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https://www.courtlistener.com/api/rest/v3/opinions/4625248/	Gabriel Field and Rose E. Field v. Commissioner.Field v. CommissionerDocket No. 51782.United States Tax CourtT.C. Memo 1956-122; 1956 Tax Ct. Memo LEXIS 173; 15 T.C.M. 631; T.C.M. (RIA) 56122; May 21, 19561956 Tax Ct. Memo LEXIS 173">173 Emanuel Thebner, Esq., for the petitioners. Emil Sebetic, Esq., for the respondent. KERN Memorandum Findings of Fact and Opinion Respondent determined deficiencies in petitioners' Federal income taxes for the years 1944 and 1945 in the respective amounts of $997.64 and $1,123.40. All of the issues arising from this determination and raised by the pleadings have been settled with one exception. The issue remaining for our determination is stated in the petition as follows: "The additional business expense of $804.82 for the purchase of materials on December 31st, 1945, should be allowed as papers proving same, which had been previously lost, have been recently found." The prayer of the petition asks that "this Court * * permit the allowance of the additional expense of $804.82 for which evidence was recently found * * ." Findings of Fact The stipulation of facts, executed and filed by the parties, is incorporated herein by this reference. Petitioners are husband and wife maintaining their office in New York City. Their books are kept and their income tax returns are prepared on the cash basis. Their returns for the taxable years were filed with the1956 Tax Ct. Memo LEXIS 173">174 then collector of internal revenue for the third district of New York. Petitioner Gabriel Field, hereinafter referred to as petitioner, is a Doctor of Dental Surgery, and was engaged in the practice of that profession during the taxable years and for many years prior thereto. Paragraph 4 of the stipulation which is pertinent to the issue before us, reads as follows: "Petitioners have made claim in their petition to this Court for an additional deduction to be allowed to them for the taxable year 1945, in the amount of $804.82, which was not claimed on petitioner's tax return for 1945 and which petitioners allege represents payment for the purchase of dental materials and supplies on December 31, 1945, to be used by petitioner Gabriel Field in the practice of his profession. The merchandise was delivered to petitioner Gabriel Field on December 31, 1945. The petitioners issued their check, number 45430, drawn on the Manufacturers Trust Company, in the amount of $804.82, dated December 31, 1945, payable to Knickerbocker Brands, Inc. as payment for such merchandise." The bill of Knickerbocker Brands, Inc., covering the merchandise sold to petitioner was dated December 21, 1945. It1956 Tax Ct. Memo LEXIS 173">175 was marked "paid" on December 31, 1945, by B. Wallach, a representative of the vendor. On that same date petitioner delivered the check to Wallach. The check was presented to and paid by petitioner's bank on February 15, 1946. On December 31, 1945, the balance in petitioner's bank account was $8,469.99. On October 31, 1945, it was $10,696.26; on November 30, it was $10,054.13; on January 31, 1946, it was $6,191.69; and on February 28, 1946, it was $4,798.02. At all times between December 31, 1945, and February 15, 1946, inclusive, petitioner's bank account contained more than ample funds with which to pay the check drawn by him on December 31, 1945, to Knickerbocker Brands, Inc. Petitioner had no occasion to make, and did not make, any request of Knickerbocker Brands, Inc., to hold up the clearance of this check. There was no understanding between him and any representative of Knickerbocker Brands, Inc. that there should be any delay on the part of the latter in negotiating or depositing the check. When the check was delivered to Wallach on December 31, 1945, petitioner said nothing to Wallach concerning the time when the check should be deposited or negotiated. It is traditional1956 Tax Ct. Memo LEXIS 173">176 in the dental profession that dentists' receipts fall off alarmingly in the months of December and January of each year and persons collecting money from dentists during those months are aware of this fact and are customarily lenient in their collections from dentists. Petitioner's account with Knickerbocker Brands, Inc. was a new account of the company in 1945. Opinion KERN, Judge: The general rule is that where there is an unqualified delivery of a check by a debtor to a creditor the check constitutes payment of the account at the time of delivery regardless of when the check is deposited or cashed by the payee. See and cases cited. Respondent does not question this rule but contends that the existence of a tradition of leniency toward dentists on the part of those collecting accounts from them during December and January infers an agreement in this case between petitioner and the payee of his check that the check would not be immediately deposited or negotiated. Under the facts of record in the instant case we are of the opinion that his contention is without merit. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625249/	PASQUALE N. CASSETTA, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentCassetta v. CommissionerDocket No. 10581-76.United States Tax CourtT.C. Memo 1979-384; 1979 Tax Ct. Memo LEXIS 139; 39 T.C.M. 188; T.C.M. (RIA) 79384; September 19, 1979, Filed Archibald U. Braunfeld, for the petitioner. Ellis L. Reemer, for the respondent. TANNENWALDMEMORANDUM OPINION TANNENWALD, Judge: Respondent determined a deficiency of $9,650.77 in petitioner's income tax for 1971. The issues presented are (1) whether section 83 1 applies to1979 Tax Ct. Memo LEXIS 139">140 a situation wherein restricted stock is received by an individual as a "finder's fee" and (2) if so, the amount of income to be included by petitioner in gross income and the proper taxable year of inclusion. All of the facts have been stipulated and are found accordingly. The stipulation of facts, together with the exhibits attached thereto, is incorporated herein by this reference. On the date on which the petition herein was filed, petitioner resided in Bronx, N.Y. He filed his income tax return for the year 1971 with the Internal Revenue Service Center, Andover, Mass.During the taxable years 1970 and 1971, petitioner was employed by the Deer Park Water Co., located in Bronx, N.Y. During the taxable year 1970, petitioner learned that Integrated Resources, Inc. (hereinafter Integrated) was interested in acquiring insurance agencies. At the time, Integrated was a real estate developer interested in diversifying its holdings. In the latter part of 1970, petitioner advised Integrated that an insurance company named1979 Tax Ct. Memo LEXIS 139">141 Shadur, LaVine and Gallop, Inc. (hereinafter Shadur) was available for purchase. By virtue of this information, Integrated acquired the controlling stock in Shadur in late 1970. In recognition of the services provided by petitioner as a "finder," Integrated, on February 9, 1971, transferred 1,000 shares of its common stock to petitioner pursuant to a "private placement" under section 4(2) of the Securities Act of 1933. At the time of the transfer of these shares to petitioner, Integrated had 3,364,463 shares outstanding. Petitioner acquired an additional 500 shares of Integrated common stock on October 1, 1971, pursuant to a 3-for-2 stock split. On November 21, 1970, prior to the completion of the initial stock transfer, petitioner provided Integrated with an "investment letter" in which he represented to Integrated that the 1,000 shares of stock were being acquired for investment purposes and that he had no present intention to sell these shares. It was further understood by the parties that each share of stock would carry a legend to the effect that the shares involved had not been registered under the Securities Act of 1933 and that a public transfer of said shares free1979 Tax Ct. Memo LEXIS 139">142 and clear of restrictions would not be made without a registration or opinion from counsel satisfactory to Integranted that a registration was not required. To this extent, petitioner could have transferred the shares "publicly" in any manner permitted under the Securities Act of 1933. In 1971, petitioner could also have transferred the shares privately pursuant to the Act. The transferee would then have had to execute an "investment letter" similar to the one executed by petitioner. Due to the restrictions placed upon the stock, any private sale would have been at a substantial discount from the market price of freely traded shares. The fair market value of freely traded shares of Integrated on the "over-the-counter" market on February 9, 197u, was $34.70 per share. In February of 1973, petitioner decided to sell the stock pursuant to Rule 144 of the Securities Act of 1933. 17 C.F.R. sec. 230.144 (1978). Rule 1448 which became effective on April 15, 1972, was designed to allow the public sale of "restricted stock" without the need of a registration statement. Beginning on February 6, 1973, petitioner sought to secure the necessary opinions1979 Tax Ct. Memo LEXIS 139">143 from the Securities and Exchange Commission (SEC), the attorney for Integrated, and the underwriter, Todd and Company, Inc., of Carlstadt, N.J., to the effect that the sale could be made pursuant to Rule 144. On February 6, 1973, the fair market value of freely traded shares in Integrated was $14.65 per share. Final clearance from all parties and from the SEC for the sale of the stock was received on July 24, 1973. The fair market value of freely traded shares of Integrated on that date was $7.50 per share. Petitioner did not sell the stock in 1973 but waited until April 19, 1976, when he sold all 1,500 shares for $3 per share. Petitioner contends that section 83 does not apply to a finder's fee situation, so that he should have recognized income in July 1973 when a public sale could have been made pursuant to Rule 144 rather than in 1971 when he received the stock. Respondent disagrees, arguing that section 83 clearly applies to this situation and that petitioner must recognize income in taxable year 1971 equal to the market value of unrestricted Integrated stock at the time of transfer. We agree with respondent. Petitioner relies on the legislative history surrounding the1979 Tax Ct. Memo LEXIS 139">144 statute to support his position that section 83 was not intended to apply to his "once in a lifetime" opportunity. Prior to 1969, when an individual made a bargain purchase of stock subject to restrictions having a significant effect on value, that person would be taxed only when the restrictions lapsed or the property was sold in an arm's-length transaction. The amount taxable as ordinary income was the lessor of the fair market value of the stock at the time of its acquisition, determined without regard to the restrictions, or at the time the restrictions lapsed, over the individual's cost of the stock. Sections 1.61-2(d)(5) and 1.421-6(d)(2), Income Tax Regs. Petitioner's position is that these rules apply, rather than section 83, because that section was enacted to prevent the abuses of restricted stock plans in the employer-employee (in particular, executive employee) and underwriting contexts. We reject petitioner's argument. While restricted stock plans involving employers and employees may have been the primary impetus behind the enactment of section 83, the language of the section1979 Tax Ct. Memo LEXIS 139">145 covers the transfer of any property "to any person other than the person for whom such services are performed" in connection with the performance of services. (Emphasis added.) The legislative history makes clear that Congress was aware that the statute's coverage extended beyond restricted stock plans for employees. H. Rept. 91-413 (Part 1) (1969), 1969-3 C.B. 200, 255; S. Rept. 91-552 (1969), 1969-3 C.B. 423, 501. The regulations state that section 83 applies to employees and independent contractors ( section 1.83-1(a), Income Tax Regs.) and that a transfer to an employee or independent contractor in recognition of services rendered is considered to be a transfer in connection with services ( section 1.83-3(f), Income Tax Regs.). There is no question but that, under the foregoing circumstances, these regulations are "not unreasonable and plainly inconsistent with the statute." Consequently, they are sustained. Fulman v. United States,434 U.S. 528">434 U.S. 528, 434 U.S. 528">533 (1978). Clearly, petitioner performed services as an independent contractor within the meaning of section 83. Thus, the stock given1979 Tax Ct. Memo LEXIS 139">146 to him in recognition of his having advised Integrated of Shadur's availability for acquisition falls with the ambit of that section. The remaining issue is to determine the value of the stock and year in which it is to be included in taxable income. Petitioner claims that the stock is to be included at its value on July 24, 1973 -- the date on which final clearance for its sale was received from all parties and the SEC. Assuming arguendo that this was the proper time under pre-1969 law, this is not the case under Section 83. Section 83(a) requires petitioner to include the fair market value of the stock at the first time his rights are either transferable or not subject to a substantial risk of forfeiture, whichever occurs earlier. Section 83(c)(1) states that "the rights of a person in property are subject to substantial risk of forfeiture if such person's rights to full enjoyment of such property are conditioned upon the future performance of substantial services by any individual." Petitioner's rights in the stock were not conditioned upon his future performance of, or refraining1979 Tax Ct. Memo LEXIS 139">147 from the performance of, any services, so that no substantial risk of forfeiture existed on February 9, 1971. Thus, the value of the stock is includable in petitioner's 1971 taxable year. The fair market value is to be determined, under section 83(a), "without regard to any restriction other than a restriction which by its terms will never lapse." Limitations imposed by registration requirements of Federal security laws are not restrictions which never lapse. Section 1.83-3(h), Income Tax Regs. This includes, not only S.E.C. Rule 144, but the investment letter as well. Section 1.83-5(c), Example (3), Income Tax Regs. 2Pledger v. Commissioner,71 T.C. 618">71 T.C. 618, 71 T.C. 618">628-629 (1979). Cf. Kolom v. Commissioner,71 T.C. 235">71 T.C. 235 (1978), on appeal (9th Cir., Jan. 26, 1979). Therefore, the value of the stock which is to be included in petitioner's income for taxable year 1971 is the fair market value of 1,000 freely traded shares of Integrated on February 9, 1971, i.e., $34,700. 1979 Tax Ct. Memo LEXIS 139">*148 We are not unaware of the hardship our holding may place on petitioner; the proceeds of his sale of Integrated stock are insufficient to cover his tax liability for the receipt of the same shares. However, we cannot ignore the unambiguous language of the statute. As we stated in Sakol v. Commissioner,67 T.C. 986">67 T.C. 986, 67 T.C. 986">996 (1977), affd. 574 F.2d 694">574 F.2d 694 (2d Cir. 1978), "[while] some unfairness and inequity may result from the operation of section 83, Congress could rationally have concluded that such a result was justified by the ease and certainty of the section's operation. Weinberger v. Salfi, 422 U.S. at 777." See also Hofert, "Tax Traps in Receiving Stock for Services," 53 Texes 27, 29 (1975). Decision will be entered under Rule 155.Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as amended and in effect in the taxable year at issue, unless otherwise stated.↩2. The Treasury Department's proposal for section 83 would have taken into account "restrictions imposed by federal securities law or imposed to comply with federal securities law," as well as "restrictions which by their very terms will never lapse." Hearings before the House Committee on Ways and Means on the Subject of Tax Reform, 91st Cong., 1st Sess. 5206 (1969) (Technical Explanation of Treasury Tax Reform Proposals, Apr. 22, 1969). The bill reported out of the House Ways and Means Committee did not include the reference to Federal securities laws (see sec. 321, H.R. 13270, 91st Cong., 1st Sess., 115 Cong. Rec. 21781, 21801 (1969) H. Rept. 91-413 (1969), 1969-3 C.B. 200↩, 254-256) and no such provision was later added.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4512658/	IN THE COURT OF APPEALS OF IOWA No. 18-1584 Filed March 4, 2020 STATE OF IOWA, Plaintiff-Appellee, vs. CARRIE ANN CARRE, Defendant-Appellant. ________________________________________________________________ Appeal from the Iowa District Court for Jasper County, Terry Rickers, Judge. A defendant appeals her convictions for possession with the intent to deliver methamphetamine and sponsoring a gathering where controlled substances were used. REVERSED AND REMANDED. Scott M. Wadding of Kemp & Sease, Des Moines, for appellant. Thomas J. Miller, Attorney General, and Timothy M. Hau and Bridget A. Chambers, Assistant Attorneys General, for appellee. Heard by Bower, C.J., and Tabor, Mullins, May and Greer, JJ. 2 TABOR, Judge. Carrie Carre appeals her convictions for possession with intent to deliver methamphetamine and sponsoring a gathering where controlled substances were used. She challenges the suppression ruling that allowed the admission of drug evidence discovered following a police officer’s warrantless entry into the home she shared with David Putz. For the same reasons we discuss in State v. Putz, No. 18-1590, 2020 WL ______, at ___ (Iowa Ct. App. Mar. 4, 2020), also filed today, we reverse Carre’s conviction and remand for further proceedings consistent with this opinion. I. Facts and Prior Proceedings We glean the following facts from the suppression hearing and the minutes of testimony. After Carre waived her right to a jury trial, the district court relied on those stipulated minutes to find her guilty of possession with intent to deliver less than five grams of methamphetamine and sponsoring a gathering where controlled substances were used. This case did not start as a drug investigation. It started over concerns for the welfare of fourteen-year-old D.B. Those concerns reached Newton Police Officer Andrew Hansen on December 12, 2016, when he fielded a call from D.B.’s sister.1 According to Officer Hansen’s testimony at the suppression hearing, the sister said D.B.’s mom “was not around. She was in Davenport. [D.B.] was on his own. He was drinking alcohol and going with older males to Sioux City.” Rather 1Our record does not contain any information about the sister’s age, her location, or any context for her concerns. Nor does it contain any information about D.B.’s mother other than she was located in Davenport. 3 than starting an investigation, Officer Hansen advised D.B.’s sister to call the department of human services (DHS). Two days later, the officer received a call from Jared Lawrence, a DHS child protection worker based in Mahaska County. Lawrence said “he wanted a law enforcement emergency removal done on [D.B.].” Lawrence believed the officer could find D.B. at a Newton residence. Lawrence’s information came from Carre, who notified DHS that D.B. was at her home. She reportedly told Lawrence D.B. was “skittish” and “she was doing the best she could to keep him at the residence.” Lawrence was prepared to testify that on December 12 he spoke with D.B.’s sister; from that conversation Lawrence understood “[D.B.]’s whereabouts were unknown” and he “had been transient for the past several months.” The next day, Lawrence called the Newton School District to see if D.B. was enrolled (he was not). And after receiving Carre’s call on December 14, Lawrence contacted Newton police to request a “law enforcement removal” of D.B. When asked what a law enforcement removal entailed, Officer Hansen said: “There’s a situation where a child is in danger. DHS would like [law enforcement] to pick them up right away, and then DHS will find placement for them in a safe environment.” The officer did not believe he needed a court order for the “emergency law enforcement removal” sought by DHS. Officer Hansen said Lawrence had spoken with the county attorney’s office and “they would fill out the paperwork the next day.” On the same evening he spoke with Lawrence, Officer Hansen went to find D.B. at the house where Carre and Putz lived. The officer knocked at the front door. He testified “a male between fifteen and eighteen years of age” answered 4 the door.2 The officer testified he did not know it then but later learned the person who answered the door was D.B.’s eighteen-year-old brother. Officer Hansen recalled asking if D.B. was there. But the occupant walked away without answering. The officer testified: “I advised him I would need to follow him in.” The officer acknowledged he did not have consent to enter the house. Rather, the officer reasoned: “I read the body language of the individual I was speaking with, and I knew something was not right. And he just walked away from me so I went to investigate what was going on.” When asked to elaborate, the Officer Hansen explained, “I was not—I did not feel I needed to run after him. But the situation was odd, and his lack of emotion and lack of acknowledgement was concerning to me so I followed him in.” The officer followed the teenager to the back of the home where a younger male emerged from a bedroom. That younger teenager identified himself as D.B. Officer Hansen told D.B. that he “would need to come with me.” But taking D.B. into custody did not end the officer’s involvement. When the bedroom door opened, the officer smelled “the burnt odor of marijuana.” Then Carre walked out of that bedroom. When the officer asked about the smell, Carre said D.B. “smoked a bowl to calm down.” Based on that admission, Officer Hansen asked for consent to search. Carre declined, telling the officer that he “would need a search warrant.” 2 A witness for the defense contradicted the officer’s version of events. A.C., Carre’s daughter, testified she answered the door that evening and “was surprised to see a cop standing there.” 5 So Officer Hansen sought a search warrant for the entire house. While waiting for the warrant, the officer gathered all the occupants into the living room. Those occupants included Carre, Carre’s two daughters, Putz, D.B., DB.’s brother, and another teenager. Officer Hansen also “did a quick visual search” to “make sure there was nobody else in the residence.” During that sweep, he noticed a marijuana pipe in another bedroom. Also while Officer Hansen awaited approval of the search warrant, Carre asked to retrieve some items from the back bedroom and to use the restroom. The officer accompanied her to the bedroom and observed her “frantically searching” for something. Carre grabbed two small bags, a toiletry kit and a tablet cover, and told Officer Hansen she wanted to take them to the bathroom. He asked to search the bags. Agitated at this point, Carre urged the bags held nothing illegal. Still worried that she might destroy evidence or have a weapon, Officer Hansen grabbed for the bags, and Carre resisted. The officer then handcuffed Carre and opened the bags before officers arrived with the search warrant. Inside the toiletry bag, Officer Hansen found a clear baggie containing methamphetamine and five additional baggies of methamphetamine each weighing approximately one gram. The warranted search of the home uncovered a glass jar with eighteen small bags of marijuana and a safe. The safe had two more glass jars, one with five small bags of marijuana and one with six small bags of marijuana. The safe also had a digital scale and additional plastic bags. Putz claimed ownership of the marijuana. 6 Based on these discoveries inside Carre’s home, the State charged her with delivery or possession with intent to deliver methamphetamine, sponsoring a gathering where controlled substances were used, and delivery or possession with intent to deliver marijuana. She moved to suppress the evidence found at her residence. That motion asserted the officer’s entry into Carre’s home violated the Fourth Amendment of the United States Constitution and article I, section 8 of the Iowa Constitution. After the district court denied that motion, the State amended its trial information to add two counts of distributing controlled substances to minors. Carre waived her right to a jury trial, and the State proceeded with a trial on the minutes of testimony for (1) possession with intent to deliver less than five grams of methamphetamine, in violation of Iowa Code section 124.401(1)(c)(6) (2016), a class “C” felony and (2) sponsoring a gathering where controlled substances were used in violation of section 124.407, a serious misdemeanor. The district court found Carre guilty on those two counts. She now appeals. II. Scope and Standard of Review We review de novo this challenge to the suppression ruling because Carre’s appeal implicates constitutional issues. See State v. Baker, 925 N.W.2d 602, 609 (Iowa 2019). We independently evaluate the totality of the circumstances as shown by the entire record. Id. We defer to the district court’s factual findings, but they do not bind us. Id. 7 III. Analysis In her appeal, Carre challenges three separate actions by the police: (1) the warrantless entry into her home, (2) the warrantless search of her toiletry bag, and (3) the warranted search of her entire residence. Because we grant relief on the first claim, we need not reach the other issues. Both the Fourth Amendment and article I, section 8 protect against unreasonable searches and seizures.3 Our supreme court has recognized the preference for search warrants. See State v. Angel, 893 N.W.2d 904, 911 (Iowa 2017). That preference is especially strong when defendants challenge a search of their home under the state constitution. See State v. Short, 851 N.W.2d 474, 502 (Iowa 2014) (expressing “little interest in allowing the reasonableness clause to be a generalized trump card to override the warrant clause in the context of home searches”). Carre contends Officer Hansen’s warrantless entry into her home violated her constitutional rights. We address that contention in a two-step analysis: (1) did Carre have a reasonable expectation of privacy in the area searched and (2) if so, did the State unreasonably invade that protected interest? See State v. Tyler, 867 N.W.2d 136, 167 (Iowa 2015). Here, no dispute arises that Carre had a reasonable expectation of privacy in the home she shared with Putz. In fact, the “chief evil” the Fourth Amendment and article I, section 8 each strive to address is such a 3 On appeal, Carre urges a different standard for interpreting the state constitutional provision when discussing consent but not for the other two exceptions to the warrant requirement raised by the State. 8 warrantless intrusion into a home. State v. Kern, 831 N.W.2d 149, 164 (Iowa 2013). So we turn to the reasonableness of the invasion of that protected interest. “Subject to a few carefully drawn exceptions, warrantless searches and seizures are per se unreasonable.” State v. Lewis, 675 N.W.2d 516, 522 (Iowa 2004). Courts recognize exceptions to the warrant requirement for searches based on consent, plain view, probable cause coupled with exigent circumstances, searches incident to arrest, and emergency aid. Id. The State bears the burden to prove an exception applies. State v. Watts, 801 N.W.2d 845, 850 (Iowa 2011). In the district court, the State argued three exceptions to the warrant requirement: consent, emergency aid, and probable cause (or its equivalent) plus exigent circumstances. The district court rejected the first two exceptions. First, the State did not show Officer Hansen received permission to enter the home: “The Court does not find that opening a door to a police officer operates as consent for the officer to enter the home.” Second, the court ruled the emergency-aid exception did not apply because the State did not show the risk of imminent danger: Even though Officer Hansen had been dispatched to perform the emergency removal of a minor, the State has failed to show that it was reasonable for Officer Hansen to believe that an emergency existed. At the time he knocked on the front door, he did not know if [D.B.] was still present in the home, or have any knowledge that showed [D.B.] was at risk for death or bodily injury. So the State was left with the warrant exception for probable cause (or its equivalent) coupled with exigent circumstances. The district court latched onto that rationale, recognizing “the State’s strong interest in safely recovering [D.B.]” as a runaway under Iowa Code section 232.19(1)(c) and finding “exigent 9 circumstances necessary” to enter Carre’s residence without a warrant based on her description of the juvenile as “skittish.” On appeal, the State does not resurrect the consent exception but does reprise its community-caretaking argument rejected by the district court, as well as advocating that entry into Carre’s home was supported by the equivalent of probable cause coupled with exigent circumstances. We will address each of those exceptions in turn. A. Community Caretaking/Emergency Aid The United States Supreme Court recognized the community-caretaking exception to the warrant requirement in Cady v. Dombrowski, holding: “Local police officers . . . engage in what, for want of a better term, may be described as community caretaking functions, totally divorced from the detection, investigation, or acquisition of evidence relating to the violation of a criminal statute.” 413 U.S. 433, 441 (1973). Community caretaking has three subdivisions: “(1) the emergency aid doctrine, (2) the automobile impoundment/inventory doctrine, and (3) the ‘public servant’ exception.” Tyler, 867 N.W.2d at 170. The emergency-aid and public-servant doctrines are “analytically similar”—though critics brand the public-servant category as “amorphous” and at risk of “swallowing up constitutional restrictions on warrantless searches all together.” See State v. Coffman, 914 N.W.2d 240, 245 (Iowa 2018); id. at 263 (Appel, J., dissenting). In this appeal, the State focuses on the emergency-aid exception, contending “the information available to Hansen would have led a reasonable person to believe emergency action was necessary.” It is true, a police officer may enter a home without a warrant to render emergency assistance. See State v. 10 Emerson, 375 N.W.2d 256, 258–59 (Iowa 1985). But the admissibility of evidence discovered after that entry hinges on this question—would a reasonable person have believed an emergency existed? State v. Carlson, 548 N.W.2d 138, 141 (Iowa 1996); see also Coffman, 914 N.W.2d at 257–58 (holding under Iowa Constitution, the State must also show officer “subjectively intend[ed] to engage in community caretaking”). Framed more broadly, we must ask (1) was Officer Hansen conducting bona fide community caretaking activity and (2) did the public’s need for that activity outweigh the intrusion on Carre’s privacy interest in her home. See Coffman, 914 N.W.2d at 244–45. The district court found insufficient proof the officer’s warrantless entry was necessary to rescue or render aid to D.B. After all, Officer Hansen did not know if D.B. was actually at the home when he knocked on the door. Neither did Officer Hansen know if the young man who answered the door was D.B. or was about to alert D.B. to the police presence.4 In fact, he described the person who answered the door as somewhat older than D.B.—fifteen to eighteen years, rather than D.B.’s fourteen years. To counter the district court’s finding, the State cites Carlson, where the police entered the defendant’s home, looking for his girlfriend who was reported missing by her distraught daughters. 548 N.W.2d at 142. That missing woman 4 Hansen testified he was the only officer at the scene and “did not want that individual running out the back door.” The officer testified while he was not familiar with the Carre residence, it was a “bungalow type house” likely with a “similar layout” to other houses of that style that featured a back door. Despite his familiarity with the bungalow layout—and Carre’s warning that D.B. was “skittish”— Officer Hansen did not take the reasonable step of bringing a second officer to the call in case D.B. tried to slip out the back. 11 was trying to end an abusive relationship with Carlson and, uncharacteristically, did not answer calls from her daughters for two days. Id. at 143. Carlson did not answer the officer’s knock at the door, but tire tracks in the snow confirmed he was at home. Id. (accepting reasonable belief that “it seemed highly likely that some terrible harm had befallen her, requiring a rescue”).5 The State compares the missing-person report in Carlson to the DHS concerns for D.B. The State’s comparison is apt on the surface. But digging deeper, the cases bear few similarities. Here, the State offered no evidence D.B. faced any harm inside the Carre residence. As Carre points out on appeal, Officer Hansen candidly testified that nobody present at the house appeared to present a safety concern. In fact, Carre herself had contacted DHS to let child protection workers know D.B. was safe at their home. At oral argument, the State pointed only to the risk of D.B. taking flight from Carre’s home, possibly out a back door. “The emergency-aid exception is subject to strict limitations.” Id. at 141. This case does not fall within those narrow constructs. We agree Officer Hansen arrived at the Carre residence to conduct bona fide caretaking activity—acting on the DHS request to find a teenager whose sister expressed concerns about his welfare. And we appreciate that peace officers must often react to changing circumstances with little time for introspection. See U.S. v. Harris, 747 F.3d 1013, 5 The State also cites State v. York, No. 12-0405, 2013 WL 530956, at 5 (Iowa Ct. App. Feb. 12, 2013) in which we approved reliance on the emergency-aid exception when “[a]n intoxicated and suicidal teenager led police to a home where they discovered signs of a forced entry and unresponsive residents.” Unlike D.B.’s situation, the facts in that case justified the officers “in fearing for the juvenile’s life.” 12 1017–18 (8th Cir. 2014) (recognizing police may be called to “make a split-second decision in the face of an emergency” to protect the public). But after Officer Hansen knocked on the front door and asked if D.B. was there, the officer switched to investigation mode. He testified the young man’s “lack of acknowledgement was concerning to me so I followed him in.” The officer’s decision to “investigate what was going on” arose from his mere hunch that something was “not right” about the situation. The officer’s “read” of that young man’s “body language” did not provide a reasonable basis to believe D.B. was present, still less that D.B. faced serious harm inside that home requiring the officer’s warrantless entry to render immediate aid. See Kern, 831 N.W.2d at 174 (holding community-caretaking exception did not justify police entry into home where officer’s motivation was to search for evidence of a crime). The lack of imminent danger was also evident from the fact that two days earlier Officer Hansen learned of the sister’s concerns but did not take any action to find fourteen-year-old D.B. Instead, the officer recommended the sister contact DHS workers to “advise them of the situation.” Nothing about the circumstances the officer encountered at Carre’s residence corroborated the corrupting influence of “older males” D.B.’s sister mentioned. The State offered no proof that D.B.’s “transient” situation had reached an emergency status that justified police in making a warrantless entry into a third party’s home. Like the district court, we reject the State’s reliance on the emergency-aid exception. 13 B. Taking Custody of a Runaway Under Exigent Circumstances That rejection leaves us with the State’s remaining argument—that Officer Hansen’s entry into Carre’s home fell under the warrant exception for probable cause coupled with exigent circumstances. The State does not argue Officer Hansen had probable cause to believe a crime was being committed in Carre’s home. Instead, the State argues—and the district court accepted—that the officer had “the equivalent” of probable cause under the child-welfare chapter. Generally, probable cause exists to conduct a search if a reasonably prudent person would believe evidence of a crime might be located at that place. See State v. Nitcher, 720 N.W.2d 547, 554 (Iowa 2006). Exigent circumstances generally involve the danger of violence or injury to police officers or others, the risk of the subject’s escape, or the probability that evidence will be concealed or destroyed if the officer waits for a warrant to act. Id. at 555. To decide if an officer faced an exigency that justified acting without a warrant, we look to the totality of circumstances. See Missouri v. McNeely, 569 U.S. 141, 149 (2013). Although the district court did not believe the State offered sufficient evidence of an emergency for the emergency-aid exception, it nevertheless decided the DHS request that police execute an “emergency removal of a minor” was the “equivalent” of probable cause. As for exigent circumstances, the district court identified Officer Hansen’s reliance on “Carre’s own expression of urgency” when describing D.B.’s restlessness and her attempts to keep the teenager at the house. We start with the probable-cause equivalency. The district court noted this case was “factually unique” because it did not involve a crime but rather “the 14 emergency removal of a minor without any type of court or administrative order.” The court then cited two provisions—Iowa Code sections 232.19 and 232.79—as “scenarios where a police officer may take a minor into custody.” The court decided “the most applicable scenario” was the authorization to seize runaway children. That code section provides: A child may be taken into custody . . . [b]y a peace officer, when the peace officer has reasonable grounds[6] to believe the child has run away from the child’s parents, guardian, or custodian, for the purposes of determining whether the child shall be reunited with the child’s parents, guardian, or custodian, placed in shelter care, or, if the child is a chronic runaway and the county has an approved county runaway treatment plan, placed in a runaway assessment center under section 232.196. Iowa Code § 232.19(1)(c). The district court assumed D.B. had “run away” from his parents because the sister reported his mother was in Davenport and he was in Newton. 7 Carre attacks that assumption on appeal. He points out the legislature did not define “runaway” in chapter 232 but did so in the criminal code. The kidnapping chapter defines “a runaway child” as “a person under eighteen years of age who is voluntarily absent from the person’s home without the consent of the person’s parent, guardian, or custodian.” Id. § 710.8(1)(c). Carre contends the State failed to prove Officer Hansen had reasonable grounds to believe D.B. was a runaway. 6 The State asserts, and we agree, that the standard of “reasonable grounds” is comparable to the “probable cause” requirement. See Kraft v. City of Bettendorf, 359 N.W.2d 466, 469 (Iowa 1984) (equating expression “reasonable ground” in arrest statute to traditional “probable cause”). 7 Carre’s daughter, A.C., testified D.B.’s sister had talked to their family “about how [D.B.] hadn’t been home much and he’d been running away and he’d just been in some trouble and so we were trying to help him out.” 15 Carre asserts: “The appellate record is devoid of evidence indicating whether D.B. ever ran away or if, instead, his mother left town without him.” We agree the State did not establish that the officer had information to show D.B. was voluntarily absent from his home without parental consent. Nothing in this record shows that between the sister’s calls on December 12 and the officer’s warrantless entry on December 14, either the DHS or the police tried to contact D.B.’s mother to check on his status. The State presented no evidence to clarify where D.B. was living. The record did show D.B.’s older brother was with him in Newton. The State cannot rely on the runaway-child provision in section 232.19(1)(c) as the equivalence of probable cause that a crime had been committed without proof the officer reasonably believed D.B. had run away from his parents. In the district court, the State also relied on section 232.79(1). That statute allows an officer to take a child into custody without a court order or parental consent if “the child is in a circumstance or condition that presents an imminent danger to the child’s life or health” and “[t]here is not enough time to apply for an order under section 232.78.”8 Hansen’s testimony at the suppression hearing points to section 232.79 as the basis for his trip to Carre’s residence. The officer cast the DHS request as an “emergency removal” where “a child is in danger.” 8 The juvenile court may enter an ex parte order for the temporary removal of a child when (1) a parent or guardian is (a) absent, (b) refuses to consent to the child’s removal, or (c) there is reasonable cause to believe that a request for consent to remove the child will further endanger the child or cause the parent or guardian to take flight and (2) where it appears that the child’s immediate removal is necessary to avoid imminent danger to the child’s life or health and (3) there is not enough time to file a petition and hold a hearing under section 232.95. See Iowa Code § 232.78(1). 16 But as Carre argues on appeal, the State did not establish D.B. was in “a circumstance or condition” that presented “imminent danger” to his life or health. Id. § 232.79(1)(a). Nor did the State show it did not have enough time to apply for an ex parte order from the juvenile court. See id. § 232.78. Because we have already rejected the State’s community-caretaker theory, we cannot conclude section 232.79 provided the officer authority to enter the Carre residence to remove D.B. Returning to the State’s theory that D.B. was a runaway, even if Officer Hansen had reasonable grounds to believe that was true, section 232.19(1)(c) only authorized the officer to apprehend the child. See State v. Ahern, 227 N.W.2d 164, 167 (Iowa 1975) (holding code section “allows a peace officer to take into immediate custody a runaway child”). It did not separately permit the officer to cross the threshold into a third party’s home to take the juvenile into custody. As the Ahern court cautioned: “Of course, that section may not authorize deprivation of fourth amendment protections.” Id. Even if the State could rely on the runaway-child provision as the equivalent of probable cause, we cannot find exigent circumstances paved the officer’s entry into Carre’s home. The State must advance “specific, articulable grounds” to support a finding of exigent circumstances. Watts, 801 N.W.2d at 851. In the context of entering a home without a warrant to make an arrest, a finding of exigency requires courts to consider these important, but not all-inclusive criteria: (1) a grave offense is involved; (2) the suspect is reasonably believed to be armed; (3) there is probable cause to believe the suspect committed the crime; (4) there is strong reason to believe he is on the premises; 17 (5) there is a strong likelihood of escape if not apprehended; and (6) the entry, though not consented to, is peaceable. State v. Luloff, 325 N.W.2d 103, 105 (Iowa 1982). The State acknowledges “the situation presented here does not fit perfectly into the Luloff factors.” Still, the State contends the record supports a finding of exigent circumstances because fourteen-year-old D.B. had been “transient” for several months, was not enrolled in the Newton schools, and was “known to be drinking and traveling to a distant part of the state with older men.” While those circumstances are indeed concerning, they are not exigent. See Exigent, Black’s Law Dictionary (10th ed. 2014) (“[r]equiring immediate action or aid, urgent”). When viewed in its totality, the record here does not support the district court’s finding of exigent circumstances. The district court focused on Carre’s description of D.B. as “skittish” to presume he was a “flight risk.” But as the district court recognized, Officer Hansen did not know if D.B. was still present in the home when he knocked on the front door. And the officer had no information that D.B. faced imminent danger if he was still inside the home or, conversely, that he faced imminent danger if he left the home. This situation was not akin to a suspect who committed a felony offense and would likely escape if not apprehended. See Jones, 274 N.W.2d at 276. Here, a sister expressed concern her teenage brother was “on his own” and making bad choices. The officer originally diverted her concerns to DHS. DHS learned from Carre that D.B. was present in her home and that she would try to keep him there. Dispatched to that house, the officer knocked on the door. When an occupant, who appeared to be in his teens answered, the officer 18 did not ask for Carre so that she could confirm D.B.’s presence in her home. Instead, based on that teenager’s body language, the officer felt compelled to walk into the house without consent. That situation did not amount to exigent circumstances. Both the Fourth Amendment and article I, section 8 draw a “firm line at the entrance to the house.” See Watts, 801 N.W.2d at 852 (quoting Payton v. New York, 445 U.S. 573, 590 (1980)). Without exigent circumstances, an officer may not cross that threshold without a warrant. Id. Here, the State failed to show specific, articulable grounds to support a finding of exigent circumstances to justify Officer Hansen’s entry. Because the State did not establish an exception to the warrant requirement justifying the officer’s entry, all evidence discovered in Carre’s home must be suppressed. See Luloff, 325 N.W.2d at 106 (“Information gained during the illegal entry led to the discovery of evidence that formed the basis for the search warrant. The exclusionary rule bars the use of both evidence directly seized in an illegal search and evidence discovered indirectly through the use of evidence or information gained in the illegal search.”). We reverse the suppression ruling and remand for further proceedings consistent with this opinion. REVERSED AND REMANDED. Bower, C.J., and Mullins, J., concur; May, J., concurs specially; and Greer, J., partially dissents. 19 MAY, Judge (specially concurring). I agree we must reverse because (1) Officer Hansen entered a home without a warrant and (2) the State failed to prove any recognized exception to the warrant requirement. I write separately to mention two points, both relating to the community-caretaking exception. First, the majority suggests Officer Hansen’s motive for entering the home was to investigate crime rather than to engage in community caretaking. I respectfully disagree. Instead, I accept the district court’s conclusion that Officer Hansen’s “sole motivation in entering the defendants’ residence was to find [D.B.,] a runaway child who was reportedly engaged in dangerous behavior and who was prone to evade authorities.” This view finds support in the hearing transcript.9 And, importantly, it was the conclusion of the suppression judge, who had the advantage of seeing and hearing Officer Hansen testify in person. See State v. Vance, 790 N.W.2d 775, 780 (Iowa 2010) (noting “[w]e give deference to the district court’s findings of fact due to its ability to assess the credibility of the witnesses” including factual findings made following suppression hearings). 9 According to the transcript, Officer Hansen testified as follows: Q. Officer Hansen, it’s true that at this time you made the decision to enter the house without a warrant, is that correct? A. Yes. Q. Can you articulate for the court at this time why you followed the teenager into the home? A. I did not know if [the teenager who had answered the door and then walked away] was actually [D.B.], and I did not want that [teenager] running out the book [sic] door. Although Officer Hansen also used the verb “investigate” when explaining his reasons for entering the home, I read those comments to mean the officer was gaining more information relating to D.B.’s situation, not investigating crime. Cf. United States v. Quezada, 448 F.3d 1005, 1008 (8th Cir. 2006) (applying the community-caretaker exception when a deputy “entered the apartment to investigate a possible emergency situation” (emphasis added)). 20 Second, the dissent suggests “the public need and interest outweigh[ed] the intrusion upon the privacy of the citizen” and, therefore, justified Officer Hansen’s entry of the home. State v. Crawford, 659 N.W.2d 537, 543 (Iowa 2003). I respectfully disagree. The word “home” deserves emphasis. Unlike many community-caretaking cases, this one does not involve an automobile in a public area. Rather, this case is about a home. And, as Justice Scalia put it, “when it comes to the Fourth Amendment, the home is first among equals.” Florida v. Jardines, 569 U.S. 1, 6 (2013). “At the Amendment’s ‘very core’ stands ‘the right of a [person] to retreat into [their] own home and there be free from unreasonable governmental intrusion.’” Id. (citation omitted). Indeed, as the majority notes, “warrantless invasion of the home was the ‘chief evil’ the Fourth Amendment and article I, section 8 each sought to address.” State v. Kern, 831 N.W.2d 149, 164 (Iowa 2013). So when a police officer walks into a citizen’s home without a warrant or invitation10 or even permission, that entry constitutes a substantial “intrusion upon the privacy of the citizen.” Crawford, 659 N.W.2d at 543. But did the “public need and interest” justify that kind of intrusion? See id. Certainly there are cases when it could. “A police officer may enter a residence without a warrant as a community caretaker where the officer has a reasonable belief that an emergency exists requiring his or her attention.” Quezada, 448 F.3d 10Although Carre had contacted the department of human services to let them know D.H. was at the home, neither she nor Putz contacted the police. Certainly, neither Carre nor Putz asked the police to walk into their home. 21 at 1007 (emphasis added). As I read the record, though, I do not believe that was the situation here. Instead, the record supports the suppression judge’s finding that: Even though Officer Hansen had been dispatched to perform the emergency removal of a minor, the State has failed to show that it was reasonable for Officer Hansen to believe that an emergency existed. At the time he knocked on the front door, he did not know if [D.H.] was still present in the home, or have any knowledge that showed [D.H.] was at risk for death or bodily injury. So, like the district court and the majority, I conclude the community- caretaking exception does not apply. 22 GREER, Judge (concurring in part and dissenting in part). I respectfully dissent in part. We must define the parameters of a police officer’s warrantless entry into a home for the pure motive of retrieving a reported runaway juvenile. While I recognize the sanctity of privacy in the home, here we must balance that right against a police officer’s emergency directive from the Iowa Department of Human Services (DHS) to locate an at-risk, fourteen-year-old child and bring him to a safe environment. Or to put it more simply, can a police officer rely upon another state agency’s emergency determination as a reasonable basis to enter a home without requiring a separate full emergency analysis by the entering officer? To address the issues, the State points to exceptions to the warrant requirement that supported the officer’s actions: probable cause coupled with exigent circumstances and the community-caretaking exception. In the end, Carre argues the both the warrantless entry into her home and the later search for drugs were unconstitutional. I agree with the majority that there was not probable cause with exigent circumstances to support the warrantless entry. Officer Hansen did not have probable cause to believe a crime had been committed or that a crime would be found when he entered the house even though the exigent circumstance—risk of the subject’s escape—was a valid concern. State v. Watts, 801 N.W.2d 845, 851 (Iowa 2011) (“Exigent circumstances sufficient to justify a search and seizure without a warrant usually include . . . risk of the subject’s escape . . . .” (quoting State v. Jackson, 210 N.W.2d 537, 540 (Iowa 1973)); see also State v. Ahern, 227 N.W.2d 164, 167–68 (Iowa 1975) (noting that circumstances involving the 23 apprehension of a runaway child could be a contributing factor in creating exigent circumstances). But the State also argues the community-caretaking exception to the warrant requirement applies here and justifies the warrantless entry. Because this limited factual situation involves the officer’s sole motive of retrieving a child as opposed to investigating a crime, I would apply the community-caretaking exception. For that reason, I respectfully dissent in part and would affirm the suppression ruling on that basis. “[L]ocal police officers . . . frequently ‘engage in what, for want of a better term, may be described as community caretaking functions, totally divorced from the detection, investigation, or acquisition of evidence relating to the violation of a criminal statute.’” State v. Crawford, 659 N.W.2d 537, 541 (Iowa 2003) (quoting Cady v. Dombrowski, 413 U.S. 433, 441 (1973)). “[W]hen in the performance of such duties they come upon evidence of crime, it does not violate the Fourth Amendment to gather it for purposes of preparing a criminal prosecution.” State v. Moore, 609 N.W.2d 502, 504 (Iowa 2000). The Iowa Supreme Court has also adopted the community-caretaking exception under the Iowa Constitution. See, e.g., State v. Coffman, 914 N.W.2d 240, 254 (Iowa 2018) (discussing the community-caretaking exception under article I, section 8). “[T]he community caretaking exception encompasses three separate doctrines: (1) the emergency aid doctrine, (2) the automobile impoundment/inventory doctrine, and (3) the ‘public servant’ exception noted in Cady.” Crawford, 659 N.W.2d at 541. Only the emergency-aid and public-servant doctrines conceivably apply here. I recognize that the State mainly addressed the 24 emergency-aid doctrine of the community-caretaking exception as opposed to the public-servant doctrine. Yet they are closely related and analytically similar. Coffman, 914 N.W.2d at 244–45 (“The emergency-aid and public-servant doctrines are closely related.”). For that reason, I will consider the officer’s conduct with both doctrines in mind. The difference between the emergency-aid and public-servant doctrines been described as follows, [O]nly a narrow distinction separates the emergency aid doctrine from the public servant exception. Under the emergency aid doctrine, the officer has an immediate, reasonable belief that a serious, dangerous event is occurring. . . . [I]n contrast, the officer in a public servant situation might or might not believe that there is a difficulty requiring his general assistance. For example, an officer assists a motorist with a flat tire under the public servant doctrine, but an officer providing first aid to a person slumped over the steering wheel with a bleeding gash on his head acts pursuant to the emergency aid doctrine. Crawford, 659 N.W.2d at 541–42 (quoting Mary E. Naumann, The Community Caretaker Doctrine: Yet Another Fourth Amendment Exception, 26 Am. J. Crim. L. 325, 333–34 (1999) [hereinafter Naumann]). One author described police conduct that has been covered by the public service doctrine in cases across the country as follows, The public servant exception has evolved to allow police action in two principal areas. First, the doctrine supports relatively minor or regular interactions with the police: approaching parked cars when the driver appears incapacitated or sick or the car is functioning improperly and approaching pedestrians who appear lost, in danger, or ill. These interactions also encompass standard police actions that do not involve criminal investigations, such as responding to citizen complaints and requests for assistance. Second, caretaking activities can involve more intrusive actions such as entering the homes of residents causing disturbances and pulling over moving vehicles when the driver appears to be in trouble or the car seems to be damaged or not operating correctly. Not all police actions, 25 however, fit neatly into even these broad categories. Generally, any time an officer approaches a vehicle, person, or house without a motivation to investigate a crime and is reasonably justified to do so under the circumstances, the courts are likely to find a legitimate restraint of liberty under the community caretaker doctrine and will allow a subsequent intrusion with its own justification. Naumann, 26 Am. J. Crim. L. at 339–41 (footnotes omitted). To determine whether the community-caretaking exception applies, we “require a three-step analysis: (1) was there a seizure within the meaning of the Fourth Amendment?; (2) if so, was the police conduct bona fide community caretaker activity?; and (3) if so, did the public need and interest outweigh the intrusion upon the privacy of the citizen?” Crawford, 659 N.W.2d at 543. There is no dispute there was a seizure under the Fourth Amendment and article I, section 8. Id. (“Implicit in any community caretaking case is the fact that there has been a seizure within the meaning of the Fourth Amendment. Otherwise there would be no need to apply a community caretaking exception.”). Our inquiry focuses on whether Officer Hansen’s conduct was a bona fide community- caretaking activity and whether the public interest outweighed the intrusion into Carre’s privacy. “Every community caretaking case must be assessed according to its own unique set of facts and circumstances.” State v. Kurth, 813 N.W.2d 270, 277 (Iowa 2012). I. Bona Fide Community-Caretaking Activity. The majority concedes Officer Hansen arrived at the residence to conduct bona fide caretaking activity. I agree. But our conflict comes in the analysis of the officer’s conduct once he crossed the threshold into the home. 26 To determine whether there was a bona fide community-caretaking activity under the Fourth Amendment, we will consider whether “the facts available to the officer at the time of the [seizure] would lead a reasonable person to believe that the action taken by the officer was appropriate.” Coffman, 914 N.W.2d at 252–53 (quoting State v. Tague, 676 N.W.2d 197, 204 (Iowa 2004)). Carre has raised an article I, section 8 claim as well. To establish the community-caretaking exception applies under the Iowa Constitution, the State must “prove both that the objective facts satisfy the standards for community caretaking and that the officer subjectively intended to engage in community caretaking.” Coffman, 914 N.W.2d at 257–58. Officer Hansen went to the house at DHS’s request to conduct the emergency removal of an at-risk child. The child had been missing for several months, living in different places, engaging in illegal behavior (drinking alcohol), and leaving the general area with older adult males. Officer Hansen had a reasonable belief the child was in the home because Carre had notified DHS the child was there. He had also spoken to the child’s sister, who described the child’s risky behaviors, and he knew that the child was “skittish.” When the officer arrived at the home, he was ignorant of the presence of marijuana. The officer was greeted at the front door by a young man, who appeared to be between fifteen and eighteen years old, who did not respond to the officer’s inquiries and walked away, leaving the door open. At that point, the officer did not know what D.B. looked like, did not know that D.B.’s brother would be at the home, and was not sure if the young man he was talking to was D.B. The officer found the young man’s actions “odd,” and while the young man did not 27 appear to be a safety concern, the officer testified, “I read the body language of the individual I was speaking with, and I knew something was not right[,]” and the officer “felt something was going on that required me to follow him.” The officer believed that if this person was D.B., he may try to flee out the back of the house. The majority, focusing on the exchange between the unknown young male and the officer at the front door, finds Officer Hansen’s conduct switched from caretaking to investigating once he entered the home. I disagree and conclude the caretaking function continued until he located D.B., at which point he smelled marijuana. The totality of the circumstances support a bona fide community-caretaking mission in the officer’s entry into the home. The officer’s only purpose in going to the house was to find D.B. The specific, articulable facts available to the officer when he entered the home were: (1) the sister’s concerns about her young brother prompting a DHS investigation; (2) Carre describing the juvenile as “skittish”; (3) allegations the juvenile engaged in harmful behavior including drinking, which could affect his safety or the safety of the public; (4) that after a child protection worker investigated the child’s situation, DHS requested emergency removal;11 and (5) that the juvenile had been missing for a few months with previous behaviors 11 Officer Hansen testified he believed the purpose of an emergency law enforcement removal was to return a child to a safe environment and meant that the child was in danger. Officers should be commended for such caretaking efforts as opposed to ignoring a DHS emergency directive. State v. Carlson, 548 N.W.2d 138, 143 (Iowa 1996) (noting that officers’ actions in entering a home to locate missing person was “model police conduct, deserving of commendation, not condemnation. Although the public cannot always demand, or even expect, model police conduct, it would doubtlessly have been surprised—and disappointed—if the officers had done less.”). 28 of going to an unknown location in Sioux City with adults.12 The risk of flight and the allegations of behavior potentially dangerous to the minor’s health are both objective and subjective considerations weighed by this officer. Helping DHS locate children in need fits the peg of a community-caretaking role. See State v. Kern, 831 N.W2d 149, 173–74 (Iowa 2013) (“The caretaking by the police in accompanying the DHS officer to Kern’s home ended when the DHS officer and the police officers removed the children from the home.”); see also United States v. Quezada, 448 F.3d 1005, 1008 (8th Cir. 2006) (concluding that an officer’s entry into a home fell under the community-caretaking exception because the officer’s observations of an entry door that easily pushed open, the television on, and no answer to officer’s inquires supported reasonable belief someone might be inside requiring aid). Reliance on an investigating agency’s determination of emergency must be given more weight under these particular facts. Officer Hansen entered the home with the sole purpose of finding D.B. He continued in this community-caretaking function until he located the child. It was at the moment he located D.B. that he smelled marijuana, which changed the officer’s function from one of community caretaking to one of investigation of a crime. For all of these reasons, the officer’s actions in entering the home to locate the missing juvenile were bona fide community-caretaking activities. 12 No one from DHS testified at the suppression hearing, and we are without the benefit of knowing all of the information DHS had that necessitated an emergency removal of the juvenile. 29 II. Balancing Public and Private Interests. Finally, we must consider whether the officer’s actions were reasonable “by balancing the public need and interest furthered by the police conduct against the degree and nature of the intrusion upon the privacy of the citizen.” Crawford, 659 N.W.2d at 542–43. “[T]he fact that the protection of the public might, in the abstract, have been accomplished by ‘less intrusive’ means does not, by itself, render the search unreasonable.” Id. at 441 (quoting Cady, 413 U.S. at 447). “Iowans expect law enforcement on patrol to offer a helping hand.” Coffman, 914 N.W2d at 258. Likewise, Iowans expect those same officers to protect and provide a safe environment to children, especially at-risk children. The public interest in ensuring the safety of juveniles and preventing them from engaging in criminal behavior that could endanger them or the public is significant and worth protecting as a pure community-caretaking effort. Under the circumstances here, the public need to conduct an emergency removal of a runaway child to return the child to a safe environment is a public need and interest that outweighs the intrusion to Carre. That the officer could have chosen to take a different action does not render his actions unreasonable. And when determining no “emergency” existed, while the suppression judge opined that as the officer knocked on the front door, he had no knowledge if the child was present in the home or if the child was at risk for death or bodily injury, it is the totality of circumstances immediately facing an officer, and not magic words, that should guide our review. The majority raises a concern a police officer might use his or her caretaking responsibilities as a pretext for entering a residence. As our supreme court noted, 30 there is a lack of case authority to help clarify the scope of this doctrine. See Kurth, 813 N.W.2d at 273–74. But if narrowed to the specific facts of this case, where both the objective and subjective facts establish that the officer is only operating for the genuine public interest and not involved in the investigation of a crime, no abuse would occur. When directed by DHS and the homeowner to retrieve a missing juvenile, one could argue it would be poor police work to stand at the door and allow the young juvenile to flee out the back. As a result, I would find that the officer’s entry into the home retrieve a missing juvenile falls under the community-caretaking exception under both United States and Iowa Constitutions. For that reason, I would affirm on this issue.	01-04-2023	03-04-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625272/	GREEN'S ADVERTISING AGENCY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Green's Advertising Agency v. CommissionerDocket Nos. 6410, 9388.United States Board of Tax Appeals8 B.T.A. 393; 1927 BTA LEXIS 2900; September 29, 1927, Promulgated 1927 BTA LEXIS 2900">2900 On the evidence, held, the petitioner was not a personal service corporation during the years 1919, 1920, and 1921. F. Mandelbaum, Esq., for the petitioner. T. M. Mather, Esq., for the respondent. MARQUETTE 8 B.T.A. 393">393 These proceedings, which were duly consolidated for hearing and decision, are for the redetermination of deficiencies in income and profits taxes in the amount of $8,020.98 for the year 1919, $19,136.99 8 B.T.A. 393">394 for the year 1920, and $17,126.58 for the year 1921. The only issue raised is whether the petitioner was during the years 1919, 1920, and 1921, entitled to classification as a personal service corporation. FINDINGS OF FACT. The petitioner is a corporation organized under the laws of California in the year 1906, with a capital stock of $25,000 divided into 10,000 shares of the par value of $2.50 each. During the years 1919, 1920, and 1921, $4,900 shares of the capital stock were held and owned by I. M. Green, 5,000 shares by T. H. Smith, and 100 shares stood on the books of the corporation in the name of Mrs. I. M. Green, wife of I. M. Green. The shares standing in the name of Mrs. Green were for the purpose of1927 BTA LEXIS 2900">2901 qualifying her as a director of the corporation. All dividends declared by the corporation were paid in equal amounts to I. M. Green and T. H. Smith. Green was president and Smith vice president of the corporation, and each of them received a salary of $6,000 per year. The business of the petitioner was that of advertising in theatres on curtains, programs, slides and films. The space on the curtains, programs, slides and films, and the privilege of displaying advertising in the theatres, were purchased by the petitioner either for a determined amount or on a commission basis, and sold to its clients, and the advertising was procured by the petitioner from advertisers and displayed in the theatres by being printed on the programs, painted on the curtains, or shown by means of slides or films. Green and Smith devoted their entire time to the petitioner's business, and they procured all the contracts for space in the theatres and on the programs, slides and films, and all contracts from the advertisers. The only person regularly employed by the petitioner was a young woman bookkeeper. The advertisements painted, printed, or shown by the petitioner for its clients, were usually1927 BTA LEXIS 2900">2902 designed by Green or Smith, although in some instances they were designed by the clients, and they were painted, printed or otherwise prepared by persons employed by the petitioner for that purpose. These persons were not, however, regularly employed by the petitioner but were hired as and when there was work to be done. Payments to the theatres for space and advertising privileges were usually made by the petitioner at the end of each month. The contracts between the petitioner and its clients usually covered a period of time, payments to be made monthly in advance. The balance sheets of the petitioner at the close of the years 1919, 1920, and 1921, were as follows: Dec. 31, 1919Dec. 31, 1920Dec. 31, 1921ASSETSCash$1,868.06$17,399.64$9,414.73Accounts receivable11,996.0818,887.7518,394.87Personal accounts2,000.00500.00280.75Furniture and Fixtures266.53466.01460.25Automobile accounts1,000.00Suspense accounts223.0875.00Advanced expense1,333.34Good will10,000.0010,000.0010,000.0026,353.7548,586.7439,625.60LIABILITIESAccounts payable214.1040.00Reserve for bad accounts140.95Capital stock25,000.0025,000.0025,000.00Dividend account (dividends declared but unpaid)23,000.0014,000.00Surplus998.70546.74625.6026,353.7548,586.7439,625.601927 BTA LEXIS 2900">2903 8 B.T.A. 393">395 The petitioner's expenditures during the years 1919, 1920, and 1921, and the amounts distributed to its stockholders as dividends in those years, were: Net earningsDividends1919$26,871.70$26,000.00192056,875.7457,000.00192152,381.0152,000.00The dividends declared and unpaid at the end for the year 1920 and the end of the year 1921 were payable during the years 1921 and 1922, respectively, as funds became available for that purpose. The balance in accounts receivable at the close of each year represented amounts which were due and uncollected from advertisers. Bills were rendered each month and were collected as soon thereafter as possible. The petitioner's expenditures during the years 1919, 1920, and 1921 were as follows: 191919201921For space and privilege of advertising in theaters$32,168.13$32,935.75$38,045.35Program expense, printing, cuts, color plates, etc8,089.1813,897.1212,395.64Curtain expense, new curtains, painting, spotlighting1,625.659,933.699,707.75Slide expense, making slides13.45119.14308.30Lamp expense244.47Salaries and commissions2,647.203,287.703,879.55Office rent960.001,060.001,080.00Automobile expense2,544.811,869.202,314.74Office supplies, postage, telephone, legal services, etc1,076.464,712.986,902.49Salaries of I. M. Green and T. H. Smith12,000.0012,000.0012,000.0061,124.8879,815.5886,878.291927 BTA LEXIS 2900">2904 8 B.T.A. 393">396 The petitioner made its return of income for the years 1919, 1920, and 1921 as a personal service corporation, and Green and Smith reported their respective shares of its earnings in their individual returns for those years. The respondent, upon audit of the petitioner's return, determined that it was not a personal service corporation and that there are deficiencies in tax in the amount of $8,020.98 for 1919, $19,136.99 for 1920, and $17,126.58 for 1921. OPINION. MARQUETTE: The parties to this proceeding are in accord as to the amount of the petitioner's net income for the years 1919, 1920, and 1921, and the sole issue is whether the petitioner was entitled to classification as a personal service corporation during those years under the Revenue Acts of 1918 and 1921. Both the Revenue Act of 1918 and the Revenue Act of 1921 define a "personal service corporation" as a corporation (1) whose income is to be ascribed primarily to the activities of the principal owners or stockholders; (2) whose stockholders are regularly engaged in the active conduct of the affairs of the corporation; (3) in which capital, whether invested or borrowed, is not a material income-producing1927 BTA LEXIS 2900">2905 factor; (4) but does not include any foreign corporation, or any corporation 50 per centum or more of whose gross income consists either of gains, profits, or income derived from trading as a principal, or of gains, profits, commissions or other income derived from a Government contract or contracts made between April 6, 1917, and November 11, 1918, inclusive. That the petitioner stockholders were regularly engaged in the active conduct of its affairs, and that the income was primarily due to their activities does not seem to be questioned by the respondent, and the evidence supports those conclusions. Likewise it is clear that no part of the income was derived from a Government contract or contracts. It is therefore necessary for us to inquire only whether the petitioner meets the other conditions prescribed by the statutes. That the petitioner was a principal is clear, since it was acting in its own behalf. Was it then dealing in a commodity or thing of such a nature that it was trading as a principal within the meaning of the Revenue Acts of 1918 and 1921? We think that it was. It was trading in a commodity that is as well defined and capable of being bought, sold and1927 BTA LEXIS 2900">2906 delivered as are iron, coal, corn or wheat. It was buying and selling space and the privilege of advertising in certain theatres, and it paid large amounts therefor, because they were valuable and readily salable. It is true that it prepared and displayed advertising for its clients, but there is nothing in the record to show that it attracted the clients, because of the high character 8 B.T.A. 393">397 or quality of the advertising it produced, or because of the skill, talent or services of its stockholders and officers, but on the other hand, the evidence strongly indicates that it was able to procure business because it owned or controlled the space and privileges in certain theatres where the clients desired their advertisements to be displayed. It seems to us that fundamentally the petitioner's position is little different from that of a newspaper that offers space in its issues to those persons or corporations who desire to advertise. The fact that the petitioner and the newspaper own space advantageous and available for advertising is the controlling factor in attracting clients, rather than the fact that they are also prepared to design and prepare the advertisements. We are1927 BTA LEXIS 2900">*2907 convinced that the petitioner was trading as a principal, within the meaning of the revenue acts cited and since all of its income appears to have been derived from that trading, it follows that it is not entitled to the classification it claims. Judgment will be rendered for the respondent.Considered by PHILLIPS, MILLIKEN, and VAN FOSSAN.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625273/	MICHAEL J. RAVIN AND BARBARA S. RAVIN, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentRavin v. CommissionerDocket No. 13072-80.United States Tax CourtT.C. Memo 1981-107; 1981 Tax Ct. Memo LEXIS 633; 41 T.C.M. 1064; T.C.M. (RIA) 81107; March 9, 1981. Ronald K. Van Wert, for the petitioners. Michael1981 Tax Ct. Memo LEXIS 633">634 Cohen and H. Lloyd Nearing, for the respondent. DAWSONMEMORANDUM FINDINGS OF FACT AND OPINION DAWSON, Judge: This case is presently before the Court on petitioners' motion to dismiss for lack of jurisdiction. The two grounds asserted in support of their motion are (1) that consents signed by the petitioners extending the statutory period for assessment with respect to the calendar year 1975 were invalid and the statute of limitations thus barred the issuance of an alleged defective notice of deficiency, and (2) that the notice of deficiency was invalid because it was issued by a person who lacked proper delegated authority. Respondent objected to the motion and a hearing thereon was held in Los Angeles, California. Subsequently the parties filed memorandum briefs. In his notice of deficiency dated April 14, 1980, respondent determined a deficiency of $ 7,043 in petitioners' Federal income tax for the year 1975. Respondent disallowed a loss of $ 9,250 claimed with respect to a partnership known as Mopic Film Company. At issue are (1) whether the consents were valid and (2) whether the deficiency notice was issued by a person with the authority to do1981 Tax Ct. Memo LEXIS 633">635 so. FINDINGS OF FACT Some of the facts are stipulated and are so found. Michael and Barbara Ravin (petitioners), who are legal residents of Los Angeles County, California, filed their Federal income tax return for 1975 on or about October 13, 1976. They signed on October 17, 1978 and October 19, 1978, respectively, a Form 872 (Consent Fixing Period of Limitation Upon Assessment of Tax) extending the period of limitation for the assessment of tax on the joint return filed by them for the year ended December 31, 1975 from October 13, 1979 to December 31, 1979. This Form 872 was signed by an authorized delegate of the Secretary on October 26, 1978. On September 18, 1979 and September 24, 1979, respectively, the petitioners signed a second Form 872 extending the period of assessment for their 1975 joint return to December 31, 1981. This Form 872 was signed by an authorized delegate of the Secretary on October 1, 1979. The form contains a statement which reads: "Making this consent will not deprive the taxpayer(s) of any appeal rights to which they would otherwise be entitled." The signing of this Form 872 was preceded by a letter from the District Director which stated in1981 Tax Ct. Memo LEXIS 633">636 part: By extending the limitation period, you will have time, if you choose, to present your views at conferences at District and Regional levels if we propose adjustments you do not agree to. Petitioner Michael Ravin, a certified public accountant knowledgeable in Federal tax matters, talked to someone in the Los Angeles Audit Division of the Internal Revenue Service who informed him that if petitioners consented to the extension they would be afforded administrative rights and the opportunity to present their views if an adverse determination was made. On or about November 21, 1979, the petitioners signed a third Form 872, requested by an Internal Revenue Agent, which extended the period for assessment with respect to the 1975 joint return to September 30, 1981. Since the second Form 872 had extended the assessment period to December 31, 1981, the third Form 872 represented a shortening of the assessment period. The third Form 872 was signed by an authorized delegate of the Secretary on November 28, 1979. It also contained a statement that the taxpayers would not be deprived of their appeal rights by executing the consent. After the third Form 872 was signed, petitioners1981 Tax Ct. Memo LEXIS 633">637 were not contacted by anyone in the Internal Revenue Service nor were they given an opportunity to present their views before the notice of deficiency was mailed to them on April 14, 1980. The notice was issued for the Commissioner by W. H. Connett, District Director. Mr. Connett's facsimile signature was stamped on the notice by Sharon Meigs, a Reviewer (Grade GS-12) in the Examination Division, Internal Revenue Service, Los Angeles, and initialed by her. Ms. Meigs had the delegated authority "to sign the name of the District Director, and send to the taxpayer, by registered or certified mail, any statutory notice of deficiency." The only limit on the District Director's power of redelegation is contained in Delegation Order No. 77 (Revisions 9 through 14). 1On November 20, 1978, the1981 Tax Ct. Memo LEXIS 633">638 Los Angeles District Director issued Delegation Order No. LA-41 (Rev. 8) which delegated authority to sign notices of deficiency to Reviewers in the Examination Division with grades not lower than GS-11. This delegation was within the scope established by Delegation Order No. 77 (Rev. 11), the revision of that Delegation Order in effect on November 20, 1978. Delegation Order No. LA-41 (Rev. 8) was effective until superseded by Delegation Order No. LA-41 (Rev. 9) issued on July 27, 1980. OPINION Issue 1. Validity of Consents--Statute of LimitationsPetitioners' principal contention is that the statute of limitations barred the assessment of tax for the year 1975. They argue that they agreed to the second and third consents (Form 872) on the condition that they were to be afforded administrative review and an opportunity to present their views prior to the issuance of the notice of deficiency. They assert that the failure of respondent to comply with such condition nullified the consents to extend the statutory period for assessment because "duress is obvious." To the contrary, respondent contends that the consents are valid and the notice of deficiency was issued by respondent1981 Tax Ct. Memo LEXIS 633">639 within the period for assessment as so extended. The parties agree that, absent valid consents, the three year period for assessment provided by section 6501(a) 2 would have expired on October 13, 1979. The first consent (Form 872) is not in controversy since it expired prior to the issuance of the deficiency notice. Thus, the crux of this issue relates to the validity of the second and third consents. In our opinion both are valid. Clearly there was no duress or coercion by respondent's agents that caused the petitioners to sign the consents nor were there any material misrepresentations. Petitioner Michael Ravin, an experienced certified public accountant, familiar with Federal tax law and procedures, merely asked an unidentified agent of the Internal Revenue Service whether his administrative appeal rights would be preserved if he signed the second consent. He apparently was told, albeit incorrectly, that his administrative rights "would be barred" if he did not sign the consent and that his administrative rights "would prevail" if he did sign it. However, 1981 Tax Ct. Memo LEXIS 633">640 Mr. Ravin made no attempt to change the Form 872 by making his administrative appeal rights an expressed condition to the issuance of the notice of deficiency. There is no written condition in the consent and, consequently, no quidproquo for extending the assessment period. Moreover, the often stated general rule is that a revenue agent does not have the authority to bind the Commissioner. See United States v. Stewart,311 U.S. 60">311 U.S. 60 (1940); Bornstein v. United States, 170 Ct. Cl. 576">170 Ct. Cl. 576, 345 F.2d 558">345 F.2d 558 (1965); Wilkinson v. United States, 157 Ct. Cl. 847">157 Ct. Cl. 847, 304 F.2d 469">304 F.2d 469 (1962). A claim of estoppel is usually rejected, although the taxpayer contends that he followed the erroneous advice of an agent and acted in reliance upon it. Cf. Montgomery v. Commissioner, 65 T.C. 511">65 T.C. 511, 65 T.C. 511">522 (1975); Boulez v. Commissioner, 76 T.C. No. 17 (February 4, 1981). Petitioners also point to the language in the cover letter sent with the second Form 872, which is quoted in our findings of fact, and their reliance on it. The weakness of their argument is that the Internal Revenue Service frequently issues notices1981 Tax Ct. Memo LEXIS 633">641 of deficiency without providing for a prior appellate conference. It is important to note that the quoted language does not state that any conferences will be automatically provided, but it merely states that by signing the Form 872 the taxpayer retains the same rights to an appellate conference prior to the issuance of the notice of deficiency as all other taxpayers. Put differently, it is nowhere indicated on the Form 872 that by signing it a taxpayer will improve his appeal rights. Here the petitioners were still entitled to an appellate conference under Rev. Proc. 79-59, 1979-2 C.B. 573, even if they had not signed the Form 872. While the statement in the letter may have been inaccurate, and the comments made by the agent may have been incorrect, they were immaterial in the sense that the petitioners suffered no serious prejudice and their administrative rights were preserved. 31981 Tax Ct. Memo LEXIS 633">642 Finally, we observe that the procedural rules with respect to administrative appeals are merely directory, and like other similar procedural rules "compliance with them is not essential to the validity of a notice of deficiency." Luhring v. Glotzbach, 304 F.2d 560">304 F.2d 560, 304 F.2d 560">563 (4th Cir. 1962); Rosenberg v. Commissioner, 450 F.2d 529">450 F.2d 529, 450 F.2d 529">532 (10th Cir. 1971), affg. a Memorandum Opinion of this Court; Collins v. Commissioner, 61 T.C. 693">61 T.C. 693, 61 T.C. 693">701 (1974); Flynn v. Commissioner, 40 T.C. 770">40 T.C. 770, 40 T.C. 770">773 (1963). Accordingly, we hold that the second and third consents are valid and the statute of limitations does not bar an assessment for the year 1975. Issue 2. Authority to Issue Deficiency NoticePetitioners also attack the validity of the notice of deficiency dated April 14, 1980, on the ground that it was not issued by the "Commissioner or his delegate," but by a person, Sharon Meigs, who lacked authority to do so. Respondent counters with the contention that Ms. Meigs, a Reviewer (Grade GS-12) in the Los Angeles Examination Division, Internal Revenue Service, was duly authorized to sign in the name of the District Director,1981 Tax Ct. Memo LEXIS 633">643 and send to the petitioners, the notice of deficiency. We agree with the respondent. We think there was a proper delegation of authority to Sharon Meigs to issue the notice of deficiency involved herein. Section 6212(a) provides that if the Secretary determines that there is an income tax deficiency, he is authorized to send a notice of deficiency to the taxpayer by certified mail or registered mail. The term "Secretary" is defined in section 7701(a)(11)(B) as the "Secretary of the Treasury or his delegate." The phrase "or his delegate" is defined in section 7701(a)(12)(A)(i) as "any officer, employee, or agency of the Treasury Department duly authorized by the Secretary of the Treasury directly, or indirectly by one or more redelegations of authority, to perform the function mentioned or described in the context." Under the provisions of section 301.7701-9(b), Proced. & Admin. Regs., when a function is vested by statute in the Secretary of the Treasury or his delegate, and the Treasury regulations provide that such function may be performed by a district director, then the provision in the regulations constitutes a delegation by the Secretary to the district director of the1981 Tax Ct. Memo LEXIS 633">644 authority to perform such function. Section 301.6212-1(a) provides that if a district director determines that there is an income tax deficiency, he is authorized to notify the taxpayer of the deficiency. Thus, the authority to issue notices of deficiency has been delegated by the Secretary to district directors. Under section 301.7701-9(c) an officer authorized by regulations to perform a function has the authority to redelegate the performance of such function except to the extent that "such power to so redelegate is prohibited or restricted by proper order or directive." Here the only limit on the power of the District Director to redelegate is contained in Commissioner's Delegation Order No. 77 (Revisions 9 through 14). When the notice of deficiency herein was issued on April 14, 1980, Sharon Meigs was a Revenue Agent (Reviewer), Grade GS-12 in the Examination Division. The delegation of authority to Revenue Agents (Reviewers not lower than GS-11) to issue statutory notices of deficiency is found in Delegation of Authority No. LA-41 (Rev. 8), issued on November 20, 1978, by the Los Angeles District Director. That delegation cites Delegation Order No. 77 (Rev. 9) as authority1981 Tax Ct. Memo LEXIS 633">645 for the redelegation. On November 20, 1978, Revision 9 of Delegation Order No. 77 had been superseded by subsequent revisions, and Revision 14 was in effect when the notice of deficiency was sent to the petitioners. The authority of a District Director to delegate his authority to issue notices of deficiency is derived from sections 301.6212-1(a) and 301.7701-9, Proced. & Admin. Regs. Section 301.7701-9(c) provides that a District Director has authority to redelegate the performance of his functions including the issuance of a notice of deficiency. The mere fact that in Delegation Order No. LA-41 (Rev. 8) the District Director incorrectly referred to Delegation Order No. 77 (Rev. 9), instead of the revision then in effect, is irrelevant. See section 301.7701-9(d). Moreover, each subsequent revision to Delegation order No. 77 provides that a District Director may redelegate to "not lower than Reviewers Grade GS-9 in the Examination Divisions" his authority to sign and send to taxpayers a statutory notice of deficiency. Ms. Meigs was a Revenue Agent (Reviewer Grade GS-12), and she was acting for the District Director in issuing the notice of deficiency herein. In addition, the revisions1981 Tax Ct. Memo LEXIS 633">646 to Delegation Order No. 77 specifically reaffirm the District Director's power to redelegate his function of issuing statutory notices of deficiency and in no way prohibit the delegations found in Delegation Order No. LA-41 (Rev. 8). See Estate of Brimm v. Commissioner,70 T.C. 15">70 T.C. 15, 70 T.C. 15">19-22 (1978). Since Delegation Order No. 77 is merely a limitation on the District Director's authority to redelegate his functions granted by section 301.7701-9(c), the fact that he erroneously believed he was required to stay within one limitation does not invalidate his action as long as he stayed within the limitation which actually applied. Moreover, to the extent that the citation of the wrong revision of Delegation Order No. 77 may constitute a defect in the chain of delegation of authority to issue notices of deficiency, the defect was extremely minor and did not prejudice petitioners' rights. See 70 T.C. 15">Estate of Brimm v. Commissioner, supra at 19-22; Perlmutter v. Commissioner, 44 T.C. 382">44 T.C. 382, 44 T.C. 382">400 (1965), affd. 373 F.2d 45">373 F.2d 45 (10th Cir. 1967); Wessel v. Commissioner, 65 T.C. 273">65 T.C. 273, 65 T.C. 273">277 (1975). There is no merit to petitioners' 1981 Tax Ct. Memo LEXIS 633">647 arguments that Ms. Meigs was not under "the supervision and control of the official [district director] having authority to redelegate" or that the statutory notice lacked validity because Ms. Meigs had no "substantive review" authority. 4Accordingly, we conclude that the delegation to Sharon Meigs was proper, and therefore the notice of deficiency was issued by a person who had the authority to do so. In conclusion, we hold that the notice of deficiency was valid and this Court has jurisdiction. Petitioners' motion will be denied. An appropriate order will be entered. Footnotes1. Revision 9 is found at 1978-1 C.B. 514; Revisions 10 and 11 at 1978-2 C.B. 475; Revision 12 at 1979-1 C.B. 475; Revision 13 at 1979-2 C.B. 484; Revision 14 at 1980-1 C.B. 573↩. These revisions allow the District Director to redelegate the authority to sign notices of deficiency to Reviewers in the Examination Division, Grade GS-9 or above.2. All section references herein are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated.↩3. Another flaw in petitioners' position is that they have treated the second and third consents in combination and with equal force. Technically, the third consent supplanted the second one, and there were no verbal or written misstatements about administrative appeal rights with respect to the third and final consent. Thus, any prior condition was, in essence, waived by petitioners.↩4. It matters not whether Ms. Meigs made a "substantive review" of the adjustments contained in the notice of deficiency. She acted within the scope of her delegated authority and responsibility, which was, as she testified, to "verify that the notice was procedurally correct, to apply the District Director's stamp, and to initial off to show that I had the authority and had reviewed the notice." A substantive review of the notice may very well have been made by others who had such duties in the Examination Division.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625275/	ESTATE OF R. J. MACKENZIE, BRUCE HEATHCOTE, ADMINISTRATOR, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Mackenzie v. CommissionerDocket No. 11141.United States Board of Tax Appeals8 B.T.A. 740; 1927 BTA LEXIS 2825; October 10, 1927, Promulgated 1927 BTA LEXIS 2825">2825 On the evidence, held that the administrator of decedent's estate properly omitted certain land from gross estate in the estate-tax return. Nat Schmulowitz, esq., for the petitioner. A. H. Murray, Esq., for the respondent. TRAMMELL 8 B.T.A. 740">740 This is a proceeding for the redetermination of a deficiency in estate taxes. The deficiency arises through the action of the Commissioner in including among the assets of the estate 640 acres of land in Kings County, California, which land was not reported in the estate-tax return. FINDINGS OF FACT. R. J. Mackenzie died March 1, 1923. He was a resident of Winnipeg, Manitoba. Bruce Heathcote was appointed ancillary administrator in California where the land in question is situated. The decedent did not at any time own any lands in Kings County, California, but Mae E. Mackenzie, wife of decedent, owned 640 acres of land in section 33, township 24, range 23 east, Mount Diablo Base and Meridian, in Tulare County, California, having received a warranty 8 B.T.A. 740">741 deed to the same on May 8, 1919, from Luther J. Holton and Mary Elizabeth Holton. This was the land erroneously referred to as being1927 BTA LEXIS 2825">2826 in Kings County, California, in the deficiency notice. The above described land was not the property of R. J. Mackenzie and was properly omitted by the administrator in the estate-tax return. OPINION. TRAMMELL: The only reason why the respondent included the land set out in the findings of fact in the assets of the decedent appears to have been the fact that one Matthew O'Brien filed a claim against the decedent's estate in connection with the property. There was no testimony as to the nature of the claim or any evidence which would indicate that R. J. Mackenzie, the decedent, had any interest whatever in the property. The claim of O'Brien against the estate was not paid by the administrator. The property in question was acquired by Mae E. Mackenzie by warranty deed and in the absence of evidence to show that the decedent had some interest in this property, it was properly omitted from the estate-tax return. Judgment will be entered for the petitioner on 15 days' notice, under Rule 50.Considered by MORRIS and SMITH.