v. Lester, supra;Chester L. Tinsman, supra. Although the cases requiring the manifestation of such an intent were concerned118 with the distinction between alimony and support payments, the principles established by them should also be applied to the issue in this case.It is clear, in this case, that the arrangement under the original decree was designed to provide for the payment of a principal sum in installments within a period of 10 years, and that under such arrangement, the husband was not entitled to deduct such payments and the wife was not required to include them in her income. The subsequent "alimony agreement" does not by its terms provide for the modified payments to be made over a period of more than 10 years, nor does such agreement indicate that the husband and wife agreed to extend the period under the original decree for payment of the installments. Thus, clearly, the original intention was not to shift the tax burden; although the alimony agreement reflects that the parties agreed to some changes in the arrangement for the payments to the wife, it does not indicate any intention to change the tax consequences of the original arrangement under the decree. The wife had no apparent reason to believe that she would become taxable on such payments as a result of the changes in the arrangement119 made by the alimony agreement. We need not decide whether the parties may, once they have agreed upon the payment of a principal sum in 641 installments, later change the agreement to provide for the periodic payment of alimony. At least, if they do wish to undertake to change the tax consequences of the original agreement, they must do so clearly so that both the former husband and former wife are aware of what they are doing. In the absence of a clear manifestation of an intention to change the original arrangement so as to achieve different tax consequences, the parties should be required to continue to follow the original arrangement and to adhere to the tax consequences to which they had clearly agreed upon. Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated.↩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.↩3. 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.4. Sec. 71(d) provides in part as follows:(d) Rule for Husband in Case of Transferred Property. -- The husband's gross income does not include amounts received which, under subsection (a), are (1) includible in the gross income of the wife, * *↩5. SEC. 71(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 periodic 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.See also sec. 1.71-1(d)(1) and (2), Income Tax Regs.↩6. For a case which makes the same distinction, see Forest R. Lemasters, T.C. Memo. 1971-47↩, on appeal (C.A. 7, June 16, 1971).7. In fact, Darrell became emancipated upon entering the Armed Forces approximately 13 months before his 21st birthday.↩8. It should be noted that the contingency talked about here differs from the type of contingency talked about in cases dealing with sec. 1.71-1(d) (3), Income Tax Regs. The contingency here referred to may affect the period for payment. The contingency that the regulation is concerned with affects the amount of the award. See Richard T. Daniel, Jr., 56 T.C. 655">56 T.C. 655, 664 (1971), affirmed per curiam 461 F. 2d 1265 (C.A. 5, 1972); William D. Price, Jr., 49 T.C. 676">49 T.C. 676, 682↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623593/	JOHN F. GRAYSON and CAROLINE GRAYSON, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentGrayson v. CommissionerDocket No. 3736-76.United States Tax CourtT.C. Memo 1977-304; 1977 Tax Ct. Memo LEXIS 141; 36 T.C.M. (CCH) 1201; T.C.M. (RIA) 770304; September 7, 1977, Filed John F. Grayson, pro se. Louis T. Conti, 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 $647.19. At trial petitioners conceded the correctness of all of the Commissioner's adjustments to their taxable income in the statutory notice of deficiency except the disallowance of expenses of $2,088.36 incurred in traveling from their residence to Petitioner John F. Grayson's place of employment. FINDINGS OF FACT Some of the facts have been stipulated. The stipulation of facts and exhibits are incorporated by reference. Petitioners, husband and wife, resided at Newark, Delaware, when they filed their petition. Throughout the taxable year 1973 they142 resided in Clayton, New Jersey. Petitioner John F. Grayson (hereinafter referred to as petitioner) was an electrician in 1973 and was employed as such in the construction of a nuclear power generating plant at Artificial Island, New Jersey, some 5 or 6 miles from Salem, New Jersey, or approximately 40 miles from petitioners' residence. During 1973 petitioner drove his automobile to work and carried his tools in the trunk of his automobile.It was necessary for him to carry his tools to work. The busline to Salem is within 100 yards of petitioners' residence which would take petitioner to Salem in 40 to 45 minutes.If petitioner had not had to transport his tools to work, he would have ridden the bus to Salem and "hitchhiked" from Salem to the job site. Hitching a ride to the job site was not difficult as 4,000 to 5,000 people drive between Salem and the job site each day. The busline which ran near petitioners' residence to Salem ran buses each 30 minutes. Petitioner had "hitchhiked" from Salem to the job site on occasion and found it to be satisfactory because many of the workers knew each other. Petitioner and others investigated the possibility of car pooling but abandoned143 the plan as being unsatisfactory. On their income tax return for the taxable year 1973 petitioners deducted $2,088.36 as travel expenses from their residence to the job sites at Artificial Island where petitioner worked. The Commissioner disallowed the deduction without stating any ground therefor in the statutory notice of deficiency. OPINION The issue to be decided in this case is difficult to frame because both parties filed "form briefs," virtually identical to those filed by the parties in Randazzo v. Commissioner, docket No. 4155-76 and respondent's brief is also virtually identical to the brief he filed in Radocy v. Commissioner,T.C. Memo 1977-282">T.C. Memo 1977-282.The issue in this case is factual and filing "form briefs" which do not focus on the evidence presented at trial is fruitless and insulting to the Court. The law is well settled that expenses in commuting from one's residence to his place of employment are generally not deductible. Sec. 262, Internal Revenue Code of 1954, as amended; Commissioner v. Flowers,326 U.S. 465">326 U.S. 465 (1946). The Supreme Court in Fausner v. Commissioner,413 U.S. 838">413 U.S. 838 (1973),*144 has held, however, that the additional cost incurred by a taxpayer who is required to transport his tools to work in excess of what he would spend to travel to work is deductible. Respondent concedes in his "form brief" that if petitioner would have traveled to work using transportation other than his automobile he would be entitled to the deduction he claimed. Instead of addressing his brief to petitioner's testimony, respondent filed a "form brief" which was addressed to contentions not even made by petitioner and respondent did not even comment on petitioner's testimony, much of which was elicited by cross-examination. Petitioner testified unequivocally as to the bus schedule of the busline which ran near his home to Salem and his ability, based on personal experience, to "hitchhike" from Salem to the job site. He testified further that he would travel to and from work in such a manner if it were not for the fact that he had to transport his tools to work. We believe the testimony of petitioner and it comes with respondent's concession. Accordingly, petitioners are entitled to deduct the travel expenses of $2,088.36. Decision will be entered under Rule 155.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623594/	JOHN M. STEVERSON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Steverson v. CommissionerDocket No. 33351.United States Board of Tax Appeals22 B.T.A. 485; 1931 BTA LEXIS 2118; February 28, 1931, Promulgated 2118 The amount of allowable deduction on account of a fire loss determined. William S. Pritchard Esq., for the petitioner. L. W. Creason, Esq., for the respondent. TRAMMELL485 This is a proceeding for the redetermination of a deficiency in income tax for the calendar year 1923 in the amount of $1,928.64. At the hearing the parties stipulated that the petitioner received a salary of $2,500 instead of $5,000 as claimed in the deficiency notice. The petitioner also withdrew an issue with respect to depreciation, leaving as the only question to be decided the amount of any deductible loss with respect to a fire. FINDINGS OF FACT. The petitioner is an individual residing at Birmingham, Ala. In 1923 the petitioner was the owner of a sawmill known as the Hillabee Mill, located about 2 1/2 miles from Hillabee, Ala. On the first of June, 1923, this mill was completely destroyed by fire. At the time of this destruction it had been built about two years. Properties destroyed consisted of two boilers, a Wheelin No. 5 mill, an Atlas engine, a Moore dry kiln, a lumber shed, a barn in which was kept feed, tools and harness, an edger, belts and pulleys, 2119 nine saws, about 15,000 to 20,000 feet of logs, about 30,000 feet of lumber in the dry kiln, and about 34,000 feet of other lumber. 486 The two boilers cost $100 and $700 each, respectively. They had an ordinary life of 30 years. The $700 boiler had been used about three years, the other about two. The Atlas engine cost $400, was about two years old at the time of its destruction and had a 10-year life. One of the saws destroyed cost $175 and the other $185. The edger destroyed cost $400, had been in use 14 months and had a life of at least 10 years. The belts and pulleys cost approximately $600 and were approximately two years old at the time of destruction. The Moore dry kiln was built in 1923 at a cost of $3,500 and its value when destroyed was approximately its cost. The shed over the mill and a log shed destroyed were built with lumber sawed from the petitioner's timber. At least 15,000 feet of logs were destroyed and their cost was $4 per thousand feet, and it cost approximately $8 per thousand to cut and bring them to the mill, making a total cost of $12 per thousand at the mill. Thirty thousand feet of lumber in the dry kiln destroyed cost $17 plus $5 dry2120 kiln cost, or $22 per thousand. About 34,000 feet of lumber destroyed cost $17 per thousand cut into lumber. Depletion has been allowed the petitioner on this lumber at the rate of $4.75 per thousand. The Commissioner disallowed a loss claimed by the petitioner in the amount of $11,575.27 on account of the destruction of the mill, machinery and lumber. OPINION. TRAMMELL: The petitioner is entitled to a deduction on account of the loss by fire of the property set out in the findings of fact based on the cost of such property less depreciation sustained, and with respect to the lumber less the amount of depletion already allowed thereon and less any amounts charged to expense in connection therewith. The respondent contended that there was not sufficient basis as disclosed by the evidence for any deduction on account of the loss above, that is was not shown to what extent the amount claimed has not already been deducted as expenses or otherwise. It is shown, however, what the property cost when acquired and, with respect to certain of the assets, their expected life. With respect, however, to the saws, we have no evidence as to how long they would last when in use and2121 we have evidence only as to the cost of two of them, apparently two of those which were in use. It may well be that saws in use do not last more than two years, for all the record discloses. We have no evidence as to the proper life of the sheds, or their cost. The dry kiln cost $3,500 and there is no evidence that this was built out of lumber from the petitioner's timber, and there is evidence that its value was approximately the same as its cost when new. It is clear, however, that some depreciation was 487 being sustained. We think, however, from the testimony that it had a life of at least 20 years, and having been in use two years, its cost should be reduced in determining the loss to the extent of 5 per cent per year. With respect to all of the lumber and logs destroyed, the cost of the manufactured lumber and that which had gone into the dry kiln should be reduced to the extent of depletion allowed at $4.75 per thousand. Since the logs delivered at the mill cost $8 per thousand, this cost should be reduced as above stated in determining the deductible loss. There is no evidence in the record to indicate whether the cost of placing the logs at the mill and manufacturing2122 and dry-kilning the lumber was deducted as an expense. Without some evidence on the question, we can not determine that it was not deducted as expense. In this state of the record such cost may not be allowed as a loss and the cost of lumber and logs should not be increased by such amounts. With respect to the edger which cost $400 and which had been in use four months when destroyed, there is no direct evidence upon which we could determine the rate of depreciation. We think, however, that this edger had a life of at least 10 years. The two boilers had a life of 30 years. No amount can be allowed with respect to the belts and pulleys because we have no evidence from which we can determine whether they might have lasted two years or longer and we can not say, therefore, that when they were destroyed the petitioner actually lost anything, or that if he did lose anything, the amount thereof. The deficiency should be recomputed upon the basis of the findings of fact and this opinion. Judgment will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623595/	ESTATE OF RALPH E. LENHEIM, DECEASED, WILLIAM R. LENHEIM AND BERNARD J. LENHEIM, EXECUTORS, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentEstate of Lenheim v. CommissionerDocket No. 38464-87United States Tax CourtT.C. Memo 1990-403; 1990 Tax Ct. Memo LEXIS 420; 60 T.C.M. (CCH) 356; T.C.M. (RIA) 90403; August 1, 1990, Filed Decision will be entered under Rule 155. Kenneth E. Mitchell, for the petitioner. Margaret S. Rigg and Bryce A. Kranzthor, for the respondent. GERBER, Judge. GERBERMEMORANDUM FINDINGS OF FACT AND OPINION Respondent determined a deficiency in petitioner's Federal estate tax in the amount of $ 230,803. In his amended answer, respondent asserts an increased estate tax deficiency of $ 384,868. The issues for decision are: 1. Whether, in determining the estate tax imposed under section 2001, 1421 section 2504(c) precludes respondent from valuing certain lifetime gifts made by the decedent at valuations higher than those reported on his gift tax returns; 2. The fair market values, at the date of several gifts, of shares in a family-owned corporation which had been gifted during decedent's lifetime; 3. The fair market value, at death, of the remaining shares decedent owned in the same family-owned corporation; and 4. Whether the family-owned corporation's sale of its subsidiary to decedent's son was a bargain sale resulting in a lifetime gift by decedent. FINDINGS OF FACT The parties' stipulation of facts and exhibits are incorporated by this reference. The decedent, Ralph E. Lenheim, a resident of Alameda County, California, died on April 17, 1984. He was survived by his three sons, William, Bernard, and Steven Lenheim. At the time of the filing of the petition, William and Bernard Lenheim, the estate's executors, each resided in California. At his death, decedent owned 3,372 shares or approximately a 20.8-percent stock interest in Nor Cal Metals, Inc., his family's company. The corporation at that point owned several pieces of commercial real estate and note receivables and was essentially a passive investment company. Previously, the corporation had sold off its stock ownership interests in two other operating companies. Decedent had started the company and over the years had gifted corporation shares to his sons. This case involves a number of decedent's gifts of shares in the family corporation during 1981, 1982, 1983, and 1984. Nor Cal Metals, Inc.Nor Cal Metals, Inc. (Metals), is a California corporation. 422 After incorporation in 1955, Metals conducted a job shop metal fabrication business which decedent had earlier owned and operated as a sole proprietorship. The company's place of business was in Oakland, California, and it served customers throughout the San Francisco Bay area. In 1960, Metals transferred its metal fabrication business to another company in which it held a 50-percent interest, Nor Cal Metals Fabricators, Inc. (Fabricators), which company is more fully described, infra. In addition to its 50-percent interest in Fabricators, Metals has owned various pieces of commercial real estate which it generally leased to tenants on a net lease basis. On April 1, 1982, Metals, concurrent with the sale of its 50-percent interest in Fabricators, purchased an industrial supplies business. The acquired business was transferred to Metals' newly formed, wholly owned subsidiary, Roll Rite, Inc. (New Roll Rite), all of which is more fully described, infra. Since its incorporation, all of Metals' issued and outstanding shares have consisted of a single class of voting common stock. Originally, decedent had owned most of the shares. Over the years he frequently gifted equal amounts 423 of Metals' stock to his three sons. Immediately prior to November 24, 1981, decedent owned 12,702 shares or approximately 65.9 percent of Metals' 19,272 outstanding shares. The remaining shares in the company were owned in equal proportions by his three sons, William, Bernard, and Steven Lenheim. On November 24, 1981, decedent gifted 560 of Metals' shares to each son. On January 4, 1982, he gifted 330 of his shares to each son. Steven Lenheim strongly disagreed with his father's decision during January 1982 to have Metals acquire the industrial supplies business. Steven further felt excluded from the company's management. As a result, Steven demanded that his Metals' shares be redeemed in exchange for $ 368,500. After negotiation, Metals redeemed Steven's 3,080 shares on May 28, 1982. Steven, in exchange, received $ 125,000 cash and a 12-percent interest per annum promissory note in the amount of $ 243,500. Minimum monthly payments of $ 5,416.12 were to be made on this note, beginning July 1, 1982. Following the redemption, Steven received no further gifts of company shares from decedent. Decedent, in his last will dated November 26, 1982, bequeathed his remaining Metals 424 shares to his other two sons, William and Bernard. During January 1983, decedent gifted 330 shares each to William and Bernard. On January 10, 1984, he gifted 3,000 additional shares each to William and Bernard. At death, on April 17, 1984, decedent owned 3,372 shares or approximately 20.8 percent of Metals' 16,192 outstanding shares. As a result of the gifts discussed above, the decedent's and his three sons' stock ownership in Metals on the dates indicated, were as follows: Date Decedent William BernardStevenTotalOutstanding11/24/8111,022(57.1)2,750(14.3)2,750(14.3)2,750(14.3)19,2721/4/8210,032(52.0)3,080(16.0)3,080(16.0)3,080(16.0)19,2725/28/8210,032(62.0)3,080(19.0)3,080(19.0)--16,1921/839,372(58.0)3,410(21.0)3,410(21.0)--16,1921/10/843,372(20.8)6,410(39.6)6,410(39.6)--16,1924/17/843,372(20.8)6,410(39.6)6,410(39.6)--16,192 Under an October 2, 1979, Restrictive Stock Agreement, decedent and his three sons each agreed that any transfers of decedent's Metals' shares during his lifetime or upon his death would generally be restricted. The agreement's stated purpose was to prevent disruption of the company's management and business by avoiding transfers of its stock to outside parties. 425 Prior to the making of any transfer, the company and then the other shareholders, in proportion to their stock holdings, were to have successive options to purchase the subject shares at prices established under the agreement. The agreement specifically excepted any shares which decedent may transfer at death from this successive option arrangement. For lifetime transfers of shares, the Restrictive Stock Agreement provided that the option price was to be based upon the company's net book value per share as determined from its most recent financial statements. For transfers caused by a shareholder's death, the option price was to be derived pro rata from the sum of: (1) The book value of the shares the company held in Fabricators ($ 25,000) and (2) the fair market value of the company's business and other assets (determined assuming such assets were sold for cash within 180 days and with no value allocated to goodwill or trade name). Real Estate Owned by MetalsFrom January 1, 1981, until April 1, 1982, Metals owned improved real property at the following addresses: (1) Third Street, Oakland, California; (2) 2360 Alvarado Street, San Leandro, California; and, (3) 823 Estabrook Street, 426 San Leandro, California. From April 1, 1982, through April 17, 1984, Metals owned the following pieces of improved real estate: (1) 8399 Edgewater Drive, Oakland, California; (2) 2360 Alvarado Street, San Leandro, California; and, (3) 823 Estabrook, San Leandro, California. Previously, Metals had operated its job shop metal fabrication business at the Third Street, Oakland, California, property. Following its 1960 transfer of that business to Fabricators, Metals had leased the Third Street property to Fabricators. On April 1, 1982, in connection with a sale of its 50-percent interest in Fabricators and acquisition of the New Roll Rite business, Metals exchanged the Third Street property for the 8399 Edgewater Drive property. Metals then allowed New Roll Rite, its wholly owned subsidiary, to use the Edgewater property rent-free. During 1982 and 1984, Metals and the Lenheims had the company's real estate appraised. The real estate appraiser determined the properties had the following fair market values on the dates indicated: PropertyDate Market value8399 EdgewaterMay 1982$ 750,000 February 1984950,000 2360 AlvaradoJanuary 1982950,000 February 19841,130,000 823 EstabrookJanuary 1982135,000 February 1984137,500 Third StreetJanuary 1982515,000 During 427 the 1982 negotiations for the disposition of the Third Street property and the acquisition of the Edgewater property, the Lenheims and their representatives had similarly valued the Third Street property at $ 515,000 and the Edgewater property at between $ 700,000 to $ 800,000. Metal's accountant, Earl Cothran (Cothran), assisted Metals in its negotiations to acquire the industrial supplies business and the Edgewater property. He recalled that the Lenheims and their representatives felt the Edgewater property was "surely worth" between $ 700,000 to $ 800,000. They were further convinced that the Roll Rite business had net current assets worth between $ 600,000 to $ 700,000. Thus, they readily agreed to pay the $ 1.5 million price demanded for both the business and the Edgewater property. They believed paying only a $ 1.5 million price would be a "fine deal." Metals would be buying the New Roll Rite business for an amount not much beyond the business's immediate liquidation value. While the April 1, 1982, agreement (under which the Edgewater and the Third Street properties were exchanged) recited that each property was worth $ 515,000, Cothran understood that the Edgewater property 428 was intentionally undervalued for tax reasons. This permitted Metals to allocate more of the overall purchase price to the acquired business's inventory and other depreciable equipment. The 1982 and 1984 appraisals of Metals' real estate do not reflect any discount for certain of the properties being subject to leases paying less than fair market rental value. As to the properties encumbered by existing leases, the remaining lease term, lease rent, and estimated market rent (as contained in appraisal reports) were as follows: RemainingMonthlyEstimatedAppraisalLeaseLeaseMonthlyPropertyDateTermRentMarket Rent2360 AlvaradoJanuary 198235 months$ 5,048$ 9,082February 198410 months5,0489,908823 EstabrookJanuary 198218 months5001,096February 1984 month-to1,0001,206 -month 1121 ThirdJanuary 1982* 56 months2,7005,486StreetFollowing decedent's death, Metals' real estate was sold on the dates indicated for the following cash prices: PropertyDatePurchase Amount8399 Edgewater11/84$ 1,300,0002360 Alvarado5/851,020,000823 Estabrook11/84195,000Fabricators429 Fabricators is a California corporation incorporated by decedent and others on October 27, 1960. Fabricators owned and operated the job shop metal fabrication business previously operated by Metals. Beginning September 1977, and through April 1, 1982, Metals owned 250 shares or a 50-percent interest in Fabricators. The remaining 50-percent interest in Fabricators was held by the Hall family (Will Hall and his three children, Robert, Susan, and Thomas). Fabricators' plant facility and principal place of business was at the Third Street, Oakland, California, property, which it leased from Metals. During 1976 through 1982, the company employed between 55 to 60 people a year. Ten of the employees were engaged in management and sales. From 1965 until June 1981, decedent and Will Hall managed Fabricators' business. Decedent was the company's president and he served primarily as chief estimator and general manager. Will Hall, who was an engineer, served in an engineering and estimating capacity. William Lenheim, decedent's son, joined Fabricators in 1962. He worked for the company in various capacities, eventually moving into management positions. Robert Hall joined the company late 430 in the 1970s. Like his father, Robert Hall had an engineering background. Shortly after joining the company, Robert Hall took an active role in its management. During June 1981, decedent retired from Fabricators and his son William Lenheim was then authorized to vote the Fabricators' stock which was owned by Metals. Metals, the Lenheim family members (decedent and his three sons), and the Hall family members (Will, Robert, Susan, and Thomas Hall) entered into a December 7, 1978, Restated Stock Purchase Agreement. The purpose of the agreement was to ensure that the respective family groups each maintained a 50-percent stock interest in Fabricators and that the Lenheim family members would retain a majority interest in Metals (the company through which the Lenheims held their 50-percent interest in Fabricators) so long as decedent or William Lenheim remained alive and Will or Robert Hall remained alive. The agreement generally restricted all transfers of Fabricators or Metals shares which would result in the Lenheim family members owning less than a majority stock interest in Metals. Before such a transfer could be made, successive options to purchase all of the Fabricators shares 431 held by Metals at the agreement's prescribed option price would exist in favor of the remaining members of the Lenheim family, then in favor of the remaining members of the Hall family and lastly, in favor of Fabricators. The Restated Stock Purchase Agreement, however, did not restrict intra-family gifts or bequests of Fabricators shares between the Hall family members or between the Lenheim family members. The agreement permitted intra-family sales of Fabricators shares between the Hall family members or between the Lenheim family members for amounts which did not exceed the agreement's option price. The agreement also permitted the Lenheims to dissolve Metals, so long as the Fabricators shares owned by Metals were distributed to the Lenheim family members. The Restated Stock Purchase Agreement provided for successive options at a prescribed option price for remaining members of the transferor's family group, members of the other family group, and Fabricators. The agreement also provided that upon a Fabricators shareholder's death, the remaining members of his family group would have the option to purchase his Fabricators shares. In the event such option was not exercised upon 432 death, Fabricators would be obligated to redeem the shares essentially at the option price prescribed in the agreement. Finally, the agreement provided, in certain circumstances, for the mandatory redemption of the Hall and Lenheim members' Fabricators shares. Upon the death of the last to die among Will Hall and Robert Hall, Fabricators would be obligated to purchase, and the Hall family members would be obligated to sell, essentially for the option price established under the agreement, all of the outstanding Fabricators shares held by all members of the Hall family. Similarly, upon the death of the last to die among decedent and William Lenheim, Fabricators would be obligated to purchase, and Metals and the Lenheim family members would be obligated to sell, essentially for the option price established under the agreement, all of the then outstanding Fabricators shares held by Metals and the members of the Lenheim family. The option purchase price for any Fabricators shares was to be based on an annual valuation of the company's shares. The valuation was to be approved by a vote of shareholders holding at least a 66.67-percent interest in Fabricators. This yearly valuation was 433 to be made within a reasonable time after the close of the company's September 30 fiscal year. The option price would be determined from the most recent annual valuation of the company's shares, with an adjustment for any net increases or decreases in the company's book value since that date. Pursuant to the Restated Stock Purchase Agreement, Fabricators' directors and shareholders had unanimously agreed that the company's shares had the following per share values on the dates indicated: DateValue Per ShareSeptember 30, 1979$ 3,500September 30, 19804,000September 30, 19814,200 Early in 1982, after decedent decided Metals should acquire the New Roll Rite business, the Lenheims entered into negotiations to sell Metals' 50-percent interest in Fabricators, along with the Third Street real property, to Will and Robert Hall. On April 1, 1982, Metals sold its interest in Fabricators to Will and Robert Hall for a total of $ 1.1 million. Metals received a $ 500,000 cash down payment and a $ 600,000 promissory note for the balance. The note was personally guaranteed by the Halls and secured with the Halls' Fabricators shares. The note bore annual interest of 12 percent and called for monthly 434 payments of $ 13,346.70 over a 5-year period, commencing May 1, 1982. As part of the transaction, William Lenheim also received a 5-year consulting contract with Fabricators calling for $ 34,000 a year. The Roll Rite Business and New Roll RiteRoll Rite, Inc. (Old Roll Rite), was a California corporation owned and operated by an individual named Carl Christensen. The company owned an industrial supplies business and the Edgewater real property which were acquired by Metals on April 1, 1982. Old Roll Rite was incorporated in 1945. During the times relevant to this case, Old Roll Rite was engaged primarily in the manufacture (through subcontractors), distribution and sale of wheels, casters, hand trucks, and related items. It sold these products primarily to end users of materials handling equipment. It owned numerous patents, as well as the special molds, tooling, and drawings, required to manufacture its products. The company also distributed other lines of wheels and casters produced by other manufacturers. Normally, no customer accounted for more than 5 percent of Old Roll Rite's annual sales and its sales averaged less than $ 500 per order. During 1981, Carl Christensen 435 was suffering from cancer and had been absent from Old Roll Rite for an extended period of time. His wife had never taken an active role in the company's business. In late 1981, Christensen became gravely ill and decided to sell his company. The Christensens and the Lenheims entered into negotiations for the sale of Old Roll Rite's assets, including the Edgewater real property. On April 1, 1982, Christensen's estate and his widow sold Old Roll Rite's assets to Metals for $ 1.5 million. The purchase contract allocated $ 515,000 to the Edgewater property and $ 985,000 to the Old Roll Rite business's other assets (plant equipment, current assets, and other assets, including intangibles and goodwill). The Lenheims and their representatives, however, believed the Edgewater property to be worth from $ 700,000 to $ 800,000. Prior to the sale, the Christensens withdrew approximately $ 100,000 of cash from Old Roll Rite. To facilitate the transaction, Old Roll Rite was liquidated and its assets were then distributed to Christensen's estate and his widow, who in turn transferred the assets to Metals. Metals exchanged its Third Street property for the Edgewater property and purchased the 436 other Old Roll Rite assets for its newly established, wholly owned subsidiary, New Roll Rite. In addition to receiving $ 515,000 cash for the Third Street property, the Christensens received $ 510,000 cash and a $ 475,000 promissory note from Metals. Interest of 12 percent per annum was payable on the note and the note was to be paid in 60 equal monthly installments of $ 5,644.35, followed by a balloon payment of $ 400,334.00 on June 1, 1987. Following the acquisition of the Old Roll Rite business, Metals permitted New Roll Rite to use the Edgewater property rent-free. New Roll Rite, until its sale in January 1984 to decedent's son William, made all payments on the Christensens' promissory note. New Roll Rite paid approximately $ 50,000 per year in interest on the Christensen note. William Lenheim served as New Roll Rite's president and managed its business. In mid-1982, he started an advertising campaign to develop new markets for the company's products. As part of this campaign, the company paid for advertising displays in telephone yellow page directories covering the San Francisco Bay area. He also added an outside sales staff comprised of three to four salesmen. These salesman 437 were furnished with company-owned vehicles, incurred travel expenses, and otherwise added to the company's overhead for items such as insurance and telephone expenses. In 1982 and 1983, William also caused the company to incur other expenditures for new internal accounting systems and a study of New Roll Rite's business by a consulting firm. Bernard Lenheim, decedent's other son, was also employed by New Roll Rite until January 1984, serving as the company's vice president and secretary. He managed the warehouse and coordinated the manufacturing activities of the company's subcontractors. Previous to joining New Roll Rite, Bernard was a self-employed contractor and had also worked at different environmental positions. Bernard was paid a salary of approximately $ 5,000 per month. He received the same salary as his brother, William, the company's president. Immediately prior to New Roll Rite's sale to William, Bernard resigned and was replaced by an individual who was paid $ 2,500 per month. In a sales agreement executed and dated January 17, 1984, but effective as of January 2, 1984, Metals sold all of New Roll Rite's outstanding shares to William Lenheim for $ 300,000. The entire 438 purchase price was payable under a promissory note with interest at 12 percent per annum and equal monthly installments of $ 4,261.51 over a 10-year period beginning February 1, 1984. Metals, effective January 1, 1984, assumed responsibility for the $ 475,000 promissory note to the Christensens. William, as part of the agreement, received up to 18 months of rent-free use of the Edgewater realty. The Edgewater property's fair market rental value was $ 8,000 per month. New Roll Rite had not been generally offered for sale to third parties. At the time of sale, New Roll Rite's fair market value was far in excess of the $ 300,000 price to be paid by William. During 1980 through 1983, Roll Rite's annual sales were between $ 1.5 million to $ 1.6 million. When Metals purchased the Old Roll Rite assets from the Christensens on April 1, 1982, the Lenheims and their representatives believed the acquired business and assets, exclusive of the Edgewater real property, were worth at least $ 698,000. New Roll Rite's balance sheet for the year ending December 31, 1983, reflects total assets of $ 800,334 (including $ 142,468 in cash or cash equivalents and $ 171,475 in net trade receivables) 439 and total liabilities of only $ 95,335, excluding the Christensen promissory note. Pursuant to the stock sales agreement, William was provided with the balance sheet and financial statements concerning New Roll Rite, as of December 31, 1983. Under the agreement, Metals warranted that no material adverse changes in New Roll Rite's financial position had since occurred and that the only changes would be those resulting from the carrying on of normal business operations. Metals also warranted that it had not received dividends or other distributions from New Roll Rite. Decedent's 1981, 1982, 1983, and 1984 Gift Tax Returns and the Estate Tax ReturnEarl Cothran was decedent's accountant. Decedent's 1981, 1982, 1983, and 1984, gift tax returns and the estate tax return were prepared by Cothran's accounting firm, Cothran & Johnson. Additionally, the accounting firm prepared Metals' and New Roll Rite's corporate Federal income tax returns and financial statements. Decedent's gifts of Metals' shares were reported on his 1981, 1982, 1983, and 1984 gift tax returns. On these returns, decedent reported the gifted shares at the following per share values: Gift Tax ReturnReported Value Per Share4th quarter 1981$ 58.371st quarter 198258.37198358.37198471.11Decedent 440 and his wife elected on each return, pursuant to the gift-splitting provisions of section 2513, to treat all gifts as being made one-half by each. Decedent did not report the May 1982 transaction in which Metals redeemed Steven Lenheim's 3,080 shares for a price of $ 120 per share on a 1982 gift tax return. He did not report Metals' January 1984 sale of New Roll Rite to William Lenheim. On the estate tax return, the 3,372 Metals shares owned by decedent at his death were reported to have a value of $ 239,783 or $ 71.11 per share. The Metals shares valuations were based on two appraisals performed by petitioner's valuation expert in August of 1981 and September of 1984. The first valuation concerned all of the company's outstanding shares as of July 24, 1981, and the second the 3,372 shares decedent owned at death. Notice of Deficiency and Respondent's Amended AnswerRespondent, in the notice of deficiency, determined there was a deficiency in petitioners' estate tax in the amount of $ 230,803. The notice of deficiency contained the following explanation: a. It is determined that the fair market value, at the date of decedent's death, of 3372 shares of common stock of * * * Metals 441 * * was $ 120.00 a share, instead of $ 71.11 a share as reported on the estate tax return. Accordingly, the reported value of this stock is increased * * . b. It is determined that the fair market value of all shares of common stock of * * Metals * * * included in the adjusted taxable gifts is $ 120.00 a share, instead of value per share as reported on the gift tax returns. Accordingly, total adjusted taxable gifts is [increased] * * . In determining decedent's total adjusted taxable gifts, respondent generally did not include the one-half of all the gifted Metals' shares and other gifts considered as made by decedent's wife under section 2513. In an amended answer, respondent asserted an increased deficiency in petitioner's estate tax. Respondent claimed that the 6,000 Metals' shares gifted by decedent in January 1984 had a value of $ 147 per share, rather than the value of $ 120 per share determined in the notice of deficiency. Respondent also alleged that the sale of New Roll Rite to William Lenheim constituted a further unreported gift by decedent. Respondent asserted that the company was worth $ 850,000, rather than the $ 300,000 for which it was sold. Valuations Made 442 by the Parties' Experts2Petitioner's and respondent's experts had greatly divergent opinions as to the values of the Metals' shares gifted by decedent and owned at his death. They also gave conflicting opinions on New Roll Rite's value. A. Valuations of Petitioner's Expert1. Valuations of Metals' shares. Petitioner's expert appraised Metals on two occasions, first in August 1981 and again following decedent's death in September 1984. In his first appraisal he opined regarding the value of Metals' 19,272 outstanding shares as of July 24, 1981. This appraisal was requested by the Lenheim family which was contemplating recapitalizing the company and issuing preferred shares to decedent in exchange for his common stock. Petitioner's expert opined that on July 24, 1981, Metals shares had a fair market value of $ 58.37 per share. He valued the company's underlying assets to arrive at his $ 58.37 per share valuation as follows: Metal's investment in Fabricators$ 497,000 Metal's real estate695,000 Metal's cash in excess of operating needs200,000 Company's Adjusted Net Asset Value1,392,000 Company's Net Asset Value1,392,000 Less 19 percent corporate form discount(264,480)Enterprise Fair Market Value1,127,520 Rounded1,125,000 Enterprise Fair Market Value Per Share58.37 (19,272 shares)443 Petitioner's expert did not use any discounts, such as discounts for minority interest and lack of marketability. Petitioner's expert, in his 1981 appraisal, ignored the annual values the Lenheim and the Hall families had placed on Fabricators shares pursuant to their 1978 Restated Stock Purchase Agreement. Additionally, his 1981 appraisal was completed before Metals sold its interest in Fabricators to the Halls for $ 1.1 million in April 1982. Petitioner's expert, at the time he made the 1981 appraisal, knew of the Fabricators stock purchase agreement. Pursuant to the agreement, the Hall and Lenheim families had agreed the Fabricators shares had a $ 4,000 value per share as of September 30, 1980. Petitioner's expert, further, was not a real estate appraiser and had attempted to value Metals' real estate "under protest." In the 1981 appraisal, he valued the company's real estate merely by capitalizing each property's annual lease income. Subsequently, a real estate appraiser hired by Metals during 1982 found that all three properties owned by the company were rented for amounts well below their current market rental values. Petitioner's expert did not adequately justify his corporate 444 form discount or explain how Metal's assets could be worth less to the company and its shareholders merely because the assets were held in corporate solution. In his 1984 appraisal, petitioner's expert opined that the 3,372 Metals' shares decedent owned at death were worth $ 71.11 per share as of April 17, 1984. He valued the company's underlying assets and arrived at his $ 71.11 per share valuation as follows: Metals' current assets and life insurance$ 262,852 Metals' notes receivable605,432 Metals' real estate2,103,971 Company's Total Assets2,972,255 Metals' long term debt(568,226)Metals' other liabilities(209,402)Company's Total Liabilities(777,628)Company's Adjusted Net Asset Value2,194,627 Company's Net Asset Value2,194,627 Less 25 percent corporate form discount(548,657)Enterprise Fair Market Value1,645,970 Rounded1,645,000 Enterprise Fair Market Value Per Share101.59 (16,192 shares)Less 30-percent discount for shares'minority interest status and lack ofmarketability30.48 Fair Market Value Per Share Of 3,372 Shares71.11 Petitioner's expert did not adequately justify the corporate form discount he applied. His 1984 appraisal report covered only the valuation of the 3,372 Metals 445 shares decedent owned at death. At trial, petitioner's expert rendered an opinion as to the fair market values of the Metals shares gifted by decedent. His values for the gifted shares were, as follows: DateEnterprise FMVFMVof GiftEnterprise FMVPer SharePer Share 11/24/81$ 1,188,032$ 61.65$ 43.161/4/821,211,66962.8744.013/29/831,440,16088.9462.261/10/841,597,74098.6769.07His Enterprise Fair Market Values for various dates were based on the values he determined as of July 24, 1981, and April 17, 1984. He used his 1981 Enterprise Fair Market Value figure of $ 1,127,520 as his starting point and added estimated appreciation to the underlying assets. He did not examine the assets held by the company as of the various gift dates. Instead, his figures were derived by prorating, over the 33-month period, the $ 520,000 difference between the values he determined in his 1981 and 1984 appraisals. He did this by assuming that during the 33 months between July 24, 1981, and April 17, 1984, the company's assets appreciated at a constant rate of $ 15,578 per month. 3446 When he performed his 1981 and 1984 appraisals, petitioner's expert was unaware of the 1979 Restrictive Stock Agreement entered into by the Lenheim family members concerning Metals' shares. He also disregarded the $ 120 per share price at which Metals redeemed Steven Lenheim's 3,080 shares in May 1982. His 1984 appraisal report contains the conclusion that Steven received a premium price in order to remove a dissident shareholder. 2. Valuation of New Roll Rite. Petitioner's expert estimated the January 1984 fair market value of New Roll Rite to be in a range from $ 300,000 to $ 415,000 and he selected a value of $ 350,000. He did not render an opinion as to New Roll Rite's 1983 value, 447 but stated the company had a $ 550,000 fair market value in April 1982. Petitioner's expert opined that Roll Rite, on March 31, 1982, had a fair market value of $ 550,000. The $ 550,000 value was reached by valuing the Edgewater real property at $ 950,000 as of March 31, 1982, and noting that Metals on April 1, 1982, had paid a combined price of $ 1.5 million for the business and the real estate. The real estate appraiser hired by Metals appraised the Edgewater property at $ 950,000 as of February 1984. Citing the 1984 appraisal of the property, petitioner's expert incorrectly (and perhaps improperly) relied upon the 1984 appraisal for a 1982 valuation stating that there had "been little movement in commercial real [estate] values in Oakland between March of 1982 and February of 1984." The real estate appraiser relied upon, however, had valued the Edgewater property at $ 750,000 as of May 1982. Petitioner's expert also valued New Roll Rite's assets and liabilities as of December 31, 1983. He concluded that the company had net assets with a fair market value of $ 414,031. No explanation was given regarding the 10-percent discount he applied to receivables or the 33-1/3-percent 448 discount he applied to the inventory. Further, he did not address whether goodwill was attributable to the business or whether it had a going-concern value, even though the company had sales of $ 1,529,139 for the year ending December 31, 1983, and 1984 sales had been projected in the same amount, by Cothran. B. Valuations of Respondent's Expert1. Valuations of Metals shares. Respondent's expert valued the Metals shares decedent gifted in 1983 and 1984, and the 3,372 shares decedent owned at death. He determined they had the following values: SharesValuation DateFMV Per Share6601/1/83 $ 1166,0001/1/84 1473,3724/17/84116In reaching his appraisal, he examined Metals' assets and liabilities on the valuation dates. A summary of respondent's expert's analysis of the Metals shares is attached to this opinion as Appendix A. (We note that some of the arithmetic is incorrect on Appendix A. The differences are insignificant and do not affect our ultimate findings.) Respondent's expert discounted the company's various notes receivable where the interest provided on the individual note was less than the current market rate. He valued the company's various notes payable at amounts essentially 449 equal to the outstanding note balances. He valued the real estate substantially by accepting the appraisals made by the real estate appraiser hired by Metals in 1982 and in 1984. That real estate appraiser determined the company's real estate was worth a total of $ 2,217,500 as of February 1984. Respondent's expert in valuing the real estate as of January 1, 1984, and as of April 17, 1984, reduced the $ 2,217,500 amount to take into account the fact that William Lenheim was permitted to use the Edgewater property rent-free for up to 18 months. The real estate appraiser determined the February 1984 market rental value of the Edgewater property to be $ 8,000 per month. Accordingly, respondent's expert made reductions of $ 144,000 ($ 8,000 X 18 months) in valuing the real estate as of January 1, 1984, and of $ 120,000 ($ 8,000 X 15 months) in valuing the real estate as of April 17, 1984. To determine the value for the real estate as of January 1, 1983, respondent's expert noted that the real estate appraiser had appraised the same individual properties at a total value of $ 1,835,000 as of early 1982, and later at a total value of $ 2,217,500 as of February 1984. He arrived at 450 his $ 2,026,000 value for the real estate by estimating that half of the $ 382,500 increase in value of the real estate would have occurred by January 1983. ($ 1,835,000 + $ 191,250 = $ 2,026,250) Respondent's expert applied a discount of 30 percent for lack of marketability and minority interest in valuing the 660 shares decedent gifted during January 1983. He noted that considered together the two gifts of 330 shares represented about a 4-percent interest in the company. He opined that a shareholder with 4 percent or less of the outstanding stock would have little say in running the company. He further noted that the company, in May 1982, had redeemed all of Steven Lenheim's 3,080 shares, which then represented about a 16-percent interest, for a price of $ 368,500 or approximately $ 120 per share. Respondent's expert concluded Steven had received a cash-equivalent price of about $ 114.50 per share and that the redemption had been at arm's-length. His report included copies of the correspondence between Steven and the company regarding the negotiation of the $ 368,500 redemption price. Respondent's expert also related that he had interviewed the petitioner William Lenheim who 451 confirmed that the same price would have been paid to any similar dissident shareholder and that family relationships played no role whatsoever in the negotiation of the redemption price. In arriving at his $ 114.50 per share cash-equivalent redemption price, respondent's expert discounted the $ 5,416 monthly installments required under the note Steven received by using a 15-percent interest rate. The cash-equivalent price reflected about a 25-percent discount from the net asset value of the company. See note 9, infra. Respondent's expert applied a 15-percent discount for lack of marketability and minority interest in valuing the shares gifted in January 1984 and the 3,372 shares decedent owned at death. He concluded that as of January 1, 1984, there were indications that the Lenheim family intended to dissolve Metals. (For example, New Roll Rite was being sold to William Lenheim. William was planning to devote his full time to that company. He also did not want his brother Bernard to remain with New Roll Rite. With its sale of its subsidiary, Metals would be a passive investment company. Further, following decedent's death, the brothers would have to liquidate the company 452 to pay the estate taxes. Decedent in his will provided that all of the estate taxes were to be paid first from the property left to the two. William and Bernard further acknowledged neither had the cash to pay the estate taxes without selling their Metals' shares.) 2. Valuations of New Roll Rite. Respondent's expert valued the New Roll Rite business enterprise using three methods: (1) A purchase price method; (2) an adjusted book value method; and (3) a capitalization of earnings method. Because the Christensen note was held within New Roll Rite during 1983, the January 1, 1983, values determined by respondent's expert were net of the note. When Metals sold the company to William Lenheim in January 1984, the Christensen note was transferred to Metals, which assumed the note effective January 1, 1984. Respondent's expert rendered opinions for the values of New Roll Rite on January 1, 1984, without considering the note by treating it as a separate liability of Metals. Appendix B to this opinion is respondent's expert's summary of his 1983 and 1984 New Roll Rite values. (We note that the averages computed in Appendix B are off by a small percentage difference, but that has not 453 affected our ultimate findings.) Respondent's expert incorrectly concluded that Metals, on April 1, 1982, paid a cash-equivalent price of $ 933,000 to acquire the New Roll Rite business and assets. He computed the $ 933,000 figure by discounting the $ 985,000 acquisition price for the business stated in the purchase contract. His appraisal report discloses that he was well aware that the purchase contract undervalued the Edgewater property at $ 515,000 and overvalued the Roll Rite business at $ 985,000. He correctly valued the Edgewater property at $ 750,000, not at $ 515,000. In determining the business's 1982 and 1983 earnings, respondent's expert considered the overstated operating expenses resulting from the overvaluation of the acquired depreciable assets. Although he properly adjusted the value of the real estate, he failed to make a corresponding adjustment to the business's value. Metals acquired the business and real property in an arm's-length transaction on April 1, 1982, for a combined stated price of $ 1.5 million, not for a price of $ 1,735,000. While respondent's expert believed that any of the three valuation methods utilized were reasonable, he believed more weight 454 should be given to the value determined under the capitalization of earnings method. He employed this method by examining the annual income and expenses for 1979 through 1983, as reflected in the financial statements of Old Roll Rite and New Roll Rite. He adjusted 1981 and 1982 income for the $ 56,548 inventory write-down taken on Old Roll Rite's 1981 amended tax return, but not otherwise reflected on its or New Roll Rite's financial statements. Appendix C to this opinion contains statements showing respondent's expert's adjusted income figures. Respondent's expert made adjustments to the expenses to properly reflect the business's actual annual earnings. These adjustments involved mostly the elimination of "nonrecurring or excessive items" as follows: (1) Eliminating the interest paid by New Roll Rite in 1982 and 1983 on the Christensen note; (2) eliminating the excessive compensation paid to Carl Christensen and his wife by Old Roll Rite in 1979, 1980, and 1981; (3) eliminating the excessive compensation paid to Bernard Lenheim by New Roll Rite in 1982 and 1983; (4) eliminating the one-time 1982 and 1983 advertising and promotional expenses incurred by New Roll Rite; (5) eliminating 455 the excessive depreciation resulting from the April 1, 1982, contract's overvaluation of the business; (6) eliminating the additional overhead expenses attributable to New Roll Rite's hiring of new outside salesmen in 1982 and 1983; (7) eliminating the 1983 expenses of Metals paid by New Roll Rite; (8) eliminating the expenses incurred in 1982 and 1983 by New Roll Rite for establishing new internal accounting systems, recruiting new salesman and commissioning a study of its business; and (9) adding the estimated economic rent which the business would incur to lease suitable facilities. Appendix D, attached to this opinion, is a schedule of respondent's expert's adjustments and adjusted earnings for the business. Respondent's expert noted that, during 1979 through 1981, the annual compensation paid Carl Christensen and his wife exceeded $ 150,000 per year, thereby reducing the corporation's taxable income to about $ 100,000. Mrs. Christensen was not actively involved in the company's business and respondent's expert was of the opinion that she should not have drawn any salary. He also thought that Carl Christensen's annual salary should have been $ 75,000 to $ 100,000, depending 456 on the business's profits for the year. Respondent's expert noted that Bernard Lenheim had no prior experience in the manufacturing or distribution of wheels and casters. Nevertheless, Bernard drew approximately $ 5,000 per month salary, similar to his brother William, New Roll Rite's president. After New Roll Rite was sold to William, Bernard was replaced by an individual who was paid $ 2,500 per month. Respondent's expert thought Bernard was overpaid and that his salary should have been $ 2,500 per year. He also noted that in 1982 and 1983, New Roll Rite engaged in a costly but unproductive advertising campaign to increase sales. The campaign did not measurably improve sales and was being scaled down by the end of 1983. In contrast, Old Roll Rite's advertising expenses never exceeded $ 11,000 per year. Respondent's expert thought that advertising expenses in 1982 and 1983 should not have exceeded $ 25,000 per year. Similarly, during 1982 and 1983, New Roll Rite incurred substantial additional overhead expenses related to its hiring of new salesmen. These salesmen were provided with new, company-owned cars, incurred travel and auto expenses, and otherwise added to other overhead 457 expenses, such as for insurance and telephone. By the end of 1983, New Roll Rite's management decided to cut back its sales force to reduce these expenses. The elimination of these salesmen would have saved the company $ 50,000 of overhead per year during 1982 and 1983. New Roll Rite incurred substantial expenses related to its purchase of the business, including new accounting systems and a study of the business by a consulting firm. Also, during the first 3 months of 1982, Old Roll Rite incurred an additional $ 29,000 in professional expenses related to the April 1, 1982 sale of its business. Respondent's expert was of the opinion that these items were also one-time, nonrecurring expenses and should not be considered part of the business's normal, ongoing operating expenses. Finally, respondent's expert noted that neither Old Roll Rite nor New Roll Rite paid any rent for occupying the Edgewater property. William Lenheim advised that no more than 8,000 to 10,000 square feet of the approximately 16,000-square-foot Edgewater facility was needed to operate the business. Based on the February 1984 appraisal of the Edgewater property's rental value, he estimated that a market rent 458 of $ 42,000 per year would be incurred to lease a 10,000-square-foot facility. Respondent's expert, after determining his adjusted earnings for the business during 1979 through 1983, calculated that the business, during this 5-year period, produced average before-tax yearly earnings of $ 195,000. He then selected a 25-percent capitalization factor and arrived at a value of $ 780,000 for the business. To the $ 780,000, he added $ 63,000, the economic benefit of 18 months of rent-free use William was permitted on the Edgewater property. Respondent's expert concluded that, under a capitalization of earnings approach, the business enterprise was worth $ 843,000 as of January 1, 1984. Respondent's expert made a number of observations in selecting his 25-percent capitalization factor. He observed that the business's sales and gross profits remained stable during the 1979 through 1983 period. While net profits fluctuated greatly due to uncontrolled overhead expenses, the business's sales and gross profits from year to year did not vary significantly. He also noted that this stability is reflective of the industry. Purchases of casters, wheels, and materials handling equipment, are 459 routine, as opposed to major expenditures for the industry's typical customers. These customers usually purchase such equipment on a periodic basis. The growth potential of the Roll Rite business was rather limited. Over the 5-year period from 1979 through 1983, sales and gross profits did not grow but remained stable. The market in the San Francisco area was highly competitive and other competitors were either larger or financially stronger. Despite this competition, the Roll Rite business had significant competitive advantages. The company (Old Roll Rite and later New Roll Rite) owned certain product distribution rights, patents and product drawings. It had a recognized name and logo and customer records and lists. Overall, it had a good reputation for offering quality products and the company was generally in strong financial condition during the 5-year period from 1979 through 1983. Current assets usually exceeded current liabilities by at least a 5-to-1 ratio. Aside from the Christensen note, the enterprise was basically free of any other debt. Respondent's expert observed that New Roll Rite's management possessed no experience in the materials handling industry. William 460 Lenheim, its president, was learning the business and had made some costly mistakes. Petitioner's Request to Bar The Revaluation of Decedent's Lifetime TransfersAt the time of trial, petitioner moved to bar respondent from revaluing decedent's 1981, 1982, 1983, and 1984 gifts of Metals shares and from claiming that the sale of New Roll Rite to William Lenheim constituted an unreported gift. Petitioner asserted that this Court lacks jurisdiction 4461 to consider such lifetime transfers because the notice of deficiency in this case pertains solely to estate tax. Petitioner alleged that the general 3-year period under section 6501(a) for assessing a deficiency in gift tax for each of the years 1981, 1982, 1983, and 1984 had run. Petitioner maintains that the values placed on the gifts in decedent's gift tax returns are binding on respondent. Petitioner sought to restrict the evidence admitted at trial to that concerning the value of the 3,372 Metals shares decedent owned at death. On December 8, 1988, this Court denied the motion. OPINION We consider here the values of a number of gifts made by the decedent during his life and the value of the remaining shares in a family-owned corporation at the time of his death. These issues all pertain to petitioner's estate tax liability. Preliminarily, we note that this Court has subject-matter jurisdiction over the valuation of the post-1976 lifetime gift transfers made by decedent. Section 2001 imposes an estate tax on the estate of every decedent who is a citizen or resident of the United States. Section 2001(b) prescribes how this tax is to be computed. In determining the amount of tax, decedent's post-1976 lifetime gift transfers must be considered. 