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625276/	Appeal of W. W. CARTER CO.W. W. Carter Co. v. CommissionerDocket No. 689.United States Board of Tax Appeals1 B.T.A. 849; 1925 BTA LEXIS 2775; March 23, 1925, decided Submitted March 2, 1925. 1925 BTA LEXIS 2775">2775 A corporation, on September 1, 1912, acquired, at a cost of $11,000, a leasehold interest for a term of 10 years at an annual rental which was greater for the first than it was for the second 5 years. In its income-tax returns for the years prior to 1920, it made no claim for exhaustion, and, on January 30, 1920, it sold the leasehold for $11,000. Held:(1) The allowance for exhaustion of the leasehold should be spread evenly over the term of the lease, without regard to the varying rentals. (2) The exhaustion to be considered, in determining invested capital of the taxpayer, as well as the gain or loss resulting from the sale, should be computed upon the basis of value of the leasehold as of March 1, 1913, rather than upon the cost thereof at the date of acquisition. Jesse I. Miller, Esq., for the taxpayer. Robert A. Littleton, Esq., for the Commissioner. JAMES1 B.T.A. 849">849 Before JAMES, STERNHAGEN, and TRAMMELL. This is an appeal from a determination of the Commissioner of a deficiency in income and profits taxes for the year 1920 in the sum of $2,836.19, not all of which is in dispute. 1 B.T.A. 849">850 The W. W. Carter Co. is an Indiana1925 BTA LEXIS 2775">2776 corporation with its principal place of business in Indianapolis, Ind.On or about September 1, 1912, the taxpayer acquired for the sum of $11,000 a leasehold interest in certain business premises located in the city of Indianapolis. The lease was for a period of 10 years from January 1, 1914, and provided for an annual rental of $3,600 for the first 5 years of the said term and $3,200 for the last 5 years thereof. To and including the year 1920 the taxpayer did not claim or deduct in its income-tax returns or on its books any depreciation or exhaustion of the said leasehold, either on the basis of cost of $11,000 or on the basis of the value of the said leasehold as of March 1, 1913. On the 30th day of January, 1920, the taxpayer sold the leasehold for the sum of $11,000. The reasonable value of the said leasehold interest on March 1, 1913, was $18,817.52. The Commissioner added to the net income of the taxpayer for the year 1920 an alleged profit on the sale of the said leasehold in the sum of $7,715.31. In computing said profit, the Commissioner determined that the taxpayer had sustained exhaustion of the said leasehold from September 1, 1912, to the date of sale, 1925 BTA LEXIS 2775">2777 computing such exhaustion at the rate of $916.67 per year. This sum was deducted from the value of the said leasehold annually from September 1, 1912, leaving a residual value at the date of sale of $3,284.69. DECISION. The deficiency should be computed in accordance with the following opinion. Final decision will be settled on consent or on 10 days' notice in accordance with Rule 50. OPINION. JAMES: The taxpayer in its appeal has submitted two contentions - first, that the Commissioner erred in computing the exhaustion of the leasehold from September 1, 1912, the date upon which the lease was acquired by the taxpayer; and, second, that the exhaustion rate should be higher in the last five years of the leasehold term by reason of the fact that the rental provided for that period was at a lesser rate than the rental rate provided for the first five years, whereas, as shown by the evidence submitted by it, the rental value increased steadily throughout the lease. In addition, the taxpayer has submitted that it is entitled to a computation of exhaustion of the leasehold based upon March 1, 1913, value, and to a computation of gain and loss also based upon that value rather1925 BTA LEXIS 2775">2778 than upon the cost of $11,000 on September 1, 1912. The Commissioner conceded the correctness of the taxpayer's position with respect to the first point. We are unable to agree with the taxpayer on the second point and are of the opinion that the exhaustion of the leasehold should be 1 B.T.A. 849">851 spread evenly over the term of the lease without regard to the rental conditions fixed therein. The method of computing the deduction for the exhaustion of a leasehold has already been determined by this Board in the . Since the value of the leasehold here in question is found to be $18,817.52 on March 1, 1913, the Commissioner should deduct, in determining invested capital of the taxpayer for the year here in question, the sum of $1,881.75 for each calendar year beginning January 1, 1914. The computation of the gain or loss on the lease here in question is governed by the decision of the Supreme Court in the case of . The total exhaustion of the leasehold based on March 1, 1913, value from January 30, 1920, is $11,447.32. Deducting this amount from the value on March 1, 1913, $18,817.52, 1925 BTA LEXIS 2775">2779 the balance, or $7,370.20, is the basis for the computation of the gain or loss. This amount, deducted from the sales price of $11,000, leaves a taxable profit of $3,629.80, in and for the year 1920. Inasmuch as the invested capital of the taxpayer is reduced by the deductions above set forth on account of exhaustion of the leasehold, the Commissioner should compute credits for tax overpaid, if any, by the taxpayer from January 1, 1914, to and including the fiscal year ended January 31, 1919, and apply such credits against the deficiency asserted herein.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625277/	MEDICAL RESOURCES, LTD., ROBERT F. PLUMMER, TAX MATTERS PARTNER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent; MED-SCIENCES, LTD.-I, SCIENCE & INDUSTRY RESOURCES, INC., TAX MATTERS PARTNER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentMedical Resources, Ltd. v. CommissionerDocket Nos. 8952-89, 10109-89United States Tax CourtT.C. Memo 1992-35; 1992 Tax Ct. Memo LEXIS 40; 63 T.C.M. 1833; T.C.M. (RIA) 92035; January 16, 1992, Filed 1992 Tax Ct. Memo LEXIS 40">40 Decisions will be entered for respondent. Rick Drake, for petitioners. J. Scott Broome, for respondent. RUWE, Judge.RUWEMEMORANDUM FINDINGS OF FACT AND OPINION Respondent determined adjustments of partnership items for the 1983 taxable year as follows: Medical Resources, LTD.ItemClaimed AmountAmount as AdjustedRent/equipment lease$ 30,000-0-Other deductions-management fee3,000-0-Property eligible forinvestment tax credit254,800-0-Med-Sciences, LTD.-IItemClaimed AmountAmount as AdjustedRent/equipment lease$ 120,000-0-Other deductions15,135-0-Property eligible forinvestment tax credit792,400-0-The issues for decision are: (1) Whether Medical Resources, Ltd. and Med-Sciences, Ltd.-I (sometimes referred to as "the partnerships") were engaged in an activity with a profit objective; and, if so (2) whether the partnerships are entitled to investment tax credits with respect to the computer systems; (3) whether the partnerships must amortize the prepaid lease payment over the life of the lease; and (4) whether the partnerships are entitled to a deduction for management fees and other expenses as claimed1992 Tax Ct. Memo LEXIS 40">41 on the partnerships' Federal income tax returns. FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulation of facts, supplemental stipulation of facts, and attached exhibits are incorporated herein by this reference. At the time the petitions were filed, the partnerships' principal place of business was in Stow, Ohio. Medical Resources, Ltd., and Med-Sciences, Ltd.-I, reported income on an accrual basis. The issues in these cases arise out of claimed investment tax credits and expense deductions related to the partnerships' purported computer system leasing activities. The partnerships were ostensibly formed for the purpose of subleasing computer systems to doctors. The partnerships initially entered into agreements to lease the systems from a company called Charta Financial Group, Inc.1 The computer system was called "The Perfect You". The Perfect You consisted of a software package combined with a Hewlett-Packard computer, printer, disk drive, graphics tablet, desk, and accessories. The software was designed to assist in treating a particular patient by providing a nutritionally balanced diet and exercise program. 1992 Tax Ct. Memo LEXIS 40">42 The software in the Perfect You system was developed by Jeffrey Kogan. In the course of its development, the program was employed at the medical practice of Mr. Kogan's brother. Mr. Kogan transferred the software to his solely owned corporation, Data-Ease, Inc. (Data-Ease). Data-Ease received an offer to purchase the Perfect You software from Di-Med Computer Systems, Inc. (Di-Med). Mr. Kogan agreed to a sales price of $ 5,000 per software package, $ 2,000 in cash, and the rest in promissory notes payable at $ 100 per month per software package. Mr. Kogan also arranged for Di-Med to purchase the systems Hewlett-Packard hardware through Data-Ease for $ 5,860 per unit. The total system cost to Di-Med was $ 10,860. Di-Med then entered into an agreement to sell Perfect You systems to Charta Financial Group, Inc. (Charta), for $ 198,000 each. Charta entered into agreements to purchase 5 systems. These agreements provided for a payment of $ 30,000 for each system upon execution of the sale agreements. The balance of the purchase price was represented by recourse notes payable over 8 years for the remaining $ 168,000 cost of each system purchased. It was these systems that were1992 Tax Ct. Memo LEXIS 40">43 leased to the partnerships. Medical Resources, Ltd., and Med-Sciences, Ltd.-I, were formed and promoted by Robert F. Plummer (petitioner). Prior to serving as promoter and general partner in the partnerships, petitioner had worked as a registered investment representative and as a mutual fund advisor. During the years at issue, petitioner promoted various tax shelter investments including: Structured Shelters, Inc., Cambridge Corporation's Children's Classics (a master recording shelter), and Century Concepts Video Game Masters (a video cartridge shelter). 2In his involvement with the last two of these promotions, petitioner worked for Leo Roussell, who was a promoter. Mr. Roussell was also president of Di-Med from whom Charta purchased the Perfect You systems. Petitioner also participated in an organization called Compow'r, International1992 Tax Ct. Memo LEXIS 40">44 which was a Charta representative for Structured Shelters, Inc. Petitioner had no expertise in the fields of computers, medicine, or nutrition. Petitioner solicited and sold interests in Medical Resources and Med-Sciences. Documents prepared with respect to the solicitation and sales of partnership interests included a "Private Placement Memorandum", "Subscription Agreement, Signature Page and Power of Attorney", "Offeree Questionnaire", "Offeree Representative Questionnaire and Investor Acknowledgement", "Limited Partner Signature Page", and some additional promotional material. The Private Placement Memorandum for each partnership was 52 pages long, of which 14 pages dealt solely with tax aspects of the investment. The additional promotional material stressed the tax advantages, stating that additions to the tax would be avoided, that a $ 5,000 investment would generate an investment tax credit of $ 2,800, and an operating loss of $ 4,835 in the first year. This material also stated that there were no preference items for alternative minimum tax purposes, and that there were no promissory notes, letters of credit, or debt. Seventeen investors bought limited partnership interests1992 Tax Ct. Memo LEXIS 40">45 in Medical Resources, and 35 investors became limited partners in Med-Sciences. Petitioner served as the general partner for Medical Resources. The general partner in Med-Sciences was Science and Industry Resources, Inc., a Texas corporation which was organized on April 7, 1983. Petitioner was the only employee of Science and Industry Resources, Inc., and he and entities he controlled were the only shareholders. The Agreements of Limited Partnership for both partnerships were executed by petitioner on December 31, 1983. The record does not contain evidence that any of the limited partners ever executed the partnership agreements or any of the related subscription documents. The Certificates of Limited Partnership were never filed with the appropriate county recorder's office as required by Ohio law for either partnership. In December 1983, the partnerships entered into agreements to lease five Perfect You systems from Charta, four by Med-Sciences, and one by Medical Resources. Charta paid Science and Industry Resources, Inc., $ 12,000 as a commission for the leasing of the four systems to Med-Sciences. Charta executed the agreements to purchase the Perfect You systems from1992 Tax Ct. Memo LEXIS 40">46 Di-Med on the same date it executed the system leases with the partnerships. The leases between the partnerships and Charta were for a term of 5 years and provided for "fixed rent" in the amount of $ 30,000 per system to be paid to Charta upon execution of the lease. The leases also provided that Charta receive 41.67 percent of gross revenues earned through subleasing the systems in the first year. For subsequent years, the leases provided that the partnerships were required to pay "percentage rent" in the amount of 50 percent of gross revenues. Med-Sciences paid Charta $ 60,000 of the "fixed rent" in December 1983 and the other $ 60,000 in January 1984. Medical Resources paid Charta $ 27,000 in January 1984. The partnerships made no other payments to Charta in 1983 or 1984. Med-Sciences also made payments to Science and Industry Resources, Inc., in December 1983, in the amounts of $ 12,000 and $ 7,500. On January 31, 1984, Charta elected to pass through the investment tax credit on each respective system to the partnerships. Neither Medical Resources nor Med-Sciences took delivery or possession of the leased systems prior to January 1, 1984. None of the systems were subsequently1992 Tax Ct. Memo LEXIS 40">47 subleased by the partnerships. Two systems were accepted by doctors for a trial period, but they were subsequently returned. One unit was also placed in the office of Mr. Hostelley on the campus of Baldwin Wallace College for demonstration purposes. Mr. Hostelley was petitioner's accountant and an accounting instructor at Baldwin Wallace College. Neither partnership reported any gross receipts for tax years 1983 through 1988, except for $ 350 reported by Med-Sciences, in taxable year 1985. For taxable year 1983, Medical Resources, which leased one system from Charta, issued Schedules K-1 reflecting property eligible for investment tax credit of $ 254,800. Med-Sciences, which leased four systems, issued Schedules K-1 reflecting property eligible for investment tax credit of $ 792,400. On April 13 and 14, 1989, respondent issued Notices of Final Partnership Administrative Adjustment disallowing claimed investment tax credits and expense deductions. OPINION The first issue for decision is whether Medical Resources Ltd., and Med-Sciences Ltd.-1, were engaged in an activity with the objective of earning a profit and were therefore entitled to the claimed deductions and investment1992 Tax Ct. Memo LEXIS 40">48 tax credits. Petitioner bears the burden of proof on all pertinent items -- profit objective, useful life, fair market value, placement in service, and others. See Rule 142(a); 3Welch v. Helvering, 290 U.S. 111">290 U.S. 111 (1933). All claimed deductions and credits are a matter of legislative grace. New Colonial Ice Co. v. Helvering, 292 U.S. 435">292 U.S. 435 (1934). Section 162 allows a deduction for all ordinary and necessary expenses paid or incurred in carrying on any trade or business. Similarly, section 212 allows a deduction for expenses paid or incurred in transactions entered into for the production of income. The claimed advanced rental, management fees, and other expenses must come within these statutory provisions to be deductible. Section 38 allows a credit for investment1992 Tax Ct. Memo LEXIS 40">49 in "section 38 property" -- generally tangible personal property which is subject to the allowance for depreciation. Sec. 48(a)(1). Depreciation is allowable on property subject to wear and tear or obsolescence and used in a trade or business or for the production of income. Sec. 167(a). The amount of this credit is limited to the percentage of a taxpayer's qualified investment in section 38 property. Sec. 46(a)(2)(A)(i). Qualified investment is a statutorily determined percentage of the basis of property placed in service. Sec. 46(c). Under section 48(d), the lessor of property, here Charta, may elect to pass through the credit to the lessee, here the partnerships. The lessee is treated as having acquired the property for its fair market value. A common threshold for allowance of the deductions and credits in issue is that the taxpayer must be engaged in a trade or business or in a transaction entered into for the production of income. In order to be engaged in either, the taxpayer must have a profit objective. Commissioner v. Groetzinger, 480 U.S. 23">480 U.S. 23, 480 U.S. 23">35 (1987); Jasionowski v. Commissioner, 66 T.C. 312">66 T.C. 312, 66 T.C. 312">318-319 (1976). Otherwise, 1992 Tax Ct. Memo LEXIS 40">50 no credits are allowed, and deductions may be allowed only to the extent there is income from the activity. Sec. 183. This Court and others have commented on the "profit objective" requirement in many "tax shelter" cases. A representative sample of these cases was summarized in our opinion in Beck v. Commissioner, 85 T.C. 557">85 T.C. 557, 85 T.C. 557">569-570 (1985): : Essential to such a showing is a demonstration that petitioner had "an actual and honest objective of making a profit." Dreicer v. Commissioner, 78 T.C. 642">78 T.C. 642, 78 T.C. 642">646 (1982), affd. without opinion 702 F.2d 1205">702 F.2d 1205 (D.C. Cir. 1983); Fuchs v. Commissioner, 83 T.C. 79">83 T.C. 79, 83 T.C. 79">98 (1984); Dean v. Commissioner, 83 T.C. 56">83 T.C. 56, 83 T.C. 56">74 (1984). While a reasonable expectation of profit is not required, petitioner's objective of making a profit must be bona fide. Fox v. Commissioner, 80 T.C. 972">80 T.C. 972, 80 T.C. 972">1006 (1983), affd. without published opinion 742 F.2d 1441">742 F.2d 1441 (2d Cir. 1984), affd. sub nom. Barnard v. Commissioner, 731 F.2d 230">731 F.2d 230 (4th Cir. 1984), affd. without published opinion sub nom. Zemel v. Commissioner, 734 F.2d 9">734 F.2d 9 (3d Cir. 1984),1992 Tax Ct. Memo LEXIS 40">51 affd. without published opinion sub nom. Rosenblatt v. Commissioner, 734 F.2d 7">734 F.2d 7 (3d Cir. 1984), affd. without published opinion sub nom. Kratsa v. Commissioner, 734 F.2d 6">734 F.2d 6 (3d Cir. 1984), affd. without published opinion sub nom. Leffel v. Commissioner, 734 F.2d 6">734 F.2d 6 (3d Cir. 1984), affd. without published opinion sub nom. Hook v. Commissioner, 734 F.2d 5">734 F.2d 5 (3d Cir. 1984). * * * "Profit" in this context means economic profit, independent of tax savings. 80 T.C. 972">Herrick v. Commissioner, supra; Surloff v. Commissioner, 81 T.C. 210">81 T.C. 210, 81 T.C. 210">233 (1983). Whether petitioner possessed the requisite profit objective is a question of fact to be resolved on the basis of all the facts and circumstances. Elliott v. Commissioner, 84 T.C. 227">84 T.C. 227, 84 T.C. 227">236 (1985), and cases cited therein. Although no one factor is determinative, greatr weight must be given to objective facts than to petitioner's mere statement of his intent. Siegel v. Commissioner, 78 T.C. 659">78 T.C. 659, 78 T.C. 659">699 (1982); Engdahl v. Commissioner, 72 T.C. 659">72 T.C. 659, 72 T.C. 659">666 (1979); sec. 1.183-2, Income Tax Regs.1992 Tax Ct. Memo LEXIS 40">52 * * [Fn. ref. omitted.]The regulations under section 183 list nine nonexclusive factors which may be used in evaluating profit objective. They are: (1) The manner in which the taxpayer carries on the activity; (2) the expertise of the taxpayer or his advisors; (3) the time and effort expended by the taxpayer in carrying on the activity; (4) the expectation that assets used in the activity may appreciate in value; (5) the success of the taxpayer in carrying on other similar or dissimilar activities; (6) the taxpayer's history of income or losses with respect to the activity; (7) the amount of occasional profits, if any, which are earned; (8) the financial status of the taxpayer; and (9) whether elements of personal pleasure or recreation are involved. Not all of these factors are applicable in every case and no one factor is controlling. Abramson v. Commissioner, 86 T.C. 360">86 T.C. 360, 86 T.C. 360">371 (1986); Allen v. Commissioner, 72 T.C. 28">72 T.C. 28, 72 T.C. 28">33-34 (1979); sec. 1.183-2(b), Income Tax Regs.Profit objective is determined at the partnership level, not at the individual partner level. Siegel v. Commissioner, 78 T.C. 659">78 T.C. 659, 78 T.C. 659">698 (1982); Brannen v. Commissioner, 78 T.C. 471">78 T.C. 471, 78 T.C. 471">501-504 (1982),1992 Tax Ct. Memo LEXIS 40">53 affd. 722 F.2d 695">722 F.2d 695 (11th Cir. 1984); Goodwin v. Commissioner, 75 T.C. 424">75 T.C. 424, 75 T.C. 424">437 (1980), affd. without published opinion 691 F.2d 490">691 F.2d 490 (3d Cir. 1982). In determining a partnership's profit objective, we focus on those individuals who actually conducted the partnership's affairs and whose expertise was relied on in making partnership decisions. Fox v. Commissioner, 80 T.C. 972">80 T.C. 972, 80 T.C. 972">1007-1008 (1983), affd. without published opinion 742 F.2d 1441">742 F.2d 1441 (2d Cir. 1984), affd. sub nom. Barnard v. Commissioner, 731 F.2d 230">731 F.2d 230 (4th Cir. 1984), affd. without published opinion sub nom. Zemel v. Commissioner, 734 F.2d 9">734 F.2d 9 (3d Cir. 1984), affd. without published opinion sub nom. Rosenblatt v. Commissioner, 734 F.2d 7">734 F.2d 7 (3d Cir. 1984), affd. without published opinion sub nom. Kratsa v. Commissioner, 734 F.2d 6">734 F.2d 6 (3d Cir. 1984), affd. without published opinion sub nom. Leffel v. Commissioner, 734 F.2d 6">734 F.2d 6 (3d Cir. 1984), affd. without published opinion sub nom. Hook v. Commissioner, 734 F.2d 5">734 F.2d 5 (3d Cir. 1984); Wildman v. Commissioner, 78 T.C. 943">78 T.C. 943, 78 T.C. 943">953-954 (1982);1992 Tax Ct. Memo LEXIS 40">54 78 T.C. 659">Siegel v. Commissioner, supra at 698; 78 T.C. 471">Brannen v. Commissioner, supra at 512. Consequently, we focus our attention in the instant case on petitioner, who, as sole employee and controlling shareholder of Science and Industry Resources, Inc., effectively acted as general partner for both partnerships. The partnerships never subleased any of the systems it "leased" from Charta. Petitioner has failed to present credible evidence of any significant attempts to sublease the Perfect You systems. Only two of the systems were ever placed on a trial basis. The partnerships have not, in any year since their formation, generated any gross revenue with the exception of $ 350 reported by Med-Sciences in 1985. Petitioner had no expertise in the areas of computers, programming, medicine, or nutrition, and failed to consult or retain advisers with expertise in those areas. Petitioner has offered very little beyond his own testimony in support of his claim that the partnership activities were undertaken with a bona fide profit objective. We do not find petitioner's testimony credible. Statements made by petitioner in the partnership offering memoranda1992 Tax Ct. Memo LEXIS 40">55 and at trial were demonstrated to be without foundation. 4For example, petitioner has failed to establish any legitimate basis for the projected revenue figures contained in the partnership offering memoranda. The projections are based on charging patients $ 240 per visit. At trial, petitioner testified that Mr. Kogan charged $ 240 per visit to patients who were put on the system in the medical practice of Mr. Kogan's brother. He also stated that 125 patients were put on the system in one day. By contrast, Mr. Kogan stated that patients at his brother's medical practice, where the system was used, were charged approximately $ 50, and that patients would not be charged that full amount for subsequent visits. Petitioner failed to present evidence of negotiation of the lease price 1992 Tax Ct. Memo LEXIS 40">56 of the systems. 5 In fact, there was a tremendous disparity between the fair market value of the systems and the price at which the partnerships leased them. 1992 Tax Ct. Memo LEXIS 40">57 Respondent offered the testimony of Donald W. McEwen who has expertise in the valuation of computer software and hardware. Mr. McEwen evaluated the Perfect You system once in Tampa, Florida, in early 1985, and also an "updated" version in 1988, at Mr. Kogan's office in Las Vegas, Nevada. In appraising the system, Mr. McEwen provided printouts generated by the system to a group of registered dieticians with graduate degrees in nutrition for evaluation; compared the system with four other nutritionally oriented systems (hardware and software); interviewed medical personnel that had used the system on a trial basis; and considered the costs of developing a similar system from the start. Based on the foregoing, Mr. McEwen appraised the software at a maximum of $ 4,800 and the hardware at $ 8,415. Installation and on-site training was appraised at $ 1,700. We found that Mr. McEwen's testimony was credible. Mr. Kogan, who developed the Perfect You system, reviewed Mr. McEwen's appraisal and agreed that Mr. McEwen's software appraisal was accurate. We note that the partnerships insured all of their personal property, including the leased systems, under an insurance policy in the 1992 Tax Ct. Memo LEXIS 40">58 face amount of only $ 18,000. Petitioner did not present evidence as to the fair market value of the systems at trial. Consequently, we find that there was no arm's-length negotiation and that the values of the systems were wildly inflated in an effort to secure tax benefits, i.e., pass through investment tax credit. Any claim of expected appreciation in the value of the leases to the partnerships cannot be seriously entertained. The partnerships paid fixed rent alone on the leased systems which was three times the $ 10,000 out-of-pocket cost to Di-Med. Such a lease price was based on the $ 198,000 purchase price "paid" by Charta. As previously stated, this purchase price was inflated. In light of petitioner's failure to conduct the partnerships' affairs in a businesslike manner, including failure to complete or file necessary organizational documentation; to negotiate reasonable lease rates; to seek advice of competent advisors; to secure an accurate appraisal of the systems; and the complete failure of the partnerships to generate any significant revenue, we find that the partnerships did not engage in the "leasing" transactions with a bona fide profit objective. Therefore, 1992 Tax Ct. Memo LEXIS 40">*59 they are not entitled to deductions under either section 162 or 212, nor are they entitled to the investment tax credit under section 38. Our holding with respect to this issue makes it unnecessary to address the remaining issues. 6Decisions will be entered for respondent. Footnotes1. In our description of the transactions at issue, our use of the terms "sold", "leased", "purchased", or "entered into agreements of sale", "lease" or "purchase", is solely for convenience. We do not intend that our use of these terms ascribes validity to the transaction.↩2. The transactions of Structured Shelters, Inc., were the subject of a previous opinion of this Court. See Rybak v. Commissioner, 91 T.C. 524">91 T.C. 524↩ (1988).3. All Rule references are to the Tax Court Rules of Practice and Procedure, and unless otherwise indicated, all section references are to the Internal Revenue Code as amended and in effect for the relevant periods.↩4. We note that petitioner was convicted of felony assault of an IRS agent in 1985, in the Northern District of Ohio. The conviction was affirmed in United States v. Robert Plummer, 789 F.2d 435">789 F.2d 435↩ (6th Cir. 1986).5. Petitioner was being paid a commission by the lessor for systems leased by the partnerships and had no incentive to keep the price down. See Fox v. Commissioner, 80 T.C. 972">80 T.C. 972, 80 T.C. 972">1009 (1983), affd. without published opinion 742 F.2d 1441">742 F.2d 1441 (2d Cir. 1984), affd. sub nom. Barnard v. Commissioner, 731 F.2d 230">731 F.2d 230 (4th Cir. 1984), affd. without published opinion sub nom. Zemel v. Commissioner, 734 F.2d 9">734 F.2d 9 (3d Cir. 1984), affd. without published opinion sub nom. Rosenblatt v. Commissioner, 734 F.2d 7">734 F.2d 7 (3d Cir. 1984), affd. without published opinion sub nom. Kratsa v. Commissioner, 734 F.2d 6">734 F.2d 6 (3d Cir. 1984), affd. without published opinion sub nom. Leffel v. Commissioner, 734 F.2d 6">734 F.2d 6 (3d Cir. 1984), affd. without published opinion sub nom. Hook v. Commissioner, 734 F.2d 5">734 F.2d 5↩ (3d Cir. 1984).6. We note that the parties' stipulation that neither partnership took delivery or possession of any of the systems prior to 1984 foreclosed allowance of the investment tax credit in 1983, regardless of the presence of a profit objective.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625278/	Estate of Charles H. James, Deceased, The First Pennsylvania Banking and Trust Company, and Charles Mason James, Executors, Petitioner, v. Commissioner of Internal Revenue, RespondentEstate of James v. CommissionerDocket No. 93291United States Tax Court40 T.C. 494; 1963 U.S. Tax Ct. LEXIS 107; June 4, 1963, Filed 1963 U.S. Tax Ct. LEXIS 107">107 Decision will be entered under Rule 50. A decedent's will left his residuary estate in trust with the income payable to certain beneficiaries for life. It also provided that the principal might be invaded on behalf of the beneficiaries, during their lives, "either for comfortable maintenance and support, for educational requirements, illness, operations, or for any reason whatsoever which shall to my Trustees, in their sole discretion, seem sufficient." The remainder interest in the trust went in fee to a charity which qualifies under section 2055 of the 1954 Code for the charitable deduction. Held: The trustees were not limited in their invasion of the trust principal by any ascertainable standard. Therefore, the value of the charitable deduction cannot be determined and is not allowable under section 2055 of the Internal Revenue Code of 1954. Edwin S. Henry, Jr., for the petitioner.Albert Squire, for the respondent. Hoyt, Judge. HOYT40 T.C. 494">495 The respondent determined a deficiency of $ 50,371.95 in the estate tax for the estate of Charles H. James, deceased. A remainder interest in the principal of the testamentary trust created by his will was bequeathed to charity. The only adjustment which is contested is the disallowance of a charitable deduction of $ 138,808.41 for this bequest. The issue for decision is whether under the provision of the will an ascertainable standard is provided which limits the invasion of trust corpus for the benefit of the income beneficiaries.FINDINGS OF FACTCharles H. James, the decedent, died testate on June 11, 1957, a resident of Philadelphia, Pa. His will was duly probated, and Charles Mason James and the First Pennsylvania Banking & Trust Co. were appointed coexecutors of the estate. The estate tax return was filed with the district director of internal revenue at Philadelphia, Pa.The decedent's will, after directing his executors to pay his debts and funeral expenses, left the entire residuary estate in trust. The will required the trustees to pay an annuity1963 U.S. Tax Ct. LEXIS 107">109 of $ 100 per month to a domestic servant in recognition of her faithful service. The balance of the trust income was to be divided between the decedent's nephew, Charles Mason James, and the decedent's niece, Elizabeh James Hart. Charles was to receive two-thirds of the balance for his life, and if he survived his sister, Elizabeth, he was to receive the entire amount. Elizabeth was to receive one-third of the balance for her life, but if she survived Charles she was to receive one-half. If she survived both Charles and his daughter, Margaret, she would receive the entire amount.Margaret, therefore, would take only on her father's death. If Charles survived Elizabeth then Margaret would receive the entire balance, but if Elizabeth survived Charles, then Margaret would receive only one-half of the remaining trust income. In either case the income was to be applied, to the extent necessary, to her maintenance, 40 T.C. 494">496 support, and education until she became 35 years of age, and then she was to receive the entire balance directly for her life.The will also provided that the principal of the trust may be invaded in accordance with the following provision:FOURTH: (Emergency 1963 U.S. Tax Ct. LEXIS 107">110 Clause.) My Trustees named herein are hereby authorized to pay at any time, and from time to time, any portion or portions of the principal of the funds held in trust hereunder unto or for the account of any beneficiary either for comfortable maintenance and support, for educational requirements, illness, operations, or for any reason whatsoever which shall to my Trustees, in their sole discretion, seem sufficient. Any payments so made shall, so far as is practicable in the discretion of my Trustees, be charged without interest against the share of principal represented by the individual benefited thereby, either at the time of such payment or at the time of any subsequent division or distribution of the said fund.Upon the death of the last survivor of Charles, Elizabeth, and Margaret (and termination of the aforementioned annuity), the will provided that the remainder of the trust would pass in fee to the Baptist Home of Philadelphia, which the parties have conceded qualifies for the charitable deduction provided in section 2055 of the Internal Revenue Code of 1954. Charles Mason James, one of the life income beneficiaries, and the First Pennsylvania Banking & Trust Co. were named1963 U.S. Tax Ct. LEXIS 107">111 as trustees to serve without bond and without the duty to file any accounting.The three named life income beneficiaries all survived the testator and at the date of decedent's death, Charles was 47 years old, Elizabeth was 44, and Margaret was 13. The gross estate consisted of assets valued at more than $ 1,300,000. The anticipated net income of the residuary trust, after commissions, taxes, and the annuity, is approximately $ 32,900. Charles' two-thirds share is around $ 21,900 and the one-third share which Elizabeth receives is about $ 10,900.For many years before the decedent's death Charles had been connected with the Industrial Research Department in the University of Pennsylvania, Department of Works School. This work was interrupted by service in the U.S. Navy during World War II, but after the war he returned to do research and writing. He also did some teaching from 1947 to 1956. From 1956 to 1959 he was connected with an educational survey at the University of Pennsylvania, and since that time he has been engaged in private research. Charles maintains a house for himself, his wife, and his daughter, Margaret. At the time of trial in 1963, the total family expenditures1963 U.S. Tax Ct. LEXIS 107">112 were approximately $ 19,000 per year. This was slightly higher than at the time of decedent's death, but they are likely to decrease in 4 or 5 years when Margaret finishes college and is financially independent.In addition to his share of the trust income, amounting to around $ 21,900 annually, Charles receives about $ 5,000 annually from an 40 T.C. 494">497 irrevocable trust created by him and will continue to receive this income for his life. As a beneficiary of his mother's estate, he will acquire an interest of between $ 50,000 and $ 60,000 when the estate is settled. Charles also has about $ 13,000 in savings accounts and Government bonds and has complete access to the income and principal of an investment advisory account with a principal of approximately $ 35,000.Elizabeth lives with her husband and has no children. Their joint expenses for the house and food amount to about $ 7,000 annually, and Elizabeth also has personal expenditures of around $ 8,300 per year. The husband has income of his own.Other than her share of the trust income, which is about $ 10,900 a year, Elizabeth has a lifetime interest in the income of another trust which is around $ 5,000 annually. Like1963 U.S. Tax Ct. LEXIS 107">113 her brother, Charles, she has an outright interest of $ 50,000 to $ 60,000 in her mother's estate and also has a right to income and principal of an investment advisory account valued at $ 35,000 to $ 45,000.OPINIONAn absolute gift to charity of a remainder interest in a testamentary trust is deductible from the gross estate under section 2055 of the Internal Revenue Code of 1954. However, if his remainder interest may be invaded for noncharitable purposes section 20.2055-2(a) of the Income Tax Regulations states that the deduction may be taken "only insofar as that interest is presently acertainable, and hence severable from the noncharitable interest." When a power to invade the remainder interest exists the regulations go on to state in section 20.2055-2(b) that, "the deduction will be limited to that portion, if any, of the property or fund which is exempt from an exercise of the power." These portions of the regulations have been in effect under successive reenactments of what is now section 2055 and are identical with those cited with approval by the Supreme Court in Merchants' Bank v. Commissioner, 320 U.S. 256">320 U.S. 256 (1943).The remainder interest1963 U.S. Tax Ct. LEXIS 107">114 left to the Baptist Home of Philadelphia does not have a value which is capable of determination unless the trustees are limited in their invasion of the trust principal by some ascertainable standard. Ithaca Trust Co. v. United States, 279 U.S. 151">279 U.S. 151 (1929). The respondent contends that the standard in the present case is not ascertainable since it provides in article Fourth for invasion,either for comfortable maintenance and support, for educational requirements, illness, operations, or for any reason whatsoever which shall to my Trustees, in their sole discretion seem sufficient.40 T.C. 494">498 In determining the extent of the power of invasion, we are concerned with the element of possibility. The fact that invasion is not probable has no effect on whether or not a standard exists; it is the ascertainability of the ultimate charitable interest as of the date of the testator's death that determines the issue. Henslee v. Union Planters Bank, 335 U.S. 595">335 U.S. 595 (1949). The gift over to charity must be sufficiently certain in monetary value to qualify as a charitable deduction; to put it another way, the standard for1963 U.S. Tax Ct. LEXIS 107">115 invasion must be capable of being interpreted in a monetary sense.There have been numerous cases dealing with the question of whether an ascertainable standard is provided under the terms of a will. 1 In 279 U.S. 151">Ithaca Trust Co., supra, the will provided that the trustees could invade principal for any sum "that may be necessary to suitably maintain her in as much comfort as she now enjoys." The Court held that this was an ascertainable standard and stated:The standard was fixed in fact and capable of being stated in definite terms of money. It was not left to the widow's discretion. * * * There was no uncertainty appreciably greater than the general uncertainty that attends human affairs.In general, an ascertainable standard has been found when the language of the will allows invasion only to the extent necessary to sustain the beneficiary's customary mode of living. Berry v. Kuhl, 174 F.2d 565 (C.A. 7, 1949); Estate of Mary Cotton Wood, 39 T.C. 919">39 T.C. 919 (1963); Estate of Oliver Lee, 28 T.C. 1259">28 T.C. 1259 (1957). We have found no case which goes beyond this in finding1963 U.S. Tax Ct. LEXIS 107">116 a reasonable standard. See State Street Bank & Trust Co. v. United States, 313 F.2d 92 (C.A. 1, 1963).In Merchants' Bank, the testator allowed invasion for the "happiness" of the beneficiary, and the trustee was directed to use his discretion with liberality. Also, in 335 U.S. 595">Henslee v. Union Planters Bank, supra, invasion was allowed for the "pleasure, comfort, and welfare" of the beneficiary. In both cases the Court states that the purposes for which the funds could and might be spent were not subject to any reliable prediction, and, therefore, held that no ascertainable standard was provided.The trustees here are empowered to distribute corpus without being required to file any accountings "for1963 U.S. Tax Ct. LEXIS 107">117 any reason whatsoever which shall to my Trustees, in their sole discretion, seem sufficient." This language goes much farther than to provide for invasion for the beneficiaries' normal standards of living. It is as vague and broad, 40 T.C. 494">499 if not more so, than that in either Merchants' Bank or Henslee, and is clearly not susceptible to any reliable prediction or certainty.In State Street Bank, the court held that the words, "and for any other reasonable requirement" following the words "for her comfortable support and maintenance" rendered the standard immeasurable. A fortiori, the language in the present case which allows the trustees to invade principal "for comfortable maintenance and support, for educational requirements, illness, operations, or for any reason whatsoever which shall to my Trustees, in their sole discretion, seem sufficient" precludes the finding of an ascertainable standard. Since no ascertainable standard is provided, the value of the charitable remainder as of the date of decedent's death cannot be determined. It is therefore not deductible under section 2055 of the 1954 Code.The petitioner argues that since the provision in question 1963 U.S. Tax Ct. LEXIS 107">118 is entitled "Emergency Clause" the invasion of corpus is limited to emergencies and, accordingly, the standard is ascertainable. That the testator here did not intend to so limit the trustees is apparent from the language of the clause itself. Invasion is permitted for "comfortable maintenance and support," for "educational requirements," "or for any reason whatsoever." Such words certainly do not connote a sense of emergency. The general heading of the clause "(Emergency Clause)" clearly does not limit the broad powers of invasion therein provided nor does it make the standard measurable. We hold that the power invested in the trustees is not limited to emergencies nor is it limited by any other definite standard. Neither does the fact that this power is to be exercised in a fiduciary capacity provide the requisite restrictions. See Strite v. McGinnes, 215 F. Supp. 513">215 F. Supp. 513 (E.D. Pa. 1963). All such discretionary powers granted to testamentary trustees are exercisable in a fiduciary capacity.The petitioner also argues that since the broad phrase, "any reason whatsoever," is preceded by specific terms that it is limited to these terms by application1963 U.S. Tax Ct. LEXIS 107">*119 of the ejusdem generis principle. However, it is also true that additional words import additional meaning, and we therefore hold that this phrase "authorized the trustees to provide something more; to wit, a higher -- and hence immeasurable -- standard." State Street Bank & Trust Co., supra. It is also significant that the phrase in question is joined to the preceding specific language by a disjunctive conjunction.As a result of our holding that no ascertainable standard is provided here we do not reach the factual question of valuation.Decision will be entered under Rule 50. Footnotes1. A summary of many of these cases is found in the appendix to the decision of Kline v. United States, 202 F. Supp. 849">202 F. Supp. 849 (N.D. W. Va. 1962), affirmed per curiam 313 F.2d 633↩ (C.A. 4, 1963).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625280/	THE THEW SHOVEL COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Thew Shovel Co. v. CommissionerDocket No. 102007.United States Board of Tax Appeals45 B.T.A. 920; 1941 BTA LEXIS 1048; December 9, 1941, Promulgated 1941 BTA LEXIS 1048">1048 CREDIT - CONTRACTS RESTRICTING DIVIDENDS. - In correspondence between petitioner and a bank from which it obtained a loan, petitioner stated that it would be its "policy" to take no action with respect to the payment of dividends without fully discussing the situation with the bank "and ascertaining that any action proposed is not considered unjustifiable." During the taxable year the petitioner requested and received the bank's consent to the distribution of a portion of its earnings as dividends. Held, under the facts shown the amount distributable as dividends during the taxable year under the consent so given was in excess of the petitioner's adjusted net income for the taxable year and petitioner is accordingly not entitled to any credit under section 26(c)(1) of the Revenue Act of 1936. David L. Johnson, Jr., Esq., for the petitioner. Thomas F. Callahan, Esq., for the respondent. TURNER 45 B.T.A. 920">920 OPINION. TURNER: The respondent determined a deficiency in income tax for the year 1936 in the amount of $49,529.66. Petitioner claims an overpayment of income tax in the amount of $1,518.67. The question presented is whether, in computing1941 BTA LEXIS 1048">1049 the surtax on undistributed profits imposed under section 14 of the Revenue Act of 1936, petitioner is entitled, under section 26(c)(1) of the Revenue Act of 1936, on account of a contract restricting the payment of dividends, to a credit against its adjusted net income. The parties have filed a written stipulation of facts with certain exhibits attached thereto, and the Board adopts such stipulation as its findings of fact. We shall recite only the facts deemed necessary to discussion of the issue presented. Petitioner is an Ohio corporation, with offices at Lorain, Ohio, and is engaged in the manufacture and sale of power shovels and related machinery. It filed its income tax return for 1936 with the collector of the eighteenth district at Cleveland, Ohio. As of July 1, 1933, an indenture agreement between petitioner and the National City Bank of Cleveland, the latter acting as trustee, was executed, which agreement provided for an issue of 847,500 principal amount of 6 1/2 percent refunding notes. As of September 30, 1935, petitioner had outstanding $491,274 principal amount of the said notes and they matured in installments on January 1, April 1, and July 1, 1936. The1941 BTA LEXIS 1048">1050 said indenture contained a covenant that, so long as the refunding notes remained unpaid, petitioner would not pay 45 B.T.A. 920">921 any dividends on its common stock and not more than 5 cents per share per year on its preferred. Prior to October 11, 1935, the National City Bank of Cleveland had made no loans to petitioner, but the president of the latter had conferred with the president and vice president of the bank concerning the possibility of obtaining a line of credit for a portion of the amount necessary to enable petitioner to redeem, before maturity, the aforesaid outstanding refund notes. On October 11, 1935, the executive committee of the bank took the following action, as stated in its minutes: Subject to further checking to the satisfaction of the officers, a line of credit for The Thew Shovel Company in the amount of $250,000.00 was approved subject to the usual conditions as to continued satisfactory financial condition and the maintenance of supporting deposit balances; also on condition that dividends shall not be paid except to the extent of two-thirds of the amount of earnings over and above $100,000.00 per year, and not to exceed $100,000.00 per year; and that the1941 BTA LEXIS 1048">1051 direct borrowings from banks shall not exceed $500,000.00 and commercial paper discounted shall not exceed $250,000.00. On October 29, 1935, the board of directors of the petitioner adopted the following resolution: Now, THEREFORE, BE IT RESOLVED that the President of this Company be and he is hereby authorized to borrow on behalf of this Company from a bank or banks an amount or amounts of money not to exceed $500,000 in addition to any and all amounts heretofore authorized, and that the proper officers of this Company be and they hereby are authorized to execute on behalf of this Company the Company's note or notes evidencing the amount so borrowed, the rate of interest to be such as the President may in his discretion determine to be the best rate available, and all other terms to be such as the President may in his discretion determine. FURTHER RESOLVED that the proper officers of this Company be and they hereby are authorized, in the event that the funds necessary therefor can be obtained, to take all steps and do all things necessary or proper to anticipate on January 1, 1936, the installments due April 1, 1936 and July 1, 1936, on the Company's 6 1/2% Refunding Notes1941 BTA LEXIS 1048">1052 dated as of July 1, 1933. On November 9, 1935, the petitioner's president wrote the bank as follows: This will confirm our understanding that the National City Bank has approved a line of credit for The Thew Shovel Co. up to $250,000. This with the similar line of credit granted by the Central United National Bank , will enable us to carry out our expressed desire to prepay on January 1st the remaining installments of our refunding notes and also retire the limited amount of debentures outstanding which have not been exchanged for the refunding notes. Under the terms of our indenture it will be necessary to deposit the funds required for the purpose with the National City Bank, Trustee, December 2nd, 1935 whereupon the Trustee will notify all registered note holders that we are taking advantage of the stipulation which permits us to make prepayment in full January 1st. 45 B.T.A. 920">922 We shall therefore wish to make use of the entire line of credit so as to have the funds available either November 30th or December 2nd. Mr. R. B. Miller, our Treasurer, will contact Mr. Shannon with reference to the preparation of the note or notes and will also ascertain if you desire any action1941 BTA LEXIS 1048">1053 by our Board of Directors beyond that taken under advice of counsel at a recent directors meeting authorizing the retirement of the notes and the borrowing of funds necessary for the purpose. It is further understood that we will at about the same time establish a working account with the National City Bank and carry balances which at the outset will not be less than 10% of the loan and which we shall hope to increase materially thereafter. It will be the policy of The Thew Shovel Co. to take no action with reference to the resumption of dividends on either preferred or common stock without fully discussing the situation with both banks and ascertaining that any action proposed is not considered unjustifiable. * * On November 13, 1935, the president of the bank replied as follows: I have your letter of the ninth, concerning the loan arrangements which we discussed the other day when you were in. As I told you, we established a line of credit for The Thew Shovel Company in the amount of $250,000, subject to the continued satisfactory financial condition of the company and the maintenance of supporting balance. It is our understanding that the borrowings of The Thew1941 BTA LEXIS 1048">1054 Shovel Company and The Universal Crane Company will not exceed $750,000., and that not more than $250,000., of this amount will be in the form of customers' paper discounted. I believe that it is our understanding that if you have occasion to increase your borrowings beyond the figure stated above, you will talk to us about it at that time. I also note what you say about dividend action and your assurances in this respect are entirely satisfactory. * * On November 29, 1935, the petitioner executed and delivered to the bank its ninety-day note for $250,000 and the funds in that amount were made available to petitioner on November 30, 1935. Thereafter, during the remainder of 1935 and the entire year of 1936, the petitioner remained obligated to the bank in the full amount of $250,000, successively renewing its note on February 27, May 27, August 25, and November 23, 1936. The entire amount was still owing to the bank on January 1, 1937. On or about December 1, 1935, the petitioner also borrowed an additional amount of $250,000 from the Central United National Bank, and with the funds borrowed from the two banks it called the aforesaid refunding notes for redemption before1941 BTA LEXIS 1048">1055 January 1, 1936. During the year 1936 petitioner paid off $100,000 of the amount borrowed from the Central United National Bank and during that year it made no written request for the bank's consent to declare or pay dividends. 45 B.T.A. 920">923 During the year 1935 and prior to October 27, 1936, the petitioner did not declare or pay any dividends on its preferred or common stock. On October 27, 1936, petitioner wrote to the National City Bank as follows: You have received our financial statement of Sept. 30, 1936 and the statement of earnings for the first nine months of the year. These earnings seem to justify a dividend distribution before the end of the year and such action is the more desirable by reason of the existing surtax upon undistributed profits. Our directors should take definite action to that end before Dec. 1st. We recognize, however, that a contractual arrangement exists in connection with our $250,000. loan from your bank as expressed in our letter of November 9, 1935 and your reply of Nov. 13, 1935 whereby we are bound to secure your approval of and consent to any dividend distribution that may be made. We therefore request that you advise us as to your attitude1941 BTA LEXIS 1048">1056 regarding the payment of dividends by us in so far as such payment relates to the loan in question. An early reply will be appreciated. On October 30, 1936, the executive committee of the bank, acting upon the request of the petitioner, took the following action, as stated in its minutes: In addition to present commitments of $250,000. for direct loans, and $150,000. to cover customers paper discounted, on motion duly made, seconded and unanimously carried it was agreed to discount for The Thew Shovel Company up to a total of $150,000. of customers paper on condition that a similar commitment will be secured from other banks. The Chairman explained to the Committee that pursuant to an agreement entered into when the direct loan of $250,000. was made to The Thew Shovel Company in October of 1935, that company has asked our permission to pay all arrearages of dividends on the preferred stock of The Thew Shovel Company; 12 1/4% of the arrearages of dividends of the preferred stock of the Universal Crane Company, and dividends of 50 cents per share on the common stock of The Thew Shovel Company, requiring the payment of a total amount of approximately $332,400.00. After a full1941 BTA LEXIS 1048">1057 discussion, on motion duly made, seconded and unanimously carried it was decided that permission be given to pay such dividends. On the same day, October 30, 1936, the vice president of the bank wrote the petitioner as follows: We have your letter of October 27, 1936 with reference to the payment of dividends prior to the end of the current year. In November, 1935 after most careful investigation we offeree to loan The Thew Shovel Company $250,000., provided that the Company could secure an additional loan of equal amount, for the purpose of retiring in advance of their due dates your outstanding refunding notes approximating $500,000 in amount. It was represented to us that the loan could and would be repaid out or prospective future earnings of the Company and this representation seemed to be substantiated by our investigations. The refunding notes which were to be retired carried a provision restricting the payment of dividends by the Company and it seemed proper to us that restrictions of a similar nature should apply to our loan. 45 B.T.A. 920">924 The records of our Executive Committee show that they authorized the loan upon the condition that no dividends should be paid1941 BTA LEXIS 1048">1058 from the first $100,000. of earnings and not to exceed two thirds of the earnings in excess of $100,000. with a further limitation that dividends in excess of $100,000, should not be declared. Your letter of November 9, 1935, while not setting forth the above arrangement in detail, stated that no dividends would be paid without our approval, thereby enabling us to enforce the conditions upon which our loan was made. We therefore stated in our reply of November 13, 1935 that your assurances in this respect were satisfactory and thereafter made the loan to you pursuant to this contractural agreement. In view of your unexpectedly large earnings we are willing to waive the limitation that dividends shall not be paid in excess of $100,000. but we do insist that you retain the first $100,000. of your 1936 earnings and one-third of earnings in excess of $100,000., and that such portion of earnings shall not be distributed as dividends, but shall be retained in the working capital of the Company. We trust that this clearly answers the question raised in your recent communications. We believe that the position we have taken is for the best interest of your Company as well as for1941 BTA LEXIS 1048">1059 the proper protection of this bank. On November 9, 1936, the petitioner's president wrote a letter to the bank, replying to the above letter, saying that: This will acknowledge your letter of October 30th which states very clearly the attitude of the National City Bank with reference to the proposed distribution of dividends by The Thew Shovel Co. We recognize the justice of your conclusions and shall be governed in our actions by the limitations originally established by your executive committee when the loan was made to us in November, 1935. On November 10, 1936, the board of directors of the petitioner declared a dividend of $33.25 per share on its preferred stock, representing all dividends accruing up to December 15, 1936, and a dividend of 50 cents per share on its common stock, amounting to a total of $316,530.75. At December 31, 1936, the petitioner was indebted to the two banks on its notes in the amount of $400,000. It was also contingently liable in the amount of $589,796.03 on customers' notes discounted. The petitioner furnished the National City Bank with quarterly financial and earnings statements and the annual reports of its independent auditors. Those1941 BTA LEXIS 1048">1060 statements showed that the net earnings of the petitioner, before provision for Federal income taxes, were $173,332.92 for the year 1935, $512,997.42 for the first nine months of 1936, and $741,939.90 for the full year 1936. The statement dated September 30, 1936, shows "Estimated normal tax" for the first nine months in the amount of $75,789.61. The balance sheets of the petitioner show capital surplus of $854,122.10 and earned surplus of $571,068.26 as of December 31, 1935, and capital surplus of $866,939.60 and earned surplus of $831,127.41 as of December 31, 1936. The corrected net income for income tax purposes, as computed by 45 B.T.A. 920">925 the respondent, before provision for Federal income taxes, was $150,296.13 for 1935 and $771,673.60 for 1936. The Federal income tax paid by petitioner for 1935 was $20,665.72. The petitioner's "adjusted net income" for the taxable year ended December 31, 1936, was $667,536.92, and its normal income tax for that year was $104,136.68. Income tax already paid by petitioner for 1936 amounts to $108,464.58. In its return for 1936 the petitioner, relying on section 26(c)(1) of the Revenue Act of 1936, 1 claimed a credit against adjusted1941 BTA LEXIS 1048">1061 net income in the amount of $315,683.69 and the respondent, in determining the deficiency herein, disallowed the credit so claimed. The credit provided by section 26(c)(1) is "an amount equal to the excess of the adjusted net income over the aggregate of the amounts which can be distributed within the taxable year as dividends without violating a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the payment of dividends." It is the contention of the petitioner that its letter of November 9, 1935, and the bank's letter1941 BTA LEXIS 1048">1062 of November 13, 1935, constituted such contract, that it could not have distributed during the taxable year as dividends any amount in excess of $356,662.66 without violating the provisions thereof, and that it is therefore entitled to a credit equal to the excess of its adjusted net income over that amount. The respondent's argument in effect is that even though a written contract did exist it did not operate as a legal restriction on or prohibition of the payment of dividends within the meaning of the statute. In its reply brief petitioner specifically disavows any claim that the resolution adopted by the executive committee of the bank on October 11, 1935, preliminary to the commitment by the bank to make the loan, was part of the contract by implication or otherwise. It does claim, however, that by its letter of November 9, 1935, it was obligated to pay no dividends without the consent of the bank and upon acceptance of the proposal by the bank in its letter of November 13, 1935, a contract within the meaning of section 26(c)(1), supra, came into existence. Cf. 1941 BTA LEXIS 1048">1063 , and (U.S. Dist. Ct., W. Dist. 45 B.T.A. 920">926 Ky., Sept. 6, 1941). See also , wherein the bank had "the right at its option to declare any note of the company [the taxpayer] held by it at once due and payable," but had no right to prevent the payment of dividends. The provisions of the above letters dealing with the payment of dividends appear as the fifth paragraph of petitioner's letter and as the second sentence of the third paragraph of the bank's letter. In the petitioner's letter it was stated that "It will be the policy of The Thew Shovel Co. to take no action with reference to the resumption of dividends on either preferred or common stock without fully discussing the situation with both banks and ascertaining that any action proposed is not considered unjustifiable." The bank's reply was signed by its president and the pertinent statement was, "I also note what you say about dividend action and your assurances in this respect are entirely satisfactory." These letters certainly meet two tests of the statute. They were1941 BTA LEXIS 1048">1064 in writing, executed prior to May 1, 1936, and they did "expressly" deal with the payment of dividends. Treating the petitioner's letter as an agreement not to pay dividends without the consent of the bank and assuming that such an agreement to the extent consent is not given is a contract within the meaning of the statute here under consideration, it still does not appear from the facts of record that the petitioner is entitled to the credit claimed or any part thereof. The petitioner under date of October 27, 1936, requested the consent of the bank to the declaration of dividends and on October 30, 1936, the bank gave its reply. The petitioner in its letter stated that it felt its earnings record would justify the resumption of dividends and in that connection called attention to its financial statement of September 30, 1936, and its statement of earnings for the first nine months of the year, both of which had been furnished the bank. In its reply the bank, after referring to the resolution of its executive committee originally authorizing the officers of the bank to make the loan to petitioner, consented to the payment of dividends in the following language: In view of1941 BTA LEXIS 1048">1065 your unexpectedly large earnings we are willing to waive the limitation that dividends shall not be paid in excess of $100,000 but we do insist that you retain the first $100,000 of your 1936 earnings and one-third of earnings in excess of $100,000, and that such portion of earnings shall not be distributed as dividends but shall be retained in the working capital of the company. The substance of the petitioner's argument appears to be that the consent of the bank to the distribution of dividends extended only to two-thirds of the excess of the 1936 earnings over $100,000, after making allowance for 1936 Federal income tax, and that the two-thirds 45 B.T.A. 920">927 of such excess amounted to $356,662.66, while as to the remainder of its earnings the restrictions of the contract still applied and distribution of any portion of such remainder would have been in violation thereof. Such an interpretation can, in our opinion, result only from a misreading of the bank's letter of consent. That consent was expressed not in terms of the earnings that might be distributed but in terms of the earnings which the bank insisted the petitioner must retain, thereby indicating its consent to the distribution1941 BTA LEXIS 1048">1066 of all other earnings. Specifically, the bank said that it was willing to waive the limitation it had originally determined upon as to the maximum amount of dividends that might be distributed in any one year, but said that it did insist that the petitioner retain the first $100,000 of its 1936 earnings and "one-third of earnings in excess of $100,000." Accordingly, the petitioner was required to retain from its total earnings the first $100,000 of its 1936 earnings and one-third of earnings in excess of $100,000, leaving it free to distribute as dividends all other earnings. With respect to earnings which could be distributed as dividends by the petitioner unless restricted by the contract between it and the bank, the parties have stipulated that net earnings for the full twelve months of 1936, before provision for Federal income tax, were $741,939.90 and that the normal income tax for 1936 was $104,136.68. A comparative balance sheet attached to and made a part of the stipulation shows that earned surplus at December 31, 1935, was $571,068.26. It is accordingly apparent that earned surplus at the beginning of the year 1936 plus net earning during that year, after provision1941 BTA LEXIS 1048">1067 for normal income tax, was slightly in excess of $1,200,000. By the terms of the bank's consent the petitioner was required to withhold from distribution the first $100,000 of 1936 earnings and "one-third of earnings in excess of $100,000." Applying that consent to the earnings which could be distributed as dividends on or prior to December 31, 1936, it appears that the petitioner could have distributed during the year 1936 a sum in excess of $700,000. The parties have stipulated that adjusted net income for the taxable year ended December 31, 1936, was $667,536.92. Accordingly adjusted net income did not exceed the amounts which could have been "distributed within the taxable year as dividends without violating provisions of a written contract" and there is no amount which may be credited against adjusted net income under section 26(c)(1) in computing the surtax on undistributed profits. Cf. ; ; and . It might, of course, be argued that a proper interpretation of the bank's consent would require the retention of only1941 BTA LEXIS 1048">1068 one-third of the 1936 earnings in excess 45 B.T.A. 920">928 of and in addition to the first $100,000 from 1936 earnings, but if that interpretation should be made, the result would be to lessen the amount of the earnings still subject to the restriction of the contract and to increase the amount which could be distributed without violation of its provisions, because in such case there would be no restriction whatever in the terms of the bank's consent to the distribution of accumulated earnings on hand at the beginning of the year. Decision will be entered under Rule 50.Footnotes1. SEC. 26. CREDITS OF CORPORATIONS. In the case of a corporation the following credits shall be allowed to the extent provided in the various sections imposing tax - * * * (c) CONTRACTS RESTRICTING PAYMENT OF DIVIDENDS. - (1) PROHIBITION ON PAYMENT OF DIVIDENDS. - An amount equal to the excess of the adjusted net income over the aggregate of the amounts which can be distributed within the taxable year as dividends without violating a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the payment of dividends. * * * ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625281/	LILLIE M. JONES, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. FRANK H. JONES, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. WALTER E. JONES, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Jones v. CommissionerDocket Nos. 28613-28615.United States Board of Tax Appeals21 B.T.A. 275; 1930 BTA LEXIS 1881; November 11, 1930, Promulgated 1930 BTA LEXIS 1881">1881 1. Henry Cappellini et al.,14 B.T.A. 1269">14 B.T.A. 1269, followed. 2. Proposed assessment of amount of deficiency in tax against transferee petitioners is barred by the statute of limitations. D. Webster Egan, Esq., for the petitioners. J. E. Mather, Esq., and R. W. Wilson, Esq., for the respondent. SEAWELL21 B.T.A. 275">275 The Commissioner assessed against the estate of Elmer E. Jones, deceased, a deficiency in income and profits tax amounting to $38,761.19 for the year 1920, which is outstanding and unpaid, and he is now proposing to assess such deficiency as a liability for said year against the petitioners as transferees of said estate, within the meaning of section 280 of the Revenue Act of 1926. The petitions and answers raise the following issues: (1) The constitutionality of said section 280; (2) whether the basis for determining the gain or loss on the sale of certain real property of the Elmer E. Jones estate acquired by him prior to March 1, 1913, is the value of the same at the date of his death or the March 1, 1913, value; and (3) whether the proposed deficiency assessment is barred by the statute of limitations. The cases1930 BTA LEXIS 1881">1882 are consolidated for hearing and decision and are submitted on the pleadings, testimony of two witnesses, exhibits, and stipulation. FINDINGS OF FACT. All of the petitioners are residents of the State of California. Elmer E. Jones died November 20, 1918, the owner of certain real estate acquired by him prior to March 1, 1913, the cost of which to him, if any, is not shown in the evidence. During 1909 to 1911 he entered into certain agreements for the leasing of certain properties, with option to purchase, to the Standard Oil Co., which purchased the property of the Elmer E. Jones estate on or about August 1, 1920, for the sum of $392,000. In the final distribution of said estate the petitioner Lillie M. Jones received property and assets of said estate exceeding in value the 21 B.T.A. 275">276 tax, with penalty and interest, involved in these proceedings. The petitioners, Frank H. Jones and Walter E. Jones each received, in the final distribution of said estate, property and assets of the value of $32,291.13. All the petitioners are transferees of the estate of said Elmer E. Jones, deceased, within the meaning of section 280 of the Revenue Act of 1926. It is agreed between1930 BTA LEXIS 1881">1883 counsel representing petitioners and respondent that if the basis for determining gain or loss on the sale of said oil properties sold by said estate on or about August 1, 1920, is the value at the date of the death of said Elmer E. Jones, then the correct deficiency due and unpaid from the said estate for additional income and profits taxes for the year 1920 is $28,459.15, with interest as provided by law. It is also agreed that if the basis for determining gain or loss on the sale of said properties so sold by said estate is as of March 1, 1913, then and in that event there is no deficiency. The income and profits-tax return of said estate required by law for the year 1920 was filed with the collector of internal revenue at Los Angeles, Calif., on or before March 15, 1921. The deficiency notice was mailed to each of the petitioners on March 22, 1927. Lillie M. Jones, as administratrix of the estate of Elmer E. Jones deceased, administered said estate and was discharged as such administratrix by order of the Judge of the Superior Court of the County of Kern, State of California, in December, 1922. A paper writing signed on August 20, 1925, by the petitioner, Mrs. Lillie1930 BTA LEXIS 1881">1884 M. Jones, reads as follows: INCOME AND PROFITS TAX WAIVER FOR TAXABLE YEARS ENDED PRIOR TO JANUARY 1, 1922. AUGUST 20, 1925. In pursuance of the provisions of existing Internal Revenue Laws E. E. Jones, Estate of E. E. Jones, Lillie M. Jones, Administratrix, a taxpayer of Bakersfield, California, and the Commissioner of Internal Revenue hereby waive the time prescribed by law for making any assessment of the amount of income, excess-profits, or war-profits taxes due under any return made by or on behalf of said taxpayer for the year (or years) 1917, 1918, 1919, 1920, 1921, under existing revenue acts, or under prior revenue acts. This waiver of the time for making any assessment as aforesaid shall remain in effect until December 31, 1926, and shall then expire except that if a notice of a deficiency in tax is sent to said taxpayer by registered mail before said date and (1) no appeal is filed therefrom with the United States Board of Tax Appeals then said date shall be extended sixty days, or (2) if an appeal is filed with said Board then said date shall be extended by the number of 21 B.T.A. 275">277 days between the date of mailing of said notice of deficiency and the date1930 BTA LEXIS 1881">1885 of final decision by said Board. (Signed) MRS. LILLIE M. JONES, Taxpayer.By ROBT. H. LUCAS, Commissioner.W.T.S. t 3/28/30. The said writing was procured from her by an internal revenue agent who filed the same in the Bureau of Internal Revenue, where it was signed by or for the Commissioner on March 28, 1930. In 1924 and in 1925 prior and subsequent to the date, August 20, 1925, of the signing of said paper by Mrs. Lillie M. Jones, one Scott Carter represented petitioners in tax matters before the Bureau of Internal Revenue. Said Carter was so employed in 1925 and in that year filed a claim in abatement in behalf of the estate of Elmer E. Jones against the assessment of an additional tax for the year 1920, which tax is the subject of these proceedings. After the date of the filing of said abatement claim some correspondence was had with the Bureau of Internal Revenue by Carter touching the subject and in December, 1927, he had conferences with officials of the Bureau of Internal Revenue in Washington, D.C., in an effort to effect a satisfactory settlement of the tax matter involved herein, but without success. On January 20, 1926, a notice addressed1930 BTA LEXIS 1881">1886 to "Mrs. Lillie M. Jones, Administratrix, Estate of Elmer E. Jones, 2004 Truxton Ave., Bakersfield, California," was mailed to her by the Assistant to the Commissioner of Internal Revenue, stating, "there has been assessed against you an income and profits tax amounting to $38,761.19 for the taxable year 1920 * ." Under date of October 12, 1926, the petitioner, Lillie M. Jones, wrote the Commissioner, referring to the said assessment, and stated that valuation data relative to the revaluation of the property (Elmer E. Jones property) as of November 20, 1918, had been compiled and was ready for presentation and requested that a date for conference be set so a representative of the estate might appear and present data. OPINION. SEAWELL: The decision of the first issue is controlled by . The second issue it is not necessary to decide, in view of our decision on the third issue. 21 B.T.A. 275">278 The third issue is whether the proposed deficiency in tax is barred by the statute of limitations. Under the provisions of section 250(d) of the Revenue Acts of 1918 and 1921, and the related provisions of subsequent acts, the1930 BTA LEXIS 1881">1887 tax against the said Jones estate could be assessed and collected within five years from the date the return was filed, or until March 15, 1926. On August 20, 1925, and within the statutory period, the paper writing set out in our findings of fact, purporting on its face to be an "Income and Profits Tax Waiver," was signed by Mrs. Lillie M. Jones, stated in the paper to be the administratrix of the estate of E. E. Jones, who was the heretofore-mentioned decedent. The paper purporting to be a "waiver," if effective as such, extended the period for such assessment against the taxpayer to December 31, 1926. At the time Mrs. Lillie M. Jones signed the alleged "waiver" she was not the administratrix of the estate of Elmer E. Jones, deceased, having by proper court proceedings been discharged as such in December, 1922. While her name appears in the body of the paper writing as administratrix, she did not sign as such and, not being in fact administratrix, had no authority to so sign. The paper writing termed a "waiver" and signed by "Lillie M. Jones, Taxpayer" on August 20, 1925, did not extend the five-year period for the determination and assessment of any tax deficiency against1930 BTA LEXIS 1881">1888 the estate of Elmer E. Jones. . The assessment of an income and profits tax of $38,761.19 against the said Jones estate for the year 1920 was made and notice of same mailed to Mrs. Lillie M. Jones, as administratrix of said estate as indicated in our findings of fact, within the statutory period of five years from the filing of the 1920 tax return by said administratrix. Cf. . The provisions of section 280(b)(1) of the Revenue Act of 1926, enacted February 26, 1926, extended the period of limitation for assessment of any liability of the petitioners, as transferees for unpaid taxes of the taxpayer, one year after the expiration of the period of limitation for assessment against the transferor or to March 15, 1927. The respondent's notices to the transferee petitioners of their liability were mailed March 22, 1927, which is more than a year after the period for assessment against the transferor expired, and assessment against the petitioners is barred. Judgment of no deficiency will be entered.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625282/	JOURNAL & TRIBUNE CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Journal & Tribune Co. v. CommissionerDocket No. 15413.United States Board of Tax Appeals15 B.T.A. 208; 1929 BTA LEXIS 2902; February 5, 1929, Promulgated 1929 BTA LEXIS 2902">2902 The amount expended in building up a capital asset designated circulation structure can not be determined from the evidence. B. I. Dahlberg, C.P.A., for the petitioner. E. W. Shinn, Esq., for the respondent. TRAMMELL15 B.T.A. 208">208 This proceeding involves deficiencies in income and profits taxes for 1920 and 1921, in the amount of $1,469.12 and $1,551.74, respectively. The errors assigned are: The action of the respondent in reducing invested capital to the extent of $26,000 on account of good will acquired at organization and the refusal of the respondent to include in invested capital an amount alleged to represent expenditures in building up circulation structure. FINDINGS OF FACT. The petitioner is a corporation, having its principal place of business at Knoxville, Tenn. It was organized in June, 1898, and acquired from Col. Sanford the physical as well as intangible assets, including good will, of the Knoxville Journal, and the good will but not the physical assets of the Knoxville Tribune, for which it issued to Sanford its capital stock in the amount of $36,000 and bonds in the amount of $35,000. The properties were acquired by Sanford1929 BTA LEXIS 2902">2903 for $69,000 in cash and immediately turned over to the corporation. The corporate charter had been granted but the organization of the company had not been completed when Sanford acquired the assets. Sanford was the principal stockholder of the petitioner corporation and one of the organizers of the company. For the years involved the respondent reduced the invested capital by the amount of $26,000, being the amount in excess of 25 per cent of the stock outstanding on March 1, 1917. The petitioner since its organization in 1898, up until the taxable year involved, has expended as much as $100,000, which it now claims was for the circulation structure, and seeks to have that amount included in invested capital. OPINION. TRAMMELL: The petitioner contended, with respect to the assets acquired at the time of organization from Sanford, that Sanford was really acting for the corporation as its agent in acquiring the assets and that the corporation in substance and effect paid cash therefor. 15 B.T.A. 208">209 This contention, however, is refuted by the evidence, which convinces us that Sanford acquired the assets and turned them over to the corporation for stock and bonds. The1929 BTA LEXIS 2902">2904 petitioner also contends with respect to this transaction that the tangible assets alone were worth substantially the par value of the stock and that all of the assets acquired were worth approximately $100,000. This contention is not supported by the evidence. There is no evidence as to the character, quality, or quantity of the assets. The testimony relates merely to the general nature thereof and there is no testimony introduced from which we could find the value of tangible assets in excess of that determined by the respondent. In view of the foregoing, we must affirm the action of the respondent with respect to the exclusion of the $26,000 invested capital on account of good will or intangibles acquired for stock. With respect to the amount claimed to have been expended in building up a circulation structure, a witness who had been connected with the paper and in charge of its management since its organization, testified that at least $100,000 had been expended in building up the circulation structure. The statement of the witness that a certain amount was expended in building up the circulation structure was merely his conclusion or opinion. What one person might1929 BTA LEXIS 2902">2905 consider as having been expended for building up circulation structure, another might not. The actual facts as to the objects and purposes of the expenditures might lead us to the conclusion that they were in their nature ordinary and necessary expenses. The witness did not testify as to what he meant by the expression "circulation structure" or as to the facts upon which he based his conclusion. No facts were presented from which we could determine what the expenditures were for, whether they or any part thereof were in fact for acquiring capital asset or assets or were ordinary and necessary expenses in carrying on business. Here the petitioner seeks for the first time to capitalize the expenditures in question by an amendment to its petition at the hearing. Apparently it had never at any time in the past considered the expenditure as other than ordinary and necessary expense. This gives great weight to the conclusion that at least some part of the expenditure was ordinary and necessary expense. In our opinion the testimony in this case is entitled to no greater weight than the testimony of the witnesses in the case of 1929 BTA LEXIS 2902">2906 ; . The court said: Examination of the evidence in the record shows that the witness who testified as to the value of the trade-mark were merely giving an opinion, not based on any concrete facts * . No effect was made to have an expert 15 B.T.A. 208">210 audit the books to determine what proportion of the amount expended for advertising should be allowed respectively to expense and capital account. It is certain that some part and probably the larger part should be considered as an expense and much weight is given to this conclusion by the charging of the total amount to expense initially. In this state of the record we are not bound by the opinion or conclusion of the witness although it is not contradicted, discredited, or impeached. On the question of the weight to be given opinion evidence, the United States Supreme Court, in the case of , said: While there are doubtless authorities holding that a jury (and in this class of cases the court acts as a jury) has no right arbitrarily to ignore or discredit the testimony of unimpeached witnesses so far1929 BTA LEXIS 2902">*2907 as they testify as to facts, and that a wilful disregard of such testimony will be ground for a new trial, no such obligation attaches to witnesses who testify merely to their opinion; and the jury may do with it as they please, giving credence or not as their own experience and general knowledge of the subject may dictate. See also ; ; affd. . From the evidence before us, we can not determine as a fact what part, if any, of the expenditures made was for acquiring a capital asset. In view of this fact, the amount should not be included in invested capital. Reviewed by the Board. Judgment will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625284/	Davis Hospital, Inc., formerly Davis Hospital and Training School for Nurses, Inc. v. Commissioner.Davis Hosp., Inc. v. CommissionerDocket No. 496.United States Tax Court1945 Tax Ct. Memo LEXIS 268; 4 T.C.M. 312; T.C.M. (RIA) 45097; March 14, 1945Newman A. Townsend, Esq., and John M. Robinson, Esq., for the petitioner. Philip A. Bayer, Esq., for the respondent. LEECHMemorandum Findings of Fact and Opinion LEECH, Judge: This proceeding involves deficiencies in Federal income taxes, declared value excess-profits taxes and penalties for the years 1937, 1938 and 1939, as follows: Declared ValueIncome25%Excess-Profits25%YearTaxPenaltyTaxPenalty1937$5,041.97$1,260.49$2,328.52$ 582.1319386,958.001,739.504,394.531,098.6319393,808.47952.125,680.911,420.23The principal issue is whether petitioner is exempt from the contested Federal taxes under the provisions of section 101 of the Revenue Acts of 1936, 1938, and the Internal Revenue Code. If the answer is in the negative an alternative1945 Tax Ct. Memo LEXIS 268">269 issue is whether petitioner is subject to the 25 per cent penalty for failure to make and file returns for the respective years involved. Another issue, whether petitioner is entitled to have its declared value excess-profits tax credit computed on the basis of the declared value set forth in the capital stock returns filed by it, is conceded by the respondent in favor of petitioner. Findings of Fact Petitioner is a corporation which was incorporated on April 15, 1937 under the laws of the State of North Carolina. It is a non-stock, non-profit corporation, unlimited as to duration. In May 1939 its charter was amended by changing its name from "Davis Hospital and Training School for Nurses, Inc." to "Davis Hospital, Inc." Since its incorporation it has engaged, and still is engaged, in operating a hospital and training school for nurses at Statesville, Iredell County, North Carolina. Petitioner's charter and by-laws declare that the petitioner shall have no capital stock. Its by-laws provide that it shall not pay dividends to its members. Article 3rd of its charter provides as follows: "3rd. The objects and purposes for which this corporation is formed are as follows: "(a) To1945 Tax Ct. Memo LEXIS 268">270 promote and advance the art of professional nursing and caring for sick human beings. "(b) To maintain and operate a school for the proper instruction and training of student nurses; to prescribe the curriculum thereof, not inconsistent with the laws of the State of North Carolina, for those who are enrolled as students in said school and upon satisfactory completion of the work so prescribed, to grant diplomas or certifiates to the graduates. "(c) To provide special courses for and give post-graduate instruction in various branches of nursing, as well as to provide for instruction in any branch of hospital administration and to award certificates to those successfully completing said courses. "(d)To train laboratory technicians and/or pathologists and award certificates to the same. "(e) To furnish practical nursing service, aid or help of any kind to any hospital which it may make a contract with for the services of its students, instructors or faculty and to use the equipment and facilities of said hospital for training of its students or post-graduate nurses or technicians. "(f) To provide for research work in the field of medicine, surgery, preventive medicine or in1945 Tax Ct. Memo LEXIS 268">271 any allied branches of study. "(g) To build, remodel, purchase, lease or sub-lease a hospital or hospitals, and any other buildings or grounds or equipment that may be necessary in connection with the operation of said hospital, or hospitals. To organize, maintain and establish a clinic, or clinics, to be used in connection with the hospital in the examination, diagnosis and treatment of the sick and ailing human beings. To purchase, lease, rent, sub-rent or sub-lease any equipment, material or anything that is necessary in connection with the operation of the clinic, hospital or training school for nurses in any way whatsoever. To make any contract necessary with any doctor, firm, corporation or others that may be necessary in connection with the carrying out of these plans and purposes. To employ help, professional or otherwise, that may be necessary. "(h) To erect, remodel, maintain and equip buildings, laboratories and other necessary structures to be used as nurses' training school, nurses' home or for any other purpose necessary or incident to the business for which the corporation is formed. "(i) To receive from any governmental agency, corporation or individual subscribers1945 Tax Ct. Memo LEXIS 268">272 grants, gifts or donations of any kind that may be approved by the trustees of the corporation for the purpose of carrying out the provisions herein enumerated and to establish and maintain an endowment fund to provide pensions, sick benefits, salaries or other remuneration fixed by the management for its officers, members or employees who may be considered entitled thereto. "(j) The corporation shall have power in connection with its endowment fund, to select and designate a trustee, corporate or individual, and prescribe the duties, powers and limitations thereof, or to operate the same through its own agents and in connection therewith, to issue to donors lifetime annuities, with such income, privileges and rights as may be determined by the corporation and to accept as a part of said endowment donations, gifts, or grants, subject to the life estate of the donor or grantor. In connection with said endowment, the corporation shall have the right to terminate any trust management so provided for, or to substitute a new or different trustee and to revoke a trust so established at any time." Prior to the incorporation of petitioner. Dr. James W. Davis, an eminent surgeon, in about1945 Tax Ct. Memo LEXIS 268">273 1922 formed a stock corporation for the purpose of operating a hospital at Statesville. Dr. Davis owned practically all the stock of that corporation. He erected hospital buildings upon lands received from his mother and uncle. He still owns the fee and the buildings in which the petitioner now operates the hospital. When the petitioner was organized in 1937, Dr. Davis and the other stockholders of the former corporation irrevocably transferred to it property and hospital equipment having a value in excess of $100,000. Petitioner accepted such gift and has since used it for the objects and purposes set forth in its charter. The stock corporation was dissolved and the charter of petitioner was amended and its name changed. During the operation of the hospital by the petitioner, large numbers of poor and indigent persons have been admitted and treated who were financially unable to pay the cost or reasonable value of the necessary medical, surgical, nursing and hospitalization services. Petitioner, during the taxable years, received no compensation from any source for services rendered to from 30 to 40 per cent of the patients admitted to and treated in its hospital. A considerable1945 Tax Ct. Memo LEXIS 268">274 number of patients were admitted and treated who were financially unable to pay the full reasonable value of such services and petitioner received only a part of the cost or reasonable value of those services. For its services to other patients during the taxable years petitioner's only compensation was by way of offset against taxes due the town of Statesville and the county of Iredell. This offset of taxes was made pursuant to a North Carolina statute, authorizing a town or county which assessed taxes against any property used by a hospital to credit those taxes and to charge its welfare fund with the reasonable value of surgical, medical, nursing and hospitalization services rendered to indigent residents of the town or county. Petitioner charges and collects from patients financially able to pay reasonable fees for surgical, medical, nursing and hospitalization services. Petitioner pays salaries to the members of its surgical staffs and applies the balance of fees to further its objects and purposes. At no time has petitioner denied admission to any person or refused necessary surgical, medical, nursing or hospitalization services to any person because he was indigent or financially1945 Tax Ct. Memo LEXIS 268">275 unable to pay the cost or reasonable value of such services. The petitioner pays no rent to Dr. Davis for the use of the hospital building and land, but does discharge the taxes assessed thereon by offsetting the taxes as aforesaid. Petitioner, in connection with the hospital, conducts a training school for nurses. During the taxable years the number of nurses in training and the number completing the course and receiving diplomas as graduate nurses were as follows: NumberYearin trainingGraduates193742111938371519394015On May 17, 1938, the respondent informed petitioner by letter that it was exempt from Federal income taxes under section 101 of the Revenue Act of 1936 and that petitioner was not required to file income tax returns for subsequent years unless its status changed. On September 25, 1940, respondent informed petitioner by letter that the exemption granted in the letter of May 17, 1938 was withdrawn. In January 1944, the members and trustees of petitioner instituted an action in the Superior Court, Mecklenburg County, North Carolina, in which the corporation and the attorney general of North Carolina were made parties1945 Tax Ct. Memo LEXIS 268">276 defendant, seeking a declaratory judgment. After setting forth certain relevant facts, not material here, the complaint as amended made the following allegations and prayer for relief: "24. The plaintiffs, being in doubt with respect to their duties in the premises, and desiring the advice and instructions of the court in regard thereto, respectfully show to the court that their duties in the premises are dependent upon the answers to the following questions of law as applied to the facts hereinbefore alleged, and particularly to the certificate of incorporation of the corporate defendant, to-wit: "(a) Could the corporate defendant be dissolved by action of all or a part of the members and/or trustees thereof under the law of North Carolina? "(b) If so, upon such dissolution, or, if not, upon a forfeiture of its charter or involuntary dissolution, would the assets of said corporation, including earnings, revert to the donors of the equipment and property donated to the corporation; or could the members or trustees legally appropriate the assets, or any part thereof, to their own use; or dispose of the same as they see fit; or would the assets of said corporation, and particularly1945 Tax Ct. Memo LEXIS 268">277 the earnings thereof, constituting assets in excess of donated assets, be preserved under orders of the court either at the instance of the Attorney General or otherwise, to be used perpetually for charitable, educational and scientific purposes, similar to those for which the corporation was formed? "(c) Is it the duty of the plaintiffs, as trustees of the corporate defendant, to file income tax returns under the Revenue Laws of the United States? "(d) Is it the duty of the plaintiffs, as trustees, to file income tax returns for the corporate defendant under the Revenue Laws of North Carolina, or is said corporation exempt under the provisions of Section 7880 (132) of the Consolidated Statutes? "WHEREFORE, in order that the plaintiffs, as trustees, may properly perform their duties, they respectfully pray the court that they be advised as to what their duties are, and particularly that they be advised as to the law of North Carolina with respect to the questions hereinbefore set forth, and they further pray for a declaratory judgment as between all the parties to this action, including the public represented by the Attorney General of North Carolina, declaring the law applicable1945 Tax Ct. Memo LEXIS 268">278 to the defendant corporation, based upon its certificate of incorporation, and the other facts hereinbefore alleged, with respect to the questions of law set forth in paragraph twenty-four hereof; and for such other and further relief to which the plaintiffs may be entitled." The corporation and the attorney general of the State of North Carolina filed answers. After hearing the cause, the Honorable Richard D. Dixon, a judge of the Superior Court of North Carolina, rendered a judgment in which he set forth his findings and conclusions. So far as material to this inquiry the judgment provides: "9. That the defendant corporation was organized, and ever since its organization has been operated exclusively, for charitable, scientific and educational purposes; while it makes a charge for board, room and medicine and surgical attention to those patients who are able to pay, the funds so collected, after paying the expenses of operation, including the salaries of the doctors and surgeons employed by the defendant corporation upon a salary basis, are set aside and held by said corporation for the purpose of continuing and expanding its charitable, educational and scientific work, consisting1945 Tax Ct. Memo LEXIS 268">279 of operating a general hospital in which a large proportion of the patients are unable to pay, and do not pay, for hospital and surgical bills, operating a training school for nurses, and conducting research work of a scientific nature. "10. That no part of the net earnings of the defendant corporation have heretofore enured, or will hereafter enure, to the benefit of any private shareholder or individual. "11. That the defendant corporation, after paying expenses, including the salaries of the surgeons and doctors who render services to the patients in the Davis Hospital, has been able to accumulate surplus earnings so that its assets at the present time substantially exceed the value of the assets donated to it. "UPON THE FOREGOING FINDINGS OF FACT, it is hereby CONSIDERED, ORDERED AND ADJUDGED as follows: "1. That inasmuch as the corporate defendant is a charitable, non-stock, non-profit corporation, and its existence under its charter is unlimited, it cannot be dissolved by any action on the part of its members or trustees. "2. That upon the dissolution of said corporation in any manner, or upon a forfeiture of its charter or involuntary dissolution, its earnings or assets1945 Tax Ct. Memo LEXIS 268">280 of any character whatever would not revert to the original donors, or to any of their representatives, nor could there be an appropriation of said assets, or any part thereof, by the members or trustees of said corporation. In the event of such dissolution all of the assets of said corporation would be preserved under the orders of the court and held in trust to be used perpetually for charitable, educational and scientific purposes similar to those for which the corporation was formed. "3. That it is not the duty of the trustees of said corporation to file Federal or North Carolina State income tax returns on behalf of said corporation, as the said corporation is exempt from the payment of such income taxes. "The plaintiffs will pay the costs of this action to be taxed by the Clerk. "(s) R. D. DIXON Judge Presiding" Opinion Petitioner claims to be exempt from income and profits taxes under section 101(6) of the Revenue Acts of 1936 and 1938 and the Internal Revenue Code. Subdivision (6) is identical in all three acts. 1 The charter granted to petitioner by the State of North Carolina determines the purposes and objects of the corporation. These have been fully set out in1945 Tax Ct. Memo LEXIS 268">281 our findings. We think the charter conclusively establishes that petitioner was formed exclusively for charitable, educational and scientific purposes and for no other purpose. The evidence establishes that during the taxable years in question it has been exclusively operated for the purposes specified in its charter. Petitioner is a nonstock corporation, forbidden by its bylaws to pay dividends. None of its net income has been or can be used for the benefit of any private shareholder or individual. It is not authorized to nor has it engaged in any activities to influence legislation by propaganda or otherwise. All three of the specifications set forth in section 101, subdivision (6), are fully satisfied. The respondent emphasizes the fact that from 1922 to 1937 Dr. James W. Davis operated the same hospital under a stock corporation which was not entitled to exemption under the statute and makes the contention that petitioner is now conducted as it then was. Such argument, we believe, misconceives the legal purport of the dissolution of the old corporation and the incorporation of a new nonprofit corporation limited to the objects and purposes specified in its present charter. Petitioner1945 Tax Ct. Memo LEXIS 268">282 is a new, separate and distinct entity from the former corporation and must be so considered in determining the application of the revenue acts in question. Respondent places considerable stress upon the fact that petitioner charged those able to pay for the services rendered. This is the usual practice of hospitals. So long as admission and treatment are not denied to those unable to pay, an institution is classed as charitable. , and authorities therein cited. The respondent's argument that petitioner, organized under the general corporation law of North Carolina, could be dissolved and its property distributed among its members, merits consideration. Petitioner's charter is silent respecting the dissolution of the corporation and the distribution of its property. In such case it may be argued plausibly that petitioner's net income might inure to the benefit of private shareholders or individuals, and thus it would not comply with one of the specifications set forth in section 101(6), supra. The possibility that such a result might be achieved is forever foreclosed by the judgment of the Superior Court of North Carolina. 1945 Tax Ct. Memo LEXIS 268">283 That court determined that petitioner was organized, and ever since its organization has been operated, exclusively for charitable, scientific and educational purposes. The court ordered and adjudged that petitioner "cannot be dissolved by any action on the part of its members or trustees", and further adjudged "That upon the dissolution of said corporation in any manner, or upon a forfeiture of its charter or involuntary dissolution, its earnings or assets of any character whatever would not revert to the original donors, or to any of their representatives, nor could there be an appropriation of said assets, or any part thereof, by the members or trustees of said corporation. In the event of such dissolution all of the assets of said corporation would be preserved under the orders of the court and held in trust to be used perpetually for charitable, educational and scientific purposes similar to those for which the corporation was formed". To the extent the court construed petitioner's charter and defined the rights and powers of its members and trustees under the laws of North Carolina which created it, we think it was adjudicating legal issues within its jurisdiction.2 To such1945 Tax Ct. Memo LEXIS 268">284 extent its decision is binding upon us. ; . However, in adjudging that petitioner was a charitable corporation for Federal income tax purposes and, as such, exempt from Federal income taxes, the Superior Court, of course, exceeded its jurisdiction and its determination is of no binding force or effect upon this court. ; . The respondent contends that such judgment was collusive and is entitled to no weight in this proceeding. ; . We do not agree. The proceeding was properly before the Superior Court of North Carolina and all persons having any interest in the controversy were made parties. The attorney general of the State of North Carolina, representing the public interest, was made a party defendant, appeared and filed an answer therein. Whether petitioner was a charitable corporation, and exempt from taxes imposed by the State of North Carolina, 1945 Tax Ct. Memo LEXIS 268">285 involved a controversy in which the public had a vital interest. We think the respondent's premise is without foundation in fact. And we will not presume that a state official, charged with the responsibility of protecting the rights of the public, would lend his office to collusive litigation. 31945 Tax Ct. Memo LEXIS 268">286 Upon this record, including the judgment of the Superior Court of North Carolina as to petitioner's purposes and the legal rights of its members, which is persuasive, we conclude that the petitioner has established its right to exemption from Federal income and profits taxes under the applicable revenue acts. It, therefore, is unnecessary to pass upon the alternative issue. The penalties fall with the tax. Decision will be entered for the petitioner. Footnotes1. SEC. 101. EXEMPTIONS FROM TAX ON CORPORATIONS. The following organizations shall be exempt from taxation under this title - * * * * *(6) Corporations, and any community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, or for the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefits 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; ↩2. ; ; ; ; North Carolina Code, Art. 25-A, Declaratory Judgments, Sec. 628 (b), (1939).↩3. The law presumes that a public officer faithfully performs the duties of his office. ; ; .↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625285/	Edward J. Kelly, Petitioner, v. Commissioner of Internal Revenue, RespondentKelly v. CommissionerDocket No. 35676United States Tax Court19 T.C. 27; 1952 U.S. Tax Ct. LEXIS 73; October 13, 1952, Promulgated 1952 U.S. Tax Ct. LEXIS 73">73 Decision will be entered under Rule 50. Gifts of trust income required to be paid to their guardians for the education, maintenance and support of minor beneficiaries held not gifts of future interests so as to eliminate permitted exclusions under section 1003, Internal Revenue Code. Madeleine N. Sharp, 3 T.C. 1062">3 T.C. 1062, affd. (C. A. 9) 153 F.2d 163">153 F.2d 163, followed. William W. Ellis, Jr., Esq., for the petitioner.Robert J. McDonough, Esq., for the respondent. Opper, Judge. OPPER19 T.C. 27">28 OPINION.A deficiency in gift tax of $ 1,483.56 for the year 1947 is in controversy. As originally presented, the case involved the applicability of the exclusion provision of Internal Revenue Code section 1003 (b)(3) to two sets of gifts on the ground that they constituted future interests. All of the facts were stipulated and are hereby found accordingly.The gift tax return for 1947 was filed with the collector of internal revenue for the second New York district. The essential facts are summarized as follows in petitioner's brief:In December, 1947, the petitioner, Edward J. Kelly, had two daughters and seven minor grandchildren. 1952 U.S. Tax Ct. LEXIS 73">74 In order to make gifts to said daughters and grandchildren, petitioner executed on December 26, 1947, two substantially identical trust instruments, one for Isabel W. Durcan and her four children, the other for Janet M. Howley and her three children.The trust instruments, after providing in Paragraph First (a) that the net income of the trust funds for petitioner's two daughters should be paid over to said daughters during their respective lives, contain the following provisions in Paragraph First (b) for petitioner's grandchildren: (b) The respective trust funds * * established for the benefit of each child of said Isabel W. Durcan [and Janet M. Howley] now living, * * * and the net income of the principal of the trusts hereby created for the benefit of each such child shall be paid to his or her lawful guardian for the education, maintenance and support of such child until such child shall attain the age of twenty-one (21) years. Any and all such net income not so paid over for the benefit of such child in any year during his or her minority shall be invested and reinvested in the manner herein provided for the principal of such trust. After each child of said Isabel W. 1952 U.S. Tax Ct. LEXIS 73">75 Durcan [and Janet M. Howley], * * shall attain the age of twenty-one (21) years, the net income of the trust hereby created for his or her benefit shall be paid to him or her at least as often as annually until he or she shall attain the age of thirty-five (35) years; whereupon there shall be paid or turned over to him or her all the principal and undistributed income of such trust fund then on hand.In addition to the usual powers, the trustee is authorized in Paragraph First (d) to invade the principal of the trust funds where necessary for the education of the beneficiaries, or because of the illness or other need of said beneficiaries.On December 29, 1947, petitioner transferred to himself as trustee under the above described trusts for each of the five Durcans, sixty shares of the common stock of Lawyers Trust Company valued at $ 2,910, and for each of the four Howleys ten shares of the common stock of Ranger Motors, Inc., valued at $ 3,200.In preparing his gift tax return for the calendar year 1947, petitioner reported the full value of the above gifts, and claimed on said return the annual exclusion of $ 3,000 for each of said gifts. This return was filed with the Collector1952 U.S. Tax Ct. LEXIS 73">76 of Internal Revenue for the Second New York District.The respondent asserted a deficiency against petitioner in the amount of $ 1,483.56, said deficiency resulting from the disallowance of any exclusions with respect to the gifts to petitioner's grandchildren, and from the limiting of the exclusion with respect to the gifts to petitioner's daughters to the date of gift value of the right to receive the trust income for their lives. The disallowance 19 T.C. 27">29 was based upon the theory that the gifts to the grandchildren were gifts of future interests and that the gifts of principal to the daughters were gifts of future interests.By mutual concessions, the only remaining controversy has been reduced to whether exclusions are permissible with respect to the income of the grandchildren's trust. Respondent concedes that the income of the trust for the daughters is immediately payable and hence constitutes a present interest; petitioner concedes "that the gifts of principal were gifts of future interests."The only distinction between the income of the grandchildren's trust and Madeleine N. Sharp, 3 T.C. 1062">3 T.C. 1062, affd. (C. A. 9) 153 F.2d 163">153 F.2d 163,1952 U.S. Tax Ct. LEXIS 73">77 is that in the Sharp case the trustee was required "to apply and pay over to the use and for the benefit of my son" the net income of the trust, whereas here the requirement is that "the net income of the principal of the trusts hereby created for the benefit of each such [grandchild] shall be paid to his or her lawful guardian for the education, maintenance and support of such [grandchild] * ."In the Sharp case, we concluded that --Such discretion [as to the payee] gives no authority or power to the trustee to determine if it will or will not pay over as it deems proper and fit * . The provision for accumulating any balance of income must be construed in the light of the other language used in article first. In our opinion this provision was purely precautionary and constituted no limitation upon the duty of the trustee to apply and pay over the net income to the son. * * The rule which respondent invokes and contends we should follow, namely, that where income to be distributed to beneficiaries of a trust is subject to the uncontrolled judgment and discretion of the trustees, such gifts of income are gifts of future interests, against which no exclusions 1952 U.S. Tax Ct. LEXIS 73">78 are allowable, is amply supported by authorities. * * * But the facts here afford no opportunity to apply the rule. We have no postponement of the minor's right to enjoy the net income of the trust in the uncontrolled judgment and discretion of the trustee. * * *We find insufficient distinction in the language of the respective trust instruments to apply a different rule here. On the sole contested issue, therefore, we conclude that exclusions are permissible as to the income of the trust for the grandchildren. Elizabeth H. Fisher, 45 B.T.A. 958">45 B.T.A. 958, affd. (C. A. 9) 132 F.2d 383">132 F.2d 383.Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625286/	ALLAN J. AND DONNA L. PEARLMAN, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentPearlman v. CommissionerDocket No. 27246-86United States Tax CourtT.C. Memo 1995-182; 1995 Tax Ct. Memo LEXIS 176; 69 T.C.M. 2460; April 18, 1995, Filed 1995 Tax Ct. Memo LEXIS 176">176 Decision will be entered for respondent. For petitioners: Lois C. Blaesing and Chauncey W. Tuttle, Jr.For respondent: Mary P. Hamilton, Paul Colleran, and William T. Hayes. DAWSON, WOLFEDAWSON; WOLFEMEMORANDUM FINDINGS OF FACT AND OPINION DAWSON, Judge: This case was assigned to Special Trial Judge Norman H. Wolfe pursuant to the provisions of section 7443A(b)(4) and Rules 180, 181, and 183. 1 The Court agrees with and adopts the opinion of the Special Trial Judge, which is set forth below. OPINION OF THE SPECIAL TRIAL JUDGE WOLFE, Special Trial Judge: This case is part of the Plastics Recycling group of cases. For a detailed discussion of the transactions involved in the Plastics Recycling cases, see Provizer v. Commissioner, T.C. Memo. 1992-177, affd. without published opinion1995 Tax Ct. Memo LEXIS 176">177 996 F.2d 1216">996 F.2d 1216 (6th Cir. 1993). The facts of this case are substantially identical to those of the Provizer case. Like Harold Provizer, one of the taxpayers in the Provizer case, Allan J. Pearlman made a payment of $ 8,333 at the end of 1981 for a 16.66-percent interest in the DL and Associates general partnership. Pursuant to petitioners' request at trial, this Court took judicial notice of our opinion in the Provizer case. Respondent determined a deficiency in petitioners' joint 1981 Federal income tax in the amount of $ 17,827 and additions to tax for that year in the amount of $ 4,317 under section 6659 for valuation overstatement, in the amount of $ 891 under section 6653(a)(1) for negligence, and under section 6653(a)(2) in an amount equal to 50 percent of the interest due on the underpayment attributable to negligence. Respondent also determined that interest on deficiencies accruing after December 31, 1984, would be calculated at 120 percent of the statutory rate under section 6621(c). 21995 Tax Ct. Memo LEXIS 176">178 The issues for decision are: (1) Whether expert reports and testimony offered by respondent are admissible into evidence; (2) whether petitioners are entitled to claimed deductions and tax credits with respect to petitioner Allan J. Pearlman's investment in DL and Associates; (3) whether petitioners are liable for additions to tax for negligence or intentional disregard of rules or regulations under section 6653(a)(1) and (2); (4) whether petitioners are liable for the addition to tax under section 6659 for an underpayment of tax attributable to valuation overstatement; and (5) whether petitioners are liable for increased interest under section 6621(c). FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulated facts and attached exhibits are incorporated by this reference. Petitioners resided in Huntington Woods, Michigan, when their petition was filed. During 1981, Allan J. Pearlman (petitioner) was corporate secretary and a partial owner of Canton China and Equipment Company (Canton China) and also was employed in a sales capacity for that company. Petitioner and his brother, Sheldon Pearlman, each own 23 percent of the stock of Canton China, 1995 Tax Ct. Memo LEXIS 176">179 and his father, Meyer Pearlman, owns the remaining 54 percent of the stock. Petitioner has been employed by Canton China since 1964. During 1981, the gross revenues of Canton China were approximately $ 5 million. In 1981, petitioner Donna L. Pearlman was a teacher. Petitioners' gross income for 1981 from wages, interest, tax refunds, and miscellaneous sources was in excess of $ 93,000 and, consequently, in the absence of significant deductions or credits, they were subject to payment of Federal income taxes in substantial amounts. Petitioner is a partner in DL and Associates, which is a limited partner in the Clearwater limited partnership. DL and Associates is the same tier partnership that we considered in Provizer v. Commissioner, supra. The underlying deficiency in this case resulted from respondent's disallowance of claimed losses and tax credits that were passed through both Clearwater and DL and Associates to petitioner. Petitioners have stipulated to substantially the same facts concerning the underlying transactions as we found in Provizer v. Commissioner, supra.3 Those facts may be summarized1995 Tax Ct. Memo LEXIS 176">180 as follows. In 1981, Packaging Industries, Inc. (PI), manufactured and sold six Sentinel expanded polyethylene (EPE) recyclers to ECI Corp. for $ 5,886,000 ($ 981,000 each). ECI Corp., in turn, resold the recyclers to F & G Corp. for $ 6,976,000 ($ 1,162,666 each). F & G Corp. then leased the recyclers to Clearwater which licensed the recyclers to FMEC Corp., which sublicensed them back to PI. All of the monthly payments required among the entities in the above transactions offset each other. These transactions were done simultaneously. We refer to these transactions collectively as the Clearwater transaction. The fair market value of a Sentinel EPE recycler in 1981 was not in excess of $ 50,000. 1995 Tax Ct. Memo LEXIS 176">181 PI allegedly sublicensed the recyclers to entities that would use them to recycle plastic scrap. The sublicense agreements provided that the end-users would transfer to PI 100 percent of the recycled scrap in exchange for a payment from FMEC Corp. based on the quality and amount of recycled scrap. In 1981, petitioner acquired a 16.66-percent partnership interest in DL and Associates in exchange for his investment of $ 8,333. DL and Associates owned a 6.188-percent limited partnership interest in Clearwater. As a result of the pass through from Clearwater, petitioners deducted on their 1981 tax return an operating loss in the amount of $ 6,668 and claimed an investment tax credit in the amount of $ 7,195 and a business energy credit in the amount of $ 7,195 for the recyclers. Respondent disallowed petitioners' claimed deductions and credits related to DL and Associates and Clearwater for taxable year 1981. In 1981, petitioner learned of DL and Associates and the Clearwater transaction from David Lichtenstein (Lichtenstein). During 1981, Lichtenstein was a very close personal friend of petitioner. In addition, Lichtenstein was petitioner's personal attorney and also had represented1995 Tax Ct. Memo LEXIS 176">182 Canton China. Lichtenstein organized DL and Associates for the purpose of enabling a group of friends and associates to acquire an interest in recyclers through Clearwater. Lichtenstein was also a partner in DL and Associates. With respect to DL and Associates, Lichtenstein's duties were purely administrative. Petitioner graduated from high school in 1960 and attended Ferris State College and Michigan State University for 3 years but did not receive a degree. Petitioner Donna L. Pearlman was educated as a teacher. Petitioners do not have any formal training in investments. They do not have any education or work experience in plastics recycling or plastics materials. Petitioners did not independently investigate the Sentinel recyclers. Petitioners did not see a Sentinel recycler or any other type of plastic recycler prior to participating in the recycling ventures. OPINION In Provizer v. Commissioner, T.C. Memo. 1992-177, a test case involving the DL and Associates partnership and the Clearwater transaction, this Court (1) found that each Sentinel EPE recycler had a fair market value not in excess of $ 50,000, (2) held that the Clearwater transaction1995 Tax Ct. Memo LEXIS 176">183 was a sham because it lacked economic substance and a business purpose, (3) upheld the section 6659 addition to tax for valuation overstatement since the underpayment of taxes was directly related to the overstatement of the value of the Sentinel EPE recyclers, and (4) held that losses and credits claimed with respect to Clearwater were attributable to tax-motivated transactions within the meaning of section 6621(c). In reaching the conclusion that the Clearwater transaction lacked economic substance and a business purpose, this Court relied heavily upon the overvaluation of the Sentinel EPE recyclers. Although petitioners have not agreed to be bound by the Provizer opinion, they have stipulated that petitioner's investment in the Sentinel EPE recyclers was similar, if not identical, to the investment described in Provizer v. Commissioner, supra, and, pursuant to their request, we have taken judicial notice of our opinion in the Provizer case. Petitioner held a partnership interest in DL and Associates, the same tier partnership in which Harold Provizer had an interest. In the present case, venue for appeal lies to the Court of Appeals1995 Tax Ct. Memo LEXIS 176">184 for the Sixth Circuit, the same Court of Appeals that affirmed Provizer v. Commissioner, supra.While petitioners were not parties to the litigation in the Provizer case and res judicata does not apply, the doctrine of stare decisis is applicable. See Simmons v. Union News Co., 341 F.2d 531">341 F.2d 531, 341 F.2d 531">533 (6th Cir. 1965). Under these circumstances, in the absence of any significant distinguishing facts, respondent must be sustained on the authority of Provizer v. Commissioner, supra.Golsen v. Commissioner, 54 T.C. 742">54 T.C. 742, 54 T.C. 742">757 (1970), affd. 445 F.2d 985">445 F.2d 985 (10th Cir. 1971). Issue 1: Admissibility of Expert Reports and TestimonyBefore addressing the substantive issues in this case, we resolve an evidentiary issue. At trial, respondent offered into evidence the expert opinions and testimony of Steven Grossman (Grossman) and Richard Lindstrom (Lindstrom). Petitioners object to the admissibility of the testimony and reports. The expert reports and testimony of Grossman and Lindstrom are identical to the testimony and reports1995 Tax Ct. Memo LEXIS 176">185 in Eisenberg v. Commissioner, T.C. Memo. 1995-180, (April 1995). In addition, petitioners' arguments with respect to the admissibility of the expert testimony and reports are identical to the arguments made in the Eisenberg case. For a detailed discussion of the reports, see Eisenberg v. Commissioner, supra, and Provizer v. Commissioner, supra. For a detailed discussion of the testimony and petitioners' arguments concerning the admissibility of the testimony and reports, see the Eisenberg case. For reasons set forth in Eisenberg v. Commissioner, supra, we hold that the reports and testimony of Grossman and Lindstrom are relevant and admissible and that Grossman and Lindstrom are experts in the fields of plastics, engineering, and technical information. We do not, however, accept Grossman or Lindstrom as experts with respect to the ability of the average person, who has not had extensive education in science and engineering, to conduct technical research, and we have limited our consideration of their reports and testimony to the areas1995 Tax Ct. Memo LEXIS 176">186 of their expertise. We also hold that Grossman's report meets the requirements of Rule 143(f). Issue 2: Deductions and Tax Credits With Respect to DL and AssociatesOn their joint 1981 Federal income tax return, petitioners claimed the following with respect to petitioner's investment in DL and Associates: (1) Deductions in the amount of $ 6,668; (2) an investment tax credit in the amount of $ 7,195; and (3) a business energy credit in the amount of $ 7,195. Respondent disallowed these claimed deductions and tax credits. The underlying transaction in this case is substantially identical in all respects to the transaction in Provizer v. Commissioner, supra. The parties have stipulated the facts concerning the deficiency essentially as set forth in our Provizer opinion. Based on this record, we hold that the Clearwater transaction was a sham and lacked economic substance. In reaching this conclusion, we rely heavily upon the overvaluation of the Sentinel EPE recyclers. Accordingly, respondent is sustained on the issue with respect to the underlying deficiency. Moreover, we note that petitioners have stated their concession of this1995 Tax Ct. Memo LEXIS 176">187 issue on brief. The record plainly supports respondent's determination regardless of such concession. For a detailed discussion of the facts and the applicable law, see Provizer v. Commissioner, supra.Issue 3: Sec. 6653(a) NegligenceRespondent determined that petitioners were liable for the additions to tax under section 6653(a). Petitioners have the burden of proving that respondent's determination of an addition to the tax is erroneous. Rule 142(a); Luman v. Commissioner, 79 T.C. 846">79 T.C. 846, 79 T.C. 846">860-861 (1982). Section 6653(a)(1) imposes an addition to tax equal to 5 percent of the underpayment if any part of an underpayment of tax is due to negligence or intentional disregard of rules or regulations. In cases involving negligence, an additional amount is added to the tax under section 6653(a)(2); such amount is equal to 50 percent of the interest payable with respect to the portion of the underpayment attributable to negligence. Negligence is defined as the failure to exercise the due care that a reasonable and ordinarily prudent person would employ under the circumstances. Neely v. Commissioner, 85 T.C. 934">85 T.C. 934, 85 T.C. 934">947 (1985).1995 Tax Ct. Memo LEXIS 176">188 The question is whether a particular taxpayer's actions in connection with the transactions were reasonable in light of his experience and the nature of the investment or business. See Henry Schwartz Corp. v. Commissioner, 60 T.C. 728">60 T.C. 728, 60 T.C. 728">740 (1973). Petitioner contends that he was reasonable in claiming deductions and credits with respect to his investment in DL and Associates and attempts to distinguish the instant case from Provizer v. Commissioner, T.C. Memo. 1992-177, by alleging the following: (1) That claiming the deductions and credits with respect to DL and Associates was reasonable in light of the "oil crisis" in the United States in 1981; (2) that in claiming the deductions and credits, petitioner specifically relied upon Lichtenstein; and (3) that petitioner was a so-called unsophisticated investor. When petitioners claimed the disallowed deductions and tax credits, they had little, if any, knowledge of the plastics or recycling industries and no engineering or technical knowledge. Petitioner did not independently investigate the Sentinel EPE recyclers and knew nothing about their value. In fact, petitioner1995 Tax Ct. Memo LEXIS 176">189 testified that the value of the recyclers did not matter to him. Petitioner declined to study or even examine the Clearwater offering memorandum. At trial, petitioner could remember almost nothing about the Clearwater transaction except the tax benefits. He could not recall the activities or the type of business in which Clearwater purportedly engaged, the assets owned by Clearwater, or the way in which Clearwater was supposed to generate income. Petitioner testified that the projected tax benefits of Clearwater were an incentive to invest in DL and Associates and that, at the time he made the investment, he was aware that within the following months he would receive tax benefits in amounts totaling at least the amount of his investment. Despite the ratio of claimed tax benefits to petitioner's cash outlay, petitioner contends that he was reasonable in claiming the deductions and credits related to DL and Associates because of the "oil crisis" in the United States during 1981. Petitioner argues that the oil, or energy, crisis led him to believe that an investment in recycling had good economic potential. He testified that the DL and Associates investment "tied in very closely" 1995 Tax Ct. Memo LEXIS 176">190 with the oil crisis. However, as respondent's expert Grossman noted in his written report: Less than 10% of crude oil is in fact converted into monomers that are subsequently utilized for making plastic materials. The cost of a final plastic product will depend to a large extent on the technology available to convert the monomer into plastic form as well as prices for competitive (alternative) materials. Studies have shown that a 300% increase in crude oil prices results in only a 30 to 40% increase in the cost of plastic products. [Footnote omitted.]Petitioner testified that he had "no idea" of the type of business, generally, in which Clearwater purportedly engaged, and that he was unaware of how DL and Associates was supposed to generate income. Still, petitioner argues that because of the oil crisis in the United States, he intended to profit from the investment. We find petitioner's vague, general claims concerning the oil crisis to be without merit. Petitioners also argue, in general terms, that due to rising oil prices in 1981, the Federal Government offered incentives to conserve energy, including the business energy credit and therefore, they were reasonable1995 Tax Ct. Memo LEXIS 176">191 in claiming large credits and deductions with respect to DL and Associates. As applied to the facts of this case, the argument is unpersuasive. Certainly, the Government was not providing tax benefits for supposed investments that actually were shams and lacked economic substance. See Greene v. Commissioner, 88 T.C. 376">88 T.C. 376 (1987). In the first year of the investment alone, petitioners claimed direct reductions in their Federal income tax, via the investment tax credit and the business energy credit, equal to 173 percent of their cash investment. Therefore, like the taxpayers in Provizer v. Commissioner, supra, "except for a few weeks at the beginning, petitioners never had any money in the deal." A reasonably prudent person would not conclude without substantial investigation that the Government was providing massive tax benefits to taxpayers who took no risk and made no investment of their own capital. A reasonably prudent person would have asked a qualified independent tax adviser if this windfall were not too good to be true. McCrary v. Commissioner, 92 T.C. 827">92 T.C. 827, 92 T.C. 827">850 (1989). In1995 Tax Ct. Memo LEXIS 176">192 fact, petitioner argues that he consulted a qualified adviser, Lichtenstein, and relied on him in claiming the disallowed losses and tax credits. Petitioner argues that his reliance on the advice of Lichtenstein insulates him from the negligence-related additions to tax. Under some circumstances a taxpayer may avoid liability for the additions to tax under section 6653(a)(1) and (2) if reasonable reliance on a competent professional adviser is shown. Freytag v. Commissioner, 89 T.C. 849">89 T.C. 849, 89 T.C. 849">888 (1987), affd. 904 F.2d 1011">904 F.2d 1011 (5th Cir. 1990), affd. 501 U.S. 868">501 U.S. 868 (1991). Such circumstances are not present in this case. Moreover, reliance on professional advice, standing alone, is not an absolute defense to negligence, but rather a factor to be considered. Id. In order for reliance on professional advice to excuse a taxpayer from the negligence additions to tax, the reliance must be reasonable, in good faith, and based upon full disclosure. Id.; see Weis v. Commissioner, 94 T.C. 473">94 T.C. 473, 94 T.C. 473">487 (1990); Ewing v. Commissioner, 91 T.C. 396">91 T.C. 396, 91 T.C. 396">423-424 (1988),1995 Tax Ct. Memo LEXIS 176">193 affd. without published opinion 940 F.2d 1534">940 F.2d 1534 (9th Cir. 1991); Pritchett v. Commissioner, 63 T.C. 149">63 T.C. 149, 63 T.C. 149">174-175 (1974). We have rejected pleas of reliance when neither the taxpayer nor the advisers purportedly relied upon by the taxpayer knew anything about the nontax business aspects of the contemplated venture. 89 T.C. 849">Freytag v. Commissioner, supra; Beck v. Commissioner, 85 T.C. 557">85 T.C. 557 (1985); Flowers v. Commissioner, 80 T.C. 914">80 T.C. 914 (1983); Steerman v. Commissioner, T.C. Memo. 1993-447. Lichtenstein did not possess any special qualifications or professional skills in the recycling or plastics industries, and he did not hire anyone with plastics or recycling expertise to evaluate the Clearwater transaction. In evaluating the transaction, Lichtenstein relied upon the offering materials, some discussion with an attorney from the law firm that provided the tax opinion letter incorporated in the Clearwater offering circular, and Gordon, and Gordon relied on the offering materials and on discussions with persons1995 Tax Ct. Memo LEXIS 176">194 involved in the transaction. Petitioner first became aware of the Clearwater investments through Lichtenstein. Lichtenstein is a close personal friend of petitioner. In addition, in 1981, Lichtenstein served as petitioner's attorney in both personal and business matters. Although Lichtenstein customarily charged petitioner for his services, he did not charge petitioner for any advice he rendered in connection with DL and Associates and Clearwater. Petitioner's testimony was general and vague, providing no details of his inquiries of Lichtenstein or the advice he received from him. Petitioner testified that, in addition to speaking with Lichtenstein about DL and Associates and Clearwater, he also spoke with other partners in DL and Associates and Fred Gordon. At trial, petitioner could not recall the details of any conversation involving Clearwater. He only recalled that Lichtenstein and Gary Eisenberg, a fellow member of Provizer, Eisenberg, Lichtenstein, and Pearlman, P.C., allegedly had advised him that Clearwater was a good investment. Petitioner testified that he relied almost entirely on Lichtenstein in making his investment in DL and Associates and in claiming the associated1995 Tax Ct. Memo LEXIS 176">195 tax deductions and credits. Lichtenstein, however, testified that each partner in DL and Associates acted for himself, that any questions about the investment were directed to Fred Gordon, and that Lichtenstein's only association with the partnership, outside of being an investor, was to organize the partnership strictly as a convenience to enable his friends and associates to invest in Clearwater. He explained: "I could not invest for them. They were not my partners. They were individually buying their interest." We do not think petitioner's purported reliance on Lichtenstein was reasonable under the circumstances here. Accordingly, we hold that petitioners are not entitled to relief from the negligence-related additions to tax under section 6653(a) because of their alleged reliance on professional advice. Petitioners' reliance on Heasley v. Commissioner, 902 F.2d 380">902 F.2d 380 (5th Cir. 1990), revg. T.C. Memo. 1988-408, is misplaced. The facts in the Heasley case are distinctly different from the facts of this case. Unlike the taxpayers in the Heasley case, petitioners are not unsophisticated. Petitioner is a financially1995 Tax Ct. Memo LEXIS 176">196 successful, experienced businessman and petitioner Donna L. Pearlman is educated as a teacher. In the Heasley case, the taxpayers read portions of the prospectus, while in this case petitioner made no attempt to read any information concerning the Clearwater investment and was remarkably oblivious to the details, or even the general concept, of the underlying transaction. Finally, the taxpayers in the Heasley case actively monitored their investment and, as the Fifth Circuit stated, intended to profit from the investment. We cannot reach similar conclusions in the instant case. Although petitioner testified that he intended to profit from the investment in DL and Associates and Clearwater, he has failed to provide evidence of any effort to monitor his investment or reliable evidence of any profit objective independent of tax savings. We consider petitioners' arguments with respect to the Heasley case inapplicable. Petitioner entered into the DL and Associates investment without any knowledge or background with respect to plastics or recycling and without seeking the advice of anyone who had such knowledge. Petitioner did not examine any Sentinel EPE recyclers prior1995 Tax Ct. Memo LEXIS 176">197 to investing in DL and Associates, and he did not seek the advice of an independent third party concerning the machines' values. Petitioners have not persuaded us that their situation is any different from that of the taxpayers in Provizer v. Commissioner, T.C. Memo. 1992-177, where the negligence additions to tax were upheld. Petitioners paid $ 8,333 and claimed a tax deduction of $ 6,668 and tax credits in the amount of $ 14,390 for the first year of the investment alone. We conclude that they were negligent in doing so. We hold, upon consideration of the entire record, that petitioners are liable for the negligence-related additions to tax under the provisions of section 6653(a)(1) and (2). Respondent is sustained on this issue. Issue 4: Sec. 6659 Valuation OverstatementRespondent determined that petitioners are liable for the addition to tax for valuation overstatement under section 6659 on the underpayment of their 1981 Federal income tax attributable to the investment tax credit and business energy credit claimed with respect to DL and Associates and Clearwater. The underlying facts of this case with respect to this issue are substantially1995 Tax Ct. Memo LEXIS 176">198 the same as those in Eisenberg v. Commissioner, T.C. Memo. 1995-180. In addition, petitioners arguments with respect to this issue are identical to the arguments made in the Eisenberg case. For reasons set forth in the Eisenberg opinion, we hold that petitioners are liable for the section 6659 addition to tax at the rate of 30 percent of the underpayment of tax attributable to the disallowed credits for 1981. Issue 5: Sec. 6621(c) Tax-Motivated TransactionsRespondent determined that interest on deficiencies accruing after December 31, 1984, would be calculated under section 6621(c). The annual rate of interest under section 6621(c) equals 120 percent of the interest payable under section 6601 with respect to any substantial underpayment attributable to tax-motivated transactions. An underpayment is substantial if it exceeds $ 1,000. Sec. 6621(c)(2). The underlying facts of this case with respect to this issue are substantially the same as those in Eisenberg v. Commissioner, supra. In addition, petitioners' arguments on brief with respect to this issue are verbatim copies of the arguments in the1995 Tax Ct. Memo LEXIS 176">199 taxpayers' briefs in the Eisenberg case. For reasons set forth in the Eisenberg opinion, we hold that respondent's determination as to the applicable interest rate for deficiencies attributable to tax-motivated transactions is sustained and the increased rate of interest applies for the taxable year in issue. Decision will be entered for respondent. Footnotes1. All section references are to the Internal Revenue Code in effect for the tax year at issue, unless otherwise stated. All Rule references are to the Tax Court Rules of Practice and Procedure.↩2. The notice of deficiency refers to sec. 6621(d). This section was redesignated as sec. 6621(c) by sec. 1511(c)(1)(A) of the Tax Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2085, 2744. For simplicity, we shall refer to this section as sec. 6621(c)↩.3. The parties did not stipulate to certain facts concerning the Provizers, facts regarding the expert opinions, and other matters that we consider of minimal significance. Although the parties did not stipulate to our findings regarding the expert opinions, they stipulated to our ultimate finding of fact concerning the fair market value of the recyclers during 1981.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625287/	Sidney W. Rosen and Lorraine S. Rosen, Petitioners v. Commissioner of Internal Revenue, RespondentRosen v. CommissionerDocket No. 5590-77United States Tax Court71 T.C. 226; 1978 U.S. Tax Ct. LEXIS 25; November 21, 1978, Filed 1978 U.S. Tax Ct. LEXIS 25">25 Decision will be entered under Rule 155. T made an unrestricted gift of property to charity A in 1972, and claimed a charitable contribution deduction in respect thereof on T's 1972 income tax return which was apparently allowed. In 1973, A returned the property to T without consideration, although under no legal or other obligation to do so. Later that year, T made an unrestricted gift of the same property to charity B, and claimed a second charitable contribution deduction in respect of that gift on T's 1973 income tax return which was allowed. In 1974, B returned the property to T without consideration, although under no legal or other obligation to do so. Held, A and B did not make "gifts" within the meaning of sec. 102(a), I.R.C. 1954, when they returned the donated property to T. Held, further, T must, under the "tax benefit rule," include in gross income for 1973 and 1974 the fair market value of the returned property on the respective dates of its return, such fair market value in each instance being less than the amount deducted the previous year. Held, further, the amount includable in T's gross income in 1974 is not reduced below the fair market value1978 U.S. Tax Ct. LEXIS 25">26 of the property on the recovery date by virtue of demolition expenses subsequently incurred that year by T in respect of the property. Nestor M. Nicholas, for the petitioners.John O. Tannenbaum, for the respondent. Raum, Judge. RAUM71 T.C. 226">226 OPINIONThe Commissioner determined deficiencies in petitioners' Federal income tax as follows: 71 T.C. 226">227 YearDeficiency1973$ 28,682.31197430,191.42Petitioners made gifts of property to charities in 1972 and 1973, and claimed charitable contributions deductions in respect thereof. Subsequently, in 1973 and1978 U.S. Tax Ct. LEXIS 25">28 1974, the property was returned to them by the donees, and the principal issue presented is whether petitioners must include in their gross income, in those 2 years, the value of the returned property. The case was submitted without trial on the basis of a stipulation of facts.Petitioners Sidney W. Rosen and Lorraine S. Rosen, husband and wife, resided in Fall River, Mass., at the time their petition herein was filed. They filed their joint Federal income tax returns for the years 1973 and 1974 with the Director, Internal Revenue Service Center, Andover, Mass.Prior to December 20, 1972, petitioners were the owners of the land and buildings located on the southeasterly corner of High Street and Walnut Street, Fall River, Mass. (hereinafter the property). The property consisted of approximately 8,010 square feet of land on which was situated a three-story frame house containing five apartments and a two-car garage. On December 20, 1972, petitioners made a gift of the property to the city of Fall River, Mass. (the city), which accepted the gift at the time it was made. The value of the property, at the time the petitioners donated it to the city, was $ 51,250. As a result of 1978 U.S. Tax Ct. LEXIS 25">29 the gift, the petitioners were entitled to a charitable contribution deduction, in the amount of $ 51,250, on their joint 1972 Federal income tax return. 1The gift to the city was made without any restrictions as to the use of the property and without imposing any obligations of any nature on the city. At the time the gift was accepted by the mayor of the city, the city officials contemplated using the property in connection with the city school department. The city council, however, argued that the school department budget was already excessive and that there was little reason to increase the budget by accepting property which would have to be adapted for school department use. The dispute between the city council 71 T.C. 226">228 and the mayor remained unresolved until April 1973, at which time it was agreed by the mayor and the city council that the property would be returned to the petitioners. 1978 U.S. Tax Ct. LEXIS 25">30 Although the city was under no obligation whatsoever, legal or otherwise, to return the property to the petitioners, the property was transferred to the petitioners by the city on April 30, 1973. 2On June 20, 1973, the petitioners made a gift of the property, less a small portion1978 U.S. Tax Ct. LEXIS 25">31 retained for themselves, to the Union Hospital, Fall River, Mass. (the hospital). The value of the property transferred to the hospital by the petitioners, at the date of transfer, was $ 48,000, and the petitioners claimed and were allowed a charitable contribution deduction of that amount in respect of the gift of the property. 3The transfer by the petitioners to the hospital was made without any restrictions as to the use of the property and without imposing any obligation of any nature on the hospital. In 1974, the hospital found itself in financial difficulty and was unable to make use of1978 U.S. Tax Ct. LEXIS 25">32 the property. In addition, the building forming part of the property had remained vacant since its receipt by the hospital, and substantial damage had been done to the building by the weather and vandals. The building had deteriorated to the point where the board of trustees of the hospital felt it was becoming a liability and, accordingly, they voted on August 27, 1974, to transfer the property back to the petitioners without consideration. 4 The hospital was under no 71 T.C. 226">229 obligation, legal or otherwise, to return the property to the petitioners.The parties have stipulated that the value of the property, 1978 U.S. Tax Ct. LEXIS 25">33 at the time it was transferred to the petitioners by the hospital, was $ 25,000. In 1974, subsequent to the receipt of the property by the petitioners from the hospital, the petitioners expended $ 5,000 to demolish the building on the property.The Commissioner determined that petitioners must include in gross income, on account of the return of the property to them by the city and later by the hospital, $ 52,990 in 1973 and $ 49,740 in 1974. The Commissioner now concedes that only $ 51,250 and $ 25,000 must be included in petitioners' gross income in 1973 and 1974, respectively, in respect of the return of the property by the city and the hospital. The petitioners claim, however, that they need include no amounts in their gross income in respect of the return of the property by either the city or the hospital. The Commissioner has not challenged the bona fides of any of the transactions, and the only question is whether petitioners must include in their gross income, in the years of the retransfers from the city and the hospital, the fair market value of the property returned. We hold that they are required to do so.It has long been established that the receipt of money or 1978 U.S. Tax Ct. LEXIS 25">34 property which might not otherwise be regarded as income may nevertheless constitute income within the meaning of the statute ( section 61, I.R.C. 1954, and corresponding provisions of prior law) if it represents the repayment, restoration, or return of an item which the taxpayer had deducted in an earlier year. The general concept has often been referred to as the "tax benefit rule." 51978 U.S. Tax Ct. LEXIS 25">35 The tax benefit rule has widespread applicability to a variety of different receipts. See 1 J. Mertens, Law of Federal Income Taxation, secs. 7.34-7.37(2) (1974 rev.). Familiar examples appear in cases involving the recovery of a bad debt which had been deducted on the returns of a prior year, e.g., Askin & 71 T.C. 226">230 , 66 F.2d 776">66 F.2d 776 (2d Cir.); Putnam Nat. Bank v. Commissioner, 50 F.2d 158">50 F.2d 158 (5th Cir.); and in cases where excises or other taxes paid and deducted from gross income in a prior year are refunded in a later year, e.g., Rothensies v. Electric Battery Co., 329 U.S. 296">329 U.S. 296, 329 U.S. 296">298; Estate of Block v. Commissioner, 39 B.T.A. 338">39 B.T.A. 338, affirmed sub nom. Union Trust Co. v. Commissioner, 111 F.2d 60">111 F.2d 60 (7th Cir.), certiorari denied 311 U.S. 658">311 U.S. 658. The principle has even been applied in appropriate cases to override specific statutory nonrecognition provisions, thus making taxable amounts otherwise excludable from income. See, e.g., TennesseeCarolina Transportation, Inc. v. Commissioner, 65 T.C. 440">65 T.C. 440,1978 U.S. Tax Ct. LEXIS 25">36 affirmed 582 F.2d 378">582 F.2d 378 (6th Cir.) (sec. 336); Estate of Munter v. Commissioner, 63 T.C. 663">63 T.C. 663 (sec. 337); McCamant v. Commissioner, 32 T.C. 824">32 T.C. 824, 32 T.C. 824">833-835 (sec. 22(b)(1)(A) of the 1939 Code, analogous to section 101(a)(1) of the 1954 Code). 61978 U.S. Tax Ct. LEXIS 25">37 Moreover, the so-called tax benefit rule has been explicitly recognized in section 111(a) of the Code which places limitations on the amounts to be included in gross income in specified types of restorations. Thus, it provides that gross income does not include the recovery of a "bad debt, prior tax, or delinquency amount" to the extent of the "recovery exclusion" which is in substance defined (sec. 111(b)(4)) to mean the amount on account of which the item in question did not result in a reduction of taxes in the earlier year. 7There can be no serious challenge to the broad sweep of the tax benefit rule, and in considering its applicability here, we even find precedent for applying the rule in a case involving property once the subject of a charitable contribution deduction that is subsequently returned to the donor. In Alice Phelan Sullivan Corp. v. United States, 381 F.2d 399">381 F.2d 399 (Ct.Cl.), there were returned to the taxpayer two parcels of real estate each of which 71 T.C. 226">231 1978 U.S. Tax Ct. LEXIS 25">38 it had previously donated and claimed as a charitable contribution deduction in a prior year. Each of the original gifts had been made subject to the condition that the property be used for a religious or educational purpose, and when the donee later determined not to use the gift, it was reconveyed to the taxpayer. The Court of Claims held not only that the recoupment properly was classified as income but also that the amount of reportable income was not limited by the more favorable tax rates which were in effect at the time of the original gifts, provided only that the taxpayer had taken full benefit of the deductions available in the earlier years. See also Mason v. United States, 513 F.2d 25">513 F.2d 25, 513 F.2d 25">30 (7th Cir.). 8Petitioners do not challenge the correctness of the result in Alice Phelan Sullivan Corp., but rather seek to distinguish it. They correctly point out that in Alice Phelan 1978 U.S. Tax Ct. LEXIS 25">39 Sullivan Corp., the subject property was returned to the taxpayer pursuant to a condition in the original gift that the property would be returned if it ceased to be used either for a religious or for an educational purpose. Here, by contrast, both of the petitioners' gifts were unconditional, and neither the city nor the hospital was under any obligation whatsoever to transfer the property back to the petitioners. From this petitioners argue that the property was returned to them by way of a "gift" from the city and the hospital excludable from income under section 102(a), 9 and that the tax benefit rule does not apply to receipts subject to section 102(a). We do not agree with the factual predicate to this argument.As a factual matter, we cannot accept the contention that petitioners received "gifts" as the concept1978 U.S. Tax Ct. LEXIS 25">40 was defined in Commissioner v. Duberstein, 363 U.S. 278">363 U.S. 278, 363 U.S. 278">285-286, when the property was reconveyed to them. We think it clear that neither charitable donee transferred the property back to petitioners out of any detached or disinterested generosity; 101978 U.S. Tax Ct. LEXIS 25">41 they made the 71 T.C. 226">232 transfers because they found the property to be burdensome and because they desired to "undo" the original gift transactions by returning the property to the parties who had originally made the gifts to them. 11 It would strain our credulity to conclude that the city and the hospital would have transferred the property to petitioners without consideration if they had originally purchased it from petitioners or had obtained it from some other source. The reconveyances to petitioners were not nontaxable "gifts" within the criteria set forth in Duberstein. We therefore need not reach petitioners' argument that section 102(a) precludes application of the tax benefit rule to these transactions. 121978 U.S. Tax Ct. LEXIS 25">42 Petitioners also contend that there has been no "recovery" within the meaning of the tax benefit rule because there has been no receipt of "amounts in respect of" the previously deducted charitable gifts. 13 Petitioners cite the absence of a legal obligation to return the property and urge us to conclude that the reconveyances were totally separate and independent transactions from the original gifts. We are unconvinced.We agree with the limited proposition that the tax benefit rule requires a sufficient factual nexus between the event producing the tax benefit and the event constituting the recovery to justify viewing the latter event together with the former. See Dobson v. Commissioner, 320 U.S. 489">320 U.S. 489, 320 U.S. 489">502; Farr v. Commissioner, 11 T.C. 552">11 T.C. 552, 11 T.C. 552">567, affirmed sub nom. Sloane v. Commissioner, 188 F.2d 254">188 F.2d 254 (6th Cir.); 1 J. Mertens, Law of Federal Income Taxation, sec. 7.37, at p. 1978 U.S. Tax Ct. LEXIS 25">43 125. See also Allen v. 71 T.C. 226">233 , 180 F.2d 527">180 F.2d 527 (5th Cir.); Continental Illinois National Bank v. Commissioner, 69 T.C. 357">69 T.C. 357, 69 T.C. 357">364-372. However, we have found that the purpose of the reconveyances was a desire by the donees to reverse the original gift transactions, and that the reconveyances without consideration would not have been made to petitioners were it not for the fact that they were the original donors of the property. The recoveries were far from the coincidental happenstances that petitioners would have us believe. This is especially true in light of the relatively short time periods between the original gifts and the reconveyances.Nor can we agree, at least in cases where the return of property is not a "gift," that a legal obligation on the part of the transferor to return the property is always a sine qua non for application of the tax benefit rule. We think it sufficient that the transferor specifically intend the transfer to be a repayment, restoration, or return of property formerly belonging to the transferee that was the subject of a previous transaction producing a tax benefit, 1978 U.S. Tax Ct. LEXIS 25">44 and that the transferee accept it for such purpose. See Bear Mill Manufacturing Co. v. Commissioner, 15 T.C. 703">15 T.C. 703, 15 T.C. 703">706-708; Excelsior Printing Co. v. Commissioner, 16 B.T.A. 886">16 B.T.A. 886, 16 B.T.A. 886">887-888. 141978 U.S. Tax Ct. LEXIS 25">45 This was the case in respect of the reconveyances by the city and the hospital -- they were intended merely to reverse previous charitable donations. Under these circumstances, we see no reason to allow a windfall tax benefit based upon two charitable contributions deductions, particularly when, in the end, petitioners owned the very same property they tried to give away. Cf. Farr v. Commissioner, 11 T.C. 552">11 T.C. 567. The purposes of the tax benefit rule 15 are well served by requiring inclusion in gross income of the fair market value of the property at the times it was returned to petitioners.In respect of the year 1974 petitioners contend that if they are required to include the receipt of the property in their gross income, the correct amount should be only $ 20,000, "computed as the fair market value of the property" when returned to them by the hospital ($ 25,000) minus $ 5,000 which they spent later 71 T.C. 226">234 that year to demolish the building. The Commissioner agrees that the amount to be included is to be measured by the $ 25,000 stipulated value rather than $ 49,740 which he had previously determined in his deficiency notice. However, he contests the reduction of the $ 25,000 amount by the subsequently incurred demolition expense. We agree that the $ 5,000 expenditure was an entirely separate item which may not be used to reduce the $ 25,000 stipulated value of the property at the time it was returned by the hospital in 1974. If petitioners are to have the benefit of that expense in 1974 they must point to some provision of the statute which gives them a deduction therefor. This they have not done, nor have they even articulated a theory upon which1978 U.S. Tax Ct. LEXIS 25">46 we might hold that they are entitled to a $ 5,000 deduction in 1974 for the demolition costs.To the extent that petitioners may suggest that the demolition costs must be taken into account in fixing the fair market value of the property by reason of its vandalized condition, the point is wholly without merit on this record. The parties have already stipulated that the fair market value of the property on the date of its return in 1974 was $ 25,000, reflecting a reduction of almost 50 percent from its value the preceding year, and we must conclude on the materials before us that such stipulated fair market value has already fully taken into account the deteriorated state of the property. No further reduction in value is called for in the light of the stipulation of the parties. The amount properly includable in their 1974 gross income in respect of the hospital's return of the property to them is its stipulated fair market value at the time of the reconveyance, $ 25,000, unreduced by any subsequent demolition expenses incurred by them. 161978 U.S. Tax Ct. LEXIS 25">*47 Decision will be entered under Rule 155. Footnotes1. There is no indication in the record that such deduction was not taken or that it was disallowed in any part by the Commissioner.↩2. The order of the city council in respect of the return of the property stated the following:"Ordered, that the Mayor be and he is hereby authorized to convey for no consideration to Sidney W. Rosen and Lorraine A. Rosen, the property located at the southeasterly corner of High and Walnut Streets, and be it further"Ordered, that this conveyance shall be subject to the restrictions that said Sidney W. Rosen and Lorraine A. Rosen reimburse the City of Fall River for all expenses incurred by the city for said property and assume liability for all outstanding bills or expenses for said property."The deed conveying the property to petitioners recited that the transfer was a gift, and that there was no monetary consideration by the Rosens.↩3. The $ 48,000 figure was stipulated by the parties. However, petitioners' 1973 return, which the parties have also stipulated, discloses that a total deduction of $ 49,740 was claimed, consisting of $ 48,000 for the real estate plus $ 1,740 for items of personal property located in the building, such as refrigerators, draperies, carpeting, and the like. No explanation of this discrepancy has been offered by petitioners.↩4. The minutes of the board of trustees meeting state that the board voted "To return to Dr. and Mrs. Rosen the property on the southeast corner of High and Walnut Streets." The deed reconveying the property to petitioners and the certificate of the clerk of the hospital recorded with the deed both contained a recital that the purpose of the conveyance without consideration was to correct a "mistake of fact."↩5. The rationale for the rule was set forth in Estate of Block v. Commissioner, 39 B.T.A. 338">39 B.T.A. 338, 39 B.T.A. 338">341, affirmed sub nom. Union Trust Co. v. Commissioner, 111 F.2d 60">111 F.2d 60 (7th Cir.), certiorari denied 311 U.S. 658">311 U.S. 658:"Income tax liability must be determined for annual periods on the basis of facts as they existed in each period. When recovery or some other event which is inconsistent with what has been done in the past occurs, adjustment must be made in reporting income for the year in which the change occurs."See also Alice Phelan Sullivan Corp. v. Commissioner, 381 F.2d 399">381 F.2d 399, 381 F.2d 399">402↩ n. 2 (Ct. Cl.).6. It has been held, however, in cases involving specific statutory nonrecognition provisions, that something must be "received" or that there must be an actual "recovery" in the subsequent year to justify inclusion of the previously deducted item in current gross income. See Nash v. United States, 398 U.S. 1">398 U.S. 1; Estate of Schmidt v. Commissioner, 355 F.2d 111">355 F.2d 111↩ (9th Cir.). This requirement is not a bar to the application of the tax benefit rule in this case because the property which was the subject of petitioners' gifts was in fact reconveyed to them in the years at issue.7. Petitioners do not contend that the statutory "recovery exclusion" applies in this case. This limitation on the tax benefit rule in specified types of cases first appeared in 1942 (sec. 116 of the Revenue Act of 1942 adding par. (12) to sec. 22(b) of the 1939 Code). However, it was certainly not intended to deny the general applicability of the rule in other appropriate situations, cf., e.g., sec. 1.111-1(a), Income Tax Regs.; Dobson v. Commissioner, 320 U.S. 489">320 U.S. 489, 320 U.S. 489">506; California & Hawaiian Sugar Refining Corp. v. United States, 311 F.2d 235">311 F.2d 235, 311 F.2d 235">238-239↩ (Ct.Cl.).8. Cf. Estate of Wasie v. Commissioner, T.C. Memo. 1977-323↩.9. Sec. 102(a), I.R.C. 1954, provides:SEC. 102. GIFTS AND INHERITANCES.(a) General Rule. -- Gross income does not include the value of property acquired by gift, bequest, devise, or inheritance.↩10. The stipulation that neither of the charitable donees was under any obligation whatsoever to return the property does not necessarily establish that the transfers were gifts. Commissioner v. Duberstein, 363 U.S. 278">363 U.S. 278, 363 U.S. 278">285. Similarly, the fact that some of the supporting documentation may have referred to such transfers as "gifts" is not controlling. 363 U.S. 278">Commissioner v. Duberstein, supra at 286. Such term was used obviously only in a descriptive sense to indicate the absence of consideration, and not to establish that the criteria set forth in Duberstein had been satisfied so as to bring into play the provisions of sec. 102(a)↩.11. The city council of Fall River conditioned the return to the property on petitioners' reimbursement of all expenses incurred by the city for the property. The board of trustees of Union Hospital felt that the property was becoming a liability due to deterioration, and that reconveyance of the property was necessary to correct a "mistake of fact." These facts lead us to conclude that the charitable donees of the property made the reconveyances primarily to return to the original status before the gifts.↩12. Petitioners' reliance on Reynolds v. Boos, 188 F.2d 322">188 F.2d 322 (8th Cir.), and Cox v. Kraemer, 88 F. Supp. 835">88 F. Supp. 835 (D. Conn.), is misplaced. Although neither case involved a recovery of property previously the subject of a charitable gift, both cases dealt with the applicability of the tax benefit rule to recoveries found to be gifts. Their factual conclusions on the gift issue appear doubtful in light of the criteria set forth in the subsequently decided Duberstein case. Finally, the question is one to be resolved by the trier of fact on the basis of the record in each case, see, e.g., 363 U.S. 278">Commissioner v. Duberstein, supra at 289, and we have no doubt on the record before us that the return of the property to petitioners by each original donee cannot fairly be found to constitute a "gift" within the meaning of sec. 102↩.13. See sec. 1.111-1(a)(2), Income Tax Regs.↩14. In Bear Mill Manufacturing Co. v. Commissioner, 15 T.C. 703">15 T.C. 703, and Excelsior Printing Co. v. Commissioner, 16 B.T.A. 886">16 B.T.A. 886↩, it was held that there was a taxable recovery of a previously deducted bad debt when a third party, not a party to the loan transaction, and not otherwise legally obligated to repay the debt, made a transfer of property to the creditor with the intention that the debt be satisfied, and the creditor accepted it for the purpose the transferor intended. It should be noted that in both cases we found that the transferor did not intend to make a gift to the creditor.15. See n. 5 supra↩.16. We do not consider the possible contention that proper application of the tax benefit rule would require a complete reversal of the deduction in the earlier year by including in income of the later year the full amount previously deducted upon complete restoration of the identical property which gave rise to the deduction. Cf. Alice Phelan Sullivan Corp. v. Commissioner, 381 F.2d 399">381 F.2d 399, 381 F.2d 399">402 (Ct.Cl.). The Commissioner now seeks to include in income in this case only the fair market value of the property when it was returned, an amount that is smaller in each instance than the amount previously deducted. In such a case, the measure of the amount included is at least the fair market value of the property recovered. See TennesseeCarolina Transportation, Inc. v. Commissioner, 65 T.C. 440">65 T.C. 440, 65 T.C. 440">448, affirmed 582 F.2d 378">582 F.2d 378 (6th Cir.); cf. Spitalny v. United States, 430 F.2d 195">430 F.2d 195, 430 F.2d 195">198↩ (9th Cir.). As set forth in our findings of fact, the parties have stipulated the "values" of the property at the times it was returned to petitioners, which we take to be fair market values.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625288/	WILLIE A. CURRY, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentCurry v. CommissionerDocket No. 7046-75.United States Tax CourtT.C. Memo 1980-378; 1980 Tax Ct. Memo LEXIS 204; 40 T.C.M. 1212; T.C.M. (RIA) 80378; September 15, 1980, Filed 1980 Tax Ct. Memo LEXIS 204">204 Francis J. Elward and Eric B. Jorgensen, for respondent. DAWSONMEMORANDUM FINDINGS OF FACT AND OPINION DAWSON, Judge: This case was assigned to Special Trial Judge Randolph F. Caldwell, Jr., for hearing and disposition of respondent's motion for partial summary judgment. The Court agrees with and adopts his opinion, which is set forth below. OPINION OF THE SPECIAL TRIAL JUDGE CALDWELL, Special Trial Judge: This case is presently before the Court on respondent's motion for partial summary judgment, filed on July 8, 1980. That motion, with notice of hearing on August 27, 1980, was served on petitioner on July 11, 1980. At the hearing on August 27, respondent appeared by his counsel, but there was no appearance by or on behalf of petitioner, nor had petitioner filed any response to respondent's motion. At the conclusion of the hearing, the motion was taken under advisement. The motion seeks a summary adjudication in respondent's favor upon the issue of whether petitioner is liable for additions to tax for fraud under section 6653(b) of the Internal Revenue Code of 19541, for the years 1968 to 1971 inclusive. 1980 Tax Ct. Memo LEXIS 204">205 In the statutory notice of deficiency, on which this case is based, respondent determined deficiencies and additions to tax for fraud against petitioner for the years 1968 through 1971, as follows: YearDeficiencyAddition to Tax1968$ 6,268.98$3,134.4919694,705.502,352.75197019,841.519,920.7619715,362.342,681.17Petitioner timely filed his petition. Respondent thereafter filed his answer, in paragraph 6 of which he alleged the facts upon which he relied to support his determination of the additions to tax for fraud. Petitioner did not file a reply to respondent's answer, and on November 28, 1978, respondent filed a motion under Rule 37(c) of this Court's Rules of Practice and Procedure, that the undenied affirmative allegations of fact set forth in subparagraphs (a) to (y), inclusive, of paragraph 6 of the answer be deemed to be admitted. That motion was granted by order dated January 3, 1979, but said order was subsequently vacated and set aside by order dated November 29, 1979. The Rule 37(c) motion was again set for hearing on January 23, 1980, and was granted by an order dated January 23, 1980. The resul is that the affirmative1980 Tax Ct. Memo LEXIS 204">206 allegations in each and all of the subparagraphs of paragraph 6 of the respondent's answer are now deemed to be admitted. Rule 37(c). The following findings of fact are based upon the portions of respondent's answer which have been deemed to be admitted. FINDINGS OF FACT During the taxable years 1968 to 1971, inclusive, the petitioner was employed by A & H Cleaners, Inc., of Fayetteville, North Carolina. The petitioner failed to maintain or to submit for examination by the respondent complete and adequate books of account and records of his income-producing activities for each of his taxable years 1968 to 1971, inclusive, as required by the applicable provisions of Internal Revenue Code of 1954 and respective regulations promulgated thereunder. The petitioner did not maintain for his taxable years 1968 to 1971, inclusive, any records of his income-producing activities except for a few bank records. These bank records were incomplete and failed to disclose all receipts and disbursements and did not properly reflect the correct taxable income for the petitioner for each of his taxable years 1968 to 1971, inclusive. The petitioner failed to file Federal individual income1980 Tax Ct. Memo LEXIS 204">207 tax returns for each of his taxable years 1968 and 1969 and to pay any portion of the income tax liability due from him for each year when, in fact, he was required by law to file returns for those years because of the income that he earned in each of those years. The petitioner prepared and filed his own Federal individual income tax return for each of his taxable years 1970 and 1971. During his taxable year 1971, the petitioner received rental income in the amount of $110 per month, each month from May of 1971 through December of 1971, which was not reported on his Federal individual income tax return which he filed for his taxable year 1971. During his taxable years 1968 to 1971, inclusive, the petitioner received income from the sale of narcotics, from prostitution, and from gambling for which he did not keep any records and which were not reported on his Federal individual income tax returns for those years. On or about June 6, 1973, the petitioner was convicted by a jury in a trial in the United States District Court for the Eastern District of North Carolina on three counts of possessing and selling heroin to an undercover agent in 1972 and was sentenced to serve1980 Tax Ct. Memo LEXIS 204">208 24 years in a Federal penitentiary. On or about November 2, 1973, the petitioner was convicted in a trial in the United States District Court for the Eastern District of North Carolina of conspiracy to distribute narcotics in 1972 and was sentenced to serve 12 years in a Federal penitentiary to run concurrently with the above mentioned sentence.During interviews in 1972 and 1973 with respondent's agents, petitioner made false and fraudulent statements which he knew were not true in order to mislead and deceive respondent's agents. The respondent has determined the petitioner's correct taxable income for each of his taxable years 1968 to 1971, inclusive, on the basis of the bank deposits and cash expenditures income reconstruction method. In making such determination the respondent has utilized all of the books and records furnished by the petitioner. Petitioner's correct taxable income for each of his taxable years 1968 to 1971, inclusive, is as follows: 1968196919701971Understatementof income$20,197.07$17,535.08$42,615.43$19,980.65Add: Reportedadjusted grossincome0 0 5,146.005,084.00Less: StandardDeductions1,000.00000ItemizedDeductions01,722.121,839.743,092.76Exemptions600.00600.00625.00675.00Correct taxableincome$18,597.07$15,212.96$45,296.69$21,296.891980 Tax Ct. Memo LEXIS 204">209 Petitioner's correct income tax liability, tax liability reported on his returns, and the understatement of tax liability for each of the taxable years 1968 to 1971, inclusive, are as follows: 1968196919701971Correct incometax liability$6,268.98$4,705.50$20,448.51$5,929.34Tax liabilityreported onreturn0 0 607.00567.00Understatementof income taxliability$6,268.98$4,705.50$19,841.51$5,362.34OPINION Respondent, in his motion for partial summary judgment under Rule 121, asks "for a summary adjudication in respondent's favor upon the issue of whether the petitioner is liable for additions to tax under I.R.C. section 6653(b) for the years 1968 to 1971, inclusive." Rule 121(a) provides that "Either party may move, with or without supporting affidavits, for a summary adjudication in his favor upon all or any part of the legal issues in controversy." (Emphasis supplied). Section 6653(b) provides for the imposition of a 50 percent addition to tax if any part of any underpayment of required to be shown on the return is due to fraud.Up1980 Tax Ct. Memo LEXIS 204">210 to this point, the Court has not determined, nor has it been asked to determine, the precise amount of the underpayment by petitioner for any of the years involved, and therefore it will not be able to determine the precise amount of the addition to tax for any such year, since the amount of the addition is inextricably tied in with the amount of the underpayment. However, propriety of additions to tax for fraud is dependent upon whether petitioner harbored an intent to evade a tax believed to be owing. That issue, it is believed, is one which is appropriate for a partial summary adjudication under Rule 121, even in the absence of the usual prior determination of the precise amount of the underpayment of tax. Respondent bears the burden of proving fraud with intent to evade tax, and that burden is to be carried by clear and convincing evidence. Rule 142(b). In most cases, such burden is met by respondent at trial where the facts are established by testimony of witnesses and the introduction of documentary evidence. However, in a number of cases, the necessary facts have been established through the pleadings of the parties, motions filed, and orders entered with respect thereto. 1980 Tax Ct. Memo LEXIS 204">211 In the present case, material allegations in the answer with respect to fraud have been deemed to be admitted by the petitioner in the Court's order of January 23, 1980. Accordingly, the respondent's burden of going forward to prove such facts in those allegations has been discharged. Black v. Commissioner, 19 T.C. 474">19 T.C. 474 (1952); Morris v. Commissioner, 30 T.C. 928">30 T.C. 928 (1958); Gilday v. Commissioner, 62 T.C. 260">62 T.C. 260 (1974); and Marcus v. Commissioner, 70 T.C. 562">70 T.C. 562 (1978). Accordingly, the question presented is whether those facts clearly and convincingly show that a part, if not all, of any underpayments of tax is due to fraud with intent to evade tax. The findings of fact clearly and convincingly establish fraud with intent to evade tax. What appear at this juncture to be substantial understatements of taxable income and substantial underpayments of tax over a period of years, failure to file any returns for two years when petitioner had substantial amounts of income, specific omissions of items of gross income from the returns which petitioner did prepare and file, failure to maintain and submit for inspection adequate1980 Tax Ct. Memo LEXIS 204">212 records of his income producing activities, and lying to respondent's agents during their investigation with the intent to mislead and deceive them -- all of these are well recognized badges of fraud. In the presence of such numerous badges of fraud, there is no doubt that whatever underpayments of tax are ultimately determined by this Court are due to fraud with intent to evade tax on the part of petitioner. It appearing that there is no genuine issue of material fact and that the respondent is entitled to prevail on the issue presented for partial summary adjudication, an order will be entered granting respondent's motion for partial summary judgment that petitioner is liable for additions to tax for fraud under section 6653(b) for each of the years 1968 through 1971. The case will remain on the docket for decision of the issue of the precise amount of the underpayment for each of the years. Decision of that issue will control the amount of the addition to tax for fraud for each such year. An appropriate order will be issued. Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated.↩. No return filed↩*. No return filed↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625290/	Crane Mills, Petitioner, v. Commissioner of Internal Revenue, RespondentCrane Mills v. CommissionerDocket Nos. 28390, 41544United States Tax Court35 T.C. 580; 1961 U.S. Tax Ct. LEXIS 248; January 18, 1961, Filed 1961 U.S. Tax Ct. LEXIS 248">248 Decisions will be entered under Rule 50. Prior to December 1939 petitioner seasoned its lumber by piling it in storage yards where it dried by air. During 1939 it installed a dry kiln for seasoning lumber to the extent of its capacity. Held, the installation of the dry kiln constituted a change in the character of petitioner's business under section 722(b)(4) of the Internal Revenue Code of 1939, as amended, and the amount of the CABPNI determined. Milo W. Smith, Esq., for the petitioner.Raymon B. Sullivan, Esq., and Aaron S. Resnik, Esq., for the respondent. Kern, Judge. KERN 35 T.C. 580">580 OPINION.Respondent determined deficiencies in petitioner's excess profits tax liability for the years 1942 and 1943 in the respective amounts of $ 15,843.78 and $ 15,843.79.Petitioner claims relief under section 722, I.R.C. 1961 U.S. Tax Ct. LEXIS 248">249 1939, resulting in alleged overpayments of excess profits taxes for the years 1940 to 1944, inclusive, in the following amounts: 35 T.C. 580">581 1940$ 1,085.20194122,846.15194232,167.69194332,167.69194433,954.78Petitioner's applications for relief under section 722 were disallowed by the respondent in full.The issue before us is whether petitioner is entitled to relief from excess profits taxes under section 722 of the Internal Revenue Code of 1939, as amended, for each of the taxable years 1940 through 1944.Petitioner seeks relief under section 722(b)(4) upon the ground that it changed the character of its business during the base period and its average base period net income does not reflect the normal operation of the business for the entire base period. The change in the character of the business upon which petitioner relies was the installation of a dry kiln during 1939.The evidence in these cases was presented before a commissioner of this Court and the report of his findings of fact was served on the parties. Petitioner took no exceptions to the commissioner's findings of fact. Respondent took exception to certain findings of the commissioner, and such1961 U.S. Tax Ct. LEXIS 248">250 exceptions have been fully examined and considered in connection herewith.The Court adopts the commissioner's report as its findings of fact with minor exceptions hereinafter noted. For the purposes of this opinion, the pertinent facts will be summarized only to the extent deemed necessary for a proper understanding of these cases. Ultimate findings of fact and conclusions appropriate for the disposition of the issue are hereinafter found.Petitioner, an Oregon corporation, organized in 1931, maintained its principal offices during the taxable years at Bly, Oregon. It issued $ 10,000 of capital stock which remained unchanged throughout the taxable years.In 1931 petitioner commenced manufacturing lumber after constructing a sawmill at Bly. Its manufacturing plant consisted of the sawmill, a planing mill, and other facilities. In manufacturing its lumber petitioner cut and logged the timber, mostly within a radius of 12 miles of its plant, and trucked the logs to its sawmill. Practically all of the timber cut by petitioner was ponderosa pine.Prior to December 24, 1939, petitioner seasoned all of its lumber by air drying. Lumber dried by this method was hauled from the sawmill1961 U.S. Tax Ct. LEXIS 248">251 to the storage yard. There it was piled 12 to 16 feet high in units of courses separated by "stickers," placed crosswise, which permitted air to circulate over and through the stacked lumber. In this type of seasoning petitioner depended upon the elements for temperature, 35 T.C. 580">582 circulation, and humidity. When winds were high and the humidity low the lumber dried unevenly creating stresses which "checked" or cracked the surface of the board and split the ends. Such checking impaired the value and lowered the grade of the lumber. Checking was a major problem with petitioner. Another problem encountered in air drying was stain from a fungus infection which developed in periods of high humidity and moderate temperatures. Some impairment to lumber resulted from steel piling bars used to keep the lumber from slipping. Checked, stained, and marred lumber was graded lower than it was when originally stacked for drying. This loss of grade was known as "degrade."In the Bly area it took from 28 days to over 6 months to dry lumber by air. Between May 1 and September 1 lumber dried in 4 to 8 weeks, depending on its thickness. After September 1 there was a little drying but it was1961 U.S. Tax Ct. LEXIS 248">252 hardly appreciable. Such lumber could not be shipped until the latter part of April or in May.In the same general locality and operating under the same general conditions as petitioner were two lumber companies operating dry kilns and producing kiln-dried lumber, two companies producing air-dried lumber, and one, Underwood Lumber Company, hereinafter referred to as Underwood, that operated in a comparable manner to petitioner and produced both air-dried and kiln-dried lumber.In December 1938 Underwood began constructing a dry kiln which it finished early in 1939. The kiln cost a little less than $ 10,000. The first charge of lumber came out of it on or about February 4, 1939.During 1939 petitioner constructed a dry kiln which was patterned closely after the Underwood kiln. It cost petitioner $ 9,527.75, and the first charge of lumber was placed in the kiln on December 24, 1939. The petitioner's and Underwood's kilns were equipped by the same manufacturer. Petitioner's kiln was a little larger as it could accommodate loads a foot higher than Underwood's kiln.In its kiln petitioner was able to control circulation, temperature, and humidity. Lumber in the kiln dried from the1961 U.S. Tax Ct. LEXIS 248">253 center outward to the surface, whereas lumber piled in the storage yards dried from the surface inward to the center. The estimated time for drying lumber in petitioner's kiln varied with the thickness of the lumber as shown by the following table:Selects and Shop grades5/4 4 1/2 to 5 days.Selects and shop grades6/4 5 days, occasionally plus.Selects and Shop grades4/4 4 days and occasionally 5 unless all stock was 4/4.Selects and Shop grades8/4 6 days plus.Common grades4/4 (heart)18 hours.Common grades4/4 (sap)1 1/2 to 2 days.Common grades5/4 & 6/41 day -- 18 percent(gov't 1 1/2 days).Common grades8/42 1/2 to 3 days.35 T.C. 580">583 The estimated maximum annual capacity of petitioner's dry kiln, based upon lumber of different thicknesses, was as follows:Lumber sizeFootage4/47,128,0005/46,840,0006/46,609,6008/46,336,000Petitioner expected to produce more and better grades of lumber with its dry kiln than it could produce from a like quantity of green lumber that was dried by air. It expected the dry kiln to reduce the amount of losses sustained from degrade. It expected the dry kiln to produce grades of select lumber1961 U.S. Tax Ct. LEXIS 248">254 higher than any selects previously produced by air drying. It expected to produce kiln-dried shop that would be acceptable to woodworking plants manufacturing interior finish that refused to buy air-dried shop. It expected to produce knotty pine paneling from the common grades of lumber, which it could not produce by air drying. By virtue of these better grades of selects, shop, and common and its knotty pine paneling petitioner expected to enlarge the markets for its products.Prior to installing its kiln petitioner's president estimated that the difference in value per M (1,000 feet board measure) between air-dried and kiln-dried lumber favored kiln-dried lumber as follows:GradeAmountSelect Moulding and Better$ 2.48 per MShop2.10 per MCommon1.10 per MDuring the base period years there was a normal market for ponderosa pine lumber.A good portion of the select lumber produced in the Klamath Falls area went to the markets in the eastern part of the United States. The shop lumber was sold principally in the Middle West markets in Illinois, Iowa, Wisconsin, and Kansas. The average freight rate on this lumber during the base period was 73.5 cents per 100 pounds. 