5462 While petitioner also disputes the valuations asserted by respondent, its primary position is that section 2504(c) precludes respondent from revaluing any of the decedent's post-1976 transfers. Since we must reach the valuation of the decedent's various lifetime transfers only if section 2504(c) is inapplicable, we will first address the parties' arguments concerning the effect of that provision on petitioner's estate tax liability. I. Effect of Section 2504(c) on Estate TaxSection 2001, which imposes the estate tax, is contained, along with other substantive estate tax provisions, in Chapter 11 of the Internal Revenue Code. Section 463 2504(c), however, is contained in Chapter 12, Gift Tax. 6 Petitioner contends that section 2504(c) 7464 is incorporated by reference into the section 2001(b) definition of the term "adjusted taxable gifts." Petitioner argues that since the decedent's post-1976 transfers are determined from the total amount of the taxable gifts he had made since December 31, 1976, within the meaning of section 2503, a gift tax provision, the gift tax valuation rule of section 2504(c) is applicable. Petitioner relies heavily on a decision by the United States District Court for the Western District of Missouri, Boatmen's First National Bank v. United States, 705 F. Supp. 1407 (W.D. Mo. 1988), wherein section 2504(c) was applied for estate tax purposes. Respondent, on the other hand, contends that the Federal District Court in Boatmen's First National Bank v. United States, supra, reached the wrong result. Respondent argues that section 2504(c), though applicable for gift tax purposes, has no effect with respect to the estate tax. Respondent contends that the express language of section 2504(c) does preclude revaluation of the prior gifts, but only for purposes of changing the gift tax. In a recent Court-reviewed opinion we addressed the identical issue raised here. Estate of Smith v. Commissioner, 94 T.C. (June 13, 1990). 465 In Smith we held that the bar of section 2504(c) was not applicable with respect to post-1976 gifts which are considered as part of adjusted taxable gifts under section 2001. Although we decided that the limitation of section 2504(c) did not preclude revaluation of the adjusted taxable gifts under section 2001(b)(1)(B) for estate purposes, we further held that the gift tax payable on such gifts under section 2001(b)(2) was to be adjusted in conformity with any increase in value. Accordingly, we agree with respondent other than with respect to the adjustment under section 2001(b)(2). II. Valuation of Metals' Shares Gifted by Decedent and Owned at DeathWe now proceed to consider the value of the gifted shares for purposes of determining the estate tax liability. The parties' valuations are far apart for the Metals shares decedent gifted in 1981, 1982, 1983, and 1984, and for those which he owned at the time of his death. In determining decedent's post-1976 lifetime transfers, each of the gifts of shares is to be valued at its fair market value on the date gifted. Sec. 2512. The 3,372 shares decedent owned at death are to be valued at their fair market value as of April 17, 1984, 466 the date of death. Sec. 2031; sec. 20.2031-1(b), Estate Tax Regs. Fair market value is the price at which property would change hands between a willing seller and a willing buyer, neither party being under any compulsion to buy or sell and both having reasonable knowledge of the relevant facts. United States v. Cartwright, 411 U.S. 546">411 U.S. 546, 550-551 (1973). The shares of Metals stock were previously reported on decedent's gift tax returns and the estate tax return at the following values: DateReported Value Per Share11/24/81$ 581/4/82581/83581/84714/17/8471 We have set forth in detail in our findings information about the opinions rendered by each party's expert. Petitioner's expert opined that the shares in issue had the following values: DateFMV Per Share11/24/81$ 43.161/4/8244.013/29/8362.261/10/8469.074/17/8471.11Respondent, on the other hand, contends the Metals shares had the following values: DateFMV Per Share11/24/81$ 1091/4/821091/831161/841474/17/84116Respondent's expert did not value the shares gifted in 1981 and 1982. 8467 A. Effect of 1979 Restrictive Stock Agreement on Values. Petitioner concedes the Restrictive Stock Agreement has no effect on the valuation of the 3,372 shares decedent owned at the time of death. The shares owned by decedent at death were expressly excluded from the agreement's coverage. Petitioner, however, contends that the restrictive agreement did have the effect of depressing the values of 468 the gifted shares. Petitioner does not contend that the agreement option price fixes the value of the gifted shares. Rather, it contends that the existence of the agreement, because of the options which it provided in the event a shareholder wished to transfer his shares, should be considered in determining values for the gifted shares. Respondent contends that the terms of the agreement had been ignored or waived on past occasions and were not, in any event, legally enforceable at the time the shares were gifted. Respondent further contends that the agreement had a tax avoidance purpose and should be disregarded in valuing the gifted shares. We agree with respondent that the Restrictive Stock Agreement concerning Metals' shares had been abandoned and was not enforceable by the time the gifts in issue were made. There is no indication that decedent, prior to making the gifts, had ever first offered the gifted shares to Metals, as was required in the restrictive agreement. Petitioner's expert testified he was not aware of the agreement when he performed both his 1981 and 1984 appraisals. In contrast, at the time he rendered the 1981 appraisal, he knew of the Restated Stock Purchase 469 Agreement between the Hall and the Lenheim families concerning Fabricators shares. If the Restrictive Stock Agreement on Metals' shares had still been in effect, the Lenheims or their representatives would likely have apprised petitioner's expert of the agreement's existence. Decedent also reported the gifted shares at values which also show the agreement no longer had any effect. Decedent, on his gift tax returns, accepted the values determined in the appraisals made by petitioner's expert who did not consider the restrictive agreement. The values placed on the 1981 and 1982 gifted shares greatly exceeded the shares' pro rata book value. The book value per share as of December 31, 1980, was $ 27.37; the book value per share as of December 31, 1981, was $ 28.36. Finally, the agreement did not appear to be considered when all of Steven Lenheim's shares in the company were redeemed in May 1982. Upon receiving Steven Lenheim's April 3, 1982, demand to have his Metals' shares redeemed, the remaining Lenheim family members retained an attorney to negotiate on their behalf with Steven. This attorney was a longtime friend of the decedent and was familiar with Metals' and decedent's 470 business affairs. The parties introduced into evidence the correspondence between Steven and the attorney concerning the redemption price to be paid. While Steven testified that the restrictive stock agreement was a legal impediment to him, there is no reference to the agreement by him or the attorney in their correspondence. The agreement, from all appearances, had no impact on the price Steven received. Steven initially demanded $ 368,500 for his shares. The other Lenheim family members, through the attorney, then made a counter offer of $ 350,000, but later agreed to the price demanded in the amount of $ 368,500. 9471 The Lenheims and their representatives, as of the times the gifts in issue were made, did not treat the agreement as though it was binding. Cf. Estate of Obering v. Commissioner, T.C. Memo. 1984-407.472 Accordingly, a willing buyer and a willing seller would have given little weight, if any, to the restrictive agreement. B. Metals' Shares Gifted in 1981 and 1982Because respondent's expert did not value the Metals' shares gifted in 1981 and 1982, petitioner argues that this Court must accept the values for the shares rendered by its expert. As trier of fact, we are not bound by an expert's opinion. Based on the other evidence in the record, we may reject an expert's testimony either entirely or in part. Commissioner v. Estate of Williams, 256 F.2d 152">256 F.2d 152 (5th Cir. 1958); Estate of Fitts v. Commissioner, 237 F.2d 729">237 F.2d 729 (8th Cir. 1956). There were a number of shortcomings in petitioner's expert's valuations of the Metals shares. We find his valuations to be seriously flawed and entitled to little weight. In his appraisals, petitioner's expert made incorrect assumptions and ignored highly relevant information concerning the properties valued. The $ 58.37 per share value he assigned to Metals' shares as of July 24, 1981, is unrealistically low. In his 1981 appraisal, he determined Metals' 50-percent stock interest in Fabricators was worth only $ 497,000 or approximately $ 1,988 per 473 share. While he testified he had been aware of the Restated Stock Purchase Agreement between the Lenheims and the Halls concerning Fabricators shares, petitioner's expert ignored the $ 4,000 per share value the Halls and the Lenheims themselves had placed on the shares as of September 30, 1980. Decedent, William Lenheim, Will Hall, and Robert Hall were intimately familiar with Fabricators and its business. All four were or had been officers and full time employees of Fabricators. Decedent, until his retirement in June 1981, had been Fabricators' president and had managed its day-to-day operations. Decedent and Will Hall had been jointly engaged in running Fabricators since the early 1960s. In annually valuing Fabricators shares for purposes of establishing the stock agreement's option price, both the Halls and the Lenheims were at arm's length and compelled to fairly value the shares. Upon the death of the last survivor of Will and Robert Hall, all of the Fabricators shares held by the Hall family would be redeemed at essentially the last agreed annual price. Similarly, upon the death of the last survivor of decedent and William Lenheim, all of the Fabricators shares held by the 474 Lenheim family or Metals would be redeemed at the same price. Another test and confirmation of the annual valuations of Fabricators shares is to be found in the Lenheims' subsequent sale of Metals' Fabricators shares to the Halls. Pursuant to the stock agreement, both families had agreed the shares were worth $ 4,200 per share as of September 30, 1981. Four thousand two hundred dollars per share was the stated price at which Metals sold its 250 Fabricators shares to the Halls on April 1, 1982. This transaction was an arm's-length sale between unrelated parties. As such, it constitutes highly probative evidence of the value of Metals' stock interest in Fabricators. In his 1981 appraisal, petitioner's expert also undervalued the real estate Metals owned in 1981. He had no expertise in appraising real property and attempted to value the properties. His valuation of Metals' real properties was achieved by capitalizing the annual lease income from the property. A real estate appraiser hired by Metals in 1982 determined that all the properties had been leased for a rent far below their fair rental values. Petitioner's expert did not adequately justify his use of a "corporate form" 475 discount. At trial, he testified such a discount was warranted because the tax deductions generated in the business's operations would not flow through to the shareholders. He also stated that the corporation could not sell its business or assets without the incidence of income tax. Upon cross-examination, he could not cite any principles of valuation for such a discount. In our view, the reasons petitioner's expert gave are inappropriate. Metals and Fabricators were successful, going enterprises. In 1981, there was little prospect either company would be liquidated. If Metals and Fabricators are valued as going concerns, the mere fact that each is a corporation does not diminish the value of the assets it owns. Petitioner's expert did not value Metals' underlying assets on the dates the shares were gifted. He instead relied on his previously determined enterprise values for the company on July 24, 1981, and on April 17, 1984. He derived his enterprise values for the company on the dates of gift by using July 24, 1981, enterprise values as his starting point. He calculated the amount by which his April 17, 1984, value exceeded his July 24, 1981, value. He then prorated this 476 difference to increase his enterprise value for the latter date covering the periods from July 24, 1981, and April 17, 1984. His enterprise values on the dates of gift were thus based on his July 24, 1981, figure and mechanically prorated increases. We find petitioner's expert's valuations to be well below the value of shares on each date shares were gifted. We do not accept the enterprise value petitioner's expert determined for Metals as of July 24, 1981. As discussed above, his 1981 appraisal was flawed. His value is much lower than the company's actual value on that date. Petitioner's expert's April 17, 1984, value is also too low because of his unjustified corporate form discount. We also note that Metals sold New Roll Rite in January 1984 for well below its then fair market value. The proper effect of this bargain sale on the date of gift was not taken into account by petitioner's expert. This is yet another shortcoming of his approach. We reject petitioner's expert's values for the shares gifted in 1981 and 1982. As of November 24, 1981, we find the 560 shares decedent gifted to each of his three sons had a fair market value of a $ 100.98 per share. We find the 330 shares 477 decedent gifted to each son on January 4, 1982, had a fair market value of $ 100.98 per share. We have reached these values after examining Metals' assets and liabilities as disclosed in the company's balance sheet for the year ending December 31, 1981. Appendix E to this opinion contains a copy of this balance sheet. We have valued the company's stock interest in Fabricators at $ 1.05 million, its real estate at $ 1.4 million, and its remaining net assets at $ 330,110 (using the book values at which its remaining assets and liabilities are listed on the company's balance sheet). In valuing the real estate, we have utilized the valuations of the properties made by the real estate appraiser hired by Metals. We have, however, discounted the appraiser's values to take into account the fact the properties were subject to leases paying well below each property's fair rental value. We thus determined the net asset value per share as of November 24, 1981, was about $ 144.26. Similarly, we determined the net asset value per share as of January 4, 1982, was also about $ 144.26. In valuing the gifted shares, we applied a 30-percent discount because of the shares' minority interest status 478 and lack of marketability. C. Values of Metals' Shares Gifted in 1983 and 1984As explained above, we rejected petitioner's expert's valuations of the Metals' shares gifted in 1981 and 1982. His 1983 and 1984 valuations are also flawed. The enterprise value figures he used do not reflect the net asset values on the dates the shares were gifted. While petitioner's expert also valued New Roll Rite, we reject his valuations of that company for the reasons stated in our findings. Among other things, he incorrectly claimed Metals had paid $ 550,000 for the New Roll Rite business in 1982. Respondent's expert, in valuing the shares gifted in 1983 and 1984, thoroughly examined Metals' assets and liabilities on the pertinent dates. His valuation of the company real estate must be adjusted to reflect the less than fair rentals of two of the properties. Concerning respondent's expert's valuation for New Roll Rite, we do not accept his figure. When Metals acquired New Roll Rite's assets in April of 1982, it paid a cash-equivalent price of $ 698,000 for the assets, not the $ 933,000 determined by respondent's expert. 10479 While he used three methods to value New Roll Rite, respondent's expert stated that 480 any of the methods would produce a reasonable value for the company. In fact, his $ 780,000 value for the company under the earnings method does not greatly exceed the $ 698,000 cash-equivalent price which Metals previously paid to acquire the Roll Rite business in April 1982. We find that New Roll Rite, excluding the Christensen note, had a fair market value of $ 698,000 as of both January 1, 1983, and January 1, 1984. The company on these dates had a value equal to what Metals had originally paid in April 1982. We find the Metals' shares gifted in January 1983 had a fair market value of a $ 105.40 per share. We have accepted most of respondent's expert's values for Metals' various assets and liabilities. We have reduced his value for the company real estate to $ 1,974,000 to take into account the below-market leases to which the Alvarado and Estabrook properties were subject. New Roll Rite, exclusive of the Christensen note, we value at $ 698,000. We also find the value of the Christensen note to be $ 456,388, which is the remaining balance Metals owed on the note as of December 31, 1983. 11 We decided that Metals, as of January 1983, had net assets worth $ 2,438,140 . Since 481 16,192 shares were outstanding, the net asset value per share would be $ 150.58. We further applied a 30-percent discount because of the gifted shares' minority status and lack of marketability. This is the same discount used by both experts. We find the Metals' shares gifted in January 1984 had a fair market value of $ 127.12 per share. In valuing the company's assets and liabilities, we have accepted most of respondent's expert's valuations. We have, however, valued the company's real estate at $ 2,163,500. We disagree with respondent's expert's $ 144,000 reduction to the value of the Edgewater property. William Lenheim received up to 18 months rent-free use of that property in connection with his purchase of New Roll Rite. Metals' sale of New Roll Rite did not occur until January 17, 1984. That bargain sale transaction represented 482 a January 17, 1984, gift by Metals' other shareholders to William. It should not affect the valuation of the shares decedent gave on January 10, 1984. In valuing the real estate, we have taken into account the below market lease on the Alvarado property. No reduction is required for the lease on the Estabrook property. The record indicates that property after June 1983 was being rented on a month-to-month basis. The $ 1,000 monthly rent charged was not far below the property's estimated $ 1,206 monthly market rental value. We have also decided the value of New Roll Rite, exclusive of the Christensen note, at $ 698,000. We decide that Metals, as of early January 1984, had net assets of $ 2,744,385. This is a net asset value per share of about $ 169.49. We applied a discount of 25 percent because of the gifted shares' minority interest status and lack of marketability. Respondent's expert used a discount of 15 percent and petitioner's expert used a discount of 30 percent. We find that a discount of 25 percent is appropriate. After completion of its sale of New Roll Rite, Metals would essentially be a passive investment company. The company would no longer have any ownership 483 interest in or be an operating business. Respondent in his amended answer alleged the 1984 gifted shares had a value of $ 147 per share and claimed an increased deficiency in estate tax. He had the burden of showing the shares' value exceeded the $ 120 per share value determined in the notice of deficiency. Rule 142(b). We have reached a $ 127.12 per share valuation for the 1984 gifted shares based upon all the evidence available in the record. D. Metals' Shares Decedent Owned at DeathWe find the Metals' shares decedent owned at his death had a fair market value of $ 108.59 per share as of April 17, 1984. We have accepted respondent's expert's values for the company's assets and liabilities, except for modifying his value for the company real estate. We found the real estate value to be $ 2,082,500 because of the below market lease on the Alvarado property. At decedent's death, Metals had net assets worth $ 2,197,971. The company's net asset value per share as of April 17, 1984, is $ 135.74. We then applied a discount of 20 percent to take into account the shares' minority interest status and lack of marketability. Respondent's expert used a discount of 15 percent; petitioner's 484 expert used a discount of 30 percent. We find a discount of 20 percent to be appropriate. III. Bargain Sale of Roll RiteIn his amended answer, respondent alleged New Roll Rite was sold to decedent's son William Lenheim for less than its fair market value and that the sale constituted an unreported gift by decedent. Since respondent is seeking an increased deficiency, he bears the burden of proof. Rule 142(b). Respondent has met his burden of showing the sale was not made for full and adequate consideration in money or money's worth. See sec. 25.2512-8, Gift Tax Regs. We have found New Roll Rite's fair market value at the time of its January 1984 sale greatly exceeded the price paid by decedent's son. As previously found, New Roll Rite in January of 1984 had a fair market value of $ 698,000. While the company was worth $ 698,000, William Lenheim paid a stated price of only $ 300,000. Moreover, Metals received a note payable over 5 years, secured by New Roll Rite's stock and no cash down payment from William. New Roll Rite's cash and receivables alone exceeded the $ 300,000 stated purchase price. New Roll Rite's other assets included sizeable inventories and a business which 485 had annual sales over the prior 4 years of $ 1.5 million to $ 1.6 million. Petitioner, nevertheless, argues that the sale was for full and adequate consideration in money or money's worth. In so doing, it relies on the "ordinary course of business" exception provided in section 25.2512-8, Gift Tax Regs. 12 We reject this contention. The record in this case reflects that during the last 2-1/2 years before his death, decedent was engaged in transferring 486 major portions of his estate to his sons. There was also a likely donative motive for the 1984 bargain sale of New Roll Rite to William Lenheim. Of decedent's three sons, William had been the one most involved in managing the decedent's business interests. William Lenheim had been an employee of decedent's other company, Fabricators, since 1962. He had worked his way up to a management position within that company. Following decedent's retirement from Fabricators, William was given the authority to vote the Fabricators stock held by Metals. When Metals sold its interest in Fabricators and acquired New Roll Rite, William became New Roll Rite's president. New Roll Rite had not been offered for sale to a third party. The $ 300,000 stated purchase price did not even represent one-half of the company's actual value. The sale was not a transaction made "in the ordinary course of business" within the meaning of section 25.2512-8, Gift Tax Regs. Kincaid v. United States, 682 F.2d 1220">682 F.2d 1220 (5th Cir. 1982). We must now decide the amount of the taxable gift which is attributable to this transaction. Where a corporation makes a gift to an individual, the company's shareholders are the ones 487 deemed to have made the gift. This rule is modified where the recipient is himself a shareholder, because he cannot be considered to have made a gift to himself. The transfer can be considered a gift from the other shareholders, but only to the extent it exceeds his own interest amount as a shareholder. Sec. 25.2511-1(h)(1), Gift Tax Regs. Respondent, on brief, concedes that the gift attributable to decedent from the transaction is tied to decedent's stock ownership interest in Metals as of the date New Roll Rite was sold. Respondent, however, argues that the sale actually took place on January 2, 1984, prior to the date decedent gave an additional 6,000 Metals' shares to his two sons. We disagree. Metals by then may have decided it would sell New Roll Rite to William Lenheim. It may also have been engaged in preparing to make such a sale. Such preparations would have included the drafting of the written stock sales agreement and the furnishing to William of New Roll Rite's financial statements as of December 31, 1983. An executory agreement to sell, however, is not a sale. Armstrong v. Commissioner, 6 T.C. 1166">6 T.C. 1166, 1173-1174 (1946), affd. 162 F.2d 199">162 F.2d 199 (3d Cir. 1947).Moreover, 488 the contract document between William and Metals was executed at the transaction's closing on January 17, 1984. While the January 17, 1984, contract states New Roll Rite's sale would be treated as if effected on January 2, 1984, no sale for tax purposes occurred until January 17, 1984. The benefits and burdens of ownership did not pass to William until January 17, 1984, and we so hold. New Roll Rite had a fair market value of $ 698,000 on the date it was sold. We further accept respondent's expert's $ 238,000 valuation of the promissory note William Lenheim gave. Decedent owned approximately a 20.8-percent stock interest in Metals on January 17, 1984. We find decedent, as a result of Metals' bargain sale of New Roll Rite, made a gift to his son William in the amount of $ 95,680 (i.e., ($ 698,000 - $ 238,000) x .208). On their 1981, 1982, 1983, and 1984 gift tax returns, decedent and his wife elected, pursuant to section 2513, to treat all gifts made by them to others in each taxable period as made one-half by each spouse. The estate tax owed by petitioner is to be determined based on decedent and his spouse's elections of this gift-splitting treatment. Cf. sec. 2001(e). See 489 S. Rept. 95-745, at 89 (1978). Decision will be entered under Rule 155. APPENDIX ASchedule 4 (Revised 12-2-88) NDR-CAL METALS, INC.Stock Valuation Summary Effective DateJanuary 1, 1983Gift Date March 29, 1983Book Value12/31/82FMVNoteAssets (Unconsolidated)ACash & Equivalents$ 230,014$ 230,014Accounts Receivable, net294294Other Current Assets9,0179,017Land, Bldgs, net179,7312,026,000CNote Rec.-Fabricators539,127508,000E ,IStock - Roll-Rite401,836445,000FNote Rec.-W. Lenheim--Cash Value - Life Ins.48,00048,000Tax Benefits2,352-Total Assets$ 1,410,372$ 3,266,325RLiabilitiesNote Pay - S. Lenheim$ 225,157$ 225,157Note Pay - Christensen--Deferred Income Taxes139,535133,000GAccrued Taxes & Other214,640214,640Total Liabilities579,332572,797Equity (16,192 Shares)$ 831,040$ 2,693,528RPro rata Value/Share$ 51$ 166RDiscount Factor:Minority Int. + Illiquidityx .7030%Fair Market Value/Share$ 116Rx No. of Sharesx 6604%FMV of Block (rounded)$ 77,000REffective Date January 1, 1984Gift DateJanuary 10, 1984Book Value12/31/83FMVNoteAssets (Unconsolidated)ACash & Equivalents$ 112,787$ 112,787Accounts Receivable, net--Other Current Assets90,40990,409Land, Bldgs, net166,1472,073,500C ,HNote Rec.-Fabricators438,232418,00E ,IStock - Roll-Rite262,314850,000FNote Rec.-W. Lenheim--Cash Value - Life Ins.50,50050,500Tax Benefits2,489-Total Assets$ 1,122,879$ 3,594,698LiabilitiesNote Pay - S. Lenheim$ 185,018$ 185,018Note Pay - Christensen-455,307Deferred Income Taxes155,531148,000Accrued Taxes & Other486486Total Liabilities341,035788,811Equity (16,192 Shares)$ 781,844$ 2,806,885Pro rata Value/Share$ 48$ 173Discount Factor:Minority Int. + Illiquidityx .8515%Fair Market Value/Share$ 147x No. of Sharesx 6,00037%FMV of Block (rounded)$ 882,000Effective DateApril 17, 1984Gift DateBook Value3/31/84FMVNoteAssets (Unconsolidated)BCash & Equivalents$ 130,655$ 130,655Accounts Receivable, net3,0303,030Other Current Assets80,91480,914Land, Bldgs, net162,6582,097,500C ,HNote Rec.-Fabricators411,069393,000E ,IStock - Roll-Rite--Note Rec.-W. Lenheim297,484234,000E ,DCash Value - Life Ins.50,50050,500Tax Benefits2,489-Total Assets$ 1,138,780$ 2,989,599LiabilitiesNote Pay - S. Lenheim$ 174,211$ 174,211Note Pay - Christensen452,000452,000Deferred Income Taxes149,917149,917Accrued Taxes & Other1,5001,500Total Liabilities777,628777,628Equity (16,192 Shares)$ 361,152$ 2,212,971RPro rata Value/Share$ 22$ 137Discount Factor:Minority Int. + Illiquidityx .8515%Fair Market Value/Share$ 116x No. of Sharesx 3,37221%FMV of Block (rounded)$ 391,000490 APPENDIX BSchedule 5(Revised 11/22/88) ROLL RITE CORPORATIONValuation SummaryAs of As of January 1,January 1, 1984 A 1983 B 1. Cash-Equivalent Purchase Price, April 1, 1982$ 933,000$ 510,0002. Adjusted Book Value Method.A. Book Value of Equity, 1/1/84$ 723,000$ 402,000B. Add Value of Accrued Income Tax Benefits(1) NOL: $ 209,000 and $ 80,000 (at 40% and 30%)84,00024,000(2) ITC: $ 19,000 (Amended 1983 Metals tax return)19,00019,000C. Add Value of Free Rent for 18 months:$ 3,500/mo. x 18 mos.63,000-D. Indicated Value of Roll Rite$ 889,000$ 445,0003. Capitalization of Earnings Method:A. Capitalized Adjusted Earnings (Schedule 4)$ 780,000$ 483,000B. Add Free Economic Rent,(at $ 3,500/mo. x 18 months)63,000-C. Indicated Value of Roll Rite$ 843,000$ 483,0004. Concluded Fair Market Value of Roll RiteStock, (Average of 1,2,3 rounded)$ 850,000$ 445,000491 APPENDIX CSchedule 2 ROLL RITE CORPORATIONComparative Statement of Income ($ 000) A Roll Rite II12 ME 12 ME 9 ME12/31/8312/31/8212/31/82Sales, net$ 1,540 $ 1,599 $ 1,202 Cost of Sales:Beg. Inventory269 - - Purchases868 1,026 Less [End Inventory]( 231)( 269)Total Cost of Sales905 994 757 Gross Profit635 605 445 Adjusted B661 501 General & Admin. Expenses:Officers' Salaries120 112 96 Salaries - Other219 185 149 Salaries - Shop21 21 21 Auto Expense19 10 7 Depreciation93 72 70 Insurance18 20 12 Sales Promotion/Advtg.83 63 63 Supplies16 8 2 Payroll Taxes25 27 17 Telephone17 12 10 Employee Benefits29 21 21 Other Expenses65 98 42 Total Gen. & Admin. Exp.725 649 510 Operating Profit [Loss]( 90)( 44)( 65)Adjusted B12 ( 9)Other Income [Expense]Expense Paid for Metals( 9)- - Interest Expense( 56)( 50)( 50)Interest Income16 12 6 Other- 2 1 Total Other Items( 49)( 36)( 43)Income (Loss) BeforeTaxes($ 139)($ 80)($ 108)Adjusted B( 24)( 52)Gross Profit Margin.41 .37 .37 Adjusted B.41 .42 Roll Rite I3 ME 12 ME 12 ME 12 ME 3/31/8212/31/8112/31/8012/31/79Sales, net$ 397 $ 1,471 $ 1,668 $ 1,690 Cost of Sales:Beg. Inventory378 187 - - Purchases245 883 - - Less [End Inventory]( 385)( 378)( 187)- Total Cost of Sales237 691 1,132 1,096 Gross Profit160 779 536 594 Adjusted B723 General & Admin. Expenses:Officers' Salaries16 180 145 159 Salaries - Other36 167 160 176 Salaries - Shop- - 31 25 Auto Expense3 11 8 3 Depreciation2 8 11 16 Insurance8 25 11 22 Sales Promotion/Advtg.- 8 10 9 Supplies6 4 12 4 Payroll Taxes10 15 17 17 Telephone2 9 7 7 Employee Benefits- - 12 11 Other Expenses56 44 34 47 Total Gen. & Admin. Exp.139 471 458 496 Operating Profit [Loss]21 308 78 99 Adjusted B252 Other Income [Expense]Expense Paid for Metals- - - - Interest Expense- - - - Interest Income6 42 - - Other1 2 - - Total Other Items7 45 64 25 Income [Loss] BeforeTaxes$ 28 $ 352 $ 142 $ 124Adjusted B296 Gross Profit Margin.40 .53 .32 .35 Adjusted B.49 492 APPENDIX DSchedule 4 ROLL RITE CORPORATIONValuation Adjustments to Earnings ($ 000), 1979-83NOTE198319821981198019791. Adjusted IncomeBefore Taxes (Sch. 2)$ 139$ 24$ 296$ 142$ 124 2. Adjust Expenses For:A. Interest - ChristensenA493 + 56+ 50--- NoteB. Compensation to B.LenheimB+ 30+ 30--- C. Compensation - Carl &Wilda ChristensenC --+ 105+ 70+ 84 D. Advertising/PromotionD + 58+ 38--- E. DepreciationE + 79+ 58--- F. Other Overhead ExpensesF + 50+ 30--- G. "Paid for Metal"G + 9---- H. Professional,Recruitment,and ConsultantsH + 10+ 30--- I. Economic RentI - 42- 42- 42- 42- 42 Total Adjustments to+ 250+ 194+ 63+ 28+ 42 ExpensesAdjusted Pretax Profit$ 111$ 170$ 359$ 170$ 166 Five-Year Average Pretax Profit$ 195 / .25 = $ 780 (Enterprise Value)Provision for income taxes(at 40%)( 78) Five-Year Average Net Profit117 / .15 = $ 780 (Enterprise Value)APPENDIX E NOR-CAL METALS(A Corporation)BALANCE SHEETASSETSDecember 31,19811980Current assets:Cash$ 330,296$ 208,502Certificates of deposits-- 56,045Accounts receivable - trade7,1551,581Accounts receivable - income tax refund2,096-- Accrued interest receivable-- 2,074Prepaid insurance553270Prepaid federal and state income taxes3,372-- Deferred income tax benefit1,635741Total current assets345,107269,213Property and equipment, at cost (Note 1 & 2)Buildings371,548371,548Furniture and fixtures1,020755Paving5,4515,451Land84,97984,979462,998462,733Less accumulated depreciation271,622257,766191.376204.967Other assets:Investment (at cost) - Nor Cal MetalFabricators (Note 5)25,00025,000Cash surrender value - officers life insurance45,50043,000Total assets$ 606,983$ 542,180 LIABILITIES AND STOCKHOLDERS' EQUITYCurrent liabilities:Accounts payable - trade$ 166$ 183Accrued payroll and payroll taxes19,22412,196Federal and state income taxes payable (Note 4)1,0222,335Dividends payable40,085--Total current liabilities60,49714,714Stockholders' equity:Common stock - no par valueIssued and outstanding 19,272 shares192,720192,720Retained earnings353,766334,746Total liabilities and stockholders' equity$ 606,983$ 542,180494 The accompanying accountant's review report and notes to the financial statements should be read in conjunction with the financial statements. Footnotes1. All section references, unless otherwise indicated, are to the Internal Revenue Code, as amended and in effect at the date of the decedent's death. All rule references are to the Tax Court Rules of Practice and Procedure.. Does not include tenant's option to extend lease for an additional 5-year term with rent to be increased on the basis of any rise in the commodity wholesale price index.↩2. Although the expert opinions are not properly the subject of factual findings, we include an evaluation here for purposes of convenience only.↩. After application of a 30-percent discount for the gifted shares being a minority interest and lacking marketability.↩3. Petitioner's expert recited that the 660 shares received in 1983 by William and Bernard Lenheim were gifted on Mar. 29, 1983. We have found that the shares were gifted during Jan. 1983. Decedent, on his 1983 gift tax return, reported each gift to have been made during "January 1983." We are not convinced the gifts were made on Mar. 29, 1983, as petitioner contends. The record reflects that Mar. 29 was only the date upon which new stock certificates covering the gifted shares were issued to William and Bernard.4. We believe that petitioner acknowledges our jurisdiction to hear this matter, but expressed its assertion that we lack jurisdiction to mean that respondent was barred from assessing and collecting the tax so that this Court, in a sense, did not have subject matter jurisdiction over the substantive merits of the gift tax matters.5. Sec. 2001(b) provides -- (b) Computation of Tax. -- The tax imposed by this section shall be the amount equal to the excess (if any) of -- (1) a tentative tax computed in accordance with the rate schedule set forth in subsection (c) on the sum of -- (A) the amount of the taxable estate, and (B) the amount of the adjusted taxable gifts, over (2) the aggregate amount of tax which would have been payable under chapter 12 with respect to gifts made by the decedent after December 31, 1976, if the rate schedule set forth in subsection (c) (as in effect at the decedent's death) had been applicable at the time of such gifts. For purposes of paragraph (1)(B), the term "adjusted taxable gifts" means the total amount of the taxable gifts (within the meaning of section 2503) made by the decedent after December 31, 1976, other than gifts which are already includable in the gross estate of the decedent.↩6. Sec. 2504(c) predates sec. 2001(b) and was enacted in 1954. See S. Rept. No. 1622, 83rd Cong., 2d Sess. 479 (1954). Sec. 2001, which is discussed in detail, infra↩, was enacted as part of the Tax Reform Act of 1976, 90 Stat. 1520, 1846.7. Sec. 2504(c) contains the following language: (c) Valuation of Certain Gifts for Preceding Calendar Periods. -- If the time has expired within which a tax may be assessed under this chapter or under corresponding provisions of prior laws on the transfer of property by gift made during a preceding calendar period, as defined in section 2502(b), and if a tax under this chapter or under corresponding provisions of prior laws has been assessed or paid for such preceding calendar period, the value of such gift made in such preceding calendar period shall, for purposes of computing the tax under this chapter for any calendar year, be the value of such gift which was used in computing the tax for the last preceding calendar period for which a tax under this chapter or under corresponding provisions of prior laws was assessed or paid.8. Respondent bases his contended values for the shares gifted in 1981 and 1982 on Metals' net assets consisting of: Real estate worth $ 1.6 million (the combined values at which the appraiser hired by Metals had appraised the company's real estate as of Jan. 1982), a stock interest in Fabricators worth $ 1.05 million (the cash-equivalent price at which Metals sold the shares to the Halls on Apr. 1, 1982), and cash and miscellaneous assets of $ 345,107 (consisting of $ 330,296 cash or cash equivalents and $ 14,811 of miscellaneous assets as disclosed in Metals' balance sheet for the year ending Dec. 31, 1981). See Appendix E to this opinion. Respondent asserts the net asset value per share on these dates was about $ 155. ($ 2,995,107 divided by the 19,272 total shares outstanding.) He then suggests applying a discount of 30 percent for the gifted shares' minority interest status and lack of marketability to arrive at his $ 109 value per share.9. The body of Steven Lenheim's Apr. 3, 1982, letter to Metals' board of directors states: I have put a great deal of thought and investigation into studying the performance of the Board of Directors * * relating to the purchase of [the Roll Rite business] and including the restructuring of * * * Metals over the past four months. It is my conclusion that steps have been taken by the Directors which are not in my interests as a shareholder and which could have serious financial consequences affecting the value of my shares in the future. Therefore, under the by-laws of the Corporation I am making a demand that all my existing shares be redeemed by the Corporation within thirty days. If the Corporation is unable to do so then I will offer such stock to the shareholders as individuals. If they are unable or unwilling to buy my shares then I will seek outside [counsel] to secure their values. In order for me to properly set a price for my outstanding shares I have had to rely on information provided by members of the Board of Directors and such information may be suspect. However, for the sake of speed and with the least amount of negotiation a price of * * * ($ 460,649.00) seems, at this time, to cover those known assets as listed on the enclosed sheet. Should the Corporation wish to use those values and guarantee there are no misrepresentations I would discount the value by twenty (20) percent to a buy-out price of * * * ($ 368,500). If unable to pay cash then these terms will need to be negotiated and another figure will be decided by those concerned.↩10. The overall stated price of $ 1.5 million for the Edgewater property and the New Roll Rite assets was partly paid by means of a $ 475,000 note. Respondent's expert determined the note had a market value of $ 423,000 on Apr. 1, 1982. Accordingly, a $ 1,448,000 cash-equivalent price was paid for the Edgewater property and the assets. This $ 1,448,000 cash-equivalent price we have decided was allocated $ 750,000 to the Edgewater property and $ 698,000 to the New Roll Rite assets. Respondent does not argue that the rule enunciated in Commissioner v. Danielson, 378 F.2d 771">378 F.2d 771 (3d Cir. 1967), applies to preclude valuing the assets at any amount other than $ 985,000 stated in the purchase agreement. In this case, respondent relies on his expert's valuation of the assets. Moreover, the Danielson rule would not apply in any event. The exchange document for the Edgewater property and the purchase agreement for the assets constitute, for practical purposes, a single contract. See Stryker Corp. v. Commissioner, T.C. Memo 1982-504">T.C. Memo. 1982-504; United Elchem Industries, Inc. v. Commissioner, T.C. Memo. 1981-376↩.Respondent has chosen to disregard the allocations made in this contract.11. In valuing the company's liabilities as of Jan. 1, 1983, Jan. 1, 1984, and Apr. 17, 1984, respondent's expert did not discount the Christensen note payable or the Steven Lenheim note payable. Essentially, he valued each liability at an amount equal to the remaining note balance owed. This is a conservative approach and is to petitioner's advantage.↩12. Sec. 25.2512-8, Gift Tax Regs., in pertinent part, states: Transfers reached by the gift tax are not confined to those only which, being without a valuable consideration, accord with the common law concept of gifts but, embrace as well sales, exchanges, and other dispositions of property for a consideration to the extent that the value of the property transferred by the donor exceeds the value in money or money's worth of the consideration given therefor. However, a sale, exchange, or other transfer of property made in the ordinary course of business (a transaction which is bona fide, at arm's length, and free from any donative intent), will be considered as made for an adequate and full consideration in money or money's worth. * * *↩A. Source: U.S. Income Tax Returns (Stmt. 5 and 7).↩C. Lawyers Appraisal Service.↩E. Total principal balance of note receivable.↩I. Fabricators 12 percent Note discounted at 15%/annum.↩F. Source: appraisal of Roll Rite. ↩R. Revised, 12-2-88.↩G. On Gain on installment sale of Fabricators (Contract Portion).↩H. Values from Corporate Procedures, Inc.↩B. Source: Financial Statement compiled by Cothran & Johnson, CPA's.↩D. Discounted at 18 percent/yr.↩A. Excludes Christensen Note Payable which was assigned to Nor-Cal Metals effective January 1, 1984.↩B. Net of Christensen Note Payable.↩A. Source: Financial Statements of Roll Rite.↩B. Adjusted to reflect $ 56,548 write-down of inventory, per 1981 Amended Tax Return. Beginning inventory (4/1/82) not adjusted to reflect $ 56,548 write-down. Thus, reported gross profit of 9-ME 12/31/82 is understated by $ 56,548.↩A. Note was assigned to Metals effective January 1, 1984.B. Bernard Lenheim was replaced in January 1984 by an employee who was paid $ 2,500/mo. ($ 5,000 - $ 2,500 = $ 2,500/mo.).↩C. Adjusted to $ 75,000/year. Mr. Christensen was absent from business much of 1981 due to illness. Wilda Christensen was not active in the business.↩D. Reduced to $ 25,000 per year, 1982, 1983.↩E. Adjusted to cost basis of $ 100,000 and seven-year useful life, or $ 14,000/yr. rounded.↩F. To reflect reduction in personnel, autos, travel, etc., per minutes of 12/83 and 1/84. Estimated at $ 50,000/yr.↩G. See "Other Income (Expense)," Schedule 2.↩H. Includes accounting systems implementation, Williams Associates, recruiting for salesmen, and cost of professional services related to the purchase of Roll Rite I.↩I. Based on actual needs of Roll Rite: 10,000 sq. ft. x .35/ft x 12 mos. = 42,000/yr.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623596/	Renner & Maras, Inc. v. Commissioner.Renner & Maras, Inc. v. CommissionerDocket No. 20949.United States Tax Court1950 Tax Ct. Memo LEXIS 189; 9 T.C.M. (CCH) 451; T.C.M. (RIA) 50139; June 2, 1950189 Benjamin Mahler, Esq., 39 Broadway, New York 6, N. Y., for the petitioner. William A. Schmitt, Esq., and William Edwards Murray, Esq., for the respondent. MURDOCK Memorandum Findings of Fact and Opinion The Commissioner determined deficiencies as follows: Declaredvalue-Excess-Excessprofits TaxProfits Tax1943$3,002.43$18,049.6819441,200.0315,882.38 He also determined a deficiency of $87.33 in income tax for 1945 which is not in controversy. The issues for decision are whether the Commissioner erred (1) in treating the amounts which the petitioner received in 1943 and 1944 from King Industries Company as rent, taxable in their entirety, instead of recognizing that the transaction was a sale and the profit was taxable to the petitioner in 1943 as a capital gain, and (2) in failing to allow a deduction of $5,922.87 in 1944 representing expenses and real estate taxes. Findings of Fact The petitioner is a corporation. It filed returns for the calendar years 1943 and 1944 with the collector of internal revenue for the first district of New York. The petitioner was engaged in manufacturing ornamental iron at a plant owned190 by it at 37-14 33rd Street, Long Island City, New York. Maras was the principal stockholder of the corporation and made all decisions on its behalf. He advertised the plant of the petitioner for sale in the early part of 1943. The depreciated cost of the property of the petitioner as of January 1, 1943 was $50,525.70. The property was encumbered by mortgages on which the unpaid balance of principal was $30,450. Maras at some time in May 1943 had negotiations with a partnership known as King Industries Company, the partners of which were Raymond H. King and John J. Tumpane. The partnership was desparately in need of a plant in which to carry on war work but had no funds with which to buy a plant. It wanted to rent the petitioner's plant but Maras offered to sell the plant to the partnership for $85,000. The plant could accommodate about 100 workmen whereas the petitioner had only about 11 employees at that time. Maras advised the partnership that it could move in under a temporary arrangement whereby it would pay rent for use of the plant and machinery until July 1. The partnership wrote Maras a letter dated May 20, 1943 which was as follows: "In accordance with our talk of191 last evening, we agree to purchase of your plants and property on July 1, 1943 for the sum of $85,000. The purchase payments to be made as follows: $2,000. on July 1st, 1943, $3,000. on August 1, 1943 and $4,000. on September 1, 1943 and $4,000. on the first of each month thereafter until the whole of the purchase price is paid. "In the meantime we are to pay you $200. per week until July 1, 1943. "It is also understood that should you at any time find another buyer with a more attractive offer or for any other reason you should wish to cancel this arrangement you may do so." The petitioner entered into a "Memorandum of Agreement" with the partnership on May 29, 1943, in which it was provided that the partnership "agrees to purchase the plant and machinery" for $85,000. The property sold and the mortgages to which it was subject were described in the agreement. The petitioner agreed to discharge the mortgages when the entire purchase price was paid but the partnership had the right to take title subject to the mortgages, in which case the unpaid balance on the mortgages was to be subtracted from the purchase price. Paragraph 9 was as follows: "King Industries Company may enter192 upon the premises immediately, but this occupancy shall be construed as that of landlord and tenant only until all payments under this contract shall have been made. "King Industries Company will pay $200.00 per week until July 1st, 1943, or a total of $1,200.00, which payments shall not be applied on the purchase price but shall be for the use of the plant until that time." Paragraph 10 provided that the $85,000 should be paid in monthly payments but that provision was later changed by an oral agreement under which the partnership was to pay $1,000 per week. The following provision of paragraph 10 was not changed: "In case of default in any of the payments aforesaid, this agreement shall come to an end and all payments made on account shall be considered rent for the use of the premises and the machinery, and King Industries Company agrees to immediately vacate the premises." Paragraph 11 provided that until the purchase price was fully paid the petitioner could conduct its business on the premises without the payment of rent; Maras could occupy the house thereon without the payment of rent; another house could be occupied by a tenant of Maras; Tribore Platers, Inc. could193 occupy the building then occupied by them; and the property of a former tenant could be left in the garage, all without the payment of any rent to the partnership but the rent paid by the tenants was to belong to the petitioner. The petitioner and all other tenants were to vacate the premises when the partnership had made all payments required of it unless they made satisfactory arrangements with the partnership at that time. The petitioner was to give the partnership a deed for the property and a bill of sale for the machinery when all payments had been made. The closing of title was to be "as of July 1, 1943" and all adjustments for water, taxes, interest and insurance were to be made as of that day. Also, interest on the purchase price was to be computed from that date. Meanwhile the petitioner was to pay all taxes, water, interest on mortgages and insurance, while power, light, telephone and other incidentals were to be adjusted monthly. Paragraph 17 provided that all worn or damaged equipment used by the petitioner was to be replaced by it at its own cost. Paragraph 20 was as follows: "A formal agreement embodying in substance the foregoing provisions, shall be executed by the194 parties within the next ten days." The parties never executed any formal agreement in accordance with paragraph 20. The agreement of May 29, 1943 was drawn by the petitioner's lawyer. The partnership had no part in drawing it and would have signed any agreement in order to get the plant. The payments called for by the agreement of May 29, 1943, as orally modified, were made until April 1, 1944, $23,000 having been paid in 1943 and $16,000 in 1944. Tumpane sold his interest in the partnership of King Industries Company in January, 1944. King continued the business thereafter, using several plants in addition to the one obtained from the petitioner, but in April, 1944 he vacated the premises here in question and they were reoccupied by the petitioner which had continued in business. The petitioner on its original return for 1943 reported no income or profit as a result of the contract of May 29, 1943 but deducted depreciation on the plant and equipment for the full year. It filed an amended return for 1943 on May 18, 1945 in which it reported $34,474.30 as a capital gain, realized in 1943 from the transaction under the agreement of May 29, 1943 and deducted no depreciation195 on the plant and equipment after July 1. The petitioner on its return for 1944 reported $3,528.90 as profit realized in that year on the transaction respecting the property here in question. That amount was arrived at by deducting $34,474.30, the profit reported for 1943, and $996.80, depreciation on the property during the period of occupancy by the partnership, from $39,000, the total cash received from the partnership. The property originally acquired by the petitioner included a strip roughly described as 30 feet wide and 188 feet long which had once been part of a public street. It was valued for tax purposes at $7,500. It was described as parcel II of the seven parcels owned by the petitioner. The City of New York assessed real estate taxes on that property but the petitioner, upon advice of counsel, had failed and refused to pay those taxes upon the theory that the property constituted a public thoroughfare and was not subject to taxes. The petitioner keeps its books and files its returns on an accrual basis of accounting but deducts taxes as paid and it had never accrued any taxes on parcel II. The city, at a sale held on February 4, 1943, bought the lien in the total196 amount of $25,080.11, representing the unpaid taxes on parcel II up to June 30, 1941. The petitioner later in 1944 set up on its books a liability of $5,000 on account of real estate taxes to be paid in connection with parcel II. It also accrued on its books during 1944, $1,209.31 representing one-half of the taxes for the period ended December 31, 1943, assessed in 1943 but due in April, 1944, and taxes for the first half of the next period assessed in 1944 and due in October, 1944. Taxes in the total amount of $6,792.62 were deducted on its return for 1944. The Commissioner allowed $1,393.88 thereof and disallowed the remainder of $5,398.74. An attorney for the petitioner went to the city taxing authorities in an effort to compromise the taxes on parcel II because of a fear that they might be made a lien against the rest of the tract. He offered to pay about $2,500 to $3,000 late in 1944 but the City Tax Collector rejected that offer and indicated that it would take about $5,000 to satisfy the tax lien. Neither the petitioner nor anyone acting in its behalf admitted to the taxing authorities during 1944 any liability for the taxes on parcel II covered by the tax lien owned by197 the city. Later, after further negotiations by another attorney employed after 1944, all taxes on parcel II up to June 30, 1941 were compromised by a payment in 1946 in the amount of $4,361. The petitioner at that time paid its attorney $750 in connection with the compromise. The petitioner, on April 11, 1947, paid in full, with interest, the taxes assessed against parcel II for the period beginning July 1, 1941 and ending June 30, 1946. The payment consisted of $1,133.25 as taxes and $254.75 as interest. The stipulation of facts is incorporated herein by this reference. Opinion MURDOCK, Judge: The respondent has held and here insists that the $23,000 received by the petitioner in 1943 and the $16,000 received in 1944 represent rent taxable as ordinary income. The petitioner contends that the payments are not rent since the contract of May 29, 1943 resulted in a conditional sale of a capital asset, the gain from which was a long-term capital gain for 1943. The Commissioner makes no objection to the petitioner's method of reporting if there was a sale. The contradictory nature of the contract of May 29, 1943, drawn by the then counsel for the petitioner, makes decision of198 the case unusually difficult. The partnership agreed to purchase the plant and machinery of the petitioner for $85,000, and it was to receive a deed for the property when it had paid in full. Those provisions and the size of the payments indicate that the agreement was one of conditional sale. However, it also contains other provisions which give the Commissioner considerable support for his view that the payments were rent. One is found in paragraph 9 to the effect that the occupancy of the premises by the partnership "shall be construed as that of landlord and tenant only until all payments under this contract shall have been made." The testimony of the attorney who drew the document that paragraph 9 was intended to be a separate contract and the quoted portion applied only to the $200 a week payments up to July 1, 1943, is not convincing. The provision in paragraph 10 that in case of default all payments made "shall be considered rent" supports the Commissioner. The same witness testified that the word "rent" in paragraph 10 was intended to mean, not rent, but liquidated damages, which latter words were not used because the New York courts frown on the payment of liquidated damages199 as unconscionable. In other words, the purpose was to take care of the petitioner in any eventuality, if the agreement came before some New York court, it would be misled into believing that the payments were rent, whereas if the agreement came before some other court, the Tax Court, the petitioner could explain that the payments were not rent but liquidated damages. Explanations of that kind are not particularly convincing. The fact that the petitioner continued its operations on the property and continued to collect rent from other tenants on the property, as well as the provisions in regard to the replacement of worn or damaged tools and damage to machinery, give some support to the Commissioner. The petitioner's action in originally deducting depreciation on the plant and equipment for the last half of 1943 likewise supports the Commissioner's view. The failure to enter into a "formal agreement" is puzzling but not helpful one way or the other. King and Tumpane disagreed as witnesses on the purpose of the agreement although both expected a formal agreement to be prepared. However, the following from the case of (March 17, 1950), 200 in which the Commissioner was contending that a sale had taken place, is appropriate here: "Cases like this, where payments at the time they are made have dual potentialities, i.e., they may turn out to be payments of purchase price or rent for the use of property, have always been difficult to catalogue for income tax purposes. A fixed rule for guidance of taxpayers and the Commissioner is highly desirable, and it is also desirable that the rule, whatever it is, be as fair as possible, both to the taxpayer and the tax collector. If payments are large enough to exceed the depreciation and value of the property and thus give the payor an equity in the property, it is less of a distortion of income to regard the payments as purchase price and allow depreciation on the property than to offset the entire payment against the income of one year. That is the rule laid down in the Judson case and it finds support in section 23 (a) (1) (A). The payee, meanwhile, is not reporting the payments, since they are purchase price rather than rent, and his gain or loss can be determined at the time of the final outcome of the transaction. The Judson Mills and Truman Bowen cases, being the most recent201 ones and seeming to establish the more equitable rule, will be followed herein and the Commissioner's disallowance of the deductions will be allowed to stand." It appeared in that case that the petitioner was not required to buy the property and was to have no legal title to it until and unless the payments equaled $70,000. That petitioner on two occasions had seriously considered giving up the contract and returning possession of the property, but it was held, nevertheless, that the payments were a part of the purchase price and not deductible by the payor. Here the only difference is that the petitioner is the payee. The payments of $1,000 per week were far in excess of depreciation on the property. Again following the rule established by the , and , cases, it is held that the payments were not rent but resulted in a capital gain. The other issue has to do with the amount which the petitioner is entitled to deduct for 1944 as taxes on parcel II. Deductions allowed for taxes on other parcels are not in controversy. $750 which it paid in 1946 to an attorney hired after 1944 is, of course, not deductible202 in 1944. The petitioner paid $4,361 in 1946 in compromise of a tax lien held by the city on parcel II relating to taxes on that parcel up to June 30, 1941. The petitioner had refused and failed to pay those taxes as they accrued and had not accrued them on its books. It did not admit liability for those taxes to the taxing authorities at any time prior to or during 1944. It set up on its books in 1944 a liability of $5,000 on account of taxes in connection with parcel II because it was afraid the lien might be extended to its other property, but that was not an admission to the taxing authorities of liability for the past due taxes. The Court in , said: "It is settled by many decisions that a taxpayer may not accrue an expense the amount of which is unsettled or the liability for which is contingent, and this principle is fully applicable to a tax, liability for which the taxpayer denies, and payment whereof he is contesting." The tax need not be contested in a court proceeding; denial of liability and refusal to pay is enough. . The Commissioner*203 did not err in disallowing the deduction of those taxes for 1944. Likewise, the taxes on this property for the period beginning July 1, 1941 and ending December 31, 1944, are not deductible in 1944. The petitioner had been denying liability for all taxes on the property and had not admitted any liability up to the close of 1944. The mere fact that it accrued these taxes on its books in 1944 because it was afraid they would become a lien against its other property is no justification for their deduction in 1944, in view of the further fact that the petitioner had always denied liability and had continued to refuse to pay them. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623597/	COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. (A DELAWARE CORPORATION), PETITIONER, v.T. W. Warner Co. v. CommissionerDocket No. 22109.United States Board of Tax Appeals19 B.T.A. 872; 1930 BTA LEXIS 2313; May 8, 1930, Promulgated 2313 1. Where the record shows the date of the filing of the return and the expiration of the statutory period for determination, collection, and assessment, the Commissioner has the burden of proving an extension and takes the risk of any defects in the documents relied upon as waivers. 2. An Indiana corporation transferred its entire assets to a Delaware corporation of the same name, subject to the assumption of liabilities, and its existence was finally terminated under the voluntary dissolution law of Indiana. The respondent asserted a deficiency against it after the expiration of the limitation period and after dissolution, and later asserted liability for the tax against the transferee. Waivers were signed by the former secretary of the transferor, which referred to the corporation in the body as of Toledo, Ohio, and contained no indication in the signature whether the corporation was the Indiana or the Delaware corporation, and the seal was omitted in one and the official designation of the signer was omitted in the other waiver. Held, the waivers were a nullity and the transferee was not liable for the deficiency in tax. George D. Welles, Esq., and F.2314 M. Fuller, Esq., for the petitioner. J. E. Mather, Esq., E. A. Tonjes, Esq., and J. A. Lyons, Esq., for the respondent. STERNHAGEN 872 OPINION. STERNHAGEN: Respondent, acting under section 280, Revenue Act of 1926, notified petitioner, a Delaware corporation, on November 4, 1926, of his determination of petitioner's liability for $69,025.80 as a transferee of the assets of T. W. Warner Co., an Indiana corporation; this being the amount of a deficiency in income and profits tax of the Indiana corporation for 1917. The facts have been agreed upon and set forth in a written stipulation, which is as follows, with such modifications in form as are necessary in order to set forth the documentary exhibits sufficiently: It is hereby stipulated and agreed by and between the parties to the above-entitled appeal, through their respective counsel, that the following facts and exhibits attached hereto, are true and may be considered as proof for the purpose of this appeal. 1. That the T. W. Warner Company of Muncie, Indiana, was incorporated under the laws of the State of Indiana in 1911. That on or about June 11, 873 1921, the Secretary of2315 the State of Indiana issued to said corporation a certificate acknowledging the filing of a certificate certifying that the corporation was then in the process of dissolution and said corporation was dissolved on or about September 23, 1921. That during the year 1917 Warren M. Sample was Vice President and D. O. Skillen, Treasurer, and T. L. Moore, Secretary of T. W. Warner Company (Indiana). That during the year 1920 Thomas W. Warner was President and Warren M. Sample was Vice President of said company. That during said year T. L. Moore was Secretary and D. O. Skillen Treasurer of said Company until December 9, 1920, on which date at an adjourned meeting of the Board of Directors of said company, T. L. Moore resigned as Secretary, and E. H. Witker was elected in his place and stead, and that no election of officers ever having been held subsequent to 1920, that they were the last duly elected officers of T. W. Warner Company (Indiana). 2. That the T. W. Warner Company (Indiana) filed its income and profits tax returns for the year 1917 on March 30, 1918. The return showed a total tax liability of $50,336.20, which amount has been fully paid. Thereafter, in December of 1919, 2316 an additional assessment was made by the Commissioner of Internal Revenue against T. W. Warner Company (Indiana) in the amount of $10,629.65, which amount was thereafter duly paid. Thereafter, in March, 1924, an additional assessment of $166,810.50 was made by the Commissioner of Internal Revenue against the T. W. Warner Company (Indiana). That said assessment appears on the Commissioner's assessment list of March, 1924, (a certified copy of which is attached hereto and made a part hereof and marked "Exhibit 1"). That the foregoing were all the assessments made against the T. W. Warner Company (Indiana) for income and profits tax for the year 1917. 3. Thereafter, on or about April 19, 1926, a certificate of overassessment for the year 1917 was issued to the T. W. Warner Company (Indiana) in the amount of $82,997.65, and that thereafter the Commissioner of Internal Revenue further reduced the outstanding assessment in the name of T. W. Warner Company (Indiana) for 1917 by applying an overassessment due the said company for the year 1920 in the amount of $14,787.05 against the amount outstanding for the year 1917. (Attached hereto and marked "Exhibits 2, 3, and 4," are transcripts2317 of the accounts of the Collectors of Internal Revenue at Toledo, Ohio, Indianapolis, Indiana, and Los Angeles, California, of T. W. Warner Company (Indiana) for the year 1917 showing all assessments, abatements, credits, payments, and refunds.) 4. That attached hereto and marked "Exhibits 5 and 6," are the only instruments in writing purporting to have been entered into in the name of the Commissioner of Internal Revenue and in the name of T. W. Warner Company (either Delaware or Indiana) which relate to the time within which assessment and/or collection of any taxes could be made; that the instruments marked "Exhibits 5 and 6" were signed by the individual whose signatures appear thereon and on or about the dates which they bear. But nothing in this paragraph contained is intended or shall be construed to be an agreement that the individual whose signature appears thereon as having signed in the name of T. W. Warner Company had any power or authority to sign said instrument in the name of either of said companies, or that the word "Secretary" (in pencil) under the name E. H. Witker on Exhibit 5 was written thereon by any one connected with either of said companies. It is agreed2318 that the notation "attach to 1917 return" was placed thereon by respondent or one of his employees. 874 EXHIBIT 5 Attach to 1917 Return.RECD AT REVENUE FEB. 9, 1923 AGENT'S OFFICE Received Apr. 23, 1925 Special Assessment Section Toledo, O., Fey., 7/23.(Date) INCOME AND PROFITS TAX WAIVER In pursuance of the provisions of subdivision (d) of Section 250 of the Revenue Act of 1921, T. W. Warner Co. of Toledo, Ohio, and the Commissioner of Internal Revenue, hereby consent to a determination, assessment, and collection of the amount of income, excess-profits, or war-profits taxes due under any return made by or on behalf of the said Company for the years 1916-1917-1918-1919 under the Revenue Act of 1921, or under prior income, excess-profits, or war-profits tax Acts, or under Section 38 of the Act entitled "An Act to provide revenue, equalize duties, and encourage the industries of the United States, and for other purposes", approved August 5, 1909, irrespective of any period of limitations. T. W. WARNER Co., Taxpayer.By E. H. WITKER; Secretary.D. H. BLAIR, Commissioner.EXHIBIT 6 CA-M-2123-12 RECEIVED APR. 23, 1925 2319 SPECIAL ASSESSMENT SECTION JANY. 18, 1924. (Date) INCOME AND PROFITS TAX WAIVER In pursuance of the provisions of subdivision (d) of Section 250 of the Revenue Act of 1921, T. W. Warner Company of Toledo, Ohio, and the Commissioner of Internal Revenue, hereby consent to a determination, assessment, and collection of the amount of income, excess-profits, or war-profits taxes due under any return made by or on behalf of the said corporation for the years 1917-1918 under the Revenue Act of 1921, or under prior income, excess-profits, or war profits tax Acts, or under Section 38 of the Act entitled "An Act to provide revenue, equalize duties, and encourage the industries of the United States, and for other purposes", approved August 5, 1909. This waiver is in effect from the date it is signed by the taxpayer and will remain in effect for a period of one year after the expiration of the statutory period of limitation, or the statutory period of limitation as extended by any waivers already on file with the Bureau, within which assessments of taxes may be made for the year or years mentioned. T. W. WARNER Co., Taxpayer Ind.By E. H. WITKER, Secy.D. H. BLAIR 2320 Commissioner.875 5. On or about December 9, 1920, the Delaware corporation, petitioner, made the following written proposition to the Indiana corporation, which was accepted and fully carried out: T. W. WARNER COMPANY (Indiana Corporation). Muncie, Indiana.GENTLEMEN: The undersigned, T. W. Warner Company, a corporation incorporated and organized under the laws of the State of Delaware, hereby proposes to purchase from T. W. Warner, Company, an Indiana corporation, all of its property and assets, both real estate and personal property, including bills and accounts receivable and moneys, not intending to limit the generality of the description of said property and assets by specifying any thereof, subject to any and all liabilities and indebtedness of said T. W. warner Company, (Indiana corporation), which said indebtedness and liabilities T. W. Warner Company (Delaware corporation) will assume and agree to pay as part of the purchase price of said property and assets. Upon the delivery to the undersigned of proper deeds, conveyances, bills of sale and assignments of all of said property and assets, the undersigned will issue and deliver to the present2321 stockholders of T. W. Warner Company (Indiana corporation) fifteen thousand (15,000) shares of the capital stock of the undersigned, of the par value of $100.00 each, said shares to be issued to said present stockholders in the same number of shares which they now severally own of T. W. Warner Company (Indiana corporation) and at the time of such delivery of said shares to said stockholders said stockholders respectively shall deliver to T. W. Warner Company (Delaware corporation) their stock in said Indiana corporation, so that each of said stockholders shall receive the same number of shares of the undersigned as they now respectively own of said Indiana corporation, and the undersigned will cause said Indiana corporation to be dissolved and said stock of the Indiana corporation to be cancelled. This proposition is open for acceptance up to and including the 20th day of December, 1920. 6. Exhibit 8 is a true copy of the minutes of the special stockholders' meeting of the Indiana corporation at which the aforesaid proposition was accepted. 7. Exhibit 9 is a true copy of the minutes of the special directors' meeting of the Indiana corporation at which the aforesaid proposition2322 was accepted. 8. Exhibit 10 is a true copy of the minutes of the Delaware corporation authorizing the aforesaid proposition. 9. That pursuant to the authority granted to the officers of said corporations, as shown by the minutes set forth in Exhibits 7, 8, 9, and 10, attached hereto, said proposition was executed and fully carried out by said officers in the name and in behalf of said corporations, and pursuant to the proposition, the Delaware corporation issued and delivered to the stockholders of the Indiana corporation, on or about December 9, 1920, 15,000 shares of the capital stock of the Delaware corporation, which then had no other stock outstanding, and the Indiana corporation on its part, pursuant to said proposition, on or about December 9, 1920, duly transferred by proper deed and bill of sale all of its property and assets to the Delaware corporation. 10. That the property and assets transferred to the T. W. Warner Company of Toledo, Ohio, (a Delaware corporation) by the T. W. Warner Company of Muncie, Indiana, (an Indiana corporation), pursuant to the agreement entered into by the two corporations, had a value in excess of the liabilities of the Indiana corporation2323 greater than the amount of taxes herein involved, plus interest as provided by law, but nothing herein is intended or shall be construed to be an agreement that the property so transferred exceeded in 876 value of the consideration paid therefor by T. W. Warner Company, a Delaware corporation, in consummation of the proposition set out in Exhibit 7 hereto attached. 11. That no suit or other proceeding for the collection of the additional assessment of 1917 taxes which the Commissioner undertook to levy against T. W. Warner Company, an Indiana corporation, in March of 1924, has ever been begun against T. W. Warner Company, an Indiana corporation. 12. That no claim had been asserted by the United States against T. W. Warner Company, the Indiana corporation, for any taxes for the year 1917 prior to the sale and conveyance of its properties to the T. W. Warner Company, the Delaware corporation, which had not been paid in full prior to such sale and conveyance. The following facts are found from the record: 13. Waivers given prior to April 1, 1924, containing no expiration date expired April 1, 1924. 14. The Secretary of State of Indiana issued the following certificate2324 on June 11, 1921, which is Exhibit 11: To all to whom these Presents Shall Come Greeting: I, ED JACKSON, Secretary of State of the State of Indiana, do hereby certify that the T. W. WARNER COMPANYhas this day filed in the office of the Secretary of State, the properly signed and attested consents, statements and papers required by Section One of an Act entitled "An Act prescribing the method and procedure for the voluntary dissolution of private corporations and voluntary associations, and declaring an emergency", approved March 14, 1913. And I further certify that said written consents, statements and papers so filed as aforesaid show that said Company and the officers thereof have complied with the provisions of said Section One of said Act, and that such corporation is now in process of dissolution. 15. Exhibit 12 consists of certified copies of the following papers filed in the office of the Secretary of State of Indiana: affidavit of a newspaper publisher that a notice was published on June 15 and June 22, 1921; affidavit of Witker, Secretary, certifying a copy of Directors' resolution of September 10, 1921, dissolving the corporation under the voluntary dissolution2325 statute; affidavit dated September 10, 1921, of Warner, president, and Witker, secretary, that the corporation's affairs were fully settled, all its debts paid and its remaining assets distributed to the stockholders. 16. The Secretary of State of Indiana issued the following certificate on September 23, 1921: To all to whom these Presents Shall Come Greeting: I, ED JACKSON, Secretary of State of the state of Indiana, do hereby certify that in accordance with the provisions of Section Four of an Act entitled "An Act prescribing the method and procedure for the voluntary dissolution of private corporations and voluntary associations, and declaring an emergency", approved March 14, 1913, T. W. WARNER COMPANYhas this day filed in the office of the Secretary of State, a certificate under oath, setting forth that it has fully and finally settled its affairs. 877 Now, therefore, under the provisions of said Section Four of said Act, all power and authority of said corporation under the laws of Indiana are hereby terminated, and such corporation is finally dissolved. The petitioner assails the respondent's determination on several grounds fully argued in its brief. 2326 It is, however, not necessary to pass on all of these points, since in our opinion the deficiency became barred at the end of the five-year period of limitations, namely, March 30, 1923, there being no valid waivers or consents in writing to a later determination, assessment or collection of tax as to 1917. The Indiana corporation, the taxpayer and alleged transferror, filed its 1917 return on March 30, 1918, paying the tax of $50,336.20 shown thereon. In December, 1919, respondent assessed an additional $10,629.65 and this was paid. Nothing more was done by respondent until March, 1924, when he made a further assessment which was subsequently reduced, resulting ultimately in the present asserted deficiency. There is no suggestion or contention that there was fraud or misrepresentation; and therefore by section 250(d), Revenue Act of 1921, respondent was required to determine, assess and collect income and profits taxes due for 1917 within the five years ended March 30, 1923, unless there was a waiver by which this period was extended. Since the record shows the date of filing the return and the expiration of the five-year period, the burden of proving an extension is upon2327 respondent, ; ; , and he takes the risk of any defect in the documents upon which he relies as waivers. ; ; . The Indiana corporation began voluntary dissolution under the proper Indiana statutes in 1921, and its existence terminated in that year. This dissolution was not null and void as respondent contends. The corporation was dead, Oklahoma &c. v. , and if by dissolution without paying its taxes, respondent was imposed upon, this does not revive the corporation, whatever may be said of other remedies by which the claim for taxes may be enforced. Thereafter no one had authority to consent for the former corporation to an extension. Witker, who signed the first alleged waiver in February, 1923, was not secretary and it is questionable whether he actually or tacitly suggested that he was. The words Toledo, Ohio, in the body2328 of the instrument, the absence of seal and the absence of official designation at the place of signature all negate the imputation to the nonexistent Indiana corporation. This is not like an involuntary dissolution in Indiana (see ) or like the procedure of dissolution in some other States (see ) where there is power *878 of prescribed persons to act for a dissolved corporation for a fixed period. Under the voluntary dissolution statute of Indiana the corporation finally terminated when the secretary of state so certified in 1921, and any attempt of any one to act for it thereafter was futile. The waiver was therefore a nullity, and since upon it rests the deficiency and in turn the petitioner's alleged liability in respect of such deficiency, it follows that there is no such liability. Judgment will be entered for the petitioner.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623598/	Ruth B. Parks, Petitioner v. Commissioner of Internal Revenue, RespondentParks v. CommissionerDocket Nos. 23041-87, 13496-88United States Tax Court94 T.C. 654; 1990 U.S. Tax Ct. LEXIS 43; 94 T.C. No. 38; April 24, 1990, Filed Decisions will be entered under Rule 155. Held, respondent's determination that petitioner had unreported cash income from an unidentified source is sustained. Held, further: Respondent must prove both an underpayment and fraudulent intent by clear and convincing evidence in order to satisfy his burden of proof with respect to an addition to tax for fraud. When allegations of fraud are intertwined with unreported and indirectly reconstructed income, respondent can satisfy his burden of proving an underpayment in one of two ways. Respondent may prove an underpayment by proving a likely source of the unreported income, Holland v. United States, 348 U.S. 121">348 U.S. 121 (1954), or where the taxpayer alleges a nontaxable source, by disproving the specific nontaxable source so alleged. United States v. Massei, 355 U.S. 595">355 U.S. 595 (1958). Held, further, respondent disproved an alleged specific nontaxable source by showing that his reconstruction of income was accurate and that the evidence as to the specific nontaxable source was implausible, inconsistent, and not supported by objective evidence in44 the record. Held, further, liability for additions to tax for fraud sustained. Held, further, liability for the addition to tax for a substantial underpayment of tax sustained. Michael J. Stengel, for the petitioner in docket No. 23041-87.Ruth B. Parks, pro se in docket No. 13496-88.Paul M. Kohlhoff, for the respondent. Whitaker, Judge. WHITAKER655 Respondent determined deficiencies in petitioner's Federal income tax and additions to tax as follows:Additions to taxYearDeficiencySec. 6653(b)(1) 1Sec. 6653(b)(2)Sec. 66611983$ 16,310$ 8,155.0050% of the$ 4,078interest on$ 16,101 219844,1472,073.5050% of theinterest on$ 4,14745 Petitioner is represented by counsel in docket No. 23041-87 and is pro se in docket No. 13496-88. The two docket numbers were consolidated because the issues are substantially identical, differing primarily in that docket No. 23041-87 pertains to taxable year 1983 and docket No. 13496-88 pertains to taxable year 1984. Respondent concedes that petitioner substantiated itemized deductions in the amount of $ 3,150 for the year 1983.The issues remaining for decision are: (1) Whether cash deposits and expenditures made by petitioner during 1983 and 1984 constituted unreported income from an unidentified source; (2) whether petitioner is liable for the additions to tax for fraud for the years 1983 and 1984; and (3) whether petitioner is liable for a section 6661 addition to tax for a substantial understatement of income tax for the taxable year 1984.FINDINGS OF FACTSome of the facts in this case are stipulated and are so found. The stipulations of fact and accompanying exhibits are incorporated by this reference. Petitioner resided in Memphis, Tennessee, at the time of filing her petitions in this case.During 1983 and 1984, petitioner was employed by the Internal Revenue Service46 at the Memphis Service Center. 656 All of petitioner's wages were paid to her in the form of checks. Those checks were deposited to petitioner's bank accounts and reported as income on her Federal income tax returns for the years in issue. Petitioner's monthly take-home pay amounted to approximately $ 800. Petitioner reported no other source of wage or salary income, other than minimal interest income, in 1983 and 1984.During the years in issue, petitioner was divorced from James W. Parks. Petitioner and Mr. Parks had one daughter. During their marriage Mr. Parks beat petitioner several times, threatened to kill both petitioner and their child, and shot at petitioner. In 1975, petitioner fired shots at Mr. Parks during a domestic dispute, for which petitioner was arrested. A divorce was granted to petitioner in 1975 on the grounds that Mr. Parks' cruel and inhumane conduct made cohabitation unsafe. Pursuant to the divorce decree, Mr. Parks was required to pay $ 10 per week in child support to the Clerk of the Circuit Court of Shelby County, Tennessee. Mr. Parks was delinquent in his child support payments, forcing petitioner to petition the Shelby County Circuit Court47 for an order garnishing Mr. Parks' wages early in 1976. Pursuant to the garnishment order, Mr. Parks paid $ 290 in child support through the Clerk's office during the remaining portion of 1976. In all subsequent years, including the years in issue, Mr. Parks made no further child support payments through the Clerk's office. The parties stipulate that no checks from Mr. Parks were deposited in any of petitioner's bank accounts during 1983 and 1984. There is no evidence that Mr. Parks ever made cash child support payments.In his determination of deficiency, respondent used the bank deposits and cash expenditures method of reconstructing income. During 1983, petitioner wrote no checks to cash. However, in addition to her wages from the Internal Revenue Service petitioner made cash deposits in 1983 in the amount of $ 11,635 to four bank accounts. In transactions unrelated to the cash deposits to her bank accounts, on October 4, 1983, and October 5, 1983, petitioner purchased six separate cashier's checks made payable to Bud Davis Cadillac. Each cashier's check was issued by a different branch of one of two banks. The total amount of 657 the six cashier's checks was $ 12,575. 48 By so purchasing cashier's checks in small amounts at several different bank branches, petitioner avoided the filing of a Currency Transaction Report. Currency Transaction Reports are prepared when customers conduct single cash transactions with banking institutions in amounts of $ 10,000 or greater.Petitioner used the cashier's checks to make a $ 12,575 down payment on a 1984 Cadillac Fleetwood Brougham. Petitioner financed the balance of the purchase price of the Cadillac through General Motors Acceptance Corporation (GMAC). Petitioner's monthly payments to GMAC were $ 418.69, an amount more than half of petitioner's monthly take-home pay.In transactions again unrelated to any deposits of cash to her bank accounts, on December 9, 1983, petitioner purchased additional cashier's checks in the amount of $ 12,000. Petitioner used those cashier's checks and cash withdrawn from a revocable trust account established for the benefit of her daughter to pay off the balance she owed GMAC on the Cadillac. Neither the cash deposits nor the cash with which petitioner purchased cashier's checks were reported as income on petitioner's Federal income tax return for 1983.During 1984, petitioner49 made cash deposits to two bank accounts in the amount of $ 8,585, purchased one cashier's check in the amount of $ 571, and paid doctors' bills totaling $ 1,925 in cash. However, petitioner wrote no checks to cash from her checking account and withdrew no cash from savings accounts under her control during 1984. Neither the cash deposits, the cash used to purchase the cashier's check, nor the cash used to pay doctors' bills were reported as income on petitioner's 1984 Federal income tax return. During the initial audit of her tax returns, petitioner stated that she received no child support in 1983 and 1984. 3 Petitioner's tax returns for 1983 and 1984 were subsequently audited by the Criminal Investigation Division (CID) of the Internal Revenue Service. After referral of her case 658 to CID, petitioner invoked the Fifth Amendment and refused to answer questions or cooperate in any other way with respondent's examiners or with CID agents. CID terminated its investigation in December 1987, without recommendation. Respondent has not identified a likely source of the cash in issue.50 OPINIONRespondent argues that petitioner had unreported cash income from an unidentifiable source for the years before the Court. Petitioner is, contends respondent, liable for the tax on such income. We agree. Respondent determined unreported income through the use of the bank deposits and cash expenditures method of reconstructing income. It is well established that when a taxpayer's method of accounting does not clearly reflect income, respondent may recompute such income. Sec. 446(b); Holland v. United States, 348 U.S. 121">348 U.S. 121, 130-132 (1954). We approve of respondent's use of the bank deposits and cash-expenditures method of recomputing income. Nicholas v. Commissioner, 70 T.C. 1057">70 T.C. 1057, 1065 (1978); Estate of Mason v. Commissioner, 64 T.C. 651">64 T.C. 651, 653 (1975), affd. 566 F.2d 2">566 F.2d 2 (6th Cir. 1977). Indeed, bank deposits are prima facie evidence of the receipt of income. Tokarski v. Commissioner, 87 T.C. 74">87 T.C. 74, 77 (1986).Petitioner argues that respondent has the burden of proving a deficiency by showing that her cash deposits and expenditures51 represented unreported income and of proving the source of such income. Petitioner further suggests that respondent must prove that the deposits and expenditures were neither gifts, inheritance, nor other nontaxable receipts. Respondent must also, according to petitioner, identify the taxable source of the unreported receipts.Contrary to petitioner's belief, the burden is upon petitioner to prove that respondent's determination of unreported income, computed using the cash deposits and expenditures method of reconstructing income, is incorrect. Nicholas v. Commissioner, supra at 1064; Zarnow v. Commissioner, 48 T.C. 213">48 T.C. 213, 216 (1967); Reaves v. Commissioner, 31 T.C. 690">31 T.C. 690 (1958), affd. 295 F.2d 336">295 F.2d 336 (5th Cir. 1961). Respondent's determination of deficiency absent such proof 659 is presumed correct. Welch v. Helvering, 290 U.S. 111">290 U.S. 111 (1933).Petitioner admits she received cash with which she made the cash deposits and the cash expenditures in issue, but would have us find that those cash deposits and expenditures did not constitute52 unreported income from an unidentified source. Petitioner asserts that all of the cash in issue came from cash child support payments. According to petitioner, her ex-husband was a gambler with a sporadic flow of income. Allegedly, when Mr. Parks was successful in his gambling pursuits, he came to petitioner's home and presented her with cash to use for the support of their daughter. Such cash child support payments, maintains petitioner, included a lump sum of $ 40,000 given to petitioner by Mr. Parks in 1980.We find that petitioner has not satisfied her burden of proving respondent's determination of unreported income in 1983 and 1984 incorrect. We find incredible petitioner's testimony that she kept a hoard of $ 40,000 in cash child support payments in a metal box inside a heating vent for 3 years, until deciding to buy a Cadillac for her daughter. Mr. Parks did not testify at trial. We accord little probative weight to, and view with suspicion, the testimony of Ms. Mormon, petitioner's close friend and only corroborating witness. Ms. Mormon testified that petitioner showed her a metal box containing a large amount of cash sometime in 1980. Petitioner testified that she53 hid the cash hoard in the metal box in the heating vent in the floor of her bedroom. Ms. Mormon, however, testified that petitioner took a metal box filled with cash out from behind a board in a wall. We are not required to accept the testimony of petitioner. Fleischer v. Commissioner, 403 F.2d 403">403 F.2d 403, 406 (2d Cir. 1968), affg. a Memorandum Opinion of this Court; Tokarski v. Commissioner, supra at 77.Moreover, even had we determined Ms. Mormon's testimony was credible, that testimony would not support petitioner's position. The witness could not verify that such cash came from child support payments, but merely that she had seen such a box containing a large amount of cash hidden in petitioner's house.660 Furthermore, with respect to the deficiency determination, petitioner's argument that respondent failed to disprove any other nontaxable source for the cash in issue is fruitless. Where a taxpayer provides respondent with no leads as to source, respondent is not required to negate every possible source of nontaxable income, a matter peculiarly within the knowledge of the taxpayer. Holland v. United States, supra at 138;54 Petzholdt v. Commissioner, 92 T.C. 661">92 T.C. 661, 695-696 (1989). Moreover, where a taxpayer admits receipt of cash, respondent need not prove a likely source of resulting cash deposits or expenditures. Cf. Tokarski v. Commissioner, supra at 76-77.Petitioner provided respondent with no books, papers, check stubs, or other leads to pursue in order to determine if the cash might have some nontaxable source other than child support. Indeed, petitioner refused entirely to cooperate with respondent's agents and the CID investigation. Therefore, for all the reasons stated above, we find that petitioner had unreported income of $ 36,210 in 1983 and $ 11,081 in 1984. Under the circumstances of this case, the fact that respondent could not identify a specific taxable source does not immunize petitioner from liability for the tax on such unreported income.Respondent determined that petitioner was liable for the fraud additions to tax pursuant to section 6653(b)(1) and (2). The existence of fraud is a question of fact to be resolved upon consideration of the entire record. Gajewski v. Commissioner, 67 T.C. 181">67 T.C. 181, 199 (1976),55 affd. without published opinion 578 F.2d 1383">578 F.2d 1383 (8th Cir. 1978); Estate of Pittard v. Commissioner, 69 T.C. 391">69 T.C. 391 (1977). Fraud is not to be imputed or presumed. Beaver v. Commissioner, 55 T.C. 85">55 T.C. 85, 92 (1970); Otsuki v. Commissioner, 53 T.C. 96">53 T.C. 96 (1969). Respondent has the burden of proving that some portion of an underpayment is due to fraud by clear and convincing evidence. Sec. 7454(a); Rule 142(b).To satisfy his burden of proof, respondent must show two things. First, respondent must prove that an underpayment exists. Where, as here, respondent has prevailed on the issue of the existence of a deficiency by virtue of a taxpayer's failure to carry his burden of proof, respondent cannot rely on that failure to sustain his burden of proving 661 fraud. Petzholdt v. Commissioner, supra at 700; Estate of Beck v. Commissioner, 56 T.C. 297">56 T.C. 297, 363 (1971). We must be careful in such cases not to bootstrap a finding of fraud upon a taxpayer's failure to prove respondent's deficiency determination erroneous. 56 Drieborg v. Commissioner, 225 F.2d 216">225 F.2d 216, 218 (6th Cir. 1955), affg. in part a Memorandum Opinion of this Court. Second, respondent must show that the taxpayer intended to evade taxes known to be owing by conduct intended to conceal, mislead, or otherwise prevent the collection of taxes. Stoltzfus v. United States, 398 F.2d 1002">398 F.2d 1002, 1004 (3d Cir. 1968); Rowlee v. Commissioner, 80 T.C. 1111">80 T.C. 1111 (1983).Respondent can satisfy his burden of proving the first prong of the fraud test, i.e., an underpayment, when the allegations of fraud are intertwined with unreported and indirectly reconstructed income in one of two ways. Respondent may prove an underpayment by proving a likely source of the unreported income. Holland v. United States, 348 U.S. 121">348 U.S. 121 (1954); Nicholas v. Commissioner, 70 T.C. 1057 (1978). Alternatively, where the taxpayer alleges a nontaxable source, respondent may satisfy his burden by disproving the nontaxable source so alleged. United States v. Massei, 355 U.S. 595 (1958); Kramer v. Commissioner, 389 F.2d 236">389 F.2d 236, 239 (7th Cir. 1968),57 affg. a Memorandum Opinion of this Court.Respondent did not prove a likely source of petitioner's unreported income. Thus, in order to satisfy his burden of proving an underpayment respondent must disprove petitioner's allegation of a cash hoard comprised of accumulated or lump-sum cash child support payments. Respondent may disprove that alleged specific nontaxable source of income through showing that his reconstruction of income is accurate combined with a showing that petitioner's allegation of a cash hoard is inconsistent, implausible, and not supported by objective evidence in the record. See Boggs v. Commissioner, T.C. Memo 1985-429">T.C. Memo. 1985-429, 54 P-H Memo T.C. par. 85,429 at 1939, 50 T.C.M. (CCH) 797">50 T.C.M. 797, 830; Phillips v. Commissioner, T.C. Memo 1984-133">T.C. Memo. 1984-133, 53 P-H Memo T.C. par. 84,133 at 472-474, 47 T.C.M. (CCH) 1289">47 T.C.M. 1289, 1304-1305.Petitioner maintains that respondent has merely shown suspicious circumstances which are insufficient to support a 662 finding of fraud. Petitioner argues, in effect, that respondent cannot satisfy his burden of disproving a cash hoard allegedly58 composed of child support payments without producing Mr. Parks to testify at trial in refutation of petitioner's allegation. However, petitioner's allegation of a cash hoard is sufficiently implausible and incredible, and respondent's reconstruction of income sufficiently accurate, that the testimony of Mr. Parks is unnecessary. Under circumstances such as we find in this case, respondent need not satisfy his burden through direct testimony by an alleged transferor refuting that he or she was the nontaxable source of unreported income.Respondent's reconstruction of petitioner's income using the cash expenditures and deposits method was accurate and reliable. Petitioner admitted making those cash deposits and expenditures. Petitioner further admitted that she did not report income represented by those cash deposits and expenditures on her returns for 1983 and 1984.However, petitioner's allegation of a nontaxable cash hoard which came from cash child support payments made by Mr. Parks is inconsistent and implausible. Similar to the taxpayer in Phillips v. Commissioner, supra, petitioner did not allege such a nontaxable59 source of the unreported income until filing her petition. Petitioner originally told the revenue agent investigating her 1983 and 1984 returns that she received no child support. Petitioner failed to mention to the revenue agent the existence of a cash hoard comprised of a $ 40,000 lump-sum child support payment claimed to have been made in 1980. Other than petitioner's testimony, the record reveals no evidence that Mr. Parks ever voluntarily paid child support. Within a year of her divorce, petitioner was forced to seek a court order garnishing Mr. Parks' wages in order to receive unpaid support payments of $ 10 per week. The only documentary evidence that Mr. Parks at any time made child support payments is the parties' stipulation that Mr. Parks paid $ 290 in 1976 pursuant to that garnishment order.The violent relationship between petitioner and Mr. Parks is further indication of the implausible and incredible nature of petitioner's allegation. Petitioner testified that her ex-husband was cruel, abusive, and a habitual gambler. In her 663 petition for dissolution of marriage, petitioner stated that she was "mortally afraid" of Mr. Parks and charged that Mr. Parks60 was guilty of abandoning and refusing to provide for her. During their marriage Mr. Parks beat petitioner several times, threatened to kill both petitioner and their child, and shot at petitioner. Petitioner was arrested in 1975, just prior to her divorce, for shooting at Mr. Parks. Nothing in the record convinces us that Mr. Parks rehabilitated his violent nature to the extent that he began appearing peacefully at petitioner's doorstep with large sums of cash to support the child he had earlier threatened to kill, or that petitioner's fear of Mr. Parks abated to the point of receiving him in her home.Petitioner testified that she kept a cash hoard hidden in her home. However, petitioner's statement that she hoarded that cash rather than deposit it in a bank for "safety" reasons is incredible in light of the fact that petitioner concurrently kept four other bank accounts, in which she deposited all of her documented income. This conclusion is supported by the fact that petitioner's home was burglarized during the period in which the alleged cash hoard was secreted in her home. Finally, the testimony of Ms. Mormon, petitioner's corroborating witness, did not support petitioner's61 description of the location of the alleged cash hoard.We conclude that petitioner's claim of a cash hoard in this case is not only inconsistent with some of her statements to the auditing agent, but is patently incredible as well. Furthermore, petitioner, who as the mother of Mr. Parks' child had an interest in keeping track of Mr. Parks, did not know where Mr. Parks might be found. Thus, knowledge of the source of petitioner's cash income rested peculiarly with petitioner. The necessity of using great care to avoid bootstrapping fraud additions upon a taxpayer's failure to prove respondent's determinations erroneous does not impose upon respondent the burden of producing Mr. Parks to testify in order to disprove the alleged specific nontaxable source of income.We follow our reasoning in Boggs and Phillips, in holding that respondent has met his burden of proving an underpayment by clear and convincing evidence. In both cases, as 664 here, a taxpayer's allegation of a specific nontaxable source of unreported income was incredible, implausible, and contrary to the objective evidence. In addition, respondent's reconstruction of unreported income was accurate in 62 all three cases. Boggs and Phillips differ from the present case primarily in that in those cases respondent both disproved an alleged nontaxable source of unreported income in the manner used here and also proved a likely source of income. However, respondent need prove the underpayment prong of the fraud test by only one of the alternate methods. United States v. Massei, 355 U.S. 595 (1958).Respondent must also prove by clear and convincing evidence that petitioner had the requisite fraudulent intent. Fraudulent intent may be proven by circumstantial evidence because direct proof of the taxpayer's intent is rarely available. Rowlee v. Commissioner, 80 T.C. 1111">80 T.C. 1111 (1983). The taxpayer's entire course of conduct may be examined to establish the requisite fraudulent intent. Stone v. Commissioner, 56 T.C. 213">56 T.C. 213, 223-224 (1971); Otsuki v. Commissioner, supra at 105-106.The intent to conceal or mislead may be inferred from a pattern of conduct. See Spies v. United States, 317 U.S. 492">317 U.S. 492, 499 (1943). A pattern of consistent63 underreporting of income, especially when accompanied by other circumstances showing an intent to conceal, justifies the inference of fraud. See Holland v. United States, 348 U.S. 121">348 U.S. 121, 137 (1954); Otsuki v. Commissioner, supra.However, the mere failure to report income is not sufficient to establish fraud. Merritt v. Commissioner, 301 F.2d 484">301 F.2d 484, 487 (5th Cir. 1962). Fraud may not be found under "circumstances which at most create only suspicion." Davis v. Commissioner, 184 F.2d 86">184 F.2d 86, 87 (10th Cir. 1950); Katz v. Commissioner, 90 T.C. 1130">90 T.C. 1130, 1144 (1988).Other badges of fraud which may be taken into account include: the making of false and inconsistent statements to revenue agents, Grosshandler v. Commissioner, 75 T.C. 1">75 T.C. 1, 20 (1980); the filing of false documents, Stephenson v. Commissioner, 79 T.C. 995">79 T.C. 995, 1007 (1982), affd. 748 F.2d 331">748 F.2d 331 (6th Cir. 1984); understatement of income, inadequate records, failure to file tax returns, implausible or inconsistent64 explanations of behavior, concealment of assets, and 665 failure to cooperate with tax authorities. Bradford v. Commissioner, 796 F.2d 303">796 F.2d 303 (9th Cir. 1986), affg. a Memorandum Opinion of this Court.We rejected petitioner's argument that her cash income was in reality child support payments. The fact that petitioner structured her purchase of cashier's checks to avoid the filing of Currency Transaction Reports indicates petitioner was trying to conceal her possession of large amounts of cash. Petitioner's statement to respondent's agent that she received no child support payments is inconsistent with her testimony before this Court. Petitioner failed to cooperate with the CID investigation of her tax returns for the years in issue. In addition, the record contains no documentary or other credible evidence supporting petitioner's claim that the unreported income was in reality child support. All the facts and circumstances of this case lead us to conclude that petitioner intentionally failed to report cash income in 1983 and 1984 in an effort to conceal that income. Thus, respondent has satisfied his burden of proving both prongs of the fraud65 test by clear and convincing evidence and petitioner is liable for the fraud additions to tax.The last issue we must decide is whether petitioner is liable for the addition to tax set forth in section 6661 for 1983. Section 6661 imposes an addition to tax if there is a substantial understatement of income tax for a taxable year. The amount of such additions assessed after October 21, 1986, is equal to 25 percent of the amount of any underpayment attributable to such understatement. Sec. 6661(a); Pallottini v. Commissioner, 90 T.C. 498 (1988). A substantial understatement is one which exceeds the greater of 10 percent of the tax required to be shown on the return or $ 5,000. Sec. 6661(b). If petitioner's understatement of income is substantial within the meaning of section 6661(b), she is liable for the section 6661 addition unless such understatement can be reduced by section 6661(b)(2)(B).By either test of section 6661(b), petitioner's underpayment is a substantial underpayment. Petitioner had no authority for her failure to report her cash income in 1983, nor did she disclose any facts pertaining to such income on her 1983 return or in a statement66 attached to her return for *666 that year. Therefore, the addition cannot be reduced through application of the provisions of section 6661(b)(2)(B). Petitioner is liable for the section 6661 addition to tax. For the foregoing reasons,Decisions will be entered under Rule 155. Footnotes1. Unless otherwise noted, all section references are to the Internal Revenue Code of 1954 as amended and in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩2. Also on the notice of deficiency, respondent determined entitlement to an excess Medicare tax credit of $ 225, and stated that petitioner therefore had a "net tax deficiency" in the amount of $ 16,085. There is no explanation for why respondent's determination of the sec. 6653(b)(2) addition for 1983 was based upon a figure of $ 16,101.↩3. Petitioner first claimed in her petition that the unreported cash in issue came from periodic cash child support payments, including a lump sum cash support payment of $ 40,000 which Mr. Parks allegedly made in 1980. However, in addition to stating to the revenue agent that she received no child support payments in 1983 or 1984, petitioner did not mention receipt of cash child support payments in previous years with which she made expenditures in 1983 and 1984.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623599/	Jesse S. Rinehart and Evelyn H. Rinehart, Petitioners, v. Commissioner of Internal Revenue, RespondentRinehart v. CommissionerDocket No. 30180United States Tax Court18 T.C. 672; 1952 U.S. Tax Ct. LEXIS 153; June 26, 1952, Promulgated 153 Decision will be entered under Rule 50. Income -- Compensation for Services -- Section 22 (a). -- Money paid to the petitioner by his employer to assist in the purchase of a house at a new work location was compensation for services taxable under section 22 (a). Thomas L. Dalrymple, Esq., and Donald M. Hawkins, Esq., for the petitioners.James A. Scott, Esq., for the respondent. Murdock, Judge. MURDOCK 672 The Commissioner determined a deficiency of $ 1,971.64 in the income tax of the petitioners for 1947. The only issue for decision is whether $ 4,000, which154 the petitioner received from his employer in order to assist him in purchasing a house, was taxable income.FINDINGS OF FACT.The petitioners are husband and wife who now reside in Toledo, Ohio. Their joint return for 1947 was filed with the collector of internal revenue for the tenth district of Ohio.The petitioner had been employed in Vineland, New Jersey, as controller of Kimble Glass Company. That company was purchased by Owens-Illinois Glass Company in June 1946 and the petitioner has been an employee of the latter company since that date. Owens-Illinois 673 Glass Company moved some of the people, including the petitioner, who were in the executive offices of the business at Vineland, to Toledo, Ohio, on or about March 1, 1947. Twenty-six employees made the move.Owens-Illinois Glass Company made an offer, to each of the 26 persons moved from Vineland to Toledo, to pay the lesser of 25 per cent of the purchase price or $ 4,000 toward the purchase price of a home purchased in Toledo, provided the employee was unable to find suitable rental housing. Only those employees who actually purchased houses pursuant to the plan received any benefit from it. The reason for 155 the offer was that a housing shortage, particularly in rental property, existed in Toledo at the time.The petitioner purchased a house in Toledo in October 1947 for $ 21,500. He notified Owens-Illinois Glass Company that he was purchasing the house, and the company, on October 10, 1947, gave him a check for $ 4,000 pursuant to its offer. The petitioner closed the deal for the purchase of the house on October 13, 1947.Owens-Illinois Glass Company deducted the $ 4,000 as a payroll expense on its return for the period including October 1947.The petitioners did not report the $ 4,000 as income on their joint return for 1947.The Commissioner in determining the deficiency added the $ 4,000 to the net income disclosed on the return and explained that it was included under section 22 (a).All facts stipulated by the parties are incorporated herein by this reference.OPINION.The petitioners do not contend that the $ 4,000 was a gift but claim that it did not represent taxable income since it merely reduced the cost of the house. The petitioner testified that he thought the price of the house was too high and he would not have bought it if he had not been able to obtain the $ 4,000 from156 his employer. Suppose he had thought that meat prices in Toledo were too high and his employer had offered to pay 25 per cent of his meat bills until a total of $ 4,000 had been paid. Could it be successfully maintained that the $ 4,000 paid for meat was not income? This $ 4,000 was paid to the petitioner by his employer. It was paid because the employer wanted the services to continue and obviously would not have been paid if the situation had been otherwise. The employer regarded the $ 4,000 as additional compensation and took a deduction on its return on that basis. It was compensation for services and, as such, was expressly taxable to the recipient under section 22 (a).The cases which the petitioner cites are distinguishable. The petitioner in , was not an employee of 674 Bache who paid a part of the amount which went to the seller when Brown acquired some stock, and the amount paid by Bache could not represent compensation to Brown. Eaton, in the case of , agreed to buy a large block of stock at a price in excess of the market provided the 157 corporation, the stock of which he was purchasing, would give him some other shares. It was held that the total amount which he paid was the purchase price of all of the shares acquired, both from the sellers and the corporation. There is no parallel here. The case of , does not involve comparable facts. It was held in , that an employee did not sustain a loss when his employer compensated him for the difference between basis and amount realized upon the sale of his residence when he moved from one place to another to accommodate his employer. Section 23 (e) does not allow deductions for any losses "compensated for by insurance or otherwise." But here the $ 4,000 paid to the petitioner was not to compensate him for any loss. He sustained no loss. It was to enable him to buy a house which thereafter belonged to him. The Schairer case is not authority for holding that the $ 4,000 was not income to the petitioner.Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623601/	PAUL G. DUBOIS and MARY G. DUBOIS, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentDu Bois v. CommissionerDocket No. 10644-78.United States Tax CourtT.C. Memo 1980-143; 1980 Tax Ct. Memo LEXIS 446; 40 T.C.M. (CCH) 263; T.C.M. (RIA) 80143; April 24, 1980, Filed 446 (1) At trial, Ps filed a motion for summary judgment contending that the deficiencies determined by the Commissioner ought not to be sustained since IRS was guilty of improper conduct toward Ps and since the Fifth Amendment to the U.S. Constitution permitted Ps to refuse to report their incomes.Ps offered no evidence to refute the deficiencies. Held, Ps' motion denied since Ps failed to prove misconduct, since such misconduct, if proved, would not affect the deficiencies, and since the Fifth Amendment does not permit Ps to refuse to report their incomes. Held, further, the deficiencies are sustained since Ps failed to carry their burden of disproving them. (2) Held, Ps were each liable for an addition to tax under sec. 6651(a), I.R.C. 1954, since they filed no returns for 1976 and showed no reasonable cause for their failure to file. (3) Held, Ps were each liable for an addition to tax under sec. 6653(a), I.R.C. 1954, since they failed to show that their underpayments of tax were not due to negligence or to intentional disregard of rules and regulations. (4) Held, Ps were each liable for an addition to tax under sec. 6654, I.R.C. 1954, since they failed447 to show that they did not underpay their estimated tax. Paul G. duBois and Mary G. duBois, pro se. Donald T. Rocen, for the respondent. SIMPSONMEMORANDUM OPINION SIMPSON, Judge: The Commissioner determined the following deficiencies in, and additions to, the petitioners' Federal income taxes for 1976: Additions to TaxSec. 