1961 U.S. Tax Ct. LEXIS 248">255 The western lumber mills computed freight charges on their lumber shipments by using standard estimated shipping weights. These freight charges were included in the invoice price. After the actual weights were determined the difference was absorbed by the seller.The weight of lumber varies with the moisture content. Lumber of the same size and moisture content weighs the same whether air-dried or kiln-dried. Due to its high moisture content green lumber usually weighs from 5,300 to 6,000 pounds per M; after drying this lumber weighs 2,500 pounds and less per M in the rough. Under extremely favorable conditions the moisture content in air-dried lumber would get as low as 10 per cent; under the artificially induced 35 T.C. 580">584 conditions of kiln drying the moisture content should be less than 10 per cent. Air-dried lumber at Bly usually had a higher moisture content than lumber that was kiln dried, except during July and August. During 10 months of each base period year petitioner estimated that its air-dried lumber averaged about 200 pounds more per M than like lumber kiln-dried. Petitioner's lumber, of the grades normally kiln dried, was shipped to points to which the freight1961 U.S. Tax Ct. LEXIS 248">256 rate was 73.5 cents per 100 pounds.Petitioner's president determined that seasoning lumber by kiln drying would reduce some operational costs and increase others. He estimated a saving in transportation costs of 10 cents per M on lumber that went directly from the sawmill to the dry kiln. Any reduction in storage-yard space eliminated such expenses as snow removal, weed control, cleaning up, etc., and cut down on other expenses such as piling, yard maintenance, general overhead, and rental on yard space. The estimated savings on these expenses were about 15 cents per M.By installing the dry kiln petitioner estimated that it would reduce subsequent inventories by 1,500,000 feet, or $ 21,000 at a cost of $ 14 per M. Petitioner estimated that it could save 6 per cent on money borrowed to finance these inventories, or $ 1,200; $ 564 on insurance on the reduced inventories; and $ 276.75 taxes on such reduced inventories. Petitioner also estimated that it would save 16 cents per M on spraying and dipping with an antistain solution since spraying or dipping was eliminated when lumber went through the dry kiln.The additional expenses and costs which petitioner expected from the operation1961 U.S. Tax Ct. LEXIS 248">257 of its dry kiln were: Increase in cost of electricity of $ 40 to $ 50 per month; interest on investment in dry kiln, at 6 per cent, amounting to $ 571.67; and insurance and taxes on dry kiln about $ 173.41 and $ 117.19, respectively.During the base period petitioner's average annual production of ponderosa pine was a little over 17 million board feet compared with an average annual production in the United States of a little over 3 billion board feet.During the years 1936 through 1939 petitioner's sales of "uppers" (selects and shop or factory grades) and its total sales were as follows:TotalYearSelectsShopUppersSales(Feet)1936(1) (1) (1) 2 15,818,33719372,221,5923,796,9696,018,56116,570,16019381,964,8921,481,1603,446,05214,345,73219392,819,2621,897,8114,717,07315,725,19035 T.C. 580">585 For the years 1936 through 1939 the prices of ponderosa pine lumber, based on index average prices of the Western Pine Association, showed the following trends based on monthly lows, highs, and annual average per M:YearPrice in low monthPrice in high monthAverageannual1936$ 20.35 -- July$ 21.43 -- December$ 20.77193724.44 -- January26.49 -- April25.24193820.80 -- October23.34 -- March21.84193921.37 -- July24.16 -- November22.401961 U.S. Tax Ct. LEXIS 248">258 After August 1940 prices increased almost every month throughout the taxable years.Petitioner's sales in feet and dollars (net), its average annual price per M (derived therefrom), and the average annual price per M of Underwood and the Michigan-California Lumber Company of Camino, California, for the years 1936 through 1939, were as follows:Petitioner's salesAverage price per MYearFeetDollarsPetitionerUnderwoodCalifornia1936 115,818,337$ 336,812.09$ 21.29$ 16.14$ 20.13193716,570,160557,132.7633.6218.2123.72193814,345,732339,509.0423.6718.2424.01193915,725,190418,485.8926.6117.2026.46For the base period years petitioner's net sales, gross profit on sales, net income, and excess profits net income computed under the 1941 law were as follows (rounded figures):YearNet salesGross profitNet incomeExcess profitson salesnet income1936$ 336,812$ 41,243$ 14,819$ 15,0811937557,13376,98022,59120,4431938339,50949,35217,46017,4601939418,48665,52029,34929,349Petitioner's net income for the taxable years 1940 to 1944, inclusive, 1961 U.S. Tax Ct. LEXIS 248">259 was stipulated as follows (rounded figures): 1940 -- $ 36,606; 1941 -- $ 109,552; 1942 -- $ 136,303; 1943 -- $ 162,833; and 1944 -- $ 121,639.Petitioner's actual average base period net income and the additional amounts allowed under section 713(f) of the Code, computed under the law applicable for the taxable years, were as follows:AdditionalYearActual ABPNIunder sec.713(f)1940$ 17,941.42$ 3,639.64194120,696.615,415.25194220,583.195,642.09194320,583.195,642.09194420,583.195,642.0935 T.C. 580">586 The index numbers of net income (less tax-exempt income) of all corporations and the lumber and wood products industry for the years 1936 to 1939, inclusive, and the base period average are as follows (1939=100):AllLumber andYearcorporationswood productsindustry193696.9277.03 193797.74112.12 193835.66(18.64)1939100.00100.00 (1)82.5867.63 During the base period years petitioner changed the character of its business and the average base period net income does not reflect the normal operation of the business for the entire base period.The installation of a dry1961 U.S. Tax Ct. LEXIS 248">260 kiln constituted a change in the operation of the business and a difference in the capacity for production and operation.The change in the method of doing business, consisting of the installation of the dry kiln by petitioner, would have resulted had it been installed 2 years before in increased sales, in increased prices of some of its products, and a reduction in some costs of operation.The constructive average base period net income of the petitioner for the taxable year 1940 is $ 25,000, and for each of the taxable years 1941 to 1944, inclusive, is $ 30,000.Petitioner seeks relief under section 722(b)(4), the pertinent portions of which appear in the margin. 11961 U.S. Tax Ct. LEXIS 248">261 Petitioner claims qualifications under (b)(4) because it changed the character of its business during the base period years. It contends that the installation of its dry kiln in 1939 brought about a change in the operation of the business, a difference in the products furnished, 35 T.C. 580">587 and a difference in the capacity for operation. It further contends that because of the change it is entitled to a constructive average base period net income of at least $ 56,583, which it concedes should be adjusted under the variable credit rule for 1940.Respondent contends that petitioner has failed to establish a qualifying factor; that if a qualifying factor exists petitioner has failed to establish that such factor led to a higher level of earnings; that any reasonable reconstruction would be unproductive of relief under (b)(4) in view of the relief that has been granted under section 713(f) of the 1939 Code; and that in case any relief is granted by the Court it would have to be adjusted under the variable credit rule.We are of the opinion that petitioner has established a change in the character of its business during the base period years. Its installation of a dry kiln in 1939 constituted1961 U.S. Tax Ct. LEXIS 248">262 a definite change in the operation of its business. Prior to December 24, 1939, all of its lumber was dried by air which took from 4 weeks to 6 months. Thereafter, it could season lumber from 18 hours to "6 days plus" depending on the grade and thickness of the lumber and to the extent of the charge that its dry kiln would accommodate. As an example, the lumber placed in the dry kiln on December 24, 1939, would have been available for sale by the end of the month, whereas lumber stacked in the storage yard would have been unavailable for sale before the latter part of April or in May 1940. Petitioner's ability to control temperature, circulation, and humidity in seasoning lumber in the dry kiln was a complete change from its air-drying operation where temperature, circulation, and humidity depended upon the elements. We hold that petitioner has established a change in the operation and the capacity for operation of its business. Schneider's Modern Bakery, Inc., 19 T.C. 763">19 T.C. 763. See also Crowell-Collier Publishing Co., 25 T.C. 1268">25 T.C. 1268, 25 T.C. 1268">1272, affd. 259 F.2d 860; Brown Paper Mill Co., 23 T.C. 47">23 T.C. 47, 23 T.C. 47">70, 23 T.C. 47">71.1961 U.S. Tax Ct. LEXIS 248">263 We cannot agree, however, that the dry kiln substantially changed the products furnished by petitioner. Triangle Raincoat Co., 19 T.C. 548">19 T.C. 548, 19 T.C. 548">565; Stonhard Co., 13 T.C. 790">13 T.C. 790.The next question is whether the facts establish that installation of the dry kiln would have produced a higher level of earnings, and, if so, whether any reasonable reconstruction under the facts would afford petitioner any relief. Obviously, petitioner obtained scant information from the operation of the dry kiln for 7 days in 1939 as to any earnings or savings that would flow therefrom. Absent such proof, petitioner rests its reconstruction upon estimated savings on freight, yard costs and expenses, interest, insurance, local taxes, a reduction in lumber lost from degrade, and increased sales realization through better quality lumber. Recognizing that some increased costs would result from operation of the dry kiln, it offset increased electrical 35 T.C. 580">588 consumption, interest on cost of kiln, increased local taxes on value of kiln, and depreciation on kiln, against anticipated savings and computed a constructive profit for 1939 from the dry kiln1961 U.S. Tax Ct. LEXIS 248">264 of $ 33,868 minimum and $ 39,127 maximum, depending upon a kiln capacity of 6,500,000 or 7 million board feet, respectively. Adding the 1939 profit before installation of the dry kiln of $ 29,349, petitioner computes a constructive average profit, minimum and maximum for 1939 of $ 63,217 and $ 68,476, respectively. Based thereon petitioner claims a constructive average base period net income of $ 56,583.We cannot agree with either the estimated savings on the dry kiln or the anticipated increased level of earnings. We are persuaded that the dry kiln would have resulted in some increase in petitioner's level of earnings had it been installed 2 years earlier. Even without the dry kiln, it is evident from an examination of petitioner's operations that it did better during the base period than its industry, particularly in 1938. We believe that petitioner would have increased its level of earnings if it had had its dry kiln in operation 2 years earlier. We doubt, however, that its kiln would have continuously operated at maximum capacity as indicated by its reconstruction. Using our best judgment, and after carefully and fully considering all of the facts and circumstances herein1961 U.S. Tax Ct. LEXIS 248">265 we are of the opinion and have found that petitioner is entitled to a CABPNI of $ 25,000 for 1940 and a CABPNI of $ 30,000 for each of the taxable years 1941 to 1944, inclusive.In view of the foregoing, we hold and find that petitioner's excess profits taxes for the taxable years 1940 to 1944, inclusive, computed without the benefit of section 722 of the Internal Revenue Code of 1939, as amended, are excessive and discriminatory.An adjustment for income taxes for the year 1940 will be made under Rule 50.Reviewed by the Special Division.Decision will be entered under Rule 50. Footnotes1. Not available.↩2. 11 months' total.↩1. 11 months' total.↩1. Average for base period.↩1. SEC. 722. GENERAL RELIEF -- CONSTRUCTIVE AVERAGE BASE PERIOD NET INCOME.(b) Taxpayers Using Average Earnings Method. -- The tax computed under this subchapter (without the benefit of this section) shall be considered to be excessive and discriminatory in the case of a taxpayer entitled to use the excess profits credit based on income pursuant to section 713, if its average base period net income is an inadequate standard of normal earnings because -- * * (4) the taxpayer * * during * * * the base period * * * changed the character of the business and the average base period net income does not reflect the normal operation for the entire base period of the business. If the business of the taxpayer did not reach, by the end of the base period, the earning level which it would have reached if the taxpayer had * * * made the change in the character of the business two years before it did so, it shall be deemed to have * * * made the change at such earlier time. For the purpose of this subparagraph, the term "change in the character of the business" includes a change in the operation or management of the business, a difference in the products or services furnished, a difference in the capacity for production or operation, * * *↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625291/	Ambac Industries, Inc., Formerly Known as American Bosch Arma Corporation, Petitioner v. Commissioner of Internal Revenue, RespondentAmbac Industries, Inc. v. CommissionerDocket No. 1665-70United States Tax Court59 T.C. 670; 1973 U.S. Tax Ct. LEXIS 172; 59 T.C. No. 66; February 13, 1973, Filed 1973 U.S. Tax Ct. LEXIS 172">172 Decision will be entered for the respondent. P and S joined in filing consolidated income tax returns for 1964 and 1965. S sustained net operating losses in 1964 and 1965, and these losses were used to offset the separate taxable income of P in each of the 2 years. S dissolved in 1965 after making liquidating distributions to P. Held, for the purpose of computing P's loss on the worthlessness of the stock and debt of S, P's basis in such stock and debt must be reduced by the sum of S's net operating losses in 1964 and 1965. Sec. 1.1502-34A(b)(2)(i), Income Tax Regs.Henry C. Beck Builders, Inc., 41 T.C. 616">41 T.C. 616, 41 T.C. 616">629-633 (1964), distinguished. William1973 U.S. Tax Ct. LEXIS 172">173 H. Brayer, for the petitioner.Rufus H. Leonard, Jr., and Steedly Young, for the respondent. Tannenwald, Judge. TANNENWALD59 T.C. 670">670 OPINIONRespondent determined a deficiency of $ 140,676.28 in petitioner's income tax for 1965. Petitioner has conceded all but one of the issues raised in the statutory notice of deficiency.The disputed issue relates to the computation of petitioner's basis in the stock and debt of its former subsidiary and will require an interpretation of the pre-1966 consolidated return regulations. 1 The specific question to be decided is whether, in computing a parent corporation's loss on the worthlessness of the stock and debt of its subsidiary, the parent must reduce its basis in such stock and debt by the 59 T.C. 670">671 amount of a net operating loss incurred by the subsidiary in the year of its liquidation.1973 U.S. Tax Ct. LEXIS 172">174 All of the facts of this case have been stipulated and are found accordingly.Petitioner was engaged in the manufacture of electronic systems and devices during the years involved in this case. Its principal place of business was in Garden City, N.Y., when it filed the petition herein. Petitioner filed a consolidated Federal income tax return for 1965 with the district director of internal revenue, Brooklyn, New York.Space Equipment Corp. (hereinafter Space) was a manufacturer of plastic parts for use in the aerospace industry.On March 31, 1964, petitioner acquired 69,167 shares of the common stock of Space out of the total 72,000 shares outstanding. Later in the same year, petitioner acquired an additional 300 shares, giving it a total of 69,467 shares, or 96.48 percent of Space's stock. These shares of stock cost the petitioner a total of $ 74,289.31.Petitioner and Space joined in filing consolidated Federal income tax returns for the calendar years 1964 and 1965.Petitioner loaned Space a total of $ 800,000 during 1964 in exchange for promissory notes of Space in like face amount. Petitioner loaned Space an additional $ 92,899.50 during 1964 and 1965, recorded on the books1973 U.S. Tax Ct. LEXIS 172">175 of petitioner as an intercompany receivable from Space and on the books of Space as an intercompany payable to petitioner. In October and November of 1964, Space made repayments of its indebtedness to petitioner in the total amount of $ 50,201.Due to the losses sustained by Space in 1964, the boards of directors of petitioner and Space, at their January 1965 meetings, resolved to cease the operations of Space and proceed to wind up its business. Pursuant to the plan of liquidation thus adopted, Space disposed of its operating assets and ceased business activities. By June 1965, its assets consisted solely of cash and accounts receivable, and by November 1965, all its creditors other than petitioner had been paid in full.From February to November 1965, Space made liquidating distributions to petitioner in the total amount of $ 367,442.91. Petitioner treated this amount as a repayment of Space's indebtedness.Space was dissolved and liquidated as of December 22, 1965. At that time, petitioner had a cost basis in its Space stock of $ 74,289.31 and a total unpaid balance due from Space, consisting of notes and intercompany accounts receivable, in the amount of $ 475,255.59.Space1973 U.S. Tax Ct. LEXIS 172">176 sustained a net operating loss of $ 153,079.88 for the period March 31, 1964, through December 31, 1964, and a net operating loss of $ 293,075.58 for the period January 1, 1965, through December 22, 1965. These losses were deducted from the separate taxable income of petitioner 59 T.C. 670">672 in 1964 and 1965 in order to compute the consolidated taxable income for each of the 2 years.The parties agree that petitioner's investment in Space (both stock and unrepaid loans) became worthless during 1965, that Space sustained the net operating losses specified above, and that the affiliated group consisting of petitioner and Space took the full tax benefit of such losses in computing its consolidated taxable income. They disagree, however, on the amount of the loss which petitioner may recognize with respect to such worthlessness.Section 1.1502-40-A(a), Income Tax Regs., governs the bad debt loss allowable to petitioner in the circumstances of this case. That section provides, in pertinent part, that "the loss shall be computed subject to the adjustments specified in § 1.1502-35A." Section 1.1502-33A governs the loss allowable to petitioner on account of the Space stock and also refers 1973 U.S. Tax Ct. LEXIS 172">177 to section 1.1502-35A for the computation of the loss. The latter section requires that the basis of the indebtedness be reduced by "the excess, if any, of the aggregate of the deductions computed under paragraph (b)(2) * * of section 1.1502-34A" over the basis of the stock.Section 1.1502-34A (b)(2) provides for a reduction in the basis of petitioner's investment in Space (both stock and debt) by the sum of:(i) All losses of * * * [Space] sustained during taxable years for which consolidated income tax returns were made or were required (whether the taxable year 1929 or any prior or subsequent taxable year) after such corporation became a member of the affiliated group and prior to the sale of the stock to the extent that such losses could not have been availed of by such corporation as net loss or net operating loss in computing its net income or taxable income, as the case may be, for such taxable years if it had made a separate return for each of such years * * When, as in this case, the adjustment to basis is applied in the context of a liquidation and resulting bad debt loss, the phrase "prior to the sale of the stock" in section 1.1502-34A(b)(2)(i) is to be read as the1973 U.S. Tax Ct. LEXIS 172">178 equivalent of "prior to the time when the debt became worthless for the purposes of deduction." Bush Terminal Buildings Co., 7 T.C. 793">7 T.C. 793, 7 T.C. 793">816-817 (1946), interpreting the same language in the predecessor of section 1.1502-34A(b)(2)(i).The parties differ on their interpretation of section 1.1502-34A(b) (2)(i). There is no dispute that the amount of Space's net operating loss for 1964 ($ 153,079.88) is a required adjustment to basis. Petitioner concedes that $ 74,289.31 of this adjustment must first be applied to reduce the basis of its stock in Space to zero and that the remaining $ 78,790.57 of the adjustment should be applied to reduce its basis in 59 T.C. 670">673 the unpaid debt of Space ($ 475,255.49). It contends, however, that no further adjustment should be made and that it is entitled to a deduction in the amount of $ 396,464.92.Respondent maintains, however, that Space's net operating loss in 1965 ($ 293,075.58) is also a required adjustment to the basis of Space's indebtedness to petitioner, with the result that petitioner's allowable deduction should be limited to $ 103,389.34.Petitioner's position is based upon the proposition that the required1973 U.S. Tax Ct. LEXIS 172">179 downward adjustment to basis is limited to the net operating losses of Space "sustained during taxable years * * * prior to" the worthlessness of the indebtedness. It argues that 1965 was not a year prior to the worthlessness of the debt of Space and that, consequently, the net operating loss of Space sustained during that year is not a required adjustment. For this reading of section 1.1502-34A(b)(2)(i), petitioner relies on Henry C. Beck Builders, Inc., 41 T.C. 616">41 T.C. 616, 41 T.C. 616">629-633 (1964).In Beck Builders, a parent and subsidiary corporation filed consolidated income tax returns for the fiscal years 1953 through 1957. The affiliation was broken within fiscal 1957, when the common stock of the subsidiary was sold. Prior to the date of that sale, but during fiscal 1957, the subsidiary had redeemed all of its preferred stock which was held by the parent. The issue presented for decision involved the question of the amount of gain which should be recognized by the parent as a result of that redemption.For the purpose of determining the parent corporation's adjusted basis in the preferred stock of its subsidiary under section 1.1502-34 (b)(2)(i), 1973 U.S. Tax Ct. LEXIS 172">180 Income Tax Regs. (now section 1.1502-34A(b)(2)(i), the regulation involved herein, see fn. 1 supra), the Commissioner urged this Court to take into account the taxable income and net operating losses of the parent and subsidiary for the fiscal years 1953 through 1957. The argument made on behalf of the parent corporation in that case -- identical to the argument of petitioner herein -- was that only the fiscal years 1953 through 1956 should be considered in computing the required adjustment to basis, because 1956 was the last taxable year prior to the redemption of the preferred stock.We accepted the argument made on behalf of the parent corporation and disregarded the year of the redemption in computing the adjustment under section 1.1502-34A(b)(2)(i). Elimination of fiscal year 1957 meant a smaller downward adjustment to the parent's basis in the preferred stock of the subsidiary and, consequently, a smaller recognizable gain to the parent as a result of the redemption.In urging us to disregard the year of the liquidation in this case just 59 T.C. 670">674 as we disregarded the year of the redemption in the Beck Builders case, petitioner itself disregards a crucial distinction1973 U.S. Tax Ct. LEXIS 172">181 between the two situations. In Beck Builders, the redemption of the preferred stock did not break the affiliation between the parent and subsidiary corporation. Thus, we noted in that case that the redemption of the preferred stock --was not the occasion for the filing of a new return * * and did not otherwise bring that taxable year [1957] to a close. * * * At the time of the redemption * * * [the subsidiary's] last prior taxable year was clearly its 1956 taxable year. [See 41 T.C. 616">41 T.C. 632.]By way of contrast, the liquidation in the present case broke the affiliation between petitioner and Space, terminated the affiliated group, and brought Space's taxable year to a close. Secs. 1.1502-13A(c) and (g) and 1.1502-31A (e). The significance of this distinction is highlighted by our reference in Beck Builders to the impact of the sale of the common stock and by the fact that it was unnecessary in that case for us to resolve the question of adjustment to the basis of that stock in respect of net operating loss deductions for, and carryovers to, the year of such sale because the parent's basis in the common stock had been reduced to zero. See1973 U.S. Tax Ct. LEXIS 172">182 41 T.C. 616">41 T.C. 632.The distinction is further accentuated by contrasting the treatment, on a consolidated return, of gain from the receipt of cash in redemption of the stock of a member of an affiliated group in an amount in excess of earnings and profits, and a worthless intercompany bad debt. The former situation gives rise to a taxable event and the gain is recognized on the consolidated return. 41 T.C. 616">Henry C. Beck Builders, Inc., supra; see sec. 1.1502-37A(a)(1)(ii), Income Tax Regs.; 8A Mertens, Law of Federal Income Taxation, sec. 46.47, fn. 58. In the latter situation, no deduction is allowable during any consolidated return period, except in the case of an intercompany bad debt "resulting from the bona fide termination of the business and operations" of the debtor affiliate. See sec. 1.1502-40A(a), Income Tax Regs.In view of the foregoing, Beck Builders is clearly distinguishable.In the final analysis, the validity of petitioner's contention depends upon when the affiliation between Space and petitioner was broken and when Space's indebtedness to petitioner became "worthless for purposes of deduction." See 7 T.C. 793">Bush Terminal Buildings Co., supra.1973 U.S. Tax Ct. LEXIS 172">183 There is no doubt that the affiliation was not broken until Space was dissolved on December 22, 1965, and petitioner does not contend otherwise. See Joseph Weidenhoff, Inc., 32 T.C. 1222">32 T.C. 1222, 32 T.C. 1222">1233 (1959). We think that "for purposes of deduction" the indebtedness of Space to petitioner became worthless at the same time. The exception contained in section 1.1502-40A(a), 59 T.C. 670">675 Income Tax Regs., supra, simply provides that the "termination of the business and operations" is the cause of the loss, with the time for taking the loss into account postponed until the debtor-affiliate ceases to be a member of the affiliated group. As a consequence, the period January 1, 1965, through December 22, 1965, during which Space sustained the net operating loss of $ 293,075.58, constituted a separate taxable year "prior to" the worthlessness of the indebtedness for the purpose of computing the required adjustment under section 1.1502-34A(b)(2)(i). 21973 U.S. Tax Ct. LEXIS 172">184 Our interpretation comports with the obvious purpose of the regulation in question, while the interpretation suggested by petitioner would confound that purpose. The theory of the adjustment prescribed in section 1.1502-34A(b)(2)(i) is that a parent corporation, after it has used its subsidiary's net operating loss to offset its own taxable income in a consolidated return year, should not be again entitled to deduct the same loss when it sells or otherwise disposes of its investment in the subsidiary. See McLaughlin v. Pacific Lumber Co., 293 U.S. 351">293 U.S. 351 (1934); Charles Ilfeld Co. v. Hernandez, 292 U.S. 62">292 U.S. 62 (1934); Greif Cooperage Corp. v. Commissioner, 85 F.2d 365 (C.A. 3, 1936), affirming 31 B.T.A. 374">31 B.T.A. 374 (1934); Commissioner v. National Casket Co., 78 F.2d 940 (C.A. 3, 1935); Commissioner v. Emerson Carey Fibre Products Co., 70 F.2d 990 (C.A. 10, 1934); United States v. Lakewood Engineering Co., 70 F.2d 887 (C.A. 6, 1934); 7 T.C. 793">Bush Terminal Buildings Co., supra;1973 U.S. Tax Ct. LEXIS 172">185 Jordahl & Co., 35 B.T.A. 1136">35 B.T.A. 1136 (1937); Denton & Anderson Co. v. Kavanagh, 164 F. Supp. 372">164 F. Supp. 372, 164 F. Supp. 372">381-384 (E.D. Mich. 1958), affirmed per curiam 265 F.2d 930 (C.A. 6, 1959). Our interpretation also implements the recent mandate of United States v. Skelly Oil Co., 394 U.S. 678">394 U.S. 678, 394 U.S. 678">684 (1969), which admittedly did not involve the consolidated return area, where the Supreme Court stated "the Code should not be interpreted to allow * * [the taxpayer] 'the practical equivalent of double deduction,' Charles Ilfeld Co. v. Hernandez, 292 U.S. 62">292 U.S. 62, 292 U.S. 62">68."We conclude that the net operating loss sustained by Space in the year of its liquidation must be included in calculating the reduction in basis under section 1.1502-34A(b)(2)(i).Decision will be entered for the respondent. Footnotes1. T.D. 6894, 1966-2 C.B. 362, promulgated a new set of consolidated return regulations applicable to taxable years beginning after Dec. 31, 1965, and designated as secs. 1.1502-0 through 1.1502-80, Income Tax Regs. The regulations applicable to taxable years beginning before Jan. 1, 1966, were redesignated as secs. 1.1502-0A through 1.1502-51A. See sec. 1.1502-0, Income Tax Regs.↩2. Compare Space's period Mar. 31, 1964, through Dec. 31, 1964, during which it sustained the net operating loss of $ 153,079.88. Petitioner's acquisition of Space's stock on Mar. 31, 1964, commenced their affiliation and brought Space's pre-affiliation taxable year to a close. Secs. 1.1502-13A (b) and (g) and 1.1502-31A(e). Space's period Mar. 31, 1964, through Dec. 31, 1964, thus constituted a separate taxable year "after [Space] became a member of the affiliated group" and the net operating loss it sustained during that period is concededly a required adjustment to basis under sec. 1.1502-34A(b)(2)(i)↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625293/	B. A. Carpenter, Petitioner, v. Commissioner of Internal Revenue, RespondentCarpenter v. CommissionerDocket No. 30631United States Tax Court20 T.C. 603; 1953 U.S. Tax Ct. LEXIS 122; June 15, 1953, Promulgated 1953 U.S. Tax Ct. LEXIS 122">122 Decision will be entered under Rule 50. 1. Income -- Cooperative -- Revolving Fund Certificates. -- Amounts retained at sole discretion of board of directors for capital purposes evidenced by revolving fund certificates issued to members in payment of patronage dividends, which certificates bore no interest, were retirable at sole discretion of the directors, were subordinate to all other debts of the cooperative, and had no fair market value held, not to be income of members in year issued.2. Income -- Year in Which Taxable. -- Stock in another corporation purchased by a cooperative on behalf of its members out of earnings of the cooperative held, to be income of the petitioner in year determined by the Commissioner rather than in year of actual receipt of stock certificate by the petitioner. Held, further, burden of proving otherwise not sustained by the petitioner. Claude L. Gray, Esq., Dorothea Watson, Esq., Roe H. Wilkins, Esq., Mac Asbill, Esq., and William A. Sutherland, Esq., for the petitioner.Ralph V. Bradbury, Jr., Esq., for the respondent. Tietjens, Judge. Turner and Bruce, JJ., concur in the result. Arundell, J., dissenting. Van Fossan, Harron, Johnson, and Withey, JJ., agree with this dissent. TIETJENS20 T.C. 603">603 The Commissioner determined the following deficiencies in income tax of the petitioner:Taxable Yearended Feb. 28Deficiency1946$ 1,103.4019472,430.0819482,450.961949544.00The issues for decision are:1. Whether the Commissioner erred in adjusting upward the petitioner's income by amounts representing his proportionate1953 U.S. Tax Ct. LEXIS 122">124 share in 20 T.C. 603">604 revolving fund certificates issued by a fruit growers' cooperative to a partnership of which he was a member and by the amounts of such certificates issued directly to him;2. Whether the Commissioner erred in increasing the petitioner's income for the year ended February 28, 1949, by the amount of stock in Pasco Packing Company allegedly received by the petitioner in that year; and3. Whether the deficiency for the year ended February 28, 1947, is barred by the limitations imposed by section 275 (a), Internal Revenue Code.Another issue has been conceded and may be reflected in a Rule 50 computation.FINDINGS OF FACT.The stipulated facts are so found and incorporated herein by reference.The petitioner resides at Orlando, Florida. He filed the returns in question on the cash basis for fiscal years ending February 28 with the collector of internal revenue for the district of Florida.During the period involved, the petitioner and a partnership of which he was a member were both members of Fosgate Growers Cooperative (hereinafter called the Cooperative), incorporated under the Florida laws for the formation and operation of an agricultural cooperative association. 1953 U.S. Tax Ct. LEXIS 122">125 The Cooperative was an exempt cooperative under section 101 (12) of the Internal Revenue Code. The petitioner and the partnership marketed their fruit through the Cooperative. The Cooperative, in accordance with the terms of its agreement with the petitioner and the partnership, as evidenced by the members' crop agreement, its articles of incorporation, and its bylaws, deducted from their fruit settlements various amounts in the taxable years for which revolving fund certificates were issued and delivered to the petitioner and the partnership.The articles of incorporation of the Cooperative authorized its directors to establish and accumulate reserves out of earnings, including a permanent surplus fund as an addition to capital. The Cooperative's bylaws authorized the directors to deduct from the proceeds of the sale of patrons' products amounts necessary to maintain adequate reserves and for other capital purposes and provided that such retained amounts be evidenced by revolving fund certificates of the type issued to the petitioner and the partnership. The directors were further authorized to pay patronage dividends in such certificates or in cash according to the discretion1953 U.S. Tax Ct. LEXIS 122">126 of the directors, and pursuant to the bylaws, the petitioner and the partnership agreed that should the directors determine to pay patronage dividends in certificates in lieu of cash, they would accept such payment.20 T.C. 603">605 The revolving fund certificates issued to the petitioner and the partnership provided that they were entitled to the amounts shown on the certificates on account of deductions for patronage refunds for revolving fund purposes, subject to the following conditions:1. This and other revolving-fund certificates of the same series are retirable in the sole discretion of the Board of Directors of Fosgate Growers Cooperative, either fully or on a pro rata basis, but certificates issued in prior years shall be entitled to priority (except as hereinafter provided) in retirement.2. The amount stated in this certificate shall bear no interest.3. This certificate is transferable only on the books of said association after the express consent of the Board of Directors of said association to such transfer has been first had and obtained.4. This and other certificates shall be junior and subordinate to all other debts of said association, both secured and unsecured. Upon1953 U.S. Tax Ct. LEXIS 122">127 the winding up or liquidation of said association in any manner, after full payment to all of its other creditors, all revolving-fund certificates shall then be retired in full or on a pro rata basis, without priority.An outstanding loan agreement and mortgage between the Cooperative and the Columbia Land Bank provided that the Cooperative could redeem the certificates only upon the written approval of that bank.The petitioner in his income tax returns for the years in question did not report as taxable income the amounts of the revolving fund certificates issued to him or his share in the amounts of such certificates issued to the partnership.Prior to March 1, 1949, the Cooperative had paid nothing on the certificates. On October 6, 1949, it did pay 25 per cent of the face amount of the series of 1944, and on October 16, 1950, it made another 25 per cent payment on that series. These payments were made with the consent of the Columbia Land Bank and were reported by the petitioner and the partnership in the fiscal years of their receipt.There have been no transfers on the books of the Cooperative of the revolving fund certificates issued by it. The petitioner has been unable1953 U.S. Tax Ct. LEXIS 122">128 to sell or borrow on the security of his certificates. The petitioner and the partnership, at the time of the hearing, still owned the certificates issued to them.The revolving fund certificates had no fair market value at the time they were issued.In the notice of deficiency sent to the petitioner the Commissioner increased the petitioner's taxable income by the amount of the revolving fund certificates issued to him and by the increase in his share of the partnership income resulting from the inclusion in the partnership ordinary net income of the face amount of the certificates issued to it.During the 1947-1948 crop season the Cooperative entered into an agreement with Pasco Packing Company whereby Pasco agreed to 20 T.C. 603">606 process 1,100,000 boxes of fruit for the Cooperative upon condition that the Cooperative buy $ 300,000 worth of Pasco stock. At the time of the stock purchase (the exact date of which is not shown), it was the intention of the directors of the Cooperative to have the stock issued in one certificate and to hold it in an escrow account for its members. Before this could be accomplished the Cooperative decided to have the stock issued directly to its members1953 U.S. Tax Ct. LEXIS 122">129 and it gave Pasco directions to that end on May 10, 1949. The delay in issuing the Pasco stock was due solely to the mechanics of figuring each member's share. The petitioner did not know of the agreement between Pasco and the Cooperative. On May 31, 1949, the petitioner was notified by Pasco that he was entitled to receive capital stock in Pasco and on July 15, 1949, a certificate for 11.2 shares was delivered to him by registered mail. This certificate had a face value of $ 1,112.69. The petitioner returned the stock as though it was a cash receipt in the fiscal year ended February 28, 1950. The Commissioner determined the shares were taxable income in the prior fiscal year.The member's agreement between the petitioner and the Cooperative provided that any contract between the Cooperative and any agency utilized by the Cooperative shall be part of the member's agreement and binding on the parties.OPINION.The Commissioner insists that the revolving fund certificates should be taxable at their face amount regardless of whether or not they had any fair market value at the time of their issuance. He argues that the Cooperative was under an obligation to distribute patronage1953 U.S. Tax Ct. LEXIS 122">130 dividends either in cash or certificates; that the petitioner by becoming a member voluntarily assented to this arrangement and pursuant thereto, when the directors determined to pay such dividends in certificates the petitioner should be treated as if he had actually received the dividends in cash and reinvested the cash in the Cooperative.Further, the Commissioner claims that by Bureau ruling and the decisions of this Court, cooperatives have been permitted to exclude the full amount of such allocated profits from income under conditions such as exist in this case. He continues, as a corollary, that he has included in the taxable income of the member the full amount of allocated profits evidenced by certificates in the same year the exclusion is allowed. He maintains that the decisions of this Court have supported this result, but rejected the theory, my holding such income taxable to the members, but on the theory that it was received at fair market value. He concludes that "Consistency and protection of the revenue support the Bureau contention that such proceeds are properly taxable at full face value." In summary, "It is the Commissioner's 20 T.C. 603">607 premise that the amounts1953 U.S. Tax Ct. LEXIS 122">131 represented by the certificate were in effect received and reinvested in the capital of the cooperative, since the amounts were used in the manner the petitioner had elected. In any event, the amounts were 'constructively received' and reinvested by the petitioner."The Commissioner cites United Cooperatives, Inc., 4 T.C. 93, and Colony Farms Cooperative Dairy, Inc., 17 T.C. 688, as cases illustrative of the proposition that the issuance of certificates or the use of earned margins as capital with the permission of the member is excludible from income by the cooperative when the cooperative is the petitioner here. When the member is the petitioner the cases cited are George Bradshaw, 14 T.C. 162; Harbor Plywood Corporation, 14 T.C. 158; P. Phillips, 17 T.C. 1027; Estate of Wallace Caswell, 17 T.C. 1190; and William A. Joplin, Jr., 17 T.C. 1526.The petitioner's position simply is that he received no taxable income by virtue of the issuance of the revolving fund1953 U.S. Tax Ct. LEXIS 122">132 certificates under any theory.Little would be gained by discussing the cases involving exclusion of patronage dividends by cooperatives. Whatever may be the virtues of consistency, it cannot always be attained. The cooperative and its patrons are different entities and we do not think it necessarily follows that what is excludible from the income of the cooperative, whether the cooperative be taxable or tax exempt, automatically becomes income to the member. See William A. Joplin, Jr., supra.We confine ourselves to the problem before us. Is the petitioner here taxable on any amount represented by the certificates issued by the Cooperative? The import of the decisions is that the member is not taxable unless the certificates have fair market value.Harbor Plywood Corporation, supra, and George Bradshaw, supra, are not too helpful. Both involved the time of accrual -- the Plywood case of credit memoranda issued to members where the income had been earned by the cooperative and would have been paid to the member but for the contingency of renegotiation, and the Bradshaw case of1953 U.S. Tax Ct. LEXIS 122">133 notes issued by a purchasing cooperative as patronage refunds. In our opinion, neither case has a direct bearing on the present question.In Estate of Wallace Caswell, supra, the cooperative, a tax-exempt cooperative, distributed interest-bearing certificates as well as cash to patrons. The Commissioner contended that the patron had received property in addition to cash under section 111 (b) and had received and realized income to the extent of the fair market value of the certificates. We upheld this contention and found not only that the certificates had fair market value, but that "the record gives no leeway for saying that such fair market value was less than face."20 T.C. 603">608 William A. Joplin, Jr., supra, was concerned with $ 25 par value preferred stock issued by the cooperative of a conceded fair market value of half its par value. Here again the decision was for the Commissioner, the Court finding, however, that the fair market value of the stock was the equivalent of its par value.That phase of P. Phillips, supra, which bears on our question involved a taxable cooperative which1953 U.S. Tax Ct. LEXIS 122">134 voluntarily issued certificates to its members much like the certificates here, except for the voluntary feature. We stated, at page 1029:Dr. P. Phillips Cooperative voluntarily issued revolving fund certificates against the amounts retained from marketing operations. Those certificates had no fair market value and did not represent income to the recipients on that basis. The Cooperative never made the funds themselves subject to the demand of any member so that constructive receipt might apply. The funds belonged to and were retained by the Cooperative. They were not income of the members for 1946. Furthermore, if a member ever receives any cash or thing of value in lieu of the certificates, that will represent an additional "amount realized" from the sale of his 1946 crop which will be taken into income at that later date if it represents unreported profit. The Commissioner has advanced no sound reason for including these amounts in the income of the petitioners for 1946.The Caswell, Joplin, and Phillips cases suggest that the patronage dividends are to be taxed or not taxed depending on whether or not they have a fair market value. We have found that the certificates1953 U.S. Tax Ct. LEXIS 122">135 with which we are dealing had no fair market value. Accordingly, they would not be taxable to the petitioner.The Commissioner, however, brushes fair market value aside and seems to stand on the theory either of "constructive receipt" or "assignment of income," though at the same time stating that the theories on which he proceeds are immaterial. As in Phillips, so here, we do not think the Commissioner has advanced any sound reason for including any amount represented by the revolving fund certificates in the petitioner's income. The petitioner never had any real dominion or control over the funds represented by the certificates. The decision to retain the funds in the business rested solely with the directors. The certificates themselves had no fair market value and we do not see that whether or not the Cooperative was obligated to issue such certificates adds anything significant to the situation. We decide for the petitioner on the first issue.On the issue involving the Pasco stock, the burden of showing the error of the Commissioner's determination that the stock constituted taxable income in the year ended February 28, 1949, rather than the succeeding year is on the1953 U.S. Tax Ct. LEXIS 122">136 petitioner. This burden, the petitioner contends, has been met by proving that he was on the cash basis, that he had no knowledge of the contract to purchase the Pasco stock, and 20 T.C. 603">609 that he actually received the stock certificate in the year in which he reported it.The facts do not show the exact date on which the stock purchase was consummated by the parties, but it evidently was previous to the taxable year in which the petitioner reported the income since the transaction was entered into during the 1947-48 growing season. It is clear that the stock was not purchased by the Cooperative for itself, but was purchased on behalf of the members including the petitioner. The petitioner's agreement as a member provided that any contract between the Cooperative and any agency utilized by the Cooperative shall be a part of the member's agreement and binding on the parties. The contract between Pasco and the Cooperative which made provision for the stock purchase seems to us to have been such a contract. The intent of the Cooperative, as shown by the facts, was that the Pasco stock was to be held in an "escrow account for its members." This means to us that upon the purchase 1953 U.S. Tax Ct. LEXIS 122">137 being made, the petitioner immediately became entitled to his proportionate share of the Pasco stock. That his exact share was not immediately determined is not significant -- that was merely a matter of arithmetical computation.The petitioner's actual knowledge of the transaction would not seem to be material. The contract with Pasco for the stock purchase was obviously for the benefit of the petitioner and the other members of the Cooperative and the Cooperative, pursuant to its original intent, was to hold the stock for the members, not for itself. In such a situation the cooperative is a conduit for passing the stock on to its members. Cf. Dr. P. Phillips Cooperative, 17 T.C. 1002. And it seems fair to say that the Cooperative, in view of the provisions of the membership agreement referred to above, was an agent of the petitioner and the other members in making the stock purchase. It was not necessary for the Cooperative to obtain any ratification by its members before the contract with Pasco became binding. No contention is made to that effect or that the Cooperative exceeded its authority in making the contract.As we view the transaction, 1953 U.S. Tax Ct. LEXIS 122">138 the petitioner's right to the stock ripened when the stock purchase was made. It did not depend upon actual issuance of the certificates by Pasco. Ownership of stock is not determined by the formality of registering and delivering stock certificates. W. F. Marsh, 12 T.C. 1083; Scientific Instrument Co., 17 T.C. 1253. The petitioner's right became fixed at the time of the contract, which was before the year in which the stock certificate was actually delivered to the petitioner and returned as income by him. In effect, the entire transaction amounted to an appropriation for the proportionate benefit of each member of $ 300,000 of the earnings of the Cooperative at the time the stock purchase was made.20 T.C. 603">610 In these circumstances we think the petitioner has not met his burden of showing the Commissioner's determination to have been erroneous, and we hold for the Commissioner on this issue.Our holding on the first issue makes it unnecessary for us to decide the statute of limitations question.Decision will be entered under Rule 50. ARUNDELLArundell, J., dissenting: I would decide the second issue in this1953 U.S. Tax Ct. LEXIS 122">*139 case for the taxpayer. He reports his income on a cash receipts basis and the shares of stock were returned at full value by him in the year in which he received the shares. He not only did not receive the shares in the year in which they are being taxed but it was not known what shares would come to him within that year; nor had he even heard of the transaction within the year. It was not until the year following the taxable year in question that the Pasco Company was given instructions to issue the shares to the members. Before a cash basis taxpayer may be charged with the receipt of income he must receive cash or property having a fair market value, or such cash or property must be unqualifiedly subject to his demand. Regulations 111, section 29.115-1. The taxpayer in this case had no right to take possession of these Pasco shares in the year in which the tax is imposed, nor would a demand for the shares have been enforceable.In my opinion, the way the taxpayer reported this income was the normal way taxpayers would follow and to attempt to upset this by the adoption of some theory of agency I think is a mistake.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625294/	Estate of Mildred Herschede Jung, Deceased, Ruth J. Conway, Executrix, Petitioner v. Commissioner of Internal Revenue, RespondentEstate of Jung v. CommissionerDocket No. 20221-88United States Tax Court101 T.C. 412; 1993 U.S. Tax Ct. LEXIS 69; 101 T.C. No. 28; November 10, 1993, Filed 1993 U.S. Tax Ct. LEXIS 69">69 Decision will be entered under Rule 155. Decedent owned 168,600 shares of Jung Corp. stock at her death.1. Held, fair market value of the shares determined. Sec. 2031, I.R.C. 1954.2. Held, further, petitioner is not liable for an addition to tax. Sec. 6660, I.R.C. 1954. Michael E. Neiheisel, James M. Moore, Paul D. Ratterman, and Thomas H. Clark, for petitioner.Joseph P. Grant, for respondent. Chabot, Judge. CHABOT101 T.C. 412">412 CHABOT, Judge: Respondent determined a deficiency in Federal estate tax against petitioner in the amount of $ 2,396,902.92. By amendment to answer, respondent asserts 101 T.C. 412">413 an addition to tax of $ 719,070.90 under section 66601 (valuation understatement).After concessions by both sides, the issues are as follows:(1) What the fair market value of decedent's 168,600 shares of Jung Corp. stock was on the1993 U.S. Tax Ct. LEXIS 69">70 date of her death (Oct. 9, 1984); and(2) whether petitioner is liable for an addition to tax under section 6660.FINDINGS OF FACT 21993 U.S. Tax Ct. LEXIS 69">71 Some of the facts have been stipulated; the stipulation and the stipulated exhibits are incorporated herein by this reference.When the petition was filed in the instant case, petitioner was an Ohio estate with a legal residence in Cincinnati, Ohio. Decedent died a resident of Ohio on October 9, 1984. Decedent's estate was probated in Hamilton County, Ohio.At her death decedent owned 168,600 voting shares of Jung Corp., which represented 20.83 percent of the outstanding voting shares and 20.74 percent of all the outstanding shares of Jung Corp. 3In the early 1900's decedent's husband cofounded Jung Arch Brace Co., the predecessor to Jung Corp. In 1949, a year after decedent's husband died, Jung Corp. was incorporated in Ohio as Jung Products, 1993 U.S. Tax Ct. LEXIS 69">72 Inc. As of January 1, 1982, the name was changed to Jung Corp. Jung Corp.'s principal place of business was in Cincinnati, Ohio.101 T.C. 412">414 On October 9, 1984, Jung Corp. owned all of the outstanding stock of the following companies: Jung International, Inc. (hereinafter sometimes referred to as JII), J.R.A. Industries, Inc. (hereinafter sometimes referred to as JRA), Rampon Products (hereinafter sometimes referred to as Rampon), Ione Realty (hereinafter sometimes referred to as Ione), and Calley & Currier; Jung Corp. also owned 96.3 percent of the stock of Theradyne.Jung Corp and its subsidiaries were primarily operating companies, except that Ione was a holding company for the real estate occupied by the operating companies. Jung Corp. consisted of two divisions -- (1) the corporate division, which provided management services to the Jung Corp. subsidiaries, and (2) the Futuro division (hereinafter sometimes referred to as Futuro), which manufactured and marketed health care products and other products, including the products of Jung Corp. subsidiaries. 4 Jung Corp. and its subsidiaries together comprised an integrated manufacturer and distributor of elastic textile goods and1993 U.S. Tax Ct. LEXIS 69">73 products, including elastic braces and supports, support stockings, and thermo comforters (elastic gloves and braces knitted with wool, which provide warmth and compression to swollen joints).Futuro marketed health supports (such as elastic braces, athletic supporters, support socks and stockings, and hernia belts), patient aids (such as wheelchairs, canes, crutches, walkers, bed pans, and sitz baths), and thermo comforters. Futuro products were marketed almost entirely through drugstores, both nationally and internationally. About 95 percent of the health supports and 70-75 percent of the patient aids that Futuro marketed were manufactured by Jung Corp. and its subsidiaries. Futuro also marketed sporting goods through its All American and Grid lines. Futuro was Jung Corp.'s most profitable business. Futuro's health supports products were number one or number1993 U.S. Tax Ct. LEXIS 69">74 two in drug stores.JII, incorporated in 1968, was the export sales agent for Jung Corp. products. JII bought goods for resale only from Jung Corp. or its subsidiaries. JII was a domestic international sales corporation (DISC) until December 31, 1984, at 101 T.C. 412">415 which time the DISC was liquidated and its successor was incorporated as a foreign sales corporation (FSC).JRA, incorporated in 1969, primarily produced coarse yarns for sale to other Jung Corp. subsidiaries and to third parties. JRA also used the yarns to make elastic webbing, and it made fine elastic yarn from which Rampon (acquired by Jung Corp. in 1965) and third parties made stockings. In 1983 JRA acquired the property, plant, and equipment of a yarn covering operation in Raeford, North Carolina, and the Raeford operations became part of JRA. The industry in which JRA competed is very capital-intensive and has very low profit margins. JRA had a low profit margin in 1984.Rampon produced knitted products including hosiery.Theradyne manufactured wheelchairs for sale to Jung Corp. subsidiaries and to third parties. Jung Corp. acquired 70 percent of Theradyne's stock in 1973. Most of the remaining stock was held1993 U.S. Tax Ct. LEXIS 69">75 by Jung family members. In 1983 Jung Corp. acquired most of the rest of Theradyne in a stock-for-stock transaction. On October 9, 1984, Jung Corp. held 96.3 percent of Theradyne's stock. In 1984 Theradyne was either marginally profitable or losing money.Jung Corp. acquired Calley & Currier in March 1984. Calley & Currier principally manufactured wooden crutches; it was the second largest wooden crutch manufacturer, with about one-third of the domestic market.Ione was incorporated in 1949 by Jung family members and was transferred to Jung Corp. in 1973. Its primary purpose was to hold real and personal property which was used by Jung Corp.'s operating subsidiaries. Ione owned the manufacturing facility that Futuro occupied, the plant that Theradyne occupied, and the Richard Grey plant (which was a part of Rampon). Ione also owned a condominium in Florida. Ione charged rent for the facilities it owned, but the rent charged was not market value.Jung Corp. had industrial revenue bond (hereinafter referred to as IRB) financing for Futuro's manufacturing site. As of October 9, 1984, the outstanding balance of Jung Corp.'s IRB loan for Futuro was $ 970,000. JRA also had IRB1993 U.S. Tax Ct. LEXIS 69">76 financing. As of October 9, 1984, the outstanding balance of JRA'S IRB loan was $ 3,030,000. The interest rate on JRA'S IRB loan was computed at 69 percent of the current prime rate at the time of payment.101 T.C. 412">416 Jung Corp. kept its books and records on a calendar year basis. Jung Corp. and its subsidiaries filed consolidated tax returns. The net income after taxes of Jung Corp. and its subsidiaries for 1970 through 1979 is shown in table 1:Table 1YearNet income1970$ 1,039,0001971379,0001972755,00019731,009,0001974720,0001975805,0001976973,00019771,477,00019781,205,00019791,344,000The audited financial statements for 1980 through 1986 show net sales and net income after taxes for the consolidated operations of Jung Corp. in the rounded amounts set forth in table 2:Table 2YearNet salesNet income1980$ 41,939,000$ 1,233,000198146,352,000944,000198248,800,0001,739,000198362,757,0001,889,000198467,918,0003,123,000198571,606,0002,098,000198654,679,0001,991,000The unaudited interim financial statement for September 30, 1984 (9 days before decedent's death), shows year-to-date1993 U.S. Tax Ct. LEXIS 69">77 net sales (rounded) of $ 52,271,000, and year-to-date net income after taxes (rounded) of $ 2,192,000. A portion of Jung Corp.'s unaudited interim consolidated balance sheet for September 30, 1984, is attached as the appendix. Complete information concerning 1984 yearend adjusting entries is not available. However, for 1984 Jung Corp. made at least three yearend adjustments as follows: (1) The inventory of Theradyne was decreased by $ 426,677, most of which was because of the discontinuance of the Titann wheelchair line, 101 T.C. 412">417 (2) the inventory of Futuro was increased by an unknown amount to account for the increased costing of freight, and (3) deferred Federal income tax was decreased by $ 541,000.Jung Corp. paid dividends of 4 cents per share from 1979 through 1983; in 1984 it paid dividends of 25 cents per share.In November 1984 Jung Corp. employed 1,025 people.In the early 1980s, Jung Corp. developed and installed computer programs which controlled its manufacturing and operating systems and produced financial statements, invoices, etc.In the 1980s, governmental policies were introduced which were designed to reduce Medicare costs by discouraging hospital stays and1993 U.S. Tax Ct. LEXIS 69">78 encouraging home health care. Because Jung Corp. marketed its products primarily through drugstores rather than through hospitals, Jung Corp. stood to benefit from this trend. Almost all the products in Jung Corp.'s product lines would benefit from an increase in home health care expenditures.Jung Corp. had formulated 5-year business forecast plans since 1975, but the emphasis was only on sales projections. In 1984 Jung Corp. began an in-depth analysis of its strengths, weaknesses, and opportunities, and it began to formulate specific business strategies. By mid-1984 Jung Corp. began to implement these strategies. Also, in 1984 Jung Corp. began involving employees in the planning and forecasting process. In mid-1984, to help with financial planning, Jung Corp. hired Jim Cox, a partner from Ernst & Whinney, and retained the services of an accounting firm. Jung Corp. decided to actively promote future growth through expanded domestic sales, and through acquisitions of other companies. It decided that Jung Corp. would become global in both sales and purchases, and it began searching for European companies to acquire. During 1984 Jung Corp. introduced additional products into1993 U.S. Tax Ct. LEXIS 69">79 the home health care market, and improved its then-current products. Beginning in 1984, each of Jung Corp.'s subsidiaries added a medical-surgical distribution service in order to provide products to surgical supply dealers, hospitals, and professionals. The year 1984 was the best sales and profit year in the history of Jung Corp.Jung Corp. also experienced growth from October 1984 through 1986. During this time Futuro became number one 101 T.C. 412">418 in the drugstore market. During 1985 or 1985, Jung Corp. introduced neoprene athletic products, which increased sales in Futuro's Grid line by 3 to 5 percent. In 1985 and 1986 Jung Corp. upgraded its equipment, installed new computer programs to manage inventory, and trained personnel to use the computers. Jung Corp. bought two English companies, Solport and Lastonet. It began sending managers to management training schools at Harvard, Stanford, and Massachusetts Institute of Technology. The planning and forecasting procedures which Jung Corp. had begun in 1984 helped it to identify both weaknesses and opportunities, and helped to give it needed impetus for growth in 1985 and 1986. Jung Corp.'s net sales in 1985 were higher than1993 U.S. Tax Ct. LEXIS 69">80 1984 net sales; however, Jung Corp.'s profits for 1985 and 1986 were lower than 1984 profits. See supra table 2. The decline in profits in 1985 and 1986 was due to the above-mentioned increased expenditures, which ultimately helped Jung Corp. Also, in 1985 and 1986 JRA and Calley & Currier changed from profitable companies to unprofitable companies. Because of the foregoing activities, and changes in the market, Jung Corp. increased in value substantially between 1984 and 1986.Since at least 1979, Jung Corp. had received letters inquiring about the possibility of acquiring Jung Corp. The standard response to these letters was that Jung Corp. was not for sale. In 1984 Jung Corp. was not for sale. From 1979 through 1986 there were not any arm's-length sales of the stock of Jung Corp. Jung Corp. stock was not publicly traded.On October 9, 1984, Ruth J. Conway, decedent's daughter, was treasurer of Jung Corp., and Ruth J. Conway's husband, Robert A. Conway (hereinafter sometimes referred to as Conway), was chairman of the board of directors. Thomas H. Clark (hereinafter sometimes referred to as Clark), decedent's nephew, was legal counsel and secretary for Jung Corp. 1993 U.S. Tax Ct. LEXIS 69">81 Mary Lois Jung, also a daughter of decedent, was a member of the board of directors of Jung Corp. and was one of two doctors who reviewed and approved the new product development literature that Jung Corp. distributed. No other members of decedent's family were employed by, or involved in, the management of Jung Corp. After a series of strokes in the period 1975-77, decedent had not been involved in the management of Jung Corp. Decedent's death had no impact 101 T.C. 412">419 on the running of Jung Corp. The Conways had eight children, none of whom was involved in the business. As of October 1984, Conway (then 57 years old) was not considering retirement; however, he was concerned about who his successor would be because none of his children was involved in the business.The holders of voting common shares of record on the date of decedent's death were as shown in table 3:Table 3Decedent168,600Robert A. Conway, TrusteeMildred H. Jung Trust24,000u.a.d. 11/9/76 Ruth A. Mary Lois Jung57,920Conway, Grantor 24,000Thomas H. Clark3,120Robert A. Conway, Jr.4,520Ruth J. Conway194,720Joseph A. Conway4,520Robert A. Conway94,320Kathleen Conway4,520Ruth J. Conway, Trust25,440Timothy J. Conway4,520Ruth J. Conway, Trust25,440Mary Ruth Conway4,520Ruth J. Conway, Trust144,000Sheila M. Conway4,520Edward R. Askew6,200Robert A. Conway, Cust.Joyce A. Russell400for Mary Lois Conway 4,520Karl V. Davis800Robert A. Conway, Cust.Paul Schwartz800for Sean Conway 4,520Carmen M. Newhaus1,080Edgar J. Mack III800Jean Dick200Paul Gamm800Walter Dimond80Geraldine Massie160Alvin C. Drury5201993 U.S. Tax Ct. LEXIS 69">82 In May 1986, Kendall Co. (hereinafter sometimes referred to as Kendall) contacted Jung Corp. in regard to an acquisition of Jung Corp. Conway told Kendall's representatives that he was not interested in selling. In the summer of 1986, Conway was invited to meet with Kendall's representatives in Boston, Massachusetts. Conway then consulted with Ruth Conway and Mary Lois Jung. Conway raised the matter at a meeting of Jung Corp.'s board of directors in September 1986. The board of directors advised that, if Conway did not plan to have family succession at Jung Corp., then he should treat Jung Corp. as any other asset, to be held or sold when he thought appropriate.Jung Corp. began negotiations with Kendall concerning the sale of certain assets of Jung Corp. The board of directors of Jung Corp. recommended that any sale be completed by December 31, 1986, because of changes in the tax law enacted by the Tax Reform Act of 1986. On December 29, 101 T.C. 412">420 1986, Kendall bought certain assets of Jung Corp. for about $ 59.5 million. On the date of decedent's death this sale was not foreseeable.The remaining assets of Jung Corp. were sold in transactions separate from the sale to 1993 U.S. Tax Ct. LEXIS 69">83 Kendall. On July 7, 1986, Jung Corp. sold Theradyne to Surgical Appliances Industries, Inc., for $ 1 million. On December 1, 1986, Jung Corp. sold assets of Futuro's Grid line to CDC Liquidators for $ 552,705. On December 23, 1986, Jung Corp. sold certain assets of JRA to Spanco Co. for $ 5,076,200. On December 29, 1986, Calley & Currier was sold for $ 750,000.In 1986 Jung Corp. did not discuss the possible sale of Jung Corp. assets with any entities other than those to which sales actually took place.On December 15, 1986, the shareholders of Jung Corp. adopted a plan of liquidation. According to the plan of liquidation, Jung Corp. was to be liquidated upon the sale to Kendall, which was to be on December 29, 1986, and dissolved by December 31, 1986. In order to accommodate the liquidation, the Jung-Conway Trust was established to serve as a conduit for transferring assets from Jung Corp. to its shareholders. The total trust equity of about $ 64 million is net of liquidation expenses, and after the buyout of the voting and nonvoting stock and stock options. The buyout price was $ 75 per share. On the date of decedent's death, this liquidation was not foreseeable.In connection1993 U.S. Tax Ct. LEXIS 69">84 with the preparation of the estate tax return, decedent's executrix relied on Clark's law firm to find an appraiser for decedent's stock in the Jung Corp. Clark's law firm retained Edwin T. Robinson (hereinafter sometimes referred to as Robinson) to prepare an appraisal report. On April 8, 1985, Robinson submitted his written valuation report to Clark, in which he valued decedent's Jung Corp. stock at $ 2,671,973 as of October 9, 1984. This valuation report was the basis for the estate's estate tax return's use of that amount as the reported value of decedent's Jung Corp. stock. Petitioner's estate tax return was filed timely, on July 9, 1985.On the estate tax return, petitioner elected under section 6166 to pay the appropriate portion of the estate tax in installments. In the course of making this election, petitioner represented that the $ 2,671,973 reported value of decedent's 101 T.C. 412">421 Jung Corp. stock is 88.1 percent of the value of the adjusted gross estate. On the estate tax return, petitioner reported the value of the gross estate as $ 3,418,971.52. The reported value of decedent's Jung Corp. stock is 78.2 percent of the value of the gross estate.Robinson is a certified1993 U.S. Tax Ct. LEXIS 69">85 public accountant and an attorney. Robinson does not have formal training or accreditation in valuation. In 1966, after being graduated from law school, Robinson spent 6 years working for the Arthur Andersen accounting firm; his work there involved some valuation questions. In 1972 Robinson joined a law firm as a tax specialist. His work at the law firm included some valuation issues. From 1979 to 1984 Robinson worked for SHV North America Corp. (hereinafter sometimes referred to as SHV), which is a U.S. holding company for a privately owned Dutch company. Robinson was vice president of acquisitions, and president of the SHV Investment Fund (hereinafter sometimes referred to as the fund), a venture capital fund. His job was to make investments for the fund in privately held businesses. Although Robinson did not prepare formal appraisal reports while he was employed by SHV, his job involved valuing companies for potential acquisition, or valuing a company held by SHV for purposes of selling it.In July 1984 Robinson joined Mayfield & Co., Inc. (hereinafter sometimes referred to as Mayfield). Mayfield provides consultation services for clients who wish to acquire businesses. 1993 U.S. Tax Ct. LEXIS 69">86 Robinson's work for Mayfield involved valuing companies, and helping clients to negotiate price, contracts, and financing. Although Robinson was not in the business of issuing written appraisals until he began working for Mayfield in 1984, he already had extensive experience for several years in valuing businesses.In preparing the appraisal report for petitioner, Robinson visited Jung Corp.'s facilities in Cincinnati and interviewed officers of Jung Corp. In his appraisal report, Robinson considered the history, economic outlook, products, and financial condition of Jung Corp. He valued Jung Corp. by (1) calculating its return on equity and its return on capital employed, and (2) using a price/earnings multiple based on market comparables and applying the multiple to Jung Corp.'s weighted earnings for 1980 through 1984. Robinson 101 T.C. 412">422 concluded that Jung Corp. should be valued at less than book value.Table 4 shows the positions of the parties, of their expert witnesses, and of the Court as to the fair market value of decedent's 168,600 shares of Jung Corp. stock on October 9, 1984.Table 4Total valuePetitioner:Estate tax return $ 2,671,973Petition 2,671,973Expert -- Robinson 2,671,973Expert -- McCoy 1 2,529,0002 Expert -- McCoy (revised) 1 2,950,500Expert -- Grabowski 2,585,000Expert -- Grabowski (revised) 1 3,372,000Briefs 2,997,708Respondent:Notice of deficiency 8,330,448Experts -- Hanan, Mitchell 5,469,000Experts -- Hanan, Mitchell (revised) 5,597,520Briefs 8,000,000Court:Ultimate finding of fact 4,400,0001993 U.S. Tax Ct. LEXIS 69">87 On October 9, 1984, Jung Corp. was worth about $ 32-34 million; decedent's shares amounted to 20.74 percent of the total and were worth about $ 6.7 to $ 7 million, without regard to discounts; the value of decedent's shares should be discounted 35 percent for lack of marketability and should not be further discounted for lack of control; and the fair market value of decedent's shares was $ 4,400,000.When Robinson prepared the appraisal report for petitioner, he was an experienced expert appraiser. Petitioner acted in good faith in claiming the valuation reported on the estate tax return. There was a reasonable basis for the valuation claimed on the estate tax return.Respondent's refusal to waive the addition to tax under section 6660 was an abuse of discretion.101 T.C. 412">423 OPINIONI. Value of1993 U.S. Tax Ct. LEXIS 69">88 Decedent's StockThe value of decedent's gross estate includes the fair market value of the stock in Jung Corp. that decedent owned at her death. Sec. 2031(a); 5United States v. Cartwright, 411 U.S. 546">411 U.S. 546, 411 U.S. 546">551 (1973); sec. 20.2031-1(b), Estate Tax Regs. Because Jung Corp.'s stock was not listed on an exchange and cannot be valued with reference to bid and asked prices or historical sales prices, the statute requires us to consider the value of stock in comparable corporations engaged in the same or a similar line of business. Sec. 2031(b).1993 U.S. Tax Ct. LEXIS 69">89 The parties have not agreed on the fair market value of decedent's stock, and so we will have to find the fair market value. Buffalo Tool & Die Manufacturing Co. v. Commissioner, 74 T.C. 441">74 T.C. 441, 74 T.C. 441">451-452 (1980).Generally, the fair market value of property is the price at which a willing buyer will purchase the property from a willing seller, when neither is acting under compulsion and both are fully informed of the relevant facts and circumstances. E.g., Palmer v. Commissioner, 523 F.2d 1308">523 F.2d 1308, 523 F.2d 1308">1310 (8th Cir. 1975), affg. 62 T.C. 684">62 T.C. 684, 62 T.C. 684">696 (1974); McShain v. Commissioner, 71 T.C. 998">71 T.C. 998, 71 T.C. 998">1004 (1979). Respondent's determination in the notice of deficiency as to the fair market value of the subject property is presumptively correct, and petitioner bears the burden of proving that the fair market value is lower. Rule 142; Welch v. Helvering, 290 U.S. 111">290 U.S. 111 (1933).At trial, both sides presented the testimony of expert witnesses to establish the fair market value of the Jung Corp. stock. It would serve no useful purpose to make a detailed analysis1993 U.S. Tax Ct. LEXIS 69">90 of the testimony of these experts to explain item by item the extent to which we agree or disagree with their analysis. Valuation is a not precise science, and the determination 101 T.C. 412">424 of the fair market value of property on a given date is a question of fact ( Kaplan v. Commissioner, 43 T.C. 663">43 T.C. 663, 43 T.C. 663">665 (1965)), to be resolved on the basis of the entire record ( McShain v. Commissioner, 71 T.C. 998">71 T.C. 1004), and without necessarily being bound by the opinions of the expert witness, Silverman v. Commissioner, 538 F.2d 927">538 F.2d 927, 538 F.2d 927">933 (2d Cir. 1976), and cases there cited, affg. T.C. Memo. 1974-285; Palmer v. Commissioner, 523 F.2d 1308">523 F.2d at 1310. However, we will note considerations that we have taken into account in our determination and explain how we reach our conclusions. See Akers v. Commissioner, 798 F.2d 894">798 F.2d 894, 798 F.2d 894">897 (6th Cir. 1986), revg. and remanding T.C. Memo. 1984-208.Petitioner contends that the value of decedent's stock on October 9, 1984, was $ 2,997,708 (after applying discounts). 1993 U.S. Tax Ct. LEXIS 69">91 Petitioner averages the per-share amounts determined by its three experts and multiplies this average ($ 17.78) by the number of shares (168,600) to arrive at its position. This position is about 12 percent greater than the amount shown on the estate tax return. On brief, in regard to the prediscount value of Jung Corp., petitioner does not offer substantive criticism of respondent's expert witness reports.In contrast, respondent finds error in all of the expert witness reports, including those of her own expert witnesses. Respondent contends that all the experts undervalued Jung Corp. Respondent criticizes each report on various grounds, and urges this Court to determine a value for Jung Corp. by determining each element used in the discounted cash-flow (hereinafter sometimes referred to as DCF) approach, 6 and by recomputing value based on that approach. Respondent contends that the DCF approach gives decedent's shares a prediscount value of $ 46.20 per share. Respondent contends that if we choose to rely in whole or in part on the comparable market approach, then we should refer to ratios of companies selected by both parties' expert witnesses, as compiled by respondent. 1993 U.S. Tax Ct. LEXIS 69">92 Respondent contends that Jung Corp. is two-thirds health care operations and one-third elastic textile operations. Respondent contends that the Court would need 101 T.C. 412">425 only to determine the appropriate normalized income to be used in the market comparable analysis, and the emphasis to be given to the home health care and elastic textile segments of Jung Corp. Respondent contends that under the comparable market approach the prediscount value of decedent's shares is $ 56.11 per share. Respondent contends that the Court should give the comparable market approach twice the weight as the DCF approach, so that the prediscount value of decedent's shares is $ 52.81 per share. As to discounts, respondent contends that a minority discount should not be applied, and that a marketability discount of 10 percent should be applied, giving decedent's stock a value after discounts of $ 47.53 per share, which results in a total that respondent rounds to $ 8 million. Respondent also contends that in valuing decedent's stock, proceeds of the 1986 sale and liquidation of Jung Corp. should be considered. Respondent's position on brief is about 4 percent less than the amount shown on the notice1993 U.S. Tax Ct. LEXIS 69">93 of deficiency and about 43 percent greater than the revised amount presented by her own expert witnesses.We agree with petitioner in part, and we agree with respondent in part.First, we briefly summarize the approaches and conclusions of the experts. Then we analyze the value of Jung Corp. as of October 9, 1984. Then we consider the appropriateness and magnitude of discounts for marketability and minority interests. Finally, we reach our conclusion as to the1993 U.S. Tax Ct. LEXIS 69">94 fair market value of the property (i.e., decedent's 168,600 shares of Jung Corp.).A. Expert WitnessesBoth sides submitted expert witness reports and presented expert witness testimony in regard to the value of decedent's stock at the date of death. Three expert witnesses testified for petitioner, and two expert witnesses testified for respondent.Petitioner -- RobinsonRobinson is a 50-percent owner of Mayfield. He is an attorney and an accountant, and has had extensive experience in valuing businesses. Robinson submitted his report to petitioner on April 8, 1985, before the estate tax return was 101 T.C. 412">426 filed, and his valuation was the amount used on the tax return -- $ 2,671,973.Robinson concluded that the best measure of value for Jung Corp. was by reference to Jung Corp.'s earning capacity. Robinson did not use the comparable sales method of valuation because he concluded that there were no public companies whose business was reasonably comparable to Jung Corp.'s. In particular, although there were publicly traded hosiery companies about the size of Jung Corp., "they are not significant participants in the health care or sports business in the [same] sense that1993 U.S. Tax Ct. LEXIS 69">95 Jung is. Competitors * * * in the sports and health care market are typically so large overall that comparisons are meaningless." Robinson concluded that Jung Corp. should be valued at less than book value, which he determined to have been $ 19,857,000, as adjusted to the first in, first out, method of inventory valuation. Robinson also valued Jung Corp. using a price earnings multiple of 9, which produced a value for Jung Corp. of $ 18,405,000 at the date of death, and which Robinson concluded was the value of Jung Corp. This led to his determination of a prediscount value of $ 3,817,104, or $ 22.64 per share for decedent's stock. Robinson then discounted this value by 30 percent to account for both lack of control and lack of marketability. Robinson did not assign separate discount rates to the control and marketability factors. This resulted in a value for decedent's stock of $ 2,671,973.Petitioner -- McCoyDavid O. McCoy (hereinafter sometimes referred to as McCoy) has more than 20 years of experience in business valuation. McCoy used three approaches in his appraisal: A market comparable approach, a discounted cash-flow approach, and a capitalization of earnings 1993 U.S. Tax Ct. LEXIS 69">96 approach. The amounts McCoy obtained for the value of Jung Corp. are shown in table 5.Table 5Market comparable method:Earnings $ 20,942,000Capital 18,510,000Sales 18,889,000Assets 18,249,000DCF method:Growth rate 3% 18,247,000Growth rate 5% 18,945,000Growth rate 7% 19,722,000Capitalization of earnings method18,213,000101 T.C. 412">427 McCoy averaged the eight amounts, and rounded the result, obtaining a prediscount value of Jung Corp. of $ 18,966,000, and a prediscount value for decedent's stock of $ 23.34 per share. McCoy then applied a discount of 35 percent for lack of marketability, but no minority discount, giving decedent's stock a value of $ 15 (rounded) per share. This comes to a total of $ 2,529,000 for the 168,600 shares.At trial, McCoy conceded a number of errors, and estimated the effects of correcting certain of these errors. As a result, petitioner evaluates McCoy's revised valuation estimate as $ 17.50 per share, which comes to a total of $ 2,950,500 for the 168,600 shares.Petitioner -- GrabowskiRoger J. Grabowski (hereinafter sometimes referred to as Grabowski) is a principal and director of Price Waterhouse Valuation Services, 1993 U.S. Tax Ct. LEXIS 69">97 and he has had extensive experience in valuing businesses. In valuing Jung Corp., Grabowski divided the various subsidiary companies of Jung Corp. into three separate groups. The health care product operations group comprises Futuro, JII, Theradyne, and Calley & Currier. The elastic textile operations group comprises JRA, Rampon, and the activities of the Richard Grey Co. (which was a part of Rampon). The third group comprises the real estate assets and machinery and equipment assets of Ione. Grabowski used the market comparable approach and the DCF approach, see supra note 6, in valuing the first two groups.In Grabowski's revised report, his market comparable approach gave the following values shown in table 6.101 T.C. 412">428 Table 6Health care operations$ 17,910,150Elastic textile operations7,520,300Book value of Ione621,143Prediscount value of Jung Corp.26,051,593Decedent's proportionate share1 5,373,483Less: Marketability discount (35%)1,880,719Postdiscount value of decedent's share3,492,7641993 U.S. Tax Ct. LEXIS 69">98 Grabowski also used the DCF approach in valuing the health care products operations and the elastic textile operations.In Grabowski's revised report, his DCF approach gives the values shown in table 7.Table 7Health care product operations$ 21,931,000Elastic textile operations10,302,000Book value of Ione Realty621,143Prediscount value of Jung Corp.32,854,143Decedent's proportionate share1 6,817,235Less: Minority discountsHealth care product operations (24%) 1,092,164Elastic textile operation (26%) 555,973Ione Realty (25%) 32,222Decedent's share before marketability5,137,056Less: Marketability discount (35%)1,797,970Fair market value of decedent's stock3,339,086101 T.C. 412">429 Grabowski concluded that the average of the two approaches was the value of decedent's stock. He concluded that decedents's Jung. Corp. stock was worth $ 20 per share (rounded). This comes to a total of $ 3,372,000 for the 168,600 shares.Respondent -- Hanan and MitchellMartin D. Hanan (hereinafter sometimes referred to as Hanan) 1993 U.S. Tax Ct. LEXIS 69">99 and Mark L. Mitchell (hereinafter sometimes referred to as Mitchell) prepared a joint expert witness report, and both of them testified. Hanan is the founder and president of Business Valuation Services and Mitchell manages the financial valuation services for Business Valuation Services. Both Hanan and Mitchell have extensive experience in valuing businesses. Hanan and Mitchell computed value by using the market comparable approach and the DCF approach. Hanan and Mitchell did not rely on the market comparable approach because they had difficulty in developing a reliable sample of comparable firms.In Hanan and Mitchell's revised report, their DCF approach gives the values shown in table 8.Table 8Value of operating assets (marketable, minority interestbasis) $ 33,413,952Plus nonoperating assets344,000Prediscount value of Jung Corp.33,757,952Less 20% marketability discount (operating assets)6,682,790Less 25% minority discount (nonoperating assets)86,000Postdiscount value of Jung Corp.26,989,162Postdiscount value of decedent's stock5,597,520SummaryThe conclusions of the expert witnesses and the Court may be summarized as shown in table1993 U.S. Tax Ct. LEXIS 69">100 9.101 T.C. 412">430 Table 9Discounts (percentage)Value ofExpertJung Corp.MinorityMarketabilityCombinedRobinson$ 18,405,0001 30McCoy18,966,000-0-3535McCoy (revised)2 22,127,000-0-3535Grabowski:Market comparable 18,071,5003 -0-1993 U.S. Tax Ct. LEXIS 69">101 3535Market comparable (revised) 26,051,5933 -0-3535DCF 26,355,1434 25355 51.25DCF (revised) 32,854,1434 25355 51.25Hanan, Mitchell32,989,0006 -0-2020Hanan, Mitchell(revised) 33,757,9526 -0-2020Court32-34 million-0-3535 B. Value of Jung Corp.1. Later-Occurring EventsRespondent contends that, in valuing Jung Corp. stock, this Court should consider the sale to Kendall, the other sales, and the ensuing liquidation of Jung Corp. Petitioner contends the 1986 sales and the liquidation are irrelevant because the sales and liquidation were unforeseeable at the valuation date.We agree in part with respondent and in part with petitioner.101 T.C. 412">431 A distinction may usefully be drawn between later-occurring events which affect fair market value as of the valuation date, and later-occurring events1993 U.S. Tax Ct. LEXIS 69">102 which may be taken into account as evidence of fair market value as of the valuation date.If a prospective October 9, 1984, buyer and seller were likely to have foreseen the 1986 sale to Kendall, and the other activities leading to the liquidation, then those later-occurring events could affect what a willing buyer would pay and what a willing seller would demand as of October 9, 1984. We conclude, and we have found that, on October 9, 1984, Jung Corp. was not for sale, the sale to Kendall was not foreseeable, and the liquidation was not foreseeable. Accordingly, we conclude that those later-occurring events did not affect the October 9, 1984, fair market of decedent's stock. Estate of Gilford v. Commissioner, 88 T.C. 38">88 T.C. 38, 88 T.C. 38">51-55 (1987).However, we have stated that "for purposes of determining fair market value, we believe it appropriate to consider sales of properties occurring subsequent to the valuation date if the properties involved are indeed comparable to the subject properties." Estate of Thompson v. Commissioner, 89 T.C. 619">89 T.C. 619, 89 T.C. 619">628-629 n.7 (1987), revd. on other grounds 864 F.2d 1128">864 F.2d 1128 (4th Cir. 1989).1993 U.S. Tax Ct. LEXIS 69">103 To the same effect are, e.g., Krapf v. United States, 977 F.2d 1454">977 F.2d 1454, 977 F.2d 1454">1458-1460 (Fed. Cir. 1992); Estate of Kaplin v. Commissioner, 748 F.2d 1109">748 F.2d 1109, 748 F.2d 1109">1111 (6th Cir. 1984), revg. T.C. Memo. 1982-440; Estate of Brown v. Commissioner, 425 F.2d 1406">425 F.2d 1406, 425 F.2d 1406">1407 (5th Cir. 1970), affg. T.C. Memo. 1969-91. See Estate of Jung v. Commissioner, T.C. Memo. 1990-5, and cases cited therein.Of course, appropriate adjustments must be made to take account of differences between the valuation date and the dates of the later-occurring events. For example, there may have been changes in general inflation, people's expectations with respect to that industry, performances of the various components of the business, technology, and the provisions of tax law that might affect fair market values between October 9, 1984, and the sales and liquidation some 2 years later. Although any such changes must be accounted for in determining the evidentiary weight to be given to the later-occurring events, those changes ordinarily are not justification1993 U.S. Tax Ct. LEXIS 69">104 for ignoring the later-occurring events (unless other comparables 101 T.C. 412">432 offer significantly better matches to the property being valued).When viewed in this light -- as evidence of value rather than as something that affects value -- later-occurring events are no more to be ignored than earlier-occurring events.Accordingly, we do not consider the sales and eventual liquidation as affecting the October 9, 1984, value of Jung Corp., but we do consider these events as evidence of the October 9, 1984, value.2. Treatment by Expert WitnessesRobinson did not consider the 1986 events in his expert witness report. This is to be expected -- his report was submitted to petitioner on April 8, 1985, and was the foundation for the valuation on the estate tax return, which was filed on July 9, 1985.At trial, on re-cross-examination, Robinson was asked if he considered Jung Corp. to be an acquisition candidate, and whether, if a company were about to be acquired at a premium, that would affect its value. Robinson agreed that one would take that into account. However, he went on to emphasize that he was not aware of that potential, and that he did not think that Jung Corp. was an 1993 U.S. Tax Ct. LEXIS 69">105 attractive acquisition candidate on October 9, 1984.McCoy did not consider the 1986 events in his expert witness report. At trial, on direct examination, he stated that he was aware of the sale, but did not know any details about it. He testified that he considered whether he should take into account the liquidation values, and made a decision that he should not take them into account. He said that the reasons the liquidation values are not relevant were (1) in 1984 there was no intention to sell Jung Corp., and (2) a minority interest holder has no power to force a liquidation or sale.Hanan and Mitchell considered the liquidation proceeds in their appraisal. After taking into account the changes in the market and the changes in Jung Corp. between October 9, 1984, and the 1986 sales and liquidation, they concluded that the proceeds obtained in the 1986 liquidation supported their date of death valuation.Grabowski did not consider the liquidation proceeds in his initial report. In his rebuttal report Grabowski contended that Hanan and Mitchell made errors in their calculations. 101 T.C. 412">433 Nevertheless, after taking into account his view of how the intervening events should 1993 U.S. Tax Ct. LEXIS 69">106 be accounted for, he concluded that the proceeds obtained by the shareholders in liquidation were consistent with his date of death valuation.Thus, Grabowski and Hanan and Mitchell evaluated the 1986 events in the manner we described supra as being appropriate (i.e., as evidence of fair market value as of the valuation date, and not as events affecting fair market value as of the valuation date) and concluded that this evidence was consistent with the results they derived from using the DCF approach.3. AnalysisRespondent urges us "to determine the appropriate rate or amount for each DCF element." Respondent also urges us to give twice the weight to the comparable market approach as to the DCF approach. Respondent concludes that Jung Corp. was worth $ 52.81 per share, which amounts to a total of about $ 43 million.In the instant case, we believe the DCF approach to valuing Jung Corp. is more reliable than the market comparable approach. The market comparable approach does not work well in the instant case because the comparable corporations do not have the same product mix (health and elastic textile) as Jung Corp. None of the experts relied exclusively on the market1993 U.S. Tax Ct. LEXIS 69">107 comparable approach, and Hanan and Mitchell and Robinson rejected the market comparable approach because they had difficulty finding companies which were similar to Jung Corp. At trial, Grabowski also stated that he did not rely on the market comparable approach.Finally, the 1986 sales of parts of Jung Corp. have been shown by Grabowski and by Hanan and Mitchell to be consistent with their conclusions of an October 9, 1984, value of $ 32-34 million for Jung Corp. See supra table 9. The lower valuations by Robinson and McCoy (about $ 18.4 and $ 22.1 million, respectively) were not reconciled with the 1986 events, and we doubt that they could be so reconciled.We conclude that Hanan and Mitchell and Grabowski accurately valued Jung Corp. using the DCF approach. We conclude (and we have found) that the prediscount value of Jung Corp. was about $ 32-34 million. Decedent's shares 101 T.C. 412">434 amounted to 20.74 percent of the total and were worth about $ 6.7 to $ 7.0 million, without giving effect to discounts.C. DiscountsThe parties agree that the date-of-death value to be assigned to decedent's shares should be discounted in some manner. Cases involving the valuation of1993 U.S. Tax Ct. LEXIS 69">108 minority holdings in close corporations ordinarily consider a discount or discounts because the stock is a minority holding and is not publicly traded. Conceptually, (1) a minority discount reflects a minority shareholder's inability to compel liquidation and thus inability to realize a pro rata portion of the corporation's net assets value, while (2) a marketability discount reflects the hypothetical buyer's concern that there will not be a ready market when that buyer decides to sell the stock. Each of these prospects (lack of control and lack of ready market) is likely to depress the price that a hypothetical buyer is likely to be willing to pay for the stock. Although we analyze them separately, it is likely that there is a significant real-world overlap between these two discounts. Estate of Andrews v. Commissioner, 79 T.C. 938">79 T.C. 938, 79 T.C. 938">952-953 (1982).Respondent does not dispute that a marketability discount should be applied. The only dispute is the amount of the discount. Respondent contends that a marketability discount of 10 percent is appropriate. Petitioner contends that decedent's stock should be discounted 35 percent for lack of marketability. 