6651(a)Sec. 6653(a)Sec. 6654PetitionerDeficiencyI.R.C. 1954 1I.R.C. 1954I.R.C. 1954Paul G. duBois$8,773.00$2,193.00$439.00$327.00Mary G. duBois515.00129.0026.0019.00448 The issues to be decided are: (1) Whether alleged improper conduct by the Internal Revenue Service toward the petitioners affected the deficiencies determined by the Commissioner; (2) whether the Fifth Amendment to the U.S. Constitution permitted the petitioners to refuse to report their incomes; and (3) whether the petitioners are liable for additions to tax under section 6651(a) for failure to file tax returns, under section 6653(a) for negligence or intentional disregard of rules and regulations, and under section 6654 for underpayment of estimated tax. The petitioners, Dr. Paul G. duBois and Mary G. cuBois, husband and wife, maintained their legal residence in Colorado Springs, Colo., at the time they filed their petition in this case. They filed a Form 1040 with the Internal Revenue Service for 1976; however, on the form, they disclosed no information relating to their incomes or deductions, and they stated that they had no tax liability. In his notices of deficiency, the Commissioner determined that Dr. duBois and Mrs. duBois were each liable for income taxes and self-employment449 taxes for 1976. He also determined that they were each liable for additions to tax under section 6651(a), relating to the timely filing of returns, under section 6653(a), relating to negligence or intentional disregard of rules and regulations, and under section 6654, relating to underpayment of estimated tax. At the trial, the petitioners filed a motion for summary judgment. Primarily, they contend that the deficiencies determined by the Commissioner ought not to be sustained since the IRS was guilty of misconduct in continually auditing them without reason, in denying them access to its records, in refusing their requests for assistance, in refusing them an audit hearing for 1976, and in refusing to sign an affidavit certifying the correctness of the determinations in the deficiency notices. However, the petitioners introduced no evidence to substantiate their allegations. It is well established that this Court generally will not look behind a deficiency notice to examine the evidence used or the propriety of the Commissioner's motives or of the administrative policy or procedures involved in making his determinations. Proesel v. Commissioner, 73 T.C. (Dec. 27, 1979); 450 Greenberg's Express, Inc. v. Commissioner, 62 T.C. 324">62 T.C. 324, 327 (1974); see also Estate of Brimm v. Commissioner, 70 T.C. 15">70 T.C. 15, 22 (1978). The failure of the IRS to follow its administrative procedures does not affect the validity of the notice of deficiency. See, e.g., Estate of Brimm v. Commissioner, supra; Boyer v. Commissioner, 69 T.C. 521">69 T.C. 521 (1977); Levine Brothers Co. v. Commissioner, 5 B.T.A. 689 (1925). Moreover, it has been recognized that the broad sweep of the Commissioner's power to enforce the revenue laws ( Donaldson v. United States, 400 U.S. 517">400 U.S. 517, 534-536 (1971); United States v. Roundtree, 420 F.2d 845">420 F. 2d 845, 850-851 (5th Cir. 1969)) vests in the Commissioner the discretion to determine which taxpayers should be audited. Greenberg's Express, Inc. v. Commissioner, 62 T.C. at 328-329. On occasion, this Court has departed from its practice of not looking back of the deficiency notice when there is substantial evidence of arbitrary or unconstitutional behavior by the IRS and the integrity of our judicial process would be compromised by permitting451 the Commissioner to benefit from such conduct. Jackson v. Commissioner, 73 T.C. 394">73 T.C. 394 (1979); Suarez v. Commissioner, 58 T.C. 792">58 T.C. 792 (1972). We have also observed that "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." Greenberg's Express, Inc. v. Commissioner, 62 T.C. at 328.In the limited situations where we look back of the deficiency notice, we do not strip the notice of all effect, as the petitioners request that we do in this case, but we merely impose on the Commissioner the burden of going forward with evidence. Jackson v. Commissioner, supra at 401; Suarez v. Commisioner, supra at 814. However, there is no evidence here that the petitioners were selected for audit on an unjustifiable criterion or that the IRS was guilty of any other arbitrary or unconstitutional conduct. The petitioners make the additional argument that the Fifth Amendment accords them the right not to report their incomes and file tax returns. This argument has been considered452 and rejected numerous times, and by now, it has become frivolous.E.g., United States v. Sullivan, 259">274 U.S. 259 (1927); United States v. Daly, 481 F. 2d 28 (8th Cir. 1973), cert. denied 414 U.S. 1064">414 U.S. 1064 (1973); Hatfield v. Commissioner, 68 T.C. 895 (1977). Accordingly, we deny the petitioners' motion for summary judgment.2The petitioners have the burden of proving the deficiencies determined by the Commissioner to be incorrect. Rule 142(a), Tax Court Rules of Practice and Procedure; Welch v. Helvering, 290 U.S. 111">290 U.S. 111 (1933).Here, the petitioners focused453 their arguments on their motion for summary judgment and introduced no evidence to refute the deficiencies. Accordingly, we sustain those deficiencies. The only other issue to be decided is whether the petitioners are liable for additions to tax under sections 6651(a), 6653(a), and 6654. Section 6651(a) provides for an addition to tax when a return is not timely filed, unless the failure to do so is shown to be due to reasonable cause; section 6653(a) provides for an addition to tax when an underpayment of tax is due to intentional disregard of rules and regulations or to negligence; and section 6654 provides for an addition to tax for underpayment of estimated tax. Since the Commissioner determined that the petitioners were liable for such additions to tax, they must carry the burden of showing that they are not so liable. Enoch v. Commissioner, 57 T.C. 781">57 T.C. 781 (1972); Reaver v. Commissioner, 42 T.C. 72 (1964); O'Donohue v. Commissioner, 33 T.C. 698 (1960). The Form 1040 filed by the petitioners did not constitute a "return" within the meaning of section 6012 because it disclosed no information relating to their income or deductions. *454 Commissioner v. Lane-Wells Co., 321 U.S. 219">321 U.S. 219 (1944); Hatfield v. Commissioner, supra.The petitioners introduced no evidence justifying their failure to file a return. They also failed to offer any evidence to show that their underpayments of tax were not due to negligence or intentional disregard of rules and regulations, and to show that they did not underpay their estimated taxes. Therefore, we sustain the additions to tax determined by the Commissioner.Decision will be entered for the respondent. Footnotes1. All statutory references are to the Internal Revenue Code of 1954 as in effect during 1976.↩2. On their Form 1040, the petitioners objected to reporting their incomes on the grounds of several other Amendments to the Constitution, and on the ground that the Federal Reserve notes they earned as income were not taxable "dollars." These arguments were never raised at trial, and we consider them to have been abandoned.See Hatfield v. Commissioner, 68 T.C. at 898 n. 2.In any event, the arguments are frivolous. See Tingle v. Commissioner, 73 T.C. (Feb. 7, 1980); Hatfield v. Commissioner, 68 T.C. at 897↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623602/	ESTATE OF VICTOR J. STRAUSS, DECEASED, VICTOR J. STRAUSS, JR., SUSAN STRAUSS ROBERTS AND JILL V. SUTTLE, CO-EXECUTORS, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentEstate of Strauss v. CommissionerDocket No. 1305-94United States Tax CourtT.C. Memo 1995-248; 1995 Tax Ct. Memo LEXIS 250; 69 T.C.M. (CCH) 2825; June 8, 1995, Filed 250 Decision will be entered under Rule 155. For petitioner: Stephen D. Reynolds For respondent: Gerald W. Douglas RAUMRAUMMEMORANDUM OPINION RAUM, Judge: The Commissioner determined a Federal estate tax deficiency of $ 405,209.03 (less $ 61,275.27 additional credit for State death taxes, if substantiated). After concessions, the only matter in controversy is whether the value of assets of a trust of which Victor J. Strauss (Victor or the decedent) was a beneficiary and a trustee is includable in his gross estate under section 2041. 1 He died on February 12, 1990, and at the time of his death, was domiciled in Danville, Illinois. The petitioner is the Estate of Victor J. Strauss, acting by and through its co-executors, Victor J. Strauss, Jr., Susan Strauss Roberts, and Jill V. Suttle. As stipulated by the parties, the "legal residence [of the co-executors] at the time of filing the251 petition herein [was] at P. O. Box 6068, Portland, Oregon." Decedent's mother, Martha V. Strauss (Martha), died on August 15, 1969. Decedent's sister, Ruth Strauss (Ruth), died without issue on April 7, 1977. Decedent's ex-spouse, Jane Strauss, died on April 4, 1991. Decedent and Jane Strauss were the parents of the three co-executors in this case, Victor J. Strauss, Jr. (Victor, Jr.), Susan Strauss Roberts, and Jill V. Suttle. The Last Will and Testament of Martha V. Strauss (the will or Martha's will) was executed on April 24, 1969. Article IV, paragraph A of the will provides, in part, as follows: The trustees shall, if my daughter Ruth survives me, create two trusts, one to be designated "RUTH STRAUSS TRUST" and one to be designated "VICTOR J. STRAUSS TRUST" and shall distribute one-half (1/2) in value * * * to Ruth Strauss Trust and one-half (1/2) in value * * * to Victor J. Strauss Trust * * Under the will, as described above, one-half of Martha's residuary estate was to be distributed to her two children, Victor and Ruth as co-trustees of the Ruth Strauss Trust, and the remaining one-half was to be distributed to the decedent and Ruth as co-trustees of the252 Victor J. Strauss Trust. Following Ruth's death on April 7, 1977, the Ruth Strauss Trust was added to and became a part of the Victor J. Strauss Trust, pursuant to Article IV, paragraph B, of Martha's will. At that time the decedent became the sole income beneficiary of the Victor J. Strauss Trust. Article IV, paragraph C. 1. of Martha's will provides, in part, as follows: The trustees shall, during the lifetime of Victor J. Strauss, pay to or use all the net income for Victor J. Strauss; if, in the trustees' sole discretion, they deem it necessary to use any or all of the principal of the Victor J. Strauss Trust for his care and comfort, considering his standard of living as of the date of my death and considering his income, right to income and other property he may have, as known to the trustees, they may pay to or use for him all or any part of the principal of that trust for such purposes.Article IV, paragraph C. 2. and 3. of the will provides that upon the decedent's death, the trust property of the Victor J. Strauss Trust should be continued in trust for the benefit of the decedent's ex-spouse, Jane Strauss, if surviving, and, if not, for the benefit of Ruth 253 Strauss for her lifetime. Article IV, paragraph D of the will provides that upon the death of the survivor of the decedent, Jane Strauss, and Ruth Strauss, the remaining trust property shall be continued in trust for the benefit of the surviving children of the decedent and the surviving lineal descendants of any deceased child of the decedent. After Ruth's death on April 7, 1977, the decedent became the sole trustee of the Victor J. Strauss Trust. The decedent continued to serve as the sole trustee from April 7, 1977, until September 12, 1977. After Ruth's death there were no distributions from the Victor J. Strauss Trust to the decedent until sometime after September 12, 1977. The parties stipulated that the "decedent began receiving distributions of income, but not principal, from the [Victor J. Strauss] Trust after September 1977." On September 12, 1977, by written instrument, the decedent appointed his son, Victor, Jr., as co-trustee of the Victor J. Strauss Trust. 2 The decedent and Victor, Jr., continued to serve as co-trustees of the Victor J. Strauss Trust from September 12, 1977, until the decedent's death on February 12, 1990. 254 In September 1984, all of the trust assets of the Victor J. Strauss Trust were transferred to Portland, Oregon, apparently the area of residence of Victor, Jr., for administration by him. The transfer of the trust assets to Oregon was done pursuant to Article VI, paragraph C, of Martha's will. The fair market value of the assets of the Victor J. Strauss Trust at the time of the decedent's death was $ 928,000. Petitioner excluded the value of the property held by the Victor J. Strauss Trust (i.e., $ 928,000) from the decedent's gross estate, and did not report that amount as an asset of the decedent on the Federal Estate Tax Return. The principal issue is whether the decedent had a general power of appointment over the trust property within the meaning of section 2041(b)(1), which defines such power as "a power which is exercisable in favor of the decedent, his estate, his creditors, or the creditors of his estate". But section 2041(b)(1)(C)(ii) provides that if such power can be exercised only "in conjunction with a person having a substantial interest in the property, subject to the power, which is adverse to its) exercise * * * in favor of the decedent -- such power shall 255 not be deemed a general power of appointment." During their respective periods as co-trustees, Ruth until her death and Victor, Jr., beginning some 5 months thereafter when appointed as co-trustee, each had a substantial interest in the property adverse to the exercise of the power as described in section 2041(b)(1)(C)(ii). And there is no disagreement between the parties that, except for that period of some 5 months, decedent's power was not a general power of appointment within the statutory definition. However, the Commissioner contends that the decedent's power ripened into a general power of appointment upon Ruth's death. Following her death the decedent, as the sole trustee, could appoint property to himself (invade corpus) according to the provisions of Martha's will. Relying upon section 2041(a)(2), the Commissioner argues further that the appointment of Victor, Jr., as a co-trustee, constituted a release of this general power of appointment "by a disposition which is of such nature that if it were a transfer of property owned by the decedent, such property would be includable in the decedent's gross estate under sections 2035 to 2038, inclusive." In particular, it 256 is the Government's position that section 2041(a)(2) is made applicable by section 2036(a)(1), relating to a transfer of property with a retained right to income for life. The Commissioner's argument requires a preliminary determination that the decedent, immediately following Ruth's death, possessed a general power of appointment which continued for some 5 months (a window of opportunity) until the appointment of Victor, Jr., as co-trustee. The definition of a "general power of appointment" found in section 2041(b)(1) was added as part of the Powers of Appointment Act of 1951, ch. 165, 65 Stat. 91. The definition survives in the Code unchanged since its original adoption in 1951. One of the principal purposes of the Powers of Appointment Act of 1951 was to provide a clear-cut definition of a general power of appointment. As the legislative history shows, the definition of a general power of appointment was intended to provide "a test of taxability which is simple, clear-cut, and easy to apply. * * * Your committee believes that the most important consideration is to make the law simple and definite enough to be understood and applied by the average lawyer, and that the present257 bill will accomplish that purpose." H. Rept. 327, 82d Cong., 1st Sess. at 4 (1951). The bill as originally introduced in the House contained the following definition of a general power of appointment: "For the purposes of this subsection the term 'general power of appointment' means only an unlimited, unrestricted power which is exercisable in favor of the decedent, his estate, his creditors, or the creditors of his estate." H.R. 2084, 82d Cong., 1st Sess. sec. 2(a) (1951). The final bill, as passed by the House and Senate, did not contain the qualifying language" unlimited, unrestricted power". The report of the Committee on Ways and Means states: While the words 'unlimited, unrestricted' have been eliminated from the definition by the committee amendment, the definition provides that, if certain limitations or restrictions are present, a power is not a general power even though exercisable by the decedent in his own favor." (Emphasis added.) H. Rept. 327, supra at 5. The committee report makes clear that limitations on a decedent's power to appoint property to himself, his estate, his creditors, or the creditors of his estate must come within the statutorily prescribed258 limits if such a power is not to be classified as a general power of appointment. While the use of this definition may mean that powers not properly considered general powers of appointment for State property law purposes will be swept into the statutory definition, adherence to that definition is said to fulfill the congressional goal of providing a test that is "simple, clear-cut, and easy to apply." 3259 H. Rept. 327, supra at 4. Thus, in its attempt to provide a bright line test for a general power of appointment for Federal estate tax purposes, the congressionally adopted definition may be both broader and more restrictive than state law definitions of a general power of appointment. 4The decedent, as the sole trustee of the Victor J. Strauss Trust from April 7, 1977, until September 12, 1977, had the power, if he deemed it necessary, "to use any or all of the principal of the Victor J. Strauss Trust for his [the decedent's] care and comfort, considering his standard of living as of the date of my [Martha V. Strauss's] death". Absent an applicable statutory exception, the decedent's power was a general power of appointment under section 2041(b)(1). However, section 2041(b)(1)(A) does contain a potentially relevant exception to the definition of" general power of appointment", 5 stating: (A) A power to consume, invade, 260 or appropriate property for the benefit of the decedent which is limited by an ascertainable standard relating to the health, education, support, or maintenance of the decedent shall not be deemed a general power of appointment.The exception found in section 2041(b)(1)(A) calls for a two-step analysis. First, the power of appointment must be limited by an ascertainable standard. Second, that ascertainable standard must relate to the health, education, support, or maintenance of the decedent. The Commissioner argues that the decedent's power to invade corpus for his "care and comfort" was not limited by an ascertainable standard. The Government's position is that "comfort" is too amorphous to provide an ascertainable standard. The Commissioner relies upon section 20.2041-1(c)(2), Estate Tax261 Regs., which states: "A power to use property for the comfort, welfare, or happiness of the holder of the power is not limited by the requisite standard." What we have here is a limitation based on "care and comfort", unlike "happiness", which is obviously an open-ended, unascertainable standard, cf. Merchants Natl. Bank of Boston v. Commissioner, 320 U.S. 256">320 U.S. 256 (1943) ("happiness"); Henslee v. Union Planters Natl. Bank & Trust Co., 335 U.S. 595">335 U.S. 595 (1949) ("pleasure"); but see Ithaca Trust Co. v. United States, 279 U.S. 151">279 U.S. 151 (1929) ("comfort" found to be an ascertainable standard). However, both parties agree that a decision as to whether a standard is ascertainable must be based on how that standard would be interpreted under applicable State law. Morgan v. Commissioner, 309 U.S. 78">309 U.S. 78, 80 (1940); Helvering v. Stuart, 317 U.S. 154">317 U.S. 154, 161 (1942). And both parties agree that Illinois law governs the Victor J. Strauss Trust. It is our opinion that the power of invasion, as it would be interpreted by the Illinois Supreme Court, is limited262 by an ascertainable standard. Of considerable importance here is an opinion of the Court of Appeals for the Seventh Circuit in an Illinois case that interprets "comfort" as a word of limitation. Pyle v. United States, 766 F.2d 1141">766 F.2d 1141 (7th Cir. 1985). Since the Seventh Circuit is the circuit that includes Illinois, its interpretation of Illinois law is entitled to particular deference. Helvering v. Stuart, supra at 163. In Pyle the Court of Appeals was called upon to decide whether a life tenant's power of invasion was limited by an ascertainable standard so that the remainder interest represented a completed gift. The life tenant could invade corpus for her "health, support, comfort and maintenance." Id. at 1144. The plaintiff focused on the word "comfort" to argue that an ascertainable standard did not exist, so a completed gift did not exist. 6 The Court of Appeals found that As Rock Island Bank & Trust Co. v. Rhoads, [187 N.E. 139">187 N.E. 139 (Ill. 1933)], illustrates, "comfort" is indeed an ascertainable standard under Illinois law. It refers to maintaining someone in the station263 of life to which that person is accustomed. Since [the life tenant's] station in life is known, the standard is measurable and hence ascertainable.Pyle v. United States, supra at 1145-1146. We find the reasoning of the Court of Appeals compelling, and see no reason to differ from it here. 7264 The Commissioner attempts to distinguish Pyle v. United States by pointing out that the standard in Pyle had other words of limitation (i.e. health, support, and maintenance), which were construed along with "comfort". However, in both the present case and in Pyle, "comfort" would provide the widest standard for invasion. Both cases are properly judged by the latitude offered by the inclusion of "comfort" as a standard. Further, the decedent's power of invasion was based on his comfort "considering his standard of living as of the date of * * * [Martha's] death and considering his income, right to income and other property as he may have". These additional words of limitation make clear that Martha intended that" comfort" be interpreted consistently with the above quoted language. We turn now to the second part of the section 2041(b)(1)(A) exception: the ascertainable standard must also relate to the health, education, support, or maintenance of the decedent. "A power is limited by such a standard if the extent of the holder's duty to exercise and not to exercise the power is reasonably measurable in terms of his needs for health, education, or support (or any combination265 of them)." Sec. 20.2041-1(c)(2), Estate Tax Regs. "Although sec. 2041(b)(1)(A) does not contain the word 'solely,' the statute must be construed as if it contained that word. Failure to so interpret sec. 2041(b)(1)(A) would obviate words chosen by Congress." Estate of Little v. Commissioner, 87 T.C. 599">87 T.C. 599, 601 n.5 (1986). The Commissioner argues that "care and comfort, considering his standard of living", as interpreted by the Illinois Supreme Court, would include items not within the meaning of "health, education, support, or maintenance." The Commissioner states: "For example, 'care and comfort' and 'standard of living' may include normal travel, entertainment, luxury items, and other expenditures which are not required for meeting the decedent's health, education, support, or maintenance." We think that the Commissioner attempts to impose too narrow a standard. No case that authoritatively defines "support" has been cited by either party. However, the Commissioner's own regulations state: "As used in this subparagraph, the words "support" and 'maintenance' are synonymous and their meaning is not limited to the bare necessities of life." Sec. 20.2041-1(c)(2), 266 Estate Tax Regs. The Supreme Court of Illinois stated that "comfort" should be interpreted so that the life tenant was maintained "in the station in life to which she was accustomed." Rock Island Bank & Trust Co. v. Rhoads, supra at 144. We fail to see how this materially differs from "support in his accustomed manner of living," an acceptable standard under the regulations. Sec. 20.2041-1(c)(2), Estate Tax Regs. This leads us to conclude that a standard designed to maintain the decedent in his station in life does relate to the decedent's health, education, support, or maintenance, as interpreted by the regulations. The Government also argues that the decedent's mother, Martha V. Strauss, knew how to restrict a power by the requisite standard when she chose to do so. The Commissioner points out that following the deaths of the decedent, Ruth Strauss, and Jane Strauss, distributions from principal could be made to the children of the decedent for their "reasonable support, comfort and education." 8267 However, the Commissioner also recognizes that the general rule for construing a trust under Illinois law is to find the settlor's intent. See Harris Trust & Savings Bank v. Beach, 513 N.E.2d 833 (Ill. 1987). In light of the fact that, at the time Martha's will was executed, the decedent was 47 years old, it is easy to conclude that Martha was not concerned with the decedent's education. Her main concern, as demonstrated by the terms of her will, was to maintain her two children in their accustomed standard of living. The terms of her will, under Illinois law, were effective in reaching that objective. Having decided that the decedent never possessed a general power of appointment as defined by section 2041(b)(1), we need not decide whether the appointment of Victor, Jr., represents a "release" of a power that requires the inclusion of the property subject to the power in the decedent's estate. We find that the decedent's power to appoint the trust corpus to himself, as interpreted under Illinois law, was limited by an ascertainable standard. We find, further, that the standard relates to the health, education, support, or maintenance of the 268 decedent. In order to reflect determinations made by the Commissioner in the notice of deficiency that were not contested by petitioner, Decision will be entered under Rule 155.Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code in effect at the date of decedent's death.↩2. There is no controversy between the parties as to the decedent's authority to appoint Victor, Jr., as co-trustee.↩3. We recognize that the effort to attain such simplicity could well result in a mirage. Cf. Foxman v. Commissioner, 41 T.C. 535">41 T.C. 535, 551, n.9 (1964), affd. 352 F.2d 466">352 F.2d 466 (3d Cir. 1965). And in 5 Bittker and Lokken, Federal Taxation of Income, Estates and Gifts, par. 128.1, at 128-3 (2nd ed. 1993), the authors referred to "all of the complexities of the tax definition", i.e., the sec. 2041(b)(1)↩ definition. (Emphasis supplied.)4. See 5 Bittker and Lokken, supra at par. 128.1 at 128-3: "In distinguishing general from nongeneral powers under sec. 2041(b)(1), federal law, rather than state nomenclature, is controlling. A power satisfying the conditions of sec. 2041(b)(1) is a 'general'power, even if state law characterizes it as 'special'; conversely, a power that does not satisfy sec. 2041(b)(1)↩ is not a general power, even if it is so labeled by state law." (Fn. ref. omitted.)5. Petitioner argues that the exception found in sec. 2041(b)(1)(C)(ii) also applies. In light of the conclusion hereinafter reached that the exception under sec. 2041(b)(1)(A)↩ applies, we need not address this point.6. Interestingly, in Pyle v. United States, 766 F.2d 1141">766 F.2d 1141↩ (7th Cir. 1985) the Government was arguing that "comfort" did represent an ascertainable standard under Illinois law, exactly the opposite of its position here. No reason for this change of position was suggested by the Commissioner here.7. See also Est. of Klafter v. Commissioner, T.C. Memo. 1973-230, holding that for purposes of secs. 2036(a)(2) and 2038(a)(1), a power of invasion to provide for the "support, maintenance, health, education and comfortable living" of the beneficiary was limited under Illinois law by an ascertainable standard (also citing Rock Island Bank & Trust Co. v. Rhoads, 139">187 N.E. 139↩ (Ill. 1933)).8. It is not evident to us why the inclusion of the word "comfort" in the standard by which distributions of principal may be made to Martha V. Strauss's grandchildren does not, under the Commissioner's argument as articulated in the case in chief, create a standard that is not limited by the requisite standard, exactly the opposite of the argument made by the Commissioner.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623603/	LEWIS W. MOORE AND SHIRLEY L. MOORE, Petitioners v. COMMISSIONER OF INTERNAL REVENUEMoore v. CommissionerDocket No. 32582-83.United States Tax CourtT.C. Memo 1987-626; 1987 Tax Ct. Memo LEXIS 671; 54 T.C.M. (CCH) 1407; T.C.M. (RIA) 87626; December 30, 1987. Thomas F. Topel, Kenneth672 L. Cutler, J. Marquis Eastwood, and Maureen H. Parkinson, for the petitioners. Randall G. Durfee and Joel A. Lopata, for the respondent. HAMBLENMEMORANDUM FINDINGS OF FACT AND OPINION HAMBLEN, Judge: Respondent determined a deficiency in petitioners' 1 Federal income tax for this year 1980 in the amount of $ 34,872.00. The primary issues for our determination are whether the ownership interest acquired by petitioner in a sale and leaseback transaction was supported by economic substance and whether petitioner acquired the benefits and burdens of any such ownership. Subsidiary issues for our determination are (1) whether the ownership interest acquired, if any, was a present depreciable interest; (2) whether the amount of the limited recourse note exceeds the fair market value of the computer equipment such that petitioner may not deduct interest paid on such note673 pursuant to section 163; 2 (3) whether petitioner was at risk for certain borrowed amounts pursuant to section 465; (4) whether petitioner was entitled to depreciate certain computer equipment pursuant to the half-year convention method of depreciation in the taxable year 1980; and (5) whether petitioner is liable for additional interest pursuant to section 6621(c). 3FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulation of facts and attached exhibits are incorporated herein by this reference. Petitioners resided in the state of Montana at the time the petition herein was filed. Petitioner is president of the Glendive Broadcasting Corporation; Moore Theatres, Incorporated; Moore Realty, Incorporated; and674 Glendive Cable Company. Petitioner and his family own all the stock of all the companies of which petitioner is president except Glendive Cable Company. Petitioner owns 50 percent of Glendive Cable Company. In a transaction that is the subject of this case, petitioner purchased from Finalco, Incorporated ("Finalco") certain used peripheral computer equipment 4 (the "Equipment") manufactured by International Business Machines Corporation ("IBM") and, in a simultaneous transaction, leased such equipment back to Finalco. 5675 FinalcoFinalco is the principal subsidiary of Finalco Group, Inc., formerly Financial Analytics Corporation, a publicly-held corporation, the stock of which is traded over-the-counter and reported in NASDAQ quotations. The principal offices of Finalco and the Finalco Group, Inc., are located in McLean, Virginia. During the years in issue, Finalco was a closely-held company. During the years in issue, Finalco typically engaged in leasing transactions involving electronic data processing equipment in which Finalco negotiated and entered into a lease with an end-user, purchased the equipment, financed the purchase with a lending institution, and resold the equipment in a sale and leaseback transaction with an independent third party. The resale of the equipment provided Finalco with much of the capital necessary to generate additional lease transactions. In addition to generating transactions through its own marketing programs, Finalco also acquired equipment subject to existing end-user leases from other leasing companies. During its fiscal year ending June 30, 1979, Finalco entered into lease transactions of approximately $ 129,000,000 based on the original cost of676 equipment. John F. Olmstead ("Olmstead") was president of Finalco at the time petitioner entered into the transaction. Lease Pro, Inc.Lease Pro, Inc., ("Lease Pro") is a Montana corporation engaged in the purchase, sale and leasing of computer equipment. Lease Pro has served as a general partner in a partnership that leases personal property, other than computer equipment, and owns an interest in a leased building. Lease Pro was owned by J. L. Dubois ("Dubois") and Dean Schennum ("Schennum"). Dubois acted as the sales agent at Lease Pro. Schennum acted as business manager and administrator. Dubois and Schennum are also the principals in Dubois-Schennum Assoc., Ltd., a Montana corporation organized in August of 1980, and registered with the National Association of Securities Dealers ("NASD") for the purpose of acting as a broker-dealer because leveraged computer investments were clarified as a security under Montana law. Lease Pro acted as sales agent for Finalco in the pursuit to locate investors. Lease Pro received a commission in the amount of ten percent of the equity investment, including cash and any recourse note. During 1979 and 1980, Lease Pro's revenue attributable677 to Finalco arranged computer investments approximated 90 percent of all revenue it earned. Lease Pro had no shareholders, officers, directors, or employees in common with Finalco Group, Inc., its affiliate, or subsidiaries. In 1980, Finalco changed the structure of Finalco arranged leveraged lease transactions to insert an intermediary purchaser into the chain of title between Finalco and the investor. Lease Pro acted as such an intermediary. The record indicates that the compensation earned by Lease Pro remained ten percent of the equity investment. Finalco prepared all documents and controlled the practice of dating documents. Lease Pro did not appraise computer equipment. Lease Pro relied on Finalco to structure and value all transactions. Comdisco Ownership and the End Users LeaseEarly in 1980 Comdisco Incorporated ("Comidsco"), owned the Equipment, some of which was leased to Canteen Corporation (the "Canteen Equipment") and some of which was leased to Aluminum Company of America (the "Alcoa Equipment"). Canteen Corporation ("Canteen") and Aluminum Company of America ("Alcoa") shall be referred to as the "End Users." LaSalle National Bank (the "Bank") financed678 the acquisition of the Equipment by Comdisco. Comdisco issued two nonrecourse Promissory Notes in favor of the Bank. One Promissory Note (the "Alcoa Note") in the principal amount of $ 219,079.69, dated March 1, 1980, with a maturity date of December 1, 1981, was secured by the Alcoa Equipment. A Second Promissory Note in the principal amount of $ 59,846.04, dated September 1, 1980, with a maturity date of October 1, 1983, was secured by the Canteen Equipment (the "Canteen Note"). The Alcoa Note and the Canteen Note may collectively be referred to as the "Bank Notes." Comdisco granted the Bank a security interest in the Equipment, End User Leases and rental payments from such leases. Pursuant to a Master Lease dated September 8, 1979 (the "Canteen Lease"), Comdisco leased the Canteen Equipment to Canteen. The Canteen Lease was a typical commercial triple net lease with an initial term of 39 months. By amendment effective May 1, 1980, the Canteen Lease contained a clause which allowed Canteen to terminate the Lease after the 24th month of the Lease without penalty if Canteen entered into a 30-month lease with Comdisco for certain equipment at a rate of 90 percent of the then-prevailing679 net IBM lease rate. Canteen does not have an option to purchase the Canteen Equipment. The terms of the Canteen Lease resulted from arm's-length negotiations between Comdisco and Canteen. The Alcoa Equipment was leased to Alcoa pursuant to a Master Lease (the "Alcoa Lease"), dated October 5, 1979. The Alcoa Lease was a typical commercial triple net lease with an initial term of 24 months, commencing January 3, 1980, and a monthly rental of $ 11,669. By amendment dated December 31, 1979, the Alcoa Lease was modified to give Alcoa the option to upgrade certain disk drives and a second option to terminate specific types of equipment during the first 12 months of the agreement. Alcoa did not have an option to purchase the Alcoa Equipment. The terms of the Alcoa Lease resulted from arm's-length negotiations. Purchase by BlackwoodIn a Purchase Agreement (the "Comdisco Canteen Purchase Agreement") dated December 1, 1980, Comdisco sold certain equipment and leases including the Canteen Equipment and the Canteen Lease to Blackwood Corporation ("Blackwood"), a wholly-owned subsidiary of Finalco Group, Inc. and a sister corporation to Finalco. Blackwood assumed debts secured680 by existing liens on the equipment. Comdisco warranted and acknowledged that all such debts were nonrecourse in nature. The sales price for the Canteen Equipment was $ 46,310.19. The fair market value as set forth in the Comdisco Canteen Purchase Agreement was $ 54,135. In a Purchase Agreement (the "Comdisco Alcoa Purchase Agreement") dated December 1, 1980, Comdisco sold certain equipment and leases, including the Alcoa Equipment and Alcoa Lease to Blackwood. Blackwood assumed debts secured by existing liens on the equipment. Comdisco warranted and acknowledged that all such debts secured by liens on the equipment were nonrecourse in nature. The fair market value of the Alcoa Equipment as specified in the Comdisco Alcoa Purchase Agreement was $ 342,325. The Comdisco Canteen Purchase Agreement and the Comdisco Alcoa Purchase Agreement will sometimes collectively be referred to as the "Comdisco Purchase Agreements." Blackwood executed three Promissory Notes in the principal amount of $ 463,291 each and one Limited Recourse Promissory Note for $ 6,472,495.07, due December 31, 1986. By Bill of Sale, dated December 1, 1980, Comdisco transferred the Alcoa Equipment to Blackwood. 681 When Blackwood acquired the Equipment, it entered into management and remarketing agreements with Comdisco ("Comdisco Management and Remarketing Agreements"). These agreements provided that Comdisco would manage the Equipment until December 30, 1986, at which time either party could terminate the agreements upon 30 days written notice. If an agreement was not terminated, Comdisco had the right to attempt to sell or re-lease the equipment covered by that agreement. Comdisco was to be paid for its services only if it was successful in its selling or releasing efforts. Comdisco, a publicly-held Delaware corporation, is unrelated to Finalco and is a competing equipment leasing company that buys and sells new and used IBM computer equipment and arranges leases on such equipment. Assignment to FinalcoIn Agreements dated December 2, 1980, Blackwood assigned all its right, title and interest in the Equipment to Finalco to enable Finalco to consummate the sale and leaseback transactions with persons desiring to acquire the Equipment. Finalco agreed to assume all of Blackwood's obligations pursuant to the Comdisco Purchase Agreement and Comdisco Management and Remarketing682 Agreement. Inquiry by PetitionersDuring 1980 and 1981, petitioner received substantially increased dividend distributions from his business entities. The increased dividend distributions were attributable, in part, to an excess accumulation of cash by Glendive Cable Company. Early in December of 1980, Curtis Ammondson ("Ammondson"), CPA, contacted petitioner regarding a possible investment in computer equipment. Ammondson had been petitioner's accountant for 20 years and was also the accountant for the closely held-corporations in which petitioner was a shareholder. Ammondson first heard of transactions involving the purchase of computer equipment from David Nortman ("Nortman"), a Lease Pro salesman in Great Falls, Montana. On December 23, 1980, Finalco prepared a sample projections (the "Projections") which Ammondson analyzed. The Projections showed that the after tax savings from the time of investment in 1980 through 1984 were projected to be $ 126,494. The taxes to be paid on the anticipated profits from 1985 through 1988 were projected to be $ 89,834 yielding an overall net tax savings of $ 36,660. The Projections assumed petitioner would make an equity investment683 of $ 77,000, which is $ 12,147 greater than their projected net tax savings. Ammondson determined that the proposed investment would be profitable if the computer equipment purchased was leased for more than six years and had a high resale value at the end of the lease. Ammondson did not consider himself to be a computer specialist nor did he believe he was qualified to value computer equipment. Ammondson relied on the representation of Nortman as to the value of the Equipment. Ammondson discussed the proposed transaction and Finalco's reputation with Robert Murray ("Murray"), a partner at McGladrey, Hendrickson and Compnay ("McGladrey"), who had personally invested in a Finalco computer leasing transaction. Murray also represented several clients who had invested in similar transactions. Ammondson recommended the investment to petitioner because, in his view, the investment had the advantages of tax deferral in early years and an economic return on investment, without regard to tax savings,in later years. Petitioner was in La Jolla, California, during December of 1980 so Ammondson explained the leasing transaction to petitioner by telephone. On December 21, 1980, petitioner684 authorized Ammondson, as petitioner's attorney-in-fact, to enter petitioner into the leasing arrangement. At the same time, Ammondson personally invested in a similar Finalco arranged leasing transaction which is a pending case before this Court. Ammondson was familiar with documents executed on behalf of petitioner. Petitioner relied solely on Ammondson for advice regarding the transaction. Agreement Between Finalco, Lease Pro And PetitionersIn 1980, Finalco adopted the practice of inserting an intermediary owner in the chain of title between Finalco and the investor. Lease Pro served as such an intermediary owner. Finalco adopted the practice on the advice of certain law firms. DuBois first learned of the intermediary structure from a sale Lease Pro executed with Finalco in which Finalco used an intermediary known as Gateway Aviation. Finalco purchased the computer equipment, arranged the end-user leases and bank financing. Lease Pro solely located equity investors. Lease Pro did not appraise or value computer equipment nor did Lease Pro determine the cost of the transaction to any investor. Finalco controlled all of the documents and controlled the dates of the685 transactions. In 1980, Finalco had adopted the practice of utilizing a one-page document to bind all parties when an investor agreed to purchase and lease equipment near the end of a taxable year. This procedure was adopted because Finalco did not have time to prepare all of the documents before the end of the year. On December 22, 1980, petitioner, who was in California, authorized Ammondson to act as his agent to purchase the Equipment for him by signing the documents required by the one-page agreement. The one- page agreement contained the essential terms of the transaction. On December 22, 1980, Ammondson, as agent for petitioner, executed a one-page agreement among petitioner, Lease Pro and Finalco (the "One-Page Agreement"). The One-Page Agreement provided that Finalco agreed to sell and Lease Pro agreed to buy the Equipment at a purchase price of $ 431,491, payable as follows: Cash$ 9,146Recourse Promissory Note67,000Full Recourse Installment Note355,345TOTAL $ 431,491The One-Page Agreement provided that Lease Pro agreed to sell and petitioners agreed to buy the Equipment for a purchase price of $ 433,045, payable as follows: 686 Cash$ 10,000Recourse Promissory Note67,700Limited Recourse Installment Note355,345TOTAL $ 433,045On such date, Ammondson did not know specifically the items of the Equipment to be acquired. Finalco agreed to lease the Equipment from petitioner for a term of 96 months at a rental of $ 5,763.83 per month. In addition, after the 72nd month of petitioner's lease to Finalco and continuing until the end of that lease, 50 percent of net rentals received by Finalco from any end user lease would be paid to petitioner ("Interim Revenue"). The parties agreed to execute documents referred to in the One-Page Agreement at a later date. Those documents were incorporated by reference in and made a part of the One-Page Agreement. Although copies of the sample documents were not physically attached, Ammondson received and reviewed copies of sample documents prior to the time petitioners executed the One-Page Agreement. Ammondson entered into a similar transaction for himself and was familiar with the content of the sample documents. DuBois executed the One-Page Agreement on behalf of Lease Pro on December 22, 1980. Finalco executed the One-Page687 Agreement on December 30, 1980. On December 22, 1980, petitioner mailed a cashier's check in the amount of $ 10,000 to Lease Pro. Petitioner incorrectly made the check payable to the order of Finalco rather than Lease Pro. On December 22, 1980, Ammondson, as agent for petitioners, executed a full recourse Promissory Note and Security Agreement (the "Recourse Note") in the amount of $ 67,700 in favor of Lease Pro. On December 22, 1980, Ammondson, as agent for petitioner, attempted to execute an Agreement of Assumption; however, neither the assumed amount or the lender were identified. Ammondson merely signed the Agreement of Assumption in blank form. The Agreement of Assumption was one of the documents that Lease Pro provided Ammondson on December 22, 1980, as part of the document package to be executed. Any payments petitioners made on the Agreement of Assumption reduces the recourse portion of the Limited Recourse Note they executed in favor of Lease Pro. The amount assumed was never intended to be in addition to the purchase price. Sale to Lease ProIn 1981, after Finalco prepared the documents required by the One-Page Agreement, Finalco and Lease Pro executed a Prchase688 Agreement (the "Finalco Purchase Agreement"), whereby Finalco transferred the Equipment to Lease Pro. The total purchase price of $ 431,491 was payable as detailed on the One-Page Agreement. Lease Pro delivered petitioner's Recourse Note for $ 67,700 to Finalco in 1981 in lieu of issuing its own note to Finalco for $ 67,700. In 1981 Lease Pro executed and delivered a Full Recourse Promissory Note for $ 355,345 in favor of Finalco. It included a deferral provision, providing that if petitioner did not pay Lease Pro amounts due on the Limited Recourse Note, Lease Pro could defer payment to the extent of the recourse amount of petitioner's Limited Recourse Note. Lease Pro's right to defer payments continued so long as petitioner was in default, but in no event could the deferral extend beyond December 1, 1990. The deferred amounts did not bear additional interest. By Bill of Sale, Finalco transferred the Equipment to Lease Pro, subject to the Lien, the End User Leases and the rights of Comdisco. Early in February of 1981, petitioner executed all documents required by and incorporated in the One-Page Agreement. These documents conformed with the sample documents Ammondson had689 reviewed before December 22, 1980. Included were the following: (a) a Purchase Agreement (the "Lease Pro Purchase Agreement") providing that petitioner purchase the Equipment from Lease Pro for a total purchase price of $ 433,045 as detailed in the One-Page Agreement. (b) a Limited Recourse Promissory Note-Security Agreement (the "Limited Recourse Note"), dated December 1, 1980, in favor of Lease Pro in the amount of $ 35,345 plus interest at the rate of 12 percent per year. (c) a second Agreement of Assumption (the "Assumption") in which petitioner assumed on a recourse basis $ 179,668 of the Bank Note. The Limited Recourse Not was to be paid by 96 equal monthly payments of $ 5,718.18 each. According to its terms, petitioner was personally liable for $ 179,668 (the "Recourse Amount") of principal plus accrued interest. Petitioner's obligations under the Limited Recourse Note in excess of the Recourse Amount could be satisfied only out of the rent and other proceeds of the Equipment. The Limited Recourse Note contained a deferral of payment provision providing that in the event that Finalco does not pay rent to petitioner, petitioner may defer payment of principal690 and interest, to the extent of the unpaid rent. The right to defer payments terminates on the earlier of the receipt of the delinquent rental payments or December 1, 1990. To secure the obligation represented by the Limited Recourse Note, the Limited Recourse Note granted Lease Pro a purchase money security interest in (i) the Equipment, (ii) any lease of the Equipment, and (iii) the proceeds from the transfer or lease of the Equipment. In February of 1981, a second Agreement of Assumption was executed to replace the earlier Agreement of Assumption signed by Ammondson in blank on behalf of petitioners on December 22, 1980. It was not intended to alter or enlarge petitioner's liability or the indebtedness being assumed. The Assumption was on a full recourse basis. Finalco sent the executed Assumption to the Bank. In the event that petitioner is required, pursuant to the Assumption, to pay amounts due on the Bank Note, all amounts paid shall be deemed prepayments of the Recourse Amount under the Limited Recourse Note. Petitioner satisfied the Recourse Note by payment of four annual installments such that the final payment on the Recourse Note was paid on December 10, 1984. 691 By June 1, 1981, the Lease Pro Purchase Agreement, Limited Recourse Note, Owner Lease, Remarketing Agreement and Finalco Purchase Agreement were amended to correct an error in the equipment listing that had been attached to those agreements. Lease to FinalcoEarly in February of 1981, petitioner executed a Lease Agreement ("Owner Lease") between petitioner and Finalco, effective December 1, 1980, providing that Finalco would lease the Equipment from petitioner. The term of the Owner Lease was from December 1, 1980, to December 31, 1988 (the "Original Term"), at a monthly rental of $ 5,763.82. Pursuant to an Assignment dated December 1, 1980, petitioner mistakenly assigned the Owner Lease to Gateway Aviation Holdings, Ltd. as additional security for payment of the balance due under the Limited Recourse Note. Gateway Aviation Holdings, Ltd, was another intermediary owner inserted in the chain of title by Finalco in Certain other transactions. The assignment reflected a drafting error as the parties intended to assign the Owner Lease to Lease Pro. Petitioner received $ 45.64 per month from Finalco which was the rent owed by Finalco after deducting the Limited Recourse Note692 payments owed by petitioners to Lease Pro (the "cashflow"). Remarketing and Residual SharingEarly in February of 1981, petitioners signed a Remarketing Agreement ("Remarketing Agreement") and Residual Sharing Agreement (the "Residual Sharing Agreement"). Pursuant to the Remarketing Agreement, petitioner agreed to pay Finalco for remarketing services performed by Finalco, ten percent of the proceeds received by petitioners from the sale or re-leasing of the Equipment at the end of the Owner Lease. The Residual Sharing Agreement provided that after the 72nd month of the Owner Lease and continuing until the end of the Owner Lease, all proceeds from leasing the Equipment will be distributed 50 percent to petitioner and 50 percent to Finalco. At the end of the Owner Lease all proceeds from the sale or re-lease of the Equipment will be distributed to petitioner until they have received 120 percent of their net equity in that Equipment. Net equity is defined as the sum of petitioner's cash payments less cash flow distributions to petitioners. Thereafter, petitioner will receive all proceeds but is obligated to pay Finalco a commission of 20 percent of the remaining proceeds693 if Finalco is responsible for the sale or re-lease of the Equipment. By amendment dated December 1, 1980, the Remarketing Agreement between Finalco and petitioner was amended to replace the Canteen Equipment schedule to conform to the schedule attached to the Purchase Agreement between petitioner and Lease Pro. The Purchase Agreement refers to the existence of the Comdisco Management and Remarketing Agreement but contains no reference to the Comdisco Management and Remarketing Agreement with respect to the effect of the remarketing provisions of the Purchase Agreement where Comdisco remarkets the Equipment. The Comdisco Management and Remarketing Agreements is referenced in a document titled "Agreement as to Prior Liens, Encumbrances, and Assignments" dated December 1, 1980 which petitioner signed at the time of entry into the transaction. According to Olmstead, Finalco is entitled to a 20 percent commission if and only i f it is responsible for the sale or re-lease of the Equipment. According to Phillip Hewes ("Hewes"), a staff attorney at Comdisco who drafted the Comdisco Management and Remarketing Agreement, Comdisco is entitled to a commission if an only if Comdisco is responsible694 for the sale or re-lease of the Equipment. Hewes provided no indication that Comdisco intended to manage and remarket the Equipment beyond the initial use of the End User or to otherwise service petitioner as Owner beyond such time as the End User terminated the use of the Equipment. The terms of the Comdisco Management and Remarketing Agreement indicate that such Agreement was drafted to benefit Comdisco and was a necessary requirement of the sale toFinalco pursuant to the Comdisco Purchase Agreement. Practice of Dating DocumentsThe Purchase Agreement and related documents were signed by petitioners in February of 1981; however, the documents bore earlier dates, generally December 1, 1980. The One-Page Agreement which required the execution of these documents was not signed by Ammondson until December 22, 1980. The documents executed by petitioners in February, 1981 were prepared by and the dates inserted by Finalco. Finalco generally dated the documents transferring title to equipment on or before the date of the end user lease so that the banks that financed the acquisition of the equipment would have a first perfected security interest in the equipment. According695 to Olmstead, Finalco's practice was never to date documents in a year prior to the tax year in which the investor purchased the equipment; if the investor purchased the equipment in the last half of a taxable year, the documents were never dated in the first half of the taxable year. The documents in this case were dated in 1980 because of the End User Leases. Finalco believed that the parties had entered into a binding agreement before the end of 1980 and the documents signed in 1981 were incorporated by reference in and made a part of the One-Page Agreement. Industry ConditionsThe market for third party leasing of computer equipment developed rapidly in the 1970's. Projections of residual values are critical to evaluate an investment in computer equipment. Such projections vary among experts and fluctuate with market conditions. Computers do not depreciate with age, but rather are subject to technological obsolescence. Because IBM dominates the computer industry, the technology advancements of IBM products have significant impact upon the residual value of progenitors. Industry experts have had varied success in the ability to predict technology advancements of IBM. 696 The volume of used computer equipment transactions can be discerned from the advertisement of the weekly trade journal Computer World. IBM has the largest market share and IBM computer prices are evidenced in the Computer Price Guide ("the Blue Book"). 