1993 U.S. Tax Ct. LEXIS 69">109 Petitioner contends that decedent's stock also should be discounted 25 percent because it is a minority interest in Jung Corp. Respondent acknowledges that a minority discount often is appropriate, but contends that under the DCF approach to valuation used in the instant case, no minority discount should be applied because the DCF approach used in the expert witness reports values the stock by reference to minority positions, so that the value obtained in the instant case is inherently the value of a minority interest.Under petitioner's approach, the combined discounts amount to a 51.25-percent reduction 7 from the undiscounted 101 T.C. 412">435 value of decedent's shares. Respondent's approach would allow an overall 10-percent discount. The experts' views, and the Court's conclusions, are shown supra, in table 9.1993 U.S. Tax Ct. LEXIS 69">110 We agree with petitioner as to the marketability discount and with respondent as to the minority discount. Thus, we apply a 35-percent reduction from the undiscounted value of decedent's shares.1. MarketabilityGrabowski reviewed six studies of transactions involving restricted stock. Grabowski's report indicated that these studies showed marketability discounts as follows:PercentageSecurities and Exchange Commission (hereinafter some-times referred to as SEC) Institutional Investor Study 25.8Gelman study33.0Trout study33.5Maher study35.4Moroney study35.6Standard research consultants study45.0Based on these studies, Grabowski concluded that a 35-percent discount for lack of marketability was appropriate. Grabowski's rebuttal report considered two additional studies, the Baird and Willamette studies. These studies compared initial public offerings to private transactions before the public offering. The Baird and Willamette studies showed median discounts in the private transactions of 66 percent and 74 percent, respectively.McCoy consulted a trade magazine that publishes information about private placements of common stock. The stocks are1993 U.S. Tax Ct. LEXIS 69">111 securities of companies that have other common shares that are registered with the SEC and are publicly traded in an active market. These securities are typically bought under an "investment letter" agreement. He reviewed all the private placements shown to have occurred in the 6 years from January 1, 1979, through December 31, 1984. After excluding certain categories of placements, he found 75 private transactions in the common stock of actively traded companies. Of 101 T.C. 412">436 the 75, 11 occurred at small premiums over the freely traded market price, 1 occurred at that market price, and 63 occurred at discounts (ranging up to 90 percent) from that market price. The average of these private placements was a discount of 27 percent. Under SEC rule 144(b), 817 C.F.R. sec. 230.144 (1984), such restricted securities will eventually become freely tradable through either registration or the passage of time. McCoy reasoned that, if such stocks with a temporary market restriction sold at an average discount of 27 percent, then Jung Corp. stock with a permanent market restriction should sell at a discount greater than 27 percent; he chose 35 percent. McCoy's rebuttal report added 1993 U.S. Tax Ct. LEXIS 69">112 comments about a Maher study and a Solberg study that supported average and modal discounts of 35 percent. In his rebuttal, he also indicated that Hanan's and Mitchell's discussions about the marketability of Jung Corp. are irrelevant to the question of marketability of a minority interest in Jung Corp.Robinson merely stated in his report: "We believe that a discount of 30% should apply to an interest such as Mrs. Jung's to account for the lack of control and lack of marketability." Robinson's report did not favor us with an explanation of his conclusion.Hanan and Mitchell concluded that a 20-percent marketability discount was appropriate. They based this conclusion on the SEC Institutional Investor Study for 19661993 U.S. Tax Ct. LEXIS 69">113 through 1969. This was a study of publicly traded stock which was restricted from trading on the open market for a certain period of time. The study shows average discounts of about 25 percent for companies with earnings similar to Jung Corp. Hanan and Mitchell concluded that because a majority of Jung Corp. stock was controlled by the Jung family, the sale of Jung Corp. could be easily accomplished. Hanan and Mitchell also concluded that Jung Corp.'s size, history of profitability, and relatively strong position in the market, and the quality of its management, indicated that the marketability discount should be less than the average marketability discount in the SEC Institutional Investor 101 T.C. 412">437 Study. Hanan and Mitchell determined the appropriate discount to be 20 percent.Here, too, respondent disagrees in part with her expert witnesses. Respondent contends that a 10-percent marketability discount is appropriate because Jung Corp. was an attractive acquisition candidate in 1984. Respondent states "that, without consideration of the acquisition potential, the marketability discount appropriate for Jung is between 15% and 20%, as was opined by BVS" (i.e., Hanan and Mitchell). 1993 U.S. Tax Ct. LEXIS 69">114 We are persuaded by the materials and analyses presented by McCoy and Grabowski. We believe that respondent, and to a lesser extent Hanan and Mitchell, gave too much weight to acquisition potential, or ease of sale, of Jung Corp. as a whole. We have found that, on October 9, 1984, Jung Corp. was not for sale, the sale to Kendall was not foreseeable, and the liquidation was not foreseeable. Also, as McCoy pointed out, we are concerned with the marketability of decedent's interest. We try to evaluate a market for decedent's 20.74-percent interest, not a market for Jung Corp. We assume a hypothetical willing seller of decedent's interest, not a hypothetical willing seller of Jung Corp. The hypothetical willing seller of decedent's shares would have to contend with an actual absence of interest in selling the entire corporation.Neither respondent nor Hanan and Mitchell presented an explanation of why the inquiries about acquiring Jung Corp. would translate into a significant market for decedent's shares, and we decline to speculate on this point.We conclude, and we have found, that a 35-percent marketability discount should be allowed.Respondent contends that a small marketability1993 U.S. Tax Ct. LEXIS 69">115 discount should be applied because Jung Corp. itself would have repurchased decedent's shares in order to keep ownership in the family. 9 Respondent supports this argument by noting 101 T.C. 412">438 that in 1972 Jung Corp. bought a 20-percent block of stock from a shareholder who was not a family member. This argument is not persuasive. Firstly, although Conway testified that he would rather decedent's stock did not fall into the hands of a third party, he also testified that Jung Corp. could tolerate a 20-percent shareholder who was not a family member. Further, the fair market value test under section 20.2031-1(b), Estate Tax Regs., contemplates a hypothetical willing buyer and a hypothetical willing seller. Propstra v. United States, 680 F.2d 1248">680 F.2d 1248, 680 F.2d 1248">1251-1252 (9th Cir. 1982); Estate of Bright v. United States, 658 F.2d 999">658 F.2d 999, 658 F.2d 999">1005-1006 (5th Cir. 1981); Minahan v. Commissioner, 88 T.C. 492">88 T.C. 492, 88 T.C. 492">499 (1987); Estate of Andrews v. Commissioner, 79 T.C. 938">79 T.C. 952-956. We will not cast Jung Corp. in the role of the hypothetical willing buyer.1993 U.S. Tax Ct. LEXIS 69">116 We hold, for petitioner, that a 35-percent marketability discount shall be applied.2. MinorityAs may be seen from table 9, supra, Grabowski did not provide for a minority discount under his market comparables approach (except for the minor matter discussed supra in table 9 note 3); McCoy did not provide for minority discount under any of the approaches he considered (see supra table 5; three-eighths of his final figures depend on a DCF approach); and Robinson's 30-percent discount was intended to take care of both marketability and minority considerations. Hanan and Mitchell provided for a 25-percent minority discount, but only for about 1 percent of the overall value, and so that minority discount had practically no effect on their conclusion. See supra table 9 note 6.Only Grabowski, among the expert witnesses, argues for a minority discount, and then only if we accept the DCF approach to valuation of decedent's interest in Jung Corp. As noted supra, (1) we accept the DCF approach to valuation of decedent's interest in Jung Corp., and (2) we accept the general concept of a minority discount in appropriate circumstances.101 T.C. 412">439 The matter now before1993 U.S. Tax Ct. LEXIS 69">117 us is whether we should allow a minority discount in addition to the 35-percent marketability discount we have already determined to allow, and, if so, then in what amount. The resolution of this issue depends on the workings of the DCF approach as used by the expert witnesses before us and explained on the record in the instant case.Grabowski contends that his DCF approach was designed to produce a control value, but concedes that a DCF approach could be used to produce a minority interest value (i.e., a value as to which a minority discount would not be appropriate). Hanan and Mitchell contend that their DCF approach embodies a minority interest value.Grabowski contends that his DCF approach leads to a control value because (a) his cash-flow assumptions for Jung Corp. were based on what a controlling interest could do to Jung Corp. to make it run better, (b) the discount rate he used did not reflect minority interest evaluation, and (c) his equity risk premium assumed large company financing synergies. We consider these contentions seriatim.(a) Grabowski's initial expert witness report states that a minority discount is needed because his DCF valuation was done on a controlling1993 U.S. Tax Ct. LEXIS 69">118 interest basis. The expert witness report states: "We presume that an investor is able to take the steps necessary to realize the projected results; therefore, a controlling interest is implicit." In his rebuttal expert witness report, Grabowski states as follows:Third, we have included one, quantifiable major synergy into our calculation which causes the formulation of the discounted cash flow approach to be a control value. Premiums for control are paid in buying entire businesses. That is, the controlling shareholders of Jung could realize a higher price if they could sell the business to a buyer who could affect [effect?] savings or synergies. (Such synergies are oftentimes categorized as operating, financial and tax synergies.)Operating savings on [or?] synergies result from increased sales or reduced costs by operating the business differently or combining businesses with a specific acquiring company.Financial synergy results form [from?] lower costs of funds because the acquiring firm or combined firms are perceived as less risky. Tax synergy results from tax savings peculiar to combining with a specific buyer (i.e., operating loss carryforwards to a specific1993 U.S. Tax Ct. LEXIS 69">119 buyer).We did not discover any major operating savings that a control-buyer of Jung could realize from changing the operations of Jung as a stand-along 101 T.C. 412">440 [alone?] company. Operating synergies and tax synergies are unique to each potential purchaser and could not be measured by the controlling shareholders of Jung. However, we did account for financing synergies which could only be realized if the existing controlling shareholders of Jung were to take action and sell their shares.In his oral testimony, Grabowski explained as follows:So we have measured available cash flow based on what we observe to be a reasonable way Jung Corp. was being run. We did not make, I grant you, any operating changes to Jung Corp. in the calculations of the cash flow. Sometimes, Your Honor, when you are doing a control basis, you will find that the controlling shareholder is taking $ 5 million of salary out. And if you are valuing on a control basis, you will add back the excess salary; he may or may not be worth $ 5 million. But if you determine that he is not, you would add that back. Because if I controlled the business, I would not run it that way.But there was no excessive amounts1993 U.S. Tax Ct. LEXIS 69">120 of compensation that we determined, excessive items that required extensive adjustments, et cetera, in valuing the control interest.In neither his expert witness reports nor his oral testimony did Grabowski suggest any other element of his calculation of the amount of the available cash-flow that would make his DCF approach a valuation of a controlling interest.From the foregoing, we gather that the only element of Grabowski's calculation of the amount of the available cash-flow that would make his DCF approach a valuation of a controlling interest is the financing synergy, which we discuss infra. As far as we can tell, in all other respects Grabowski's calculation of the amount of the available cash-flow was done on a basis which, by itself, would not result in a control premium, or minority discount.(b) The second area of dispute is whether the discount rate applied by the expert witnesses puts the DCF approach valuations on a minority basis. In their initial expert witness report, Hanan and Mitchell stated that no minority discount was needed in their DCF valuation because their discount rate was derived by using equity return data from the trading of minority interests1993 U.S. Tax Ct. LEXIS 69">121 in publicly traded companies.As explained previously, supra note 6, the DCF approach involves calculating the sum of the present value of the available cash-flow and the present value of the terminal value. A discount rate, which represents the required rate of return of an investor in an alternate investment opportunity, is used in this calculation. The discount rate is the weighted 101 T.C. 412">441 average of the required rate of return on equity capital and the required rate of return on debt capital. Both Grabowski and Hanan and Mitchell determined the required rate of return on equity capital by using the capital asset pricing model (hereinafter sometimes referred to as CAPM). The CAPM is the risk-free rate plus the product of the beta 10 for the specific company and an equity risk premium.1993 U.S. Tax Ct. LEXIS 69">122 The risk-free rate is the yield to maturity on 20-year (Grabowski) or 30-year (Hanan and Mitchell) U.S. Treasury bonds on the valuation date. This yield is available to investors in the market, without regard to control or minority status. Accordingly, this element of the discount rate does not affect the question of whether the DCF approach results in a controlling interest value or a minority interest value.Although the establishment of a beta for Jung Corp. involves consideration of many matters (e.g., selecting comparable companies the securities of which are commonly traded on stock exchanges, "unlevering" and "relevering"), it is enough for our purposes to observe that Grabowski and Hanan and Mitchell agree that the Jung Corp. beta was a little under 1. Also, because the betas for the companies and industries that these expert witnesses used are derived from reported stock exchange trading data, which is almost entirely the data of trading in minority interests, this element of the discount rate suggests that ordinarily the DCF approach results in a minority interest value.Grabowski and Hanan and Mitchell based their equity risk premiums on Ibbotson and Associates' publication, 1993 U.S. Tax Ct. LEXIS 69">123 "Stocks, Bonds, Bills, and Inflation". Grabowski based his calculations --on the arithmetic mean of actual investor returns over the period of 1950-1984 and consists of an overall excess return for the stock market as a 101 T.C. 412">442 whole of 7.34% (the additional return common stock investors earned in excess of the return on long-term government bonds).Hanan and Mitchell used the same source and --concluded that the market risk premium [a different term for equity risk premium] equals 6.9%, the average annualized total return on equity investments (defined as the S&P 500) in excess of the average annualized bond yield (income) return on long-term government bonds over the period January 1926 to December 1983.The modest difference between Grabowski's equity risk premium and that used by Hanan and Mitchell is one of many differences between them that were largely balanced out so that their bottom-line values for Jung Corp. differed by less than 3 percent. See supra table 9. What is important for purposes of the minority discount question is that the basic data these experts used are the data of stock market trading, which is almost entirely the data of trading in minority1993 U.S. Tax Ct. LEXIS 69">124 interests. Thus, this element of the discount rate also suggests that ordinarily the DCF approach results in a minority interest value.In his rebuttal expert witness report Grabowski contends that the discount rate represents the minimum rate of return which the corporation must earn on its investments, including acquisitions of controlling interests. He notes that the prospective controlling investor will control the total available cash-flow of the acquired corporation. However, this explanation does not persuade us that the discount rate in Grabowski's DCF calculation implies control, because this rate of return is developed from data that reflect the actions of minority investors and generally not the actions of controlling investors.We agree with respondent that the discount rates used by the expert witnesses in the instant case reflect the minority position. 111993 U.S. Tax Ct. LEXIS 69">125 101 T.C. 412">443 (c) Grabowski's main argument is his third argument. He contends that his equity risk premium assumed large company financing synergies. He contends that his equity risk premium of 7.34 percent is appropriate only if Jung Corp. were to be acquired by a large company which could incorporate financing synergies into Jung Corp. He contends that Hanan and Mitchell also assumed financing synergies in determining their equity risk premium of 6.9 percent. In his rebuttal expert witness report Grabowski contends that taking into account Jung Corp.'s small size, the equity risk premium should be 16.73 percent rather than 7.34 percent. Grabowski asserts that a premium of 16.73 percent is appropriate based on the equity risk premiums of the smallest companies traded on the New York Stock Exchange. Stated otherwise, Grabowski is contending that a "small stock" premium of 16.73 percent should have been applied in the DCF valuation, and that because he did not apply a small stock premium, a minority discount is needed to make up for his error. Grabowski did not make this contention in his initial expert witness report. He made this contention only when his minority discount1993 U.S. Tax Ct. LEXIS 69">126 was challenged. We do not agree that a small stock premium is appropriate in the instant case, and we do not agree that a minority discount is appropriate in the instant case.Firstly, if Grabowski had applied the small stock premium in his DCF approach to Jung Corp.'s value, then his prediscount value would be only about $ 20 million. 12 That 101 T.C. 412">444 number is even less than McCoy's revised estimate. See supra table 9. Grabowski has not shown us how a $ 20 million October 9, 1984, valuation (or any valuation calculated with Grabowski's small stock premium) could be reconciled with the 1986 sales and liquidation proceeds. We rejected McCoy's $ 22 million valuation in part because of McCoy's failure to so reconcile, and accepted Grabowski's $ 33 million valuation because it could be reconciled with the 1986 events.1993 U.S. Tax Ct. LEXIS 69">127 Accordingly, we reject Grabowski's contention that he had erred by failing to use a small stock premium in his initial expert witness report calculation in the instant case. Because a small stock premium would not have been appropriate in the instant case (whatever may be the general validity of the small stock premium concept), there is no force to Grabowski's contention that a minority discount is appropriate in order to make up for Grabowski's failure to use a small stock premium.Secondly, Mitchell testified that small companies tend to be more risky because they tend to be in risky industries. Thus, the apparently greater equity risk premiums for small companies, on which Grabowski relies, are merely a reflection of the risk involved in the type of activity and not a greater risk arising merely or primarily because of corporate size. As a result, it is not at all clear that there is any general validity in the small stock premium concept, except as a substitute for a beta rating. See Pratt, Valuing a Business: The Analysis and Appraisal of Closely-Held Companies 76-77 (2d ed. 1989).Thirdly, at trial when Grabowski was asked to explain the differences in risk and1993 U.S. Tax Ct. LEXIS 69">128 rates of return in regard to an investment in a small company like Jung Corp., and an investment in a large publicly traded company, Grabowski discussed lack of control and lack of marketability, factors which are taken into account by the DCF approach and a discount for lack of marketability. Grabowski did not provide the Court with any evidence that Jung Corp. is a riskier investment simply because of its small size. In addition, Grabowski did not provide any explanation of why the size of the corporation affects 101 T.C. 412">445 the appropriateness of a discount for a minority interest in the corporation.We conclude that in the instant case financing synergies do not justify a minority discount, on top of the 35-percent marketability discount that we have already determined to allow.At trial, the Court raised the question of whether some amount of minority discount is appropriate to account for the difference between a minority shareholder in a publicly traded corporation and a minority shareholder in a closely held corporation. On brief petitioner contends that there is a difference between minority shareholders in private and publicly traded companies, but petitioner provides1993 U.S. Tax Ct. LEXIS 69">129 neither authority nor persuasive reasoning to support the contention. Respondent contends that although there may be differences, the differences generally do not affect the value of the stock, and in any event do not affect the value of decedent's stock in the instant case. The Court has not found any authority for using the public-private distinction as a basis for applying a minority discount. Accordingly, in the instant case we do not apply a minority discount based on the differences between public and private minority shareholders.We conclude that the DCF calculations by Grabowski and by Hanan and Mitchell in the instant case were on a minority basis, and we have found that in the instant case no minority discount should be applied to the values determined using the DCF approach.Petitioner contends that in Northern Trust Co., Transferee v. Commissioner, 87 T.C. 349">87 T.C. 349, 87 T.C. 349">383 (1986), affd. sub nom. Citizens Bank & Trust Co. v. Commissioner, 839 F.2d 1249">839 F.2d 1249 (7th Cir. 1988), this Court approved the use of a minority discount when the DCF approach is used in valuation. Respondent tells us that the instant case provides1993 U.S. Tax Ct. LEXIS 69">130 us "with an opportunity to reconsider issues" in Northern Trust Co., Transferee.In Northern Trust Co., Transferee, stock of a closely held corporation was valued. Grabowski submitted an expert witness report and testified in that case. Grabowski used the DCF approach, and he used the CAPM to determine the discount rate. After deciding on a value for the corporation, he applied a minority discount. 87 T.C. 349">87 T.C. 369. This Court concluded that the DCF approach correctly determined the value 101 T.C. 412">446 of the stock. We also allowed both minority and marketability discounts. Id. However, in Northern Trust Co., Transferee, respondent did not contend that no minority discount was appropriate. Rather, respondent merely argued for a lower minority discount than the discount for which the taxpayer contended. Id. Because the parties in Northern Trust Co., Transferee did not present to the Court the question of whether a minority discount could be allowed in conjunction with the DCF approach, the opinion in that case did not explore whether the DCF approach that Grabowski used in that case was calculated on a control basis rather than1993 U.S. Tax Ct. LEXIS 69">131 on a minority basis. See Estate of Fusz v. Commissioner, 46 T.C. 214">46 T.C. 214, 46 T.C. 214">215 n.2 (1966).Thus, we do not accept respondent's invitation to reconsider our opinion in 87 T.C. 349">Northern Trust Co., Transferee v. Commissioner, supra, and we also conclude that that opinion does not require us to allow a minority discount in the instant case.We hold, for respondent, that no minority discount shall be applied.D. ConclusionIn determining the date-of-death value of decedent's shares in Jung Corp., we have concluded that the value of Jung Corp. was $ 32-34 million. We have concluded that the prediscount value of decedent's shares was $ 6.7 to $ 7 million, and that this must be discounted by 35 percent.We are obligated to set a specific number on the value of decedent's interest. We are not so presumptuous as the parties, who claimed the wisdom in the estate tax return and in the notice of deficiency to determine the value to seven significant figures ($ 2,671,973 and $ 8,330,448, respectively). Taking into account the "inherently imprecise" nature of this issue, Messing v. Commissioner, 48 T.C. 502">48 T.C. 502, 48 T.C. 502">512 (1967),1993 U.S. Tax Ct. LEXIS 69">132 we determine this value to two significant figures -- $ 4,400,000. We have so found.We hold for neither party on this issue, although we note that our conclusion is significantly closer to petitioner's position than it is to respondent's position.101 T.C. 412">447 II. Section 6660In her amendment to answer, respondent asserts an addition to tax under section 6660. See sec. 6214(a). Respondent asserts that the value claimed on the tax return is less than 40 percent of the correct value, and so the addition to tax should amount to 30 percent of the underpayment attributable to the valuation understatement. On brief, respondent does not specifically ask for the 30-percent rate, but rather asks for an addition to tax "in an amount to be computed based upon the value of the decedent's interest in Jung as determined by the Court." Respondent contends that petitioner did not have a reasonable basis for the valuation claimed on its tax return and that respondent did not abuse her discretion in refusing to waive the addition.Petitioner contends that there should be no addition to tax because (1) there is no valuation understatement, and (2) even if there is a valuation understatement, 1993 U.S. Tax Ct. LEXIS 69">133 the addition to tax should be waived because (a) there was a reasonable basis for the estate tax return value, (b) petitioner claimed this value in good faith, and (c) respondent "wrongfully refused to waive the addition to tax".Respondent relies on our opinion in Mailman v. Commissioner, 91 T.C. 1079">91 T.C. 1079 (1988). Petitioner seeks to distinguish that case because (1) it is based on a different Code section (sec. 6661, not sec. 6660, as is the instant case), (2) in Mailman we relied on regulations under section 6661 while there are no regulations under section 6660, and (3) in Mailman there was no expert evidence or evidence of the taxpayer's efforts to determine proper tax liability, while in the instant case there is substantial evidence in both categories.We agree with respondent that there is a valuation understatement, but we agree with petitioner that the resulting addition to tax should be waived.Section 666013 provides for an addition to tax if there is an underpayment of tax of at least $ 1,000 attributable to a 101 T.C. 412">448 valuation understatement for purposes of estate or gift tax. There is a valuation understatement if the value 1993 U.S. Tax Ct. LEXIS 69">134 stated on the tax return is 66 2/3 percent (or less) of the correct value. Respondent may waive all or part of this addition to tax if there was a reasonable basis for the valuation claimed on the return and the claim was made in good faith.1993 U.S. Tax Ct. LEXIS 69">135 Because respondent did not determine the addition to tax in the notice of deficiency, but asserted it in the amendment to answer, respondent has the burden of proof on all of the elements of section 6660. Rule 142(a); see Reiff v. Commissioner, 77 T.C. 1169">77 T.C. 1169, 77 T.C. 1169">1173 (1981); Achiro v. Commissioner, 77 T.C. 881">77 T.C. 881, 77 T.C. 881">889-891 (1981).We consider first whether there is a valuation understatement and, if so, then whether the addition to tax should be waived.101 T.C. 412">449 A. Valuation UnderstatementAs shown supra in table 4, we hold that the correct value of decedent's interest in Jung Corp. is $ 4,400,000, and petitioner claimed on its estate tax return that the value is $ 2,671,973. The claimed value thus is about 60.7 percent of the correct value. It follows that there is a valuation understatement, sec. 6660(c), and that the applicable percentage is 10 percent, sec. 6660(b). It is apparent that the underpayment of estate tax attributable to the valuation understatement is at least $ 1,000. Sec. 6660(d).As a result, an addition to tax of 10 percent of the attributable underpayment is to be imposed on account of the valuation1993 U.S. Tax Ct. LEXIS 69">136 understatement, unless the addition to tax is waived.B. WaiverSection 6660(e) provides that the Secretary may waive all or part of the addition to tax under section 6660 if the taxpayer shows both (1) that there was a reasonable basis for the valuation claimed on the tax return, and (2) that the taxpayer acted in good faith in claiming that valuation. The denial of a waiver by the Secretary is reviewable by this Court on an abuse-of-discretion basis. Mailman v. Commissioner, 91 T.C. 1079">91 T.C. 1082-1084. 141993 U.S. Tax Ct. LEXIS 69">137 In other words, for petitioner to win on this issue it is not enough for us to conclude that we would have waived the addition to tax -- we would have to conclude that, in refusing to waive the addition to tax, respondent has exercised this discretion "arbitrarily, capriciously, or without sound basis in fact." Mailman v. Commissioner, 91 T.C. 1079">91 T.C. 1084; 15 see Capitol Fed. Sav. & Loan v. Commissioner, 96 T.C. 204">96 T.C. 204, 96 T.C. 204">213, 96 T.C. 204">223 (1991).101 T.C. 412">450 In the instant case, respondent has the burden of proof on the section 6660 addition to tax. If respondent were to prove that either (1) there was not a reasonable basis for the valuation claimed on the tax return, or (2) the valuation claim was not made in good faith, then1993 U.S. Tax Ct. LEXIS 69">138 respondent would have proven that petitioner failed to meet the statutory predicate for consideration of a waiver. Failing that, respondent could prevail if she were to prove that her refusal to waive the addition to tax (1) was not arbitrary, (2) was not capricious, and (3) had a sound basis in fact.We consider first whether the valuation claim was made in good faith, then whether there was a reasonable basis for the valuation, and finally whether respondent abused her discretion in failing to waive the addition to tax.1. Good FaithIt was clear that decedent's interest in the Jung Corp. constituted substantially all of decedent's estate. The executrix proceeded promptly to retain the services of Robinson, an experienced appraiser. Robinson examined financial records and interviewed officials of Jung Corp. On April 8, 1985, he submitted a report which provided some explanation of his conclusions. Petitioner's estate tax return, incorporating Robinson's valuation, was filed timely, on July 9, 1985. Respondent does not direct our attention to any evidence pointing to lack of good faith.We conclude (and we have found) that petitioner acted in good faith in claiming1993 U.S. Tax Ct. LEXIS 69">139 the valuation reported on the estate tax return.2. Reasonable BasisIt is a close question whether there was a reasonable basis for the valuation claimed on the return.On the one hand, Robinson undervalued decedent's stock by about $ 1.7 million -- an undervaluation of about 39 percent of what we have determined to be the correct value. Robinson's report is short, it is deficient in providing data and support for its conclusions, and the Court has given little weight to it in valuing the stock. 161993 U.S. Tax Ct. LEXIS 69">140 101 T.C. 412">451 On the other hand, Robinson's analysis does have some validity, and his conclusions were based on his extensive experience as an appraiser. Robinson's report, although poor for purposes of assisting the Court in determining the value of decedent's interest, does give some explanation of Robinson's conclusion, analysis, and process. Also, it is evident that valuing decedent's interest is a difficult task. After all, in the notice of deficiency respondent overvalued decedent's interest by about 89 percent. Even on brief, after having access to all the expert witness reports and other evidence of record (more than 3 1/2 linear feet of exhibits and almost 1,000 pages of transcript), respondent overvalued decedent's interest by about 82 percent. Thus, petitioner's valuation was much closer to the mark than was respondent's valuation.Petitioner does not contend that Robinson's value for Jung Corp. ($ 18,405,000) can be reconciled with the proceeds which were obtained by the shareholders through the sale of Jung Corp.'s subsidiaries and assets; however, this does not negate our finding of a reasonable basis. When the appraisal report was prepared and the estate tax return1993 U.S. Tax Ct. LEXIS 69">141 was filed, neither Robinson nor the executrix of the estate knew that Jung Corp.'s subsidiaries and assets would be sold, and what the liquidation proceeds would amount to.Under the circumstances, we conclude (and we have found) that there was a reasonable basis for the valuation claimed on the estate tax return.3. Abuse of DiscretionIf our role were to determine whether petitioner had reasonable cause and acted in good faith, then our determinations under items 1 and 2, supra, would be enough, and petitioner would prevail. However, for the years before the Court our role is much more limited. See supra the last paragraph of note 13. As we stated in Mailman v. Commissioner, 91 T.C. 1079">91 T.C. 1079, 91 T.C. 1079">1084 (1988) --101 T.C. 412">452 Unlike other additions to tax such as for failure to timely file (sec. 6651(a)(1)), the statute does not provide that the taxpayer's proof of reasonable cause will excuse the taxpayer's misfeasance.To put it another way, under the statute's language petitioner's showing of reasonable basis and good faith serve only to bring petitioner to the point where respondent "may waive all or any part of the addition to the tax". 1993 U.S. Tax Ct. LEXIS 69">142 Sec. 6660(e) (emphasis added). That is, such a showing gets petitioner into the game; in order for petitioner to win the game, we must consider whether respondent's refusal to waive is an abuse of discretion. In the instant case we have to determine whether respondent has carried her burden of persuading us that her discretion was not exercised "arbitrarily, capriciously, or without sound basis in fact." Mailman v. Commissioner, 91 T.C. 1079">91 T.C. 1084. On the one hand, petitioner's actions have satisfied the good faith and reasonable basis requirements, but not so clearly as to make respondent's refusal to waive arbitrary or capricious. On the other hand, it is evident that respondent's view of the situation was affected by a view of the facts that was far from the view that we took.As we have noted, respondent overvalued the property by $ 3.6 million on brief, while petitioner undervalued the property by a little more than $ 1.7 on the tax return. From respondent's position on brief, petitioner's tax return undervaluation was enormous. From our view of the facts, the amount of petitioner's tax return undervaluation was less than one-half the amount 1993 U.S. Tax Ct. LEXIS 69">143 of respondent's overvaluation on brief. We conclude that respondent's discretion was exercised "without sound basis in fact." Mailman v. Commissioner, 91 T.C. 1079">91 T.C. 1084.We conclude, and we have found, that respondent's refusal to waive the addition to tax under section 6660 was an abuse of discretion.In Estate of Berg v. Commissioner, T.C. Memo. 1991-279, affd. in part and revd. in part 976 F.2d 1163">976 F.2d 1163 (8th Cir. 1992), we held that respondent's discretion had not been abused in refusing to waive the section 6660 addition to tax. The Court of Appeals reversed on that issue. The record in the instant case is far more favorable to petitioner than the record presented by the taxpayer in Estate of Berg.101 T.C. 412">453 In Estate of Berg, the taxpayer did not commission an appraisal until more than 4 years after the decedent's death; in the instant case petitioner did commission an appraisal promptly, and the value on the timely filed estate tax return was based on that appraisal. In Estate of Berg, the estate tax return did not provide support for the claimed valuation, except for a reference1993 U.S. Tax Ct. LEXIS 69">144 to another opinion of this Court; in the instant case, Robinson's appraisal was deficient in terms of evidentiary standards, but provided some substantive support for the claimed valuation. In Estate of Berg, we agreed with respondent's determination of value; in the instant case, respondent overvalued the property by more than twice as much as petitioner undervalued it. Thus, our conclusion in the instant case that respondent's discretion was abused is consistent with our conclusion in Estate of Berg that respondent's discretion was not abused.In Estate of Berg, the Court of Appeals held that respondent's discretion was abused. This is the same result that we reach in the instant case.We conclude that, under these circumstances, the instant case is not an appropriate vehicle for determining whether we agree with the analysis presented by the Court of Appeals for the Eighth Circuit in Estate of Berg v. Commissioner, 976 F.2d at 1166-1167.We hold for petitioner on this issue.To take account of the foregoing and concessions on other matters,Decision will be entered under Rule 155.APPENDIXJung Corp. -- Consolidated as of September1993 U.S. Tax Ct. LEXIS 69">145 30, 1984Assets Current assets:Cash $ 1,582,396 Short-term investments and cer- tificates of deposit 591,804 Dividends receivable -0- Accounts receivable: Trade 9,613,349 Other 1,711,458 Allowance for doubtful accounts 168,167CRTotal accounts receivable 11,156,640 Inventories 9,188,984 Prepaid expenses 84,113 Prepaid employee benefit plan 1,091,709 Advances & receivables from affiliates 2,583,493 Deferred income taxes 241,649CRTotal current assets 26,037,490 Investment and advance tosubsidiaries -0- Property, plant & equipment:Land 466,484 Building 4,920,540 Leasehold improvements 338,494 Machinery & equipment 12,603,710 Construction work in progress 217,050 Total 18,546,278 Less allowance for depreciation 9,402,491CRTotal property plant & equipment 9,143,787Other assets:Cash surrender value of life insurance, net 403,899 Due from officers 267,174 Sundry 121,373 Total other assets 792,446Excess of cost over equity in sub-sidiary at date of acquisition 393,419Total assets 36,367,142Liabilities Current liabilities: Notes payable to banks $ 1,700,000 Current portion of capital lease obligations and long-term debt 178,996 Trade accounts payable 3,438,694 Advances and payable to affiliates 2,673,689 Other accounts payable and accrued expenses 1,920,586 Accrued profit sharing 895,061 Accrued employee benefit plan 1,095,028 Dividend payable -0- Federal and State income tax 267,201 Total current liabilities 12,169,255 Capital lease obligations 900,000 Long-term debt 3,277,568 Deferred Federal income taxes 1,040,281 Accrued executive retirement net of deferred taxes 135,622 Minority interest in subsidiaries 14,556 Total liabilities 17,537,282Shareholders' equity: Capital stock -- class B 33,600 Common stock 1,216,241 Additional paid-in capital 1 Retained earnings 17,580,018 Total stockholders' equity 18,829,860Total liabilities & equity 36,367,1421993 U.S. Tax Ct. LEXIS 69">146 Footnotes1. Unless indicated otherwise, all section references are to sections of the Internal Revenue Code of 1954 as in effect for the date of decedent's death.↩2. Rule 151(e)(3) provides, in pertinent part, as follows:RULE 151. BRIEFS(e) Form and Content: All briefs shall contain the following in the order indicated:* * (3) * * In an answering or reply brief, the party shall set forth any objections, together with the reasons therefor, to any proposed findings of any other party, showing the numbers of the statements to which the objections are directed; in addition, the party may set forth alternative proposed findings of fact.In the instant case, the parties filed simultaneous briefs. Petitioner's answering brief does not include responses to respondent's proposed findings of fact. Under the circumstances, we have assumed that petitioner does not object to respondent's proposed findings of fact except to the extent that petitioner's proposed findings of fact are clearly inconsistent therewith.Unless indicated otherwise, all Rule references are to the Tax Court Rules of Practice and Procedure.↩3. On Oct. 9, 1984, 900,000 voting shares were authorized and 809,560 were outstanding; 100,000 nonvoting shares were authorized and 3,360 were outstanding. Neither the parties nor the expert witnesses appear to attribute different values to the voting and nonvoting shares.↩4. So stipulated. Apparently Jung Corp. also had an MIS division, which coordinated all the management information services activities within Jung Corp.↩1. The indicated expert witness reports provided only per-share values. The total value numbers set forth in this table are the product of the respective per-share value and decedent's 168,600 shares.↩2. At trial, McCoy revised several of his numbers. Petitioner evaluated these changes as increasing McCoy's estimate of per-share value from $ 15 (rounded) to $ 17.50 (rounded).↩5. Sec. 2031 provides, in pertinent part, as follows:SEC. 2031. DEFINITION OF GROSS ESTATE.(a) GENERAL. -- The value of the gross estate of the decedent shall be determined by including to the extent provided for in this part, the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated.(b) VALUATION OF UNLISTED STOCK AND SECURITIES. -- In the case of stock and securities of a corporation the value of which, by reason of their not being listed on an exchange and by reason of the absence of sales thereof, cannot be determined with reference to bid and asked prices or with reference to sales prices, the value thereof shall be determined by taking into consideration, in addition to all other factors, the value of stock or securities of corporations engaged in the same or a similar line of business which are listed on an exchange.↩6. The DCF approach computes the present value of the estimated future cash-flow. First, the available cash-flow of the business is determined for a certain projection period. Second, a discount rate is applied to determine the present value of the cash-flow. Third, the residual value of the business at the end of the projection period is determined. Fourth, the present value of the residual value is computed. Fifth, the present value of the projected cash-flow is added to the present value of the residual value. The sum is the value of the business.↩1. Before calculating decedent's proportionate share, Grabowski reduced the book value of Ione by 25 percent as a minority discount. In calculating decedent's proportionate share, Grabowski used 20.75 percent, rather than the 20.74 percent we have found.↩1. In calculating decedent's proportionate share, Grabowski used 20.75 percent, rather than the 20.74 percent we have found.↩1. Robinson's 30-percent discount is intended to take into account both marketability and minority holding consideration.↩2. As noted supra↩, petitioner understands the effect of McCoy's trial testimony as increasing his valuation of decedent's shares from $ 15 per share to $ 17.50. This table shows what would be the result if McCoy were to apply the same proportionate increase (i.e., one-sixth) to his estimate of fair market value for the Jung Corp.3. As may be seen from table 6 note 1, supra, Grabowski (in his market comparable approach) does not apply a minority discount to Jung Corp.'s operating assets, but does apply a 25-percent minority discount to Jung Corp.'s nonoperating assets only. Because the operating assets, in Grabowski's analysis, are about 97.5 percent of the total, this is the equivalent of applying a minority discount of about 0.6 percent across the board. After applying the method of calculating combined discounts, described infra↩ note 7, this increases the combined discount to about 35.4 percent.4. This is the average of the minority discount rates that Grabowski applies to the different parts of Jung Corp.↩5. See infra↩ note 7 for the method of calculating the combined discount.6. As may be seen from table 8, supra↩, Hanan and Mitchell apply a 20-percent marketability discount to Jung Corp.'s operating assets only, and a 25-percent minority discount to Jung Corp.'s nonoperating assets only. Because the operating assets, in Hanan's and Mitchell's analysis, are almost 99 percent of the total, this is the equivalent of applying one 20.05-percent discount across the board.7. The discounts are calculated in series in Grabowski's report. Thus, the 35-percent marketability discount would reduce the value to 65 percent of the undiscounted value. The 25-percent minority discount would be applied to the remaining value and would reduce it by another 16.25 percent of the undiscounted value. (25 percent times 65 percent equals 16.25 percent.) Thus, application of the two discounts would result in an aggregate reduction of 51.25 percent. (35 percent plus 16.25 percent.) The commutative laws of mathematics cause the result to be the same, even if the multiplications are made in the reverse order.↩8. The language of SEC rule 144(b) was unchanged during 1979-84 (the years from which the statistics were taken). The definition of "restricted securities" was revised during 1979-84, but we doubt that these changes affected the results of the statistics upon which McCoy based his marketability discount.↩9. Respondent relies on Estate of Neff v. Commissioner, T.C. Memo. 1989-278, where this Court considered the willingness of a corporation to repurchase its shares in determining the amount of a marketability discount. In Estate of Neff, Rand McNally repurchased stock because of its self-avowed commitment to maintain its status as a closely held corporation with a limited number of shareholders. Further, in repurchasing the stock, Rand McNally was willing to pay full or premium value. This Court considered Rand McNally's history of repurchases in determining the proper marketability discount. The instant case is distinguishable because (1) in the instant case there is a showing of one repurchase 12 years before the valuation date, while in Estate of Neff, the corporation "repurchased shares on numerous occasions" and made a major repurchase in the same year as the valuation date; and (2) in the instant case there was no evidence of a willingness to pay full value or premiums for repurchased shares, while in Estate of Neff, there was a general offer to repurchase shares (which expired about 1 month before the first valuation date) at a price about 40 percent above↩ what we determined to be a fair market value without any discount.10. Hanan and Mitchell define and illustrate beta as follows in their expert witness report:Systematic risk is measured by beta * * *, and is the risk associated with those economic factors that threaten all businesses. Such factors are the reason that stocks have a tendency to move together. Beta provides a measure of the tendency of a security's return to move with the overall market's return (e.g., the return on the S&P 500). For example, a stock with a beta of 1.0 tends to rise and fall by the same percentage as the market (i.e., S&P 500 index). Thus, "[beta] = 1.0" indicates an average level of systematic risk. Stocks with a beta greater than 1.0 tend, on average, to rise and fall by a greater percentage than the market. Likewise, a stock with a beta less than 1.0 has a low level of systematic risk and is therefore less sensitive to changes in the market.Grabowski's use of this term is essentially the same.↩11. See Zukin & Mavredakis, Financial Valuation: Businesses and Business Interests, par. 6.9[2], at 6-39 (1990).[2] Discount for Minority InterestIn many valuation situations, the block of stock to be appraised represents minority ownership interests in the company. Minority blocks of stock, by themselves, generally do not have the power to effect change in the bylaws of a corporation, effect any significant corporate change, sellout, recapitalization or other conversion of assets, determine dividend policies and employee shareholder salaries, or effect any other significant change in corporate policy. A minority stockholder without a ready market for his stock would also find it difficult to dispose of his stock and realize a capital gain.The fair market value of a marketable minority interest is the price at which the securities trade in a free and active market. In essence, the prices quoted in the Wall Street Journal for public companies whose shares trade on any of the various exchanges or in the over-the-counter market represent the per-share value of marketable minority interests. It therefore follows that a discount is inapplicable in instances where the value of the subject company minority position is predicated upon indices derived from prices of securities of publicly traded companies.On the other hand, where indications of value are predicated upon control or complete ownership, a discount must be applied to provide indications of value for a minority or less-than-controlling interest. In short, discounts for the subject minority interest are appropriate for some methodologies but inappropriate for others.To the same effect, see Pratt, Valuing a Business: The Analysis and Appraisal of Closely-Held Companies 118-119 (2d ed. 1989).↩12. In his rebuttal expert witness report, Grabowski explains that his small stock premium calculations would result in reducing by 35 percent the value of Jung Corp.'s health care component and by 55 percent the value of Jung Corp.'s elastic textiles component. He does not indicate any change in the value for Ione. Thus, he would reduce his original prediscount valuation for Jung Corp. from under $ 26.5 million, see supra table 9, to under $ 16 million, an overall reduction of about 40 percent. When Grabowski revised his calculations, increasing his original $ 26.5 million to $ 33 million, see supra↩ table 9, he did not also recalculate the effect of his small stock premium calculations. We have assumed, for purposes of our analysis, that his revised valuation also would be reduced by 40 percent, thus reducing his prediscount valuation for Jung Corp. from under $ 33 million to under $ 20 million.13. SEC. 6660. ADDITION TO TAX IN THE CASE OF VALUATION UNDERSTATEMENT FOR PURPOSES OF ESTATE OR GIFT TAXES.(a) ADDITION TO THE TAX. -- In the case of any underpayment of a tax imposed by subtitle B (relating to estate and gift taxes) which is attributable to a valuation understatement, there shall be added to the tax an amount equal to the applicable percentage of the underpayment so attributed.(b) APPLICABLE PERCENTAGE. -- For purposes of subsection (a), the applicable percentage shall be determined under the following table:If the valuation claimed is thefollowing percent of the correct The applicablevaluation -- percentage is:50 percent or more but not more than66 2/3 percent 1040 percent or more but less than50 percent 20Less than 40 percent30(c) VALUATION UNDERSTATEMENT DEFINED. -- For purposes of this section, there is a valuation understatement if the value of any property claimed on any return is 66 2/3 percent or less of the amount determined to be the correct amount of such valuation.(d) UNDERPAYMENT MUST BE AT LEAST $ 1,000. -- This section shall not apply if the underpayment is less than $ 1,000 for any taxable period (or, in the case of the tax imposed by chapter 11, with respect to the estate of the decedent).(e) AUTHORITY TO WAIVE. -- The Secretary may waive all or any part of the addition to the tax provided by this section on a showing by the taxpayer that there was a reasonable basis for the valuation claimed on the return and that such claim was made in good faith.(f) UNDERPAYMENT DEFINED. -- For purposes of this section, the term "underpayment" has the meaning given to such term by section 6653(c)(1).[Subsec. (f) was added by sec. 1811(d), Tax Reform Act of 1986 (TRA 86), Pub. L. 99-514, 100 Stat. 2085, 2833, retroactively as if included in sec. 6660 when sec. 6660 was enacted, TRA 86 sec. 1881, 100 Stat. 2914. The subsequent amendments of this provision by TRA 86 sec. 1899A(57), 100 Stat. 2961; and by sec. 7721(c)(2) of the Omnibus Budget Reconciliation Act of 1989 (OBRA 89), Pub. L. 101-239, 103 Stat. 2106, 2399 (which repealed sec. 6660), do not affect the instant case.][As a result of OBRA 89, the substance of sec. 6660 may now be found in subsecs. (g) and (h)(2)(C) of sec. 6662.][The waiver provision has been replaced by a reasonable cause exception (which now appears as sec. 6664(c)(1)) which is similar to the circumstances which, under pre-OBRA 89 law, could have been the basis for consideration of a waiver.]↩14. Although, as petitioner notes, Mailman v. Commissioner, 91 T.C. 1079">91 T.C. 1079 (1988), was a sec. 6661 case, the abuse of discretion standards there set forth have been used in other areas where the Internal Revenue Code has specifically given discretion to respondent. E.g., Citrus Valley Estates, Inc. v. Commissioner, 99 T.C. 379">99 T.C. 379, 99 T.C. 379">464 (1992), on appeal (9th Cir., May 19, 1993); Capitol Fed. Sav. & Loan v. Commissioner, 96 T.C. 204">96 T.C. 204, 96 T.C. 204">213 (1991). The use of the Mailman standard in the instant case is specifically appropriate because the language of sec. 6660(e) that we interpret is essentially similar to the language of sec. 6661(c) interpreted in Mailman. See, e.g., Zuanich v. Commissioner, 77 T.C. 428">77 T.C. 428, 77 T.C. 428">442-443↩ (1981).15. We conclude that respondent had adequate opportunity to exercise her discretion under sec. 6660(e). See Mailman v. Commissioner, 91 T.C. 1079">91 T.C. 1084 n.5. Petitioner objected to the addition to tax in the reply to respondent's amended answer, stating as an "affirmative defense" the allegation that petitioner had a reasonable basis for the valuation and that the valuation was made in good faith. The waiver issue was discussed at trial. Further, respondent does not contend that she did not have adequate opportunity to exercise her discretion. Compare Estes v. Commissioner, T.C. Memo. 1992-531 with Klieger v. Commissioner, T.C. Memo. 1992-734 and Sotiros v. Commissioner, T.C. Memo. 1991-95↩.16. See 15 Mertens, Law of Federal Income Taxation, sec. 59.08, at 26 (1992).A common fallacy in offering opinion evidence is to assume that the opinion is more important than the facts. To have any persuasive force, the opinion should be expressed by a person qualified in background, experience, and intelligence, and having familiarity with the property and the valuation problem involved. It should also refer to all the underlying facts upon which an intelligent judgment of valuation should be based↩. The facts must corroborate the opinion, or the opinion will be discounted. [Fn. refs. omitted; emphasis added.]	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625296/	WALDEN KNIFE CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Walden Knife Co. v. CommissionerDocket Nos. 12977, 26163.United States Board of Tax Appeals17 B.T.A. 1236; 1929 BTA LEXIS 2167; November 5, 1929, Promulgated 1929 BTA LEXIS 2167">2167 AFFILIATION. - Upon the facts proven petitioner held to be affiliated with the Associated Simmons Hardware Companies during 1921 and 1922 and with the Winchester Repeating Arms Co. during 1923. H. Stanley Hinrichs, Esq., for the petitioner. Leroy Jones, Esq., for the respondent. TRUSSELL 17 B.T.A. 1236">1236 These proceedings, consolidated for hearing and decision, are in respect to deficiencies determined by respondent for calendar years and in amounts as follows: 1921$4,317.5019225,363.15192312,361.34Only one issue is presented, this being whether petitioner was affiliated with the Associated Simmons Hardware Companies during the calendar years 1921 and 1922, and with the Winchester Repeating Arms Co. during the calendar year 1923, it having filed consolidated returns for such years and the several deficiencies to the extent questioned in these proceedings, having resulted from the denial of affiliation by respondent and the computation of its tax liability upon the basis of a separate return for each year. 17 B.T.A. 1236">1237 FINDINGS OF FACT. Petitioner is a New York corporation located at Walden and has for many years1929 BTA LEXIS 2167">2168 manufactured cutlery. From a date prior to the year 1918 through the taxable years involved in this proceeding the capital stock of petitioner was 2,000 shares of a par value of $10 each. The Associated Simmons Hardware Companies, hereafter referred to as Simmons, is a Massachusetts trust created by a declaration of trust dated April 26, 1920, and is the successor of a similar trust of the same name created by a declaration of trust dated October 2, 1911. It controls by stock ownership a number of corporations, some engaged in the manufacture and others in the sale and distribution of hardware. It is also the owner of certain brands, trade-marks, and trade-names, among which are Keen Kutter and Oak Leaf, under which the products of the controlled corporations are marketed. Title to the trust estate is held by three trustees, designated by the declaration of trust and who have charge and control of the estate with power to manage, operate, sell and convey its property, to manage and operate the corporations controlled by it, and to perpetuate its existence by electing new trustees to fill vacancies. The interests of its beneficaries were represented upon its creation by 51,0001929 BTA LEXIS 2167">2169 shares preferred, negotiable in character, of a par value of $100, each, and 93,000 common negotiable shares of a par value of $10, each, with authority given the trustees to increase the issued preferred shares to 150,000 and the common to 1,000,000, such increase to be only for acquisition of additional property. The trustees declare and pay dividends upon the shares representing the interests of the beneficiaries from the income of the trust property accruing from their direction, management and operation of the various owned or controlled businesses. Upon its creation Simmons acquired from the predecessor trust of the same name 1,400 of the 2,000 shares of stock of petitioner, 500 of the remaining 600 shares being owned by one E. Whitehead, and 100 shares by Samuel Andrews. It also acquired at the same time an opinion dated November 12, 1915, held by the predecessor trust upon the aforementioned 50 shares of stock belonging to Whitehead, and an option dated January 21, 1918, upon the 100 shares of stock belonging to Andrews. These option agreements were in effect and held by Simmons from the time acquired through the taxable years 1921 and 1922. The purposes of the organization1929 BTA LEXIS 2167">2170 of Simmons, which purposes were from that time and during the taxable years in question carried out were the active control and operation of the subsidiary corporations 17 B.T.A. 1236">1238 which it dominated through stock ownership. From the time of its acquisition of the 1,400 shares of stock of petitioner, Simmons took entire charge of the business, all of petitioner's officers and directors from that time forward being officers and employees of Simmons, with the one exception of E. Whitehead, who served continuously as a director of petitioner during that period. During this time Simmons operated petitioner through its officers mentioned, purchased its supplies, fixed the prices at which petitioner sold its product, and took and marketed from 95 to 98 per cent of its entire yearly output, handled all of its finances, controlled and audited its financial statements, and determined its policy. Petitioner's sales organization had long since been abolished and its product had for some years been manufactured under the trade-marks and trade-names of Simmons. During the period in question an arrangement existed, agreed to by petitioner's minority stock interests, whereby Simmons guaranteed1929 BTA LEXIS 2167">2171 to petitioner distributive earnings of $30,000 per year, or 150 per cent upon its total outstanding stock, any amount by which petitioner's earnings fell short of this sum to be made up by Simmons and any amount by which this sum was exceeded to be rebated to Simmons and not participated in by petitioner's stockholders as such. Prior to the acquisition of its stock by Simmons there had been the same character of control and operation of the business by the aforementioned predecessor trust, from which Simmons acquired petitioner's stock, and the same arrangement between petitioner and such trust as to a guaranteed dividend. Under this arrangement the following sums were rebated by petitioner to the predecessor trust and to Simmons: For 1919$65,902.08192023,621.5819218,898.83192223,503.40In each of the years mentioned directors' meetings were held by petitioner and the action determined for petitioner by Simmons was uniformly taken without dissenting vote. Effective January 1, 1923, a reorganization was carried through by Simmons in conjunction with the Winchester Repeating Arms Co., a Connecticut corporation, whereby a new corporation was created, 1929 BTA LEXIS 2167">2172 known as the Winchester-Simmons Co., which acquired 98 1/2 per cent of the outstanding shares of Simmons and practically all of the common stock of the Winchester Repeating Arms Co. Under this reorganization the Winchester Repeating Arms Co. acquired from Simmons all of its subsidiary manufacturing companies and the latter retained only its subsidiaries engaged in sale and distribution and became a distributor of all of the products of the Winchester Repeating Arms Co. except arms and ammunition. 17 B.T.A. 1236">1239 Under this reorganization the Winchester Repeating Arms Co. acquired from Simmons the 1,400 shares of stock of petitioner theretofore owned by Simmons and the options of that company upon the Whitehead and the Andrews stock, these 1,400 shares of stock and these options being thereafter held by that corporation throughout the taxable year 1923. Shortly after the close of the taxable year 1923, a recapitalization of petitioner was effected, nonvoting preferred and voting common stock being issued in place of the former stock. In this reissue the Whitehead and the Andrews interests took, in place of their former stockholdings, preferred stock in an amount upon which the fixed1929 BTA LEXIS 2167">2173 dividends would slightly exceed the sum of the 150 per cent dividend guaranteed on their former stockholdings under the arrangement in effect in prior years. In this recapitalization the Winchester Repeating Arms Co. took all of the issued common or voting stock of petitioner. For the calendar year 1920 petitioner filed a consolidated return with Simmons and for the two prior years it filed consolidated returns with the predecessor trust and for such years such returns were accepted by respondent and its taxes determined upon the basis of affiliation. During the years 1921 and 1922 substantially all of the petitioner's stock was owned or controlled by the Associated Simmons Hardware Companies, and for the year 1923 substantially all of such stock was owned or controlled by the Winchester Repeating Arms Co. OPINION. TRUSSELL: The only issue presented is whether petitioner was affiliated in 1921 and 1922 with the Associated Simmons Hardware Companies and in 1923 with the Winchester Repeating Arms Co. under section 240(c) of the Revenue Act of 1921. It filed consolidated returns with the two organizations mentioned in those years and the dificiencies to the extent here appealed1929 BTA LEXIS 2167">2174 from arise from the disallowance by respondent of the claim of affiliation and the computation in consequence of petitioner's tax liability for each year on the basis of a separate return. The record herein shows that the Associated Simmons Hardware Companies is a Massachusetts trust, organized for the purpose of deriving a profit for its shareholders through the ownership, control and use of the trust estate, which consisted of stock in various companies and certain trade-marks and trade-names. In the case of certain of these companies all of their outstanding stock was owned by Simmons, and others it controlled by majority stock ownership. Some of these companies were engaged in manufacture and some in distribution and sale, and all were actively controlled, managed, 17 B.T.A. 1236">1240 directed and operated by Simmons. The owned and controlled manufacturing companies made their products under the trade names owned by Simmons and the latter took those at prices which it fixed and marketed them to the trade through these subsidiary companies engaged in sale and distribution. Its income, which the trustees distributed to its shareholders, was not limited to the dividends received upon1929 BTA LEXIS 2167">2175 the stock which it owned in these subsidiary corporations. Section 2 of the Revenue Act of 1921 provides that when used in such Act: The term "corporation" includes associations, joint-stock companies and insurance companies. By section 240(c) of that Act it is provided: For the purpose of this section two or more domestic corporations shall be deemed to be affiliated (1) if one corporation owns directly or controls through closely affiliated interests or by a nominee or nominess substantially all the stock of the other or others, or (2) if substantially all the stock of two or more corporations is owned or controlled by the same interests. In , the court defined a "Massachusetts trust" as: A form of business organization, common in that state consisting essentially of an arrangement whereby property is conveyed to trustees, in accordance with the terms of an instrument of trust, to be held and managed for the benefit of such persons as may from time to time be the holders of transferrable certificated issued by the trustees showing the shares into which the beneficial interest in the property is divided. 1929 BTA LEXIS 2167">2176 It was held that such organizations, holding and managing the trust property in business operations were "associations" within the meaning of section 1 of the Revenue Act of 1918, which defines corporations in similar language to section 2 of the Revenue Act of 1921 above quoted. See also ; ; ; . The proof as to the organization, purposes and activities of Simmons during the taxable years before us shows, in our opinion, beyond question that it was engaged actively in carrying on business and was under the rule laid down in , and followed in the cited cases, an association within the meaning of section 2 of the Revenue Act of 1921, subject to classification as a corporation for purposes of that Act and consequently subject to affiliation under section 240(c) of such Act if all requisites of ownership or control of stock required thereby are met. On this question the record shows that during the taxable years here1929 BTA LEXIS 2167">2177 involved 70 per cent of petitioner's stock was owned by Simmons and that this organization also held an option on the 30 per 17 B.T.A. 1236">1241 cent minority stock which it could exercise at any time. It is further shown that all of this minority stock with the exception of 100 shares was owned by an individual who for many years, including the taxable years before us, had served as a director of petitioner, occupying such position wholly at the sufference of such majority stockholder, his election being controlled and brought about by the majority stock. It is further shown that under an arrangement in effect for many years including the years in question, and agreed to without dissent by the two minority stockholders, petitioner's entire business was completely controlled and directed by Simmons, its product being all produced under and stamped with the trade-marks belonging to that organization and the latter fixing a price upon such product and taking itself practically all of it, petitioner's sales organization having been abolished long before, because of such condition, and that Simmons during this period guaranteed earnings to petitioner of 150 per cent upon its capital stock and1929 BTA LEXIS 2167">2178 took for itself all earnings in excess of this amount. The picture presented by these proven facts is one of absolute control of petitioner's business by the organization with which it claims affiliation, economic dependence by petitioner upon the continued existence of such control, and ownership of 70 per cent of its stock by such organization with the power existing to make, at any time, that ownership absolute and complete. We have on several occasions approved and reannounced the rule, laid down by us in , that each case of affiliation must be determined upon the particular facts presented. In the case before us it may be that none of the several conditions proven, existing alone, would show control of the minority stock by the majority interests, but when all of these conditions exist it is thought idle to say that the minority stock was not controlled, when to vote it against the wishes of the majority would not only have no effect on the result, but could result, at the option of the majority, not only in the loss by Whitehead of his voice in the management of the company, nominal though it might be, but the surrender by1929 BTA LEXIS 2167">*2179 him and by Andrews of all connection with petitioner, even as stockholders. Cf. ;. We hold that petitioner was affiliated with and entitled to file consolidated returns with the Associated Simmons Hardware Companies for the calendar years 1921 and 1922 and with the Winchester Repeating Arms Co. for the calendar year 1923. Reviewed by the Board. Judgment will be entered pursuant to Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625297/	MRS. H. C. WALKER, JR., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. H. C. WALKER, JR., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. MRS. ELIAS GOLDSTEIN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. ELIAS GOLDSTEIN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Walker v. CommissionerDocket Nos. 33331, 33332, 36117, 36118.United States Board of Tax Appeals23 B.T.A. 1; 1931 BTA LEXIS 1939; May 1, 1931, Promulgated 1931 BTA LEXIS 1939">1939 1. The petitioners reported in their returns for the years 1921, 1922, 1923, and 1924, upon the installment basis, the amounts of cash actually received by them in those years from their interests in an oil and gas lease. Held, upon the facts that the petitioners are taxable in the years 1923 and 1924 upon the amounts of cash actually received by them and reported in their returns for those years. 2. Deductions for depletion allowances on the lease denied. H. C. Walker, Jr., et al.,6 B.T.A. 1142">6 B.T.A. 1142. Elias Goldstein, Esq., for the petitioners. J. Arthur Adams, Esq., and Frank A. Surine, Esq., for the respondent. SMITH 23 B.T.A. 1">1 These proceedings, which were duly consolidated, involve deficiencies for the years and in the amounts as follows: PetitionerDocket No.YearDeficiencyMrs. H. C. Walker, Jr333311923$2,906.7119241,988.55H. C. Walker, Jr3333219232,906.7119241,987.39Mrs. Elias Goldstein3611719232,400.1719241,713.67Elias Goldstein3611819232,437.4319241,711.06The petitioners allege, first, that the respondent erred in his determination1931 BTA LEXIS 1939">1940 that they derived any taxable income in 1923 and 1924 23 B.T.A. 1">2 from the sale by them in 1920 of certain royalty interests in an oil and gas lease, and, in the alternative, that the respondent erred in disallowing deductions in those years for depletion allowances on the lease. FINDINGS OF FACT. Prior to June 1, 1920, H. C. Walker, Jr., and Elias Goldstein acquired from one George West a lease on certain oil lands situated in Claiborne Parish, Louisiana, in what is known as the Homer Oil Field. George West retained a one forty-eighth royalty interest in the lease for himself. Walker and Goldstein in turn assigned the lease to the Gulf Refining Company of Louisiana, reserving to themselves a one twenty-fourth royalty interest therein. Subsequently, a suit was brought in the United States District Court for the Western District of Louisiana against Walker, Goldstein, and West by the law firm of Foster, Looney & Wilkinson on behalf of one L. G. Taylor, who was an adverse claimant to title to the lands under lease by West to Walker and Goldstein. L. G. Taylor had formerly executed a lease on the same lands to the Caddo Central Oil & Refining Corporation, reserving to herself1931 BTA LEXIS 1939">1941 a one-eighth royalty interest. Foster, Looney & Wilkinson had acquired from L. G. Taylor a one-half interest in her rights in the disputed oil lands. Under their respective claims Foster, Looney & Wilkinson were entitled to a one-sixteenth interest, Walker and Goldstein a one twenty-fourth interest, and West a one forty-eighth interest in all the oil and gas produced from the lands in question. On June 23, 1920, while the aforesaid suit was pending in the United States District Court, Walker, Goldstein, and West on the one side, and Foster, Looney & Wilkinson on the other entered into an agreement, the material provisions of which are set forth in our findings of fact in H. C. Walker, Jr., et al.,6 B.T.A. 1142">6 B.T.A. 1142, and are incorporated in the present findings of fact by reference thereto. The agreement in question purports to be a sale by Walker, Goldstein, and West, called the vendors, of all their interests in the oil lands in question and leases thereon to Foster, Looney & Wilkinson, called the vendees, for a consideration of $200.00 to be paid out of the proceeds from the oil produced from the lands by the lessees of either the vendors or the vendees. The vendees1931 BTA LEXIS 1939">1942 were to receive immediately the proceeds of all the oil produced up to June 1, 1920, and the proceeds of the oil thereafter produced were to be deposited with the City Savings Bank & Trust Company of Shreveport, La., designated "Agent of all parties hereto," and credited by it to an account entitled "Escrow Account George West, H. C. Walker, Jr., and Elias Goldstein." On the second day of January in each of the years 1921, 1922, 1923, and 1924, there being sufficient funds, the bank 23 B.T.A. 1">3 was to transfer $50,000 from the aforesaid account to the credit of the vendors in the proportion of one-third each. In any event the vendors were to receive the sum of $200,000 and no more from the proceeds of the oil and gas when and if produced to the extent of that amount. The agreement carried the usual habendum clause indicative of a complete transfer of the interests of the vendors in the properties involved. The lease in question proved highly productive. Pursuant to the terms of the aforesaid agreement the following amounts were paid to the bank for the West, Walker, and Goldstein account by the Gulf Refining Company of Louisiana, lessee, on the dates shown: July 16, 1921$50,000.00September 14, 1921143,134.54October 6, 19211,520.61November 7, 19212,080.84December 8, 19212,525.84January 6, 1922738.18Total200,000.011931 BTA LEXIS 1939">1943 Out of this account the bank paid to Walker and Goldstein $50,000 in each of the years 1921, 1922, 1923, and 1924 in accordance with the terms of the agreement. Walker and Goldstein had in the meantime purchased the one forty-eighth royalty interest which West had reserved under his lease to them. The petitioners reported their income from the sale of the lease upon the installment basis for the taxable years 1921 to 1924, inclusive. Each petitioner reported income in the amount of $12,500 under the aforesaid agreement; the wives, petitioners herein, filed separate returns and reported their income under the community property laws of Louisiana. In those returns the petitioners each claimed a deduction for depletion allowances on the aforesaid lease, which deductions were disallowed by the respondent. The action of the respondent in disallowing the deductions claimed was approved by the Board in the former proceedings referred to above. OPINION. SMITH: The petitioners make the contention that the income in dispute was taxable to them in 1921 and 1922 when under the terms of the agreement of June 23, 1920, the oil produced from their royalty interest was sold and the1931 BTA LEXIS 1939">1944 proceeds from such sales were deposited in the City Savings Bank & Trust Company to their credit. The respondent contends that there was a completed sale by the petitioners of their royalty interest in the lease at the time of the execution of the agreement and that since the petitioners elected to report their income from the sale on the installment basis, that is, $50,000 in each of the years 1921, 1922, 1923, and 1924, they should 23 B.T.A. 1">4 not now be permitted to change and report on a different basis when so doing would result in throwing a large part of the income back in a prior year for which assessment and collection would be barred by the statute of limitations. The petitioners in support of their contentions rely principally upon the decisions in Looney v. United States, 26 Fed.(2d) 481; affirmed by the Circuit Court in United States v. Looney, 29 Fed.(2d) 884. The lower court there held, contrary to the Commissioner's determination, that the $200,000 paid to the bank, as depositary, under the provisions of the above agreement of June 23, 1920, and finally distributed to the petitioners herein, was never received by and did not1931 BTA LEXIS 1939">1945 constitute income taxable in any year to Looney and his associates. The Circuit Court, in affirming the lower court, said: * * An effect of that agreement was a settlement and compromise of that dispute by the parties on one side of it relinquishing in favor of the other parties the claim of the former to the oil royalty mentioned, except a stated interest in that royalty, and by the firm of which one of the appellees was a member relinquishing in favor of the other parties to the agreement the claim of the firm to that royalty accruing from June 1, 1920, until the sum of $200,000 should be realized therefrom. For a valuable consideration moving to the firm mentioned, [Foster, Looney & Wilkinson] namely, the relinquishment of an adverse claim to the oil royalty, that firm parted with all right or interest in or to the royalty accruing from June 1, 1920, until it amounted to the sum of $200,000. Though before the compromise agreement was made the firm mentioned owned the royalty which was the subject of that agreement, upon the execution of that agreement the other parties to it became the owners of the part of that royalty which, under the terms of the agreement, was to be1931 BTA LEXIS 1939">1946 paid to them. In other words, prior to 1921, the firm mentioned ceased to own all of that royalty which accrued during that year. It follows that neither of the appellees was entitled to a share of that royalty accruing in 1921. Rents or royalties are included in the income of their owner, though they are not actually received by him, but pursuant to his direction are paid to another. Houston Belt & Terminal Ry. Co. v. United States (C.C.A.) 250 F. 1">250 F. 1; Blalock v. Georgia Ry. & Electric Co. (C.C.A.) 246 F. 387">246 F. 387. But rents or royalties are not properly included in the income of one who did not own, receive, or control them; the ownership thereof being vested in another when they accrued. We conclude that the above-mentioned ruling was not erroneous. The judgment is affirmed. In Katherine Wilkinson Barnette,16 B.T.A. 1390">16 B.T.A. 1390, we held upon authority of the decision of the Circuit Court that the other members of the partnership of Foster, Looney & Wilkinson were not taxable upon any portion of the $200,000. The Board had previously held in 1931 BTA LEXIS 1939">1947 H. C. Walker, Jr., et al.,6 B.T.A. 1142">6 B.T.A. 1142, referred to above, that the identical petitioners herein were not entitled to any deduction for depletion allowances in respect of their interests in the lease in 1921 and 1922, since by the terms of the agreement they had sold and transferred all such interests in a prior year. We are convinced, however, that the construction placed upon the agreement of June 23, 1920, by the Circuit Court in United States v.23 B.T.A. 1">5 Looney,supra, is contrary to our holding in 6 B.T.A. 1142">H. C. Walker, Jr., et al., supra, that by such agreement there was a completed sale by the petitioners of their interest in the lease to Foster, Looney & Wilkinson. Under the construction given the agreement by the court the petitioners were recognized as owners of the disputed royalty interest "until the sum of $200,000 should be realized therefrom." At that time the ownership of the interest was to vest in Foster, Looney & Wilkinson. This amount of $200,000 had been realized from the royalty interest and deposited with the bank under the terms of the agreement at January 6, 1922. The petitioners thereafter did not own1931 BTA LEXIS 1939">1948 any interest in the lease. It follows that the petitioners are not entitled to a depletion allowance in respect thereof in the years 1923 and 1924. Counsel for the petitioners stated at the hearing had in these proceedings that the petitioners did not delay in making their contention that all of the $200,000 realized from their royalty interest was income in 1921 and 1922 until after the statute had barred the assessment and collection for the prior years with any intention of avoiding the tax, but that the contention was made "after the Circuit Court of Appeals, and subsequently the Board of Tax Appeals, in the other cases had decided that the construction was wrong." The court, however, did not have these petitioners before it in the cases referred to and there has been no determination by the court of the petitioners' tax liability in respect of these amounts for any of the years under consideration. We have before us in these proceedings different petitioners and a different set of facts. The ruling of the court that the right to receive the royalties in question when accrued was the property not of Foster, Looney & Wilkinson, but of the petitioners, Walker and Goldstein, 1931 BTA LEXIS 1939">1949 is not determinative of the year in which he petitioners should report the amounts as their taxable income, regardless of the methods used by them in keeping their accounts and reporting their income. The facts are that the petitioners reported in each of the years 1921, 1922, 1923, and 1924 their proportionate parts of the $50,000 actually received by them in those years; that is to say, they reported all of the proceeds to which they were entitled in those years and which were subject to their use and enjoyment. In Otto Braunwarth,22 B.T.A. 1008">22 B.T.A. 1008, we held that where, upon the sale of a business, title passed to the vendee and part of the purchase price was paid in cash and the remainder in Liberty bonds, which were placed in escrow to be delivered to vendor in installments over a period of years upon the filing by him each year of an affidavit that he had not competed in business, although the transaction was closed in the year of sale, the right to the deferred payments was not the equivalent of cash and the installment payments were not income to the petitioner, the vendor, until received. 23 B.T.A. 1">6 The petitioners reported the income in question upon the1931 BTA LEXIS 1939">1950 installment basis. The Commissioner's regulations, article 42, Regulations 45, 62, and 65, provided for reporting income in this manner and the Commissioner accepted the returns filed by the petitioners as a basis for computing their tax liabilities. Presumably the petitioners thus acquired a benefit by distributing their income over a period of several years and avoiding the high taxes that would have resulted from reporting a larger amount in any single year. The petitioners now seek to report their income upon another basis which would throw the greater part of it back into a year which is barred by the statute of limitations. In Commissioner of Internal Revenue v. Moore, 48 Fed.(2d) 526, the Circuit Court of Appeals, Tenth Circuit, confronted with a similar situation, said: The sole question involved on these appeals is whether the profit derived from the sale of certain oil stock should be charged into the income of the taxpayers for the year 1918, when the contract of sale was made, or whether it should be charged into the years in which the payments on the purchase price were actually received. The Board of Tax Appeals held that the entire profit1931 BTA LEXIS 1939">1951 was taxable in the year 1918, and since the statute of limitations had run on the assessment of taxes for that year, that there was no taxable liability. * * * * * * The taxpayers were on a cash basis of accounting, and in line with the statute above quoted, they did return the profits from this sale "in the gross income for the taxable year in which received by the taxpayer," proportioning the profit in accordance with the quoted Regulation. Conceding, for the argument, that the statute and regulation afforded the taxpayers the election of treating the obligations of the purchaser as the equivalent of cash, the taxpayers otherwise elected; they may not now change that election, particularly since the result would be to throw all of the profit into a year where collection is barred by limitations. Lucas v. St. Louis National Baseball Club (C.C.A. 8) 42 F.(2d) 984; Rose v. Grant (C.C.A. 5) 39 F.(2d) 340; Alameda Investment Co. v. McLaughlin (C.C.A. 9) 33 F.(2d) 120; Holmes on Federal Income Tax (6th Ed.) 1278. Another point is worthy of notice. Section 212(d) of the Revenue Act of 1926 (26 USC 953)1931 BTA LEXIS 1939">1952 is made retroactive by Section 1208 of the same Act (26 USC 953-a). That section, and the regulation promulgated thereunder (Reg. 69, Art. 42) permits the distribution of profits on a sale on deferred payments in the case of "casual sale * * for a price exceeding $1,000 * * * if the initial payments do not exceed one-fourth of the purchase price." The section defines "initial payments" as cash or property other than evidences of indebtedness of the purchaser. The case at bar falls within the four corners of this retroactive statute. We think that the petitioners properly reported in the taxable years 1923 and 1924 the amounts of cash actually received by them in those years under the terms of the agreement of June 23, 1920, and that they have no reasonable grounds for asking a redetermination of their tax liability for those years. Judgment will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625298/	Erard A. Matthiessen and Elizabeth C. Matthiessen, Petitioners, v. Commissioner of Internal Revenue, RespondentMatthiessen v. CommissionerDocket No. 24666United States Tax Court16 T.C. 781; 1951 U.S. Tax Ct. LEXIS 228; April 13, 1951, Promulgated 1951 U.S. Tax Ct. LEXIS 228">228 Decision will be entered for the respondent. Petitioners are husband and wife. In 1934 the husband organized a corporation and acquired 60 of the 65 shares. The paid-in capital of the corporation was $ 6,500. In payment for his share the husband transferred to the corporation unimproved real estate on which houses were built and sold by the corporation. Simultaneously with the formation of the corporation the husband advanced $ 20,000 to the corporation on its unsecured, demand, interest bearing note. During the period 1934 to 1941, in order to furnish funds for the corporation, petitioners advanced other sums to the corporation taking its unsecured demand notes. Some of the notes were interest bearing but interest was not ever fully paid. The corporation operated at a deficit in every year and was liquidated in 1941.Held, petitioners' advances of funds to the corporation were contributions to capital, not loans, and petitioners' losses thereon were capital losses. Donald M. Dunn, Esq., for the petitioners.William A. Schmitt, Esq., for the respondent. Van Fossan, Judge. VAN FOSSAN 16 T.C. 781">782 The respondent determined a deficiency of $ 34,521.83 in the petitioners' income tax liability for the year 1941.The sole issue is whether advances made by petitioners to a corporation controlled by them were loans or investments.FINDINGS OF FACT.Such of the facts as were stipulated are so found, and in so far as they appear pertinent to the issues, are incorporated in the other facts below.Petitioners Erard A. and Elizabeth C. 1951 U.S. Tax Ct. LEXIS 228">230 Matthiessen are husband and wife. They filed a joint income tax return prepared on a cash basis for the taxable year 1941 with the collector of internal revenue for the second district of New York.Erard A. Matthiessen (hereinafter referred to as "petitioner") is an architect. On January 11, 1934, he caused Tiffany Park, Inc., to be formed under the laws of the State of New York. Tiffany's stated purpose was to acquire, maintain, and develop real estate and to engage in a general real estate and brokerage business. Petitioner felt that in his principal business, as an architect, it would be well not to have his name connected with a venture of the nature Tiffany was to undertake other than as an officer and director of the corporation.The petitioner was elected president of Tiffany. On February 9, 1934, Tiffany resolved to purchase from petitioner for $ 6,000 two unimproved parcels of property in Irvington, New York. In payment for this property Tiffany issued petitioner six shares of its stock. On February 9, 1934, Tiffany's officers were authorized to execute contracts necessary to erect two buildings on the property. Tiffany's board of directors voted to accept petitioner's1951 U.S. Tax Ct. LEXIS 228">231 offer to lend Tiffany $ 20,000 on a demand note bearing interest at 6 per cent. Petitioner advanced to Tiffany the sum of $ 20,000.Tiffany subsequently built two houses on the property acquired from petitioner. One house was sold in 1936; the other was completed and sold in 1938.On June 16, 1936, petitioner advanced to Tiffany for its general corporate purposes the sum of $ 1,000 and received in exchange therefor its demand promissory note in that amount and of that date with no rate of interest specified.16 T.C. 781">783 On November 10, 1938, petitioner advanced to Tiffany the sum of $ 11,155 taking a demand note with interest at 6 per cent.In 1931 the petitioner had purchased unimproved property in the Town of Greenburgh, Westchester County, New York, for $ 35,000, for the purpose of developing the property, building houses thereon and selling them. In 1936 the petitioner transferred this property to Tiffany and received therefor its promissory demand note in the amount of $ 35,000, which note specified no rate of interest. Nothing was ever done with this property by Tiffany. At the time of the liquidation of Tiffany on December 29, 1941 (to be referred to below), this property1951 U.S. Tax Ct. LEXIS 228">232 was transferred to the petitioner's nominee in exchange for the $ 35,000 note.Elizabeth C. Matthiessen, since 1930, had been the owner of certain improved real property, approximately 11 acres, in Irvington, New York, assessed by the Town of Greenburgh for 1940 and five previous years at $ 123,550. This property had been rented for a number of years. On August 12, 1940, Elizabeth C. Matthiessen contracted to exchange the property for two apartment houses in Mount Vernon, New York, at an agreed price of $ 60,000 over and above existing mortgages thereon totaling approximately $ 180,000. The consideration to be paid by Elizabeth C. Matthiessen was the transfer of the Irvington property valued at $ 45,000 and $ 15,000 in cash. On August 29, 1940, Tiffany's board of directors resolved to buy Elizabeth C. Matthiessen's interest in the exchange contract in payment for which Tiffany agreed to give its demand promissory note for $ 39,000 with interest at 5 per cent and 60 shares of Tiffany's $ 100 par value stock. Elizabeth C. Matthiessen assigned her interest in the exchange contract to Tiffany and received Tiffany's promissory note for $ 39,000 with interest at 5 per cent and 60 shares1951 U.S. Tax Ct. LEXIS 228">233 of its stock. Tiffany also gave petitioner its promissory note payable on demand in the amount of $ 16,871.98 with interest at the rate of 5 per cent. This note to petitioner was to cover the sum of $ 15,000 in cash advanced by him in order to consummate the exchange contract and the additional sum of $ 1,871.98 representing tax adjustment, insurance and title acquisition costs. Elizabeth C. Matthiessen took no part in the negotiation involving the exchange contract and merely signed the necessary papers. She believed that the result of this transaction would be to give her an equal position with her husband in Tiffany.On September 12, 1940, petitioner advanced for Tiffany the sum of $ 906.84 in payment for the legal services of attorneys who acted for Tiffany in the closing of the exchange contract referred to above. A note in this amount with interest at 5 per cent was issued to the petitioner.On January 30, 1941, petitioner advanced $ 3,500 on behalf of Tiffany in payment of taxes on the apartment house owned by Tiffany in 16 T.C. 781">784 Mount Vernon, New York. Petitioner received Tiffany's note in the amount of $ 3,500 dated January 30, 1941, and payable on demand with interest1951 U.S. Tax Ct. LEXIS 228">234 at 5 per cent.On May 14, 1941, petitioner paid on Tiffany's behalf the sum of $ 1,050 to the rental agents for the Mount Vernon property, and on that date took Tiffany's note in the amount of $ 1,050 payable on demand with interest at 5 per cent.On July 28, 1941, petitioner advanced on Tiffany's behalf $ 3,500 for the payment of taxes due on the Mount Vernon property and received in exchange therefor Tiffany's demand note for that amount bearing interest at 5 per cent.On December 23, 1941, Tiffany sold the Mount Vernon property for $ 7,000 in cash subject to the mortgages thereon.Tiffany's 1934 Federal income tax return had written on its face "No income at all." Its 1935 return showed gross receipts of $ 15,000, cost of operations at $ 22,176.55, and a deficit of $ 7,409.66. Deductions were taken in a total of $ 233.11 consisting of payment for taxes, legal fees, blueprints, and sundries. Cash at the end of 1935 was shown to be $ 12,374.76, and work in process $ 3,017.51.Tiffany's 1936 return showed an operating loss of $ 3,020.96 and a payment of interest in the amount of $ 2,924.17 on notes payable to petitioner.At the beginning of 1937, Tiffany had cash on hand of $ 15.17, 1951 U.S. Tax Ct. LEXIS 228">235 at the end of that year, $ 341.60; "construction in process" at the beginning of the year was $ 15,893.09 and at the end, $ 19,828.94. There was a year-end deficit of $ 12,778.50.Tiffany's 1938 return showed a net loss of $ 8,306. Its 1939 return is blank, showing no gross income and no deductions. Tiffany's return for 1940 showed income only from rents in the amount of $ 11,865.77. Deductions exceeded gross income resulting in a net loss of $ 1,433.15. Deductions included an interest payment of $ 2,070.43.There was never any security given by Tiffany to petitioners for the advances made by them to that corporation. Tiffany never received advances from anyone other than petitioners and it gave no promissory notes other than those to petitioners.Dissolution of Tiffany was authorized at a meeting of its directors and stockholders on December 29, 1941, and its dissolution duly followed. Pursuant to a plan of liquidation the stockholders surrendered their shares of stock in the corporation for cancellation and redemption. The cash in bank of $ 5,479.66 was distributed 50.15 per cent to petitioner and 49.85 per cent to his wife, Elizabeth C. Matthiessen. The promissory notes1951 U.S. Tax Ct. LEXIS 228">236 of Tiffany outstanding at that time were of the principal amount of $ 76,983.82. The distributions of cash in bank were accomplished on December 29, 1941.16 T.C. 781">785 The notice of deficiency contains the following explanation of adjustments:(a) and (b) It is held that the following advances made by you to Tiffany Park, Inc. represent additional investments in the capital stock of that corporation. (1) Advances by Erard A. Matthiessen in the amount of $ 37,983.82It is further held that upon complete liquidation of the above corporation in 1941 you sustained a loss of $ 35,235.78 on your investment, the deductibility of which is limited by the provisions of section 117 (b) of the Internal Revenue Code since the capital stock of that corporation constituted a capital asset as defined in section 117 (a) of the Code and said stock was held by you for more than 24 months. Accordingly, the long-term capital loss deduction of $ 4,675.24 claimed on your return has been increased by $ 17,617.89 (50% of $ 35,235.78) and the bad debt deduction claimed in the amount of $ 35,235.78 has been disallowed.