6The computer industry has been dominated by the technological advancements and the strategic product planning of IBM for nearly three decades. In 1964, IBM introduced the IBM 360 Series of computers. The 360 unified a diverse line of computers into a single new compatible family. In 1971, IBM introduced the 370 series. The available 370 configurations were designed to extend from low demand end users to high demand end users. The sales performance of mid-range products was unsatisfactory to IBM. High demand end users were willing to acquire the latest technology697 thereby creating a market demand for high demand end users. The emergence of a significant market in the low demand end user market created a market demand for low demand end user products. In June of 1976, IBM announced the 370/138 and the 370/148 computers which were designed to enhance the sales performance of the products within the mid-range 370 series. The price performance capabilities of the 370/138 and 370/148 out distanced the earlier 370 series computers. The initial market reaction was highly favorable such that during 1977 the fair market value in the used equipment market of 370/138 and the 370/148 exceeded the IBM list price. The computer industry was generally tranquil during the mid-1970's. In March of 1977, IBM introduced the 303X computer. Despite introduction of the 303X and the IBM price reductions on the 370/158 and 370/168, prices of used computers remained at relatively high and stable values. The Blue Book stated in the July, 1977 issue that most of the equipment in general use at that time will have substantial value at the end of the 1980's. In October of 1977, IBM announced two additional 303X computers, the 370/3032 and the 370/3031. Datamation698 magazine, an industry publication, noted that the new processors were so similar to the 370/158 and the 370/168 that "the industry yawned as IBM this fall announced the much rumored 3031 and 3032 central processor." The 370/158 and 370/168 were of comparable price performance capabilities to the 370/303X family. During the late 1970's, IBM was faced with increased competition from manufacuturers of plug compatible equipment, imitation IBM equipment designed to displace IBM equipment, particularly plug compatible central processors. IBM also faced increased competition from manufacturers of mini computers. In January of 1979, IBM introduced the 4300 series. The industry had not expected the drastic increase in the price performance capabilities presented by the 4300 series. The IBM marketing strategy undertaken to react to the plug compatible processors and the mini computer market significantly reduced the previous prognostications of mainframe residual values. While the mainframe market was devastated following the introduction of the 4300 series in January of 1979, the market for peripheral equipment remained somewhat stable. The primary factor for such occurrence was that699 most peripheral equipment for the 360 and 370 series was compatible with the 303X series and, significantly, the 4300 series. The residual value of IBM peripheral equipment for any such series was generally insulated from the adverse market effect of subsequently introduced central processors due to the compatibility of most peripheral equipment. Furthermore, the basic electromechanical nature of peripheral equipment precluded the rapid technological advancements inherent to mainframe products. The Equipment and Expert Testimony of ValuePetitioner purchased the following IBM peripheral equipment: Year ofMachineMarketEnd UserQuantityTypeDescriptionDeliveryAlcoa23211-1Pringer Unit197023211-1Control Unit197023333-1Dual Master1971Disk Drive 13330-1Dual Share1971Disk Drive 43350B2Dual Share1976Disk Drive 13350A2Dual Master1976Disk Drive 13830-2Disk Control1972with Features 7Canteen13803-1Tape Control1971Unit 33420-7Magnetic Tape1971Unit 700 Esmond C. Lyons, Jr. ("Lyons") was qualified to testify as an expert on behalf of petitioner. Lyons is the principal management consultant in the Information, Services and Systems Division of SRI International ("SRI"), formerly known as the Stanford Research Institute. SRI is a not-for-profit corporation which is involved in technology research and management consulting for business and government clients. Dee Morgan ("Morgan") was qualified to testify as an expert on behalf of respondent. Morgan has worked for IBM as a systems service representative and for Burroughs Corporation as a technical service representative. From 1965 through 1983, Morgan was employed by the General Services Administration ("GSA") as a computer equipment analyst and data processing systems coordinator. While employed with GSA, Morgan provided estimates of residual value and economic life of computer equipment to the Defense Contract Audit Agency. Lyons determined the following fair market values for the Equipment as of December, 1980: IBMBlue BookEnd UserList PriceValueAlcoa$ 516,860$ 335,959Canteen99,82037,932$ 616,680$ 373,891Lyons concluded701 within his report that petitioner's cost to acquire the Equipment was somewhat high, unless special conditions were attendant to the transaction. Lyons determined the eight-year residual value of the Alcoa Equipment as of the December, 1980 to be as follows: Alcoa EquipmentQuantityMachine TypeResidual ValuePercent of IBMList PriceDollar Value23211/381110-305,000 - 15,00013830-210-207,000 - 14,00033333/33300-10 0 - 10,000 53350 A2, B210-2015,000 - 30,000Considering the 3830-2, the two 3211/3811's, the three 3330/3333's and the five 3350's, the cumulative eight-year residual value of the Alcoa Equipment as determined by Lyons as of December, 1980 would have been between $ 45,000 and $ 70,000, 8 or approximately 10 to 15 percent of the IBM list price. Lyons determined the eight-year residual value of the Canteen Equipment as of December of 1980 to be as follows: Canteen EquipmentResidual ValueQuantityMachinePercent of IBMList PriceDollar Value13803-115-203,500 - 5,00033420-78-10 2,000 - 2,500702 Considering the 3803-1 and the three 3420's, the cumulative eight-year residual value of the Canteen Equipment as determined by Lyons as of December of 1980 would had been between $ 10,000 and $ 13,000, or approximately 10 to 13 percent of the IBM List price. Morgan determined the following fair market values of the Equipment as of December, 1980: 9IBMBlue BookEnd UserList PriceValueAlcoa$ 548,050$ 356,000Canteen88,52049,500$ 636,570$ 405,500Morgan concluded that the fair market value of the Equipment during December of 1980 was $ 396,460, such amount being approximately five percent below the Blue Book asking price and also being the fair market amount as indicated in the Comdisco Purchase Agreements. Morgan concluded that in December of 1980 it would have been reasonable to conclude that the residual value of the Equipment on December 1, 1986, the703 Interim Revenue date pursuant to the Residual Sharing Agreement, and on December 1, 1988, the termination date of the Owner Lease to be as follows: End UserMachineResidual ValueEquipmentTypeQuantity12-1-198612-1-1988Alcoa3350-824$ 10,000$ 2,0003350-A213,5007003820-2 13,0001,500Canteen-0--0-$ 16,500$ 4,200Tax ReportingPetitioner is a cash basis reporting on a calendar year basis. After the close of calendar year 1980, petitioner received from Finalco documents entitled Tax Summary for the year ending December 31, 1980, for the Canteen Equipment and the Alcoa Equipment, setting forth the following information which was used by petitioner in filing his 1980 Federal income tax return: Finalco Lease Income$ 5,763.82 Expenses (Depreciation)( 64,956.75) Taxable Income (Loss)($ 59,192.93)Finalco prepared a completed Class Life Asset Depreciation Range System Form 4832 for the year 1980, a copy of which petitioner attached to the 1980 Federal income tax return. Petitioner elected the half-year convention using 150 percent declining balance method of704 depreciation and a five-year useful life. For each of calendar years 1980 through 1984, inclusive, petitioner reported on his Federal income tax return a net loss from his equipment purchase and leaseback transactions with respect to the Equipment, as follows: Taxable Year EndedNet LossDecember 31, 1980 59,192.93 December 31, 198191,854.39December 31, 198251,987.84December 31, 198338,888.41December 31, 198431,279.00For calendar year 1985, Finalco projected that petitioner would recognize taxable income from his equipment purchase and leaseback transaction in the amount of $ 9,907.00. OPINION The present case in a companion case selected as a representative test case for a large number of dockets involving the investment in Finalco arranged sale and leaseback transactions of leveraged computer equipment. 10 The issues presented here are similar to those presented in the companion cases except that the transactional structuring differed in certain pertinent respects. 705 At the outset, we address respondent's primary assertion that petitioner's transactions with respect to the Equipment were a tax-avoidance scheme devoid of economic substance which is to be disregarded for Federal income tax purposes. Petitioner asserts that ownership of the Equipment for Federal income tax purposes has been established where petitioner entered the transaction with the requisite business purpose and the transaction was supported by economic substance. Taxpayers are generally free to structure their business transactions as they please, though motivated by a tax reduction considerations. Gregory v. Helvering293 U.S. 465">293 U.S. 465 (1935); Rice's Toyota World, Inc. v. Commissioner,81 T.C. 184">81 T.C. 184, 196 (1983), affd. on this issue 752 F.2d 89">752 F.2d 89 (4th Cir. 1985). However, it is well settled that a transaction entered into solely for the purpose of tax reduction and which is without economic, commercial or legal purpose other than the expected tax benefits is a sham without effect for Federal income tax purposes. Frank Lyon Co. v. United States,435 U.S. 561">435 U.S. 561 (1978); Rice's Toyota World, Inc. v. Commissioner,81 T.C. at 196;706 Grodt & McKay Realty, Inc. v. Commissioner,77 T.C. 1221">77 T.C. 1221, 1243 (1981). The existence of tax benefits accruing to an investor does not necessarily deprive a transaction of economic substance. Frank Lyon Co. v. United States, supra;Estate of Thomas v. Commissioner,84 T.C. 412">84 T.C. 412, 432 (1985). A transaction which is devoid of economic substance is not recognized for Federal income tax purposes. Frank Lyon Co. v. United States,435 U.S. at 573; Knetsch v. United States,364 U.S. 361">364 U.S. 361, 366 (1960). In the sale and leaseback context, we set forth a standard that the nonuser-owner recipient of tax benefits must specifically establish that the entry into the transaction was motivated by business purpose to justify the form of the transaction and that the transaction was supported by economic substance. Rice's Toyota World, Inc. v. Commissioner,81 T.C. at 201-203. 11 In Rice's Toyota World, Inc., we stated that the tests developed under the sham transaction doctrine are applied to determine whether a threshold level of business purpose or economic substance is present. Rice's Toyota World, Inc. v. Commissioner,81 T.C. at 196.707 12Our inquiry of business purpose and economic substance is inherently factual as indicated in several recent cases concerning sale and leaseback transactions of computer equipment. Torres v. Commissioner,88 T.C. 702">88 T.C. 702 (1987); Bussing v. Commissioner,88 T.C. 449">88 T.C. 449 (1987), Supplemental Opinion 89 T.C. (filed Nov. 24, 1987); Gefen v. Commissioner,87 T.C. 1471">87 T.C. 1471 (1986); Mukerji v. Commissioner,87 T.C. 926">87 T.C. 926, 968 (1986); James v. Commissioner,87 T.C. 905">87 T.C. 905 (1986); Coleman v. Commissioner,87 T.C. 178">87 T.C. 178 (1986), affd. per curiam 833 F.2d 303">833 F.2d 303 (3d Cir. 1987); Estate of Thomas v. Commissioner, supra; Rice's Toyota World, Inc. v. Commissioner, supra.13708 We noted in Rice's Toyota World that the drawing of a precise line of demarcation between valid and invalid transactions is invariably difficult. Rice's Toyota World, Inc. v. Commissioner,81 T.C. at 197. In this context, petitioner bears the burden of proof as respondent's determination that the transaction was a tax-avoidance scheme devoid of economic substance is presumptively correct. Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933); Rule 142(a). Based on our review of the record herein, we conclude that the transaction was not motivated by a business purpose and was devoid of economic substance so as to be disregarded for Federal income tax purposes. We are convinced that the form of the transaction and the attendant inquiry demonstrated by petitioner belies a determination that petitioner manifested a business purpose. Petitioner relied solely on the advice and inquiry of Ammondson. Ammondson explained the computer leasing transaction by telephone conversation while petitioner was in La Jolla, California. Petitioner authorized Ammondson to sign the One-Page Agreement based on such telephone conversation. Ammondson did not specifically know709 the items of the Equipment at the time he executed the One-Page Agreement as petitioner's attorney-in-fact other than that IBM manufactured the Equipment. Petitioner was in Montana during the last week of December and made no effort regarding the transactions. Ammondson's sole inquiry concerning the fair market and residual valuation of the Equipment was to confer with Murray at the accounting firm of McGladrey. Ammondson was aware that the existence of economic profit depended upon significant residual value of the Equipment and the receipt of contingent Interim Revenue, yet no effort to determine or otherwise evaluate the economic potential for profit was performed. Petitioner and Ammondson were clearly motivated by the attendant tax considerations of the Finalco arranged lease. We find that the fact Ammondson and Murray had entered similar transactions with Finalco to be immaterial to our determination. We are convinced that petitioner did not manifest a business purpose necessary to justify the form of the transaction. We perform an objective analysis of the transaction to determine whether any realistic opportunity for economic profit existed exclusive of the propitious710 tax benefits. In so doing, we analyze the transaction as a prudent investor. Rice's Toyota World, Inc. v. Commissioner, 1 T.C. at 209. The parties rely on expert testimony to establish the fair market value and residual value of the Equipment as of December of 1980. We are not bound by the opinion of any expert witness when that opinion is contrary to our own judgment. Chiu v. Commissioner,84 T.C. 722">84 T.C. 722, 734 (1985). We may embrace or reject expert testimony, whichever, in our best judgment, is appropriate. Helvering v. National Grocery Co,304 U.S. 282">304 U.S. 282 (1938); Silverman v. Commissioner,538 F.2d 927">538 F.2d 927, 933 (2d Cir. 1976), affg. a Memorandum Opinion of this Court. Based on our analysis of this record, we determine that the transaction was not supported with economic substance such that the transaction did not present a realistic potential for profit. The Purchase Agreement between petitioner and Lease Pro 14 included the Alcoa Equipment and the Canteen Equipment. The Purchase Agreement stated that the cost of the Equipment to be the amount of $ 433,045 but did not separately state the individual cost of the Alcoa711 Equipment and the Canteen Equipment. 15 Petitioner's expert Lyons determined the separately stated purchase price to be as follows: Alcoa Equipment$ 378,91016Canteen Equipment 54,135$ 433,045We are satisfied that petitioner paid an amount in excess of fair market value for the Equipment. The experts did not agree on the IBM list price or the Blue Book value of the Equipment712 even though each expert valued the Equipment as of December of 1980. We appreciate the difficulty encountered to prognosticate a 96-month residual value of computer equipment; however, we are somewhat perplexed as to the disagreement regarding the IBM list price and the published Blue Book value in December of 1980. Petitioner's expert, Lyons, separately stated the petitioner's cost of the Alcoa Equipment to be $ 378,910 and the Blue Book value to be $ 335,959. Morgan determined the Blue Book value to be $ 356,000. Because Morgan viewed the Blue Book as a negotiable asking price, she determined the fair market value of the Alcoa Equipment to be $ 342,325 such amount being designated in the Comdisco Purchase Agreement as the fair market value of the Alcoa Equipment. Finalco through Blackwood paid the amount of $ 342,325 for the Alcoa Equipment. We attribute a reasonable degree of value to the circumstance that petitioner acquired an arranged leveraged lease subject to an end-user commitment. Mukerji v. Commissioner,87 T.C. at 965. We find no justification for the amount petitioner paid for the Alcoa Equipment other than the desire of Finalco to inflate the713 purchase price. See James v. Commissioner, supra.The fair market value of the Alcoa Equipment as arranged by Finalco was not in excess of the Blue Book amount of $ 356,000 as determined by Morgan. The Blue Book amount offered by Lyons is less than the amount Finalco paid through Blackwood pursuant to the Comdisco Purchase Agreement. For such reason, we find Morgan's view to be more accurate. Within his report, Lyons stated that "unless there were special conditions to the transaction, we consider the price that was paid to be somewhat high." We agree with Lyons in this respect. The special conditions were the inflated basis to generate an excessive depreciation deduction and the benefit of operating cash flow to Finalco at such time as the Alcoa Note was satisfied. We are also certain that petitioner paid an amount in excess of fair market value for the Canteen Equipment. The Purchase Agreement as executed by petitioner did not schedule the correct equipment due to administrative error at Finalco. By amendment backdated to December 1, 1980, Finalco attempted to correct the equipment schedule. However, Finalco incorrectly represented that petitioner acquired714 five IBM 3420-7 Magnetic Tape Units. The Canteen Equipment in fact included three IBM 3420-7 Magnetic Tape Units as represented in the Comdisco Purchase Agreement. Lyons submitted two reports so as to value each scenario. Lyons determined that the amount of $ 54,135 was a "beneficial" price to pay for five IBM 3420-7 Magnetic Tape Units. Lyons concluded that the purchase price of $ 54,135 was "somewhat high" to acquire three IBM 3420-7 Magnetic Tapes Units. At trial, Lyons stated that the purchase price paid for the three units actually acquired was "within the range" of the premium to be paid for an arranged leveraged lease subject to an end-user commitment. While we find the methodology and testimony of Lyons to be generally credible, we find such assertion to be without support. Lyons determined the Blue Book value of the Canteen Equipment to be $ 37,932 with the acquired three IBM 3420-7 Magnetic Tape Unit price at $ 8,101 per unit; yet, he asserts that $ 54,135 was "within the range" of a reasonable value. Such statement is without basis and sets the perimeters of ranges at unacceptable limits. In our view, petitioner paid the fair market value or a "beneficial price" 715 for five IBM 3420-7 Magnetic Tape Units, and we agree with Lyons that the amount of $ 54,135 was a fair market value for such equipment if included in the Canteen Equipment. Nonetheless, the record is clear that petitioner in fact acquired only three IBM 3420-7 Magnetic Tape Units and that petitioner paid, according to Lyons, 54 percent of the IBM list price at such time that the Blue Book asking price for the Canteen Equipment was 38 percent. We are certain that petitioner paid for equipment not included in the Canteen Equipment. Consequently, petitioner paid an amount in excess of fair market value. While we attribute a reasonable degree of value to the circumstance that petitioner acquired an arranged leveraged lease subject to by an end user commitment, the amount paid by petitioner was excessive. See James v. Commissioner,87 T.C. at 920; compare Mukerji v. Commissioner,87 T.C. at 965. We now address whether the residual value of the Equipment and any Interim Revenue to be received by petitioner provided petitioner with a realistic potential for profit. Petitioner is entitled to cash flow during the 96-month Owner Lease in the amount of716 $ 4,381.44. Lyons provided a range of residual value for each transaction. 17 We found the general methodology of Lyons to be credible. We are satisfied that Lyons relied solely upon methods and data available in December of 1979 to determine the residual values. Lyons analyzed the historical performance of pre-existing equipment designed to perform functions similar to that of the Equipment to determine economic life. Lyons reviewed the previous price performance of the Equipment and analyzed current developments to determine whether the technological obsolescence of the Equipment was expected. Lyons noted that the prognostication of residual values was subject to different views within the industry. To illustrate such point, Lyons appended to his report an article from the December 1, 1980 issue of Fortune Magazine titled "Fortune-Tellers in the Computer Bazaar." Such article compared the predictions firms made in 1979 and 1980 for the 198a residual value of the IBM 3033. The Owner Leases at issue were for 96 months rather than a one- to two-year period which presented the fortune-teller of the Equipment with a formidable task. Consequently, the prognostication in December717 of 1979, of the 96th month residual values at issue was certainly a task thick with mist. As one computer broker quoted in the Fortune Magazine article stated, "all the estimators do is throw darts at a board." In this context, we do not fault the opinion testimony of Lyons which cast the residual values in their form of range. For such reasons and as further discussed herein, we accept the low-range residual value of Lyons in each transaction. The testimony of Lyons is flawed in an aspect of paramount significance in this transaction. The record indicates that a critical aspect of the transactions at issue was the effect of the Residual Sharing Agreements in the performance of our objective analysis. The Residual Sharing Agreements provided that petitioner was entitled to share 50 percent of all Interim Revenue with Finalco commencing after the 72nd month of the Owner Lease. An opinion as to the amount of contingent Interim Revenue to be received is a fundamental variable in our objective analysis. 718 Interim Revenue is to be shared for a period of 24 months which we find to be a significant aspect of the transaction from an economic view. The Residual Sharing Agreements provided that petitioner was entitled to all Residual Revenue until petitioner received cumulative cash distributions equal to 120 percent of Net Equity. Any Interim Revenue received by petitioner reduced the Net Equity amount as did the cash flow generated from the Owner Lease. Lyons provided residual values for the Equipment solely as of the termination of the Owner Leases. Lyons provided no contingent rent analysis regarding Interim Revenue to assist in our determination of economic substance. The record provides no indication as to the criteria used by Finalco to determine the Interim Revenue sharing commencement date. We are not satisfied that the ranges of residual value are sufficient to imbue the transaction with economic substance. The Interim Revenue provision which provided that petitioner receive 50 percent of any rental income generated by Finalco during the last 24 months of the Owner Lease is pivotal to any determination. The record does not indicate the December of 1980 prognostication of reasonable719 rents commencing in December of 1986. The record does not indicate whether renewal by an end user was typical or the degree of negotiation concerning any rental rate of end user. The lease commitments structured by Comdisco with Alcoa and Canteen were short-term leases which provided the end user flexibility. We are unable to discern whether Interim Revenue was realistic and, if so,in an amount sufficient to imbue the transaction with economic substance. Based on our examination of this record, we conclude that Finalco primarily packaged a program of tax benefits for sale to petitioner and retained economic benefits during the original term of the Owner Leases and retained a further interest in the Remarketing Agreements and the Residual Sharing Agreements. In Murkerji, the taxpayer Mukerji entered into a transaction which provided "additional rent" similar to the Interim Revenue provisions herein to be paid by Comdisco to the taxpayer during the last 24 months of an owner lease. Mukerji v. Commissioner,87 T.C. at 929. In that case, Comdisco retained no remarketing and residual interest in the transaction similar to those which Finalco retained here that720 further reduce any economic profit to the taxpayer. In the instant case, Finalco has exerted much imagination to retain the economic benefits of the transactions while giving the appearance of economic substance. We have stated previously that the drawing of a precise demarcation between those transactions that are supported with economic substance and those that are not so supported is invariably difficult. Based on this record, the omission of Lyons to provide testimony of reasonably expected Interim Revenue coupled with the retained interests of Finalco in the Remarketing Agreement as well as the Residual Revenue provisions and Interim Revenue provisions of the Residual Revenue Sharing Agreement has to a significant extent thwarted our analysis of economic substance. We restate that in this critical respect, the burden of proof is on petitioner as respondent's determination that the transactions were tax-avoidance schemes devoid of economic substance is presumptively correct. Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933); Rule 142(a). The Alcoa equipment included two printers and two generations of disk drives. The printer and the earlier generation of disk drive721 were both introduced in 1971. The newer generation disk drive, the IBM 3350, was introduced in 1976. Morgan determined a 15-year economic or technological life for the printers and a 14-year economic or technological life for the disk drives based on a historical analysis of progenitor products. Morgan also considered plug compatible competition with respect to the disk drives and IBM price reductions of 20 percent in October of 1978 and May of 1979 with resepct to the IBM 3350 disk drive. Morgan determined the residual value of the Alcoa Equipment to be $ 16,500 in December of 1986 and $ 4,200 in December of 1988 at the termination of the Owner Lease. The Canteen Equipment included the IBM 3420-7 Magnetic Tape Units and the IBM 3801 Control Unit. Morgan determined that prior generations of tape drives had an economic life of 15 years. Lyons stated that he was not aware of any historical precedent to indicate a longer life than 15 years. Based on the introduction date of 1971, Morgan concluded that the Canteen Equipment would be of zero residual value in 1986 at the Interim Revenue commencement date and zero at the termination date of the Owner Lease in 1988. We are persuaded722 that historical analysis of progenitor products is simply one aspect of residual valuation. Morgan relied solely on historical analysis of economic life. We are certain, as is indicated in the Fortune Magazine article, that residual valuation in December of 1980 for a period of 96 months was without question a difficult task. Our determination must be whether the 96-month residual value offered petitioner a realistic opportunity for profit. Given this industry, the age of the equipment, and the length of the owner leases, we are satisfied that the prudent investor would question whether the Equipment would retain significant residual value. 18 We fault Morgan's analysis for reliance solely on historical analysis. We fault Lyons' analysis, however, for the failure to delineate the historical analysis relied upon to determine residual values. In our view, the low-range 96-month residual value offered by Lyons was realistic to expect as of December of 1980. We accept Morgan's view as to the residual value of the Equipment at the commencement of the Interim Revenue. 19723 We are impelled to address the interest acquired by petitioner due to the Comdisco interest in the Comdisco Remarketing and Management Agreement and the Finalco interest in the Residual Sharing Agreement and the Remarketing Agreement. The record does not indicate that other dealers of computer equipment in the secondary market were available and capable to remarket Equipment at more favorable rates to petitioner. Finalco knew the location, status, and condition of the Equipment. We find it a fair inference that Finalco was relied upon by petitioner and was the sole source of expected assistance in any remarketing effort of petitioner at the termination of the Owner Lease. 20 Our determination to factor the 20-percent commission due to Finalco in our objective analysis is indeed appropriate. James v. Commissioner,87 T.C. at 923 n. 4. 724 The Remarketing Agreement provided that Finalco receive a ten percent fee for any remarketing service. Pursuant to the Residual Revenue Agreement, Finalco was entitled to 20 percent of all Residual Revenue received for the sale or re-lease of the Equipment after petitioner received 120 percent of Net Equity as reduced by any cumulative cash flow. According to Olmstead, the remarketing provisions required Finalco to perform such services to be entitled to the 20-percent compensation. Petitioner argues that, as owner of the Equipment, he may select any individual or entity other than Finalco to remarket the Equipment. In Rice Toyota World, Inc., Finalco retained a 30-percent interest in any revenue generated either through sale or re-leasing of the equipment irrespective as to whether Finalco actually performed any remarketing services. Rice's Toyota World, Inc. v. Commissioner,81 T.C. at 195. 21 Notwithstanding the terms which indicate that Finalco must remarket the Equipment to be entitled to a remarketing fee or the 20-percent Residual Revenue, we find that petitioner intended to rely on Finalco for such services and that the substance of the transaction725 is that petitioner must rely on Finalco to remarket the Equipment.Petitioner lacks experience and resources to remarket the Equipment without assistance. We believe that petitioner as individual owner of peripheral computer equipment such as the Equipment must rely on any remarketing or residual revenue to be generated by Finalco. Based on our determinations as to Interim Revenue, residual value, and the interests of Finalco, we determine that the transaction was structured as tax-avoidance scheme devoid of economic substance and must be disregarded for Federal income tax purposes. 22726 In Rice's Toyota World, Inc., the Court of Appeals for the Fourth Circuit held that a sham determination did not preclude the deduction of interest paid on a recourse installment note. Rice's Toyota World, Inc. v. Commissioner, 752 F.2d at 96. In Rose v. Commissioner,88 T.C. 386">88 T.C. 386, 423 (1987), we adopted the view of the Court of Appeals for the Fourth Circuit. Consequently, petitioner is entitled to deduct interest paid on the Recourse Note. However, petitioner incurred no interest expense on the Recourse Note during the year 1980. By amendment to answer, respondent asserts the increased rate of interest provisions of section 6621(c) attributable to tax-motivated transactions. Respondent bears the burden of proof. Rule 142(a); Rose v. Commissioner, supra;Zirker v. Commissioner,87 T.C. 970">87 T.C. 970 (1986). Section 6621(c) provides for an interest rate of 120 percent of the adjusted rate determined under section 6621(b) where there is a substantial underpayment in any taxable year attributable to one or more tax-motivated transactions. A substantial underpayment exists where such underpayment attributable to a tax-motivated727 transaction exceeds $ 1,000. Sec. 6621(c)(2. Section 6621(c) is applicable solely with respect to interest accruing after December 31, 1984, even though the transaction was entered into prior to the date of enactment of section 6621(c). Solowiejczyk v. Commissioner,85 T.C. 552">85 T.C. 552 (1985), affd. per curiam without published opinion 795 F.2d 1005">795 F.2d 1005 (2d Cir. 1986). Respondent asserts the provisions of section 6621(c) are applicable because the transaction at issue is defined as tax-motivated transactions where losses are disallowed by reason of section 465(a). Sec. 6621(c)(3)(A)(ii). We have determined that the transaction was a tax-motivated scheme devoid of economic substance. Section 6621(c)(3)(A)(v) added by Congress specifically includes within the definition of tax-motivated transactions "any sham or fraudulent transaction." 23 We have previously determined that "any sham or fraudulent transaction" within the meaning of section 6621(c)(3)(A)(v) includes a transaction which lacked subject profit motive and which was without economic substance. Patin v. Commissioner,88 T.C. 1086">88 T.C. 1086, 1128-1129 (1987). We have recently determined that*728 the presence of profit motive does not preclude the determination that a transaction lacks economic substance and is, therefore, an economic sham. Cherin v. Commissioner, 89 T.C. (Nov. 23, 1987). In this case, we determined that petitioner did not manifest a subjective profit motive and that the transaction was not supported with economic substance. Consequently, petitioner is liable for additional interest on the substantial underpayment of tax attributable to a tax-motivated transaction within the meaning of section 6621(c)(3)(A)(v) where we have determined the Equipment transaction to be a sham or fraudulent transaction. Decision will be entered under Rule 155.Footnotes1. Petitioner Shirley L. Moore did not appear at trial and no reference exists within the record concerning her involvement in the transactions at issue other than as signatory to the documents. Unless otherwise specified, petitioner shall refer only to petitioner Lewis W. Moore. ↩2. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954, as amended and in effect during the year in question. All rule references are to the Tax Court Rules of Practices and Procedure. ↩3. Former sec. 6621(d) has been redesignated as sec. 6621(c) pursuant to sec. 1511(c), Tax Reform act of 1986, 100 Stat. 2744. We use the reference to the Internal Revenue Code as redesignated and amended. ↩4. Peripheral computer equipment feeds information into and out of the central processing unit. The central processing unit, sometimes referred to as mainframe equipment, actually performs the data processing functions. ↩5. The use of such terms as "purchase," "lease" and other like words does not imply that we consider the underlying transaction to be a fact construed as a "purchase" or "lease" for Federal income tax purposes. We probe beyond the labels given by the parties to determine whether an actual economic investment existed. Rice's Toyota World, Inc. v. Commissioner,81 T.C. 184">81 T.C. 184, 210 (1983), affd. on this ground 752 F.2d 89">752 F.2d 89↩ (4th Cir. 1985). 6. The Computer Price Guide is a quarterly journal published by Computer Merchants, Inc. The Computer Price Guide was the computer industry's first regularly published source of price and market information for both new and used computer equipment and is widely relied upon in the industry. See Mukerji v. Commissioner,87 T.C. 926">87 T.C. 926, 946-947↩ (1986). 7. The record indicates that much confusion has existed as to the actual peripheral items contained in the Canteen Equipment as purchased by petitioner. The Comdisco Canteen Purchase Agreement between Comdisco and Blackwood correctly set forth the items of the Canteen Equipment. At some point in time, Finalco attached an incorrect equipment schedule to the Finalco Purchase Agreement between Finalco and Lease Pro regarding the ultimate sale to petitioner. The incorrect equipment included by Finalco to Lease Pro identified the following IBM peripheral equipment: QuantityEquipmentDescription13340-A2Direct Access StorageFacility 13340-B2Direct Access StorageFacility The Comdisco Purchase Agreement set the fair market value of the incorrect equipment to be $ 41,798. By amendment back dated to December 1, 1980, Finalco attempted to correct the inaccuracy in the equipment schedule. However, Finalco incorrectly amended the pertinent agreements among Finalco, Lease Pro, and petitioner to indicate that the Canteen Equipment included five units of the IBM 3420-7 Magnetic Tape Units rather than the three units of the IBM 3420-7 Magnetic Tape Unit in fact purchased. It is not clear as to the point in time that the parties learned that the Canteen Equipment in fact included only the three magnetic tape units. Morgan valued the Canteen Equipment to include five of such units. We have adjusted her determinations purely on a mathematical basis. Lyons submitted two expert reports covering each scenario. Such inconsistency is further evidence of the ambivalence to accuracy and attention to detail in the documentation of these transactions as indicated by the administrative practices of Finalco. See also Sturm v. Commissioner,T.C. Memo. 1987-625↩. 8. The separately stated dollar value of each machine type does not agree to the cumulative eight-year residual value of the Alcoa equipment indicated within Lyons report. ↩9. We have adjusted Morgan's report figures. Morgan valued five magnetic tape units rather than the acquired three units included in the Canteen Equipment. Morgan's calculations of the Alcoa Equipment Blue Book value contained a mathematical error. See footnote 7, supra.↩10. The companion cases are: Larsen v. Commissioner, 89 T.C. (1987); Sturm v. Commissioner,T.C. Memo 1987-625">T.C. Memo. 1987-625; Shriver v. Commissioner,T.C. Memo 1987-627">T.C. Memo. 1987-627; Casebeer v. Commissioner,T.C. Memo. 1987-628↩. 11. Carlson v. Commissioner,T.C. Memo. 1987-306↩. 12. The presence of business purpose does not entitle a business transaction to be recognized for Federal tax purposes where objective indicia of economic substance indicating a realistic potential for economic profit are not manifest. Cherin v. Commissioner,↩ 89 T.C. (Nov. 23, 1987). 13. Dobbs v. Commissioner,T.C. Memo. 1987-361; Kaufman v. Commissioner,T.C. Memo 1987-350">T.C. Memo 1987-350↩. 14. Although not material to our determination of economic substance, we are impelled to find that Lease Pro served no legitimate business purpose in the transaction and was inserted into the chain of title by Finalco solely for tax considerations. See Bussing v. Commissioner,88 T.C. 449">88 T.C. 449 (1987), Supplemental Opinion 89 T.C. (filed Nov. 24, 1987); Coleman v. Commissioner,87 T.C. 178">87 T.C. 178, 206 (1986), affd. per curiam 833 F.2d 303">833 F.2d 303 (3d Cir. 1987); Tolwinsky v. Commissioner,86 T.C. 1009">86 T.C. 1009↩ (1986). 15. Compare the companion case Larsen v. Commissioner,↩ 89 T.C. (1987). 16. The Canteen Equipment allocation of $ 54,135 is the amount represented in the Comdisco Purchase Agreement as the fair market value. ↩17. ↩EquipmentPercent ofTransactionRange of ValueIBM ListAlcoa$ 45,000 - $ 70,00010 - 15 percentCanteen$ 10,000 - $ 13,00010 - 13 percent18. In Estate of Thomas v. Commissioner,84 T.C. 412">84 T.C. 412 (1985), the parties stipulated that the equipment would at least retain 14 percent residual value at the end of the lease terms and that the equipment would retain three years of useful life at the termination of the lease term. The instant case presents facts in contrast to those presented in Estate of Thomas. See also Gefen v. Commissioner87 T.C. 1471">87 T.C. 1471, 1492↩ (1986). 19. Morgan determined the residual value of the Equipment in December of 1986 to be the amount of $ 16,500. We assume that petitioner may expect to receive a pro rata one-half of such amount as Interim Revenue during the Owner Lease, the amount of $ 8,250. ↩20. Based on our review of the record, we determine that the interest of Comdisco in the Equipment pursuant to the Comdisco Management and Remarketing Agreement was intended to provide a benefit to Comdisco where the End Users executed a renewal of the End User Lease. Comdisco located the End Users and installed the Equipment. The End User aspects of the transaction were complete as of the date of transfer to Finalco through Blackwood. The Alcoa Lease is a triple net 24-month lease to terminate in December of 1981 without an option to purchase. The Canteen Lease was a triple net 39-month lease to terminate in November of 1983 without option to purchase. The Comdisco Management and Remarketing Agreement was to terminate in December 30, 1986, at which time either Comdisco or petitioner as owner may terminate upon 30 days notice. The Owner Lease was a 96-month lease to terminate in December of 1988. We are persuaded that Comdisco required the Comdisco Management and Remarketing Agreement as a condition of sale to Finalco. Phillip Hewes, the Comdisco staff attorney who drafted the Comdisco Management and Remarketing Agreement, provided no testimony as to whether Comdisco intended to solicit offers on behalf of petitioner other than from the End User. Our conclusion is that Comdisco intended to benefit solely from any sale or re-lease of the Equipment to the End Users immediately upon termination of the End User Leases. If the Equipment remained on lease through Comdisco in December of 1986, Comdisco would retain an interest in remarketing the Equipment with the End User. In our view, Comdisco did not realistically expect the End Users to continue to lease the Equipment until December of 1986. We are certain that Comdisco had no interest in dealing with petitioner where the Equipment was no longer on lease with the End User… The Comdisco Management and Remarketing Agreement provided Comdisco an exchange option. We assume any such exchange benefited Comdisco not petitioner. We find no evidence that petitioner as the owner of the Equipment was able to select the most competitive offer between Comdisco and Finalco or any other remarketing source as petitioner asserts. Notwithstanding the testimony of Olmstead, the remarketing terms of the Purchase Agreement are not clear as to whether Finalco is entitled to remarketing compensation concerning "renewals under the lease" or "referral of a willing buyer or seller" where the End User renewed the Equipment during the term of the Comdisco Management and Remarketing Agreement. We note that as to petitioner, Finalco delivered the End Users not Comdisco. ↩21. The terms and effect of the Remarketing Agreement and Residual Sharing Agreement retained by Finalco in the instant case are in substance not materially different than the residual interest retained in Rice's Toyota World, Inc. v. Commissioner,81 T.C. 184">81 T.C. 184 (1983), affd. in part, revd. in part 752 F.2d 89">752 F.2d 89↩ (4th Cir. 1985). 22. ↩Net Equity:Cash $ 10,000 Recourse Note 67,700 Less Interim Revenue 8,250 Less Cash Flow 8,381 120 percent times 61,069 Net Equity $ 73,283 Residual Value:Alcoa $ 45,000 Canteen 10,000 Petitioner $ 55,000 Finalco -0- $ 55,000 Economic Profit:Cash flow $ 8,381 Interim Revenue 8,250 Residual Revenue 55,000 Less Remarketing Fee - 10 percent ( 5,500)$ 66,131 Petitioner Investment:Cash $ 10,000 Recourse Note 67,700 Interest on Recourse Note 22,136 $ 99,836 23. Pub. L. 99-514, sec.1535(a), 100 Stat. 2085, 2750. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623604/	PUBLIC OPINION PUBLISHING CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Public Opinion Publishing Co. v. CommissionerDocket No. 4474.United States Board of Tax Appeals6 B.T.A. 1255; 1927 BTA LEXIS 3298; May 6, 1927, Promulgated 3298 Commissioner's determination as to capital expenditures approved. Harry Harper, C.P.A., for the petitioner. S. S. Faulkner, Esq., for the respondent. MORRIS1255 This proceeding is for the redetermination of deficiencies in income and profits taxes of $6,022.15 for 1920, and $1,705.06 for 1921. The issue raised is whether certain expenditures made during the respective years should be capitalized or deducted as ordinary business expenses. FINDINGS OF FACT. The petitioner, a South Dakota corporation located at Watertown, was organized approximately 19 years ago. It is engaged in job printing and publishing a daily newspaper. The capital stock of the corporation was and is $25,000. Prior to 1920 the Non-Partisan League established a newspaper in Watertown, which was at the time supporting the daily published by the petitioner. Watertown has a population of about 10,000. The subscription campaign carried on by the newspaper cut down the circulation of the petitioner. To offset the losses sustained the petitioner held subscription campaigns in 1920 and 1921. The petitioner's subscription list before the first campaign numbered3299 approximately 5,200 subscribers. The campaign was conducted 1256 by a professional campaign manager and field men. Premiums were offered and subscriptions solicited for periods from six months to three years. Most of the subscribers took the paper for a period of one year. All subscriptions were paid in advance. The cost of the 1920 campaign was $15,839.64. At the conclusion of the campaign the petitioner's subscription list had increased to 5,500. The 1921 campaign inaugurated late in 1920 cost the petitioner $11,592.59. It increased the circulation list to 7,200 subscribers. The expenditures made in 1920 and 1921 on the subscription campaigns covered money paid for the subscription contest manager, the people employed, general expenses in the way of getting subscribers and the premiums offered. The petitioner did not place a value on its subscription lists, but the 1920 amended return carried them as an asset valued at $25,000. Another time an auditor of the petitioner's books carried the subscription lists at a value of $20,000 in certain statements which he prepared. The amounts expended for the campaign in 1920 and 1921 were taken as deductions from gross3300 income in the respective years by the petitioner. The respondent disallowed the deductions, capitalized the expenditures, and determined the asserted deficiencies. OPINION. MORRIS: There is no doubt that the circulation structure of a newspaper is a capital asset, ; . It is likewise well settled that the circulation structure of a daily newspaper is an intangible asset. . When such an asset is purchased, the amount expended therefor is a capital expenditure. ;; . The specific question presented by this proceeding is whether when such an asset is developed by the corporation itself and the cost thereof charged to expense, such cost is a capital expenditure. The facts show that the purpose of the two campaigns was not only to maintain the number of subscribers, but to increase it. To the extent that the expenditures maintained3301 the number of subscribers, they may be ordinary and necessary expenses, but we are unable to determine the amount allocable thereto. The Commissioner held that they were capital expenditures, and we can not determine from the record that he erred in that regard. Judgment will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623605/	FLORENCE V. CRUICKSHANK, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. F. G. CRUICKSHANK, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Cruickshank v. CommissionerDocket Nos. 16449, 21790.United States Board of Tax Appeals13 B.T.A. 508; 1928 BTA LEXIS 3241; September 24, 1928, Promulgated 3241 The income of a husband and of a wife, both residents of California, derived from separate estates and individual earnings is taxable to the spouse owning the estate or earning the income, irrespective of an antenuptial agreement to the effect that such income should be used for the common benefit of both and any surplus invested in property the joint property of both. Ralph W. Smith, Esq., and Claude I. Parker, Esq., for the petitioners. Clark T. Brown, Esq., for the respondent. MILLIKEN 509 These proceedings were by motion made and granted consolidated for hearing and final decision and involve deficiencies in income tax. In the appeal of Florence V. Cruickshank the deficiencies are for the calendar years 1920 and 1921 in the respective amounts of $3,550.02 and $2,207.75, and in the appeal of F. G. Cruickshank the deficiencies are for the calendar years 1922 and 1923, in the respective amounts of $3,149.63 and $2,393.38. The only error assigned in each case is that the respondent in computing the income of petitioners, who are husband and wife, erred in refusing to compute such income in accordance with an antenuptial agreement entered3242 into between them. FINDINGS OF FACT. Petitioners were married in 1909 and have been since that date husband and wife and residents and citizens of the State of California. Prior to their marriage and on August 1, 1909, petitioners entered into the following agreement: This Ante-nuptial Agreement, made and entered into this first day of August, 1909, by and between F. G. Cruickshank, of Pasadena, California, party of the first part, and Florence Vandevort, of the same place, party of the second part, WITNESSETH THAT: Whereas, the parties hereto contemplate intermarrying and are desirous of adjusting all property rights and interests; and Whereas, the party of the first part is the owner of property of the value of $10,000.00, and the party of the second part is the owner of property of the value of $760,000.00 (household furniture and furnishings and jewelry excepted), and Whereas, the parties are desirous of keeping the above principals intact, free from any claim of the other, but are desirous of sharing in the income and accumulations therefrom; Now therefore, in consideration of the premises and of the marriage herein contemplated, the parties do agree, each with3243 the other, as follows, to-wit: That the property which each of the parties now has shall be and remain the separate property of the party so owning the same and shall be free from any claim of the other, except as herein provided. That during the continuance of said marriage the income and accumulations derived from said properties and the earnings of the parties and all moneys received by them from any and all sources shall be used by the partis hereto for their mutual comfort and enjoyment and shall be under the joint control of the parties hereto and any unused portion of the income and accumulations, shall, from time to time, be invested for the joint benefit of the parties hereto and shall be under their joint control. The parties agree to keep accurate books of account showing the moneys received and disbursed on account of said properties, and the amounts received from other sources and all moneys advanced to the parties hereto, and at least once a year to balance said books and to appraise the property so as to show the actual amount of property on hand. Should any statement show the property on hand to be of greater value than $770,000.00 the excess shall be the3244 property of the parties hereto, the same to be under their joint control during the continuance of said marriage, but should 510 any statement show that the value of said property is less than $770,000.00, then the parties hereto must make up such deficit in said principal sum to the party whose principal has been impaired. For the purposes of this agreement the payment of $200.00 per month upon the first day of each month to Charlotte E. Gleason for the term of her natural life, shall be considered a charge upon the property of the party of the second part and paid out of the income before any other payments or advancements are made. Upon the dissolution of said marriage by death or otherwise, each of the parties (or the estate of the deceased party) shall be entitled to the amount they have contributed, as above set forth, and one-half of all earnings, accumulations, income and other moneys received from whatever source. Provided, however, that the household furniture and furnishings and jewelry which the second party now has shall be the property of the second party in addition to the above, and provided further that either party shall have the right, at any time3245 to impair their principal by gift, but if so impaired it shall be entered upon the books of the parties hereto and the amount so impaired shall not be replaced out of income. This agreement may be changed, cancelled or modified by an instrument in writing signed by the parties hereto. The parties agree to devote so much of their time, without compensation, to the care, management and conservation of said property as may be necessary. In Witness Whereof, the parties hereto have hereunto set their hands and seals the day and year first above written. F. G. CRUICKSHANK (SEAL.) FLORENCE VANDEVORT (SEAL.) The above agreement has been in full force and effect since its execution and has in all particulars been carried out and observed by the parties. F. G. Cruickshank was at all times a practicing attorney at law and was during the years 1921, 1922, and 1923 a member of a partnership. Petitioners made for each year a separate income-tax return and each returned one-half of the total income which both received from all sources. For the years 1920 and 1921, respondent restored to the gross income of F. G. Cruickshank all the income he derived from his profession and all3246 his income from all other sources other than the property covered by the agreement, and apportioned the income from said property 1/77 to F. G. Cruickshank and 76/77 to Florence V. Cruickshank. For the years 1922 and 1923 he followed the same procedure except that he apportioned the income from the property covered by the agreement in equal parts between petitioners. OPINION. MILLIKEN: Petitioners contend that under the antenuptial agreement each was absolutely and without a qualification entitled to receive one-half of the total income of both; that since this agreement was entered into prior to the adoption of the Sixteenth Amendment to the Constitution it is apparent it was not made to evade income tax; and that this right is a property right which can not be disregarded for the purpose of taxation or any other purpose. 511 Since the antenuptial agreement is valid and binding, it is immaterial for income-tax purposes whether it was executed before or after the adoption of the Sixteenth Amendment. We have not before us a question of tax evasion. Cf. 3247 United States v. Isham,17 Wall. 496">17 Wall. 496. The issue presented is not whether that agreement did in fact result in an enforcible right to an equal division of the income between the parties, but is, What is the effect of the agreement upon the taxable income of each? The agreement was carefully drawn and meticulously sets out the rights and liabilities of the parties. It clearly appears that the property mentioned in the agreement remained the absolute separate property of each party free from any claim of the other but under joint control; that the income and accumulations from such properties and all other income received by either party from any source whatever should be used by the parties for their mutual comfort and enjoyment; that any unused portion of such income and accumulations should be invested for the joint benefit of the parties, such investments to be under joint control; and that upon the dissolution of the marriage the parties (or the estate of the deceased party) should be entitled to the amounts each contributed and one-half of all the earnings, accumulations, income or other moneys from whatever source. 3248 We will first discuss the effect of the antenuptial agreement on the taxable income of the husband other than that derived from the property covered by the agreement. The case of Blair v. Roth, 22 Fed.(2d) 932 (certiorari denied, 277 U.S. 588">277 U.S. 588), is in point. In that case the court said: * * As exemplified in actual practice, the agreement of the appellee and his wife amounted to substantially this: They would contribute their earnings to a common fund, out of which their personal and community expenses would be paid; and of the savings, if any, and the property in which such savings were invested, they were to be the owners upon an equal footing. By the appellant it is not contended that, under the California statutes (sections 159, 160, Civ. Code; Wren v. Wren,100 Cal. 276">100 Cal. 276, 34 P. 775">34 P. 775, 38 Am. St. Rep. 287">38 Am. St. Rep. 287; Kaltschmidt v. Weber,145 Cal. 596">145 Cal. 596, 179 P. 272">179 P. 272; Smith v. Smith,47 Cal. App. 650">47 Cal.App. 650, 191 P. 60">191 P. 60; Perkins v. Sunset T. & T. Co.,155 Cal. 712">155 Cal. 712, 103 P. 190">103 P. 190), a husband and wife domiciled in that state may not make valid agreements relating to either their separate or3249 their community property, or that it would be incompetent, by appropriate agreement between them, to constitute the earnings of the wife her separate estate. In essence his contention is that, at most, the agreement here was for an assignment by each of the parties of one-half of his or her earnings to the other; that, at the instant they were received, the salaries were, by the law, impressed with the status of community property, and were taxable with reference to that status; and that the obligation to pay the tax so computed could not be escaped by contributing such incomes to the so-called partnership between the two members of the community, any more effectually than by contributing it to a like enterprise as between one member of the community and a third person. In this view we concur. 512 The above is decisive of this particular issue. Besides, it appears that during three of the years involved, the husband was a member of a partnership. This feature brings this proceeding in so far as said years are concerned, within the decision of 3250 Mitchel v. Bowers, 15 Fed.