(2) Advances by Elizabeth C. Matthiessen in the amount of $ 39,000.001951 U.S. Tax Ct. LEXIS 228">237 It is further held that upon complete liquidation of the above corporation in 1941 you sustained a short-term capital loss of $ 36,268.38 on your investment, since the capital stock of that corporation constituted a capital asset as defined in section 117 (a) of the Internal Revenue Code and said stock was held by you for less than 18 months. Accordingly, the bad debt deduction of $ 36,268.38 claimed on your return has been disallowed and the short-term capital loss recognized cannot be availed of as a deduction in 1941 due to the limitation provisions of section 117 (d) of the Internal Revenue Code. * * OPINION.Petitioners contend that the sums they advanced to Tiffany Park, Inc., represent loans and the loss upon liquidation of the corporation is a bad debt loss. Respondent determined that petitioners' losses were capital losses subject to the provisions of section 117 of the Internal Revenue Code.Tiffany Park, Inc., was formed by petitioner Erard A. Matthiessen in order that he could keep separate his professional activities as an architect and the venture Tiffany was to undertake. Petitioner transferred unimproved real estate to the corporation in exchange for 60 shares1951 U.S. Tax Ct. LEXIS 228">238 of its $ 100 par value capital stock. Petitioner simultaneously advanced $ 20,000 to Tiffany, taking its unsecured promissory note, and with this money Tiffany proceeded with the erection of two buildings on the property. We have set out in our Findings of Fact, in detail, the list of subsequent advances made by petitioners to Tiffany, the use to which those advances were put and the ultimate dissolution of the corporation in 1941. There is no need to comment at length on the disproportionate relationship between Tiffany's capital structure and the total of money advanced to the corporation by petitioners. It is obvious that the corporation was inadequately capitalized and 16 T.C. 781">786 that a comparison of the capital structure with the amount of advances is alone sufficient to support the conclusion that the money advanced by petitioners was at all times put at the risk of the business as capital. It is apparent from the nature of the operations to be conducted by Tiffany that it was never intended to stand on its own feet financially and operate without petitioners' continuing supply of funds.Aside from the relationship of Tiffany's capital to the amount of advances, the lack1951 U.S. Tax Ct. LEXIS 228">239 of any adequate security for the advances negatives completely petitioners' insistence that they were bona fide loans and not capital contributions. The possibility is remote indeed that a disinterested lender of money would have made the initial unsecured loan of $ 20,000 to Tiffany in order to provide that corporation with the working capital necessary to embark on a speculative building project. It would be even more improbable that such a lender would continue to advance funds for a venture such as Tiffany which was showing an increasing deficit in every year. The petitioners' self-serving statements that the advances were intended to be loans bear little weight in the face of the other facts of record. Petitioners' references to the interest paid on the notes does no more than point out that interest payments were made in only two years and that other interest accrued from time to time was never paid.There is nothing novel in the situation presented here. We have recently considered in the following cases the subject of inadequate capitalization, holding that under the facts advances were capital contributions and not loans: Edward G. Janeway, 2 T.C. 197,1951 U.S. Tax Ct. LEXIS 228">240 affd., 147 F.2d 602; Sam Schnitzer, 13 T.C. 43, affd., 183 F.2d 70; Isidor Dobkin, 15 T.C. 31, on appeal, C. A. 2; Hilbert L. Bair, 16 T.C. 90. See, also, Harry Sackstein, 14 T.C. 556, holding that a taxpayer's payments of a share of the losses of a corporation created to furnish a source for otherwise unattainable merchandise, were capital contributions and not taxpayer's ordinary and necessary business expenses.In Isidor Dobkin, supra, we said: * * When the organizers of a new enterprise arbitrarily designate as loans the major portion of the funds they lay out in order to get the business established and under way, a strong inference arises that the entire amount paid in is a contribution to the corporation's capital and is placed at risk in the business. Cohen v. Commissioner, 148 Fed. (2d) 336; Joseph B. Thomas, 2 T.C. 193. The formal characterization as loans on the part of the controlling stockholders1951 U.S. Tax Ct. LEXIS 228">241 may be a relevant factor but it should not be permitted to obscure the true substance of the transaction. Sam Schnitzer, 13 T.C. 43, 60.The record made in this case falls far short of providing a valid distinction such as to merit our holding for petitioners on this issue. 16 T.C. 781">*787 Respondent, therefore, did not err in his determination that petitioners' advances to Tiffany Park, Inc., were contributions to the capital of that corporation and not loans.Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625300/	National Creations, Inc. et al. 1 v. Commissioner. National Creations, Inc. v. CommissionerDocket Nos. 34994, 34995, 34996.United States Tax Court1953 Tax Ct. Memo LEXIS 362; 12 T.C.M. 182; T.C.M. (RIA) 53062; February 20, 1953William J. Reinhart, Jr., Esq., for the petitioners. Robert Margolis, Esq., for the respondent. MURDOCK Memorandum Findings of Fact and Opinion The Commissioner determined deficiencies in the income taxes of National Creations, Inc., of $1,221.90 for 1945, $3,890.86 for 1946 and $972.44 for 1947 and he also determined that Louis E. Pakula and Jerry Rappaport are liable for those deficiencies as transferees of the assets of the taxpayer. There are two issues for decision (1) whether deductions for officers' salaries taken by the taxpayer for 1946 and 1947 are prohibited1953 Tax Ct. Memo LEXIS 362">363 by section 24 (c) and, (2) what are reasonable allowances for salaries of the officers of the taxpayer for 1946 and 1947 for personal services actually rendered by them. Findings of Fact National Creations, Inc., was incorporated under the laws of New York in 1941. Its returns for the taxable years were filed with the collectors of internal revenue for the Second and Third Districts of New York. Pakula was president, Rappaport was treasurer, and Alexander Greene was secretary of National. They each owned one-third of its stock until May 1948 and they were also equal one-third partners in Du Barry Novelty Company until May 1948, at all times material hereto. Pakula and Rappaport bought out Greene's interest in National and in Du Barry in May 1948. National was engaged, during 1946 and 1947, in manufacturing and boxing costume jewelry. Du Barry was its only customer. Du Barry fixed the style and quantity of and sold the products manufactured by National. The three officers and partners managed the business of both during the taxable years. National carried on its operations partly in New York and partly in Providence, Rhode Island. The metal was assembled and the novelty jewelry1953 Tax Ct. Memo LEXIS 362">364 was fabricated or stamped out, cleaned, buffed and plated in Providence. The semi-finished jewelry was sent to New York where National set stones, attached pins, clasps and chains as necessary, placed the jewelry on cards, wrapped it and turned it over to Du Barry. National had an average of 18 employees in Providence and 40 to 50 in New York during the taxable years. Du Barry and National had but one administrative office and shared the same space in New York. The operations in New York were managed principally by Rappaport. He laid out the work, distributed it among the help, saw that it was done properly, helped do it and in general made sure that things went well. He occasionally went to Providence if Pakula or Greene was ill or on the road. Greene had charge of the operations in Providence. Pakula divided his time between New York and Providence. His work in Providence was entirely for National but his time in New York was divided between National and Du Barry. He worked six days a week during 1946 and 1947, including long hours during the summer months and at other times when it was necessary. He did most of the selling for Du Barry but the other two did a small amount. 1953 Tax Ct. Memo LEXIS 362">365 Du Barry had no other salesmen. Most of the selling was in New York but a small amount was in Providence. Pakula spent about 85 per cent of his time with National and about 15 per cent with Du Barry. Rappaport gave National about 40 per cent of his time and Du Barry 60 per cent. Greene spent practically all of his time with National. National kept its books and made its returns on an accrual calendar year basis. The three stockholders reported their incomes on the cash basis. National credited salaries of $5,000 to each of the officers by entries on its books dated December 31, 1946. Each reported the $5,000 as income for 1946 and paid the tax thereon. Those amounts were not paid within 1946 or within 2 1/2 months after the close of that year. National credited salaries of $3,000 to each of the officers by entries on its books dated December 31, 1947. Each reported the $3,000 as income for 1947 and paid the tax thereon. Those amounts were not paid within 1947 or within 2 1/2 months after the close of that year. The Commissioner, in determining the deficiencies, held that deduction of the salaries was barred by section 24 (c). He also determined that the amounts of the1953 Tax Ct. Memo LEXIS 362">366 salaries were excessive. The officers' salaries mentioned above for 1946 and 1947 were unqualifiably subject to the demand of the officers without restriction as to time or manner of payment or condition upon which payment was to be made. The corporation was able to pay them. They were constructively received by the three individuals at the time they were credited on the books of the corporation. The salaries were reasonable in amount. The facts stipulated by the parties are incorporated herein by this reference. Opinion MURDOCK, Judge: The individual petitioners admit that they are liable as transferees for any taxes due from the taxpayer. There is no issue for decision relating to 1945 except as a loss for a later year may produce a carry-back. The first issue for decision is whether the taxpayer is to be denied a deduction for officers' salaries under section 24 (c). Those salaries were not actually paid during the taxable year to which they applied or within 2 1/2 months after the close of that year. However, three conditions must co-exist if deductions otherwise allowable are to be disallowed because of section 24 (c). One of those is that the amount of the unpaid salary1953 Tax Ct. Memo LEXIS 362">367 is not includible in the gross income of the officer for the taxable year unless actually paid because of his method of accounting. That condition is not present in this case. Each of these officers reported his salary for each year as he was required to do under the circumstances. Each received his salary constructively in the year in which it was credited to him on the books of the corporation because it was then unqualifiably subject to his demand without reservations or restrictions of any kind, each could have withdrawn his salary, and the corporation was in position to pay it. Section 24 (c) does not apply. Ohio Battery & Ignition Co., 5 T.C. 283">5 T.C. 283; Michael Flynn Manufacturing Co., 3 T.C. 932">3 T.C. 932. The Commissioner disallowed the entire deduction of $15,000 claimed for 1946 and the entire deduction of $9,000 claimed for 1947. He did that because of the provisions of section 24 (a). He made no determination of what would be reasonable allowances for salaries. The corporation had paid no salaries for 1944 and 1945, although the corporation had net profits for each of those years. The amounts are not large. These three men were almost entirely responsible for1953 Tax Ct. Memo LEXIS 362">368 the success of the corporation. All of the factors disclosed by the stipulation, including the fact that the corporation paid no dividends, have been taken into account and a conclusion has been reached that the salaries as determined and credited by the corporation for each year were reasonable in amount. Decisions will be entered under Rule 50. Footnotes1. Proceedings of the following petitioners are consolidated herewith: Louis E. Pakula, Docket No. 34995; Jerry Rappaport, Docket No. 34996.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625301/	ESTATE OF SYLVIA H. ROEMER, DECEASED, ELIZABETH TAYLOR, EXECUTOR, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentEstate of Roemer v. CommissionerDocket No. 22286-81.United States Tax CourtT.C. Memo 1983-509; 1983 Tax Ct. Memo LEXIS 281; 46 T.C.M. 1176; T.C.M. (RIA) 83509; August 22, 1983. 1983 Tax Ct. Memo LEXIS 281">281 From 1970 to 1975 decedent and her daughter lived together. In 1975 decedent purchased another house and the two moved there. Shortly thereafter decedent deeded the house to her daughter. The motive was an expression of gratitude for her daughter's giving up her own residence in 1970. Held,sec. 2036, I.R.C. 1954, is not applicable and value of house is not includable in decedent's estate. Facts show each considered that title to house had changed and acted accordingly. Stephen W. Phillips and James W. Zeeb, for the petitioner. Richard Patrick, for the respondent. STERRETTMEMORANDUM FINDINGS OF FACT AND OPINION STERRETT, Judge: By notice of deficiency dated May 29, 1981, respondent determined a deficiency in the Federal estate tax1983 Tax Ct. Memo LEXIS 281">282 of petitioner-estate in the amount of $47,737.48. Due to concessions by petitioner, the sole issue for decision is whether the decedent, Sylvia H. Roemer, retained, within the meaning of section 2036, I.R.C. 1954, the possession and enjoyment of certain real property for her life even though she had deeded it to her daughter more than 3 years prior to her death. FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulation of facts and exhibits attached thereto are incorporated herein by this reference. Elizabeth Taylor is the daughter of the decedent, Sylvia H. Roemer, and is also the appointed personal representative for the Estate of Sylvia H. Roemer. Mrs. Taylor resided in Tucson, Arizona at the time of filing the petition herein. The Federal estate tax return was filed with the Internal Revenue Service Center, Ogden, Utah. From sometime in 1970 through early 1975, decedent and Mrs. Taylor resided together at 9530 E. Morrill Way, Tucson, Arizona. Early in 1975, decedent sold this home and on February 11, 1975, purchased a residence at 2494 Camino Valle Verde, Tucson, Arizona for a price of $66,000. Decedent and1983 Tax Ct. Memo LEXIS 281">283 Mrs. Taylor moved into the latter residence in March of 1975 and jointly occupied it until decedent's death in January 1979. Shortly after the move to the new residence, decedent approached her attorney, Mr. Daniel J. Sammons, with the idea of giving the residence to Mrs. Taylor. The motives behind the proposed gift were an expression of appreciation for Mrs. Taylor's having given up her own home and moving in with decedent to care for her in her old age and a desire on the decedent's behalf to provide Mrs. Taylor with her own home. Decedent explained to Mr. Sammons that her son and her other daughter were both married and had homes at that time, and she wanted Mrs. Taylor also to have a home of her own. Mr. Sammons informed her at their meeting that, if she undertook such action, she would completely lose ownership and control over the residence and could be "kicked out" at any time by her daughter. After reflecting for a period of time upon her attorney's advice, decedent transferred the real property located at 2494 Camino Valle Verde to her daughter Elizabeth Taylor on June 27, 1975. In connection with the gift, decedent filed a United States Quarterly Gift Tax Return on1983 Tax Ct. Memo LEXIS 281">284 July 9, 1975 reflecting such transfer and paying the gift tax due thereon based upon the full fair market value of the residence. Although Mrs. Taylor did not charge her mother any rent for living in her house, after making the gift the decedent referred to her daugher as her landlord and expressed fears of going to a nursing home. She also began asking Mrs. Taylor's permission before inviting friends to the residence. After the June 1975 gift of the residence, for the first time Mrs. Taylor assumed responsibility for arranging maintenance, redecorating and landscaping of the gifted residence. The decedent continued to pay the expenses for the maintenance, insurance, and utilities on the residence; however, the property taxes and grocery bills were paid by both the decedent and her daughter, and the first post-gift payment of property taxes due on the residence was made from Mrs. Taylor's separate checking account. She also paid for the cost of landscaping the residence. For the period 1975 to 1978, the decedent's Federal tax returns reflect gross income in excess of $27,000 per year, while Mrs. Taylor's tax returns for the same period show gross income of less than $4,3001983 Tax Ct. Memo LEXIS 281">285 per year. Although decedent remained in the gifted residence for the rest of her life, she never mentioned the existence of any agreement or understanding that she would so remain to either her attorney or friends. Decedent died on January 27, 1979 at the age of 86 from an acute myocardial infarction. In the Federal estate tax return filed by Mrs. Taylor as personal representative of the estate, the residence at 2494 Camino Valle Verde was not included as an asset of the estate. In his notice of deficiency respondent included the value of such property in decedent's gross estate, explaining: It is determined that the value of real property located at 2494 Camino Valle Verde, Tucson, Arizona, is includable in the gross estate since the decedent kept a life estate in the property. The fair market value of the property was $99,000.00 at the date of death. Therefore, the taxable estate is increased $99,000.00 OPINION The sole issue for our consideration is whether the value of decedent's residence must be included in her gross estate pursuant to section 2036, which provides in pertinent part as follows: 1983 Tax Ct. Memo LEXIS 281">286 SEC. 2036. TRANSFERS WITH RETAINED LIFE ESTATE. (a) General Rule.--The value of the gross estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer (except in case of a bona fide sale for an adequate and full consideration in money or money's worth), by trust or otherwise, 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, * * . This section requires that the residence be included in the decedent's estate if it is found that she retained the actual possession or enjoyment thereof, regardless of whether she had any enforceable right to do so. Estate of Rapelje v. Commissioner,73 T.C. 82">73 T.C. 82, 73 T.C. 82">86 (1979); Estate of Honigman v. Commissioner,66 T.C. 1080">66 T.C. 1080, 66 T.C. 1080">1082 (1976). It is well settled that possession or enjoyment is considered to be retained by the donor when there is an1983 Tax Ct. Memo LEXIS 281">287 express or implied understanding to that effect among the parties at the time of the transfer. Guynn v. United States,437 F.2d 1148">437 F.2d 1148, 437 F.2d 1148">1150 (4th Cir. 1971); 73 T.C. 82">Estate of Rapelje v. Commissioner,supra at 86; 66 T.C. 1080">Estate of Honigman v. Commissioner,supra at 1082. In the instant case, there clearly was no express agreement allowing decedent to retain possession and enjoyment of the gifted residence. However, respondent contends that there was an implied agreement or understanding between the decedent and her daughter whereby decedent would continue her occupation of the residence. The burden is on petitioner to disprove the existence of any implied agreement or understanding. Skinner's Estate v. United States,316 F.2d 517">316 F.2d 517, 316 F.2d 517">520 (3d Cir. 1963); 73 T.C. 82">Rapelje v. Commissioner,supra at 86. In determining whether an implied agreement or understanding existed between the parties, we must consider all relevant facts and circumstances surrounding the transfer and subsequent use of the property. In this respect, 1983 Tax Ct. Memo LEXIS 281">288 the two factors that the courts have found particularly significant are the continued exclusive possession by the donor and the withholding of possession from the donee. 437 F.2d 1148">Gynn v. United States,supra at 1150; 73 T.C. 82">Rapelje v. Commissioner,supra at 87. Neither of these factors is present in the instant case. In point of fact, the decedent and her daughter lived together in two different homes for a period of approximately 9 years. This co-occupancy began 5 years prior to the gifting of the residence in question and continued until decedent's death in January 1979--almost 4 years after the residence was transferred to Mrs. Taylor. Because the decedent in the present case did not retain exclusive possession of the gifted residence, we find all such cases cited by respondent easily distinguishable and therefore not dispositive of the factual situation with which we are faced. See, i.e., 437 F.2d 1148">Guynn v. United States,supra;73 T.C. 82">Estate of Rapelje v. Commissioner,supra;66 T.C. 1080">Estate of Honigman v. Commissioner,supra. There are, however, a number of cases in which the courts have been called upon to address the1983 Tax Ct. Memo LEXIS 281">289 application of section 2036 to intrafamily transfers in which the donor continues to reside in the gifted residence with the donee by virtue of his relationship to the donee. Union Planters National Bank v. United States,238 F. Supp. 883 (W.D. Tenn. 1964), affd. 361 F.2d 662">361 F.2d 662 (6th Cir. 1966); Estate of Binkley v. United States,358 F.2d 639">358 F.2d 639 (3d Cir. 1966); Diehl v. United States, an unreported case ( W.D. Tenn. 1967, 21 AFTR 2d 1607, 68-1 USTC par. 12,506); Stephenson v. United States,238 F. Supp. 660 (W.D. Va. 1965); Estate of Gutchess v. Commissioner,46 T.C. 554">46 T.C. 554 (1966); Estate of Wier v. Commissioner,17 T.C. 409">17 T.C. 409 (1951).In each of these cases, the courts have uniformly rejected the advocation of section 2036's applicability based on the mere fact that the donor continued to live in a residence which he had conveyed without a showing of an express or implied agreement that the donor would have the right to continue to live in the residence. Although it is true that most of the cases involved interspousal transfers, we do not read the decisions in such cases to1983 Tax Ct. Memo LEXIS 281">290 be so limited. For example, in a court-reviewed decision, this Court rejected the application of section 2036 to an intrafamily transfer stating: The transferor husband's use of the property by occupancy after the transfer is a natural use which does not diminish transferee wife's enjoyment and possession and which grows out of a congenial and happy family relationship.Such post-transfer use is insufficient to indicate any prior agreement or prearrangement for retention of use by the transferor. [Emphasis added.] [46 T.C. 554">Estate of Gutchess v. Commissioner,supra at 557.] We note that if we had intended in Gutchess to limit our decision to interspousal transfers, then we could well have inserted the term "marital" in place of our usage of the term "family." The clear inference to be drawn from our choice of words is that the logic employed is not limited merely to interspousal transfers. With respect to the present case, we know of no cases, and respondent has offered none, in which section 2036 has been applied to a decedent's transfer of legal title of1983 Tax Ct. Memo LEXIS 281">291 a residence to his or her child, where the donor and donee thereafter co-occupy that residence until the decedent's death. In fact, the precedential case law, given the above-stated parameters, can be narrowed to one case, 437 F.2d 1148">Diehl v. United States,supra.1 The facts in Diehl closely resemble those in the case at hand. In Diehl, the decedent was 80 years old and in ill health when his wife died. After the wife's death, decedent's son, daughter-in-law, and their two young children sold their own house and moved in with the decedent. Seven months later the decedent deeded the residence to his son and daughter-in-law. Thereafter, the decedent continued to co-occupy the residence, contributing toward household expenses and paying the utility bills, until his death 9 years later. 1983 Tax Ct. Memo LEXIS 281">292 In rejecting the Government's proposed application of section 2036, the trial court stated: We believe and so find that, though there was an assumption by all concerned that the father would continue to live in the residence, there was no agreement or understanding, express or implied, between the father and the son that the father would have the right to continue to live in the residence. [Diehl v. Commissioner,supra at 1608.] After a thorough examination of the evidence in the instant case, we believe that there was no agreement or understanding, express or implied, between the decedent and her daughter with respect to the decedent's continued occupancy of the residence. This is not to say that decedent's continued occupancy was not considered a possibility; however, such an assumed possibility does not rise to the level of an implied agreement. The evidence in the record clearly demonstrates the change in the decedent's state of mind regarding the residence after giving it to her daughter. After that time, she referred to Mrs. Taylor as her landlord and spoke to her friends of her fear of going to a nursing home. While her daughter had formerly consulted with1983 Tax Ct. Memo LEXIS 281">293 her before asking someone to the house, she began asking her daughter's permission before inviting friends to the residence. Furthermore, she never mentioned the existence of any sort of agreement or understanding to either her attorney or her close friends. Considering the fact that her attorney cautioned her regarding the ramifications of the giving of her residence, it seems illogical that she would not have informed him of the existence of any agreement regarding her continued occupancy--either express or implied. Her mind-set with respect to ownership of the house had changed. Mrs. Taylor's actions following the gifting of the residence also changed. For the first time, she assumed responsibility for maintenance arrangements, as well as the tasks of redecorating and landscaping. She also made the first post-gift payment of property taxes due on the residence from her separate checking account. We find that the actions of both parties were consistent with a true transfer of ownership and that decedent's continued occupancy was attributable to her close family relationship with her daughter rather than any implied agreement or understanding. Mrs. Taylor testified that, 1983 Tax Ct. Memo LEXIS 281">*294 if there had ever been a falling out with her mother, her mother would have been the one to have moved. We find her testimony credible. The fact that no such falling out occurred should not be the determining factor in this case.Accordingly, we hold that the residence in question was properly excluded from decedent's estate. To reflect the foregoing, Decision will be entered under Rule 155.Footnotes1. We find respondent's reliance on our memorandum decision in Estate of Callahan v. Commissioner,T.C. Memo. 1981-357, to be misplaced. In Callahan,↩ the decedent transferred title to her residence to a bank as trustee under a trust whereby the decedent was the beneficiary of one-third interest in the residence and her three children were the beneficiaries of the remaining two-thirds interest. This case is distinguishable from the present case on its facts.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625303/	Estate of Robert L. Clymer, Deceased, Edward O. Steely and Doylestown Trust Company, Executors v. Commissioner.Estate of Clymer v. CommissionerDocket No. 48525.United States Tax CourtT.C. Memo 1954-112; 1954 Tax Ct. Memo LEXIS 132; 13 T.C.M. 715; T.C.M. (RIA) 54218; July 30, 1954, Filed George Craven, Esq., Packard Building, Philadelphia, Pa., and James F. Gordy, Esq., for the petitioners. Daniel A. Taylor, Esq., for the respondent. MURDOCK Memorandum Opinion MURDOCK, Judge: The Commissioner determined a deficiency in income tax of the estate of $6,629.54 for its fiscal year ended July 31, 1950 and one of $573.21 for its fiscal year ended July 31, 1951. The only issue for decision is whether the estate is entitled to a deduction of $24,774.17 for the first year and one of $4,314.31 for the second year under section 162(a). The facts have been1954 Tax Ct. Memo LEXIS 132">133 stipulated and the stipulation is adopted as the findings of fact. The income tax returns for the taxable years were filed with the collector of internal revenue for the First District of Pennsylvania. The decedent at the time of his death, July 31, 1949, was a partner in Clymer's Department Store of Doylestown, Pennsylvania. The partnership used a cash method of reporting its income. The partnership agreement of the partnership known as "Clymer's Department Store" provides, inter alia, as follows: "Article 19. All of the accounts receivable shall be closed at the end of the day of the retirement or death of a partner, and the surviving partners shall proceed to collect said accounts as soon as possible and shall pay over to the retiring partners, or the legal representatives of a deceased partner monthly one-third of all such collections made during said month, less a collection charge of five per cent of said amount." The decedent's estate received $26,093.24 in the year ended in 1950 and $4,482.19 in the year ended in 1951 as its share of the collections of such accounts receivable, which amounts were reported as income of the estate in the amended income tax return of1954 Tax Ct. Memo LEXIS 132">134 the estate for the year ended in 1950 and in the income tax return of the estate for the year ended in 1951. Article 11 of the decedent's will is as follows: "All the rest, residue and remainder of my estate I give, devise and bequeath to Doylestown Trust Company, in trust, to hold and invest the same and to pay over annually beginning one year after the date of my death, the sum of $1,000 per year of principal plus any interest earned during the previous year, to the Village Improvement Association, a Pennsylvania corporation, located at Doylestown, Pa. for the purpose of providing food and clothing for poor people of Doylestown and vicinity. I request that purchases of food and clothing by said organization shall be made, as far as possible, from Clymer's Department Store so long as said store is in existence under the present management." The Village Improvement Association is a charitable organization which meets the requirements of section 23(o) and section 101(6) of the Internal Revenue Code. The petitioner estate subtracted from its shares of the collections and credited the balances of $24,774.17 for the first year and $4,314.31 for the second1954 Tax Ct. Memo LEXIS 132">135 year to the principal of the residuary estate. Those balances were deducted by the petitioner on its income tax returns for the taxable years and disallowed by the Commissioner in determining the deficiencies. The parties agree that the collections were properly included in gross income under section 126(a)(1)(A) which provides that gross income of a decedent not includible in his income up to the date of his death "shall be included in the gross income, for the taxable year when received, of: (A) the estate of the decedent, if the right to receive the amount is acquired by the decedent's estate from the decedent." Section 162(a) allows a deduction, in lieu of the deduction for contributions under 23(o), of "any part of the gross income, without limitation, which pursuant to the terms of the will * * is during the taxable year * * * permanently set aside for the purposes and in the manner specified in section 23(o)." The Commissioner concedes that the amounts here in question were permanently set aside for charitable purposes pursuant to the terms of the will. His contention is that those amounts "did not constitute gross income of the estate within the provisions of section1954 Tax Ct. Memo LEXIS 132">136 162(a) of the Code" because they became a part of the principal or corpus of the decedent's residuary estate immediately upon receipt and were "set aside" for the charity as principal, not as income. The petitioner contends that the Commissioner's argument is directly contrary to the express provisions of section 126(a)(1)(A) that the amounts are to be included in the gross income of the estate; they can not be "included in" and at the same time not "constitute" gross income of the estate for income tax purposes; if these amounts were gross income of the estate for the purpose of the provisions of the Code imposing the tax they must also be gross income of the same estate for the purpose of the provisions of the Code allowing deductions; section 22 defines "gross income" for both purposes of the income tax provisions of the Code; there is no question here as to whether the decedent's share of the collections was a part of his gross estate for estate tax purposes and cases on that subject are not in point; the question here depends upon the income tax provisions; the amounts are a part of the gross income of the estates for income tax purposes; if this were not true the estate would1954 Tax Ct. Memo LEXIS 132">137 not be subject to income tax on those amounts; and there is no reason apparent, in the legislative history of the provisions or elsewhere, why Congress did not intend to allow a deduction in a situation like this. Cf. Bowers v. Slocum, 20 Fed. (2d) 350; Peoples Trust Co., 10 B.T.A. 1385">10 B.T.A. 1385. The burden of the tax falls solely upon the charity. Cf. Old Colony Trust Co. v. Commissioner, 301 U.S. 379">301 U.S. 379. This Court has twice considered substantially this same question, has decided it for the Commissioner in each and has been affirmed on the point by the two Courts of Appeals to which those decisions were appealed. Estate of Ralph R. Huesman, 16 T.C. 656">16 T.C. 656, affd. 198 Fed. (2d) 133; Rose J. Linde, 17 T.C. 584">17 T.C. 584, 17 T.C. 584">592, affirmed on this point 213 Fed. (2d) 1 (May 4, 1954). Those cases are controlling here, but my decision would be for the petitioner had this Court not already taken the opposite view. Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625304/	John I. Morrill v. Commissioner.Morrill v. CommissionerDocket No. 12687.United States Tax Court1949 Tax Ct. Memo LEXIS 259; 8 T.C.M. 163; T.C.M. (RIA) 49033; February 21, 19491949 Tax Ct. Memo LEXIS 259">259 Scott P. Crampton, Esq., and Geo. E. H. Goodner, Esq., Munsey Bldg., Washington, D.C., for the petitioner. Frank M. Thompson, Jr., Esq., for the respondent. LEMIRE Memorandum Findings of Fact and Opinion This proceeding involves income and victory tax deficiencies for 1943 and 1944, in the respective amounts of $18,055.91 and $7,708.92. The year 1942 is also under consideration because of the provisions of the Current Tax Payment Act of 1943. The entire deficiencies for both years result from the respondent's determination that the petitioner's daughter was not a partner in his business, and that the income therefrom is all taxable to the petitioner. The correctness of this determination is the only issue before us. Findings of Fact The petitioner is a resident of Mobile, Alabama. He filed his income tax return for the years involved with the collector for the district of Alabama. In 1919 the petitioner acquired ownership of a wholesale and retail hardware and marine supply business located at Mobile, Alabama, which he thereafter operated as a sole proprietorship under the name of "A. H. McLeod & Company." In the fall of 1941 the petitioner undertook to1949 Tax Ct. Memo LEXIS 259">260 make his daughter, Mary Morrill Jackson, a partner in the business. The daughter, an only child, was then 25 years of age. She had been married and divorced and was living with the petitioner. She had no children. To effectuate the partnership, the petitioner, on December 31, 1941, executed an assignment to the daughter of a one-fourth undivided interest in the A. H. McLeod & Company business, including the accounts receivable, inventory, good will, and all other assets. The petitioner reported the gift in a gift tax return which he filed for 1941 at a value of $28,797.21. The return showed no gift tax due. On the same date that the above-mentioned assignment was made, the petitioner and his daughter executed a partnership agreement setting forth the terms under which they proposed to operate the business as partners. Under this agreement, the petitioner was to have the active management of and control over the business and was required to sign all checks, notes, and other writings pledging the credit ofr the firm. He was to have a three-fourths interest in the business, and the income therefrom, and his daughter a one-fourth interest. Both the profits and losses were to be shared1949 Tax Ct. Memo LEXIS 259">261 by them in that proportion. No other capital was paid into the firm by either the petitioner or his daughter. Due to ill health, the daughter never took any part in the operation of the business of A. H. McLeod & Company. She died in 1947 of Bright's disease. During the existence of the alleged partnership, from January 1, 1942, to the date of the daughter's death, the profits of the business were shown in the firm's books and reported in its partnership returns as belonging to and being distributable to the petitioner and his daughter in the proportions of three-fourths and one-fourth, respectively. The following amounts were shown as credits to the daughter's account and withdrawals made by her: CalendarAmountYearEarningsWithdrawn1942$18,602.23$ 4,031.88194318,530.2431,372.98194410,390.839,266.48194511,845.212,504.03194611,402.386,004.701947 (3 months)2,583.96987.57The daughter received $100 a month, regularly, on a drawing account and from time to time made other withdrawals, which were charged to her in the books. In 1943 a residence was purchased in the daughter's name at a cost of approximately $16,000. She1949 Tax Ct. Memo LEXIS 259">262 and her father and mother lived together in the residence until her death. In an audit made by the United States Government in connection with the petitioner's, or A. H. McLeod & Company's, cost plus war contracts with agencies of the Government the petitioner was allowed a salary of $15,000 per year. There was no change in the operation of the business after the execution of the partnership agreement. The petitioner continued to manage it as a sole proprietor. It was not the intention of either the petitioner or his daughter that they should conduct the business as a bona fide partnership. Opinion LEMIRE, Judge: The petitioner's claim for recognition of the alleged partnership between him and his daughter rests entirely upon her contribution to the business of the one-fourth interest which he gratuitously assigned to her for the purpose of making her a partner. The daughter invested none of her own funds in the business and took no part whatever in its conduct. On the evidence we cannot find that either she or her father ever intended that they should join in conducting the business as a bona fide partnership. Rather, it is indicated that their purpose was to make a division1949 Tax Ct. Memo LEXIS 259">263 of the profits of the business without any substantial effect upon its operation. Under the decisions of the Supreme Court in , and , and other numerous cases of like import, such as , affd., , certiorari denied, ; , affd., , certiorari denied, ; promulgated January 24, 1949, recognition of the partnership for income tax purposes must be denied. The petitioner argues in the alternative that in the event the partnership is not recognized the profits of the business should be apportioned between him and his daughter on the basis of their respective capital interests, after determination of the amounts of profits attributable to his personal services and those attributable to capital. He contends that 30 per cent of the profits should be attributable to his services and 70 per cent to capital. That, in effect, would require an allocation of profits to a person on1949 Tax Ct. Memo LEXIS 259">264 account of capital contributed by, or originating with, another person. No case is cited and none has been found to support such a principle. The petitioner submits that this principle has been recognized "in part" in , reversed, , and . In both of these cases, however, as the petitioner points out, the allocation of profits to the taxpayers' wives was based on capital which the wives had contributed out of their own separate funds. The distinction between those cases and the instant case is, we think, decisive. Since the daughter here made no contribution of her funds to the business, we see no justification for allocating to her any of the profits as a return on her capital. Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625305/	LORRAINE MANVILLE GOULD DRESSELHUYS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Dresselhuys v. CommissionerDocket No. 88887.United States Board of Tax Appeals40 B.T.A. 30; 1939 BTA LEXIS 916; June 6, 1939, Promulgated 1939 BTA LEXIS 916">916 Petitioner transferred to a trustee funds to be paid to a child, then about 18 years of age, upon attainment of the age of 35 years, but not to be paid unless petitioner's husband (or petitioner after death of the husband) delivered to the trustee formal written consent to such payment. If the husband (or petitioner after his death) did not file such consent with trustee, the trust terminated at attainment by the child of age 35, and the funds would revert to petitioner or her estate. If both petitioner and her husband died before attainment by the child of the age of 35 years, the obligation of the trustee to pay to the child should become absolute. Held, that the transfer was not subject to tax under section 501 of the Revenue Act of 1932. Mark Eisner, Esq., and Ferdinand Tannenbaum, Esq., for the petitioner. E. O. Hanson, Esq., and Harold F. Noneman, Esq., for the respondent. DISNEY40 B.T.A. 30">30 OPINION. DISNEY: This proceeding involves liability for gift tax. Deficiency was determined in the amount of $15,000.24 (of which only $4,337.89 is now in issue) for the year 1934. The facts are stipulated, and will be set forth herein1939 BTA LEXIS 916">917 only so far as necessary to consideration of the issue presented. That issue is whether petitioner made two gifts, each of the present worth of the right to receive $25,000 at age 35, one to a person aged 18 years, the other to a person aged 19 years. There is no disagreement as to the valuation, so that the only question presented is as to whether gifts were made. Property was on January 30, 1934, transferred to a trustee, with directions to make a payment of $25,000 to each of two children, upon the attainment by each of the age of 35 years, with the provision, however, that the payments were to be made only if the husband of the donor should execute and file with the trustee a formally acknowledged written consent to the payment, and, in case donor's husband should have died prior to the attainment of age 35 by the child involved, then only if the donor should execute and file with the trustee similar written consent to the payment. If neither donor nor her husband should execute and file the written consent, the $25,000 upon the termination of the trust should revert to donor, or, if deceased, to her estate, but if both donor and her husband should be deceased at the attainment1939 BTA LEXIS 916">918 of age 35 by the child involved the obligation of the trustee to make payment would be absolute. 40 B.T.A. 30">31 Does this situation show gift, within the purview of section 501 of the Revenue Act of 1932? Though the parties discuss section 501(c) of the Revenue Act of 1932, we find consideration thereof unnecessary to determination of the issue here, which is whether transfer by gift is involved at all. If so, the tax is applicable. Petitioner cites cases as to the general question of conditional gifts. Respondent emphasizes the element of mere possibility of reverter as to any dominion by the grantor, under the thought expressed in ; and , construing estate tax law, and adds reference to , as to similar treatment of the law as to gift tax. The case last cited states: "The two statutes are plainly in pari materia", and proceeds to consider the concept of transfer as essentially the same in both statutes, and as "identified more nearly with a change of economic benefits than with technicalities1939 BTA LEXIS 916">919 of title." There is undoubtedly close connection between the gift tax and the tax upon transfers that take effect at death, as also dwelt upon in the case last cited, and each statute is a complement to the other; nevertheless we think that the respondent's application of ;; also , is not valid here. In order for the statute to apply there must be a gift, in trust or otherwise, direct or indirect. Here, although the property was placed in trust, the trust would terminate at a certain time and the corpus here involved would return to the donor, unless a certain event took place, upon which event, and only in which event, the gift was effected, to wit, the execution of a written consent, primarily by the donor's husband, and secondarily in case of his death, by the donor. In the absence of such affirmative action, the child took nothing from the trust. We think that, under primary principles as to the nature of gifts, such a positive condition precedent dictates that here there was no1939 BTA LEXIS 916">920 gift. A gift must be complete, subject to no condition precedent, or it is void, is no gift at all. Citation of authority is hardly necessary, so uniform and elementary is the rule. ; . Although it is true under many cases that the revenue law is not to be too closely inhibited by strict legal rights, nevertheless we think it can not fairly be thought that section 501 of the Revenue Act of 1932, merely because it involves gifts, should be given the effect of taxing conditional gifts which under uniform interpretation can not be said to constitute gifts. Moreover, section 510 of the Revenue Act of 1932 provides that the tax may fall upon the donee, to the extent of value of gift, which indicates well, we think, that there must be a 40 B.T.A. 30">32 donee possessing something to tax. There was no such donee in this case. Moreover, we think , bears out petitioner's theory when properly applied to this proceeding. If in that case a gift was effected when a settlor canceled a power of revocation, we think that herein the gift would1939 BTA LEXIS 916">*921 be effected only if the husband filed the consent, or when, after the death of donor's husband, she so filed, or gave up the power to fail or refuse to give written consent to the payment to the child - but in the absence of such action, which would of course entail a wholly new provision in, or modification of, the trust instrument, the child could not secure the payment. This only serves to emphasize that the original trust agreement did not provide a gift. We therefore conclude and hold that the Commissioner erred in applying section 501 of the Revenue Act of 1932 and in determining the deficiency herein involved. Nevertheless, because of another element in the proceeding which it has not been necessary herein to discuss, Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625306/	SPENCER D. STEWART AND MARY JANE STEWART, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentStewart v. CommissionerDocket No. 1697-78.United States Tax CourtT.C. Memo 1982-209; 1982 Tax Ct. Memo LEXIS 532; 43 T.C.M. 1119; T.C.M. (RIA) 82209; April 21, 1982. James Powers, for the petitioners. Brad S. Ostroff, for the respondent. KORNERMEMORANDUM FINDINGS OF FACT AND OPINION KORNER, Judge:* Respondent determined deficiencies in petitioners' Federal income taxes of $ 210,751.13 for 1966 and $ 45,444.21 for 1967. After concessions by the parties, the remaining issues for decision are: 1982 Tax Ct. Memo LEXIS 532">533 (1) whether the interest received by petitioners during 1966 from the City of Phoenix is excludible under section 103(a); 1 and (2) whether the gain on the sale of certain securities transferred by petitioner Spencer D. Stewart to John Porter Manufacturing Co., and sold by it on the same days when transferred, is attributable to petitioners for income tax purposes. FINDINGS OF FACT Some of the facts have been stipulated and are so found. Spencer D. Stewart ("petitioner") and Mary Jane Stewart, husband and wife, resided in Phoenix, Arizona, when they filed their petition. During calendar years 1966 and 1967, petitioners timely filed joint Federal income tax returns and paid in full the tax liabilities shown to be due thereon. 1982 Tax Ct. Memo LEXIS 532">534 I In 1943 or 1944, petitioner purchased various water utilities under the name of Consolidated Water Company ("Consolidated"). Consolidated supplied water through underground pipes to households on the outskirts of Phoenix. The Phoenix municipal water department provided service to residents within the city. Consolidated was wholly owned by the petitioner. During the 1950's, the city's boundaries expanded considerably so that part of the area serviced by Consolidated became located within the Phoenix city limits. As a result, petitioner sold several water systems to the City of Phoenix ("City") prior to 1961. In 1961 or early 1962, the City began negotiations with petitioner to acquire additional portions of the Consolidated system, serving an area of northwest Phoenix recently annexed by the City. In the early part of 1962, the City made an offer to petitioner which he refused. On July 2, 1962, the City instituted a condemnation action in the Superior Court of the State of Arizona, Maricopa County ("Superior Court"), to condemn Consolidated's water system serving this area, and to determine its value. After the commencement of the condemnation action in Superior Court, 1982 Tax Ct. Memo LEXIS 532">535 the parties entered into Agreement No. 6905 ("Agreement"). Both parties had different reasons for entering into the Agreement. The City wanted to take immediate possession of the condemned portion of the Consolidated system and did not wish to post a bond two and one-half times the value of the property, as provided by existing Arizona statutes. Petitioner realized that the loss of his property was inevitable, and desired to obtain funds quickly. The Agreement was accordingly entered into as part of, and in the overall context of the condemnation action in the Superior Court. The final Agreement between petitioner and the City provided, inter alia, that the Superior Court would proceed to dispose of the condemnation action and determine the exact amount of the award. 2 The agreement further provided: (d) Any sums which become payable by either party to the other under the terms of the final judgment entered in said condemnation action (and1982 Tax Ct. Memo LEXIS 532">536 after deduction of credits to which the judgment debtor is entitled) shall bear interest at the statutory rate of six percent per annum from the date City obtains possession of said utility property to the date of payment by the judgment debtor. Pending final action by the Superior Court, petitioner received $ 1,750,000 in cash contemporaneously with the transfer of possession of the condemned property to the City. The City also agreed to assume certain additional financial obligations of the petitioner. The total amount paid to or for petitioner's benefit was stated to be $ 2,450,000. The City in turn, was allowed to finance all or a portion of the final award granted petitioner by the Superior Court through the issuance of water revenue bonds. On July 23, 1962, the Superior Court entered an Order approving the Agreement and incorporated the Agreement as a part of the condemnation proceedings. On September 3, 1964, the Superior Court entered a $ 3,400,000 judgment in favor of petitioner which the City appealed. On June 22, 1966, the Arizona Supreme Court affirmed the Superior Court's judgment. On October 18, 1966, in satisfaction of the above judgment, the City paid petitioner1982 Tax Ct. Memo LEXIS 532">537 an additional $ 1,180,611.61 of which $ 239,137.06 3 represented interest as required by the Agreement. Petitioners excluded the interest payment froim their 1966 Federal income tax return on the basis that the interest was excludible from gross income under section 103. Upon audit of petitioners' 1966 return, respondent determined that such interest was taxable ordinary income to petitioners in 1966. II Prior to March 15, 1962, petitioner acquired controlling stock interests in two corporations, John Porter Manufacturing Company ("JPMC") and N. Porter Mercantile Company ("Porters"). JPMC was engaged in the manufacture of western wear and Porters was a retail operation engaged in the business of selling saddles, western clothing and related items. Porters subsequently filed a petition in the bankruptcy court and was adjudicated bankrupt. JPMC purchased some of the retail outlets from Porters bankruptcy estate and began its own retail operations. JPMC reported net operating losses for fiscal years ended June 30, 1962, to June 30, 1966, as follows: Fiscal Year EndedNet IncomeJune 30or (Loss)1962( 9,574.39)1963( 86,053.00)1964(110,299.00)1965( 31,521.11)1966(117,894.31)1982 Tax Ct. Memo LEXIS 532">538 As of June 30, 1967, JPMC had available net operating loss carryovers of $ 326,272.32. Petitioners wanted to strengthen JPMC's financial position in order to aid its continued operation. The Corporation's "Balance Sheet" for June 30, 1966, reflected the following liabilities: Bank Overdrafts$ 9,506.59Accounts Payable30,548.88Notes and Contracts34,659.04Accrued Taxes Payable10,327.35Mortgages Payable on"Apacheland" PropertyHome Savings & Loan$ 89,000.00Spencer Stewart111,763.00200,763.00Other Land & Buildings25,996.45Note Payable to SpencerStewart56,602.17$ 368,403.48JPMC's books and records reflect that on August 1, 1966, the "Apacheland" property was acquired by Wilderness Enterprises, in consideration of the assumption of the remaining mortgage debt on the property. This eliminated JPMC's largest debt then outstanding. Prior to January 1, 1967, petitioner had advanced or caused other corporations or partnerships which he controlled to advance money to JPMC. At December 31, 1966, the balances of such debts were as follows: CreditorAmountPetitioner$ 224,284.00Stewart Motors8,700.00B. Bar L Land & Cattle Co.(later called StewartProperty Management Co.)and Stewart ManagementCompany140,753.20Moo Soo Ranch3,000.00Wilderness Enterprises1,028.97Consolidated Water Company6,041.97TOTAL$ 383,808.141982 Tax Ct. Memo LEXIS 532">539 Petitioner personally guaranteed all loans made to JPMC. At June 30, 1965, JPMC's balance sheet showed that it owed petitioner $ 313,559.60, all of which was subordinated to the claims of other creditors. Petitioner agreed to convert $ 230,000 of this indebtedness into an equal amount of JPMC preferred stock, but no stock certificates were actually prepared or issued to the petitioner. Nevertheless, it was apparnelty treated as though the stock had been issued, and $ 230,000 was transferred from debt to capital account on JPMC's books. In December, 1966, entries were made on JPMC's records showing that JPMC called in and cancelled $ 230,000 in preferred and $ 10,000 in common stock and increased its retained earnings account (which was a deficit) by $ 240,000. This cancellation covered all of JPMC's outstanding stock. Early in 1967, petitioner transferred to JPMC the following publicly trades stocks, which he personally owned, which JPMC, as purported owner, sold on the same day: Date TransferredPetitioner'sto JPMC and DateNumberBasis inNet SalesNet Capitalof Sale by JPMCof SharesSecuritiesProceedsGain1/03/671,441$ 4,445.51$ 45,397.71$ 40,952.201/17/672,0006,170.0464,029.7757,859.732/07/672,0006,170.0466,742.0960,572.053/02/672,00013,629.2228,570.0014,940.783/02/672,00010,400.0164,300.8253,900.81$ 40,814.82$ 269,040.39$ 228,225.571982 Tax Ct. Memo LEXIS 532">540 In exchange for the stock, JPMC issued 4,000 shares of $ 10 par common stock to petitioner. JPMC used part of the above proceeds to purchase, and promptly resell, certain other securities, at a net loss of $ 769.99. Thus, the net proceeds of all these stock transactions to JPMC was $ 268,270.40. The record 4 establishes that JPMC used some of the sales proceeds to repay $ 42,500 to petitioner, $ 69,637.86 to Stewart Property Management Co. ("SPMC"), a company in which petitioner then owned a 45 percent interest, 5 $ 74,835.41 to Consolidated Water Co., a sole proprietorship business owned by petitioner, and $ 22,633 to Valley National Bank ("VNB"). In turn, of the sale proceeds given to SPMC by JPMC, $ 10,000 was paid to VNB and $ 12,300 was given to petitioner. The $ 74,835.41 paid to Consolidated Water Co. ("Consolidated") by JPMC was, in turn, distributed by Consolidated (together with additional funds) to SPMC and VNB in the amounts of $ 52,503.79 and $ 46,435.41, respectively. The record does not establish that a single JPMC creditor, other than petitioner or businesses that petitioner owned or controlled, was paid any of the proceeds from the sale of these stocks.1982 Tax Ct. Memo LEXIS 532">541 The record does not establish that VNB, the other identifiable distributee, was a creditor of JPMC. The distribution to Consolidated was, in fact, more than 12 times larger than JPMC's debt to Consolidated. After the above distributions of the stock sales proceeds were made, JPMC retained for its own use not more than $ 35,193.34. The company went out of business in 1970. In its tax return for its fiscal year ending June 30, 1967, JPMC reported net capital gains from the above stock transactions in the amount of $ 228,225.57. JPMC then reported net income for the year of $ 173,390.07, which was fully absorbed by its net operating loss carryforwards from prior years, in the amount of $ 326,272.32. As a result, JPMC paid no income tax for 1967. Respondent's deficiency notice states: It is determined that you realized a capital gain of $ 228,225.571982 Tax Ct. Memo LEXIS 532">542 in the tax year 1967 when you transferred various securities to John Porter Manufacturing Co., purportedly within the purview of Sec. 351 of the Code. It is determined that such transfer was for the purpose of avoidance and/or evasion of taxes. Accordingly, the long-term capital gain realized thereon of $ 228,225.57 is reallocated to you within the purview of Sec. 482 of the Internal Revenue Code. Respondent's trial memorandum, received by the petitioners prior to trial, states the issue and the legal principle involved as follows: ISSUE 2. Whether capital gain in the amount of $ 228,225.57 realized on the sale of stock by John Porter Manufacturing Co. on the same day as contributed to it by petitioner Spencer D. Stewart is taxable to petitioners. LEGAL PRINCIPLE 2. The transfer of appreciated property followed by the sale of such property by the transferee will be treated for tax purposes as a sale by the transferor where such transferee was used merely as conduit through which to pass title. Commissioner v. Court Holding Co.,324 U.S. 331">324 U.S. 331 (1945);1982 Tax Ct. Memo LEXIS 532">543 Hallowell v. Commissioner,56 T.C. 588">56 T.C. 588 (1971). Petitioners were the true sellers of the securities transferred by them to JPMC in January, February and March, 1967, and sold on the same days when transferred. OPINION I Section 103(a)(1), as it read in 1976, provided for an exclusion from a taxpayer's gross income for interest on … the obligations of a State, a Territory, or a possession of the United States, or any political subdivision of any of the foregoing, or of the District of Columbia;…. However, section 103(a)(1) applies only to interest paid on obligations incurred in the exercise of the governmental unit's borrowing power. By contrast, a condemnation action is the exercise of the government unit's eminent domain power. Therefore, interest on a condemnation award is not excludible under this provision. Holley v. United States,124 F.2d 909">124 F.2d 909 (6th Cir. 1942), cert. denied 316 U.S. 685">316 U.S. 685; Drew v. United States,551 F.2d 85">551 F.2d 85, 551 F.2d 85">87 (5th Cir. 1977); United States Trust Co. of New York v. Anderson,65 F.2d 575">65 F.2d 575, 65 F.2d 575">577-578 (2d Cir. 1933),1982 Tax Ct. Memo LEXIS 532">544 cert. denied 290 U.S. 683">290 U.S. 683 (1933); Newman v. Commissioner,68 T.C. 433">68 T.C. 433 (1977). We have found that the Agreement was integral to the condemnation proceedings and not a separate arrangement as alleged by petitioner, and this is determinative of the issue. The provision in the Agreement that provides for interest at the statutory rate of six percent is based on the terms of the final judgment entered in the condemnation action.The Agreement merely provided a means for petitioner to obtain funds quickly and for the City to take immediate possession of Consolidated properties without the posting of a bond. To separate the interest obligation from the condemnation award would be to ignore the express language of the Agreement. Therefore, the interest received by petitioner as a part of the condemnation award is taxable income, not included within the exclusion provided by section 103(a)(1). 124 F.2d 909">Holley v. United States,supra;Isham v. Commissioner,26 B.T.A. 1040">26 B.T.A. 1040 (1932); King v. Commissioner,77 T.C. 1113">77 T.C. 1113 (1981). II The remaining issue relates to the exchange of petitioner's personal securities, 1982 Tax Ct. Memo LEXIS 532">545 valued at $ 269,040.39, and in which he had a cost basis of $ 40,814.82, for 4,000 shares of JPMC common stock, followed immediately by the sale of such stock by JPMC. First, however, we must address a procedural complaint which petitioner raised in his reply brief, i.e., whether respondent's reliance on a substance-over-form argument signifies the abandonment of the section 482 issue raised in respondent's statutory notice of deficiency. Petitioner claims that respondent's reliance on the substance-over-form argument is a new issue which should not be considered by the Court since the advancement of this argument has both surprised and disadvantaged petitioner.This Court will not consider issues not properly pleaded. Markwardt v. Commissioner,64 T.C. 989">64 T.C. 989, 64 T.C. 989">997 (1975); Estate of Mandels v. Commissioner,64 T.C. 61">64 T.C. 61, 64 T.C. 61">73 (1975); Estate of Horvath v. Commissioner,59 T.C. 551">59 T.C. 551, 59 T.C. 551">556 (1973). The propriety of the pleadings depends on whether the Court and the parties have been given fair notice of the matters in controversy and the basis1982 Tax Ct. Memo LEXIS 532">546 of their respective positions. Rule 31(a), Tax Court Rules of Practice and Procedure. We must decide, therefore, whether petitioner was surprised and disadvantaged by respondent's reliance on the substance-over-form doctrine. Schuster's Express v. Commissioner,66 T.C. 588">66 T.C. 588, 66 T.C. 588">593 (1976), affd. 562 F.2d 39">562 F.2d 39 (2d Cir. 1977); 64 T.C. 989">Markwardt v. Commissioner,supra.Petitioner asserts that his first notice of respondent's substance-over-form theory was in respondent's opening brief. Petitioner contends that his evidence at trial would have been wholly different had he known that respondent was going to raise the substance-over-form doctrine. He specifically states that he would have: (1) submitted evidence indicating that the transferred securities were in fact re-registered in JPMC's name or, (2) refused to stipulate that the securities were sold on the same day that they were delivered to JPMC. We disagree that petitioner was surprised and disadvantaged by respondent's reliance on the substance-over-form doctrine. Further, we have expressly found that petitioner was notified of respondent's intentions to argue a substance-over-form1982 Tax Ct. Memo LEXIS 532">547 theory through his trial memorandum, served on petitioner prior to trial. 6Petitioner complains that respondent has abandoned the issue of whether the tax attributable to the sale of securities by JPMC is allocable to petitioner because he is no longer relying on section 482. We disagree. In Commissioner v. Transport Manufacturing and Equipment Co.,7 the Eighth Circuit Court of Appeals addressed a similar issue where the respondent had not pleaded section 482 but had initially relied upon something analogous to an adequacy-of-consideration theory. In that case the respondent failed to notify petitioner that he intended to reply on section 482. The Court of Appeals affirmed the Tax Court's determination that respondent's failure to notify petitioner in his answer, or at trial of his intended theory for sustaining this deficiency, was inadequate and had surprised and disadvantaged petitioner. In resolving this procedural issue, the Court of Appeals noted, however, that: 1982 Tax Ct. Memo LEXIS 532">548 * * * [I]f * * * a certain code section, theory or regulation has not been specifically raised in the notice of deficiency, * * * and if there is an absence of surprise on the taxpayer's part, the taxpayer has no reason to complain. 8We conclude that the notification given prior to trial to petitioner of respondent's reliance on the substance-over-form doctrine was sufficient to overcome any claim by petitioner that he was surprised or disadvantaged. Further, the evidence would not have been appreciably different had petitioner been expressly notified earlier of respondent's intent to raise the substance-over-form theory. Petitioner's failure to stipulate to dates concerning the transfer and sale of petitioner's personal stock would not have hindered us from making the same findings that we have made in this case. 9 Moreover, the evidence introduced at trial was germane and relevant to the substance-over-form1982 Tax Ct. Memo LEXIS 532">549 inquiry. The evidence submitted by respondent focused on the history of JPMC, the transfer of petitioner's securities to JPMC and their subsequent sale, JPMC's financial position, petitioner's advancement of personal funds, and JPMC's large carryover losses. Finally, the Court must decide whether respondent's reliance on this doctrine constitutes a new matter or issue which would shift the burden of proof to respondent. Rule 142(a) of the Tax Court Rules of Practice and Procedure.If the new theory either alters the original deficiency or necessitates the introduction of different evidence, it presents a "new matter". Achiro v. Commissioner,77 T.C. 881">77 T.C. 881, 77 T.C. 881">890 (1981); Tauber v. Commissioner,24 T.C. 179">24 T.C. 179, 24 T.C. 179">185 (1955). If, however, the new theory merely clarifies or develops respondent's original determination, there is no1982 Tax Ct. Memo LEXIS 532">550 new matter and the burden of proof is not shifted. 77 T.C. 881">Achiro v. Commissioner,supra;Estate of Sharf v. Commissioner,38 T.C. 15">38 T.C. 15, 38 T.C. 15">27-28 (1962). We hold that respondent's substance-over-form argument does not constitute a new matter since respondent's reliance on this doctrine does not increase the original deficiency nor require the introduction of different evidence. The only issue is, and has been, whether the capital gain realized on the sale of stock by JPMC on the day that Mr. Stewart contributed these stocks to the corporation is taxable to petitioner. Respondent's reliance on the substance-over-form theory of defense, rather than section 482, does not vitiate respondent's statutory notice nor shift the burden of proof to him. 10The substance-over-form doctrine1982 Tax Ct. Memo LEXIS 532">551 requires that, after viewing the steps of a transaction as a whole, the incidents of taxation falls on the true seller and not on a mere conduit through which title passes. Commissioner v. Court Holding Company,324 U.S. 331">324 U.S. 331, 324 U.S. 331">334 (1945). Whether a series of transfers constitutes one or more transactions for tax purposes is a question of fact. Commissioner v. Court Holding Company,supra at 332; United States v. Cumberland Public Service Co.,338 U.S. 451">338 U.S. 451, 338 U.S. 451">454 (1950). Although a taxpayer is entitled to minimize his tax liabilities by lawful means, the steps he takes to do so must have a valid business purpose, apart from tax-savings motives. Gregory v. Helvering,293 U.S. 465">293 U.S. 465, 293 U.S. 465">469 (1935). Therefore, it is for us to decide whether petitioner's contributions of securities to JPMC had a legitimate business purpose, of whether JPMC was merely the conduit through which petitioner sold his personal stock, hoping to avoid tax thereon. In making this determination, three earlier decisions of this Court are especially helpful. Of the three, the first two highlight the kind of evidence that would indicate that1982 Tax Ct. Memo LEXIS 532">552 the petitioner had used the Corporation as a conduit through which to pass title; while the last decision illuminates those facts and circumstances that would justify the contribution by a taxpayer of large amounts of stock to a closely held corporation. In Hallowell v. Commissioner,56 T.C. 600">56 T.C. 600 (1971), we held that the taxpayer, and not the corporation that he controlled, was taxable on the sale of appreciated securities that he transferred to the corporation and which the corporation sold a short time later. In reaching this decision, the Court noted that the annual distributions made by the corporation to the taxpayer corresponded roughly with the amount of gain derived annually from the sale of donated stock. 56 T.C. 600">Hallowell v. Commissioner,supra at 607. We concluded, therefore, that the sale of these securities was made for the benefit of the taxpayer. As in the case before us, the corporation in this earlier decision had large net operating losses available for carry forward in the years of sale, and the proceeds from the sale were returned to the taxpayer in the form of repayments of loans. In an earlier but equally pertinent decision, 1982 Tax Ct. Memo LEXIS 532">553 this Court held in Abbott v. Commissioner,T.C. Memo. 1964-65, affd. per curiam, 342 F.2d 997">342 F.2d 997 (5th Cir. 1965), that the taxpayer, and not the company in which he had a 50 percent interest, was taxable on the sale of appreciated stock. Although this Court found that the proceeds from the sale were used in the company's operations, it stated that the reduction of corporate taxes resulting from the additional transfer of taxpayer's personal securities to one of the corporations he controlled, was not a sufficient business purpose to justify separate treatment for tax purposes of several transactions taken to arrive at an originally intended result. By contrast, the taxpayer in Smalley v. Commissioner,T.C. Memo. 1973-85, had sufficient business purpose for contributing appreciated stock to his closely-held corporation, even though the corporation subsequently sold the stock and utilized large net operating losses available for carryover in the year of the sale. This decision turned on the fact that most of the proceeds from the sales were used to repay bank loans, the repayment of which was a precondition to further business negotiations1982 Tax Ct. Memo LEXIS 532">554 with an unrelated company. In conclusion, it is important to note the facts and circumstances that distinguish Smalley from Hallowell or Abbott. First, unlike the taxpayer in Smalley, the petitioner in Hallowell realized personal gain as a consequence of the sale of the securities he had previously transferred to the corporation. Second, in Abbott, the petitioner was taxed on the sale of the appreciated stock because the questioned transaction had no legitimate business purpose other than the reduction of taxes. Finally, the petitioner in Smalley had both a strong business purpose and benefited personally only to the extent that the sale of these stocks was a prerequisite to continued business negotiations with an unrelated third party. In the case now before us, the factors cited by this Court in Smalley,supra, are noticeably absent. Petitioner contributed appreciated securities to JPMC which were sold by the corporation on the same day. Of the $ 268,270.40 net sales proceeds, JPMC distributed $ 64,500.00 or approximately 24 percent directly to petitioner or to a third party (Valley National Bank) for petitioner's benefit. 1982 Tax Ct. Memo LEXIS 532">555 An additional $ 144,473.27 or approximately 53.86 percent went to either Consolidated, a sole proprietorship owned by petitioner, or to SPMC, a company in which petitioner held a 45 percent (and effectively controlling) interest. It is also revealing that JPMC distributed $ 74,835.41 to Consolidated when the record indicates that the sums advances to JPMC by Consolidated totaled only $ 6,041.97. Although petitioner claims that the transfer of the securities was intended to improve JPMC's financial position, we fail to see how the company's position was measurably improved in light of the fact that JPMC retained no more than $ 35,193.34, or 13 percent of the sale proceeds, and most, if not all, of the balance went either to petitioner, one of his many other businesses, or to Valley National Bank. 11 Furthermore, the record does not indicate that outside creditors or business associates, potential or actual, were demanding that JPMC strengthen its position as a prerequisite to any dealing. We conclude, therefore, that petitioner has not shown any valid business purpose, other than tax savings, for the formalistic1982 Tax Ct. Memo LEXIS 532">556 "transfer" of his stocks to JPMC in exchange for its shares; that JPMC was acting merely as a conduit for petitioner; and that petitioner was the true seller of the securities. Accordingly, petitioner and not JPMC is taxable on the capital gain. To give effect to the above, as well as the other issues herein which have been stipulated by the parties, Decision will be entered under Rule 155.Footnotes. This case was tried before Judge Cynthia Holcomb Hall who subsequently resigned from the Court. By order of the Chief Judge dated February 1, 1982, the case was reassigned to Judge Jules G. Korner III↩. 1. All statutory references are to the Internal Revenue Code of 1954, in effect during the years in issue.↩*. Petitioner Mary Jane Stewart is involved herein only because of signing a joint return with Spencer D. Stewart for the years in issue.↩2. While the Agreement provided for certain amounts to be transferred to petitioner at the time of the Agreement, the exact amount of the award would not be known until a final judgment was rendered in the condemnation proceedings.↩3. This amount was incorrectly stated as $ 239,137.04 in respondent's deficiency notice.↩4. The figures on the exhibit showing the disposition of these proceeds do not add up to the total net sales proceeds. This discrepancy is unexplained. ↩5. At this time, petitioner's secretary and his accountant each owned five percent interests and F.T. Thum, petitioner's business associate, owned a 45 percent interest.↩6. Respondent contends that petitioner was notified of his intentions to rely on the substance-over-form doctrine at a pre-trial conference held in June of 1979, but this is not in the record.↩7. Commissioner v. Transport Manufacturing and Equipment Co.,478 F.2d 731">478 F.2d 731, 478 F.2d 731">734↩ (8th Cir. 1973).8. 478 F.2d 731">478 F.2d at 735, n. 8. See also: Mills v. Commissioner,399 F.2d 744">399 F.2d 744, 399 F.2d 744">748↩ (4th Cir. 1968), affg. Memorandum Opinion of this Court.9. At the trial Mr. Munson, petitioner's accountant, initially testified that the dates differed. After reviewing the journal entries which he himself made, he stated that the sale dates corresponded to the contribution dates.↩10. Indeed, the two theories overlap considerably, since section 482 is aimed at situations where commonly-controlled taxpayers may have their income distorted by unreal, artificial or non-arms-length arrangements. See sec. 1.482-1(b), Income Tax Regs.↩11. The record does not show that JPMC owned any money the VNB.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625307/	READING HARDWARE CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Reading Hardware Co. v. CommissionerDocket No. 5059.United States Board of Tax Appeals7 B.T.A. 337; 1927 BTA LEXIS 3198; June 15, 1927, Promulgated 1927 BTA LEXIS 3198">3198 1. There is no basis under section 207 of the Revenue Act of 1917 and section 326 of the Revenue Act of 1918 for a revaluation of petitioner's assets for invested capital purposes at the time of the financial reorganization in 1911, as a result of which other corporations were merged with it, though assets of other companies which were paid in at this time may be included in its invested capital at their cash value at the time paid in. 2. A reduction in surplus, when surplus has been improperly increased in the first instance on account of assets which have not been paid in as contemplated by the statute, restores the surplus, or deficit, to its original condition and does not give rise to an operating deficit which did not theretofore exist. H. F. Kantner, Esq., for the petitioner. R. P. Smith, Esq., for the respondent. LITTLETON7 B.T.A. 337">338 The Commissioner has asserted deficiencies in income and profits tax for the years 1916, 1918, and 1920, in the respective amounts of $121.33, $676.33, and $19,900.11, and has determined overassessments for the years 1917 and 1919 in the respective amounts of $1,145.09 and $1,310.54. The petitioner questions1927 BTA LEXIS 3198">3199 the correctness of the Commissioner's determination in respect of the years 1917, 1918, 1919, and 1920, but concedes the correctness of his determination in respect of the year 1916. The Commissioner entered a plea in bar to the jurisdiction of the Board to make a determination as to the taxable year 1917, for the reason that the proposed adjustments in the tax liability for that year involve a refund of and not a deficiency in tax. FINDINGS OF FACT. Petitioner, a Pennsylvania corporation with principal office at Reading, was originally incorporated in 1886, with an authorized capital of $900,000 consisting of 6,500 shares of common and 2,500 shares of preferred stock having a par value of $100 a share. All of the common stock and 1,000 shares of the preferred stock had been issued and were outstanding at the time of a financial reorganization in 1911. In 1903 certain individuals who had secured a controlling interest in the petitioner through the acquisition of more than 50 per cent of its outstanding common stock organized the Consolidated Hardware Co., hereinafter referred to as the Consolidated Company, under the laws of the State of Delaware. These individuals transferred1927 BTA LEXIS 3198">3200 to the newly organized company their entire stock holdings in the petitioner, comprising 4,101 shares of common stock, in consideration of the issuance to them by that company of $757,100 par value of its "Collateral Trust 5% Gold Bonds," hereinafter sometimes referred to as the "Reading Bonds." The Consolidated Company executed a purchase-money collateral indenture, covering the stock of petitioner thus acquired, to the Colonial Trust Co. of Reading, Pa., as trustee, to secure an initial issue of such bonds in the aggregate principal sum of $757,100, with the right, upon the pledge of additional shares of the common stock of petitioner, to issue additional bonds in payment therefor at the rate of $184.6154 per share; and with the right, upon the pledge of the preferred stock and floating obligations of the petitioner, to issue additional bonds of a par value of $200,000 in payment therefor. Interest on these bonds was payable semi-annually, on the first days of January and July, and they were callable on July 1, 1913, or any interest date thereafter, 7 B.T.A. 337">339 at par and accrued interest with a premium of 5 per cent, the entire issue maturing on July 1, 1943. Subsequently, but1927 BTA LEXIS 3198">3201 prior to the year 1911, the Consolidated Company acquired the balance of petitioner's outstanding common stock by the issuance of additional bonds under the indenture hereinbefore referred to, making a total of $1,200,000 par value of bonds, "Reading Hardware Company Series," given in exchange for $650,000 par value of common stock of the petitioner. At the time of the first exchange of bonds for stock, as referred to above, a controlling interest in the petitioner, consisting of more than 50 per cent of petitioner's common stock, was vested in Albert A. Gerry and John E. Harbster, and after all of the said bonds had been issued and until 1911, ownership of the $650,000 par value of the common stock of the petitioner was vested in the Consolidated Company. In 1904, the Consolidated Company purchased 3,560 shares of the preferred stock of the National Brass and Iron Works, hereinafter sometimes referred to as the Brass Company, at a price of $50 per share, which were paid for by the issuance of $178,000 par value of its "Collateral Trust 5% Gold Bonds, National Brass and Iron Works Series," hereinafter sometimes referred to as the "Brass bonds." It executed a purchase-money collateral1927 BTA LEXIS 3198">3202 indenture, covering the stock of the Brass Company thus acquired, to the Colonial Trust Co. of Reading, Pa., as trustee, to secure an initial issue of such bonds in the aggregate principal sum of $178,000, with the right, upon the pledge of additional shares of the preferred stock of the Brass Company, to issue additional bonds in payment therefor, at the rate of $50 per share. Interest on these bonds was payable semiannually, on the first days of April and October, and they were callable on April 1, 1914, or any interest date thereafter, at par and accrued interest with a premium of 5 per cent, the entire issue maturing April 1, 1934. Subsequently, but prior to the financial reorganization in 1911, the Consolidated Company acquired additional preferred stock of the Brass Company through the issuance of additional bonds under the terms of the last-named indenture to the extent that the Consolidated Company acquired substantially all the preferred stock of the Brass Company, for which Brass bonds had been given in exchange of the same par value, which condition of ownership existed in 1911. The indentures covering both issues contained appropriate provisions as to remedies of1927 BTA LEXIS 3198">3203 trustees and bondholders in the event of default in the payment of interest or principal. Prior to 1910, the Keystone Hardware Co., hereinafter referred to as the Keystone Company, was incorporated, and its plant was, 7 B.T.A. 337">340 at the time of petitioner's financial reorganization in 1911, under lease to the petitioner for a terms of 999 years. Some of the stockholders in the petitioner were likewise interested, through the ownership of stock, securities or otherwise, in the Consolidated Company, the Brass Company, and the Keystone Company to the extent that in 1911, and for several years prior thereto, there was a substantial community of interest as far as the four companies were concerned. In March, 1910, a reorganization committee was appointed by petitioner's board of directors, and on July 1, 1910, an agreement, embodying certain plans for the reorganization of the petitioner, the Consolidated Company, the Brass Company and the Keystone Company, was entered into by this committee together with the holders of the securities of the other companies aforementioned. On May 1, 1911, a new agreement, known as "Modification of Plan and Amendment of Agreement of Reorganization1927 BTA LEXIS 3198">3204 dated July 1, 1910," was entered into by the reorganization committee as parties of the first part; such of the holders (therein referred to as the "Reading Bondholders") of the "Consolidated Hardware Company Forty Year Five Per Cent. Gold Bonds" (therein referred to as the "Reading Bonds") secured by the common stock of the Reading Hardware Co. (therein referred to as the "Reading Company"); such of the holders (therein referred to as the "Brass Bondholders") of "Consolidated Hardware Company Thirty Year Collateral Trust Five Per Cent. Gold Bonds, National Brass and Iron Works Series" (therein referred to as the "Brass Bonds") secured by preferred stock of the National Brass and Iron Works (therein referred to as the "Brass Company"); such of the holders (therein referred to, respectively, as "Consolidated common stockholders" and "Consolidated preferred stockholders") of the common and preferred stock of the Consolidated Hardware Company (therein referred to as the "Consolidated Company"); such of the holders (therein referred to as the "Reading preferred stockholders") of the preferred stock of the Reading Company; such of the holders (therein referred to, respectively, as "Brass1927 BTA LEXIS 3198">3205 preferred stockholders" and "Brass common stockholders") of the preferred and common stock of the Brass Company; and such of the holders (therein referred to as the "Keystone stockholders") of the capital stock of the Keystone Company - as may become parties to the agreement in the manner therein provided, and referred to jointly as the "Depositors," parties of the second part; the Pennsylvania Trust Company of Reading, Pennsylvania (therein referred to as the "Depositary"), as party of the third part; and the petitioner herein, as party of the fourth part. Said agreement on May 1, 1911, merely embodied the amendments and modifications of the original agreement 7 B.T.A. 337">341 of July 1, 1910, and provided that "All provisions of the original agreement not modified or amended hereby, are hereby confirmed." It further provided as follows: 3. - Section E of Paragraph Fifth of the original plan and agreement relative to the proposed increase of common stock and the exchange thereof, shall be and is hereby amended to read as follows: The present $650,000 of common stock of the Reading Company shall be increased by a dividend of $950,000 to $1,600,000. Of this latter amount, $1,200,000, 1927 BTA LEXIS 3198">3206 or so much thereof as may be necessary, shall be given to the depositing Reading Bondholders, so that each depositing bondholder of Reading Bonds shall be entitled to receive one share of common stock of the Reading Company of the par value of $100, for each and every $100 of bonds deposited by said depositor. Of the remaining common stock, $350,000, or so much thereof as may be necessary, shall be given to the depositing Brass Bondholders, and the depositing, Brass Preferred Stockholders, so that each depositing bondholder of Brass Bonds and each depositing Brass Preferred Stockholder shall be entitled to receive one share of common stock of the Reading Company of the par value of $100 for each and every $100 of bonds or preferred stock deposited by said depositor. Of the remaining common stock, $50,000, or so much thereof as may be necessary, shall be given to the depositing Keystone stockholders, so that each depositing stockholder of Keystone stock shall be entitled to receive one share of common stock of the Reading Company of the par value of $100, for each and every $600 of Keystone stock deposited by said depositor; Any Reading common stock left undistributed, shall1927 BTA LEXIS 3198">3207 remain in the hands of the Committee for sale or pledge by it, or for use by it otherwise under the terms of the original reorganization agreement. If any such undistributed Reading common stock shall finally remain undisposed of, the Committee shall assign said undistributed Reading common stock before their final discharge to the Reading Company to be held by it as Treasury stock and to be disposed of as the Board of Directors of the Reading Company shall decide. At a meeting of petitioner's board of directors on July 20, 1911, the following resolution was adopted: WHEREAS the Capital Stock of the Company outstanding and authorized is as follows: Preferred stock$100,000.Common stock650,000.Preferred Stock authorized by Stockholders March 10, 1903 $150,000.00 making a total of $900,000; and WHEREAS, the reorganization agreement as amended contemplates the increasing of the capital stock from the said sum of $900,000 to $1,700,000. all of the said stock excepting the $100,000 of preferred stock already outstanding and $100,000 of additional of preferred stock, that is to say, $1,500,000 of capital stock issued, be issued as common stock; and WHEREAS, 1927 BTA LEXIS 3198">3208 it is the purpose to issue the additional $100,000 of preferred stock in exchange for the new outstanding preferred stock, thus leaving about $1,600,000 of common stock available for issuance; and WHEREAS, the additional common stock is to be issued as a stock dividend on the basis of the surplus and reserve of the company, and it is necessary 7 B.T.A. 337">342 that the surplus and reserve be ascertained and stated so that it shall be plain that no stock shall be issued pursuant to the said plan in excess of the surplus and reserve. THEREFORE RESOLVED: (1) That the sum of $26,250 stated in the balance sheet of June 30th, 1911, as owing for rental to the Keystone Hardware Company, be reduced on account of the shares of Keystone Hardware Company, which have been deposited under the reorganization agreement as amended, being virtually owned by the Reading Hardware Co., and only such part of the said rental as might be supposed payable to the stockholders of the Keystone Hardware Co. who have not deposited their stock under the said agreement, is or will be a liability of the Reading Hardware Company, the said sum being $5,586.88, so that the said liability instead of being, $26,250. 1927 BTA LEXIS 3198">3209 is only $5,586.88. (2) That a proportion of the value of the Keystone Hardware Company's plant which also virtually becomes the property of the Reading Hardware Co., be to the extent of the proportion of stock of the Keystone Hardware Co., deposited under the reorganization agreement as amended, added to the assets of the Reading Hardware Co., the said proportion being $39,358.33. (3) That 33/35 of the value of the National Brass Works property, that being the proportion of the Consolidated Hardware Co., bonds, National Brass series, which have been deposited under the reorganization agreement as amended, be also added to the assets of the Reading Hardware Company, the said property being valued at $75,000 less an encumbrance of $12,000 and 33/35 thereof being $59,400. The above will make the surplus and reserve of the Reading Hardware Company, considerably in excess of the additional stock proposed to be issued. The foregoing action was approved by petitioner's stockholders on the same day. Petitioner's board of directors adopted the following resolution on September 26, 1911, which action was approved by petitioner's stockholders on the same day: WHEREAS, after the1927 BTA LEXIS 3198">3210 adoption of RESOLUTION of July 20, 1911, the Manufacturers' Appraisal Company was procured to extend its appraisement of August 31, 1910, to August 31, 1911, including the National Brass & Keystone plants; and WHEREAS, taking the said appraisement and taking also the current assets including the securities as they appear on the books, which are not embraced in the said appraisement, and making deductions of all liabilities, there is shown net assets amounting to $1,649,550.43; and WHEERAS, in order to carry out the Reorganization Agreement as amended WHEREAS, in order to carry out the Reorganization Agreement as amended additional capital stock amounting to $935,100.00, but $40,500.00 thereof would be issuable to the Reading Hardware Company on account of securities held by it, and the same purpose can be accomplished by simply leaving such stock unissued; and WHEREAS, by leaving such stock unissued there will be issuable to parties other than the Reading Hardware Company, who have deposited their securities, $895,400.00, making altogether with the outstanding stock $1,645,400.00 a sum less than the amount of net assets. NOW THEREFORE BE IT RESOLVED, That in furtherance1927 BTA LEXIS 3198">3211 of the said agreement, there be declared a stock dividend of 138 per centum on the outstanding common stock of $650,000.00, the total dividend being $897,000; that the said 7 B.T.A. 337">343 stock be issued as full-paid common stock and not subject to further calls or assessments. RESOLVED, That the above RESOLUTIONS be submitted to the stockholders at a meeting called to be held this day. On motion duly seconded the following resolution was ordered to be submitted to the stockholders at a special meeting to be held this day for their approval or disapproval. WHEREAS, a stock dividend of 138 per centum has been declared upon outstanding common stock, therefore: RESOLVED, That the $100,000 of Preferred stock authorized by the stockholders to be issued in exchange for existing preferred stock, be issued as follows: (1) The stock to entitle the holder thereof to receive cumulative yearly dividends of six per centum payable semi-annually on the first days of April and Cotober each year before any dividend shall be set apart or paid on the common stock; and also in the event of liquidation or dissolution, to be paid in full, both principal and accrued dividends, before any amount1927 BTA LEXIS 3198">3212 shall be paid to the holders of common stock. The stock not to entitle the holder to vote and to be redeemable at 105 and accrued dividends, at any dividend paying period after ninety days' notice. (2) The said stock shall be issued only in exchange for existing preferred stock and from time to time as any holder of existing preferred stock shall surrender his stock, a certificate or certificates for a like number of shares of such new preferred stock, shall be delivered to the surrendering stockholder in exchange, so that the aggregate amount of preferred stock outstanding shall at no time exceed $100,000. The Common Stock of the Company issued and authorized to be issued is: Outstanding$650,000Preferred stock unissued but authorized Mar. 10, 1903,and now to be issued as common stock150,000Additional stock authorized by stockholders July 20,1911800,000Total$1,600,000This total of $1,600,000 shall be issued in pursuance of the reorganization agreement as amended, that is to say, to the holders of Consolidated Hardware Company bonds - National Brass series - $350,000, or so much thereof as may be necessary to satisfy depositing bondholders. 1927 BTA LEXIS 3198">3213 To the Keystone Hardware Company $50,000, or so much thereof as may be necessary to satisfy depositing stockholders. To the holders of the Consolidated Hardware Company bonds, Reading Hardware Company series - $1,200,000, or so much thereof as may be necessary to satisfy depositing bondholders. The said stock shall be issued to the Reorganization Committee upon that Committee surrendering for cancellation the outstanding $650,000 of common stock. On or shortly prior to August 31, 1910, the Manufacturers' Appraisal Co. made an appraisal of petitioner's plant and that of the Keystone Company on the basis of reproduction new less an estimated amount for accrued depreciation and the books of the petitioner were adjusted in conformity therewith, showing therein the properties of both plants. When the financial reorganization in question was decided upon the same appraisal company extended the 1910 appraisals for the 7 B.T.A. 337">344 petitioner's plant and theKeystone plant to August 31, 1911, and the books were again adjusted in conformity therewith, the following entries being made: Reserve for Depreciation of Fixed Assets$452,185.55To Profit and Loss$452,185.55To close account.Profit and Loss$213,353.21To Buildings and Building Equipment - Main Plant73,365.96To Buildings and Building Equipment - Keystone1,040.51To Manufacturing Machinery and Minor Equipment - Main Plant57,715.10To Manufacturing Machinery and Minor Equipment - Keystone4,863.18To Power Plant Operating Equipment - Main Plant13,433.15To Dies, Tools, etc44,951.43To Furniture and Fixtures - Factory7,241.39To Furniture and Fixtures - Keystone427.98To Furniture and Fixtures - Lawn Mower Department167.08To Furniture and Fixtures - Main Office589.77To Stable Equipment1,310.62To Electros and Wood Cuts8,247.04To correct accounts to conform with Appraisal Companyvalues as of August 31, 1911.Power Plant and Equipment - Keystone$965.10Patterns and Drawings1,034.29To Profit and Loss1,999.39To correct accounts to conform with Appraisal Company's values of August 31, 1911.1927 BTA LEXIS 3198">3214 By means of the foregoing entries, surplus was increased by two amounts, $452,185.55 and $1,999.39, and decreased by one amount, $213,353.21, making a net increase of $240,831.73. In addition to the foregoing entries, the following entry was made on the same date to set up securities which had not theretofore appeared on the books of the petitioner: 280 Shares Reading Preferred Stock$28,000.00$40,500 Consolidated Hardware Company Bonds (Reading Series) being $40,500 of capital stock or ($1,200,000) $21,937.50 of $650,000 common stock Book value $238;00 per share52,211.254,723 Shares Keystone Hardware Company Stock, based on Manufacturers' Appraisal Company's Values of August 31, 1911 of $55,514.1843,698.91$340,850 Bonds, Consolidated Hardware Company (National Brass and Iron Works Series) and Preferred Stock of National Brass and Iron Works, based on Manufacturers' Appraisal Company Values of August 31, 1911 of $85,976.23 less $12,000 mortgage72,042.281,500 Shares Reading Machine Screw Company, being 3/8 of Capital Stock based on valuation of its plant $28,000 less mortgage and debts of $15,0004,875.0020 Shares Philadelphia Bourse at $4.00 per share80.00To Profit and Loss$200,907.441927 BTA LEXIS 3198">3215 7 B.T.A. 337">345 In order to carry into effect the resolution of the petitioner's board of directors "That the sum of $26,250 stated in the balance sheet of June 30, 1911, as owing for rental to the Keystone Hardware Company, be reduced on account of the shares of Keystone Hardware Company, which have been deposited under the reorganization agreement as amended, being virtually owned by the Reading Hardware Company, and only such part of the said rental as might be supposed payable to the stockholders of the Keystone Hardware Company who have not deposited their stock under the said agreement, is or will be a liability of the Reading Hardware Company, the said sum being $5,586.88, so that the said liability instead of being $26,250 is only $5,586.88," and to make further adjustment in the same account due to the rental period from June 30, 1911, to August 31, 1911, not already considered, the following journal entry was made: Keystone Hardware Company Rental$22,631.04To Profit and Loss$22,631.04Rental on 4,723 shares of stock held by the reorganization committee. From October 1, 1909 to August 31, 1911 - 1-11/12 years at $2.50 per share.After giving effect1927 BTA LEXIS 3198">3216 to the foregoing entries, the surplus as shown by the books of the petitioner on August 31, 1911, was $899,550.43, exclusive of the outstanding capital stock, or a total of net assets shown by petitioner's books, after adjustment for the appraisal and current assets not included in the appraisal, of $1,649,550.43 ($899,550.43 surplus plus $750,000 outstanding capital stock). Prior to the making of the aforementioned appraisals, the officers of the Consolidated Company and the petitioner had removed machinery, equipment, supplies, etc., from the plant of the Brass Company and these assets are included in these appraisals, but are not segregated in any manner by which it is possible to identify either the assets or the value placed thereon. The plant of the Brass Company, exclusive of machinery, equipment, supplies, etc., is not included in the appraisals, though it was in the control of the petitioner on July 7, 1911, when the following resolution was adopted by petitioner's board of directors: Upon motion duly made and seconded the Finance Committee was authorized to investigate the matter of the disposition of the National Brass and Iron Works plant and report as to whether1927 BTA LEXIS 3198">3217 it can be sold or rented and at what terms together with their recommendation. On September 26, 1911, a stock dividend was declared from the above-indicated surplus of $1,649,550.43, in accordance with the resolution of September 26, 1911, heretofore referred to. The journal entries on account of this issuance of stock were as follows: Profit and Loss$897,000To Dividend$897,000For dividend of 138% declared September 26th, payable in stock to stockholders of record this day.Dividend897,000To Capital Stock897,000For stock dividend declared September 26th and issued October 28, 1911.7 B.T.A. 337">346 Prior to October 28, 1911, the 6,500 shares, common stock, of the petitioner were acquired by the Reorganization Committee at a foreclosure sale had by the Colonial Trust Co., trustee in the indenture under which this stock was pledged as collateral when the Consolidated Company issued bonds in 1903 denominated "Reading Hardware Company Series." When the stock, on account of the stock dividend declared by petitioner on September 26, 1911, was issued the entire amount went to the Reorganization Committee, making a total in their hands of 15,470 shares, 1927 BTA LEXIS 3198">3218 which stock was distributed and was outstanding after the financial reorganization had been completed. During 1912 the 6,904 shares, preferred stock, of the Brass Company were sold at a foreclosure sale had by the Colonial Trust Co., trustee in the indenture under which this stock was pledged as collateral, when the Consolidated Hardware Co. issued bonds in 1904 denominated "National Brass and Iron Works Series," purchase being made by the Reorganization Committee, in the interest of the petitioner, for $531.02. During 1911 and 1912 substantially all of the other stocks and bonds which were to be transferred to the Reorganization Committee in accordance with the reorganization agreement as amended, had been so transferred and before, on, or shortly after November 26, 1912, the petitioner, the Reorganization Committee, and the Pennsylvania Trust Co., depositary, took the necessary steps for the delivery of the stocks, bonds and papers held by the Reorganization Committee and the Pennsylvania Trust Co. to the petitioner. The Reorganization Committee was thereupon ordered discharged from further duties and responsibilities. After the above transactions had taken place, the petitioner1927 BTA LEXIS 3198">3219 held 6,904 shares of preferred stock of the Brass Company out of a total of 7,000 shares and steps were taken to effect its dissolution, such dissolution being finally effected shortly prior to March 25, 1913. Prior to its dissolution, its plant was sold by the assignee for the benefit if its creditors at a public sale on December 27, 1911, and was purchased by the Reorganization Committee in the interest of the petitioner, the principal creditor, for $5,000, subject to a mortgage of $12,000. No payment was made of the purchase price, but, instead, the plant was conveyed to the petitioner on account of its 7 B.T.A. 337">347 claim. In 1912, petitioner sold it for $50,000, the purchaser assuming the aforementioned mortgage of $12,000. When the stocks and bonds of the Consolidated Company were received by the petitioner, they were ordered canceled by the petitioner's board of directors and the final papers relative to the receivership of the Consolidated Company were presented to petitioner's board of directors on March 25, 1913. In the year or years covered by the financial reorganization, the petitioner did not secure a new charter, but continued to operate under the old charter1927 BTA LEXIS 3198">3220 with which it came into existence in 1886. The Keystone Company continued in existence at least later than 1912. On March 12, 1912, the board of directors of the petitioner authorized its treasurer to set up an account on its books "to cover the patents, good will and trade-marks, of the company not now represented in any of the assets, to an amount not exceeding $500,000," and in accordance with such authority its accountants entered upon its books an account of this character, which was debited with the sum of $500,000, and the surplus account was credited with a similar amount. On December 31, 1917, the sum of $400,000 was written off by debiting surplus and crediting patents, good will and trademarks and the balance of $100,000 was subsequently written off in the same manner, thereby closing this account. The petitioner, in determining its invested capital for profits-tax purposes for 1917 and subsequent years restored the foregoing account as an asset, thus increasing its invested capital. The Commissioner, however, for the same purpose, eliminated the $500,000 from the par value of the capital stock, thus reducing invested capital and changing the tax liability accordingly, 1927 BTA LEXIS 3198">3221 though he now admits that since good will was originally set up as a credit to surplus, the elimination should have been from surplus and not from capital stock. OPINION. LITTLETON: The errors assigned by the petitioner are: (1) Failure to make proper adjustment in its invested capital for 1917, 1918, and 1919 on account of a "loss on Keystone Hardware Co. stock" which was taken by the petitioner as a deduction from gross income in 1916, but not allowed by the Commissioner until 1918. (2) Elimination of $500,000 for good will restored by a charge against capital stock instead of a charge against surplus in determining invested capital for 1917, 1918, 1919, and 1920. The Commissioner filed a plea in bar to the right of the petitioner to maintain this proceeding as to the year 1917 on the ground that 7 B.T.A. 337">348 "the adjustment in the tax liability for the said year, against which the taxpayer appeals, is a refund and not a deficiency." The position of the Commissioner is well taken in so far as it applies to a consideration of the amount of refund which may be due for 1917. 1927 BTA LEXIS 3198">3222 . It should be noted, however, that the appeal comes before the Board on a notice of deficiencies for 1918 and 1920 and the major item on account of which the appeal is taken carries through for all years. Section 274(g), Revenue Act of 1926 provides: The Board in redetermining a deficiency in respect of any taxable year shall consider such facts with relation to the taxes for other taxable years as may be necessary correctly to redetermine the amount of such deficiency, but in so doing shall have no jurisdiction to determine whether or not the tax for any other taxable year has been overpaid or underpaid. We said in the :In determining the correct amount of the deficiency, we may consider such facts with relation to taxes for other taxable years as may be necessary correctly to redetermine the amount of the deficiency involved; for example, in determining the invested capital for the year for which the deficiency against a corporation has been determined, we may determine what was the tax liability during a preceding year. The plea of the Commissioner is, 1927 BTA LEXIS 3198">3223 therefore, overruled in so far as a consideration of 1917 may be necessary for a correct determination of the deficiencies for 1918 and 1920. At the hearing the petitioner and respondent filed a Joint Exhibit marked "Exhibit A" in which they agreed as to the adjustment which should be made on account of the first error assigned above, and therefore this point will not be considered further. Before considering the other point raised, we find it necessary to go beyond the pleadings and consider the real issue in the case, an issue not raised either in the petition or in the answer by the Commissioner, but one on account of which almost the entire evidence was presented and one which is fundamental in a determination of the petitioner's invested capital, viz., the amount of the surplus or deficit at the time good will was increased by $500,000, which, in turn, involves the effect on invested capital of a financial reorganization in 1911. The facts relative to what took place in 1911 are quite complicated and the evidence with respect thereto is not very clear. We are handicapped in the first instance by the failure of the petitioner to submit the original plan of reorganization, 1927 BTA LEXIS 3198">3224 and we have had to rely on the amendments to the original plan and secondary evidence presented to show what was agreed as the complete plan of bringing the four allied companies together. Further, the evidence is incomplete 7 B.T.A. 337">349 in many particulars which would have been helpful in tracing the detailed steps in the consummation of the plan. Petitioner's counsel states in his brief filed after the hearing, with respect to the additional point which we find it necessary to consider, as follows: The invested capital of the taxpayer for the year 1917 and subsequent years must be based on the amount of capital stock of Reading Hardware Company issued by it under the reorganization plan effected in 1911, subject only to proper additions and deductions for later years. In this we can not concur. The above position is evidently based upon the proposition that there was such a change of status of the allied corporations in 1911 that it would be considered that their assets were paid in to the petitioner at this time as contemplated by section 207, Revenue Act of 1917 and section 326, Revenue Act of 1918. In 1911 there was a revaluation of the assets of the petitioner, the1927 BTA LEXIS 3198">3225 Keystone Company and such assets of the Brass Company as had been taken from that plant and intermingled with the assets of the petitioner. On the basis of the surplus which was shown by setting up this valuation on the books of the petitioner and by setting up certain securities which came to the petitioner through the financial reorganization plan of July 1, 1910, as modified by the amended plan dated May 1, 1911, a stock dividend was declared on September 26, 1911, of $897,000, par value of common stock of the petitioner, which, together with the capital stock already outstanding and the surplus remaining after the declaration of the stock dividend, the petitioner contends should be the starting point for invested capital purposes. Before considering the question of the correctness of the valuation on which petitioner's invested capital is based, we must determine whether there was a basis for such valuation in 1911, i.e., whether the assets of the allied companies on which the valuations were placed can be considered as having been "paid in" in 1911 as contemplated by the provisions of the statutes heretofore referred to. In the first place, were the assets which were owned1927 BTA LEXIS 3198">3226 by the petitioner prior to 1911 again paid in to the petitioner in 1917? The question answers itself in the negative when we consider that the corporation with which we are here dealing is the same legal entity which came into being in 1886, and its legal existence was not changed in the slightest by what took place in 1911 and 1912. It has the same charter in the taxable years under consideration with which it began business in 1886. There were changes in stock ownership during the period of its existence, but this did not affect the ownership of its assets. That the ownership of stock and ownership of assets are not identical and that changes of ownership in stock may 7 B.T.A. 337">350 occur without affecting the ownership of the assets has been so long recognized that it hardly admits of questioning. See ; ; and . In , the Board said: We need not dwell upon the well recognized distinction between a corporation and its stockholders, nor repeat what so1927 BTA LEXIS 3198">3227 frequently has been said to the effect that the ownership by a corporation is not the ownership of its stockholders, and that the rights and liabilities of the former are separate from those of the latter. What, therefore, happened in 1911 with respect to the petitioner did not affect the legal existence of the corporation, even though there were changes as to stockholdings, and the value of its assets for invested capital purposes, in so far as it relates to assets which it acquired prior to the financial reorganization, must be based upon the original cost at date of acquisition. These assets were not paid in to the petitioner at this time, but were paid in from 1886 until this time. Nor does the fact of a stock dividend in 1911 aid the petitioner in its contention, since nothing thereby came in to the corporation in so far as its previously owned assets were concerned. In , the court said: A stock dividend really takes nothing from the property of the corporation, and adds nothing to the interests of the shareholders. Its property is not diminished, and their interests are not increased. After such a dividend, as before, 1927 BTA LEXIS 3198">3228 the corporation has the title in all the corporate property; the aggregate interests therein of all the shareholders are represented by the whole number of shares; and the proportional interest of each shareholder remains the same. The only change is in the evidence which represents that interest, the new shares and the original shares together representing the same proportional interest that the original shares represented before the issue of the new ones. In , this statement is made in regard to a stock dividend: That distribution, in substance and effect, was an internal transaction, in which the company received nothing from the stockholders any more than they received anything from it. We must hold, therefore, that to the extent that petitioner's invested capital is based on a revaluation of assets in 1911 which were acquired prior to this time, it can not be sustained. Our next consideration is to determine whether there were other assets which can be said to have been paid in to the petitioner at the time of this financial reorganization. We will first examine the Brass Company. In 1904, substantially1927 BTA LEXIS 3198">3229 all of its preferred stock was acquired by the Consolidated Company in exchange for an issue of bonds, which condition of ownership 7 B.T.A. 337">351 existed in 1911. The Brass Company also had a relatively small issue of common stock, but this was of so little consequence that it was given but negligible consideration in the working out of the financial reorganization plans. By the deposit of securities under the reorganization plan this preferred stock of the Brass Company came to the Reorganization Committee and the petitioner issued a part of the stock dividend heretofore referred to of like par value as the preferred stock in exchange therefor. When this occurred, the petitioner acquired tangible assets, viz., preferred stock, which can be considered at its actual cash value as paid in at this time. Likewise, in 1913, when the petitioner, through ownership of substantially all of the stock of the Brass Company, effected a dissolution in liquidation of the Brass Company, it became the owner of the Brass Company assets, if any, and was entitled to a valuation for invested capital purposes at their cash value as paid in in 1913. 1927 BTA LEXIS 3198">3230 For a like reason as in the case of the Brass Company, the interest in the stock of the Keystone Company which came to the petitioner through the reorganization plans and which was not formerly owned by the petitioner may properly be included in the invested capital of the petitioner at its cash value at date of acquisition in 1911. Through the financial reorganization the petitioner also received the stock and bonds of the Consolidated Company, but we do not see anything here of value as having been paid in, which is not otherwise accounted for. This company was organized as a holding company and issued its bonds for the entire common stock of the petitioner and substantially all the preferred stock of the Brass Company. With the surrender to, and cancellation by, the petitioner of these bonds, the petitioner was not thereby relieved of any liability nor did that constitute a payment of anything of value in to the petitioner. The stock of the petitioner, which was the only asset back of the Reading bonds of the Consolidated Company, did not become an asset of the petitioner, but merely passed to the persons entitled thereto1927 BTA LEXIS 3198">3231 under the reorganization agreement who thereby became stockholders of the petitioner. The stock of the Brass Company for which the Brass bonds of the Consolidated Company were issued, and which became an asset of the petitioner is accounted for in another connection. As to the capital stock of the Consolidated Company we are convinced that counsel for the petitioner made a correct statement of its status in these words, when presenting the case to the Board: Of course, from the figures that I have given you, it is evident that the Consolidated Hardware Co. stock should not or could not be given any value because there was not sufficient there for that purpose, and that was all lost in the transaction, and surrendered. 7 B.T.A. 337">352 As further indicating its lack of value we find that while the stockholders of the Consolidated Company are mentioned as parties to the reorganization agreement, no provision is made for the receipt by them of any payment for their stock upon the surrender thereof. We next consider the valuation of the several classes of assets which may properly be considered as entering into petitioner's invested capital on the basis hereinbefore indicated. 1927 BTA LEXIS 3198">3232 We have already stated that as to petitioner's assets which were owned by it prior to 1911 there could be no revaluation in 1911, but that original cost to the petitioner should be used. From the evidence submitted we find that the petitioner has not attempted to use an original cost basis. In the first place an appraisal was made in 1910 of its assets on the basis of reproduction new less an estimated amount for accrued depreciation, and included in this appraisal were certain assets of the Brass Company to which it did not have title, and assets of the Keystone Company. On August 31, 1910, on the basis of this appraisal, new fixed-asset accounts were set up by the petitioner in accordance with the classification of assets and values fixed in the appraisal, the old accounts being charged off, and a depreciation reserve provided for on account of these fixed assets. On August 31, 1911, the 1910 appraisal was extended to that date and the fixed-asset accounts on petitioner's books again adjusted in conformity therewith, the entire depreciation account being closed out as a credit to profit and loss, various fixed assets reduced or increased, the net effect being an increase in1927 BTA LEXIS 3198">3233 surplus of $240,831.73. The above net increase in surplus of $240,831.73 is attributable not only to a revaluation of petitioner's assets, but also of assets of the Brass Company which it had removed to its plant prior to the vesting of a property right therein and to which it did not have title when the foregoing appraisals were made, and assets of the Keystone Company. Obviously any part of this increase which may be due to the Brass Company assets is properly to be eliminated, since title thereto had not yet vested in the petitioner. As to the Keystone Company assets we have found that this company's plant was being operated under a 999-year lease at and prior to 1911, that through the financial reorganization 4,723 shares of its stock came to the petitioner and that the company continued in existence as late as 1913. To permit of the inclusion of these assets in the invested capital of the petitioner on account of the 1911 appraisal, it must be held that these assets were paid in to the petitioner in 1911. This, however, is inconsistent with the facts as the most that was acquired at this time was 4,723 shares of Keystone Company stock, which we have heretofore said in this1927 BTA LEXIS 3198">3234 opinion is different from the acquisition of the assets. Any of the foregoing increase in the petitioner's surplus in 1911 on account of the Keystone assets was, therefore, erroneous. 7 B.T.A. 337">353 We are constrained, therefore, to hold that in a redetermination of petitioner's income and profits tax for the years on appeal the increases in surplus in 1911 in the amount of $240,831.73 should be eliminated from invested capital. At the same time that adjustments were made for the appraisals referred to above, there was a further increase in surplus of $200,907.44 on account of securities which came to the petitioner through the deposit of securities under the reorganization agreement. The first item entering into this total is "280 Shares Reading Preferred Stock $28,000." The record is not sufficiently complete to show exactly the manner in which this stock of the petitioner was returned to the petitioner, but regardless of whether acquired by gift or purchase, it could not give rise to an increase in invested capital. If received by gift, it would not operate to increase invested capital until disposed of, when the amount realized therefrom in the form of assets would serve1927 BTA LEXIS 3198">3235 to increase invested capital. See . If acquired by purchase, the amount paid therefor by the petitioner would amount to a return of capital to the stockholders and, therefore, would operate to reduce capital originally paid in. Suffice it to say, therefore, that in either event, an increase in invested capital would not arise as indicated by the foregoing journal entry, and to the extent that proper elimination has not already been made, invested capital should be adjusted accordingly. The second item entering into the aforesaid credit to surplus is entitled: $40,500 Consolidated Hardware Company Bonds (Reading Series) being $40,500 of capital stock or ($1,200,000) $21,937.50 of $650,000 common stock book value $238.00 per share - $52,211.25. The foregoing entry sets up as an asset $40,500 of the Reading bonds which were issued by the Consolidated Company for stock of the petitioner in 1903 and their value is determined from the book value of petitioner's stock. That bonds held by one corporation of another corporation are tangible property we admit, and if we should concede further that bonds of the1927 BTA LEXIS 3198">3236 Consolidated Company issued for the petitioner's stock would be an asset in the hands of the petitioner, the bonds would not bring anything of value to the petitioner for invested capital purposes when the Consolidated Company passes from the picture, which was what happened in this case prior to the taxable years on appeal. The only asset back of them was the common stock of the petitioner, which, if it came to the petitioner, would be treasury stock, which we have heretofore said in this opinion, could not serve to increase invested capital while retaining its status as treasury stock. 7 B.T.A. 337">354 Consistent with the foregoing, we must hold that the additions to surplus of $28,000 and $52,211.25 set up as assets on account of the preferred stock of the petitioner and Reading bonds of the Consolidated Company, respectively, can not be allowed as assets which would operate to increase the invested capital of the petitioner. Our next consideration is to value the 6,904 shares of preferred stock of the Brass Company which we have said should be valued for invested capital purposes at the time it came to the petitioner through the reorganization plans in 1911. Much difficulty1927 BTA LEXIS 3198">3237 arises here for the reason that some of this company's assets had been transferred to petitioner's plant prior to 1911 and the earnings attributable to these assets, if any, were reflected in the petitioner's earnings. In other words, there was not in 1911, nor had there been for at least a short time prior thereto any operation of the Brass Company as such. When the stock itself was sold by the Colonial Trust Co. under the indenture in which this stock was pledged as collateral for the issuance of the Brass bonds of the Consolidated Company, the highest bid received therefor was $531.02, sale being made at this price. Prior to the dissolution of the Brass Company in 1913, its plant was sold by the assignee for the benefit of creditors at a public sale on December 27, 1911, and was purchased in the interest of the petitioner, the principal creditor, for $5,000, subject to a mortgage of $12,000. No payment was made of the purchase price, but instead, the plant was conveyed to the petitioner on account of its claim, and in 1912, petitioner sold it for $50,000, the purchaser assuming the mortgage. In the increase in surplus previously referred to on account of securities which had1927 BTA LEXIS 3198">3238 not theretofore appeared on the books of the petitioner, there appears this item: $340,850 Bonds, Consolidated Hardware Company (National Brass and Iron Works Series) and preferred Stock of National Brass and Iron Works, based on Manufacturers' Appraisal Company Values of August 31, 1911 of $85,976.23 less $12,000 mortgage$72,042.28This amount is a part of the surplus out of which the stock dividend was declared, and presumably has been considered in computing petitioner's invested capital. Whether the cash value of the assets received in the form of securities affecting the Brass Company - preferred stock of the Brass Company and bonds of the Consolidated Company, National Brass and Iron Works Series - in 1911, or assets of the Brass Company to which a property right vested in the petitioner upon dissolution of the Brass Company in 1913, was greater or less than the amount shown by the foregoing journal entry, we consider the evidence insufficient to show, but since we do know that assets were received in 1911 and 1913, we will not disturb the amount which has apparently been allowed as a result of the merger of the Brass Company with the petitioner. 7 B.T.A. 337">355 1927 BTA LEXIS 3198">3239 A similar situation exists with respect to the Keystone Company stock which we have said could be included in petitioner's invested capital at its cash value when acquired in 1911. In connection with the increase in surplus on account of securities there also appears this item: 4,723 shares Keystone Hardware Company stock, based on Manufacturers' Appraisal Company's Values of August 31, 1911 of $55,514.18$43,698.91One hundred additional shares of this stock were purchased by the Reorganization Committee for the petitioner at $6 per share, which amount plus the value placed on the 4,723 shares in the foregoing journal entry equals the loss claimed on Keystone stock in 1916, but which was not allowed by the Commissioner until 1918. Again we are without sufficient evidence to increase or decrease this addition to surplus, but on the entire evidence in the case we will leave this part of petitioner's invested capital undisturbed. This brings us to the final issue in the case, viz., the reduction of invested capital due to an arbitrary increase in surplus in 1912 when good will, patents and trade-marks were charged and surplus credited in the amount of $500,000. 1927 BTA LEXIS 3198">3240 The Commissioner in his determination reduced capital stock by this amount which he now admits was erroneous and agrees with the petitioner that the reduction should have been from surplus, the account which was originally credited, but, on the other hand contends that this latter method will not alter his original determination of invested capital. The petitioner, however, insists that when the latter method is followed an operating deficit is created which can not be used to reduce capital pain in. A reduction in surplus when surplus has been improperly increased in the first instance on account of assets which have not been paid in as contemplated by the statute restores the surplus or deficit to its original condition, and does not give rise to an operating deficit which did not theretofore exist. The reason for the rule, which has been generally applied in an intrepretation of the Revenue Acts of 1917 and 1918, that capital or surplus actually paid in is not required to be reduced because of an impairment of capital in the nature of an operating deficit is based on the proposition that the several acts do not require such a reduction and contemplate that invested capital1927 BTA LEXIS 3198">3241 shall at all times include capital or surplus actually paid in until there has been a liquidation or return of the original investment to the stockholders. In , we said: Section 326 of the Revenue Act of 1918 makes no provision for the reduction of invested capital of a corporation by reason of an operating deficit. It provides, and we think with reason, that invested capital shall at all times include capital or surplus actually paid in. Earned surplus and undivided profits, 7 B.T.A. 337">356 of course, may vary in amount from year to year. We are of the opinion, therefore, that capital and surplus actually paid in remain part of the invested capital of a corporate taxpayer, except where such capital or surplus has been directly or indirectly returned to the stockholders. The surplus which was created in this case by setting up good will was not a surplus which arose on account of assets paid in or on account of earnings; it was an improper addition in the first instance, and, therefore, its elimination must serve to reduce invested capital in its entirety, even though a deficit may result from such elimination. 1927 BTA LEXIS 3198">3242 A redetermination should, therefore, be made on the basis of the foregoing, taking into consideration not only the adjustment for the item of $500,000 in the manner set out above, but also the several reductions in surplus, totaling $321,042.98, to the extent adjustment has not already been made therefor, and the treatment of the loss on the Keystone stock on which the parties have reached an agreement. Judgment will be entered on 30 days' notice, under Rule 50.TRUSSELL TRUSSELL, dissenting: I am unable to agree with the conclusion reached in the foregoing opinion and decision. We have here four corporations; three of them operating companies and the fourth a holding company, holding substantially all of the stock of two of the operating companies, while a large majority of the third operating company is held by one of the other operating companies. For many years these corporations had existed in a complexity of stock and security ownership and interrelationship of business and operating transactions. The situation appears to have led to confusion and to financial embarrassments, and finally the four corporations, together with their controlling stockholders, 1927 BTA LEXIS 3198">3243 join in the appointment of a reorganization committee. Theis committee determines that the solution of their difficulties lies in the consolidation of all the four companies into one corporate entity. To bring about this result the reorganization committee, together with the four corporations and their controlling stockholders, enter into a written agreement of consolidation, the general terms of which provided that all the assets of each of the operating companies be inventoried, appraised, and valued, and that all of such assets be thrown together into a single aggregate of physical assets valued in accordance with the appraisal; that the stock and security holders of the three operating companies deposit their stock and securities with the reorganization committee and receive in exchange from such committee the stock of the reorganized consolidated company. In carrying this purpose into effect the reorganization committee selected the charter 7 B.T.A. 337">357 of one of the operating companies; caused it to be modified and amended in such manner as to accommodate it to the requirements of the consolidated enterprise. Then, when substantially all the stock and securities of the three1927 BTA LEXIS 3198">3244 operating companies had been deposited with the committee, the stock of the consolidated company was caused to be issued, deposited with the reorganization committee and by such committe distributed to the depositing stock and security owners, thus bringing into existence an entirely new corporate enterprise. The fact that the reorganization committee chose to make use of the charter of one of the old operating companies after having procured its modification and amendment, can not be interpreted to mean that the reorganized enterprise was simply a continuation of the former operating company whose charter was amended and used, nor can it defeat the purpose of the reorganization in effecting its intent to bring into existence a new corporate enterprise. Cf. Yazoo & M.V. Ry. Co. v. Adams,180 U.S. 1">180 U.S. 1. I am of the opinion, under the circumstances shown in the record of this case, that the reorganized and consolidated Reading Hardware Co. acquired, in 1911, a new grant of corporate franchise, separate and distinct from the entity formerly existing under that name, and that the assets of all of the companies constituting the reorganized corporate entity were paid1927 BTA LEXIS 3198">3245 in for stock upon the values fixed by the appraisal of such assets and accepted by the reorganization committee and the controlling owners of all of said companies, and that for the purpose of this action the computation of invested capital must start with the asset values paid in for stock of the consolidated enterprise.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625308/	Appeal of CITIZENS LOAN ASSOCIATION.Citizens Loan Asso. v. CommissionerDocket No. 412.United States Board of Tax Appeals1 B.T.A. 518; 1925 BTA LEXIS 2902; January 31, 1925, decided Submitted January 14, 1925. 1925 BTA LEXIS 2902">2902 Under the facts disclosed by this appeal the income of the taxpayer was that of a corporation in the calendar years 1918 and 1919 and properly taxable as such; for the year 1920 the income of the taxpayer was that of a copartnership and should be apportioned among the partners according to their interests and taxed accordingly. Charles R. Napier, Luther F. Speer, and Fred A. Woodis, Esqs., for the taxpayer. Robert A. Littleton, Esq. (Nelson T. Hartson, Solicitor of Internal Revenue) for the Commissioner. KORNER1 B.T.A. 518">519 Before IVINS, KORNER, and MARQUETTE. This appeal involves income and profits taxes for the calendar years 1918, 1919, and 1920, determined by the Commissioner as deficiencies arising in those years in the amount of $22,748.11. The deficiencies arise by reason of the determination of the Commissioner that the Citizens Loan Association is and was during the years in question a corporation or an association taxable as a corporation, and that the income in question was the income of such corporation or association. The taxpayer admits that the Citizens Loan Association had an existence in law and in fact as a corporation during1925 BTA LEXIS 2902">2903 the years in question, but contends that the income sought by the Commissioner to be taxed was not the income of the corporation but was the income of a group of individuals doing business during the period here under consideration as copartners under the name of Citizens Loan Association. FINDINGS OF FACT. 1. On March 1, 1905, three men, Lewis E. Crews, Loren F. Bronte, and John A. Breen, entered into a partnership agreement to engage as copartners in the business of private banking and lending money. The style of the firm was "Crews, Bronte, & Breen." By the terms of its agreement the firm had a life of 10 years. These partners immediately began business in the city of Chicago, Ill., with business quarters at 840 West Sixty-third Street, and at 608 Tacoma Building, 5 La Salle Street. It does not appear from the record at what time the partnership business assumed the name and style of "South Side Savings Bank," but it does appear that by the beginning of the year 1910 this partnership had definitely assumed that name. The Sixty-third Street place of business had the appearance of the ordinary bank. The office at 5 La Salle Street was on an upper floor and had the appearance1925 BTA LEXIS 2902">2904 of a regular loan office. No banking business was done at the latter address and no deposits were accepted there, but only the small loan or "chattel loan" business was there engaged in. 2. On June 19, 1914, an agreement was entered into between L. E. Crews, John A. Breen, K. J. Phelan, and A. B. Monroe wherein it is recited in the preamble that Crews and Breen are doing business as partners in the banking and chattel loan line under the name and style of "South Side Savings Bank"; this agreement further provides for the sale by Crews to the other parties to the instrument of certain of his interest in this business, as follows: To Phelan, 8 per cent; to Monroe, 9 per cent; to Breen, 13 per cent. The agreement provides how payment shall be made and it is stipulated that the purchase price of these percentage interests shall be Phelan, $15,666.76; Monroe, $17,625.11; Breen, $25,458.49. 1 B.T.A. 518">520 3. In January, 1910, Crews, Bronte, and Breen, formed a new business which they called "Half Rate Loan Company." It was not located at either of the offices of the South Side Savings Bank and it did not accept deposits. It first had a temporary office on Sixty-third Street for a1925 BTA LEXIS 2902">2905 short time and was thereafter located at Sixty-third and Halstead Streets. On February 1, 1910, the Half Rate Loan Company was incorporated under the Laws of the State of Illinois. The certificate of incorporation was to C. A. Leatzow, E. C. Lindsey, and S. J. Dillon, and provided for a capitalization of $2,500 divided into 25 shares of the par value of $100 each. The original subscribers to the capital stock of this corporation were C. A. Leatzow (1 share), Alice R. Leatzow (1 share), M. Schaub, (5 shares), M. L. Statler (18 shares). From the time of the organization of this corporation until its name was changed by amendment of its charter to "Citizens Loan Association," about August 4, 1917, (as appears in paragraph 8 hereinafter) Crews, Bronte, Breen, and South Side Savings Bank, furnished all the capital of this business and appropriated all of the profits - except that Bronte died in 1914. From about 1914 the Half Rate Loan Company corporation was self sustaining and did not need any more advances of money from the South Side Savings Bank or from the individuals mentioned. Monroe and Phelan, who were partners in the South Side Savings Bank, had no interest in the corporation, 1925 BTA LEXIS 2902">2906 never advanced any moneys to it and never shared in any profits from it. With the exception of Leatzow, the original subscribers and stockholders in the corporation were dummies and had no actual interest in it. After the death of Bronte the actual interests in the corporation were Crews, Breen, and Leatzow. The interests in the South Side Savings Bank, the copartnership, were Crews, Breen, Phelan and Monroe. During this period the individuals named carried on the business of making small loans as above outlined at the Halstead Street office. During that same period there were only five stock transfers. These occurred some time prior to November 1, 1912, and involved the transfer of eight shares to Crews. During that period none were issued or transferred to Bronte or Breen. 4. At the expiration of the ten-year contract referred to in paragraph 1, another partnership agreement was executed. This agreement was dated March 1, 1915, and the parties thereto were Crews and Breen. Therein the parties agreed to engage as partners in the banking and loan business in Chicago (at the same offices mentioned in the prior contract of March 1, 1905) under the name and style of "South1925 BTA LEXIS 2902">2907 Side Savings Bank." The parties agreed to furnish funds in proportion to their respective interests necessary to maintain a balance in bills receivable of $160,000. It was further agreed that Crews and Breen should divide between themselves 64 per cent of the profits - 25 per cent to Crews and 39 per cent to Breen. Losses were to be shared on the same basis. The remaining 36 per cent of gains and profits was stipulated to be divided between Monroe and Phelan (and losses on a similar basis) in accordance with the contract referred to in paragraph 2 which was by reference specifically made a part of the agreement of March 1, 1915. The term of this agreement was ten years. It was further stipulated that neither of said partners should endorse or become surety on any obligation without the consent of the other party to this agreement, and that 1 B.T.A. 518">521 each should execute a will appointing the other party to the agreemen as his executor and therein direct such executor to continue the business for two years after his decease, and at the end of such two years the surviving partner should have the option of buying the deceased partner's interest at its then book value. The parties1925 BTA LEXIS 2902">2908 signing this instrument were Crews and Breen. 5. On February 7, 1917, an agreement was executed by Crews, Breen, Monroe, and Phelan, reciting that they are partners engaged in the business of lending money, under the name and style of "South Side Savings Bank," located at 724 West Sixty-third Street and at suite 314 Tacoma Building, Chicago, III. The agreement further recites that it is the desire and intention of each of said copartners that the death of any one or more of them shall not, as between the survivors of them, dissolve or terminate said copartnerships. To effectuate this intent the agreement provided: 1. That the interest of each copartner in said copartnership and the assets thereof shall be limited (except as hereinafter provided) to a life estate only, terminating immediately upon such copartner's death, and that no interest in said copartnership, nor the assets thereof shall ever pass by will or descent, but that this contract shall in no wise affect such interest during the life of such copartner. 2. That upon the death of any one of said copartners, the survivors of them shall at once become jointly liable to the estate of such decedent in a sum of money1925 BTA LEXIS 2902">2909 exactly equal to the book value of such decedent's interest in said copartnership and the assets thereof next immediately before his death, and said survivors shall pay said sum to the executor or administrator of such decedent within sixty (60) days subsequent to the time such executor or administrator shall qualify as such and enter upon the discharge of his duties. 3. That in making any payment provided for by this contract the then surviving copartners shall contribute thereto (as between themselves) in the same proportion as they are then interested in said copartnership and the assets thereof. 4. That when only one of said copartners shall survive, and he shall have paid all moneys for which he became liable under the terms of this contract to the person or persons entitled thereto, then this contract shall become null and void, but until that time it shall remain in full force and effect, and be applicable at the death of each copartner. 6. At the beginning of their affairs under the agreement referred to in paragraph 1, the partners, Crews, Bronte, and Breen, had placed on the doors of their places of business the words: "Crews, Bronte, and Breen." Later, as the1925 BTA LEXIS 2902">2910 name "South Side Savings Bank" began to be used, that name was also placed on the doors with the names of Crews, Bronte, and Breen immediately underneath. After the death of Bronte the names so appearing underneath were those only of Crews and Breen. The letterheads of the business were in similar form. During all the times referred to in the foregoing paragraphs the bank accounts were carried in the name of "South Side Savings Bank." When money way borrowed to use in the business the note evidencing the loan was signed "South Side Savings Bank. J. A. Breen and L. E. Crews, partners." Notes, mortgages, etc., taken as evidence of debt for moneys loaned by this business were taken either in the name of South Side Savings Bank or in the individual names of Crews, Bronte, and Breen. As heretofore stated, the business transacted was a combination of banking, including the acceptance of deposits, issuance of certificates of deposit, cashier's checks, etc., and that of small loans or "chattel loans" as distinguished 1 B.T.A. 518">522 from banking. Of the total business done, approximately 20% was banking business and 80% was small-loan business. During this period the leases to the premises1925 BTA LEXIS 2902">2911 at Sixty-Third Street and at La Salle Street ran in the names of the individual partners. 7. On June 14, 1917, the Legislature of the State of Illinois enacted a statute known as the "small-loan act." This statute became effective on July 1, 1917, and was entitled "An act to license and regulate the business of making small loans in sums of $300 or less, secured or unsecured, at a greater rate of interest than 7 per centum per annum, prescribing the rate of interest and charge therefor * * ." This statute fixed the maximum rate of interest on loans $300of or less at 3 1/2 per cent per month; changed the then-prevailing method of computing and collecting interest thereon; regulated the taking of security for such loans; provided for supervision of lender's offices by a public department and for giving of bonds and issuance of licenses. Pursuant to this act licenses were taken out on January 2, 1918, as follows: To C. A. Leatzow, doing business as "Citizens Loan Association," as 5 North La Salle Street; to A. B. Monroe, doing business as "Citizens Loan Association," at 724 West Sixty-third Street; and on January 1, 1919, licenses were issued to L. E. Crews and J. A. Breen, doing1925 BTA LEXIS 2902">2912 business as "Citizens Loan Association," at 5 North La Salle Street; and to L. E. Crews and J. A. Breen, doing business as "Citizens Loan Association," at 724 West Sixty-third Street. Each of the licenses referred to was for a period of one year. 8. A short time prior to July 1, 1917, the name "Citizens Loan Association" began to be used and, although the record is not entirely clear on this point, it appears that this name was used interchangeably with that of "South Side Savings Bank" to designate the partnership business. It definitely appears that on July 1, 1917, the doors at both the Sixty-third Street office and the La Salle Street office bore the names "South Side Savings Bank" and "Citizens Loan Association" - the latter immediately underneath the former. These names so appeared there until December 30, 1920. About this time (the record does not disclose the exact date) application was made by the Half Rate Loan Co., the corporation, for an amendment to its charter enlarging its powers and changing its name to "Citizens Loan Association." The following certificate was received in evidence at the hearing: CERTIFICATE OF CHANGE OF NAME AND ENLARGEMENT OF OBJECT OF1925 BTA LEXIS 2902">2913 HALF RATE LOAN COMPANY, A CORPORATION. The undersigned, the President of said Corporation, does hereby certify that at a special meeting of the Stockholders of said Corporation, at which all of the said stockholders were present in person or proxy, a motion to change the name of said corporation from "Half Rate Loan Company" to "Citizens Loan Association" and to enlarge the object of said corporation to include the carrying on of a general and special advertising business, the soliciting of orders for goods, wares, and merchandise for and on behalf of other persons, firms, and corporations, and the soliciting of applications for loans (secured and unsecured) for and on behalf of other persons, firms and corporations, was duly made, seconded, and carried by a unanimous vote of all of the stockholders of said Corporation. [SEAL.] Seal of Corporation. (Signed) CHARLES A. LEATZOW, President.1 B.T.A. 518">523 STATE OF ILLINOIS, County of Cook, ss:CHARLES A. LEATZOW, being first duly sworn, deposes and says that he has read the foregoing certificate by him subscribed, and that the statements in said certificates contained, and each of them, are true of his own knowledge, 1925 BTA LEXIS 2902">2914 and further affiant saith not. (Signed) CHARLES A. LEATZOW. Subscribed and sworn to before me on this the 20th day of July, A.D. 1917. [SEAL.] (Signed) G. J. DICKSON, Notary Public.The above was duly published in the Chicago Daily Law Bulletin for the requisite statutory period beginning July 21, 1917, and on August 4, 1917, the name of the corporation "Half Rate Loan Co." was changed to "Citizens Loan Association." Five hundred shares of the stock of the capital stock of the Citizens Loan Association, of the par value of $10 each, were issued immediately, as follows: Breen, 176 shares; Crews, 125 shares; Monroe, 65 shares: Phelan, 69 shares; Leatzow, 65 shares. Certificates evidencing the ownership of this stock were issued to the stockholders as shown above. The share holdings of these men in the Citizens Loan Association, the corporation, were in the same ratio and percentage as their respective interests in the Citizens Loan Association, a trade name or alter ago of South Side Savings Bank before the incorporation of the Citizens Loan Association. 9. At the time of the change of its name to "Citizens Loan Association," a corporation, or just prior1925 BTA LEXIS 2902">2915 thereto, the Half Rate Loan Co. distributed its net assets in the amount of approximately $46,000. Monroe and Phelan did not share in this distribution, as they had never been stockholders or had any interest in the Half Rate Loan Co., although they had interests as partners, as above stated, in the Citizens Loan Association before the latter became a corporation, and were likewise partners in the South Side Savings Bank. The business of the Half Rate Loan Co. was discontinued as such and all the partners of the Citizens Loan Association became stockholders in the successor corporation by that name, as set out in paragraph 8, above. Just prior to this time it had been determined that the banking business, which was proving the less profitable venture, would be gradually liquidated and closed out. Accordingly, $60,000 (approximately) of the funds engaged in the business was set aside to pay off depositors on the banking side. From that time on to its end the South Side Savings Bank gradually paid off its depositors and went out of business - still carrying its name of South Side Savings Bank. On the other hand the small loan business which was by far the major portion of the business1925 BTA LEXIS 2902">2916 assumed the name of Citizens Loan Association and the loan business was carried on separately under that name. The assets of the business were approximately $216,000. Of this amount $60,000 was allocated to the banking side for its liquidation. The remaining $156,000 (approximately) was carried to a separate account for the prosecution of the loan business then beginning to be done under the name "Citizens Loan Association." Two separate sets of books were set up, one the South Side Savings Bank and the other the Citizens Loan Association. The five men above mentioned in paragraph 8 had the same moieties of interest in both the South Side Savings Bank and the 1 B.T.A. 518">524 Citizens Loan Association - and upon the incorporation of the Citizens Loan Association (as successor to Half Rate Loan Co.), which occurred at about this time, these five men became its stockholders in the same ratio. 10. From August 4, 1917, when the old corporation became the Citizens Loan Association, the banking business carried on as South Side Savings Bank dwindled to its end and became extinct at the close of the year 1920. The corporation now known as Citizens Loan Association continued to exist without1925 BTA LEXIS 2902">2917 change in stockholders or their interests until early in 1920, at which time the corporate minute book shows a transfer by Breen of 2 per cent of his stock to Leatzow and 2 per cent to an employee named Olendorf. The same loan business continued to be carried on under the name of Citizens Loan Association throughout this same period. There were distributions at irregular intervals of the profits of the Citizens Loan Association and these were regularly entered on the corporate books and denominated "dividends," although it appears from the evidence that there was no meeting of directors in regular form declaring such dividends and ordering their payment. It further appears from the evidence that the distributions of profits formerly made in South Side Savings Bank, a copartnership, and in the Citizens Loan Association before its incorporation were similarly denominated "dividends." The lease on the premises at 724 West Sixty-third Street from May 1, 1917, to April 30, 1918, ran in the name of Crews & Breen trading as South Side Savings Bank, while the lease at 5 North La Salle Street ran for the same period to Crews & Breen. During the period from August 4, 1917, through the year1925 BTA LEXIS 2902">2918 1920 no legal action or suit brought by the Citizens Loan Association was ever brought as a corporation. The funds of the Citizens Loan Association were not banked as a corporation and its checks were not drawn in corporate form. 11. From the year 1913 to the end of its existence, corporation income tax returns were filed each year by the Half Rate Loan Co. During that same period the partners filed informative partnership returns of the income of the South Side Savings Bank and paid tax thereon as individuals. Likewise, after its coming into existence as a corporation in 1917, the Citizens Loan Association regularly filed its income tax returns as a corporation and paid its taxes as such for the years 1917, 1918, and 1919. The return of income of South Side Savings Bank was made on a partnership basis. Similarly the Citizens Loan Association regularly executed and filed capital stock tax returns. The income, excess profits, and capital stock tax returns were introduced in evidence at the hearing of this appeal and filed as exhibits in the record. 12. Matters went along in this wise until some time in 1919, shortly after June 10, 1919, when the Citizens Loan Association1925 BTA LEXIS 2902">2919 filed its corporation returns for the year 1918 in the manner set out above. Here we let Mr. J. A. Breen, President and Acting Treasurer of Citizens Loan Association, tell the story under examination by his counsel: Q. Did any question ever come up between the gentlemen as to the propriety of making corporation returns for the earnings of this business? A. What do you mean? 1 B.T.A. 518">525 Q. Did any such question ever come up? A. Yes. Q. When? A. The first time was in 1917, when we filed - Q. And later on? A. And later on in 1920. Shortly after we filed for 1920 (sic) - shortly after March, 1919, we had occasion to hire two or three Government men in Chicago to work on this account, and when we stated the nature of the business that we filed for, for the last two or three years, they laughed at us and stated that we were entitled to file as copartners; that started this proposition. They told us to file an appeal together with amended returns; that was some time in 1920, and shortly after we filed our 1919 taxes. Q. Did you think that that was good advice? A. Yes, we thought it was. We did not seem to get anywhere, but we thought it was good1925 BTA LEXIS 2902">2920 advice. We got out information from two different sources, that is, two different Government revenue men who were in the service, and both advised us the same thing. Q. Prior to the time you concluded to file a petition for a refund, were any steps taken, so far as you know, to clear up this matter? A. We formed another partnership agreement. Q. That is, you mean you entered into another agreement? A. We still had one running, but we entered into another. The agreement referred to by the witness was executed December 27, 1919, and is as follows: This agreement between Lewis E. Crews, John A. Breen, Kieran J. Phelan, Archa B. Monroe and Charles A. Leatzow all of the city of Chicago, Illinois, made December 27, 1919.Witnesseth: (a) Whereas, the parties hereto are all of the stockholders of Citizens Loan Association, an Illinois corporation, which has offices at No. 5 North La Salle Street, No. 724 West Sixty-third Street and No. 6240 Cottage Grove Avenue, in said city, where small loan businesses are conducted by said parties as principals or employees, and, (b) Whereas, the law of Illinois do not permit a corporation to carry on such a business, 1925 BTA LEXIS 2902">2921 and (c) Whereas, said corporation has caused increased taxation to said parties and confusion in the transaction of said business, and (d) Whereas, said parties desire to reorganize said business so that it will apparently as in fact conform to law and be exempt from inequitable taxation, and It is therefore agreed by and between said parties: 1. That a copartnership be and hereby is organized to carry on a small loan business at the places above named under the name and style of Lewis E. Crews, and John A. Breen, doing business as Citizens Loan Association, Copartners: 2. That the interests in said copartnership shall be held as follows: Lewis E. Crews, twenty-five per cent (25) of the whole, John A. Breen, thirty-five and 2/10 (35-2/10) per cent of the whole. Kieran J. Phelan, thirteen and 8/10 (13-8/10) per cent of the whole. Archa B. Monroe, thirteen (13) per cent of the whole. Charles A. Leatzow, thirteen (13) per cent of the whole. 3. * * * 4. * * * 5. * * * 6. * * * 7. That all of the assets of said corporation including good will, shall on January, 1920, at the opening of business be paid, assigned, delivered, and turned over to said copartnership, 1925 BTA LEXIS 2902">2922 which shall continue said business substantially as theretofore and said corporation shall be dissolved, in the manner provided by the Statute, as soon as it conveniently can be done. 8. That this contract shall remain in full force and effect for a period of eight (8) years from and after January 1st, A.D. 1920, and, that the death, disability, withdrawal or removal of any one or more of said copartners shall 1 B.T.A. 518">526 not work a dissolution of said copartnership as to those copartners who survive or remain. Witness the hands and seals of the parties hereto on the day and the year first above written. LEWIS E. CREWS. [SEAL.] JOHN A. BREEN. [SEAL.] KIERAN J. PHELAN. [SEAL.] ARCHA B. MONROE. [SEAL.] CHARLES A. LEATZOW. [SEAL.] (Italics ours.) 13. Thereafter, on January 30, 1920, a meeting of the stockholders of the Citizens' Loan Association was held, at which meeting the following resolution was adopted: Resolution adopted by the stockholders of Citizens' Loan Association, a corporation, held January 30, 1920: Whereas, on or about the 1st day of January, 1920, all of the stockholders of said corporation entered into a certain contract1925 BTA LEXIS 2902">2923 by and between themselves pursuant to which they were to and did take over the entire assets of said corporation including the good will of the business theretofore carried on by said corporation and whereupon said corporation at once ceased to engage in any kind of business, and, Whereas at that time the corporation was not indebted in any sum whatever to any person, firm, or corporation, except for county, State, and Federal taxes, to become due and payable in 1920, and, Whereas it is the desire and intention of said stockholders to dissolve said corporation and surrender the charter thereof, now therefore, Be it resolved, That each and every of said stockholders assume and become liable to pay all of said taxes in the name of and for the use and benefit of said corporation to the taxing body entitled thereto, and, Be it further resolved, That said corporation be and the same is hereby dissolved and the president and secretary thereof be and hereby are directed to take such steps as may be required by law to effect said dissolution. (Italics ours.) Thereafter, on February 19, 1920, the corporation duly filed a corporation and profits tax return1925 BTA LEXIS 2902">2924 for the calendar year 1919, which return was, at the hearing, made a part of the record in this appeal. 14. On March 16, 1921, a partnership return of income was filed by the Citizens' Loan Association, by John A. Breen as a copartner. 15. On audit the Commissioner determined that the Citizens Loan Association was during the years 1918, 1919, and 1920, a corporation and taxable as such. Upon that basis he computed the taxes of the Citizens Loan Association and determined that a deficiency existed for the years mentioned, as follows: $2,686.83 for 1918, $2,788.70 for 1919, and $17,272.58 for 1920, a total of $22,748.11. He notified the taxpayer of such determination by registered letter dated September 3, 1924, and from that determination the taxpayer appeals. Petition was filed October 18, 1924. DECISION. The tax should be computed in accordance with the following opinion. Final decision of the Board will be settled on consent or on seven days' notice in accordance with Rule 50. OPINION. KORNER: The only question for determination here is whether the income reported by the Citizens Loan Association, a corporation, for the years 1918 and 1919 and by the Citizens1925 BTA LEXIS 2902">2925 Loan Association, a copartnership, for the year 1920, belonged in fact to the corporation 1 B.T.A. 518">527 or the copartnership. If the income reported is attributable to the corporation the determination of the Commissioner should be approved; if it is attributable to the partnership the determination of the Commissioner should be disapproved and the income in question apportioned among the several members of the copartnership, in accordance with section 218(a) of the Revenue Act of 1918. Taxpayer admits that there was during the years 1918, 1919, and 1920, a corporation organized under the laws of the State of Illinois, and known as the Citizens Loan Association. It contends, however, that there was in existence during those years a copartnership also operating under the name of the Citizens Loan Association and that the income reported by the corporation for the years 1918 and 1919 and also the income reported by the copartnership for the year 1920, now proposed to be taxed as corporation income, was earned by the copartnership and, as a matter of fact and law, belonged to the copartnership and should be reported by and taxed as income to the several partners. With this contention1925 BTA LEXIS 2902">2926 we are unable to agree. The testimony in this case is not entirely clear. On the other hand it is full of conflicting statements and as to the material points is sometimes vague and confusing. However, the testimony when considered with the other evidence, establishes the following pertinent facts which we believe are decisive of the issue presented. The evidence clearly establishes to our mind that prior to July 1, 1917, there was in existence a corporation organized under the laws of the State of Illinois and known as the Half Rate Loan Co. There was also a partnership operating under the trade name of South Side Savings Bank. Some time in the month of July, 1917, the Half Rate Loan Co. amended its charter, increased its authorized copital and changed its corporate name to Citizens Loan Association. It immediately distributed its assets to its then stockholders, and then issued its capital stock to the members of the copartnership, the South Side Savings Bank, in exact proportion to their respective interests in the partnership and received in exchange all the assets of the partnership which had been used in its "small loan business." The partnership then and there became1925 BTA LEXIS 2902">2927 completely divorced and separated from the small loan business taken over by the corporation, although it continued to operate for the purpose of liquidating the savings bank side of its business. The corporation continued in business during the years 1918 and 1919 and reported its corporate income. On December 27, 1919, the stockholders, by written instrument, agreed to form a new partnership composed of themselves, to take over the assets and business of the corporation, and recited in the agreement their reasons therefor, to wit, that "the laws of Illinois do not permit a corporation to carry on such a business" (the small-loan business), and that "the corporation has caused increased taxation to said parties." On January 1, 1920, the assets of the corporation were delivered to the new partnership and soon thereafter it was resolved by the stockholders of the corporation that the corporation should be dissolved. It was not in law dissolved but it was in fact abandoned and became dormant on January 1, 1920, and has transacted no business since that time. The claim made by taxpayer that the business operated as the Citizens Loan Association during the years 1918 and 1919 did1925 BTA LEXIS 2902">2928 not belong to the corporation but to a partnership of the same name, is 1 B.T.A. 518">528 not borne out by the evidence. In fact, it does not appear that there was ever a partnership by that name prior to January 1, 1920. It is true that in February, 1917, a partnership was formed which operated under the name of the South Side Savings Bank, but its assets, with the exception of those used exclusively in the banking end of its business, were, in July, 1917, taken over by the corporation in exchange for its capital stock. This partnership which became practically lifeless when the small loan business was transferred to the corporation, appears to have used at times the name "Citizens Loan Association" as well as its own trade name. This fact does not, however, establish any ownership by the partnership of the assets of the corporation. The small loan business of the partnership was transferred to the corporation, belonged to it from the time of such transfer and was operated as a corporation business during the years 1918 and 1919. This fact is clearly established by the act of the stockholders on December 27, 1919, when they formed a new partnership, for a formal legal instrument which1925 BTA LEXIS 2902">2929 recites that the assets in question belonged to the corporation. That they did not belong to the old partnership is further established by the fact that a new partnership was formed composed of the same members who composed the old partnership. If the assets in question did belong to the old partnership the forming of the new partnership to take them over was a useless and unnecessary action. After full and careful consideration of the evidence in this case, we are of the opinion that the Citizens Loan Association, a corporation, succeeded to the small loan business of the South Side Savings Bank in 1917, and continued in business during the years 1918 and 1919, and that the income in question for those years is properly attributable to it and not to any partnership of the same name. The determination of theCommissioner as to those years is therefore approved. With reference to the year 1920, we find that the assets of the corporation were on January 1, 1920, transferred to a partnership known as the Citizens Loan Association, and that the corporation ceased its operations on that date. The income in question for the year 1920, therefore is the income of the new partnership1925 BTA LEXIS 2902">2930 and should be apportioned among and reported by the several partners in their individual returns. The determination of the Commissioner as to the year 1920 is therefore disapproved.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625309/	George D. Meriwether and Sherron F. Meriwether v. Commissioner.Meriwether v. CommissionerDocket No. 2732-69.United States Tax CourtT.C. Memo 1971-297; 1971 Tax Ct. Memo LEXIS 36; 30 T.C.M. 1256; T.C.M. (RIA) 71297; November 23, 1971, Filed 1971 Tax Ct. Memo LEXIS 36">36 Petitioner made three personal loans totalling $23,200 to the president of a closely held loss corporation. The loans were cancelled by petitioner in consideration of which petitioner was to receive, from the president of the corporation, 6,200 shares of that corporation's stock. As part of the cancellation agreement, petitioner also promised to become executive vice president of the corporation and to cosign a note for the corporation. Held, petitioner did not receive compensation income equal to the amount by which the value of the stock he received upon cancellation exceeded the amount of the cancelled loan. If indeed a bargain cancellation did exist, the record does not indicate that petitioner performed any services for the corporation in respect of which the alleged bargain would represent compensation. George D. Meriwether, 1971 Tax Ct. Memo LEXIS 36">37 pro se, 3014 3rd Ct. , East, Tuscaloosa, Ala. Robert G. Faircloth, for the respondent. IRWINMemorandum Findings of Fact and Opinion IRWIN, Judge: Respondent asserted a deficiency in petitioners' income tax for the taxable year 1965 in the amount of $7,300.36. At trial and pursuant to Rule 17(a), Tax Court Rules of Practice, respondent amended his answer to place a deficiency of $9,419.30 in issue. We must decide whether male petitioner received compensation income when a debt owing to him was cancelled in 1965 by the transfer to him of stock, 1257 such stock allegedly having a fair market value in excess of the amount of the debt. Findings of Fact Some of the facts have been stipulated and, along with the exhibits pertinent thereto, they are herein incorporated by this reference. Petitioners are residents of Tuscaloosa, Ala., and filed their joint income tax return for 1965 with the district director in Chamblee, Ga. Hereafter, "petitioner" will be deemed to refer to male petitioner, George D. Meriwether. For several years prior to 1964, petitioner was employed by the First National Bank of Tuscaloosa, Ala., as a vice president in charge of the bank's1971 Tax Ct. Memo LEXIS 36">38 installment loan department. Beginning in late 1964 and early 1965, petitioner assumed management duties for Crown Investment Corporation ("Crown"). By June 1965, petitioner had become executive vice president of Crown. Petitioner's 1965 return indicates Crown as his employer and his salary with Crown as $9,050. One E. E. Rivers was in the advertising business and a customer of the First National Bank of Tuscaloosa. He was acquaintdd with petitioner. In the early part of 1964, Rivers and his wife owned 10,000 shares of Crown, and Rivers was the president of Crown. On three occasions in late 1964 and early 1965, petitioner personally loaned amounts of money to Rivers. The dates of these loans and the corresponding amounts are as follows: DateAmountNovember 20, 1964$13,600December 30, 19648,000January 30, 1965 1,600Total$23,200 In connection with the aforesaid loans, Rivers executed three promissory notes to petitioner, each note payable one year from the date of the loan. Rivers executed these notes in his name only and not in the name of Crown. Also, these loans were not consummated under the auspices of the bank where petitioner was employed. 1971 Tax Ct. Memo LEXIS 36">39 The three loans were personal transactions between petitioner and Rivers. Rivers utilized the borrowed funds to obtain additional stock in Crown. On February 8, 1965, petitioner and Rivers orally agreed to cancel the three notes. At this time, Rivers agreed to transfer 6,200 shares of Crown stock to petitioner in exchange for (1) the cancellation of the three notes; (2) petitioner's agreement to assume the position of executive vice president of Crown; and (3) petitioner's agreement to cosign with Rivers a $219,000 note for Crown's benefit to the Gulf States Paper Corporation. Petitioner did become executive vice president of Crown and the note was eventually cosigned with Rivers. The 6,200 shares of Crown stock destined for petitioner were transferred in two blocks and in two different manners. The first block was a 600-share transfer on February 8, 1965, accomplished in conjunction with Rivers' program of buying additional but previously unissued shares of Crown with the funds borrowed from petitioner. Rivers used the November loan proceeds to purchase an additional 1,700 shares at $8 per share. With the $9,600 proceeds from the December and January loans he caused the corporation1971 Tax Ct. Memo LEXIS 36">40 to issue on February 8, 1965, 600 shares to his wife and 600 shares to petitioner. The second block, 5,600 shares, was transferred by Rivers' wife, Dora, on June 9, 1965, to petitioner's wife in her name and as custodian for petitioner's children. Crown stock was not publicly traded although there were occasional purchases of previously unissued Crown stock. On January 23, 1964, John C. Malone, who had no connection with Crown, purchased 4,000 shares of Crown for $25,000 ($6.25 per share). At trial, Rivers testified that in January 1965 he and his wife owned 10,000 shares of Crown stock for which $40,000 had been paid in the aggregate ($4 per share). Rivers used the loan proceeds to purchase unissued stock at $8 per share. On May 1, 1965, petitioner purchased 100 previously unissued shares at the same price. Crown operated at a loss during the taxable period involved here. Respondent in his deficiency notice determined that the stock transferred to petitioner in 1965 had a fair market value in excess of the amount of the debt cancelled and that such excess represented compensation for services performed by petitioner. Petitioner has denied that he received any compensation from1971 Tax Ct. Memo LEXIS 36">41 this debt cancellation; that the only compensation he received in 1965 from Crown was his salary; and that, in any event, the stock received upon cancellation of the debt was equal in value to the amount of the debt. 1258 Opinion We must determine whether petitioner negotiated a bargain cancellation of the debt owing to him or whether the cancellation was a scheme to provide him with compensation for services performed. The facts here reveal that petitioner had, in late 1964 and early 1965, loaned $23,200 to the president of a closely held loss corporation. Within eight days of the final $1,600 loan to Rivers (the president of the corporation), the debt was cancelled and an oral agreement was reached whereby petitioner would receive 6,200 shares of the corporation's stock in consideration of which petitioner would cancel the debt, become executive vice president of the corporation, and would cosign a note with Rivers. It is well established that a mere purchase of property does not result in the realization of income. Palmer v. Commissioner, 302 U.S. 63">302 U.S. 63 (1937). On1971 Tax Ct. Memo LEXIS 36">42 the other hand, it is equally well established that if stock is sold at a bargain for the purpose of compensating an individual, such purchase does constitute the receipt of income by the purchaser. Commissioner v. Smith, 324 U.S. 177">324 U.S. 177 (1945); Commissioner v. Lobue, 351 U.S. 243">351 U.S. 243 (1956). This dichotomy is resolved by ascertaining whether the taxpayer is merely a wise or fortunate purchaser of stock or whether he was allowed the bargain for the purpose of compensating him. William H. Husted, 47 T.C. 664">47 T.C. 664 (1967). Section 1.61-2 (d)(2), Income Tax Regs., is clear that if property is transferred by an employer to an employee for an amount less than its fair market value, regardless of whether in the form of a sale or exchange, the difference between the amount paid and the fair market value at the time of the transfer is taxable compensation. Petitioner in this case has exchanged his $23,200 debt and two additional promises for 6,200 shares of Crown stock. Respondent has asserted in his deficiency notice that the value of the stock exceeded the amount of the debt cancelled and that services were performed by petitioner1971 Tax Ct. Memo LEXIS 36">43 as a quid pro quo for this bargain; ergo petitioner has received compensation income equal to the difference between the amount of the debt and the fair market value of the transferred stock. The question of the actual existence of the bargain aside for the moment, it is necessary and essential to respondent's case that a direct relationship be found between the alleged bargain and certain services performed by the petitioner for the corporation. Such services must be the consideration for the bargain element. In this case, the service element, if present, can only be found in the duties petitioner performed for Crown as manager or executive vice president, or in the additional promise to cosign a note tendered by petitioner upon the cancellation of the debt. The record in this case is such, however, that there is no service element which will stand as consideration for the alleged bargain. No doubt petitioner did perform some managerial services for Crown beginning in late 1964 and early 1965. Indeed, at trial, petitioner did indicate that sometime in late 1964 or early 1965, he did cause a financial statement of Crown's operation to be prepared. However, this occurred before1971 Tax Ct. Memo LEXIS 36">44 any verbal agreement as to the debt cancellation was reached by the parties. Aside from the preparation of a financial statement, the record does not reveal any other managerial duties, either from a qualitative or quantitative standpoint, which may be tied to the alleged bargain. Also, there is no doubt that petitioner did become executive vice president of Crown in June 1965. But again, the record is barren with respect to the nature of that position. It is impossible to determine whether the new position fashioned new responsibilities for which petitioner would be compensated by the alleged bargain in the debt cancellation. It may very well be that the position of executive vice president was a position requiring few duties or a position which was simply a better vantage point for petitioner to observe the workings of this corporation in which he had now become a stockholder. In the absence of a more detailed record, the new executive position cannot be tied to the alleged bargain. Petitioner received a $9,050 salary from Crown in 1965. The reasonableness and adequacy of that salary is not disputed and the record does not indicate any written agreement to furnish petitioner with1971 Tax Ct. Memo LEXIS 36">45 any additional salary, either in the form of cash, stock, or a bargain debt cancellation. Further, the promise made by petitioner on February 8, 1965, to cosign the note to Gulf States and his subsequent fulfillment of that promise are not sufficient proof of "service performed" for Crown. Petitioner's 1259 cosignature on the note to Gulf States Paper Corporation was clearly within his interest as stockholder in Crown. It is not unusual for stockholders to concern themselves with the financial dealings of their companies. One is compensated for rendering services, securing customers, developing new lines of trade, etc. - not merely for cosigning a note for the corporation's benefit. If no direct relatingship can be drawn between the alleged bargain element in the debt cancellation and specific services rendered for such bargain, a finding of compensation income is unwarranted. On the basis of the meager record before us, we are satisfied that there was no service element to tie to the alleged bargain acquisition in this case. Respondent's assertion of compensation income is unfounded1971 Tax Ct. Memo LEXIS 36">46 on the record. As to the existence of the bargain itself, the record is again spotty, save for indications of isolated transactions in unissued treasury stock of Crown. Crown was closely held and its stock was not regularly or even occasionally traded on any market. Unissued treasury stock had been issued for as low as $6.25 per share and as high as $8 per share, and in early 1965, Rivers and his wife were holding 10,000 shares of Crown stock at an average cost of $4 per share. However, Crown had been operating at a loss and, indeed, these isolated purchases of unissued treasury stock may indicate a somewhat optimistic and inflated value. In view of our opinion that no service element existed here, our consideration of the amount of the bargain in the debt cancellation, if any, becomes somewhat academic. With a paucity of information in the record regarding the financial soundness of Crown, its operations, and its prospects for the future, we can only say at best, that some bargain may have been obtained by petitioner. It is impossible to determine actual fair market value of Crown stock solely on the basis of the infrequent treasury stock purchases of Crown stock. Another point1971 Tax Ct. Memo LEXIS 36">47 must be emphasized. The record does not show that Rivers was the alter ego of Crown. His relationship to Crown and his activities in its behalf cannot be gleaned from the record. We note that the three loan transactions between petitioner and Rivers were personal between those two parties and that absent a finding that Rivers was the alter ego of Crown, it can well be that petitioner was cancelling his debt in order to obtain a possibly fruitful investment in Crown. The situation in this case can be analogized to a bargain purchase of stock by an individual where the individual has rendered no services to the corporation whose stock he is purchasing. Decision will be entered for the petitioners.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625310/	Richard M. Gooding and Marcella M. Gooding, Husband and Wife v. Commissioner.Gooding v. CommissionerDocket No. 85694.United States Tax CourtT.C. Memo 1961-299; 1961 Tax Ct. Memo LEXIS 50; 20 T.C.M. 1542; T.C.M. (RIA) 61299; October 30, 1961Joe S. Gullo, Esq., for the petitioners. Charles C. Shaw, Jr., Esq., for the respondent. MULRONEY Memorandum Opinion MULRONEY, Judge: The respondent determined a deficiency in the petitioners' income tax for 1958 in the amount of $221. The deficiency arose from respondent's disallowance of a bad debt deduction in the amount of $1,000 claimed by the petitioners for the year 1958. Petitioners in their pleadings claim1961 Tax Ct. Memo LEXIS 50">51 there was no deficiency for the year 1958, and, in fact, an overpayment of approximately $351 on their income tax for 1958. However, in the same petition petitioners claim "ALTERNATELY" an overpayment of approximately $10,130 on their 1958 tax, based upon a purported overpayment of their 1951 income tax in the amount of $10,000. Petitioners now abandon their first claim and press the second. With the exception of one exhibit (a letter from the assistant regional commissioner in Cincinnati, which has no bearing on the issues) introduced in evidence by petitioners' counsel, all of the facts have been stipulated. Richard M. Gooding and Marcella M. Gooding, husband and wife, are residents of Arlington, Virginia. They filed a joint income tax return for 1958 with the district director of internal revenue at Richmond, Virginia. Richard will hereinafter be called the petitioner. Petitioner is a petroleum chemist and during the period here involved was employed by the Bureau of Mines, Department of the Interior, Washington, D.C. On November 23, 1950 petitioner married Frances R. Lee of Dallas, Texas. On March 15, 1951 petitioner and Frances filed a joint declaration of estimated tax1961 Tax Ct. Memo LEXIS 50">52 for 1951 with the collector of internal revenue for the second district of Texas. The declaration showed an estimated tax of $11,052.40 for 1951 and a credit for estimated withholdings of $1,052.40. Of the balance of $10,000 estimated tax declared, Frances paid $7,500 and the petitioner paid nothing. Petitioner and Frances were divorced on June 20, 1951. On January 15, 1952 Frances filed a purported amended declaration of estimated tax for herself and petitioner showing an estimated tax of $43,800, a credit of $1,300 for estimated withholding, payments of $7,500 on prior declarations, and an unpaid balance of estimated tax in the amount of $35,000. Frances paid $35,000 with this amended declaration, which payment, together with the $7,500 she had paid on the prior declaration, made a total payment of $42,500. The amended declaration was not signed by petitioner, but Frances signed petitioner's name to the declaration without his knowledge. Subsequent to June 20, 1951 and within the year 1951 petitioner married Marcella and they filed a joint income tax return for 1951 on February 29, 1952 in which they reported their combined salaries in the amount of $10,301.03, computed a tax of1961 Tax Ct. Memo LEXIS 50">53 $1,600.24, claimed a credit of $1,754.28 for withholdings, and claimed an overpayment of tax in the amount of $154.04. On March 15, 1952 petitioner and Marcella filed an amended joint return for 1951 in which they reported Marcella's salary, excluded one-half of petitioner's salary for the period of January 1, 1951 to June 20, 1951, when petitioner was married to Frances, with the explanation that such salary was community income of which one-half belonged to Frances, included a one-half share of purported community income received by Frances, consisting of partnership income, dividends and interest, and also claimed one-half of a loss sustained by Frances on Texas ranch property. Petitioner and Marcella on their amended joint return, also claimed a credit for taxes paid in the amount of $16,123.73, consisting of $1,754.28 withheld from the salaries of petitioner and Marcella and $14,369.45 of the $42,500 paid by Frances as estimated tax. Based on these items, petitioner and Marcella claimed an overpayment of tax in the amount of $3,643.07. On July 2, 1954 the respondent mailed a statutory notice of deficiency to petitioner and Marcella showing a determination of a deficiency in1961 Tax Ct. Memo LEXIS 50">54 their income tax for 1951 in the amount of $883.60, with the explanation that petitioner's entire salary for 1951 was includible in gross income for that year. Petitioner and Marcella filed a petition with the Tax Court on September 14, 1954 alleging (1) that one-half of his salary from January 1, 1951 to June 20, 1951 was excludable from gross income; (2) that petitioner had erroneously included in his income for 1951 one-half of the community income belonging to Frances; (3) that they were entitled to tax payment credits in the amount of $16,123.73 ($14,369.45 plus $1,754.28); and (4) that they were entitled to a refund of about $15,800, which represented a purported overpayment of their income tax for 1951. The trial of this case resulted in an opinion and decision in favor of respondent, Richard M. Gooding, 27 T.C. 627">27 T.C. 627. In the opinion it is stated the questions for decision were as follows: 1. Did petitioner Richard M. Gooding, upon or after a prior marriage to a Texas resident in November 1950, change his domicile from the State of Virginia (a non-community property State) to the State of Texas (a community property State), and thereby establish a marital community1961 Tax Ct. Memo LEXIS 50">55 in Texas, so that there is includible in his gross income for the year 1951, pursuant to the community property laws of Texas: (a) Only oneha-lf the salary which he received from employment in Washington, D.C., during the period of January 1 to June 20, 1951, which preceded the termination of such marriage by divorce; and (b) one-half of certain income which his former wife received during the same period, when she was maintaining a separate residence in Texas? 