(2d) 287. The reasoning in the opinion in Blair v. Roth, supra, is equally applicable to the taxability of income derived from the properties covered by the antenuptial agreement. That instrument provides that the property of each of the parties shall, subject to the right to the joint use of the income and the right of joint control, remain the separate property of the party owning it at that time and should be free from any claim of the other. Income from such property is under the law of California separate property. As such it is first the income of the owner of the property and the obligation to pay tax thereon can not be escaped by contributing such income to the common use of both. Such also has been the consistent holdings of the Board. See Samuel V. Woods,5 B.T.A. 413">5 B.T.A. 413; Fred W. Warner,5 B.T.A. 963">5 B.T.A. 963; Guy C. Earl,10 B.T.A. 723">10 B.T.A. 723; and H. A. Belcher,11 B.T.A. 1294">11 B.T.A. 1294. Cf. C. R. Thomas,8 B.T.A. 118">8 B.T.A. 118. We are of opinion that each party is taxable on the income drerived from the property owned by him or her at the date of the agreement3251 and from any other property representing property then owned. Counsel for petitioner calls to our attention the provisions of section 161(a) of the Civil Code of California enacted as a law July 28, 1927, and contends that "such section, while not a law during the years in question, was a declaration by the Legislature as to what it has always intended to mean in reference to the respective rights or interests of a husband or wife in California community property." It seems sufficient to observe that, whatever may be the import of the section of the California statute in question, that it was not a law during the years here before us can have no bearing on the taxable status of the income theretofore earned. The treatment that should be accorded such income is controlled by the decision of the United States Supreme Court in United States v. Robbins,269 U.S. 315">269 U.S. 315. Counsel also contends that the antenuptial agreement presents a joint venture. It seems sufficient to point out that there was no combination of property, money, efforts, skill or knowledge in some specific venture or common undertaking. Since it does not appear from the record whether there3252 is any income from property purchased with surplus income, we refrain from discussing that phase of the case. It appears that for the years 1920 and 1921, respondent allocated the income from the property covered by the agreement 1/77 to the husband and 76/77 to the wife and that for the years 1922 and 1923 513 he allocated such income to each in equal shares. This appears to be quite inconsistent, but we have not sufficient facts before us to make findings on this point. It is true that in the wife's case, involving the years 1920 and 1921, an accountant was introduced to testify as to what he discovered on certain books of account. Whether such books were properly kept does not appear. The pleadings do not contest the determinations of respondent, except to the extent of alleging that he did not allocate the income in accord with the terms of the agreement. It appears from the deficiency letter that respondent made certain changes in petitioner's income as reported. The figures given by the witness are not in all respects in harmony with those in the deficiency letter. Besides, on cross-examination this witness testified: Q. You don't know, you can't tell, from*3253 your examination, can you, how much income can be attributed to the increase over the $10,000 or over the $760,000 or how much can be attributed to those particular items? A. No. Judgment will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623606/	Elliott J. Roschuni and June G. Roschuni, Petitioners, v. Commissioner of Internal Revenue, RespondentRoschuni v. CommissionerDocket No. 4935-62United States Tax Court44 T.C. 80; 1965 U.S. Tax Ct. LEXIS 100; April 16, 1965, Filed 100 Decision will be entered under Rule 50. Issue 6. -- Held, the assessment of any tax for the year 1958 against petitioners Elliott and June is barred by the statute of limitations, although for a reason different from the reason given in our report filed December 16, 1964, the reason being that under clause (ii) of section 6501(e)(1)(A), I.R.C. 1954, no amount of capital gain from the sale of the Briarcliff Hotel should be "taken into account" in determining the amount omitted from gross income under subparagraph (A) of section 6501(e)(1), since Briarcliff had made a full disclosure of the capital gain in its "information" return for 1958, which return was incorporated by reference in petitioners' 1958 return, and the disclosure was made in a manner adequate to apprise the respondent of the so-called omitted amount of gross income, thus making inapplicable the 6-year period within which to make the assessment. The principle of Jack Rose, 24 T.C. 755">24 T.C. 755 (headnote par. 1), applied. William R. Frazier, for the petitioners.James D. Ritter, for the respondent. Arundell, Judge. ARUNDELL80 SUPPLEMENTAL FINDINGS OF FACT AND OPINIONOn January 8, 1965, respondent filed a motion for reconsideration 101 of our report filed December 16, 1964, insofar as it pertained to issues 3 and 6 (which also involves issue 2). On January 14, 1965, we issued an order that the motion be served on petitioners and that petitioners be given until February 10, 1965, to file objections to said motion, or otherwise move. On February 10, 1965, petitioners filed a memorandum of objections to respondent's motion for reconsideration, which memorandum was duly served on the respondent on February 10, 1965. On February 17, 1965, respondent filed a motion for leave to file a response to petitioners' memorandum, which was granted. On March 26, 1965, respondent filed his response, which response was duly served on petitioners on March 30, 1965.The issue we are now reconsidering is issue 6, namely: Is the assessment of the tax for 1958 barred by the statute of limitations? By reason of our holding herein that the assessment is barred, although for a reason different from the reason given in our report filed December 16, 1964, it remains unnecessary to decide issue 3. Issue 2 is referred to only insofar as it is necessary better to understand issue 6.SUPPLEMENTAL FINDINGS OF FACTIssues 2, 3, and 6We incorporate 102 herein by reference, without any change, all of our findings made under the above heading in our report filed December 81 16, 1964, down to the paragraph beginning, "Statute of Limitations for 1958."Statute of Limitations for 1958. -- Petitioners Elliott and June reported gross income on their return for the taxable year 1958 in the amount of $ 101,541.07, computed as follows:Salary:Systems (June)$ 600.00Paradise (Elliott)5,950.00No. 10 (Elliott)1,200.00Systems (Elliott)600.00$ 8,350.00Subchapter S dividends as ordinary income (Sch. H) Paradise2,763.92Subchapter S dividends as long-term capital gain (Sch. D)Briarcliff1 34,190.00Business or profession (Sch. C) Gilbert Hotel No. 1956,237.15Total gross income reported101,541.07Petitioners, in Schedule D of their individual return (Form 1040) for the taxable year 1958, in reporting that part ($ 34,190) of their above-mentioned gross income of $ 101,541.07, stated: "See -- Gilbert Hotel, Inc. (Schedule D, Form 1120-S) $ 34,190.00." See footnote 2 of our report filed December 16, 1964, wherein we state that Gilbert Hotel, Inc., is to be referred to as Briarcliff.On March 17, 1959, Briarcliff filed 103 a U.S. Small Business Corporation Return of Income, Form 1120-S, and reported a net long-term capital gain of $ 34,190 from the sale of the Briarcliff Hotel which, in "a statement attached to the return [sec. 6501(e)(1)(A)(ii), I.R.C. 1954]," it explained thus:COMPUTATIONS FOR INSTALLMENT REPORTING OF GAIN ON SALEOF BRIARCLIFF HOTELSelling price$ 125,000.00Less:Adjusted basis$ 28,468.23Expense of sale5,286.2033,754.43Profit to be realized91,245.57Assumption by buyer of 1st mortgage48,486.03Assumption by buyer of 2d mortgage9,798.5058,284.53Selling price125,000.00Less: Assumption of above mortgages58,284.53Total payments to be received66,715.47Cash payment25,000.00$ 25,000.00 X $ 91,245.57/$ 66,715.47 = $ 34,190.00 recognized gain82 This explanation was adequate to apprise the respondent of the nature and amount of what the gain would be on the sale of the Briarcliff Hotel on a completed basis rather than an installment basis.The only item to be taken into account in determining the amount petitioners Elliott and June omitted from their gross income in their individual return for 1958 was the $ 133.20 from Systems (issue 1) which is less than 25 percent of the gross income reported on 104 their return of $ 101,541.07.The assessment of any tax for the year 1958 against Elliott and June is barred by the statute of limitations.OPINIONIn our report filed December 16, 1964, we held that the assessment of any tax for the year 1958 against Elliott and June was barred by the statute of limitations for the reason that the respondent did not have 6 years in which to make the assessment under section 6501(e)(1)(A) of the 1954 Code. In our opinion we said:We held under issues 1 and 2 that for the year 1958 petitioners Elliott and June omitted from gross income the respective amounts of $ 133.20 and $ 16,914.23, or a total omission of $ 17,047.43 which is less than 25 percent of the amount of gross income stated in the return of $ 84,446.07. Therefore, under section 6501 (e)(1)(A), supra, the 6-year period within which to make the assessment would not be applicable. However, the respondent contends that in determining whether the so-called omitted amount is greater or less than 25 percent of the amount of gross income stated in the return the long-term capital gain from the sale of the Briarcliff Hotel (issue 2) should be taken in the computation at 100 percent instead of 50 105 percent. To illustrate, instead of $ 17,095 as being the capital gain stated in the return, the respondent would use $ 34,190 as stated in the return and, instead of $ 16,914.23 determined by us as omitted from gross income by Briarcliff, the respondent, assuming he accepted the corrected profit as being $ 71,743.07, would contend that the amount omitted from gross income by Briarcliff was $ 33,828.46 (twice times $ 16,914.23, or $ 68,018.46 minus $ 34,190). This contention by the respondent is contrary to our holdings in Emma B. Maloy, 45 B.T.A. 1104">45 B.T.A. 1104, 1107, and Frank W. Williamson, 27 T.C. 647">27 T.C. 647, 662.We think respondent is correct in his motion for reconsideration in contending that the cases of Emma B. Maloy, 45 B.T.A. 1104">45 B.T.A. 1104, 1107, and Frank W. Williamson, 27 T.C. 647">27 T.C. 647, 662, involved taxable years beginning prior to October 20, 1951 (the date the Revenue Act of 1951 was approved), and are, therefore, no longer controlling authority due to section 322(a)(2) of the Revenue Act of 1951, 1106 which was carried into the Internal Revenue Code of 1954, section 1202. 283 Section 117(b) of the Internal Revenue Code of 1939 provided that in the case of a taxpayer, other than a corporation, the gain or loss recognized upon the sale or exchange of a capital asset shall be "taken into account" at 100 percent or 50 percent, depending upon whether the capital asset had been held for not more than 6 months or more than 6 months. Under that law a long-term capital gain would be "taken into account" at only 50 percent whereas a short-term capital loss would be "taken into account" at 100 percent. The result would 107 be that under the 1939 Code a $ 1 short-term capital loss would wipe out a $ 2 long-term capital gain. Congress, by section 322 of the Revenue Act of 1951, amended the 1939 Code (which was carried into the 1954 Code) so as to provide that all long-term capital gains are to be included in gross income at 100 percent and 50 percent of the excess of the net long-term capital gain over the net short-term capital loss "shall be a deduction from gross income." 3 Petitioners, in their memorandum of objections to respondent's motion for reconsideration, nevertheless contend that under clause (ii) of section 6501(e)(1)(A), I.R.C. 1954, 4108 no amount of capital gain from the sale of the Briarcliff Hotel should be "taken into account" in determining the amount omitted from gross income under subparagraph (A) of section 6501(e)(1). We think there is merit in this contention. In our findings in our report filed December 16, 1964, under the heading, "Issues 2, 3, and 6," which we have incorporated herein by reference, we found that Briarcliff duly made an election and qualified for treatment as a small business corporation. See sec. 1372, I.R.C. 1954. Under this election, Briarcliff's income is taxed to its sole stockholder, 109 June, instead of to the corporation. See secs. 1373 and 1375 (a)(1), I.R.C. 1954. However, Briarcliff, under section 6037, I.R.C. 1954, 5110 duly filed for the calendar year 1958 a U.S. Small Business Corporation 84 Return of Income, Form 1120-S, and disclosed in a statement attached to this return all the data concerning the sale of the Briarcliff Hotel such as the selling price, the adjusted basis for determining gain or loss, the expense of sale, the profit to be realized, and the mortgages assumed by the buyer. It reported the sale as an installment sale and as such reported a net long-term capital gain of $ 34,190. In Schedule D of petitioners' individual return for 1958, Elliott and June reported the $ 34,190 as a net long-term capital gain and on this schedule said: "See -- Gilbert Hotel, Inc. (Schedule D, Form 1120-S) $ 34,190.00."We think this statement on petitioners' return for 1958, together with the statement attached to the return for 1958, filed by Briarcliff and set out in our findings, was sufficient and adequate to apprise the respondent of the nature and amount of the so-called omitted item of $ 33,828.46 ($ 68,018.46 minus $ 34,190). All the respondent did in his determination was to determine that the profit to be realized, 6 as shown in the statement, was in fact all realized in 1958, since under section 1.453-4(c) of the regulations under the 1954 Code Briarcliff was not entitled to report on the installment basis. In other words, the so-called omitted amount is due entirely to including the gain from the sale of the hotel 111 on a completed basis rather than on the installment basis. All the facts for either basis were shown "in a statement attached to the return" filed by Briarcliff and incorporated by reference in petitioners' individual return. In his reply brief, respondent makes this statement:The Form 1120-S return of a Subchapter S corporation is an information return required by section 6037 of the Internal Revenue Code of 1954. See 7 Mertens, Law of Federal Income Taxation, sec. 41 B.04 (1962).We agree with the above statement for we think Congress, by section 6037, supra footnote 5, intended the return to be an "information" return.The respondent, however, in 112 his response filed March 26, 1965, called our attention to the above quotation from his reply brief and stated:It is here reaffirmed that such return is an information return so long as a valid Subchapter S election is made. This is not to say, however, that a Subchapter S corporation is anything other than a separate entity which, under 85 no circumstances, is to be considered as a partnership or an association. Rather, it seems quite clear that, insofar as the disclosure rule is concerned, the Subchapter S corporation is an absolutely separate taxable entity for such purposes.We fail to see wherein this statement is of any aid to the respondent. A "valid Subchapter S election" was made. It was stipulated that "Each of the corporations, Gilbert Hotel, Inc. * * have duly made an election and qualify for treatment as a small business corporation pursuant to Subchapter S of Chapter 1 of Subtitle A of the Internal Revenue Code of 1954 for the years 1958." Therefore, in the respondent's own words, "It is here reaffirmed that such return is an information return." We agree that Briarcliff is a separate entity and is not to be considered as a partnership or an association. No one contends 113 that it should be so considered. But we definitely do not agree with the last sentence of respondent's statement that Briarcliff "is an absolutely separate taxable entity [emphasis supplied]." Section 1373, supra, provides that "The undistributed taxable income of an electing small business corporation for any taxable year shall be included in the gross income of the shareholders of such corporation [emphasis supplied]." The shareholders paid the tax, not the corporation. Therefore, the corporation was not a taxable entity.The principle here is substantially the same as in Jack Rose, 24 T.C. 755">24 T.C. 755 (headnote, par. 1). In that case, in determining whether in the case of individual taxpayers there had been an omission of more than 25 percent of gross income within the meaning of section 275(c) of the 1939 Code, we held, notwithstanding the fact that section 275(c) of the 1939 Code contained no provision similar to clause (ii) of section 6501(e)(1)(A), supra footnote 4, that a so-called partnership return filed on Form 1065 "was merely an adjunct to the individual returns of Jack and Mae Rose and must be considered together with such individual returns and treated as part of them." In 114 the course of our opinion, we also said:The burden of proving that the 5-year period provided in section 275(c) is applicable is on the respondent. * * ** * * The Ventura store was not operated by a partnership. It was community property of the petitioners and the income therefrom was community income. Each of the petitioners, therefore, should have reported one-half of the gross income from the business. Leslie A. Sutor, 17 T.C. 64">17 T.C. 64, 67. The respondent urges that they did not do so in their individual returns, and that their failure to do so is an omission from gross income by each of them. But we think it is unrealistic to say that the petitioners did not report the gross income of the Ventura store * . The so-called partnership return filed for 1943 reported the gross income of the Ventura store in which petitioners each had an equal interest. It was not the return of another taxable entity. * * It showed income of the community, a nontaxable entity. In the circumstances we think that the so-called partnership return filed for the Ventura store was 86 merely an adjunct to the individual returns of Jack and Mae Rose and must be considered together with such individual returns 115 and treated as part of them. * * * [Emphasis supplied.]The respondent in his response has attempted to distinguish the Jack Rose case, as follows:In Switzer [20 T.C. 759">20 T.C. 759, remanded by C.A. 9 for decision per stipulation], the Commissioner conceded that the Tax Court had erred in not reading the information return of the partnership with the returns filed by the partners for purposes of section 275(c). Jack Rose reached a similar result notwithstanding the Commissioner's claim that the partnership itself was invalid. However, the importance of Jack Rose is in the Court's factual distinction that the return filed by the partnership was not "the return of another taxable entity." * * We do not regard this as a valid distinction of the Jack Rose case from the facts of the instant case. As we have previously stated, Briarcliff was not a "taxable" entity. The return it filed like the so-called partnership return in Jack Rose, due to its election to have its income included in the gross income of its shareholders, was an information return. Actually, what we said in Jack Rose applies more forcefully here by reason of the fact that section 275(c) of the 1939 Code contained no provision 116 similar to clause (ii) of section 6501(e) (1)(A), supra footnote 4.We think it follows that, under section 6501(e)(1)(A)(ii), supra footnote 4, the so-called omitted amount "shall not be taken into account." We hold, therefore, that the respondent did not have 6 years from the time petitioners' 1958 return was filed to make the assessment, and that the assessment of any tax for the year 1958 against Elliott and June is barred by the statute of limitations. See sec. 6501(a), I.R.C. 1954. In view of this holding, issue 3 need not be considered.Decision will be entered under Rule 50. Footnotes1. Before 50-percent capital gain reduction.↩1. Sec. 322(a)(2) of the Revenue Act of 1951 provides: "Section 117(b) [I.R.C. 1939] (relating to treatment of long-term capital gains and losses) is hereby amended to read as follows:'(b) Deduction From Gross Income. -- In the case of a taxpayer other than a corporation, if for any taxable year the net long-term capital gain exceeds the net short-term capital loss, 50 per centum of the amount of such excess shall be a deduction from gross income↩. * * ' [Emphasis supplied.]"2. SEC. 1202 [I.R.C. 1954]. DEDUCTION FOR CAPITAL GAINS.In the case of a taxpayer other than a corporation, if for any taxable year the net long-term capital gain exceeds the net short-term capital loss, 50 percent of the amount of such excess shall be a deduction from gross income↩. [Emphasis supplied.]3. See S. Rept. No. 781, 82d Cong., 1st Sess., Calendar No. 737, accompanying the Revenue Act of 1951, 2 C.B. 458">1951-2 C.B. 458, 481; H. Rept. No. 586, 82d Cong., 1st Sess., accompanying the Revenue Act of 1951, 2 C.B. 357">1951-2 C.B. 357↩, 440.4. SEC. 6501. LIMITATIONS ON ASSESSMENT AND COLLECTION.(e) Omission From Gross Income. -- Except as otherwise provided in subsection (c) -- (1) Income taxes. -- In the case of any tax imposed by subtitle A -- (A) General rule. -- If the taxpayer omits from gross income an amount properly includible therein which is in excess of 25 percent of the amount of gross income stated in the return, the tax may be assessed, or a proceeding in court for the collection of such tax may be begun without assessment, at any time within 6 years after the return was filed. For purposes of this subparagraph -- * * (ii) In determining the amount omitted from gross income, there shall not be taken into account any amount which is omitted from gross income stated in the return if such amount is disclosed in the return, or in a statement attached to the return, in a manner adequate to apprise the Secretary or his delegate of the nature and amount of such item.↩5. SEC. 6037. RETURN OF ELECTING SMALL BUSINESS CORPORATION.Every electing small business corporation (as defined in section 1371(a)(2)) shall make a return for each taxable year, stating specifically the items of its gross income and the deductions allowable by subtitle A, the names and addresses of all persons owning stock in the corporation at any time during the taxable year, the number of shares of stock owned by each shareholder at all times during the taxable year, the amount of money and other property distributed by the corporation during the taxable year to each shareholder, the date of each such distribution, and such other information↩, for the purpose of carrying out the provisions of subchapter S of chapter 1, as the Secretary or his delegate may by forms and regulations prescribe. * * [Emphasis supplied.]6. The respondent in his determination originally determined that the profit to be realized was the amount of $ 91,245.57 which was the "amount" disclosed by Briarcliff in the statement attached to the return filed under sec. 6037, supra↩ fn. 5. At the hearing, we reduced this profit to $ 68,018.46 by agreeing with the respondent that the $ 91,245.57 should be reduced by the operating loss of Briarcliff of $ 3,724.61 and by agreeing with petitioner that the $ 91,245.57 should be reduced by the discount of the third mortgage of $ 19,502.50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623607/	George M. Still, Inc., Petitioner, v. Commissioner of Internal Revenue, RespondentGeorge M. Still, Inc. v. CommissionerDocket No. 25744United States Tax Court19 T.C. 1072; 1953 U.S. Tax Ct. LEXIS 221; March 12, 1953, Promulgated 221 Decision will be entered for the respondent. During the fiscal year ended July 31, 1945, two of petitioner's officers and stockholders withheld from petitioner the proceeds of certain cash sales, thereby causing sales to be understated in petitioner's books. The father of one of these officers was the dominant stockholder in petitioner; he discovered the situation prior to the close of the taxable year, and obtained promises of restitution from them. Such restitution was actually made in October 1946. Petitioner's tax returns failed to reflect such sales in its gross income. Held:1. In the circumstances of this case, petitioner has failed to show that income thus improperly omitted from its returns was offset by a deductible embezzlement loss.2. The subsequent filing of an amended return and payment of tax shown therein did not deprive the Commissioner of the right to assert the so-called fraud penalty. Herbert Eck, 16 T. C. 511, followed.3. Respondent's determination of fraud sustained. George R. Sherriff, Esq., for the petitioner.Joseph F. Lawless, Jr., Esq., for the respondent. Raum, Judge. RAUM1072 OPINION.The respondent determined a deficiency in tax and 50 per cent additions to tax for fraud, for the fiscal year ended July 31, 1945, as follows:AdditionsKind of taxDeficiencyto taxDeclared value excess-profitsNone$ 1,251.78Excess profits$ 222.2112,020.56All of the facts have been stipulated, and the stipulation is adopted as our findings of fact.The petitioner, a wholesale dealer in oysters and clams, is a New York corporation organized in 1905. Its president, Sidney A. Still (now deceased), owned 50 per cent of its capital stock. His daughter, Nancy S. Milliken, was vice president and owned 10 per cent of its stock. Michael Weissman, secretary of the corporation, also owned 10 per cent of its stock. The remaining stock was owned by members of the Still family inactive in the management of the corporation. 223 Petitioner filed timely corporation income and declared value excess-profits, and excess profits tax returns for its fiscal year ended July 31, 1945, on the accrual basis, with the collector of internal revenue for the second district of New York on October 15, 1945. Petitioner failed to report in these returns cash sales of $ 30,015.64 made during that year. It reported therein that no declared value excess-profits 1073 tax was owed and that the amount of its excess profits tax was $ 2,760.89.On October 17, 1946, the petitioner filed amended returns for its fiscal year ended July 31, 1945, on the accrual basis, with the collector of internal revenue for the second district of New York. These amended returns disclosed additional sales in the aggregate amount of $ 30,015.64. In the amended returns the petitioner reported its liability for declared value excess-profits tax to be $ 2,503.55, and for excess profits tax $ 26,579.80 (which was $ 23,818.91 in excess of that reported in the original excess profits tax return). The petitioner then paid $ 2,503.55 declared value excess-profits tax and $ 23,818.91 additional excess profits tax.The $ 30,015.64 sales which petitioner224 failed to report in its original returns were not recorded on its corporate books. They were cash sales which petitioner made to Shine's Restaurant and to Charles' Restaurant. During the period commencing in October 1944 and continuing until June or July 1945, Nancy Milliken and Michael Weissman made unauthorized withdrawals and retained for themselves the proceeds of these sales. They had been employed by petitioner for approximately 25 years.During the fiscal year ended July 31, 1945, the petitioner paid Nancy compensation of $ 1,800 per annum for her services as vice president, and paid Michael $ 5,940 for his services as secretary. In affidavits filed with this Court they stated that in the fall of 1944, they discussed their low salaries and the probability that they could obtain no increases "because of the limitation on increases by law those days" and decided they would take for themselves certain monies representing cash sales by petitioner to Shine's Restaurant and Charles' Restaurant and would not enter these sales in the day book used for posting to the regular set of books. They continued this practice until June or July 1945.In June or July 1945, Sidney Still, 225 petitioner's president, learned that Nancy and Michael were wrongfully withdrawing and retaining for their own use the proceeds of these sales, whereupon the practice ceased and Nancy and Michael promised to return to the corporation the unauthorized withdrawals.Sidney, Nancy, and Michael, the responsible officers of petitioner, all knew of petitioner's unreported sales in the sum of $ 30,015.64, at least a full 2 1/2 months prior to the filing of the corporation's original tax returns for the fiscal year ended July 31, 1945.The original returns of petitioner for the fiscal year ended July 31, 1945, were prepared by William J. Umbach of the firm of Bergen and Willvonseder, certified public accountants, from the books and records of petitioner. At the time of their preparation Umbach told Michael 1074 that the gross profit reported on the returns did not look right to him. Michael then stated that it had become necessary for the corporation to make cash purchases at high prices to fill its needs and that it was selling this merchandise at the same prices, without profit, to regular customers.In December 1945, Charles F. Evans, attorney for petitioner, conferred with George226 L. Bergen of the firm of Bergen and Willvonseder and told him that he had just learned that some sales had not been reported in the return of petitioner for 1945, and asked for Bergen's opinion as to what should be done. Upon being advised that the omitted income covered sales to two customers who always paid in cash, Bergen told Evans, and the latter agreed, that an amended return should be prepared and filed and any additional taxes paid as promptly as possible. The officers of petitioner were informed of their decision. However, no such returns were filed at that time.In August 1946 Bergen and Willvonseder were advised by petitioner that internal revenue agents wanted to examine its return for the fiscal year ended July 31, 1944. Umbach, who had also prepared the petitioner's returns for that year, was directed to assist revenue agent Elmer Baumgarten who visited petitioner's office at that time to make a field audit. Umbach spent several days with Baumgarten and then learned that the officers of petitioner were under the impression that his firm would prepare the returns of petitioner for the fiscal year ended July 31, 1946. He reported this to Bergen, and a letter was 227 written to petitioner by the accounting firm in which petitioner was advised that the firm would not prepare the returns for the current fiscal year because petitioner had not followed its advice in connection with the filing of an amended return for the previous fiscal year.In September 1946, Bergen and Willvonseder prepared amended returns for the fiscal year ended July 31, 1945, in which the sales which had been omitted from the original returns were included in income. Subsequent to the filing of these returns in October 1946, revenue agent Baumgarten revisited the office of petitioner to make a field audit of its returns for the fiscal year ended July 31, 1945. He was informed that amended returns had been filed for that year. When he questioned Nancy and Michael about the omission of the cash sales from the original returns, they told him that these sales were not reported because they believed that monies from these cash sales would be necessary for future black market purchases and they accordingly set such funds aside and these sales were not reflected on petitioner's books.The unauthorized withdrawals by Nancy and Michael were not covered by insurance, and, although 228 they were not repaid during the 1075 fiscal year ended July 31, 1945, they were in fact restored to petitioner in October 1946 by Nancy and Michael.On July 2, 1948, the petitioner filed with the collector of internal revenue for the second district of New York a claim for refund of declared value excess-profits tax of $ 2,503.55 and excess profits tax of $ 23,818.91. This claim was signed by Nancy S. Milliken, as vice president of petitioner.1. There is no dispute between the parties that sales in the amount of $ 30,015.64 were improperly omitted from petitioner's original returns for the fiscal year ended July 31, 1945. However, petitioner contends that no deficiency resulted because it was entitled to a deduction in the same amount by reason of loss from theft or embezzlement, and that it accordingly overpaid its taxes in connection with the amended returns. It claims the deduction under section 23 (f) of the Internal Revenue Code, which allows a deduction to corporations for "losses sustained during the taxable year and not compensated for by insurance or otherwise."We think that petitioner sustained no such deductible loss in the year ended July 31, 1945. When their229 wrongdoing was discovered during the taxable year, Nancy and Michael promised to make restitution. This is a promise that may not lightly be ignored. No criminal charge appears to have been lodged against either of them. Neither was discharged or suspended; both continued to serve as officers of petitioner; and both did in fact make repayment in October 1946. In these circumstances, it seems clear to us that the unauthorized withdrawals did not constitute "losses" which were "not compensated for by insurance or otherwise." (Italics supplied.)The petitioner relies upon various cases such as First National Bank of Sharon v. Heiner, 66 F. 2d 925 (C. A. 3); Peterson Linotyping Co., 10 B. T. A. 542; Piggly Wiggly Corporation, 28 B. T. A. 412; Gottlieb Realty Co., 28 B. T. A. 418; Alabama Mineral Land Co., 28 B. T. A. 586; Grenada Bank, 32 B. T. A. 1290; and Summerill Tubing Co., 36 B. T. A. 347, all of which applied the general rule that losses from embezzlement230 are deductible in the year in which property is wrongfully taken. But cf. Alison v. United States, 344 U.S. 167">344 U.S. 167. None of these cases involved circumstances indicating the likelihood that the victimized taxpayer would obtain restitution from the wrongdoer, and, of course, a mere hope of recovery is not sufficient to deprive a taxpayer of his deduction. Cf. United States v. White Dental Manufacturing Co., 274 U.S. 398">274 U.S. 398. In at least one of the cited cases the absence of any promise of repayment by the embezzler was specifically noted. Summerill Tubing Co., 36 B. T. A. at p. 352.In Charles D. Whitney, 13 T. C. 897, this Court said (p. 901):Losses, to be deductible under the revenue laws, must be actual, realized losses, and in any case where there is a reasonable ground for reimbursement 1076 the taxpayer must seek his redress and may not secure a loss deduction until he establishes that no recovery may be had. "It is a startling proposition that a taxpayer may, for reasons of his own, decline to enforce a valid claim against a responsible concern231 and then assert that he has sustained a business loss which the Government should share." Lee Merchantile Co. v. Commissioner, 79 Fed. (2d) 391. It is true one does not have to be an incorrigible optimist, and, if there is no reasonable ground to expect reimbursement, the loss is allowable, although perchance recovery may be had in a later year. * The petitioner had the burden of proving that it sustained an actual loss from embezzlement in its fiscal year ended July 31, 1945. It did not satisfy this burden merely by showing that two of its officers and stockholders made unauthorized withdrawals of its funds and did not make restitution prior to the end of the year. It had to establish that it did not then have reasonable grounds for believing that it would receive reimbursement, by insurance or otherwise. Here the two officers and stockholders of petitioner who had withheld the funds in question promised to make restitution when their wrongful conduct was discovered during the taxable year. Cf. Douglas County Light & Water Co. v. Commissioner, 43 F. 2d 904 (C. A. 9). Such a promise in the circumstances232 of this case is entirely different from the obligation to repay which arises by operation of law against an embezzler and which is not likely to carry with it any real expectation of being discharged.The obligation thus explicitly undertaken by the two officers in this case gave petitioner a basis for a reasonable conclusion that it would obtain reimbursement. Certainly, it has not been shown otherwise, and the facts affirmatively disclosed in the record plainly suggest that petitioner could reasonably have expected reimbursement. One of the officers was the daughter of the dominant stockholder, and it seems unlikely that she would have become a defaulting fugitive. Both officers continued in petitioner's employ (indeed, both of them verified the original petition filed with this Court), and the subsequent actual repayment of the amounts involved by them confirms the conclusion that no deductible loss had been sustained. Petitioner has not met its burden of proof in this regard. The return originally filed understated petitioner's income in the amount of $ 30,015.64, and it is not entitled to any deduction that would neutralize its failure to report that amount as income.2. 233 The petitioner makes the alternative contention that there is no deficiency upon which an addition to tax for fraud can be based because the additional tax was paid and assessed prior to the mailing of the deficiency notice. This contention is not novel. It has been made by other taxpayers who, after filing returns in which items of income were fraudently omitted, filed amended returns in which the omitted items were included, and paid the additional tax. This Court 1077 has consistently held that the "total deficiency" for the purpose of computing the 50 per cent additions to tax for fraud under section 293 (b) of the Internal Revenue Code, is the difference between the tax liability and the amount shown on the original return, and that a taxpayer who has filed a fraudulent return may not, by subsequently filing an amended return and paying the tax due, bar the respondent from assessing additions to tax for fraud. Herbert Eck, 16 T. C. 511; Harry Sherin, 13 T.C. 221">13 T. C. 221; Aaron Hirschman, 12 T.C. 1223">12 T. C. 1223; Maitland A. Wilson, 7 T. C. 395; Thomas J. McLaughlin, 29 B. T. A. 247.234 Cf. P. C. Petterson, 19 T.C. 486">19 T. C. 486; Nick v. Dunlap, 185 F. 2d 674 (C. A. 5).Any other result would make sport of the so-called fraud penalty. A taxpayer who had filed a fraudulent return would merely take his chances that the fraud would not be investigated or discovered, and then, if an investigation were made, would simply pay the tax which he owed anyhow and thereby nullify the fraud penalty. We think Congress has provided no such magic formula to avoid the civil consequences of fraud. Stanley A. Anderson, 11 T. C. 841, relied upon by petitioner, does not involve this issue. See also McConkey v. Commissioner, 199 F. 2d 892 (C. A. 4).3. The petitioner's remaining contention is that the respondent has not sustained his burden of alleging and proving fraud by clear and convincing evidence. In his answer to the petition the respondent alleged that petitioner made understatements of income in its original returns and that all or part of the tax liabilities over and above the amounts reported on those returns were due to fraud with intent to evade 235 tax.Petitioner is a corporation, and as such can act only through its officers. During the taxable year ended July 31, 1945, Sidney Still was its president and treasurer, Nancy its vice president, and Michael its secretary. All three were aware, prior to the close of the taxable year and prior to the filing of the original corporate returns, that all sales were not reflected on its books. Despite this knowledge on the part of these officers, the corporation filed tax returns in which this unrecorded income was not disclosed. These returns were signed by Sidney Still as president and treasurer and notarized by Michael Weissman. Although petitioner was advised by its attorney and its accountant in December 1945, that amended returns should be filed disclosing the unreported income and that any additional taxes should be paid as promptly as possible, no such action was taken at that time. Amended returns were filed and additional taxes paid only at a later time when there was reason to believe that a revenue agent was hot on the trail.The uncontroverted facts produced in this proceeding clearly support the conclusion that the petitioner willfully and fraudulently, 1078 with236 intent to evade tax, failed to report its true and correct income for its fiscal year ended July 31, 1945, in the original returns filed by it for that year. It follows that petitioner is liable for the 50 per cent additions to tax for fraud determined by the respondent.Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623608/	EDITH HENRY BARBOUR, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Barbour v. CommissionerDocket No. 100714.United States Board of Tax Appeals44 B.T.A. 1117; 1941 BTA LEXIS 1230; July 29, 1941, Promulgated 1230 1. Increase, due to delay in payment, in award paid to petitioner under Michigan law in condemnation of property of which she retained possession until payment, held, taxable as capital gain and not as interest. Estate of Edgar S Appleby,41 B.T.A. 18">41 B.T.A. 18, followed. 2. Depreciation on condemned property between determination of value and relinquishment of possession held not allowable. John M. Hudson, Esq., and Samuel E. Gawne, Esq., for the petitioner. Homer J. Fisher, Esq., for the respondent. OPPER1118 OPINION. OPPER: This proceeding involves a deficiency in income tax for the year 1937 in the amount of $816.11 and a claimed overpayment for the same year in the amount of $5,655. Petitioner filed her income tax return for the year in question with the collector of internal revenue for the district of Michigan. Two questions are presented: Whether a sum paid to petitioner as "interest" on a condemnation award is taxable as ordinary income, or as part of the capital gain from the condemnation, and whether petitioner, who retained possession of the condemned premises after the condemnation judgment and1231 until payment of the award, is entitled to an allowance for the depreciation of the condemned premises during that period. We adopt as our findings the stipulated facts. From these it appears that petitioner acquired by inheritance in 1922 an undivided one-half interest in three parcels of real estate fronting on Woodward Avenue in Detroit, upon which were located three buildings which since that time have been used in petitioner's trade or business. In July 1927, following the approval by the voters of the city of Detroit of a plan for widening Woodward Avenue, the city's common council passed a resolution of necessity for the improvement, the resolution being conditioned upon the signing of financing agreements by at least 75 percent of the property owners to be affected. Such agreements were necessary because of the inability of the city to comply with title VIII, chapter I, section 16 of its charter and section 3801, Compiled Laws of Michigan, 1929, requiring payment for condemned property to be made within one year after confirmation of the condemnation award and prohibiting the taking of possession until payment has been made. The required number of property owners signed1232 such agreements, although petitioner and her joint owner did not. Pursuant to its charter provisions relating to condemnation, the city, on or about November 17, 1927, filed with the recorder's court of the city a petition setting forth that the city had declared the necessity for widening Woodward Avenue and that to accomplish that purpose it was necessary to condemn certain property, including 20 feet of the premises occupied by the three buildings in question. The proceedings were thereafter brought on for trial, resulting in a written jury verdict rendered on February 16, 1932, finding the taking of the requisite portions of the three parcels to be necessary and awarding the compensation therefor, the sum of $180,935.90 being fixed for the condemned portion of the parcel occupied by one of the buildings. On July 21, 1932, the verdict as to necessity and damages or compensation was confirmed by the recorder's court, 1119 resulting in the condemnation of 20 feet of the premises occupied by the three buildings. On November 26, 1937, the city paid to petitioner and her joint owner the sum of $180,935.90, being the amount of the award for the condemned portion of one1233 parcel as aforesaid. This sum was deposited by the joint owners in a special building account with a bank, and petitioner duly filed with the Commissioner of Internal Revenue an application to establish a replacement fund with respect to her share of $90,467.95. On November 26, 1937, her share of the award exceeded her portion of the cost basis of the land and building which had been condemned and for which the award was paid. The judgment award for the condemned portions of the other two parcels had not been paid by the city at the time of the hearing herein, and possession of no part of the condemned portions of any of the three parcels had as yet been taken by the city at that time. On December 21, 1937, the city paid to petitioner and her joint owner the further sum of $48,345.97, being interest upon the award of $180,935.90 from July 21, 1932, the date of confirmation of the award, to December 21, 1937, at the rate of 5 percent per annum, as prescribed by section 14555, Compiled Laws of Michigan, 1929. Petitioner appropriated to her own uses her one-half share of the $48,345.97, and upon her income tax return for 1937 she reported $24,172.98 representing her share of the1234 interest, as income taxable in full. She now contends that the sum of $24,172.98 is taxable as capital gain rather than as ordinary income. During the years 1932 to 1937, inclusive, petitioner received and retained her one-half share of the rentals of the entire three buildings, and beginning with the year 1933 the city eliminated the condemned portion of the properties from city taxation. This case is similar to and controlled by , unless distinctions between the procedure in Michigan, as pursued in the present case, and in New York in the Appleby case, require a different result. See also ; ; certiorari cenied, . In the Appleby case property of the petitioners was acquired in condemnation proceedings by the city of New York. After the acquisition $683,555.50 was awarded for the property. When payment was made "the city paid to the petitioners $751,129.45, of which $67,573.95 was an increase in the original condemnation award because of the1235 lapse of time between condemnation and payment." The Board held that the latter item "is part of the award and not interest." The question here is the same. If petitioner is correct that the amount added to the original award is not interest, 1120 her proposed treatment of the amount as capital gain must be approved. Respondent seeks to distinguish the Appleby case on two grounds, first, that the New York law permits taking prior to payment, whereas in Michigan the public authorities are not permitted to enter upon the property until payment has been made or set aside; and, second, that under New York law the "interest" is declared by statute to be payable "as a part of the compensation" whereas in Michigan it is treated as similar to interest upon a judgment. In our view neither of these distinctions is persuasive. We are unable to accept the requirement that compensation must be paid before entry as adequate to distinguish the cases. The compensation is paid for the property, which includes both title and the right to possession. Without attempting to consider whether there was a passage of title upon completion of the condemnation proceedings, see 1236 ; , it is at least clear that under Michigan law there was a "constructive taking" at that time. ; . From the standpoint of depriving the owner of the ordinary rights of disposition and management, this seems to us sufficiently to resemble the actual taking which occurs in New York. And, if the city must make payment prior to acquiring possession as the final element of ownership, there is, if anything, an added reason for concluding that all items of the payment made at that time are components of the compensatory price received by the owner for parting with the complete bundle of rights constituting ownership. Respondent contends, in effect, that it is only where the property is taken prior to payment that "it appears to be 'uniformly held' that payment of interest constitutes a payment of 'damages' and is part of the 'just compensation' required by the Constitution." If in fact, however, the total amount received by the petitioner for the property was greater by reason of an addition to the original award1237 caused by delay in payment, it seems to us to make little difference whether this additional compensation was required by the Constitution or proceeded from some statutory provision or public policy of the State of Michigan. Respondent does not contend that for tax purposes a distinction should be drawn between "just compensation" for the property, as a capital item, and "just compensation" for the use of petitioner's money, as an income item, and the cases dealing with the adequacy of compensation generally to which he refers attempt no such classification. If he did, the same objection could be taken to the result reached in the Appleby case. Nor does he dwell upon the possibility that even where possession preceds award, there may be a further 1121 interval prior to payment, as there was in the Appleby case, compensation for which can not presumptively be included in the original award. We think it clear that the amount received by petitioner, including that attributable to the delay in payment, was compensation. Whether it was constitutionally required can not, in our view, affect the question before us, which is the extent to which it may be considered as1238 a capital gain on the one hand or ordinary income on the other. Nor do we regard as an adequate distinction the failure to specify that the "interest" is part of the award. That it is compensatory appears with sufficient certainty, as we have seen, from the requirement of payment before entry. Thus the minor difference in Michigan's statutory structure is without significance. True, there is no express provision that the additional payment is to be included in the award. But under Compiled Laws of Michigan (1929), section 3801, there must be set aside in the city treasury before the city can take possession of the property "the amount required to make compensation." This includes such additional sum as is required by law on account of delay in payment. ; . Whether there be two awards or one, the whole is necessary to pay for the property. It follows that the respondent's action in this respect was error. The second issue relates to petitioner's claim for depreciation on the property subsequent to the condemnation proceedings and prior to relinquishment of possession. On this item we think1239 respondent's action was correct. While ownership may not be a prerequisite to the right to a depreciation deduction, see , it is conversely true that not even ownership necessarily entitles the owner to deduct depreciation. The test is whether the claimant to depreciation is in such a position as to suffer an economic loss as a result of the decrease in value of the property due to the depreciation. ; ; affd. (C.C.A., 4th Cir.), ; certiorari denied, . Here we think it apparent that petitioner can not bring herself within such a classification. When judgment was entered upon the award and no appeal taken, the rights and obligations of the parties were legally adjudicated and fully fixed. The amount of defendant's indebtedness for the land it compelled plaintiff to sell was as finally and forcibly determined as by any other judgment * * . [1240 ; ] The date of payment of the condemnation awards might be uncertain, and even their ultimate amount for that reason incapable of computation; yet there is nothing to indicate that they will be diminished by reason of any change which may take place in the character *1122 of the property, and still less, by reason of any of the natural processes of deterioration compensation for which is theoretically furnished by the depreciation deduction. Since petitioner will never be the poorer by reason of depreciation, there is no necessity of permitting her to deduct an amount from current income for the purpose of making herself whole in that contingency. Reviewed by the Board. Decision will be entered under Rule 50.ARUNDELL and BLACK dissent for the reason set forth in their dissent in .	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623609/	ANDRE and RUTH FISCELLA, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentFiscella v. CommissionerDocket No. 2202-73.United States Tax CourtT.C. Memo 1976-120; 1976 Tax Ct. Memo LEXIS 283; 35 T.C.M. (CCH) 548; T.C.M. (RIA) 760120; April 20, 1976, Filed Morris A. Kaplan, for the petitioners. Michael P. Casterton,Bernard Goldstein, for the respondent. QUEALYMEMORANDUM FINDINGS OF FACT AND OPINION QUEALY, Judge: The respondent determined deficiencies in the joint Federal income tax returns of petitioners for the taxable years 1968 and 1969 in the amounts of $10,443.11 and $5,376.01, respectively. Due to concessions by the parties the issues for our decision are as follows: (1) Whether petitioners abandoned their franchise in the taxable year 1968 thereby sustaining a loss. 1284 (2) Alternatively, whether petitioners are entitled in each of the years 1968 and 1969 to a deduction for amortization of the franchise. FINDINGS OF FACT Some of the facts have been stipulated. Such facts and exhibits attached thereto are incorporated herein by this reference. Petitioners, Andre and Ruth Fiscella, are husband and wife. At the time of the filing of the petition herein they resided in Middletown, New York. They filed joint Federal income tax returns for the taxable years 1968 and 1969 with the District Director of Internal Revenue, Albany, New York, using the cash method of accounting. Andre Fiscella is a physician. For some years prior to 1967, petitioners had been looking for an investment which would result in additional income to them, particularly for the years when their children were in college. On or about July 12, 1967, petitioners entered into an agreement with Drive In Management Corporation (hereinafter sometimes referred to as "Carrols"). Under the terms of such agreement, petitioners acquired from Carrols, a territorial franchise in the State of New Jersey for a period of 20 years, with the option of extending the agreement for an additional285 period of five years. The agreement was signed by petitioners as individuals. The cost to petitioners of acquiring such franchise aggregated $80,300, consisting of the purchase price of $75,000 plus $5,300 of legal fees. Under the terms of said agreement, petitioners, as franchisee, were granted the exclusive franchise to secure licensees in the designated territory for "Carrols Drive Ins" upon certain conditions and were also granted licenses to maintain and operate their own Carrols Drive Ins either as an individually owned operation, or through a partnership or corporation in which they had a controlling interest. Petitioners were not empowered to enter into any license agreements. Each licensee was required to enter into a license agreement with Carrols and pay a store opening fee which varied depending on whether the particular licensee was the franchisee (or a corporation or partnership controlled by the franchisee) or an outsider. The agreement further provided that petitioners, as the franchisee, would receive from Carrols a fixed percentage of store opening fees which would become payable to Carrols by any licensees upon the opening of a Carrols Drive In, plus $500286 each year for each store in operation, plus a royalty of.8 percent of gross sales. Without the approval of Carrols, petitioners could not assign their agreement or their rights under the agreement unless they assigned the rights to a company wholly owned by them. In the case of bankruptcy, Carrols could terminate the franchise agreement without further notice. Petitioners, concurrently with the execution of the aforesaid agreement, caused to be organized a corporation known as Fis-Cop Holding Co., Inc., (hereinafter sometimes referred to as "Fis-Cop"), which was to act as a holding company of all the capital stock of any corporation which would be subsequently organized to operate a Carrols Drive In. Between July 1967 and the first half of 1968, Fis-Cop organized and owned all of the capital stock of five separate corporations which were to operate Carrols Drive Ins. Each of the five subsidiary corporations had to pay a store opening fee of $5,000 as licensee. During the time that they were involved with Carrols, petitioners did not attempt to get any outsiders to open up Carrols Drive Ins in their franchised territory. Carrols had tol petitioners that the drive ins "were287 such good money making stores" that it would be advisable for petitioners to operate them. Carrols also indicated to petitioners that they would provide them with a good supervisor. Mrs. Fiscella maintained an active role in the various business communications to and from Carrols and with other individuals, but generally petitioners remained separate from the day-to-day operation of the five drive ins. Carrols provided petitioners one of their former employees to manage the drive ins. However, in the spring of 1968, the manager was relieved and Mrs. Fiscella went to New Jersey and personally attempted to run the drive ins. All five of the drive ins soon experienced severe financial reverses, thereby causing Fis-Cop to file a petition in bankruptcy under Chapter XI of the Bankruptcy Act, on or about July 1, 1968. As of October 28, 1968, Carrols became the successor for purposes of the New Jersey employees disability insurance, to the five corporations which had been organized by Fis-Cop. In this connection, the treasurer of Carrols agreed to assume the obligations and liabilities of the predecessors commencing October 28, 1968. On or about November 6, 1968, Fis-Cop was288 adjudicated a bankrupt. The bankruptcy papers show that at that time Fis-Cop had assets of $85,666 and liabilities of $98,447 with no present value assigned to the capital stock of the five subsidiaries. Each of the five subsidiaries showed an excess of liabilities over assets. Four of the five subsidiaries showed an amount owed to Fis-Cop in the amount of $12,000 and Fis-Cop showed a corresponding accounts receivable due from the four subsidiaries of $48,000 for security deposits advanced for their accounts to the Drive In Management Corporation. The bankruptcy papers also reflect a loan from petitioners to Fis-Cop in the amount of $15,374.03. After the bankruptcy, all five drive ins were closed. Petitioners, because of the bankruptcy of Fis-Cop and because of family problems, decided to get themselves out of a difficult situation and to forget about the franchise. They ceased all work at the five drive ins and walked away. Carrols took over the five drive ins and has never rendered an accounting to petitioner with respect thereto. Petitioners have not subsequently received any money with respect to the franchise nor have they attempted to sell it. Since 1968, drive ins in289 the territory covered by the franchise agreement of July 12, 1967, have been operated either by Carrols or by a licensee of Carrols whose license extends only to the particular location. As a result of the bankruptcy of Fis-Cop and the discontinuance of the business operations of the five subsidiary corporations with the resultant failure to make the required rental and other payments to Carrols, Carrols through its subsidiaries instituted nine separate actions on or about September 24, 1968, against petitioners, all of which are still pending. Such suits are based on two separate causes of action: First, that petitioners are liable as the allege d guarantors for the operating corporations and secondly, that petitioners assumed personal liability on equipment leases. Petitioners have filed counterclaims for $300,000 against Carrols for fraud and misrepresentation. On their 1968 income tax return petitioners claimed an ordinary loss on the franchise venture in the amount of $80,300.The respondent determined that the loss is not allowable because petitioners did not establish that the franchise became worthless or was abandoned during the taxable year 1968. OPINION Petitioners290 invested $80,300 in 1967 for a 20 year territorial franchise from Carrols. Shortly after the signing of the franchise agreement in July 1967, petitioners incorporated Fis-Cop Holding Company, Inc. and five subsidiary corporations which were licensed to do business as Carrols Drive Ins. During 1968, the five corporations experienced financial difficulties, thereby causing Fis-Cop, in July 1968 to file a petition in bankruptcy. On or about November 6, 1968, Fis-Cop was adjudicated a bankrupt, and all five operating drive ins were closed. Subsequently, through its subsidiaries Carrols instituted various lawsuits against the petitioners, all of which are still pending. Petitioners have filed counterclaims against Carrols in these actions for damages of $300,000 for fraud and misrepresentation. Petitioners contend that their franchise being worthless, they abandoned it in 1968 and are entitled to a loss in that year of $80,300 pursuant to section 165(a). 2 Respondent argues that neither the worthlessness nor the abandonment in 1968 has been established. Section291 165(a) permits the deduction of "any loss sustained during the taxable year and not compensated for by insurance or otherwise." Recognizing that a loss deductible under section 165 may occur on the abandonment of property, section 1.165-2(a), Income Tax Regs., states: (a) Allowance of deduction. A loss incurred in a business or in a transaction entered into for profit and arising from the sudden termination of the usefulness in such business or transaction of any nondepreciable property, in a case where such business or transaction is discontinued or where such property is permanently discarded from use therein, shall be allowed as a deduction under section 165(a) for the taxable year in which the loss is actually sustained. For this purpose, the taxable year in which the loss is sustained is not necessarily the taxable year in which the overt act of abandonment, or the loss of title to the property, occurs. In order to claim an abandonment loss, the taxpayer must demonstrate an intention to abandon the property together with an act of abandonment. These requirements, plus a determination of the year in which the loss is sustained, must be ascertained from all the facts and292 circumstances. Massey-Ferguson, Inc.,59 T.C. 220">59 T.C. 220 (1972); Burke v. Commissioner,283 F.2d 487">283 F.2d 487 (9th Cir. 1960); affg. 32 T.C. 775">32 T.C. 775 (1959). On the basis of the record in this case, it appears that in the taxable year 1968 the petitioners abandoned all intention to proceed with the development of the Carrols Drive In franchise. The drive ins were closed in 1968. At that time all five operating corporations were insolvent, as was Fis-Cop, the holding company. Carrols took over the drive ins and since 1968, drive ins in the territory covered by petitioners' franchise agreement have been operated by Carrols or their licensees. Mrs. Fiscella testified that the petitioners entertained no hope of recovery on their counterclaims to the suits instituted by Carrols and that such counterclaims were filed merely as a defensive measure. Although Carrols is still pursuing the matter, under the circumstances of this case, the existence of pending litigation is not sufficient to postpone the loss. See United States v. White Dental Co.,274 U.S. 398">274 U.S. 398 (1927); Parmelee Transportation Company v. United States,351 F.2d 619">351 F.2d 619 (Ct. Cl. 1965);293 section 1.165-1(d) (2), Income Tax Regs.The petitioners admittedly paid $80,300 to acquire a territorial franchise. As of the close of the taxable year 1968, they had lost everything. To them, the franchise had no value. The petitioners abandoned any attempt to further exploit the franchise. Accordingly, petitioners sustained an abandonment loss in 1968 amounting to $80,300. Boehm v. Commissioner,326 U.S. 287">326 U.S. 287 (1945); United States v. White Dental Co.,supra;A. J. Industries, Inc. v. United States,388 F.2d 701">388 F.2d 701 (Ct. Cl. 1967); cert denied 393 U.S. 833">393 U.S. 833 (1968); A. J. Industries, Inc. v. United States,503 F.2d 660">503 F.2d 660 (9th Cir. 1974). Our conclusion that the petitioners suffered a loss in 1968 on the abandonment of their franchise, makes it unnecessary for us to decide petitioners' alternative contention. In accordance with the above, Decision will beentered under Rule 155.Footnotes1. On brief the respondent concedes for purposes of this case that if the franchise is found to have been worthless or abandoned in 1968, the petitioners are entitled to an abandonment loss for that year.↩2. All statutory references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623610/	LORNE A. JOHNSTON, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentJohnston v. CommissionerDocket No. 110-82.United States Tax CourtT.C. Memo 1984-374; 1984 Tax Ct. Memo LEXIS 298; 48 T.C.M. (CCH) 553; T.C.M. (RIA) 84374; July 23, 1984. Joseph V. Sliskovich, for the petitioner. Darren M. Larsen, for the respondent. DRENNENMEMORANDUM FINDINGS OF FACT AND OPINION DRENNEN, Judge: This case was assigned to and heard by Special Trial Judge Peter J. Panuthos pursuant to the provisions of section 7456(c), 1 and General Order No. 8 of this Court, 81 T.C. XXIII (1983). After review of the record, we agree with and adopt his opinion set forth below. OPINION OF THE SPECIAL TRIAL JUDGE PANUTHOS, Special Trial Judge: Respondent determined a deficiency in petitioner's 1977 Federal income tax in the amount of $4,026.09 and an addition to tax under section300 6651(a)(1) in the amount of $1,006.52. The issues for decision are (1) Whether a partnership agreement was modified so as to reduce the distributive share of partnership income to be allocated to petitioner; and (2) whether petitioner's failure to timely file his Federal income tax return was due to reasonable cause under section 6651(a)(1). Some of the facts in this case have been stipulated and are so found.The stipulation of facts and attached exhibits are incorporated herein by this reference. The petitioner resided in Goleta, California, at the time the petition herein was filed. I. Partnership Income.In 1973, petitioner and two other individuals formed the Oxnard Drywall Supply partnership. Petitioner's partners were William Rogers and Larry Rogers, father and son, respectively. Petitioner was responsible for sales, yard operations, dispatching, and truck driving. Larry Rogers managed the financial affairs of the business. Each of the three partners shared equally in the profits and losses of the partnership. From 1973 until sometime in 1977 the partners had an oral partnership agreement. In the fall of 1977, petitioner signed a written partnership agreement301 dated January 1, 1977. Paragraph 19(c) of the agreement gives any two partners in the partnership the right to buy out the third partner by giving him written notice of their intent to do so. Paragraphs 19(e) and 19(f) provide for the valuation of the withdrawing partner's interest and for the payment for that interest by the remaining partners.Paragraph 19(e) provides that the value of a partner's interest shall be equal to the sum of the following items: (1) The credit balance in the partner's capital account using book value for each asset. Accounts receivable shall be decreased by a 2 percent reserve for bad debts, and liabilities and contingent liabilities shall be based on the principal balance due or claimed to be due; (2) The amount of any debt owed to the partner by the partnership; (3) The partner's proportionate share of the partnership's net profit for the current fiscal year to the date on which the computation is made and not yet reflected in the partner's capital account; or if the partnership operations for that period show a loss, the partner's proportionate share of any such loss shall be deducted; and (4) Less any debt owed by the partner to the partnership.302 Petitioner was a partner in the partnership during the entire taxable year of 1977. In February of 1978, Larry Rogers informed petitioner that he and his father were exercising their right under paragraph 19(c) of the partnership agreement to purchase his interest in the partnership under the terms specified in paragraphs 19(e) and (f) of the agreement. Petitioner was told that he would be entitled to draw a salary for the remainder of that month, but that his services and duties were to cease immediately. Larry Rogers provided petitioner with letters from the partnership's attorney and accountant detailing the terms of the acquisition of his interest and valuing his interest in the partnership. Petitioner was informed that his share of the partnership's income for 1977 was $32,137. Eventually petitioner received two Schedules K-1 for 1977; the first for the period beginning January 1, 1977 and ending August 31, 1977; and the second beginning September 1, 1977 and ending December 31, 1977. On both forms the words "tentative K-1" were written in the upper right-hand corner. 2 Petitioner never received any other Schedule K-1 from the partnership. 303 Petitioner filed his income tax returns for 1977 on October 19, 1978. On that return he reported his distributive share of partnership income from Oxnard Drywall Supply in the amount of $32,505.36. The partnership information return for 1977 filed for Oxnard in February of 1979 reported petitioner's share of ordinary income to be $49,058.00. In December of 1978, petitioner signed a "Mutual Release Agreement" with his ex-partners. Petitioner was told that the agreement would release him from any continuing joint and several liability. Petitioner was thereafter unable to get any further information regarding the partnership finances or his proper share of the partnership income and losses for the taxable year of 1977. Respondent contends that petitioner is liable for income tax on his one-third distributive share of 1977 partnership income in the amount of $48,485 as set forth in the partnership return (as adjusted by respondent). Respondent also included in petitioner's income the $12,000 petitioner received in 1977 as a guaranteed payment. 3Petitioner's position is that the termination of his interest in the partnership,304 coupled with the accounting given him by the Rogers showing his share of partnership income for 1977 to be $32,505.36 and his inability to get any financial information other than the "tentative" Schedule K-1 forms from the remaining two partners, constituted a modification of the partnership agreement. Thus, he argues that he correctly reported his distributive share of partnership income in the amount of $31,838 ($32,505.36 less $666.66 additional first year depreciation). In support of his position petitioner relies on Smith v. Commissioner,T.C. Memo. 1962-294, affd. 331 F.2d 298">331 F.2d 298 (7th Cir. 1964). Section 701 provides that each partner, and not the partnership, is liable for income tax. Each partner must take into account separately his distributive share of the partnership's income. Section 702(a). In general, a partner's distributive share of income and losses is determined by the partnership agreement. Section 704(a). Each partner is taxed on his distributive share of the partnership income without regard to whether the amount is actually distributed305 to him. Sec. 1.702-1(a), Income Tax Regs. Thus, to the extent that the partnership had income in 1977, petitioner is liable for his distributive share of that income whether or not he received it. United States v. Basye,410 U.S. 441">410 U.S. 441, 453 (1973). The partnership agreement includes oral or written modifications. Section 761(c) and sec. 1.761-1(c), Income Tax Regs.Section 761(c) provides as follows: (c) Partnership Agreement. - For purposes of this subchapter, a partnership agreement includes any modifications of the partnership agreement made prior to, or at, the time prescribed by law for the filing of the partnership return for the taxable year (not including extensions) which are agreed to by all the partners, or which are adopted in such other manner as may be provided by the partnership agreement. The burden is on petitioner to prove the existence of any written or oral modification. See Martin v. Commissioner,T.C. Memo 1982-226">T.C. Memo. 1982-226. Although petitioner argues that there was a modification306 of the partnership agreement, he did not present sufficient evidence to meet his burden of proving a modification. There is no evidence that the partners agreed to, or even discussed modifying the partnership agreement. This case is distinguishable from Smith v. Commissioner,supra, wherein the record established the existence of an oral agreement that, in effect, modified the original partnership agreement. Accordingly, respondent's determination is sustained. 4II. Addition to Tax under Section 6651(a)(1).Petitioner filed his 1977 Federal income tax return on October 19, 1978. Petitioner was granted a extension of time (until June 15, 1978) to file his return. A second request for extension was mailed on June 20, 1978, by petitioner's accountant. The second request for an extension was untimely and was not granted. Section 6651(a)(1) provides for an addition to tax in the case of a failure to file a return " * * unless it is shown307 that such failure is due to reasonable cause and not due to willful neglect * ." Sec. 301.6651-1(c)(1), Proced. & Admin. Regs., provides that if a taxpayer exercises ordinary business care and prudence and is still unable to file the return within the statutory period, then the delay is due to reasonable cause. The burden of proof is on petitioner to establish the existence of reasonable cause. Estate of Direzza v. Commissioner,78 T.C. 19">78 T.C. 19, 32 (1982). Petitioner argues that the traumatic expulsion from the partnership coupled with reliance upon professional advisers constitutes reasonable cause for the delinquent filing. While petitioner was a credible and forthright witness, the record is inadequate to sustain petitioner's burden of proof on this issue. We have no doubt that petitioner suffered some upset in his expulsion from the partnership. However, this expulsion occurred in February of 1978. Petitioner provided no further details to establish that he was under some emotional or other disability after that date. With respect to petitioner's argument that he relied upon professional advisers, once again he provided few facts to adequately prove such308 reliance. Also, petitioner's testimony was vague as to when he received sufficient information to prepare the return. Petitioner stated that he received the Schedule K-1 forms "several months" after February 15, 1978. We cannot conclude on this record that there was a delay in receiving this information which prevented petitioner from filing his return before the due date as extended. 5 Accordingly, respondent is sustained on this issue. Petitioner agreed that the remainder of the adjustments set forth in the statutory notice were correct and accordingly a decision may be entered for the full amount of the deficiency and addition to tax. Decision will be entered for the respondent.Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated.↩2. In the record there was a copy of the Oxnard Drywall Supply Form 1065 with the Schedules K-1 for each of three individuals who were partners in 1977. The Schedule K-1 for petitioner has an entry under item 1(b) "Ordinary Income" of $49,058. None of the forms have a date on them. However, the parties stipulated in paragraph 4 of the stipulation of facts that these forms were filed with the Audit Division of the Internal Revenue Service on February 3, 1979.↩3. Petitioner does not contest this adjustment.↩4. While we sympathize with petitioner's plight we are clearly bound by the provisions of the Internal Revenue Code.↩5. It is probable that had petitioner requested an additional extension prior to June 15, 1978, because of his inability to get the required information, such request would have been granted. Or petitioner could have timely filed the return he filed late and amended it later if necessary.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623611/	APPEAL OF EDWIN SCHIELE DISTILLING CO.Edwin Schiele Distilling Co. v. CommissionerDocket No. 3521.United States Board of Tax Appeals3 B.T.A. 873; 1926 BTA LEXIS 2543; February 18, 1926, Decided Submitted November 23, 1925. 2543 To be included in statutory invested capital, intangible assets paid in for stock must have actual cash value when so paid in. A. M. Frumberg, Esq., for the taxpayer. Briggs G. Simpich, Esq., for the Commissioner. LANSDON 873 Before STERNHAGEN, LANSDON, and ARUNDELL. This appeal is from the determination of a deficiency in income and profits taxes for the years 1918 and 1919, in the amount of $37,858.54. The taxpayer alleges that the Commissioner erred in disallowing value of intangibles in the computation of invested capital and as a basis for determining loss resulting from national prohibition legislation. FINDINGS OF FACT. The taxpayer is a Missouri corporation, with its principal office in St. Louis. It was incorporated on June 28, 1907, with an authorized capital of $250,000, divided into 2,500 shares of the par value of $100 each. Fifty per cent of the authorized capital was common stock, and 50 per cent was preferred stock, with provisions for cumulative dividends at the rate of 7 per cent per annum, and with no voting power. At the date of incorporation, taxpayer acquired all the tangible and intangible assets of Edwin2544 Schiele & Co., a partnership, and paid therefor to the partners of such company its common and preferred stock in the amount of 1,925 shares. Of this payment, 1,460 shares were for tangibles and 465 shares were for intangibles. A small number of shares were subscribed for by others than the partners, at the date of incorporation, at $100 a share. Edwin Schiele & Co., hereinafter referred to as the partnership, was established in 1892, for the purpose of dealing in whisky at wholesale. It was its practice to buy whisky in large quantities, in barrels, and to then bottle portions of such bulk whisky for sale 874 to the liquor trade under its own trade-marks, brands, and labels. Prior to June 20, 1907, it had established eight such trade-marks or brands and registered the same in Mida's Trademark Bureau. It had also registered one of its brands, "Autocrat," in the United States Patent Office. The partnership expended large sums of money in advertising its trade-marked whisky. For the years 1903, 1904, 1905, and 1906, such expenditures were made in the amount of $38,578.02. Prior to 1903, approximately $100,000 had been so spent. The effect of such advertising was2545 to create a demand for the trade-marked whisky at prices that averaged at least 25 per cent higher than could be obtained for the same goods when sold in barrels without any distinguishing trade names or labels. At June 28, 1907, the partnership enjoyed a large patronage and its business was profitable. From 1903 to 1906, inclusive, the financial statements of the partnership, as of January 1 of each of such years, show the following: Year.All tangible assets.Net worth of tangibles.Net earnings.1903$166,453.55$96,103.55$16,994.641904221,725.26111,205.449,670.901905246,409.58113,881.8311,271.741906253,429.17120,778.4416,612.61Average221,754.54110.492.3113,637.49Salaries for services rendered in the operation of the business were paid in equal amounts to the two partners, Edwin Schiele and David Kriegshaber, for the years 1903, 1904, 1905 and 1906, or in the total amount of $29,400 for the four years. During the same years the partnership used tangible assets in its business operations in the total annual average amount of $236,251.64, of which $125,759.33 was borrowed capital, for which interest was paid in2546 the average annual amount of $6,757.83, at the rate of approximately 5 per cent. In its income and profits tax returns for the year 1917, the taxpayer included in its invested capital the amount of $65,462.32, alleged to represent value of intangible assets acquired by it from the partnership at June 28, 1907, in exchange for 460 shares of its preferred stock, but in its appeal it asks that only $46,500 of the value of such intangibles be included in its invested capital. In its returns for 1918 and 1919, the taxpayer deducted certain amounts, not disclosed by the record, from its gross income for such years, as losses due to obsolescence of its intangible property resulting from national prohibition legislation. Upon audit of such returns, the Commissioner advised the taxpayer, "That no good-will value can be computed either as at the date of incorporation, for invested capital purposes, or as of March 1, 1913, for obsolescence," and determined 875 the deficiences for 1918 and 1919 that are in controversy in this appeal. DECISION. The determination of the Commissioner is approved. OPINION. LANSDON: The issues of this appeal grow out of the taxpayer's contentions2547 that, when incorporated at June 30, 1907, it acquired intangible assets from a predecessor partnership, which, at that date, had a value of not less than $46,500; and that it had intangible assets of substantial value at March 1, 1913, which should be made the basis for computing deductions from gross income of the years 1918 and 1919, on account of obsolescence resulting from prohibition legislation. The evidence is conclusive that stock of the par value claimed was issued for intangibles at the date of incorporation. The taxpayer asserts that, if intangible property of the value alleged was paid in for capital stock, such value must thereafter be included in its invested capital for the purpose of determining its liability for profits taxes and as a basis for obsolescence of intangibles resulting from national prohibition legislation. Intangibles of the nature involved in this appeal are property, and, if the value of such property at the date it was paid in for stock is established by competent evidence, the taxpayer's theory is sound as to the first point asserted, without in any way affecting the basis for the computation of obsolescence of intangibles resulting from prohibition2548 legislation, which must depend on proved value as of March 1, 1913. Invested capital for excess-profits tax purposes is a creature of statutory definition. Obsolescence relates to matters of fact that must be established by competent evidence. The taxpayer, to sustain its contention, must prove that the specified intangibles were bona fide paid in for stock at June 28, 1907, that, on that date, they had an actual value of not less than $46,500, the par value of the stock received therefor, and that no statutory provisions can be applied to reduce such value as an element of invested capital. In support of its contention of value, it relies (1) on the fact that shares of stock of the par value of $46,500 were issued in exchange for such intangibles and that some sales of such stock were made at par; (2) on proof that large sums of money, aggregating something like $150,000, were spent in advertising for the purpose of creating a commercial demand for the merchandise bearing its labels, trade-marks and trade names; and (3) that the application of A.R.M. 34 to the tangible assets and the net earnings of the partnership for the years 1903, 1904, 1905, and 1906, 876 proves2549 that the intangible assets had value in the amount of $50,056.35 at January 1, 1906. The Board does not agree with the taxpayer's contention that the value of the intangibles paid in for stock may be determined by the few sales of shares made at par on or about the date of incorporation. It is true that some shares were so sold, but for the most part such sales were to the partners, to persons closely associated with them, or to persons from whom the partnership had borrowed money and were, in fact, original subscriptions for stock of the corporation then in process of organization rather than sales to the public. None of the sales was on an open market or of such a nature as to establish a market value of the stock at $100 per share. The taxpayer proved that the partnership expended large amounts for advertising, but there is nothing in the evidence to indicate that such expenditures produced results that may be reduced to terms of dollars and cents for inclusion, even in part, in the capital structure of the partnership. The only proved effect of the advertising is the testimony of one of the partners that the partnership sold trade-marked brands of whisky in bottles for2550 prices about 25 per cent higher than those obtained for the same merchandise marketed in bulk. During the entire life of the partnership, the cost of all advertising was charged to expense. Whether such expenditures resulted in the development of intangible values is a matter of fact that is best determined by a scrutiny of the financial statements which reflect the income of the partnership for the years involved. The parties agree on the amounts representing tangible assets and total earnings for the years 1903 to 1906, inclusive, but differ widely on the results obtained by the application of the formula suggested in A.R.M. 34 to such amounts for the purpose of ascertaining value of good will. The taxpayer contends that, for any given period, all the net earnings of a partnership, including any amounts paid to partners as salaries, must be regarded as profits, and that such profits must be attributed in their entirety to the earning power (1) of the net worth of the tangible assets, and (2) of the intangible assets. Counsel for the Commissioner contends that reasonable salaries paid to partners for services rendered in the operation of the business must be deducted from earnings2551 before the formula can be applied, and that the total value of the tangible assets, regardless of the debts of the partnership, must be considered. The application of the formula, as interpreted by the taxpayer, indicates that intangible property of the value of $50,056.35 at January 1, 1907, was paid in for stock at June 28, 1907. The Commissioner's interpretation and application of the formula to the same amounts indicates that such intangibles had no value at either of such dates. 877 The taxpayer's assumption that all the earnings are attributable either to tangible or intangible property invested in, at risk, and used in the business is not sound. If any intangible property is employed in the business operations of a partnership, the net earnings must be attributed to at least three factors - tangible assets, intangible assets, and the services of the partners who devote their time and minds to the business. To determine the earning value of the intangibles, a proper portion of the net returns must first be attributed and allocated to the other two income-producing elements. In the instant appeal, there is no controversy over the value of the services rendered2552 by the partners. By agreement between themselves they fixed their own salaries, and, in the absence of controversy, the amounts so determined and paid must be accepted as the measure of their personal contributions to the income of the partnership and deducted from earnings before any allocation of profits can be made either to tangibles or intangibles. Even after reducing the earnings by the amounts attributable to the personal services of the partners, we are still unable to make any proper allocation of the remaining profits, without considering the additional element of borrowed capital. The record discloses that all borrowed capital involved in this issue is tangible property. It must be presumed, therefore, that, equally with tangible assets representing paid-in capital, it is entitled to a reasonable annual return for its services. In the case of breweries and distilleries, the Commissioner has suggested that 10 per cent is such a return. In the instant appeal, the cost of borrowed capital was 5 per cent per annum, which, if 10 per cent is allocated to tangibles, indicates a net gain of 5 per cent as the result of its use. The average amount of borrowed capital employed2553 by the partnership for each of the years 1903 to 1906 was $125,759.33, and its average annual net earnings at 5 per cent was $6,287.46, or a total for the four years involved of $25,149.84. If the taxpayer's contention that 10 per cent shall be attributed only to the net worth of the tangibles, without considering the net income resulting from the use of borrowed capital, is sustained, the earnings attributable to intangibles will be increased in the annual average amount of $6,287.46. On the other hand, if 10 per cent per annum is first attributed to the gross annual average value of the tangibles, without any adjustment for bills payable, the result so obtained will be too large by the exact net amount earned by the tangibles that represent borrowed capital. The taxpayer's calculation increases the amount of earnings attributable to intangibles, and the Commissioner increases the amount attributable to tangibles. The correct amount of earnings attributable to intangibles, in the conditions of this appeal, can be found only by subtracting from the 878 total net earnings (1) salaries paid to the partners, (2) the net earnings of borrowed capital, and (3) a reasonable2554 return on owned assets. Using the amounts set forth in our findings of fact, the following computation determines the value of intangibles paid in for stock when this taxpayer was incorporated, if such value can be ascertained by the use of the suggested formula: Findings(1) Total earnings 1903 to 1906, inclusive$83,949.95Findings(2) Salaries paid partners same period29,400.00(1)-(2)= (3) Earnings of all assets54,549.95Findings(4) Net earnings of borrowed assets25,149.84(3)-(4)= (5) Earnings of net worth of all assets29,405.311/4 of (5)= (6) Average yearly earnings of all assets7,351.33Findings(7) Average net worth of tangibles110,492.3110% of (7)= (8) Annual earnings attributable to tangibles11,004.92(6)-(8)= (9) Attributable to intangiblesNothing.Inasmuch as the basis for the computation of obsolescence for any year subsequent to March 1, 1913, is value at that date, the Commissioner suggested that careful consideration should be given to the question of the value, if any, of the taxpayer's intangible assets at March 1, 1913. As we have found that the intangibles acquired by the taxpayer at the date of incorporation2555 were without value as property paid in for stock or shares, it is obvious that any good will or other intangibles owned by it at March 1, 1913, must have been paid in or otherwise acquired subsequent to incorporation, and should appear on the balance sheets of the taxpayer either as earned or paid-in surplus. During the last five years of this period the taxpayer's business operations resulted in net losses that aggregated $46,591.55 at December 31, 1912. The evidence adduced is conclusive that no good will or other intangibles of value were developed or acquired between June 28, 1907, and March 1, 1913. The Board is of the opinion that the taxpayer has failed to establish any value for intangibles alleged to have been paid in for stock in the amount of $46,500 at June 28, 1907, and that at March 1, 1913, it owned no good will or other intangibles that could be uses as a basis for obsolescence. It follows, therefore, that the Commissioner's refusal to include any value of intangibles in the taxpayer's invested capital for 1917 and subsequent years, either for profits-tax purposes, or as basis for computing obsolescence due to national prohibition legislation, must be approved. 2556	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623612/	O'Donnell and Elizabeth M. Patrick, Petitioners, v. Commissioner of Internal Revenue, RespondentPatrick v. CommissionerDocket No. 66799United States Tax Court31 T.C. 1175; 1959 U.S. Tax Ct. LEXIS 217; March 20, 1959, Filed 217 Decision will be entered under Rule 50. Held, that the improved and unimproved lots sold in 1953 and 1954 were, in the years in which such sales were made, held primarily for sale to customers in the ordinary course of business within the meaning of sections 117(a)(1)(A) and 117(j) of the Code of 1939 (1953) and sections 1221(1) and 1231(b)(1)(B) of the Code of 1954 (1954), and the profits therefrom are not entitled to capital gains treatment. Thomas H. Krise, Esq., for the petitioners.Bernard J. Boyle, Esq., for the respondent. Fisher, Judge. FISHER1175 Respondent determined deficiencies in income tax and additions to tax of petitioners218 as follows:Additions to taxYearDeficienciessec. 294(d)(2), I.R.C. 19391953$ 2,164.6319543,704.18$ 335.231176 The primary issue presented is whether certain improved and unimproved lots sold in 1953 and 1954 were, in the years in which said sales were made, held by petitioners for sale to customers in the ordinary course of business.Subsidiary issues relating to self-employment taxes of O'Donnell Patrick for the years 1953 and 1954, and additions to tax for substantial understatement of estimated tax for 1954, are dependent upon our determination of the primary issue referred to above, and are to be determined under Rule 50.FINDINGS OF FACT.O'Donnell and Elizabeth M. Patrick, husband and wife, filed joint Federal income tax returns for the calendar years 1953 and 1954 with the district director of internal revenue for the district of Indiana. In 1953, petitioners paid income tax in the amount of $ 5,321.90 by $ 4,208.39 through withholding, $ 400 by declaration of estimated tax, and final payment of $ 713.15 on or before March 15, 1954. In 1954, petitioners paid income tax in the amount of $ 6,263.19 by $ 3,872.20 through withholding, $ 400 219 by declaration of estimated tax, and final payment of $ 1,990.99 on or before April 15, 1955.In July 1950, petitioners purchased, as tenants by the entireties, approximately 37 acres of unimproved real estate located in the vicinity of Michigan Road and 66th Street, Marion County, Indiana. The tract was approximately 9 1/2 miles from the center of Indianapolis, in an area that had not been developed at the time of purchase. The closest business to the tract was a small drugstore and grocery, 7 blocks away.The cost of the tract above referred to was as follows:Original cost$ 18,937.50Abstract35.00Improvements9,186.30Surveying971.00Utility (powerline)117.00Total29,246.80The improvements consisted primarily of the construction of a gravel road on 67th Street, through the center of the tract, together with the construction of a drainage ditch. Petitioners did not make improvements on 66th Street which street had been previously constructed.Petitioners' original purpose in purchasing the tract was to hold it as an investment and as a site for their residence. The purchase was made from joint funds.At the time of the acquisition of the tract, and220 prior thereto, O'Donnell Patrick was a salesman and his wife was employed as a 1177 stylist. At or about the time the construction of homes began on lots in said tract, O'Donnell Patrick, hereinafter sometimes referred to as petitioner, had the tract surveyed, measured, and numbered by lots.Patrick entered into an understanding in 1952 with a builder in which it was planned that about 100 houses would be built on various lots in the tract. Two houses were started, but due to a disagreement with the builder, the arrangement with him fell through. Patrick completed the two houses and sold them in two separate transactions in 1952.During the year 1953, Patrick, as a builder, built and sold two houses and during the year 1954 built and sold four houses. The sales price allocable to the improved lots (as distinguished from the sales price of the improvements) was as follows: Lot 15, $ 1,250; lots 18 and 19, $ 1,900.Petitioner had six transactions involving the sale of improved and unimproved lots on the tract here under consideration during the year 1953, as follows:Lot involvedCost basis -- lots,(numbered)notice of deficiency1$ 463.402372.054403.378424.1315361.9918 and 19 ($ 361.99 x 2)723.98221 Lots 1, 2, 4, and 8 were sold in 1953 without houses. Petitioner built a house on lot 15 and a house on lots 18 and 19. These two houses and lots were sold in 1953.The total selling price of lots 1, 2, 4, and 8 was $ 4,450.The basis of each lot sold as set forth in the notice of deficiency (as distinguished from the basis of improvements on the improved lots) should be increased by the amount of $ 33.76, in accordance with the stipulation of the parties.During the year 1954, petitioners sold the following unimproved lots in five transactions. Said lots had the following sales price and cost basis:Sales priceCost basisTotal$ 9,250Lots 3$ 1,228.047424.1213 and 14759.6330 and 31759.6342346.441 236.32Total3,754.181178 In addition to the sale of unimproved lots in 1954, petitioners built and sold in that year four houses located on various lots in the tract, as follows:Lot involvedCost basis -- lots,(numbered)notice of deficiency16$ 361.9917361.9920361.9921361.99The basis of each lot sold (as distinguished from the 222 basis of the improvements thereon) should be increased by the amount of $ 33.76 over the basis set forth in the notice of deficiency in accordance with the stipulation of the parties. The sales price allocable to these improved lots (as distinguished from the sales price of the improvements thereon) was as follows: Lot 16, $ 1,250; lot 17, $ 1,250; lot 20, $ 1,250; lot 21, $ 1,500.On the sale of improved lots, there was no separation of the sales price with respect to the house and lot.Petitioners did not advertise their unimproved lots for sale, did not pay a commission on the sales thereof, and the purchasers (largely contractors but also homesite buyers) solicited or approached petitioner. Although petitioner O'Donnell Patrick maintained an office in his home, he did not have a separate business telephone in his home, nor did he have a real estate license. The houses built and sold by petitioner O'Donnell Patrick in 1953 and 1954 were sold through real estate agents who received commissions of 3 1/2 per cent.During the years involved herein, petitioner O'Donnell Patrick did not receive income from any occupation or business other than that received from the building and sale223 of improved and unimproved lots on the tract. The income from L. S. Ayres & Company shown on the returns for 1953 and 1954 is for petitioner Elizabeth Patrick.Petitioner continued to build and sell improved and unimproved lots from the tract during the years 1955 and 1956.During the years in issue, petitioner O'Donnell Patrick handled the financing for the houses built, superintended construction (although subcontracting a great deal of the work), arranged for subcontractors, procured materials, and, in general, did about everything a contractor would do. He also handled the transactions for the sale of both improved and unimproved lots. He maintained an office at his residence where he kept books and files.During the years 1953 and 1954, the improved and unimproved properties sold were held primarily for sale to customers in the ordinary course of business carried on in said years by petitioner O'Donnell Patrick.1179 OPINION.The primary issue presented is whether or not respondent was correct in determining that the profits from the sale of improved and unimproved lots were to be taxed as ordinary income upon the principle that such lots were, in the years and at the224 time of sale, held primarily for sale to customers in the ordinary course of business within the meaning of sections 117(a)(1)(A) and 117(j) of the Code of 1939 (with respect to sales in 1953), and sections 1221(1) and 1231(b)(1)(B) of the Code of 1954 (with respect to sales in 1954). The several Code provisions are identical in language insofar as here material. Petitioners argue that such profits are entitled to long-term capital gains treatment under the same sections.The problem of whether sales of lots, whether improved or unimproved, were 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 which may have weight in resolving the issue in the particular case. Criteria which may be significant in some settings are of little if any aid in others. All of the cases agree that the issue is primarily one of fact under all of the circumstances of the particular case, and that no single factor is likely to be controlling. In our judgment, a review of the authorities would unduly extend this opinion and would serve no useful purpose here. We confine ourselves225 to a discussion of the evidence before us in the instant case, the factors which emerge therefrom, and the arguments in relation thereto as advanced on behalf of the parties.Petitioner testified, in part, that he and his wife purchased the original tract of 37 acres in July 1950 intending to hold it as an investment, and also to build a home for themselves on it; that he farmed about 10 acres of it (in a part of the tract removed from the lots ultimately sold) in 1951 and 1952; and that (prior to 1953) he made two efforts to sell the tract as a whole. We believe this testimony, and we recognize that if the property had retained its character as investment property, the profits arising from sale in liquidation of the investment would be entitled to capital gains treatment. We think it clear, however, that this is not what actually occurred.In 1952, petitioner discussed with a contractor the building of a home on the tract for himself and wife. The contractor "sold" him the idea of building about 100 houses on various lots and selling the houses and the lots on which they were built. At least a general understanding was reached, and in the same year, the building of two 1180 226 houses was begun. After they were 40 to 50 per cent complete, petitioner and the contractor had a falling out, and petitioner decided to go on with the project himself. He completed and sold the two houses (together with the lots on which they were built) in 1952. While the precise date in 1952 cannot be determined from the record, we think it evident that petitioner, in 1952, embarked upon a business enterprise, namely, the building of houses, and the sale of the houses together with the lots on which they were built. This enterprise continued through 1953 and 1954 (the years in issue) and on at least into 1955 and 1956. Petitioner, during 1953 and 1954, devoted most of his time to the building of houses, and such time as was required to consummate transactions for the sale of such improved lots. The actual procurement of purchasers was handled through real estate agents who received 3 1/2 per cent commission on such sales. The record is bare of any evidence of whether or not the real estate agents advertised the properties to be sold, but it is clear that the sales of such improved properties were effected by such agents. Petitioner had no occupation in 1953 or 1954 except227 with respect to the building of houses, the sale of the improved lots through agents employed by him, and the sale of unimproved lots (to be discussed infra). Petitioner, during this period, superintended construction, handled finances, made arrangements with subcontractors, procured materials, and did about "everything a contractor would do." He had previously had the lots marked out by a survey and had put in a gravel road on 67th Street and a drainage ditch.Petitioner recognizes, on brief, that he is not entitled to capital gains treatment on the houses sold, and agrees that he was in the business of building houses for sale but argues that the very lots on which the houses were built are entitled to different, i.e., capital gains, treatment on the basis of allocated costs and selling prices. The lots and the houses, however, were sold as one, and the improved lots were just as much devoted to the overall activities of petitioner's business as the houses which were built upon such lots. The business enterprise encompassed both. We think there is no merit in petitioner's contention in this respect, and we find no authority to support it. We add for completeness that there228 is no evidence of any intention to retain the lots with houses for rental purposes.Petitioner also maintains that the profits on sales of unimproved lots in 1953 and 1954 are entitled to capital gains treatment. Here he points to the fact that he did not advertise, solicit sales, employ real estate agents to sell, or push the sales of such lots in any way. He also states that the sale of such lots took little of his time.1181 It is true that petitioner's basic plan was to build first and then sell house and lot as one. On the other hand, it is apparent that disposition of the lots, from the outset of his business undertaking, was part of his general plan of business activity, awaiting only the time and opportunity to build houses on them. It is evident that when he began to build houses, contractors operating in the area, seeking sites for home building, and some who desired to be homeowners, became aware of the fact that lots were available. Advertising and soliciting were unnecessary because the prospects sought out petitioner. There is no suggestion in the record that he was unwilling to sell unimproved lots, and there is every indication that he did sell them whenever229 he received a satisfactory offer. We think that the unimproved lots were held as an integral part of his business plan and that the circumstances of their sale show that at the various dates of sale their disposition had become a part of the active conduct of his business. Clearly such sales were not a part of the liquidation of an investment.Petitioner emphasizes the fact that he was not a licensed real estate broker or dealer. There is no suggestion in the record, however, that he was engaged in selling real estate for others on a commission basis, or any showing that a license was required for him to sell houses or lots or both when the properties sold were owned by himself and his wife, or that he was any the less engaged in the business of selling unimproved lots or selling lots improved by houses built by him.We have carefully examined all of the cases referred to in the briefs and we find them so clearly distinguishable from the instant case, on the facts, that a case by case analysis would serve no useful purpose.As already indicated, we conclude that both the lots improved by houses and the unimproved lots sold in 1953 and 1954 were in those years primarily held for*230 sale to customers in the ordinary course of the business carried on by O'Donnell Patrick, and we sustain respondent subject to conceded adjustments which will be reflected in the Rule 50 decision.It is apparent that the issues relating to self-employment taxes in 1953 and 1954, and additions to tax for 1954 under section 294(d)(2) are disposed of by our holding in relation to the primary issue of whether or not the gains from the sale of improved and unimproved lots are to be treated as ordinary income, and, subject to conceded adjustments, will be reflected in the Rule 50 decision.Decision will be entered under Rule 50. Footnotes1. Addition of $ 33.76 to each lot per stipulations.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4623614/	James A. Carpenter and Cloris A. Carpenter, Petitioners, v. Commissioner of Internal Revenue, Respondent. Richard E. Nealy and Verda Nealy, Petitioners, v. Commissioner of Internal Revenue, RespondentCarpenter v. CommissionerDocket Nos. 79509, 79510United States Tax Court36 T.C. 797; 1961 U.S. Tax Ct. LEXIS 104; July 31, 1961, Filed 104 Decision will be entered under Rule 50. Petitioners, partners in a logging business, entered into an agreement on January 21, 1953, with persons who held option to purchase timber from a company which claimed to be owner thereof even though the title was involved in litigation. Agreement provided that if consent of the claimed owner could be obtained logging would be commenced without the partnership being required to exercise the option. Such consent was obtained on January 30, 1953, and logging began. The other claimant to title to the timber obtained a temporary injunction against logging by the partnership and the partnership entered into an agreement in March of 1953 with the other claimant to title whereby the partnership was granted a license to cut timber for the balance of the year 1953, which agreement was extended in March of 1954 for another year. The timber cut by petitioners' partnership was sold on the open market. Petitioners elected to have the provisions of sec. 631(a), I.R.C. 1954, apply in determining their taxes for the years 1954, 1955, and 1956. Held, petitioners had a contract right to cut timber for sale which they had held for more than 6 months105 prior to the beginning of each of the taxable years 1954, 1955, and 1956, and having so elected are entitled to have the provisions of sec. 631(a) apply in determining gain or loss from the timber sold. Charles P. Duffy, Esq., for the petitioners.John D. Picco, Esq., for the respondent. Scott, Judge. SCOTT 797 Respondent determined deficiencies106 in income tax against petitioners James A. Carpenter and Cloris A. Carpenter in the amounts of $ 9,297.02, $ 17,001.46, and $ 12,935.42 for the years 1954, 1955, and 1956, respectively, and against petitioners Richard E. Nealy and Verda Nealy in the amounts of $ 22,601.16, $ 39,827.06, and $ 27,628.26 for the years 1954, 1955, and 1956, respectively.The sole issue for decision is whether a partnership composed of James A. Carpenter and Richard E. Nealy had a contract right to cut certain timber which it had held for a period of more than 6 months before the beginning of each of the taxable years, thus entitling petitioners to treat the proceeds from the cutting of the timber during each of the years 1954, 1955, and 1956 in accordance with the provisions of section 631(a) of the Internal Revenue Code of 1954. Respondent determined in the case of each petitioner for each of the taxable years involved that the cutting of the timber did not qualify for capital gains treatment within the provisions of section 631(a) or any other section of the Internal Revenue Code of 1954.798 FINDINGS OF FACT.Petitioners James A. Carpenter and Cloris A. Carpenter are husband and wife residing107 at Corvallis, Oregon. They filed joint income tax returns for the years 1954 and 1955 with the district director of internal revenue at San Francisco, California, and a joint income tax return for 1956 with the district director of internal revenue at Los Angeles, California.Petitioners Richard E. Nealy and Verda Nealy are husband and wife residing at Grants Pass, Oregon. They filed joint income tax returns for the years 1954, 1955, and 1956 with the district director of internal revenue for the district of Oregon.Commencing April 1, 1952, and continuing through the taxable years here involved, petitioners Richard A. Nealy (hereinafter referred to as Nealy) and James A. Carpenter (hereinafter referred to as Carpenter) were the sole members of Nealy Logging Company, a partnership, Nealy having a two-thirds interest therein, and Carpenter, a one-third interest.The partnership filed a partnership return of income for the year 1954 with the district director of internal revenue at Portland, Oregon, and partnership returns of income for the years 1955 and 1956 with the district director of internal revenue at San Francisco, California.Nealy Logging Company (hereinafter referred to108 as the partnership) kept its books and records on an accrual method of accounting. Its business was logging of timber and selling the logs produced therefrom on the open market and its principal place of business was Gasquet, California.In 1952 Nealy Logging Company became interested in the merchantable timber located upon certain real property in Del Norte County, California, which will hereinafter be referred to as the John Paul tract. The John Paul tract had belonged to the John Paul Lumber Company, a Wisconsin corporation, for many years. The corporation was inactive from 1930 to about 1947. In 1944 certain individuals became aware that the John Paul tract had increased in value and unless redeemed might be sold for taxes. One Samuel Agnew furnished the funds with which the taxes were paid and secured deeds to the timberlands from certain individuals who purported to act on behalf of the John Paul Lumber Company. In 1947 the John Paul Lumber Company brought a quiet title action against Agnew in the California Superior Court. The John Paul Lumber Company prevailed in the Superior Court pursuant to decision entered June 27, 1952. Agnew appealed to the District Court of 109 Appeals, Third District, California. On May 28, 1954, the appellate court affirmed the decision of the lower court, the appellate court decision being reported as John Paul Lumber Co. v. Agnew, 270 P. 2d 1044799 (1954). Agnew was unsuccessful in seeking review of this decision by the California Supreme Court and the litigation ended.At about the time the partnership was formed Carpenter and Nealy had talked to one Everett Skeeter about a supposed contract that the John Paul Lumber Company had with O. O. Barker, involving certain interests in the John Paul tract. The partnership made an agreement with Skeeter and James C. Rodger acting under a power of attorney for O. O. Barker, for the cutting of timber on the John Paul tract sometime in August 1952 and shortly thereafter commenced logging operations on the tract.After the partnership had been logging the tract for a few days an action was brought against them by Ted R. Webb, Fred Linkhart, and the John Paul Lumber Company to enjoin their cutting timber on the John Paul tract and the court granted the injunction in September 1952.Under date of May 22, 1951, the John Paul Lumber Company110 entered into a written agreement entitled "Timber Sales Contract and Option Agreement" with Ted R. Webb. This agreement provided for the sale to Webb, immediately upon the execution of the contract, of the merchantable timber located on certain lands in Del Norte County, California, other than the John Paul tract here involved and in addition thereto granted Webb an option to purchase the timber located on the John Paul tract. The agreement of May 22, 1951, between John Paul Lumber Company and Ted R. Webb provided, in part, as follows:This Agreement made by and between TED R. WEBB of O'Brien, Oregon, hereinafter called BUYER, and JOHN PAUL LUMBER COMPANY, a Wisconsin corporation, authorized to do business in the State of California, hereinafter called SELLER,Witnesseth:1. Buyer agrees to buy and Seller agrees to sell to Buyer all merchantable timber located upon the following described real property in Del Norte County, California:The Southeast quarter of the Southeast quarter of Section 24 and the South half of the Northwest quarter and the North half of the Southwest quarter and the Southwest quarter of the Southeast quarter of Section 25, Township 17 North, Range 3 East. 111 2. The total purchase price for said timber shall be $ 6.00 per thousand board feet, of which sum the amount of $ 12,500.00 shall be paid to Seller upon the execution of this agreement. The balance of said purchase price shall be paid by the Buyer to the Seller in monthly installments as said timber is cut and removed, payable on the 15th day of each month for all timber cut and removed during the preceding month. Payment shall be made by cashier's check mailed to Seller at 701 Citizens Building, West Palm Beach, Florida. * * 4. Buyer agrees to either cut and remove or have cruised and pay for all of said merchantable timber within a period of two (2) years from the date hereof, except that in the event Buyer exercises his option hereinafter granted, then 800 this time limit shall not apply. Standing timber paid for may remain on the premises no later than May 21, 1961. Any taxes levied against the timber separate from the land shall be paid by Buyer.5. The Seller agrees to furnish to Buyer a title insurance policy in the usual form in the amount of $ 10,000.00, showing title to said real estate to be vested in Seller and in good marketable condition. Said policy of112 title insurance shall be at Buyer's expense.6. The Buyer shall not create nor permit to be created any lien upon the property of Seller and the Seller reserves the right to post notices of nonresponsibility upon said premises. Buyer shall carry adequate compensation and liability insurance at his own expense for the protection of the Seller and agrees to hold Seller free and harmless from any liability arising because of Buyer's operations on the premises. * * 8. In further consideration of the mutual covenants herein contained and the purchase of said timber by Buyer, Seller does hereby grant unto Buyer an option to purchase from Seller all of the remaining timber upon all lands owned by Seller in Del Norte County, California. The parties hereto recognize that title to said real property is presently in litigation and that this option must be exercised by Buyer at any time prior to a day which shall be sixty (60) days after Buyer is notified by Seller in writing that Seller is able to furnish good merchantable title to the said timber, said merchantable title to be evidenced by a title report or other evidence of title acceptable to Buyer. If Buyer requires a policy of title113 insurance it shall be at the expense of Buyer.9. Said option shall be exercised so as to constitute a binding contract by Buyer's giving Seller written notice of his intention to exercise said option, by registered mail, accompanied by a cashier's check in the amount of $ 25,000.00.10. In the event Buyer exercises his option in the manner above described then the terms of this contract shall be extended automatically to the timber covered by said option and the provisions of the preceding paragraphs hereof as to the purchase price of $ 6.00 per thousand board feet, as to the time, place and method of payment and in all other respects shall be extended to include said timber, subject to the next succeeding paragraph.11. If Buyer exercises said option it is understood that he must exercise it to purchase as one lot all of the said timber covered by this option. In the event that the present quiet title suit determines that Seller owns only a portion of the land described in said action, then this option shall include that portion.In the event said option is exercised by Buyer the payment of $ 25,000.00 shall be a payment in advance on the purchase price of said timber. Buyer 114 covenants in said event that he will purchase and pay for a minimum of at least 10,000,000 board feet per year.12. Buyer shall have the right to enter upon any lands of Seller in order to remove and log said timber. * * 14. This agreement shall be binding upon the heirs and assigns of all parties hereto. Time is of the essence hereof. Performance on the part of Buyer of each and every covenant by him to be performed hereunder shall be a condition precedent to performance hereof by the Seller. In the event that Buyer is in default of any of the covenants and conditions by him to be performed hereunder, and such default is not remedied within a period of thirty (30) days after Seller's giving Buyer written notice thereof, then Buyer shall forfeit all of his rights hereunder and Seller shall be entitled to retain any and all payments theretofore made by Buyer under the terms of this agreement as 801 additional consideration for the granting of this option. It is understood that this contract is an entire contract and not severable.In Witness Whereof, the parties hereto have executed this agreement at Auburn, California, this 22nd day of May, 1951.Webb assigned to Fred115 Linkhart and S. H. & W. Lumber Company, an Oregon corporation, a one-third interest each in the option to purchase the timber on the John Paul tract, which he had under his agreement with John Paul Lumber Company dated May 22, 1951. After the partnership had been enjoined from logging operations on the John Paul tract, Nealy and Carpenter began negotiations with Webb, and under date of January 21, 1953, the partnership and Webb, Linkhart, and S. H. & W. Lumber Company entered into an agreement which provided, in part, as follows:This Agreement, made and entered into this 21st day of January, 1953, by and between TED R. WEBB, FRED M. LINKHART and S. H. & W. LUMBER COMPANY, an Oregon corporation, hereinafter known as the Sellers, and RICHARD E. NEALY and JAMES A. CARPENTER, doing business under the assumed name of Nealy Logging Company, hereinafter known as the Buyers, Witnesseth:Whereas, the Sellers have an option dated May 22, 1951, with the John Paul Lumber Company, a Wisconsin corporation, for the purchase of certain timber in Del Norte County, California, a copy of which option is attached hereto marked "Exhibit A" and hereby made a part hereof; andWhereas, the Sellers herein116 are the sole owners and holders of said option; andWhereas, the Buyers herein are also asserting certain claims to all or a portion of the timber covered by said option, and certain litigation is now pending in the State of California involving the parties to this agreement, as well as other parties, and in which litigation it is sought to settle and determine the various questions relative to the title to said timber; andWhereas, the parties to this agreement represent conflicting claims to said timber but have heretofore agreed upon a complete and final settlement of their respective and conflicting differences and claims and desire to reduce the same to writing,Now, Therefore, for and in consideration of the foregoing, the mutual promises and agreements herein contained and the payments to be made by the Buyers, the Sellers do hereby sell, assign and transfer to the Buyers their option of May 22, 1951 with the John Paul Lumber Company, a Wisconsin corporation, subject to the terms and provisions of this agreement. There is included in said option agreement of May 22, 1951 a provision for the purchase of all the merchantable timber on the following described real property in117 Del Norte County, California:The Southeast Quarter of the Southeast Quarter of Section 24 and the South Half of the Northwest Quarter and the North Half of the Southwest Quarter and the Southwest Quarter of the Southeast Quarter of Section 25, Township 17 North, Range 3 East.The parties specifically agree and understand that this contract refers only to the option to purchase and does not extend to or cover the merchantable timber on the land just above described.802 It is Agreed that the purchase price for the assignment of said option is the sum of SIX HUNDRED THOUSAND DOLLARS ($ 600,000.00), which the Buyers promise and agree to pay to the Sellers as follows:1. The sum of THIRTY-FIVE THOUSAND DOLLARS ($ 35,000.00) upon the execution of this agreement, the receipt whereof is hereby acknowledged by the Sellers.2. The sum of FIFTEEN THOUSAND DOLLARS ($ 15,000.00) on or before May 1, 1953.3. The sum of FIFTY THOUSAND DOLLARS ($ 50,000.00) when the Buyers shall exercise the said option of May 22, 1951 with the John Paul Lumber Company.4. The $ 100,000.00 to be paid as provided in Subparagraphs 1, 2 and 3 above provided is in payment of the last $ 100,000.00 due on the purchase118 price.5. The remaining $ 500,000.00 of the purchase price shall be paid by the Buyers paying the Sellers at the rate of SIX DOLLARS ($ 6.00) per thousand board feet for all timber logged and removed by the Buyers from the lands covered by the option of May 22, 1951. Such payments shall be made by the Buyers on or before the 15th day of each calendar month for all timber logged and removed from the optioned property during the preceding calendar month.6. Notwithstanding the provision of the payment of the balance of the purchase price at the rate of $ 6.00 per thousand, a minimum annual payment of SEVENTY-FIVE THOUSAND DOLLARS ($ 75,000.00) shall be made on the purchase price each calendar year in installments of not less than $ 37,500.00 on or before January 1 and $ 37,500.00 on or before July 1 of each year. The first of such minimum semi-annual installments shall be due on January 1 or July 1 of any calendar year which is more than 119 days after the date of the order lifting the restraining order preventing logging operations on the optioned property which is now in effect in the proceedings in the courts of California in which both of the parties to this agreement are parties. 119 The payments made by the Buyers on the basis of the $ 6.00 per thousand board feet, as above provided, shall be applied on the minimum payments herein provided to be made, but if the payments made on the basis of $ 6.00 per thousand board feet do not equal the specified minimum payments, the Buyers shall make up the difference on the dates specified. In the event the Buyers' payments exceed the minimum annual payment of $ 75,000.00 in any calendar year, they shall have the right and privilege of applying such excess against the minimum payment due for the succeeding calendar year or years. In no event, however, shall the Buyers be relieved from paying at the rate of $ 6.00 per thousand board feet for all timber logged and removed, as herein provided.* * * It is Agreed that the provision for the payment of $ 15,000.00 on the purchase price on or before May 1, 1953 is made upon the expectation of the parties that the Buyers will be able to start logging operations on a portion of the property as soon as weather conditions permit. If, either by action of the John Paul Lumber Company or the restraining order of any court having jurisdiction in the matter, the Buyers are prevented120 or restrained from conducting such logging operations, the time for the payment of the $ 15,000.00 shall be extended by a period equal to the period between the date on which the Buyers are so prevented or restrained from proceeding with their logging operations and May 1, 1953. This extension shall apply equally whether it should go into effect prior to the starting of logging operations by the Buyers or after the Buyers have started logging operations and prior to May 1, 1953.It is Agreed that the Buyers specifically assume all payments to be made to the John Paul Lumber Company under said option, a copy of which is attached 803 as Exhibit A hereto. The Buyers further assume and agree to perform all the terms and conditions of said option once the same has been exercised and to keep the same free and clear of any default on their part. * * It is Agreed and recognized by the parties that the title of the John Paul Lumber Company to the optioned timber is subject to court litigation between the said John Paul Lumber Company and one Samuel Agnew in the courts of the State of California; that the trial court has decided said litigation in favor of the John Paul Lumber Company. 121 In the event that the ultimate and final decision in said litigation should be against the John Paul Lumber Company so that neither the John Paul Lumber Company nor O. O. Barker is able to supply merchantable title to said timber, then either party may terminate and end this agreement and the Buyers shall be under no further obligation or liability hereunder, except as to any liabilities or obligations which had accrued as of the date of termination. The Buyers shall have no claim for damages or otherwise as against the Sellers and the Sellers shall keep and retain as their own all payments theretofore made to them by the Buyers under this agreement in the event of such termination. The Buyers accept the entire risk of title and shall have no claim of any kind against the Sellers in the event title is not provided under said option.* * * It is Agreed that the Sellers shall and they do hereby warrant and represent to the Buyers that they are the sole owners and holders of said option of May 22, 1951 and that, other than such assignment and transfer as may be made between themselves, they have made no other or prior assignment, transfer or encumbrance of said option. The Sellers122 further warrant and represent to the Buyers that they have the present right to sell, assign and transfer said option to the Buyers.* * * It is Agreed that from and after the execution of this agreement the risk of loss, damage or destruction to or of the said timber covered by the option of May 22, 1951, whether by fire or other casualty, rests upon the Buyers and the damage to or destruction of the timber from any cause shall not relieve the Buyers from their obligation hereunder to pay the full purchase price.It is Agreed that said option agreement of May 22, 1951 gives the purchaser a period of not to exceed sixty (60) days after the purchaser has been notified by the seller in writing that the seller is able to furnish a good merchantable title to said timber. The Buyers agree to exercise the said option within the first forty-five (45) days of said 60-day period. In the event the Buyers shall not exercise said option within the first 45-day period, the Sellers herein shall have the right to exercise the said option, and in such event this agreement shall terminate and end, as well as all the Buyers' rights hereunder, and the Sellers shall keep as agreed and liquidated 123 damages any and all payments which the Buyers may have heretofore made under this contract. The Buyers herein agree that forthwith after the execution of this agreement they shall notify the John Paul Lumber Company of their acquisition of the said option agreement and that the notice of merchantable title shall be given to them as the optionee under said agreement. * * It is Agreed that time is of the essence of this agreement and in the event the Buyers shall default in making any of the payments herein provided to be made and such default shall continue for a period of 15 days, and in the event they shall default in the performance of any of the other provisions of this agreement and such default as to anything other than money payments shall 804 continue for a period of 30 days, that the Sellers shall, in either event, have the right and option to terminate and end this agreement and the Buyers' rights to exercise the option, or under the option, if the option shall have been exercised, shall terminate and end and the Sellers shall become repossessed of all their former rights and all of the Buyers' rights under said option, either exercised or unexercised, or any contract124 which might be executed after the exercise of the option. In the event of default, as herein provided, the Sellers may, as alternative relief, declare the entire balance of the purchase price due and payable and proceed to collect the same or bring suit or action to avail themselves of any other remedy which may be available to them in law or equity. The failure of the Sellers to insist upon the strict and literal performance of the terms of this contract by the Buyers shall not constitute a waiver of the time essence clause, nor require any further or new notice that thereafter time shall again be the essence of this agreement. * * It is Agreed that this agreement shall be binding upon and inure to the benefit of the heirs, executors, administrators, successors and assigns of the parties. The Buyers shall not assign nor transfer this agreement, nor their rights hereunder, however, without the written consent of the Sellers be first had and obtained. The sellers shall not unreasonably withhold their consent to the assignment of this agreement.It is Agreed that it is the desire of all parties that logging operations be started on the optioned property as soon as possible. 125 The parties are also in agreement that two things will have to be accomplished before such logging operations can start. These are:1. The consent of the John Paul Lumber Company to the conducting of logging operations on the property must be obtained.2. The present pending litigation in the State of California as between the parties to this agreement, in addition to other parties, has a restraining order prohibiting any logging operations on the property. This restraining order must be terminated and ended.Both parties agree to use their best efforts toward a speedy settlement and dismissal of the said California court proceedings between them and the termination of the restraining order now in effect. The parties are in agreement that the start of such logging operations in advance of the John Paul Lumber Company supplying merchantable title shall not constitute nor be deemed an exercise of the option and that agreement of the John Paul Lumber Company to this effect should be obtained.Since reading the foregoing portion of this contract, and before executing it, the parties have agreed upon the following modification of Subparagraph 6 appearing on Pages 2 and 3 of this agreement. 126 The paragraph shall be modified by the addition of the following paragraph:No such minimum semi-annual payments as provided in Paragraph 6 shall be due if either by action of the John Paul Lumber Company or by restraining order of the court in the litigation between the John Paul Lumber Company and Samuel Agnew in which the trial court has previously rendered a decision the Buyers are prevented or restrained from conducting logging operations on said property and no such minimum semi-annual installments shall be required during the time the Buyers are so prevented from conducting logging operations on the optioned property. * After entering into this agreement of January 21, 1953, with Webb, Linkhart, and S. H. & W. Lumber Company, the partnership obtained the consent of the John Paul Lumber Company to proceed with 805 logging operations on the John Paul tract. This consent was granted to the partnership by a letter from John Paul Lumber Company to the partnership dated January 30, 1953, as follows:This is to authorize you to enter upon and log over property owned by the John Paul Lumber Company, Del Norte County, California, beginning as of this date.You have full127 authority to cut and remove timber, construct roads, and to do any and all things necessary and adjunct to your logging operations, provided that you comply fully with all the provisions, terms and agreements contained in the agreement between the John Paul Lumber Company and Mr. Ted R. Webb of O'Brien, Oregon, dated May, 1951, and as modified or enlarged upon in the agreement between yourselves and Messrs. Webb, Linkhart and Hogan, dated January 21, 1953. We understand that your acting hereunder does not constitute an exercise of the option contained in said agreement.On or about January 30, 1953, the partnership entered into an undated agreement with John Paul Lumber Company reading as follows:It is hereby agreed by and between Richard E. Nealy and James A. Carpenter, dba Nealy Logging Co. and John Paul Lumber Co. that the former will pay in addition to any sums called for in the option agreement dated May 22, 1951, the sum of 12 1/2 cents per thousand board feet until such time as a total sum of $ 12,500 has been paid.Under date of January 31, 1953, Webb, Linkhart, and S. H. & W. Lumber Company entered into an agreement with John Paul Lumber Company which provided, in part, 128 as follows:For and in consideration of the JOHN PAUL LUMBER COMPANY permitting the undersigned and their assignees to immediately commence logging operations upon lands of the company without exercising their option therefor and also agreeing to lift the injunction pending against such assigns, and waiving its rights to double stumpage, damages and costs that might be recoverable in the litigation pending and other considerations;The undersigned [Webb, Linkhart, and S. H. & W. Lumber Company] jointly and severally agree to pay to the JOHN PAUL LUMBER COMPANY, in addition to any and all sums provided for in that certain agreement dated May 22, 1951, between Ted R. Webb and John Paul Lumber Company, an additional sum of 37 1/2 cents per M board feet upon any and all merchantable logs cut and removed from the property of the company in Del Norte County, California, whether cut and removed by the undersigned or their agents or assigns, until a total sum of $ 37,500 has been paid hereunder. These payments to be made at the same time and in accordance with the same conditions as those for payments for stumpage set forth in the agreement of May 22, 1951. The above additional payments129 do not apply to any timber already purchased prior to this date.Any defaults in payment of said 37 1/2 cents to be considered the same as defaults under said prior agreement referred to and will constitute a default of said prior agreement.The partnership began logging operations on the John Paul tract shortly after January 31, 1953. On February 13, 1953, Agnew secured an injunction in the California Superior Court, compelling the partnership 806 to cease logging operations. Thereafter, Agnew and the partnership entered into an agreement entitled "Timber Cutting Agreement." This agreement dated March 23, 1953, provided, in part, as follows:This Agreement made and executed this 23rd day of March 1953, by and between SAMUEL A. AGNEW, hereinafter referred to as Agnew, and RICHARD E. NEALY and JAMES A. CARPENTER, doing business as co-partners under the name and style of NEALY LOGGING COMPANY, hereinafter referred to as Nealy,WITNESSETH:Whereas litigation is now pending between John Paul Lumber Company, a Wisconsin corporation, and Agnew, relating to the ownership of a certain tract of timberland situated in Del Norte County, California * * * and,Whereas, said action was 130 brought in the Superior Court of the State of California in and for the County of Del Norte and entitled "John Paul Lumber Co., a corporation, vs. Samuel A. Agnew, et al", No. 4022; and,Whereas an appeal is now pending from a judgment entered in said action; andWhereas Nealy represents that it has made certain arrangements with John Paul Lumber Co. whereby Nealy claims the right to cut, remove and appropriate timber from all of the lands involved in said action, and whereas Nealy has heretofore cut, appropriated and removed certain timber from the lands involved in said action; and,Whereas Agnew has heretofore commenced a suit against Nealy, naming therein as defendants also B. B. Hughes and George Cook, seeking damages for the cutting and removal of said timber and an injunction to prohibit further removal thereof, which action was filed in the Superior Court of the State of California in and for the County of Del Norte and entitled "Samuel A. Agnew, plaintiff, vs. Richard E. Nealy, et al, defendants", No. 4955 in the files and records of said court; and,Whereas, a preliminary injunction has been granted in said suit prohibiting the persons named above as defendants from cutting, 131 removing or appropriating timber from certain lands, being the same lands described in the suit entitled "John Paul Lumber Co., vs. Samuel A. Agnew, et al"; and,Whereas the parties hereto desire to settle said damage and injunction suit upon the terms and conditions hereinafter set forth with the view of protecting the rights of all the parties in interest in the event of either an affirmance or a reversal of the judgment entered in the action entitled "John Paul Lumber Co. vs. Samuel A. Agnew, et al",Now, Therefore, the parties hereto agree as follows:1. Agnew hereby grants to Nealy the license and privilege until January 1, 1954, to enter upon the lands involved in the action entitled "John Paul Lumber Co. vs. Samuel A. Agnew, et al" and to cut, remove and appropriate the timber standing, lying or being thereon in accordance with the terms of this agreement. It is expressly agreed that Agnew does not warrant or represent that he has title to said lands or the right to grant this license. The within consideration passing to Agnew under the terms of the within agreement shall be in full compensation to him for all his right, title and interest, if any, in and to any and all timber132 heretofore and hereafter cut, removed and appropriated by Nealy in accordance with the terms of this agreement.2. In exercising the license and privilege herein granted, Nealy shall not log and remove any quantity in excess of 15 million board feet of merchantable 807 timber. Timber heretofore cut and removed by Nealy from the lands subject to this agreement shall not be included in said 15 million feet.3. Nealy agrees within 15 days after the execution of this agreement to deposit with the escrow agent, hereinafter named, scale sheets showing the quantity of timber removed by Nealy or his agents, contractors, employees or licenses prior to the date of this agreement from the lands hereinabove described, including timber removed by S H & W Lumber Company under license from Nealy. Nealy agrees within 60 days after the execution of this agreement to deposit with the escrow agent, hereinafter named, a sum of money equal to $ 15.00 per thousand board feet for all said timber heretofore removed from the lands hereinabove described. Said sum shall be held by said escrow agent in accordance with the terms and conditions hereinafter set forth with reference to timber hereinafter133 cut and removed.4. Nealy will deposit in escrow with the Bank of America, Eureka, California Branch, the sum of $ 15.00 per thousand feet for all timber scaled under the terms of this agreement. Payments into escrow will be made twice monthly. Payment for timber scaled during the period from the 1st to the 15th of each calendar month shall be deposited on or before the 25th of the month, together with the scale slips, showing the quantity and species of the timber scaled, together with the area from which it has been removed. A similar payment and supporting data will be made on or before the 10th day of each calendar month for timber scaled from the 16th to the end of the preceding calendar month. The terms of the escrow agreement shall require that such funds be held by the escrow agent pending final determination of the action entitled "John Paul Lumber Co. vs. Samuel A. Agnew, et al", and upon such final determination the funds shall be paid to Samuel A. Agnew if he rather than John Paul Lumber Co. is determined to be the owner of the real property subject to this agreement. If John Paul Lumber Co. is finally determined to be the owner of said real property the funds shall134 be paid to the individuals named and set forth in a certain escrow agreement entered into between Nealy, Ted R. Webb, Fred M. Linkhart, S H & W Lumber Company, a corporation, James C. Rodger as attorney in fact for O. O. Barker, Everett Skeeter and Siebert L. Sefton, and the same escrow agent hereinabove referred to. In the event the final determination in said action is that some portion of the lands are owned by Agnew and the other portions by John Paul Lumber Co., then the funds shall be allocated as between Agnew and said escrow agent for the benefit of the above individuals in said separate escrow agreement, in accordance with the ownership of the lands from which the scale tickets show that the timber was removed.* * * 6. It is agreed that logging is to proceed in an orderly fashion, taking into account the terrain and economical logging practices. In performing the logging operation Nealy shall cut the area clean of merchantable timber as the logging progresses. * * 12. In the event Nealy defaults in the payment of any money due under the terms of this agreement for a period of 5 days after written notice of such default addressed to it at its office at Grants Pass, 135 Oregon, then Agnew, if he so elects, shall require Nealy, in addition to paying the sum or sums due with interest thereon at 7% per anum from date it became due, to suspend operations hereunder so long as said default shall continue. The injunction heretofore issued in the action entitled "Samuel A. Agnew vs. Richard E. Nealy, et al" shall insofar as the parties hereto are concerned, be dissolved and the suit dismissed as to the parties hereto with each party to bear his own costs and 808 expenses. Nealy does hereby release Agnew from all liability or claims arising out of the filing of said action or the obtaining of the temporary restraining order or preliminary injunction granted therein and Nealy does hereby exonerate the surety upon the undertakings given upon said temporary restraining order and preliminary injunction.13. Nealy agrees to have the form of the agreement attached hereto and entitled Addendum Agreement executed by B. B. Hughes, George Cook, Ted R. Webb, Fred M. Linkhart, S H & W Lumber Company, a corporation, and John Paul Lumber Company, a corporation, within 10 days from the date hereof * .14. Agnew hereby releases Nealy, B. B. Hughes, George Cook136 and their representatives, agents, servants, employees, independent contractors and vendees, together with John Paul Lumber Company, Ted R. Webb, Fred M. Linkhart, and S H & W Lumber Company, from any and all liability or claims on account of or arising out of the cutting, removal or appropriation of timber upon lands subject to this agreement by Nealy or his agents, contractors, employees or licensees prior to the date of this agreement, to the extent that the scale on such timber is reported and the deposit made in escrow as required by paragraph 3 of this agreement.15. It is understood and agreed that by the execution of the within agreement Nealy does not recognize any right, title or interest of Agnew in and to the timber above described but that the within agreement was entered into in order to avoid further litigation and in order to prevent further litigation between the parties.16. It is agreed that during the term of this agreement, or the earlier final determination of John Paul Lumber Co. vs. Samuel A. Agnew, no logging shall take place upon the lands subject to the agreement, except as herein provided. Each of the parties represent that to the best of their knowledge137 and belief no person has any claim to logging rights thereon except the parties to this agreement and to the attached Addendum agreement. * * ADDENDUM AGREEMENTIn consideration of the execution of the within agreement and particularly the granting of the privilege and license to Nealy Logging Company in accordance with the terms and condition of the attached agreement dated March 23rd 1953, TED R. WEBB. FRED M. LINKHART, S H & W LUMBER COMPANY, B. B. HUGHES, GEORGE COOK and JOHN PAUL LUMBER COMPANY, and each of them, do hereby consent that the suit entitled "Samuel A. Agnew vs. Richard E. Nealy, et al", now pending in the Superior Court of the State of California in the County of Del Norte under clerk's file No. 4955, may be dismissed and the temporary restraining order and preliminary injunction issued in connection therewith will be dissolved, each party to bear his own costs and expenses.The undersigned, and each of them, do hereby release Samuel A. Agnew from any and all liability or claims arising out of the filing of said action or the obtaining of the temporary restraining order and preliminary injunction granted therein and do hereby exonerate the surety upon138 the undertakings given upon said temporary restraining order and preliminary injunction.The undersigned further agree that during the term of the within agreement or until the earlier final determination of John Paul Lumber Company vs. Samuel A. Agnew they will not engage in logging operations on the property or authorize any one else to do so.809 On March 19, 1953, the partnership, Agnew, and the Bank of America executed an escrow agreement, providing that the partnership was to deposit in escrow with the Bank of America $ 15 per thousand board feet of timber cut pending final determination of the litigation between the John Paul Lumber Company and Samuel A. Agnew. The escrow agreement further provided that should the final determination of the litigation result in a decision that the property was owned by Agnew the escrow funds were to be delivered to him and provided the various parties to whom the funds were to be distributed should the final determination in the litigation be that the property was owned by the John Paul Lumber Company.On March 27, 1953, the partnership entered into a modification agreement with Webb, Linkhart, and S. H. & W. Lumber Company postponing139 the date of payment of $ 15,000 which was to be paid by the partnership to Webb, Linkhart, and S. H. & W. Lumber Company on May 1, 1953. Under the modification agreement $ 5,000 was to be paid to each of the sellers Webb and Linkhart on or before June 1, 1953, and the remaining $ 5,000 of the $ 15,000 previously due to paid on or before May 1, 1953, was to be paid to S. H. & W. Lumber Company at the conclusion of the litigation between Agnew and John Paul Lumber Company or by May 1, 1954, whichever event occurred first. This modification agreement further provided, in part, as follows:2. The Buyers shall continue their logging operations on the optioned property in accordance with the agreement entered into between them and one Samuel Agnew, who is the Defendant in the action in Del Norte County, California, brought by the John Paul Lumber Company, which is now on appeal in the District Court of Appeals. The Buyers shall, however, instead of making payments to the Sellers as provided for under the contract of January 21, 1953 between the parties above referred to, pay said money into escrow as provided under the Buyers' agreement with said Samuel Agnew, which money shall be paid140 to the Eureka California Branch of the Bank of America. * ** * * 4. Said escrow instructions to be executed by the Buyers to the Eureka California Branch of the Bank of America shall further instruct the said escrow bank, in the event the appeal of said Samuel Agnew is unsuccessful, to remit to the Sellers the sum of $ 6.00 per thousand board feet, less the Sellers' proportionate share of the cost of the escrow, which shall cover the payment to the Sellers for the timber removed under the contract of January 21, 1953. It is understood that the other $ 6.00 of the $ 12.00 due the Sellers under the contract of January 21, 1953 shall be remitted to the John Paul Lumber Company.5. If the John Paul Lumber Company shall not be successful in the final determination of the case between the said John Paul Lumber Company and Samuel Agnew no further payment of any kind shall be due the Sellers from the Buyers. * 6. It is recognized by the parties that subsequent to the execution of the contract of January 21, 1953, the parties to said contract and to this modification agreement agreed to pay to the said John Paul Lumber Company an additional 810 50 cents per thousand board141 feet, with 12 1/2 cents of said sum to be paid by the Buyers and 12 1/2 cents of said sum to be paid by each of the Sellers. It is recognized that by reason of payments being made into escrow with the Eureka Branch of the Bank of America under the agreement with Samuel Agnew that there will be cross-demands between some of the parties with regard to the payment of the 12 1/2 cents per thousand from each of the different parties, as herein stated. The parties hereto agree that all of said cross-demands shall be adjusted by the parties within thirty (30) days from the final determination of the appeal brought by Samuel Agnew and each party shall pay the other the sums necessary to adjust their respective cross-demands. * Under date of March 1, 1954, Agnew and the partnership executed an agreement entitled "Extension Agreement" which provided, in part, as follows:Whereas, Agnew and Nealy have heretofore entered into a certain "Timber Cutting Agreement" dated March 23, 1953, to which there was appended a certain "Addendum Agreement" dated March 23, 1953, executed by B. B. Hughes, George A. Cook, Ted R. Webb, Fred M. Linkhart, S. H. and W. Lumber Company and John Paul Lumber Company; 142 andWhereas, the said Timber Cutting Agreement and Addendum Agreement were entered into for the purpose of regulating the terms and conditions under which lumbering and logging operations might be conducted upon certain timberlands, the title to which was involved in litigation; andWhereas, the term of said two contracts, dated March 23, 1953, expired on January 1, 1954, and the litigation involving the title to said timberlands has not yet been finally concluded.Now, Therefore, the parties hereto agree as follows:(1) The term of the Timber Cutting Agreement dated March 23, 1953, is hereby extended to and including December 31, 1954. Except as herein provided, all of the provisions of said Timber Cutting Agreement shall be applicable to the additional term herein provided for.(2) Nealy shall not log and remove any quantity of timber during the extension period herein provided, in excess of 15 million feet of merchantable timber. Logs scaled and paid for prior to January 1, 1954 but not removed from the premises by that date, may be removed without counting against the total that may be removed under this extension. Logs not reported and paid for prior to January 1, 1954 and143 not removed from said lands shall be counted against the total to be removed under this extension, it being the intention of the parties that under the contract dated March 23, 1953 and this extension thereof, Nealy is given the right and privilege to cut and remove from said lands a sum total of 30 million feet of timber.(3) The sum to be deposited in escrow by Nealy for all timber logged during the extended period herein provided for shall be $ 15 per thousand board feet.(4) The areas to be logged by Nealy are designated on the logging plan attached hereto and marked Exhibit A * .(5) Timber shall be scaled as soon as practicable after it is felled * .(6) In lieu of delivering scale tickets to the escrow agent, as provided in the agreement of March 23, 1953, Nealy will deliver the scale tickets to Agnew along with three copies of a summary sheet * . The parties hereto agree to execute such supplementary escrow instructions as Bank of America may require to carry out the agreements contained in this paragraph. * * *811 (12) Nealy agrees to have the Addendum Agreement attached hereto executed by John Paul Lumber Company within thirty (30) days from the date hereof144 and this extension agreement shall terminate unless it is so executed within said time.(13) It is the intention of the parties hereto that no logging shall take place on the timberlands subject hereto during the term of this extension agreement or until the earlier final determination of John Paul Lumber Company v. Samuel A. Agnew, et al., except for Nealy's operations pursuant to the terms hereof. In that connection, Nealy represents that to the best of their knowledge and belief they have acquired the sole and exclusive logging rights from all persons other than Agnew claiming under John Paul Lumber Company.* * * ADDENDUM AGREEMENTIn Consideration of the execution of the within extension agreement, JOHN PAUL LUMBER COMPANY agrees that during the term thereof or until the earlier final determination of John Paul Lumber Company v. Samuel A. Agnew, et al., it will not engage in logging operations on the timberlands subject to the within agreement or authorize anyone other than Nealy Logging Company to do so.Under date of April 2, 1954, the partnership entered into an agreement with Webb, Linkhart, S. H. & W. Lumber Company and with William J. McLean and William M. McAllister, 145 which provided, in part, as follows:This Agreement made and entered into this 2nd day of April, 1954, by and between Ted R. Webb, Fred M. Linkhart and S. H. & W. Lumber Company, an Oregon corporation, hereinafter known as the Sellers, and William J. McLean and Wm. M. McAllister, Trustee, hereinafter known as the Assignees, and Richard E. Nealy and James A. Carpenter, doing business as the Nealy Logging Company, hereinafter known as the Buyers, WITNESSETH:* * * Now, Therefore, for and in consideration of the foregoing and the mutual promises and agreements herein contained, and the payments to be made by the buyers, the parties do hereby contract and agree with each other as follows:1. It is understood that paragraph 3 on page 2 of said agreement of January 21, 1953, provided that the additional sum of Fifty Thousand Dollars ($ 50,000.00) should be paid by the buyers when they exercised the option of May 22, 1951, with the John Paul Lumber Company, and that the buyers have not exercised said option because the litigation pending between John Paul Lumber Company and Samuel A. Agnew has not been determined, and the parties desire to modify the provisions of said agreement146 with regard to the payment of said sum of Fifty Thousand Dollars ($ 50,000.00). In consideration of the permission granted to the buyers to remove timber from the premises described in said option of May 22, 1951, prior to the termination of said litigation and the exercise of said option, the buyers hereby covenant and agree to pay to the sellers and said assignees the said sum of Fifty Thousand Dollars ($ 50,000.00) whether or not the buyers exercise said option and regardless of the outcome of the said litigation pending between the John Paul Lumber Company and Samuel A. Agnew, which sum shall be payable as follows:a. The sum of Ten Thousand Dollars ($ 10,000.00) upon the execution of this agreement.b. The sum of Five Thousand Dollars ($ 5,000.00) per month, with the first such payment due on or before April 10, 1954, and a like payment of not less 812 than Five Thousand Dollars ($ 5,000.00) on or before the 10th day of each successive and consecutive calendar month thereafter until the entire Fifty Thousand Dollars ($ 50,000.00) has been paid in full; provided that in the event the buyers do exercise the option of May 22, 1951, any balance of the Fifty Thousand Dollars147 ($ 50,000.00) remaining unpaid shall become immediately due and payable.c. In the event that the buyers fail to pay any of said Five Thousand Dollar ($ 5,000.00) installments when due, the entire unpaid balance of the sum of Fifty Thousand Dollars ($ 50,000.00) shall at the option of the sellers and assignees become immediately due and payable.It is agreed that the sum of Fifty Thousand Dollars ($ 50,000.00) required to be paid under the provisions of this paragraph shall be credited upon the purchase price to become due and payable to the sellers and assignees if the said option of May 22, 1951, is exercised by the buyers.2. Each and all of the payments made by the buyers under this agreement shall be paid as follows to the respective parties:* * * 3. As provided in said extension agreement of the 1st day of March, 1954, the buyers shall deposit with the Bank of America, Eureka, California Branch, the sum of Fifteen Dollars ($ 15.00) per thousand board feet for all timber logged by them during 1954 from the lands described in said extension agreement, and the buyers shall furnish to the sellers and assignees copies of the scale tickets showing the footage of logs removed148 by the buyers from said lands during 1954.4. It is agreed that immediately after the execution of this agreement, the parties hereto will join in the preparation and execution of escrow instructions to the Bank of America, Eureka, California Branch, to provide for the disposition of the money deposited with or which may hereafter be deposited with said bank by Richard E. Nealy and James A. Carpenter, doing business as Nealy Logging Company, or any other person, firm or corporation on account of the cutting of timber from the lands described in said timber sale contract and option agreement of May 22, 1951. Said escrow instructions shall instruct the bank that in the event that the litigation between the said John Paul Lumber Company and Samuel A. Agnew is finally determined in favor of the said Samuel A. Agnew, all of said moneys deposited with, or which may hereafter be deposited with said bank as aforesaid, shall be paid to the said Samuel A. Agnew. Said escrow instructions shall further instruct said bank that in the event said litigation is finally determined in favor of the John Paul Lumber Company, the money now deposited with, or which may hereafter be deposited with said149 bank as aforesaid, shall be disbursed as follows:a. The sum of $ 6.50 per thousand board feet to John Paul Lumber Company.b. The sum of $ 1.87 1/2 per thousand board feet to Ted R. Webb of the sellers.c. The sum of $ 1.12 1/2 per thousand board feet to the seller, Fred M. Linkhart.d. The sum of $ 0.75 per thousand board feet to the assignees, William J. McLean and Wm. M. McAllister, trustee, to be paid by check payable to William J. McLean and Wm. M. McAllister, trustee, Post Office Box 226, Medford, Oregon.e. The sum of $ 1.87 1/2 per thousand board feet to the seller, S. H. & W. Lumber Company.f. The sum of $ 4,500.45 to S. H. & W. Lumber Company.g. The balance remaining in escrow after the above payments to be remitted to the buyers.h. From each of the above payments shall be deducted the recipient's proportionate share of the escrow expense * * *813 6. The parties all recognize and agree that this and the prior agreements and actions of the Buyers do not constitute an exercise by them of the option of May 22, 1951.7. Except as provided in said modification agreement of March 27, 1953, and as modified by the terms hereof, said agreement of January 21, 1953150 shall remain in full force and effect according to the terms thereof.Beginning shortly after March 23, 1953, when the agreement between the partnership and Agnew was executed, the partnership began to cut and remove timber from the John Paul tract and continued to cut and remove the timber therefrom from that time throughout the taxable years here involved.The litigation between John Paul Lumber Company and Agnew terminated in May 1954 with decision in favor of the former. As a result John Paul Lumber Company was judged the owner of the John Paul tract, the claim of Samuel A. Agnew was denied, and the escrow terminated. On July 18, 1955, Nealy Logging Company exercised the option on the John Paul tract. The option was exercised by mailing to the John Paul Lumber Company a cashier's check for $ 25,000 in a letter dated July 18, 1955, in accordance with the option provisions of the Timber Sales Contract and Option Agreement dated May 22, 1951. The body of the letter dated July 18, 1955, is as follows:Enclosed is a cashiers check #7050 for $ 25,000.00. We herewith exercise our option to purchase the timber on all the John Paul Lumber Co. lands in Del Norte County, California, 151 as per that certain agreement entered into between John Paul Lumber Co. as seller and Ted R. Webb as buyer dated May 22, 1951. This agreement and right to exercise the option was purchased by us from Ted R. Webb, et al, on January 21, 1953.In exercising this option we wish to state the following as a matter of record:1. We are not accepting the title report as presenting a merchantable title and in no way shall the exercising of the option be construed to be a waiver of any defect appearing against the title.2. We are in no way accepting liability for any of the items outstanding against the title, and in the event of any claim will hold the seller responsible for clearance of the title, however should the occasion require it, we will provide any documents or information we may have that would be of help in maintaining the present status of the timber ownership and income therefrom.3. We request a new report showing clearance of the defects as listed in your letter of May 30, 1955 to us.We would appreciate a letter from you stating that the $ 25,000.00 has been received and the option exercised as agreed to.Following the commencement of logging operations on the John Paul tract152 the partnership made expenditures for road maintenance with respect to such property as follows:1953$ 3,142.9219541,651.1619556,349.35814 These amounts were charged to road maintenance and deducted as expense on the partnership returns for the years 1953, 1954, and 1955, respectively.For the taxable year July 1954 through June 1955, the County of Del Norte assessed taxes on the John Paul tract to S. A. Agnew and John Paul Lumber Company. The portion of the taxes so assessed allocable to the land was paid by John Paul Lumber Company, and the portion allocable to the timber was paid by the partnership.During the taxable year 1954 the partnership cut 17,631,000 board feet of fir timber from the John Paul tract. The fair market value on January 1, 1954, of this timber was $ 22 per thousand board feet.During the taxable year 1955 the partnership cut 17,872,000 board feet of fir timber and 188,000 board feet of pine timber from the John Paul tract. The fair market value on January 1, 1955, of this fir and pine timber was $ 28 and $ 30 per thousand board feet, respectively.During the taxable year 1956 the partnership cut 9,787,000 board feet of fir timber153 from the John Paul tract. The fair market value on January 1, 1956, of this timber was $ 33 per thousand board feet.In its partnership returns, the partnership reported long-term capital gains from the cutting of timber on the John Paul tract in the amounts and years as follows:1954$ 120,243.681955231,901.101956167,823.46Such gains were reported pursuant to election of the partners to claim the benefits of section 631(a) of the Internal Revenue Code of 1954 and deductions for depletion were claimed from ordinary income of the partnership in like amounts.On their individual income tax returns for the taxable years petitioners reported their respective shares of income or loss from the partnership as reflected on the partnership returns.In his deficiency notices respondent determined that the petitioners were not entitled to the benefits of section 631(a) of the 1954 Code and disallowed the claimed deductions for depletion, thereby increasing the ordinary income of the partnership for the years 1954, 1955, and 1956 by the amounts of $ 120,243.68, $ 231,901.10, and $ 167,823.46, respectively, and long-term capital gains were decreased in like amounts.The agreement154 between Webb, Linkhart, S. H. & W. Lumber Company and the partnership dated January 21, 1953, together with the authorization of the John Paul Lumber Company dated January 30, 1953, to petitioners to enter upon the property for the purpose of logging as of that date granted to the partnership a contract right to cut timber on the John Paul tract. The logs produced from the 815 John Paul tract were sold by the partnership for its own account on the open market.The stipulated facts are found accordingly.OPINION.The petitioners contend that they come squarely within the provisions of section 631(a) of the Internal Revenue Code of 1954. 1155 Respondent admits that the petitioners elected on their return to treat the cutting of timber from the John Paul tract under the provisions of section 631(a) and does not contend that the timber cut by petitioners from the John Paul tract in each of the taxable years here involved was not cut for sale or for use in petitioners' trade or business. However, respondent contends that petitioners did not have a contract right to cut such timber which they had held for a period of more than 6 months before the beginning of each of the taxable years here involved. It is respondent's contention that petitioners obtained no contract right to cut the timber from the John Paul tract until July 18, 1955, when the partnership exercised the option to purchase the timber on the John Paul tract. Respondent relies, in support of his contention, primarily on Ah Pah Redwood Co. v. Commissioner, 251 F. 2d 163 (C.A. 9, 1957), reversing in part 26 T.C. 1197">26 T.C. 1197 (1957), and George L. Jantzer, 32 T.C. 161">32 T.C. 161 (1959), affd. 284 F. 2d 348 (C.A. 9, 1960). The two cases relied on by respondent 156 involved the question of whether the taxpayers therein had disposed of timber owned by them with a retention of an economic interest therein so as to come within the provisions of section 117(k)(2) of the Internal Revenue Code of 1939, which in substance contains the same provisions as section 631(b) of the Internal Revenue Code of 1954. Each of those cases held that an oral arrangement between the owner of timber and the logger whereby the logger paid to the owner an agreed 816 price for timber cut but was not required to cut any specified quantity of timber constituted a license to cut and not a contract disposing of timber. The disposal of the timber under the license arrangements was held to have occurred as the timber was felled at which time title passed and the prior owner retained no economic interest in the timber. The question involved in each of those cases was whether the oral arrangement between the owner of the timber and the logger constituted a "disposal" of the timber at the time the oral arrangement was made.There are substantial differences in the provisions of sections 631(b) and 631(a) of the Internal Revenue Code of 1954. Section 631(b) provides for157 the treatment of income from disposal of timber by the owner thereof under a contract by virtue of which such owner retains an economic interest in the timber, whereas section 631(a) (as did its predecessor section 117(k)(1) of the Internal Revenue Code of 1939) provides for the taxpayer who elects to do so to treat the cutting of timber, if he is the owner of such timber or has a contract right to cut such timber, as a sale or exchange of such timber cut during the year, and contains a special provision as to the method of computation of the gain or loss to be recognized as a capital gain or loss in the event the taxpayer elects to have the section apply. Cf. Joe S. Ray, 32 T.C. 1244">32 T.C. 1244, 1250 (1959), affd. 283 F. 2d 337 (C.A. 5, 1960).Were the issue here involved whether the agreement between Webb, Linkhart, and S. H. & W. Lumber Company and the partnership or John Paul Lumber Company and the partnership was sufficient to constitute a disposal by them of the timber on the John Paul tract within the provisions of section 631(b) of the Internal Revenue Code of 1954, the Ah Pah Redwoood Co. case and the George L. Jantzer158 case would be in point. Even then those cases would not be necessarily controlling in view of the differences in the contracts involved. Cf. Springfield Plywood Corporation, 15 T.C. 697 (1950). However, the requisites for an agreement to constitute a "disposal" of timber are not helpful in determining the requisites for an agreement to constitute a "contract right to cut" timber.The cases cited by the parties in their briefs which involve section 117(k)(1) of the Internal Revenue Code of 1939 deal primarily with whether the taxpayers therein were entitled under the various agreements involved to sell the timber cut for their own account or use it in their trade or business. However, in several of those cases, the right to cut the timber was under a contract which did not transfer title to the timber to the taxpayer there involved until the logs were felled. Cf. Volney L. Pinkerton, 28 T.C. 910 (1957); United States v. Johnson, 257 F. 2d 530 (C.A. 9, 1958); Gilmore v. United States, 180 F. Supp. 354 (Ct. Cl. 1960); and Wirkkala v. United States, 181 F. Supp. 338">181 F. Supp. 338817 (W. D. Wash. 1960).159 In United States v. Johnson, supra, the contract involved referred to the timber company from whose land the taxpayer cut the logs as the "owner" and the partnership performing the cutting as the "logger." It is clear from these cases, as it is from the statute itself, that it is not necessary under section 631(a) of the 1954 Code that the taxpayer be the owner of the timber or that the timber be disposed of to him by the owner thereof prior to the time the logs are felled if he has a contract right to cut the timber which he has held for more than 6 months. We have set forth in some detail in our Findings of Fact the provisions of the various agreements entered into between the partnership and the various claimants to interests in the John Paul tract. We think it clear that the January 21, 1953, agreement between Webb, Linkhart, and S. H. & W. Lumber Company and the partnership granted to the partnership both an option to purchase and a right to cut the timber on the John Paul tract, the right to cut prior to exercise of the option being subject to obtaining the agreement thereto of John Paul Lumber Company. The agreement of January 21, 1953, 160 contemplated that the partnership would exercise the right to cut the timber prior to exercise of the option to obtain ownership of the timber. When on January 30, 1953, John Paul Lumber Company granted to the partnership the immediate right to cut and remove timber in accordance with Webb's agreement with it and the partnership's agreement with Webb, Linkhart, and S. H. & W. Lumber Company, the petitioners had a complete contract right to cut timber. It is true that at that time Agnew was contending that the parties who had entered into the contracts with the partnership giving it a right to cut timber on the John Paul tract had no legal right to do so because of the claims of Agnew to ownership of the John Paul tract which had not been finally determined at that date. As finally determined, the John Paul Lumber Company did have ownership of the John Paul tract and had the right to dispose of the timber on that tract. However, on March 23, 1953, petitioners obtained the consent of Agnew to proceed with logging operations throughout the year 1953, and this agreement was extended in March of 1954 for a period that did not expire until after the final termination of the litigation161 between Agnew and John Paul Lumber Company. Because of the temporary injunction obtained by Agnew after the partnership commenced logging operations under its agreements with Webb, Linkhart, and S. H. & W. Lumber Company and with John Paul Lumber Company, it was necessary if the partnership was to continue logging of the John Paul tract that it either obtain the consent of Agnew to proceed with logging or attempt to have the temporary injunction removed. It is logical that the partnership should pursue the course of obtaining a license to cut from Agnew, when it was able to obtain a license and consent from Agnew which would be 818 without cost to it if the property was finally determined to be owned by John Paul Lumber Company. The agreement between Agnew and the partnership expressly provided that the partnership did not recognize that Agnew had any title to the property. This license and consent given by Agnew to the partnership to proceed immediately with the cutting of timber, while enabling petitioners to cut the timber without further litigation with Agnew, did not change the fact that petitioners had contracts with Webb, Linkhart, and S. H. & W. Lumber Company and*162 with John Paul Lumber Company giving it a right to cut timber from the John Paul tract. The license from Agnew merely permitted the partnership to exercise its right to cut timber under its contract with the owner of the timber sooner than it would have been able to do if it had not obtained the license and consent from Agnew. The partnership had a contract right to cut the timber on the John Paul tract from January 30, 1953, when it had entered into agreements giving it such right with the owner of the timber and its assignees.We, therefore, hold that each petitioner as a partner in Nealy Logging Company had a contract right to cut timber for sale from the John Paul tract which he had held for a period of more than 6 months before the beginning of any one of the taxable years here involved and having elected to do so is entitled to compute gain or loss under the provisions of section 631(a) of the Internal Revenue Code of 1954.The parties have agreed to certain net operating loss carryback adjustments which make it necessary that decision be entered under Rule 50.Decision will be entered under Rule 50. Footnotes1. SEC 631. GAIN OR LOSS IN THE CASE OF TIMBER OR COAL.(a) Election to Consider Cutting as Sale or Exchange. -- If the taxpayer so elects on his return for a taxable year, the cutting of timber (for sale or for use in the taxpayer's trade or business) during such year by the taxpayer who owns, or has a contract right to cut, such timber (providing he has owned such timber or has held such contract right for a period of more than 6 months before the beginning of such year) shall be considered as a sale or exchange of such timber cut during such year. If such election has been made, gain or loss to the taxpayer shall be recognized in an amount equal to the difference between the fair market value of such timber, and the adjusted basis for depletion of such timber in the hands of the taxpayer. Such fair market value shall be the fair market value as of the first day of the taxable year in which such timber is cut, and shall thereafter be considered as the cost of such cut timber to the taxpayer for all purposes for which such cost is a necessary factor. If a taxpayer makes an election under this subsection, such election shall apply with respect to all timber which is owned by the taxpayer or which the taxpayer has a contract right to cut and shall be binding on the taxpayer for the taxable year for which the election is made and for all subsequent years, unless the Secretary or his delegate, on showing of undue hardship, permits the taxpayer to revoke his election; such revocation, however, shall preclude any further elections under this subsection except with the consent of the Secretary or his delegate. For purposes of this subsection and subsection (b), the term "timber" includes evergreen trees which are more than 6 years old at the time severed from the roots and are sold for ornamental purposes.↩	01-04-2023	11-21-2020

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