2. Are Gooding and his present wife entitled to apply as a credit, against their joint income tax liability for the year 1951, an arbitrary portion of amounts which the former wife paid, both before and after the divorce, with respect to a joint declaration and a purported amended joint declaration of estimated income tax for such year? As to the first issue, the Tax Court held that petitioner did not establish that he and Frances had a marital domicile in Texas during the period of January 1 to June 20, 1951 and that, consequently, his gross income for 1951 should be recomputed to include all the salary of his 1951 employment in Washington, D.C. and to exclude therefrom any portion of the income which Frances derived in1961 Tax Ct. Memo LEXIS 50">56 Texas. On the second issue involving the claimed credit for taxes paid in the amount of $14,369.45, the Tax Court, after stating that since the petitioner and Marcella "did not pay any of the [$14,369.45] for which they claim credit, such amount cannot represent an overpayment by them", held that in recomputing the joint tax liability of petitioner and Marcella for 1951 "no credit should be allowed for any portion of the $42,500 which Frances Lee paid on the * * * declaration of estimated tax." The Tax Court was affirmed in Gooding v. Commissioner, 250 F.2d 765 (App. D.C. 1957). Respondent argues that the doctrine of collateral estoppel is applicable here in that the same issue was presented, litigated and decided in the Gooding case, supra, between the same parties who are now before us, and that the controlling facts and applicable legal rules remain the same. It is apparent that petitioner is once more trying to recover a portion of the 1951 prepayment of tax made by his former wife, and although we agree with respondent that the doctrine of collateral estoppel effectively prevents relitigation of this issue, see Commissioner v. Sunnen, 333 U.S. 591">333 U.S. 591,1961 Tax Ct. Memo LEXIS 50">57 Stern & Stern Textiles, Inc., 26 T.C. 1000">26 T.C. 1000, affirmed 263 F.2d 538, certiorari denied 361 U.S. 831">361 U.S. 831, it is not necessary to rest our decision on that ground. The jurisdiction of the Tax Court is limited to the year, or years, covered by the respondent's statutory notice of deficiency. Sections 6212, 6214, Internal Revenue Code of 1954. 1In the case of overpayments, the jurisdiction of the Tax Court is defined in section 6512, as follows: SEC. 6512. LIMITATIONS IN CASE OF PETITION TO TAX COURT. * (b) Overpayment Determined by Tax Court. - (1) Jurisdiction to Determine. - If the Tax Court finds that there is no deficiency and further finds that the taxpayer has made an overpayment of income tax for the same taxable year, * * or finds that there is a deficiency but that the taxpayer has made an overpayment of such tax, the Tax Court shall have jurisdiction to determine the amount of such overpayment, and such amount shall, when the decision of the Tax Court has become final, be credited or refunded to the taxpayer. 1961 Tax Ct. Memo LEXIS 50">*58 In this case the respondent's deficiency notice only covered the year 1958, and, consequently, our jurisdiction is limited to that year. 2 We have no jurisdiction to consider any purported overpayments for the year 1951, the year for which Frances made the payments on estimated tax which petitioner is here seeking to recover in part. CIBA Pharmaceutical Products, Inc., 35 T.C. 337">35 T.C. 337; Robert J. Dial, 24 T.C. 117">24 T.C. 117; and F. A. Gillespie Trust, 21 T.C. 739">21 T.C. 739. Decision will be entered for the respondent. Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended.↩2. Section 6214(b)↩ authorizes the Tax Court to consider any facts with relation to taxes of other years which might be necessary to correctly determine the amount of the deficiency in the year before it, "but in so doing shall have no jurisdiction to determine whether or not the tax for any other year has been overpaid or underpaid."	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625311/	NEWARK MILK AND CREAM COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Newark Milk & Cream Co. v. CommissionerDocket No. 22350.United States Board of Tax Appeals23 B.T.A. 14; 1931 BTA LEXIS 1942; May 1, 1931, Promulgated 1931 BTA LEXIS 1942">1942 Chas. D. Hamel, Esq., and Lee I. Park, Esq., for the petitioner. Maxwell E. McDowell, Esq., and F. B. Schlosser, Esq., for the respondent. SMITH 23 B.T.A. 14">14 OPINION. SMITH: This proceeding is for the redetermination of a deficiency of $17,893.89 in the petitioner's income and profits taxes for the calendar year 1921. The petitioner alleges that the Commissioner: * * * has erroneously failed and refused to allow as a deduction from gross income * * * ordinary and necessary expenses of the business in respect of payment of forty five thousand dollars for legal services and expenses, which payment was made * * * in accordance with the provisions of a certain contract between the petitioner and the heirs of William H. Bennett. All other issues raised by the pleadings were abandoned at the hearing. The facts upon which this proceeding is based are set forth in ; affd., , 23 B.T.A. 14">15 and are incorporated herein by reference. In that appeal, involving the taxable years 1922 and 1923, we held that the amounts paid by the petitioner upon its guaranty to the Bennett1931 BTA LEXIS 1942">1943 estate were not deductible from gross income as ordinary and necessary expenses. The payment here in controversy was made pursuant to the following provision of the agreement, whereby the dispute among the stockholders was settled and one group of stockholders acquired control of the petitioner corporation: 1. The party of the first part [petitioner] agrees with the party of the third part to pay unto William Harris, Esquire, counsel of the parties of the third part, [Bennett heirs] the sum of Forty-five Thousand ($45,000.00) Dollars, said sum to be in full payment of his fees as counsel of the parties of the third part in the litigation [instituted by Bennett heirs] above referred to, and to also cover all disbursements made or incurred for expenses of every kind whatsoever in connection with said litigation, said sum to be paid coincidentally with the date of the execution of this agreement. The petitioner argues that this payment is deductible as an ordinary and necessary business expense under the rule of . In that case the Supreme Court held that fees paid to an attorney for defending an action brought1931 BTA LEXIS 1942">*1944 by a former partner for an accounting of the partnership business were expenses directly connected with the taxpayer's business and deductible. Whereas, here the payment was made as part of the settlement just as the guaranty payments in controversy in the prior appeal, and, like those payments, was a consideration for the transfer of the stock held by the Bennett estate. In disposing of this taxpayer's contentions regarding the guaranty payments, we said: The distinction is clear between cases where amounts are paid out as a result of litigation or as a means of settling a dispute arising from ordinary business transactions and cases such as the instant one where the payments were made in order to gain control of a business. For the reasons set forth in our earlier decision, which has been affirmed by the Circuit Court of Appeals for the Second Circuit, we are of the opinion that the respondent properly disallowed the claimed deduction. Judgment will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625312/	Maurice A. Mittelman and Carmyle Mittelman, Petitioners, v. Commissioner of Internal Revenue, RespondentMittelman v. CommissionerDocket No. 6647United States Tax Court7 T.C. 1162; 1946 U.S. Tax Ct. LEXIS 33; November 15, 1946, Promulgated 1946 U.S. Tax Ct. LEXIS 33">33 Decision will be entered under Rule 50. 1. Petitioner, in 1940, agreed to exchange his stock in M corporation, and a cash payment in an amount to be determined by accountants according to an agreed formula, for all the capital stock of two wholly owned subsidiary corporations of M. The accountants determined the amount of the cash payment required to be $ 18,399.71, and petitioner paid that amount and transferred his stock, which had cost him $ 20,000, and received the stock of the subsidiaries as agreed. He reported his gain on the transaction for taxation and computed and paid the tax on the basis of $ 38,399.71 cost. In 1941, it was discovered that the accountants had erred in computing the amount of the cash payment, which should have been only $ 9,199.86. Petitioner undertook litigation against the accountants for damages, but later in 1941 accepted $ 8,000 in compromise settlement thereof. The accountants were reimbursed for this amount by the M corporation. Held, petitioner is taxable in 1941 on account of the receipt of the $ 8,000 payment in that year to the extent that he benefited tax-wise in 1940 from the erroneous use in that year of the higher basis.2. 1946 U.S. Tax Ct. LEXIS 33">34 In January 1941 petitioner purchased the assets of the two corporations whose stock he had acquired in 1940 and the price he paid was computed on the basis of an inventory value of $ 73,433.70, this being the invoice price less discount. The amount of his taxable gain upon the subsequent liquidation of the corporations was controlled by the value thus used. He computed his profit on the sale of the merchandise during the remainder of 1941 on the basis of a $ 76,915.54 cost of the merchandise, which was the gross inventory price to the corporation without deduction of discounts, on the theory that the corporations had already reported the discounts for taxation, while they held the merchandise in the previous year. Held, petitioner's basis for the inventory was its cost to him, which was $ 73,433.70.3. A corporation sold at retail nationally advertised brands of shoes, under exclusive but oral and indeterminate franchises, in space leased from a well known department store, in whose name all advertising and billing and all public contacts and services were carried on. Held, corporation had no good will susceptible of valuation on liquidation.4. Held, petitioner entitled, 1946 U.S. Tax Ct. LEXIS 33">35 under the evidence, to a deduction of $ 2,100 for traveling expenses paid in 1941 in connection with his business. Sidney N. Weitz, Esq., for the petitioners.L. R. Bloomenthal, Esq., for the respondent. Kern, Judge. KERN 7 T.C. 1162">1162 The Commissioner determined a deficiency in petitioners' income tax for the calendar year 1941 in the amount of $ 21,049.59. Of the five issues originally presented, respondent has conceded error with 7 T.C. 1162">1163 respect to one. The four issues remaining relate to the respondent's action in including in the taxable income of petitioners the sum of $ 7,185.35 received by petitioners in connection with the settlement of a suit for damages; in increasing petitioners' reported gain on liquidation of a corporation by the amount of $ 18,965.13 representing good will of the corporation; in disallowing certain claimed business expenses; and in including in petitioners' taxable income an additional item of income in the amount of $ 3,481.84 resulting from an alleged overstatement of inventory acquired from two solely owned corporations.FINDINGS OF FACT.The facts have been stipulated in part, and such facts are found to be as stipulated.Petitioners1946 U.S. Tax Ct. LEXIS 33">36 are husband and wife, residing in Cleveland, Ohio. They filed their joint income tax return with the collector of internal revenue at Cleveland. For the sake of convenience, petitioner Maurice A. Mittelman will be identified herein as the petitioner.Issue No. 1. -- Petitioner and Adolph M. Goetz owned all the capital stock of a Michigan corporation originally known as I. Miller Salon, Inc., but the name of which was subsequently changed, first to Goetz, Mittelman, Inc., and later to A. M. Goetz, Inc. The corporation was engaged in the business of selling shoes at retail, and operated a store for this purpose in Detroit, Michigan. On January 31, 1940, and for several years prior thereto, the Michigan corporation also owned, among its assets, all the issued and outstanding shares of a New York corporation called I. Miller Stores, Inc., which operated a retail shoe store in Buffalo, New York, and all the issued and outstanding shares of a Delaware corporation, known as Goetz & Mittelman, Inc., which engaged in the sale of footwear at retail in Cleveland, Ohio.Pursuant to stipulation of the parties, we incorporate herein by reference our findings of fact in the case of .1946 U.S. Tax Ct. LEXIS 33">37 On January 13, 1940, petitioner entered into an agreement with Adolph M. Goetz which provided, among other things, that the Michigan corporation would transfer to petitioner all the outstanding stock of the New York and Delaware corporations owned by that corporation, in consideration of petitioner's transfer to the Michigan corporation of all petitioner's shares in that corporation and the payment by petitioner of a sum of money to be determined in accordance with a formula set out therein. The authority to determine the sum to be paid by petitioner was delegated to S. D. Leidesdorf & Co., certified public accountants in New York. S. D. Leidesdorf & Co. determined the amount to be so paid by Mittelman to be $ 18,399.71, which Mittelman 7 T.C. 1162">1164 paid and the transaction involving the separation of the business interests of Mittelman and Goetz, for which purpose the contract was entered into, was consummated on January 31, 1940, when the exchange of stock and payment of the money occurred.Petitioner, in his income tax return for the year 1940, reported for taxation his gain from the disposition, as above described, of his stock in the Michigan corporation, using as his basis for1946 U.S. Tax Ct. LEXIS 33">38 the computation thereof the original cost to him of the Michigan stock, which was $ 20,580.40, plus $ 18,399.71, paid by him in cash, a total of $ 38,980.11. Petitioner's income tax for the year 1940, as disclosed by that return was in the amount of $ 5,928.76, and was paid by him in the year 1941.In March of 1941 it was discovered that petitioner should have been required to pay to the Michigan corporation only $ 9,199.86, or one-half of the amount which he had been required to pay. He made a demand upon S. D. Leidesdorf & Co. for the return to him of the overpayment. He caused a petition to be prepared by counsel for the purpose of instituting litigation, which was done on June 21, 1941. In this petition he demanded damages in the sum of $ 9,199.85, with interest thereon from April 1, 1940. A settlement was reached as of August 18, 1941, by payment of $ 8,000 to petitioner by S. D. Leidesdorf & Co., out of which petitioner paid legal fees and expenses amounting to $ 814.65. S. D. Leidesdorf & Co. was reimbursed directly or indirectly, for the payment so made by it by A. M. Goetz or the Michigan corporation. Petitioner accepted the $ 8,000 in full settlement of his claim 1946 U.S. Tax Ct. LEXIS 33">39 against S. D. Leidesdorf & Co., and executed releases to S. D. Leidesdorf & Co. and to Adolph M. Goetz, individually, and the Michigan corporation.Issue No. 2. -- As the result of the transaction hereinbefore described, petitioner, in January 1940, acquired ownership of all the capital stock of the New York corporation, I. Miller Stores, Inc., and the Delaware corporation, Goetz & Mittelman, Inc., the name of which was changed to M. A. Mittelman, Inc. Each of these corporations was engaged in the business of selling ladies' shoes at retail, the former in Buffalo, New York, and the latter in Cleveland, Ohio.In January of 1941 petitioner entered into a contract with each corporation for the purchase of its assets as of January 31, 1941, at an amount equivalent to their book values as of that date. The purchase price was to be paid by the assumption by petitioner of the corporation debts and the execution by petitioner of notes payable to each corporation in a total amount equal to the excess of the sale price over the debts of the corporation thus assumed. These notes were later distributed by the corporations to petitioner as dividends and liquidating dividends. Included 1946 U.S. Tax Ct. LEXIS 33">40 in the assets of the corporations thus acquired by petitioner was the merchandise owned 7 T.C. 1162">1165 by each. The merchandise was recorded on the books of each corporation on a gross basis against which there was a reserve for discounts. This reserve was treated on the books of each corporation for accounting purposes as deferred income, but, for tax purposes, the corporations treated the discounts as income, since they were on an accrual basis.In determining the book value of and consequent price at which the business and assets of each corporation were transferred to petitioner, there was included a figure for inventory which was computed on a discounted inventory basis, and the total of these figures in the sum of $ 73,433.70 was the figure employed by petitioner in computing and reporting for taxation his capital gain incident to the liquidation of the corporations immediately after the transfers in 1941.In computing for 1941 the net profit from the business formerly carried on by the two corporations and operated by him individually in 1941, petitioner included in the total of "merchandise bought for sale" the amount of $ 76,915.54, which was the gross basis of such inventory1946 U.S. Tax Ct. LEXIS 33">41 in the hands of the corporations, i. e., the cost without deduction of discount.Issue No. 3. -- The Delaware corporation, M. A. Mittelman, Inc., was, prior to its dissolution by petitioner in 1941, engaged in the operation of the shoe department in the department store owned and conducted by the Lindner Co. in the city of Cleveland. In his 1941 tax return petitioner reported a gain from the liquidation of M. A. Mittelman, Inc., of $ 4,246.99. Respondent has increased this gain by the amount of $ 18,965.13 determined to represent the "going concern value of the business" of that corporation.M. A. Mittelman, Inc., had a lease with the Lindner Co. which provided, among other things, for the use by the Mittelman corporation of the specified space in the department store, where a full line of new and salable stock of merchandise should be kept for sale during the business hours of the store, and in accordance with all the rules of the store; that if the store should be moved to another location, the shoe department would also move to the new location; that the lessor should supply to the lessee twine and wrapping paper, heat, light, local telephone service, janitor, elevator, 1946 U.S. Tax Ct. LEXIS 33">42 and delivery service, charge account service to the lessor's charge customers only, pay roll and window trimming service, and sales books and sales checks. The lessee agreed to employ the help necessary to conduct its business, and to purchase its supplies, equipment and merchandise, to expend each year for advertising an amount equal to 4 per cent of the aggregate net sales for the preceding year, which advertising was to be done under the general direction and in the name of the Lindner Co., in publications approved by it, the copy to be approved by the Lindner Co. The lessee 7 T.C. 1162">1166 agreed to sell all its goods in the name of the Lindner Co. and to stamp the name of the Lindner Co. upon the lining of all except nationally advertised brands of shoes such as I. Miller shoes.The lease described above, and the later extension thereof, were assigned by M. A. Mittelman, Inc., with the consent of the Lindner Co., to M. A. Mittelman individually, who has continued to operate the business.All sales made in the shoe department in the Lindner Co. were made in the name of that company, and the name M. A. Mittelman was never used in the public operation or advertising of the business. 1946 U.S. Tax Ct. LEXIS 33">43 Petitioner has had continuous business relationships with I. Miller & Sons Co., a manufacturer of women's shoes, since 1917, and has been selling I. Miller shoes in Cleveland since 1924, and since 1936 in the Lindner Co. store. They are excellent and expensive shoes, and the Lindner Co. is one of the best stores in Cleveland.Petitioner, or the corporation before its dissolution, has had the exclusive right to sell I. Miller shoes in Cleveland from 1922 through the tax year. This right was granted to petitioner by oral license and was terminable at will. In 1936 the I. Miller Corporation agreed with the Lindner Co. in writing that, if petitioner and the Lindner Co. terminated their agreement before the expiration of its five-year term, I. Miller Corporation would continue to sell its shoes in the Lindner Co. during the balance of the term. This agreement was extended in 1941 for another five years, and a similar agreement was in effect for the same extended term with the Carlisle Shoe Co., from which Mittelman also had held exclusive sales rights for the Cleveland territory. These latter rights were also created orally, were for an indeterminate period and were cancellable at1946 U.S. Tax Ct. LEXIS 33">44 will.Issue No. 4. -- In his income tax return for 1941, petitioner claimed deductions for business expenses in the sum of $ 5,131.31, representing travel expenses incurred in carrying on the business of the stores in Cleveland, Rochester, and Buffalo. The respondent allowed a deduction on that account of $ 1,218.23, and disallowed the balance.Petitioner, in 1941, made twenty-two trips to Rochester and Buffalo from Cleveland, and ten trips to New York on behalf of all the stores. He paid all his actual transportation costs, hotel bills, meals, taxicab fares, and costs of entertainment of the persons with whom he had business contacts and dealings, as well as telephone and telegraph expenses.While on these trips he spent a total amount of $ 3,960. No itemized record was kept of these expenditures. The amount of expenditures made by petitioner in payment of ordinary and necessary business expenses incident to these trips during the taxable year was $ 2,100.7 T.C. 1162">1167 OPINION.Issue No. 1. -- The first of the four issues presented here for our decision is whether there was error in the respondent's determination that petitioner realized taxable income when he received1946 U.S. Tax Ct. LEXIS 33">45 in 1941 the net amount of $ 7,185.35 in settlement of a cause of action arising out of the error of a firm of accountants which resulted in petitioner's having paid in 1940 an excessive price for stock of a certain corporation which, in the same year, was exchanged by him for certain other stock. This exchange was a taxable transaction. Petitioner's basis for computing his taxable gain on the 1940 transaction included the excessive payment, and his tax, so paid, was less in amount than it would have been had the accounting error, and the payment pursuant thereto, not been made.Petitioner argues simply that the amount of $ 7,185.35 received by him in 1941 was a return to him of a portion of his capital, and can not therefore be taxed as income.It is the respondent's position that, petitioner having received a tax benefit in 1940 from the use of the higher cost basis as the result of a mistake, his recovery, in 1941 upon the rectification of the error, of a part of that expenditure which was so used to reduce his 1940 taxes is taxable as income, under the tax benefit theory.The fact that the basic character of the item in question is capital in nature does not preclude the application1946 U.S. Tax Ct. LEXIS 33">46 of the tax benefit theory. See ; ; .We are of the opinion that, under the facts before us, the petitioner is properly taxable on the net amount of his recovery to the extent that he received a tax benefit in 1940 by reason of the payment thereof. The extent of this benefit and the consequent extent to which the amount of his recovery is includible in petitioner's taxable income for 1941 may be determined under Rule 50.We are not persuaded to a different conclusion because the recovery came, nominally, at least, from the accountants who made the error, in view of the evidence which indicates the accountants served mainly as conduit for the return of the money from the payee to petitioner. See ; ; affd., .Regardless of the fact that petitioner chose to institute action1946 U.S. Tax Ct. LEXIS 33">47 formally against the accountants instead of the corporation to which the amounts in question had been mistakenly paid, and the fact that the releases given recite the receipt of the money paid to petitioner in settlement of his claims to have been received (except for the nominal amount of $ 1) from the accountants, we can not close our eyes to the 7 T.C. 1162">1168 realities of the situation. The amounts mistakenly paid by petitioner in 1940 were to the Michigan corporation, or, beneficially, to Goetz; those payments resulted in increasing his cost basis of the Michigan corporation stock transferred by him in a taxable exchange in that year; this increased cost basis was used by him in computing his gain on this exchange and the gain thus computed was included in his income reported for taxation in 1940; his taxes for that year were thereby reduced from the amount which they would have been had a correct basis for the Michigan corporation stock been used; the real reason for the payments made to petitioner in 1941, regardless of the legal causes of action pleaded by him in the suit against the accountants, was to rectify, to the extent of these payments, the mistake of 1940, and the greater1946 U.S. Tax Ct. LEXIS 33">48 part, at least, of these payments came to petitioner indirectly from the corporation to which the excessive payment had been made by mistake in 1940.Respondent also makes a contention upon this issue which he summarizes on brief as follows:This was an amount received in settlement of litigation and it is impossible to determine from the evidence whether any portion of such payment is properly allocable to capital recovery; as an alternative, the respondent contends that the pleadings on which the litigation was founded set forth claims for the recovery of lost profits rather than for recoupment of capital.This contention, as well as the contention of petitioner that the recovery in question was simply the recovery of damages based on a claim of misfeasance against the accountants and should be treated as such, with no regard to the taxable transactions of 1940, are equally specious in that they both exaggerate the importance of the formal pleadings and releases in the suit against the accountants, and minimize the realities of the transactions of which this suit was but a part.Issue No. 2. -- In January 1941 petitioner purchased the assets of two solely owned corporations1946 U.S. Tax Ct. LEXIS 33">49 at a price equivalent to the book value of their assets at the time of purchase. The payment of this price was by the assumption of the corporation's debts and the execution of notes to the corporations in the amount of the excess of the book value of their assets over these debts. In 1941 the corporations were liquidated and petitioner reported as taxable gain the difference between his cost basis of the stock owned by him and the face amount of his notes distributed to him by the corporations as liquidating dividends. In computing the book value of the assets of the corporations, and, consequently, the amount of the notes, the inventory of merchandise of the corporations was treated as having a book value of $ 73,433.70, which was their invoice price less discount. This discount was carried on the books of the corporations in a so-called "Reserve" account. As merchandise was sold by the corporations, the discount in the 7 T.C. 1162">1169 reserve account was charged out to profit and loss; in effect, deferring the income from discounts until the merchandise was sold. For income tax purposes, however, the corporations, being on an accrual basis, reported the discounts taken during 1946 U.S. Tax Ct. LEXIS 33">50 the entire year for taxation, whether the merchandise was sold or not in that year. The figure at which the inventories were carried on the corporate books, invoice price less discount, was, as of the time of the liquidation, $ 73,433.70 instead of $ 76,915.54, which was the gross invoice price of the inventories. Petitioner reported as his gain on the liquidation the difference between his cost of the stock turned in and the amount of the notes distributed to him on liquidation of the corporations. The amount of these notes, and, consequently, the amount of petitioner's taxable gain, would have been greater in the amount of $ 3,481.84 had the gross invoice figure for inventory been used. Petitioner took the inventories up on his individual balance sheet as of February 1, 1941, at the net cost at which they had been carried on the corporate books, or $ 73,433.70. But, in reporting his profit on the sale of the merchandise during 1941 for taxation, he computed his profit by the use of the gross inventory cost figure, which was $ 76,915.54, resulting in a smaller taxable profit.Petitioner is attempting to adopt, it seems to us, inconsistent positions with respect to this item of1946 U.S. Tax Ct. LEXIS 33">51 inventory. He purchased the assets of his solely owned corporations in January 1941 at a price which was computed by ascribing a value of $ 73,433.70 to the inventory in question. Therefore, this was petitioner's basis for the inventories thus acquired by him. As we have pointed out it was also the figure adopted by him for the purpose of determining the amount of the purchase money notes given by him to his corporations, and later distributed to him upon their liquidation; and his capital gain upon such liquidation was less by $ 3,481.84 than it would have been had the gross inventory figures been used. For the petitioner to be permitted to then use the gross inventory figures to calculate his profit from the sale of merchandise would result in an inconsistency not warranted by the statute. The bookkeeping methods or tax accounting practices of the corporations are extraneous to the issue. We are of the opinion that there was no error in respondent's determination on this point.Issue No. 3. -- The next issue relates to the determination by the respondent that petitioner's taxable income for 1941 arising from the liquidation by petitioner in that year of M. A. Mittelman, 1946 U.S. Tax Ct. LEXIS 33">52 Inc., should be increased by the amount of $ 18,965.13 representing good will or going value of that corporation.It is petitioner's contention that M. A. Mittelman, Inc., had no good will, since the business conducted by it in Cleveland, Ohio, was conducted in the name of the Lindner Co., the department store in which the shop was located under a lease. All the advertising was carried on 7 T.C. 1162">1170 in the name of the Lindner Co.; the charge sales were made only to Lindner Co. charge customers, who were billed by the Lindner Co. therefor; the shoes so sold, except for specified brands, were stamped with the name of the Lindner Co. The name of M. A. Mittelman, Inc., never appeared to the public in connection with advertising, sales, or operation of the business.The corporation had exclusive franchises for the sale of I. Miller and Carlisle shoes in the Cleveland area, but the agreements under which these franchises arose were oral and for an indeterminate period, cancellable at the will of the manufacturers. In spite of their disabilities, these franchises were without doubt valuable assets of the corporation. But they were assets, within themselves, separable and distinguishable1946 U.S. Tax Ct. LEXIS 33">53 from all other assets, including good will, and susceptible to separate valuation. Similarly, the lease under which M. A. Mittelman, Inc., occupied the space in the Lindner Co.'s department store was doubtless a valuable asset of the corporation. It was not, however, good will, but a separate asset susceptible of valuation as such.These are the factors which, respondent argues, go to make up the item of good will which he valued at $ 18,965.13. He admits that the chief elements of good will are continuity of place (which the Mittelman Co. had only by virtue of a nonassignable lease) and continuity of name (and the Mittelman corporation's name had never appeared before the public in connection with the operation of its business). As we have seen, whatever value existed in the location is attributable to the lease, and no value can be attributed to the corporate name itself. It seems to us that whatever intangible value attached to petitioner's business sprang from the sale of well known and respected brands of shoes, and from the sale of those shoes in a location known to the public as a part of the Lindner Co.'s store. We can find no basis, in these peculiar circumstances, 1946 U.S. Tax Ct. LEXIS 33">54 for the allocation of any value for good will of M. A. Mittelman, Inc. We conclude, therefore, that the respondent erred in this particular.Issue No. 4. -- Petitioner claimed a deduction in his 1941 return in the amount of $ 5,131.31 for traveling expenses paid in 1941 in connection with twenty-two trips to Rochester and Buffalo in New York and ten trips to New York City on business. Respondent allowed $ 1,218.23. At the hearing, petitioner testified that he had spent $ 3,960 on these trips, and had been reimbursed by his office for $ 3,900. He testified generally that the money was spent for railroad fare, hotel, meals, taxicabs, tips, and business entertainment. He did not offer any memoranda or documentary evidence to support his estimate. He spoke of the existence of memoranda of his expenses which he had made at or about the time of each trip, but he did not offer them in evidence, nor were any bookkeeping or other office or personal 7 T.C. 1162">1171 records of any kind offered, although it seems most probable that such evidence was peculiarly available to the petitioner.In our efforts to arrive at a reasonable allowance, we are especially handicapped by the complete lack1946 U.S. Tax Ct. LEXIS 33">*55 of any evidence of any kind from which we could determine the usual or average duration of petitioner's stays in New York, Buffalo, and Rochester, and by the generality of the evidence with regard to items of expenditure.Under the rule of , and upon all the evidence in the record, we have determined that petitioner's ordinary and necessary business expenses incident to these trips amounted to $ 2,100.The fifth issue which was originally involved herein has been resolved by the concession of respondent that a gain of $ 1,693.87 from the disposition of certain assets reported by petitioner is taxable only to the extent of 50 per cent as a long term capital gain. Effect will be given to this concession under Rule 50.Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625313/	Lillian R. Chertoff, Petitioner, v. Commissioner of Internal Revenue, Respondent. George J. Chertoff, Petitioner, v. Commissioner of Internal Revenue, RespondentChertoff v. CommissionerDocket Nos. 4382, 4383United States Tax Court6 T.C. 266; 1946 U.S. Tax Ct. LEXIS 286; February 27, 1946, Promulgated 1946 U.S. Tax Ct. LEXIS 286">286 Decisions will be entered under Rule 50. Petitioners, husband and wife, each created a trust for the benefit of each of their three children, naming themselves as trustees. The assets of the trusts consisted of interests in a business operated by the husband. The powers and discretion conferred upon the trustees in respect of the trusts, their investments, administration, and termination were comprehensive and absolute. Held, the income of the trusts is taxable to the respective grantors under the principle announced in Helvering v. Clifford, 309 U.S. 331">309 U.S. 331. Lawrence M. Rich, Esq., for the petitioners.Thomas F. Callahan, Esq., for the respondent. Hill, Judge. Murdock and Leech, JJ., concur in the result. Arundell, Van Fossan, Black, Tyson, and Disney, JJ., dissent. HILL 6 T.C. 266">267 The respondent determined deficiencies in income tax against George J. Chertoff for the years 1937, 1940, and 1941 and against Lillian R. Chertoff for the years 1940 and 1941 in the aggregate amounts of $ 22,951.86 and $ 9,071.55, respectively. The deficiencies indicated resulted from including in the taxable income of each petitioner the income of certain trusts created by them.The issues are: (1) whether the income of certain trusts created by the petitioners is taxable to them under the provisions of section 22 (a), 166, or 167 of the Internal Revenue Code; and (2) whether the income of a partnership created in December 1940 is properly taxable one-half to each petitioner, as held by the respondent.FINDINGS OF FACT.The facts are all contained in a stipulation, 1946 U.S. Tax Ct. LEXIS 286">288 together with the exhibits attached thereto. They may fairly be summarized as follows:The petitioners, George J. Chertoff and Lillian R. Chertoff, are husband and wife and live at Shaker Heights, Ohio. Returns for the years in controversy were filed with the collector of internal revenue for the eighteenth district of Ohio. For convenience, the petitioners will hereafter individually be referred to as Chertoff and Mrs. Chertoff, respectively.Chertoff is a chemist. In 1917 he caused the formation and incorporation of the Synthetic Products Co., hereinafter called the company, to engage in the business of producing water-repellent powder necessary in the manufacture of rubber paint. The powder is made by a formula which was owned by Chertoff and which he transferred to the company in exchange for 450 shares of its capital stock. Since about 1924 the company has been a manufacturer of chemicals.On September 15, 1937, the company had 900 shares of stock outstanding, of which Chertoff owned 451 shares and Mrs. Chertoff 449 shares.The petitioners have three children: Garry, born in 1922; Arlyne, born in 1923; and Gertrude, born in 1925. On September 15, 1937, Chertoff executed1946 U.S. Tax Ct. LEXIS 286">289 three indentures of trust, one of which was for the benefit of his son, Garry, who was then 15 years old, and the other two for the benefit of each of his daughters, Arlyne and Gertrude, who were 6 T.C. 266">268 14 and 12, respectively. In all material respects the trust indentures are identical. George J. Chertoff and Lillian R. Chertoff are named therein as trustees. In each case Chertoff, as settlor, "unconditionally and irrevocably" transferred to the trust 150 shares of common stock of the company. The provisions of the instrument, as typified by those of the Garry Chertoff trust, are as follows:This Indenture Made at Cleveland Heights, Ohio, this 15th day of September, 1937, by George J. Chertoff, hereinafter known as the "Settlor" and George J. Chertoff and Lillian R. Chertoff, hereinafter known as the "Trustees,"Witnesseth:Whereas, The Settlor in consideration of the premises simultaneous herewith unconditionally and irrevocably has given, assigned and transferred to the Trustees and their successors all of his right, title and interest in and to 150 shares of the common stock of The Synthetic Products Co., an Ohio Corporation, in Trust, Nevertheless, for the benefit of Garry1946 U.S. Tax Ct. LEXIS 286">290 B. Chertoff, which said shares are now evidenced by stock certificate No. 20 of said company, such certificate, however, being made to George J. Chertoff and Lillian R. Chertoff, Trustees.Now, Therefore, in order to more particularly set forth the benefits to be derived by said Garry B. Chertoff under and by virtue of said gift and this trust, the Trustees, do hereby declare and acknowledge that they hold such stock for the sole and exclusive use and benefit of said Garry B. Chertoff as hereinafter set forth.The Trustees shall have and hold the corpus and invest the same, receive the income, rents, issues and profits arising therefrom and pay said income over to said Garry B. Chertoff or his legal guardian without restrictions as to use or purpose, and upon his death to pay over the principal and any accumulation of income to such person or persons and in such shares and lawful estates as the said Garry B. Chertoff may nominate and appoint by his Last Will and Testament, or other valid written instrument, and in default of the same to pay and transfer the same in equal shares to George J. Chertoff and Lillian R. Chertoff or the survivor of them.It Is Further Expressly Covenanted1946 U.S. Tax Ct. LEXIS 286">291 that the Trustees shall have authority, without order of Court, to invest and re-invest all sums of money coming into their possession, according to their absolute discretion in such ventures, loans, stocks, securities and real estate as they shall deem for the best interests of the beneficiary hereunder, irrespective of any statutes, rules or practices of Chancery Courts now or hereafter in force, limiting the class of investments of trustees generally, giving to the Trustees absolute discretion as to the terms, conditions and rate of interest in respect to such investment, and with the right to transpose the stock above described and any other investments into others of like or similar nature, as they may deem for the best interests of the beneficiary.The Trustees Are Hereby granted the power and authority in their sole discretion to pay to the beneficiary hereunder or his legal guardian from the principal from time to time such sum or sums as said Trustees may deem advisable without restrictions as to use or purpose. The receipts of the beneficiary, when of age, shall be sufficient discharge to the Trustees for payments made.This Trust Shall terminate:(a) As Garry B. Chertoff1946 U.S. Tax Ct. LEXIS 286">292 becomes 30 years of age and the Trustees hereby covenant that they will, as or at any time after said Garry B. Chertoff becomes 30 years of age, at the latter's request, assign, transfer and convey all of the right held by the Trustees hereunder to him.6 T.C. 266">269 (b) Upon the decease of Garry B. Chertoff prior to his becoming 30 years of age in which event they will assign, transfer and convey to the persons entitled thereto, all of the rights held by the Trustees hereunder.In the event of either of the Trustees dying, resigning the aforesaid trust or becoming incapable of acting in the same, the survivor or remaining Trustee shall continue and act in the place and stead of the two Trustees herein appointed with the same power and authority as is herein granted to the two of them.In the event of the death of the surviving Trustee, the executor or executors named in the Will of George J. Chertoff shall act as trustee or trustees under the same terms and conditions as is herein provided for the original trustees.The trustees hereby accept this trust and covenant that they will execute the same with due fidelity, it being understood, however, that they or either of them, or their 1946 U.S. Tax Ct. LEXIS 286">293 successors, shall not be held liable or accountable for any mere error of judgment in the execution of said trust and that they or either of them may at any time resign from said trust; that by joining in the execution hereof, they hereby acknowledge the receipt of said certificate of stock and signify their acceptance of the trust thereby created.In the event that any person in whose favor any trust of income or principal as hereinbefore declared shall, at any time or times, while so in the possession and control of the trustees, alienate, charge or dispose of the income or principal sum or part thereof to which he shall be, or but for this proviso, would be entitled, or if, by reason of his bankruptcy, or any other event happening, such income shall, or, but for this proviso, would, wholly or in part, fail or cease to be enjoyed by such person as aforesaid, then such income shall immediately thereupon cease and determine, and the devise to such person of a principal sum shall be deemed revoked and thereafter my Trustees shall pay or apply the principal and/or income, the trust whereof shall have so failed or determined, to and for the benefit of the person or persons who would be1946 U.S. Tax Ct. LEXIS 286">294 entitled thereto under this trust, if such person aforesaid were dead.Execution and delivery of the three trusts are admitted.The stock books of the company as of September 15, 1937, show the transfer of 450 shares into the names of George J. Chertoff and Lillian R. Chertoff as trustees for the respective trusts.In 1938 Chertoff filed a gift tax return showing the 450 shares of stock so transferred to the trustees. Each share was valued at $ 22, or $ 9,900 for the 450 shares. The gifts were within the exemption provisions of the gift tax law at that time in force and no gift tax was due or paid.On December 13, 1937, Chertoff, doing business as Synthetic Products Sales Co., entered into a contract with the company to act as the sole and exclusive sales agent and distributor of the products of the company for a period of ten years, beginning January 1, 1938.The sales of the company prior to January 1, 1938, were made entirely by and in behalf of that corporation and all profits accruing therefrom were reported in its income tax returns. During the years 1938, 1939, and 1940 sales of the company's products were made at a price slightly in advance of their cost to Chertoff. The1946 U.S. Tax Ct. LEXIS 286">295 sales reported 6 T.C. 266">270 in his individual income tax returns for the years 1938 to 1940, inclusive, were as follows:1938$ 86,692.791939125,508.801940170,978.25The net profits reported by him from these sales were as follows:1938$ 8,985.70193913,810.94194023,484.44The salaries paid to Chertoff by the company during the years 1935 to 1940, inclusive, were as follows:1935$ 8,500193618,000193718,0001938$ 3,60019395,20019407,500On December 11, 1940, the net assets of the company were sold to Chertoff and the company was liquidated. The certificate of dissolution is dated December 11, 1940, and it was filed with the State of Ohio on December 17, 1940.On December 12, 1940, Mrs. Chertoff executed three indentures of trust for the benefit of her minor children, naming herself and Chertoff as trustees. She transferred 75 shares of stock of the company to the trustees under each trust. The trust indentures are identical to those executed by Chertoff on September 15, 1937, except for the settlor. Execution and delivery of the three trusts are admitted.On December 12, 1940, the petitioners, as individuals and as trustees, entered1946 U.S. Tax Ct. LEXIS 286">296 into a partnership agreement, the material portions of which are as follows:Article 1. That the parties hereto have agreed to and do by these presents agree as of January 1st, 1941, to become partners under the firm name and style of The Synthetic Products Co. with the principal office and place of business in the City of Cleveland, Ohio.Article 2. The purpose and business of said partnership is the purchase, manufacturing and sale of chemicals and synthetic products and the doing of all things necessary and incident thereto.Article 3. The said George J. Chertoff shall contribute to the capital of said partnership his skill, knowledge and experience in the business to be conducted by the partnership and his entire time, attention and $ 10,000.00, together with the right to the use of the name The Synthetic Products Co., which right he now has.The said Lillian R. Chertoff, George J. Chertoff and Lillian R. Chertoff as Trustees for Garry B. Chertoff, George J. Chertoff and Lillian R. Chertoff as Trustees for Arlyne E. Chertoff, and George J. Chertoff and Lillian R. Chertoff as Trustees for Gertrude H. Chertoff, shall each contribute to the capital of said partnership the sum of 1946 U.S. Tax Ct. LEXIS 286">297 $ 10,000.00 in cash.6 T.C. 266">271 It is understood and agreed that George J. Chertoff and Lillian R. Chertoff are trustees under two separate trusts for each of the above named children, Garry B. Chertoff, Arlyne E. Chertoff and Gertrude H. Chertoff. That the trusts created September 15th, 1937, are each contributing $ 6666.67 and the trusts created December 11th, 1940, are each contributing $ 3333.33 to the partnership but for purposes of this agreement, the contribution from the two trusts of each child totalling $ 10,000.00 shall be deemed one share, a (one-fifth 1/5th interest) [sic] in the partnership, that is, the partnership shall recognize the two trusts of each child as one partner.Article 4. The said George J. Chertoff will devote his entire time, skill and experience to advancing and rendering profitable the interest and business of said partnership.Article 5. It shall be the further duty of George J. Chertoff, as agent of each of the other partners, to attend to and have charge of the business of the partnership including the buying, selling, manufacturing and finances of the firm. Contracts shall be made and taken only in the firm name. The appointment of George 1946 U.S. Tax Ct. LEXIS 286">298 J. Chertoff as agent of the various partners is terminable at the will of any partner. For the services of George J. Chertoff under this contract, he shall receive a compensation exclusive of his share of profits equal to 2% of the annual sales of the firm. Notwithstanding the duties of George J. Chertoff as in this contract defined, the management of the partnership shall at all times be in the partners.Article 6. Each partner agrees that all gains, profits and advances, which shall arise by reason of the copartnership, shall be, from time to time during the existence of the copartnership, equally divided between them, share and share alike, and all losses and expenses as shall happen or be incurred in said business without fraud, shall be paid and borne equally between them.Article 7. Each partner shall promptly pay his individual debts and liabilities and shall at all times indemnify and save harmless the partnership property therefrom.Article 8. There shall be kept at the principal office and place of business of said firm at all times during the continuance of said partnership true, accurate, full and complete books of account in which shall be entered all transactions of1946 U.S. Tax Ct. LEXIS 286">299 the partnership.Article 9. All moneys received on behalf of the partnership shall be deposited in the bank of said partnership to the account and credit of the partnership and debts and obligations of said firm shall be paid by check on said bank account or accounts.Article 10. This agreement shall be binding and in force and the term of this partnership shall be for a period of ten years from the date hereof unless sooner terminated by the death of a partner hereto, or other cause.Article 11. On dissolution of said partnership, any partner may make a written offer or offers to the other partners of the sum or price in cash for which he will purchase the interest of such others in said partnership, or for which he will sell his own interest therein to such partners, and the partners receiving such offers shall, within thirty (30) days thereafter, make an election in writing whether to sell or purchase for said sum or price, and if he fails so to do within said time, the partner who has made such offer is hereby given the right and option within ten (10) days after the expiration of said time at his own election to purchase the interest of such other partner or partners or to sell1946 U.S. Tax Ct. LEXIS 286">300 his own interest to such other or others for the sum or price so offered.6 T.C. 266">272 Article 12. The death of a partner, the transfer or attempted transfer of any interest in this partnership shall operate to dissolve and terminate this partnership.As of January 1, 1941, the manufacturing and sales activities of the company were consolidated and were so conducted throughout the year 1941.The entries on the books of the Synthetic Products Co. showing liquidating assets and liabilities were as follows:DebitsCreditsGeorge J. Chertoff$ 40,049.12Loans Payable -- Products sales10,000.00Accruals Payable -- Frt. NKP Railroad482.25" " -- Steam850.00" " -- Power125.00" " -- Old Age Insurance56.15" " -- Unemployment Insurance110.78George J. Chertoff -- Personal account900.00Cash -- Central National Bank$ 13,170.07Accounts Receivable703.90Inventory -- Raw materials25,530.00Machinery & Equipment -- Net book value13,169.33Capital Stock -- outstanding9,000.00Surplus -- December 31, 194031,049.12George J. Chertoff40,049.1292,622.4292,622.42To liquidate Assets -- Liabilities1946 U.S. Tax Ct. LEXIS 286">301 -- Capital Stock and Surplus of The Synthetic Products Co., Inc., as at December 31, 1940 per agreement made at Cleveland, Ohio, December 11, 1940, between The Synthetic Products Co., Inc., and George J. Chertoff, his heirs and assigns.Distribution -- Capital Stock & Liquidating DividendsLiquidatingStockDividendsLillian R. Chertoff$ 2,250.00$ 7,750.00Garry B. Chertoff -- Trust No. 11,500.005,166.67Garry B. Chertoff -- Trust No. 2750.002,583.33Arlyne E. Chertoff -- Trust No. 11,500.005,166.67Arlyne E. Chertoff -- Trust No. 2750.002,583.33Gertrude H. Chertoff -- Trust No. 11,500.005,166.67Gertrude H. Chertoff -- Trust No. 2750.002,583.33George J. Chertoff49.129,000.0031,049.126 T.C. 266">273 The opening entries on the books of the "unincorporated company" were as follows:Opening Entries -- January 1st, 1941Synthetic Products Co. -- UnincorporatedDebitsCreditsCash -- Central National Bank$ 13,170.07Accounts Receivable703.90Inventory -- Raw materials25,530.00Machinery & Equipment13,169.33Loans Payable -- Product Sales Co$ 10,000.00Accruals Payable -- Freight482.25" " NKP Railroad0.00" " Steam850.00" " Power125.00" " Old Age Insurance56.15" " Unemployment Insurance110.78George J. Chertoff, Personal account900.00George J. Chertoff, Personal account40,049.12Investment AccountsGeorge J. Chertoff10,000.00Loans Payable -- Product Sales Co10,000.00Lillian R. Chertoff10,000.00Garry B. Chertoff -- Trust No. 16,666.67Garry B. Chertoff -- Trust No. 23,333.33Arlyne E. Chertoff -- Trust No. 16,666.67Arlyne E. Chertoff -- Trust No. 23,333.33Gertrude H. Chertoff -- Trust No. 16,666.67Gertrude H. Chertoff -- Trust No. 23,333.33George J. Chertoff -- Personal Account49.12George J. Chertoff -- Personal Account40,049.12102,622.42102,622.421946 U.S. Tax Ct. LEXIS 286">302 Income tax returns were filed for each of the trusts created by Chertoff for the years 1937, 1940, and 1941 and for each of the trusts created by Mrs. Chertoff for the years 1940 and 1941. Income shown thereon consisted of dividends from the company for 1937, liquidating dividends for 1940, and partnership profits for 1941. The tax shown due on such returns was paid by the trusts, respectively.The trusts have never been revoked and such sums as were collected were retained by the trustees in the respective trusts. The statements of account set up for each trust on the books of the partnership show withdrawals only for taxes, insurance, and bond purchases.The petitioners have treated all the trusts as valid and subsisting trusts.The partnership return of income for 1941 showed total sales in the amount of $ 307,459.72, gross income of $ 114,979.04, and total deductions 6 T.C. 266">274 (including $ 14,021.34 for commissions paid) of $ 38,268.33. Net income shown by the return was $ 76,710.71, distributable as follows:George J. Chertoff$ 15,342.15Lillian R. Chertoff15,342.14Garry Chertoff15,342.14Arlyne Chertoff15,342.14Gertrude Chertoff15,342.14Total76,710.711946 U.S. Tax Ct. LEXIS 286">303 OPINION.The first issue is whether the petitioners are taxable on the income of the trusts created by them in 1937 and 1940. If respondent is correct in his contention that the petitioners are so taxable, we need not consider whether they are likewise so taxable in 1940 and 1941 under the partnership aspects of the case. Respondent contends that the petitioners are taxable on the income of these trusts under section 22 (a), Internal Revenue Code, as construed in Helvering v. Clifford, 309 U.S. 331">309 U.S. 331, and that in any event the income is taxable to them under sections 166 and 167 of the code. Petitioners contend that they have parted with all vestige of ownership and control over the trust properties and that they have no legal power to recapture the corpus of the trusts or to use the income thereof for their own purposes. They insist that any powers given to them by the trust agreements are powers in trust and that they should not be treated as the real owners of the trust property or income, Estate of Benjamin Lowenstein, 3 T.C. 1133. They further contend that because the various trusts are separate entities the1946 U.S. Tax Ct. LEXIS 286">304 partnership formed in December 1940 is valid and entitled to recognition for Federal tax purposes.On September 15, 1937, petitioner Chertoff created a trust for each of his three children with a corpus of 150 shares of the stock of the Synthetic Products Co., a corporation. At that time the corporation had 900 shares of stock outstanding. He owned 451 shares and his wife owned 449 of such shares. Chertoff and Mrs. Chertoff were made trustees of each trust. The children were minors when the trusts were created and were also minors during the tax years here involved. Chertoff controlled the corporation in all its operations prior to the creation of the trusts and continued to exercise such control subsequent to such creation. He held in his own name only one share of the corporation's stock after creation of the trusts, but obviously his control of the corporation was not minimized or otherwise affected by his transfer in trust to himself and Mrs. Chertoff of 450 shares of his original holding of 451 shares. Chertoff and Mrs. Chertoff, as holders of stock individually and as trustees of the trusts which Chertoff created in 1937, were in complete control of the corporation, of1946 U.S. Tax Ct. LEXIS 286">305 whose 6 T.C. 266">275 stock they owned individually only 50 percent. Under such control Chertoff continued to receive large amounts as compensation for services to the corporation by virtue of agreements between him and the corporation. Chertoff's compensation for services to the corporation for 1937 and the two preceding years totaled $ 44,500. His compensation for such services for 1938, 1939, and 1940 totaled $ 62,581.08.The instrument provides for the termination of the trust upon the happening of either of the following four specified events: (1) Request of the beneficiary at or at any time after he becomes 30 years of age for the conveyance to him of the trust property; (2) alienation of the trust income or principal by the beneficiary, or the latter's bankruptcy, or any other event whereby the benefits should wholly or in part cease or fail to be enjoyed by the beneficiary; (3) the payment at any time in the sole discretion of the trustees to the beneficiary or his legal guardian of the principal of corpus of the trust; and (4) the death of the beneficiary, provided neither of the specified events (1), (2), or (3) has occurred.The trust provides that upon the death of the beneficiary1946 U.S. Tax Ct. LEXIS 286">306 the principal and any accumulation of income shall be paid to the beneficiary's appointee under his last will and testament or other valid written instrument, or, if no such appointment has been made, then to petitioners, George J. and Lillian R. Chertoff, in equal shares or to the survivor of them. This same provision as to the devolution of the trust property is made applicable by the trust instrument in the case of termination of the trust under the above specified event numbered (2).Since the beneficiary would be under legal disability to make a valid appointment by will or otherwise during his minority, it is apparent that in the event of his death during minority the trust corpus with the accumulation of any trust income would go in equal shares to Chertoff and Mrs. Chertoff or in toto to the survivor of them. In this connection attention is directed to the stipulation that all moneys which have been collected under the trust have been retained in the trust. The stipulation further shows that the income of the trust for each of the years 1937, 1940, and 1941 was reported as the income of the trust and that the tax shown to be due thereon was paid by the trust. In other1946 U.S. Tax Ct. LEXIS 286">307 words, all of the trust income has been accumulated and none has been distributed to the beneficiary. It appears, therefore, that the death of the beneficiary during his minority or in the event of his death after reaching his majority without having exercised validly his power of appointment as to the trust property, the corpus and accumulated income of the trust would devolve upon the petitioners or the survivor of them. Also, the same devolution would result in the case of the termination of the trust by virtue of the above specified event numbered (2) in the absence of a valid exercise of the power of appointment by the beneficiary.6 T.C. 266">276 The power of petitioners as trustees to terminate the trust at any time is inherent in the trust provision under which the trustees may "in their sole discretion pay to the beneficiary hereunder or his legal guardian from the principal from time to time such sum or sums as said trustee may deem advisable without restriction as to use or purpose." By the exercise of this power the trustees may entirely eliminate the beneficiary's appointee as a remainderman or may reduce as they choose the amount of trust property which shall go in remainder1946 U.S. Tax Ct. LEXIS 286">308 to such appointee. Also, by the exercise of such power the trustees may pay to themselves as guardians of the beneficiary during his minority a part or the whole of the principal of the trust (including therein the accumulated trust income) and devote such payments to any use or purpose without restriction, including the discharge of their parental obligation to support, educate, and maintain such minor, as well as the carrying on of business enterprises completely controlled and managed by petitioners to their economic benefit. In such case petitioners' powers as guardians in relation to such funds would be as broad as their powers as trustees.In view of the above enumerated provisions of the trust it appears that if the beneficiary should die before he attains the age of 21 years the corpus of the trust and the accumulated income thereon would be paid in equal shares to the petitioners or in toto to the survivor of them, since the beneficiary can not make a valid appointment during his minority. Should the beneficiary die before reaching the age of 30 years without having made a valid appointment the corpus of the trust and the accumulated income would likewise be paid to1946 U.S. Tax Ct. LEXIS 286">309 petitioners in equal shares or in toto to the survivor of them. Also, should the beneficiary die, having made a valid appointment, the appointee would receive the corpus and the accumulated income. In neither of the events enumerated will the beneficiary receive the corpus or the accumulated income of the trust, or the current income thereof, unless petitioners as trustees choose to pay it to him, notwithstanding that the trust instrument purports to confer upon him at least a life estate in the trust property.During the taxable years here involved the beneficiaries of the various trusts were minors. Under the law of Ohio a husband and wife living together are the joint natural guardians of their minor children and are equally charged with their care and welfare, as well as the care and management of their estates. 1 In addition, Ohio seems to follow the common law rule that a father has paramount right to the custody of his minor children and, further, can name a guardian for them by will. See In re Coons, 20 Or. C. D. 208; sec. 10507-13, Pages' Ohio General Code, Ann.1946 U.S. Tax Ct. LEXIS 286">310 The trust instruments provide that the petitioners, as trustees, may pay the income to the beneficiary of the trust or his legal guardian 6 T.C. 266">277 without restriction as to its use or purpose. They are further granted the power in their sole discretion to pay to the beneficiary or his legal guardian such part of the principal as they may deem advisable without restriction as to its use or purpose. Petitioners seek to make quite a point of the fact that neither of them is the "legal" guardian of their children. Inasmuch as in Ohio a natural guardian has the care and management of a child's estate and a legal guardian has the same rights and powers, we can not agree that the use of the term "legal guardian" in the trust instruments has any real significance. 2 The record does not disclose and petitioners disclaim the appointment of a legal guardian for the beneficiaries of the trusts. In such situation it appears that under Ohio statutes the petitioners are natural guardians of their minor children, with the powers of a legal guardian as to their estates. Therefore, each of the petitioners is grantor in three of the trusts, is a cotrustee in all of the trusts, and has the1946 U.S. Tax Ct. LEXIS 286">311 status of legal guardian of the estates of the beneficiaries.The three trusts which petitioner Lillian R. Chertoff created on December 12, 1940, are identical with the George Chertoff trusts in respect of their terms and provisions. Hence, a discussion of such terms and provisions as to any one of the trusts applies equally to the others. Each of these latter trusts was created with a corpus of 75 shares of stock of the Synthetic Products Co. after the resolution to dissolve the corporation was passed and only five days before the dissolution became effective. By the provisions of the trust agreements petitioners are given absolute discretion in the control and management of investments. They are not accountable as ordinary trustees would be under similar circumstances. It would be difficult to formulate or visualize broader administrative powers in respect of the trust properties and investment and reinvestment of trust funds than those invested in 1946 U.S. Tax Ct. LEXIS 286">312 the trustees herein. In so far as the powers of management of the trust estates are concerned, they are practically the same as those which an individual might exercise over his own property. These powers were availed of to serve the economic interests of Chertoff.It is stipulated that when it was determined to liquidate and dissolve the corporation in December 1940 the net assets thereof were sold to George. The sale to Chertoff was effected, as shown by entries on the books of the corporation, at the price of the net book value of the assets. The method of arriving at such net value is disclosed by a balance sheet contained in the stipulation of facts.The purported transactions covering the sale of the corporation's net assets to George Chertoff, the liquidating distribution to the stockholders, the taking over of the corporation's debts, assets, and business 6 T.C. 266">278 by the partnership, and the investment accounts in the partnership were effectuated solely by the closing book entries of the corporation and, simultaneously therewith, the opening book entries of the partnership. The result, as thus shown, was the passing of the corporation and the emergence of the partnership. 1946 U.S. Tax Ct. LEXIS 286">313 Nothing was paid and no property or cash was distributed. The assets, liabilities, and business of the corporation passed directly to the partnership. A partnership agreement was executed by petitioners individually and the six trusts through Chertoff and Mrs. Chertoff as trustees. The two trusts for each child were assigned jointly a one-fifth interest in the partnership and petitioners each had a one-fifth interest therein. The agreement provided that the partnership should continue for a period of ten years beginning January 1, 1941. Chertoff was to "contribute to the capital of said partnership his skill, knowledge and experience in the business * * and his entire time, attention and $ 10,000 together with the right to the use of the name The Synthetic Products Co., which right he now has." The agreement constituted George the agent of each of the other partners and gave him exclusive control and management of the partnership business, with a compensation, exclusive of his share of the profits, equal to two percent of the sales.It is true that the agreement provides that, "Notwithstanding the duties of George J. Chertoff as in this contract defined, the management of 1946 U.S. Tax Ct. LEXIS 286">314 the partnership shall at all times be in the partners," yet it is obvious that his powers and duties in this respect can not be curtailed without his consent, since he is a cotrustee of the trusts holding a three-fifths interest in the partnership and also a holder in his own right of a one-fifth interest therein.It is at once apparent that the continuance of Chertoff's absolute control of the business which he formerly conducted for the corporation throughout the latter's existence was assured under the partnership arrangement and also that his own economic interests were conserved and continued under the latter arrangement.The provision of the trust instrument for paying the trust income to the beneficiary or his legal guardian was not observed by the trustees, but instead such income was accumulated. However, had the trust income been distributed in compliance with such provision it would have been paid in the taxable years by petitioners as trustees to themselves as guardians of the beneficiary. They would have received it in the latter capacity without restriction as to its use or purpose and accordingly could have invested and controlled it in a way to subserve their own 1946 U.S. Tax Ct. LEXIS 286">315 economic interests under as broad powers as if it had been handled under the trust.In addition to the fact that from the time of the creation of the trusts no distribution, either of income or principal, was made to the beneficiaries named, it should be borne in mind that during the taxable 6 T.C. 266">279 years involved the corpora of the existing trusts were employed in the business of which George J. Chertoff was the sole manager at a lucrative compensation in addition to a share of the profits of the business, under contractual arrangement which could not be terminated without his consent. It thus appears that petitioners have retained control of the business and the use of the trust estates therein through the power as trustees to control investments. See Anna Morgan, 5 T.C. 1089. We think that for all practical purposes these petitioners continued to remain the substantive owners of the property constituting the corpus of these trusts. As was said in Stockstrom v. Commissioner, 148 Fed. (2d) 491, affirming 3 T.C. 255: * * Certainly, what in the hands of an outsider-trustee may only 1946 U.S. Tax Ct. LEXIS 286">316 amount to administrative powers over property can well as to a settlor-trustee have more than a fiduciary significance or value in the nexus of previous ownership, family economics, technical dedication, and continued control. * It is well established that in construing the effect of 309 U.S. 331">Helvering v. Clifford, supra, on such trust agreements, all the facts and circumstances surrounding the execution of the trust must be examined to determine whether or not there has been a real change in the economic position of the settlors. No one factor is determinative. It is the sum total of the different rights and powers that is important. In the light of all the circumstances surrounding the creation of the trusts, can it be said that respondent erred in ignoring the separate entity of the trusts and taxing the income therefrom to the petitioners? Would we be justified in holding that the execution of the trust instruments effected a material change in the economic position of the petitioners? We think not.The contingencies set up in the trust instrument and the powers of control over the principal and income of the trust conferred upon the trustees, 1946 U.S. Tax Ct. LEXIS 286">317 together with the power either to terminate the trust within the lifetime of the beneficiary or permit it to continue for his lifetime, and also to withhold or distribute to the beneficiary the income of the trust, creates such a problematical status in respect of the property interests of the beneficiary and the remainderman under the trust as to render it impossible to determine whether the beneficiary named or his appointee or the petitioners will ultimately receive the corpus and/or the income of the trust. At least, it can not be said that, so long as the contingencies, controls, and powers hereinabove referred to continue, the beneficiary named, or any potential remainderman, has any measurable or determinable vested right in the trust property. Also, the broad powers of management granted to the petitioners, the retention of the trust assets in the business conducted by George J. Chertoff, and the rights conferred upon petitioners by the laws of Ohio in so far as their children's property is concerned 6 T.C. 266">280 all lead inevitably to the conclusion that the petitioners are taxable on the income of the trusts under section 22 (a) of the Internal Revenue Code, and we so hold. 1946 U.S. Tax Ct. LEXIS 286">318 Under such circumstances we are impelled to hold that petitioners have retained such a bundle of rights in respect of the trust property as to amount, for Federal tax purposes, to substantial ownership thereof and that each is taxable on the income of the respective trusts which he created. 309 U.S. 331">Helvering v. Clifford, supra;Rose Mary Hash, 4 T.C. 878; affd., 152 Fed. (2d) 722; Morris Eisenberg, 5 T.C. 856. Cf. Commissioner v. Estate of Holmes, 326 U.S. 480">326 U.S. 480.Decisions will be entered under Rule 50. Footnotes1. Sec. 10507-8, Pages' Ohio General Code, Ann.↩2. Secs. 10507-7 and 10507-8, Pages' Ohio General Code, Ann.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625314/	ESTATE OF CLYDE ROGERS, DECEASED, EARLENE ROGERS, ADMINISTRATRIX, and EARLENE ROGERS, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentEstate of Rogers v. CommissionerDocket No. 5770-74.United States Tax CourtT.C. Memo 1979-178; 1979 Tax Ct. Memo LEXIS 348; 38 T.C.M. 749; T.C.M. (RIA) 79178; May 8, 1979, Filed 1979 Tax Ct. Memo LEXIS 348">348 Howard W. Muchnick, for the petitioners. Robert N. Armen, Jr., for the respondent. HALL MEMORANDUM FINDINGS OF FACT AND OPINION HALL, Judge: Respondent determined a $30,823.98 deficiency in petitioners' income tax for 1970, plus additions to the tax of $1,541.19 for late filing of petitioners' 1970 return and $1,541.19 for negligence. Petitioners do not dispute the amount of the deficiency or the additions to the tax. The sole issue is whether petitioner Earlene Rogers is entitled to be relieved of liability for payment of the deficiency and the additions to the tax under the "innocent spouse" provisions of section 6013(e). 1FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. Earlene Rogers ("Earlene") was a resident of Cleveland Heights, Ohio, when the petition was filed. Earlene filed a joint return for 1970 with her husband Clyde Rogers ("Clyde"), now deceased, and she is administratrix of Clyde's estate. Clyde and Earlene were married in 1962. During the year in issue, Clyde owned and operated two small retail grocery stores in Cleveland. 1979 Tax Ct. Memo LEXIS 348">349 Clyde also owned and operated a notary and tax service and a juke-box and pinball machine rental company. Between 1966 and 1968 Clyde and Earlene acquired two parcels of real estate consisting of (1) a brick commercial building which housed one of Clyde's grocery stores and two rental suites and (2) a residential building containing six rental apartments. Title to the properties was held in the joint names of Clyde and Earlene Rogers. During 1970 Clyde, Earlene and their two children resided in one of the apartments. In 1968 Clyde individually acquired a single family dwelling. This building was rented for part of the year in issue. In 1969 Clyde individually acquired a commercial building which was used throughout 1970 to house his other retail grocery store. In 1970 Clyde acquired individually an unimproved lot for $9,000. On June 16, 1970, Earlene acquired for $2,900 a 1970 Ford automobile, title to which was solely in her name. As of December 31, 1970, the automobile was unencumbered. Throughout 1970 Clyde and Earlene maintained a joint checking account. This was the only bank account they maintained during the year in issue. Earlene often discussed the couple's financial 1979 Tax Ct. Memo LEXIS 348">350 matters with Clyde. Neither Clyde nor Earlene received any gifts or inheritances during 1970. Earlene did not maintain regular fulltime employment in 1970. She did, however, occasionally work at one of Clyde's grocery stores when a regular employee failed to appear for work. Also, she occasionally collected rent from occupants of the couple's jointly-owned rental properties. On September 21, 1971, Clyde and Earlene jointly purchased a single family residence at 1345 Forest Hills Boulevard in Cleveland Heights for $47,500, making a $14,850 down payment. In 1973 Clyde and Earlene were in the process of obtaining a divorce when Clyde died. After Clyde's death, Earlene received $4,000 and the children received approximately $25,000 from Clyde's estate. By 1975 the probate of Clyde's estate was still incomplete. During 1973 and 1974 Earlene earned income from the operation of an escort service. She also worked occasionally as a typist, and at one time took care of an older woman. At the time of trial, Earlene and her two children lived in the Forest Hills Boulevard home. On their 1970 return, Clyde and Earlene reported $76,670 gross receipts from the grocery store business and 1979 Tax Ct. Memo LEXIS 348">351 rentals plus $1,000 income from Clyde's notary and tax service. They claimed the following costs of goods sold and business deductions: Cost of goods sold$ 50,616.00Depreciation10,767.00Miscellaneous other deductions30,528.36$ 91,911.36Adjusted gross income reported on the return was minus $14,241.36 ($77,670 business and rental income minus costs of sales and business deductions of $91,911.36). The remainder of Form 1040 for 1970 consists of zeros in the columns for the amount of tax, credits, total tax withheld, 1970 estimated tax payments, and overpayments. Both Clyde and Earlene signed the return, which was prepared by an income tax return preparer. Clyde and Earlene filed a joint income tax return for 1971 on which they reported adjusted gross income of $13,487.17. Using the net worth method for reconstructing income, respondent determined that Clyde and Earlene understated their adjusted gross income for 1970 by $91,063.36 as follows: Assets1/1/7012/31/70Cash in bank $ 270.00 $ 231.00Inventory3,200.0029,600.00Automobile02,900.00Business depreciable assets024,900.00Real estate125,200.00134,200.00$128,670.00$191,831.00LiabilitiesNotes and mortgages payable 2$ 72,518.00$ 62,169.00Reserve for depreciation 304,688.00$ 72,518.00$ 66,857.00Balance$ 56,152.00$124,974.00Balance, 1/1/7056,152.00Increase in net worth$ 68,822.00Add: Personal living expenses8,000.00Economic income$ 76,822.00Statutory adjustments for adjusted gross income0Adjusted gross income as corrected$ 76,822.00Add: Negative adjusted gross income as reported14,241.36Understatement of adjusted gross income$ 91,063.361979 Tax Ct. Memo LEXIS 348">352 The deficiency notice was computed on this basis. OPINION The sole issue for decision is whether petitioner Earlene Rogers ("Earlene"), in her individual capacity, is an innocent spouse entitled to relief from payment of the deficiency and additions to the tax under section 6013(e). Respondent contends that Earlene does not qualify for relief as an "innocent spouse" because she cannot satisfy the requirements of section 6013(e). Under section 6013(e) a wife [or husband] is relieved from liability for the deficiencies resulting from omitted gross income on a joint return filed with her husband if three prerequisites are met: (1) on the joint return filed for the taxable year there was erroneously omitted gross income attributable to her husband which is in excess of 25 percent of the amount of gross income stated in the return; (2) in filing the return she did not know of and 1979 Tax Ct. Memo LEXIS 348">353 had no reason to know of such omission; and (3) after taking into account all the facts and circumstances, including the significant benefit she received from the omitted income, it is inequitable to hold her liable. The spouse seeking relief from liability under section 6013(e) carries the burden of proof and must establish that all three requirements are satisfied. Adams v. Commissioner,60 T.C. 300">60 T.C. 300, 60 T.C. 300">303 (1973). In this case, respondent contends that none of these requirements have been satisfied, and we agree. Respondent contends, first, that the 25 percent omission from gross income requirement under section 6013(e)(1)(A) is not satisfied. On their 1970 return Clyde and Earlene Rogers reported $76,670 gross receipts from rentals and the grocery store business plus $1,000 income from Clyde's notary and tax service, and an adjusted gross income of minus $14,241.36. Using the net worth method, respondent determined that Clyde and Earlene understated their 1970 adjusted gross income by $91,063.36. This determination is not disputed. Section 6013(e)(2)(B) provides that the amount omitted from gross income is determined with reference to section 6501(e)(1)(A). For such purposes, 1979 Tax Ct. Memo LEXIS 348">354 in the case of a trade or business, the term "gross income" means amounts received from the sale of goods prior to diminution for the cost of such sales. Section 6501(e)(1)(A)(i).Omission of gross income is not equivalent to the understatement of adjusted gross income or net income; such income can be understated, for example, due to excessive deductions. Hurley v. Commissioner,22 T.C. 1256">22 T.C. 1256, 22 T.C. 1256">1264-1265 (1954), affd. 233 F.2d 177 (6th Cir. 1956). In this case we know that adjusted gross income was understated by $91,063.36. However, the amount of omitted gross income is not readily ascertainable. In order to equate the unreported adjusted gross income figure as determined by respondent to omitted gross income, Earlene must show that the unreported adjusted gross income does not result from excessive deductions or overstated cost of goods sold. Resnick v. Commissioner,63 T.C. 524">63 T.C. 524, 63 T.C. 524">527 (1975); 22 T.C. 1256">Hurley v. Commissioner,supra at 1265. Total deductions and cost of sales stated on the return were $91,911.36 of which $4,688.00, representing depreciation, was allowed by respondent as a deduction.Earlene has failed to prove that the remaining $87,223.36 claimed deductions and costs of 1979 Tax Ct. Memo LEXIS 348">355 sales were not excessive. When the amount of unreported adjusted gross income ($91,063.36) is reduced by the total amount of excessive deductions taken on the return ($87,223.36), the result is $3,840. This figure represents the amount of unreported income which is known to result from items of omitted gross income. See Courtney v. Commissioner,28 T.C. 658">28 T.C. 658, 28 T.C. 658">669 (1957); Micciche v. Commissioner,25 T.C.M. 710, 35 P-H Memo. T.C. par. 66,138 (1966). Because $3,840 is not in excess of 25 percent of the gross income stated in the return, 4 the 25 percent omission from gross income requirement is not satisfied. In addition, Earlene has not demonstrated that the omissions are attributable solely to Clyde. During 1970 Earlene occasionally worked in one of Clyde's grocery stores and collected rentals. She also received rental income from properties held jointly with Clyde. Earlene has failed to prove that the omitted income was not, in part, attributable to her efforts or investments. Respondent contends, second, that Earlene failed to establish that in signing the return she did not know 1979 Tax Ct. Memo LEXIS 348">356 of and had no reason to know of the omission. Earlene signed the 1970 joint return which displayed an adjusted gross income figure of minus $14,241.36. However, during 1970 the couple's net worth increased $68,822, and they expended $8,000 for personal living. In addition, in the summer of 1970 Earlene acquired a $2,900 automobile which was unencumbered at the end of the year. The only bank account maintained by either Clyde or Earlene throughout 1970 was a joint checking account. We have no reason to believe that Earlene did not have full access to this account. Although Earlene may not have asked Clyde about the specifics of the couple's financial affairs, Clyde and Earlene did discuss their financial matters. In addition, there is no showing that the books and records for the couple's business ventures were not available to Earlene. See Adams v. Commissioner,60 T.C. 300">60 T.C. 300, 60 T.C. 300">303 (1973). On the basis of these facts, we conclude that Earlene knew that the income reflected in Clyde and Earlene's 1970 joint return was understated. The only direct evidence of Earlene's lack of such knowledge is her assertion to that effect. However, we find her entire testimony conflicting, unworthy 1979 Tax Ct. Memo LEXIS 348">357 of belief, and unsupported by the factual record. 5Third, respondent contends that Earlene failed to prove that she did not significantly benefit, directly or indirectly, from the items omitted from gross income. Earlene, however, asserts that she did not receive any significant benefit. We find her testimony unsupported by the facts. On June 16, 1970, Earlene acquired a 1970 Ford automobile for $2,900. As of December 31, 1970 the automobile was unencumbered. During 1970 improvements were made to real estate owned jointly by Clyde and Earlene. In addition, the mortgage balances on the rental units held by Clyde and Earlene decreased by approximately $7,000 resulting in a decrease in Earlene's personal liability on these notes. Moreover, 1979 Tax Ct. Memo LEXIS 348">358 Earlene received a benefit from this understatement of income in subsequent years. Under section 1.6013-5(b), Income Tax Regs., benefit may consist of transfers received subsequent to the year in which the omitted item of gross income should have been included. In this case, Clyde and Earlene acquired a single family residence in 1971 for $47,500 with a down payment of $14,850. Initially, Earlene maintained that Clyde had no property interest in this parcel and that the down payment was made with funds given to her by her father. She later admitted at trial, however, that she had lied and that she did not know the source of the down payment. The amount of the down payment exceeded Clyde's and Earlene's 1971 reported adjusted gross income. Earlene did not offer any evidence to show that the funds were from sources other than the 1970 omitted income. In light of the above facts, we conclude that Earlene received significant benefit, both directly and indirectly, from the items omitted from gross income in 1970. Earlene contends, nonetheless, that it would be inequitable to hold her liable for this deficiency. Section 6013(e)(1)(C) provides, notwithstanding that a spouse received 1979 Tax Ct. Memo LEXIS 348">359 significant benefit from the omitted items, that if all the other facts and circumstances of the case make the imposition of the tax inequitable, the spouse may be relieved of liability. The facts here, however, do not support Earlene's claim that imposition of the tax would be inequitable. After Clyde died, the children received approximately $25,000 and Earlene received $4,000 from Clyde's estate. The probate of the estate had not been completed at the time of trial, so we do not know what additional assets Earlene might receive. Although a widow, Earlene is not without financial resources. During 1973 and 1974 she derived income from the operation of an escort service. She also worked as a typist and took care of an older woman. At the time of the proceedings before this Court, Earlene and the children still resided in the house on Forest Hills Boulevard. In light of the above facts, we believe that it would be neither harsh nor inequitable to decline to relieve Earlene of her statutory duty. Compare Dakil v. United States,496 F.2d 431, 433 (10th Cir. 1974). Accordingly, Decision will be entered for the respondent.Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as in effect during the year in issue.↩2. There was approximately a $7,000 decrease of the mortgage balance on property held jointly by Clyde and Earlene. The remaining mortgage balance reduction is attributable to reduction of Clyde's individual liabilities. ↩3. Respondent allowed $4,688 of the $10,767 depreciation deduction claimed by petitioners.↩4. Gross income stated in the return is $77,670. Twenty-five percent of this amount is $19,417.50.↩5. At trial respondent's counsel offered Exhibits U and V solely for purposes of impeachment of petitioner Earlene Rogers' testimony under Rule 609, Federal Rules of Evidence.↩ We sustained petitioner's objections to the admissibility of these documents, but permitted respondent to argue for their admissibility on brief. Since we do not find the testimony given by Earlene at trial credible, we need not reconsider the admissibility of these documents.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625315/	DOROTHY A. D. ALLEN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Allen v. CommissionerDocket No. 88569.United States Board of Tax Appeals38 B.T.A. 871; 1938 BTA LEXIS 817; October 13, 1938, Promulgated 1938 BTA LEXIS 817">817 A gift in trust absolute on its face made by an infant is not subject to tax after the infant attains majority since section 501(c) of the Revenue Act of 1932 applies to power to revest retained in the trust instrument and not to the right given by law to infants to avoid their gifts. Edward H. Green, Esq., for the petitioner. Eugene G. Smith, Esq., and Lawrence A. Baker, Esq., for the respondent. MURDOCK 38 B.T.A. 871">871 OPINION. MURDOCK: The Commissioner determined a deficiency in gift tax for the year 1933 in the amount of $133,826.03. The petitioner contends that she made the gift prior to the enactment of the gift tax. The Commissioner argues that the gift became absolute and took effect only after June 6, 1932, the effective date of the gift tax, since the petitioner did not attain her majority until August 9, 1933, and she had by law the right to avoid the gift until that date. The facts are found as stipulated by the parties. The petitioner transferred the property involved herein in trust on June 4, 1932. The transfer was absolute on its face. The petitioner did not reserve any power of revocation. She became of age on August 9, 1933. 1938 BTA LEXIS 817">818 She has never revoked the transfer in trust. The trust was for the benefit of her mother, father, brother, and the children of the latter. The question is, Is this gift subject to gift tax under section 501 of the Revenue Act of 1932? That section is as follows: SEC. 501. IMPOSITION OF TAX. (a) For the calendar year 1932 and each calendar year thereafter a tax, computed as provided in section 502, shall be imposed upon the transfer during such calendar year by any individual, resident or nonresident, of property by gift. (b) The tax shall apply whether the transfer is in trust or otherwise, whether the gift is direct or indirect, and whether the property is real or personal, tangible or intangible; but, in the case of a nonresident not a citizen of the United States, shall apply to a transfer only if the property is situated within the United States. The tax shall not apply to a transfer made on or before the date of the enactment of this Act. (c) The tax shall not apply to a transfer of property in trust where the power to revest in the donor title to such property is vested in the donor, either alone or in conjunction with any person not having a substantial adverse1938 BTA LEXIS 817">819 interest in the disposition of such property or the income therefrom, but the relinquishment 38 B.T.A. 871">872 or termination of such power (other than by the donor's death) shall be considered to be a transfer by the donor by gift of the property subject to such power, and any payment of the income therefrom to a beneficiary other than the donor shall be considered to be a transfer by the donor of such income by gift. If the gift was made on June 4, 1932, it escapes tax because the act applies only to gifts made after its enactment and it was not approved and did not become a law until June 6, 1932, at 5 p.m. The Commissioner contends, however, that the petitioner had a power to revoke the gift during infancy and for a reasonable period thereafter, which made the gift incomplete until that power no longer existed. The parties agree that there is a rule of law to the effect that an infant can avoid his conveyances at any time up to the date upon which he attains his majority and during some reasonable period thereafter, but this right is personal to the infant or his legal representatives and his conveyances are not subject to collateral attack. Thus, by law, this petitioner had the1938 BTA LEXIS 817">820 right to avoid her transfer of June 4, 1932, and she continued to have it until some rather indefinite and undisclosed time after June 6, 1932, when the gift tax became effective. Nevertheless, the transfer was not subject to the tax. Subsection (c) provides that the tax shall not apply to the transfer in trust where the power to revest title to such property is vested in the donor but the relinquishment or termination of such power shall be considered as the taxable transfer, and any payment of income to the beneficiary in the meanwhile shall be a taxable gift. This language was not intended to apply to the power given by law to an infant to avoid his transfers, but was intended to apply to a transfer in trust where in the trust instrument a power was retained, either directly or indirectly, by the donor. Cf. . The latter kind of a power is well known in the law and does not include such a right as an infant has to avoid his transfers. The present grantor, in the trust deed, retained no power. The protective power which by law remains in the infant donor, is not technically a power to revest but a power to render the gift 1938 BTA LEXIS 817">821 void, i.e., to make it a nullity, as if nothing had ever passed from the donor or been vested in the donee. 1 Thus, it is not the kind of a power described in (c). The power of the infant extends not only to gifts by transfers in trust but also to direct gifts. Clearly (c) would not apply to the latter. Yet Congress could not have intended to tax the gift in trust and leave the other untaxed. The language of (c) is not appropriate had Congress had in mind a situation 38 B.T.A. 871">873 like the present where the right to avoid is a condition which the law imposes for the protection of infants. There would be a serious administrative difficulty of determining when such a right terminates. The last provision in (c), taxing the income as gifts when paid, would not apply, on the Commissioner's theory, because those gifts too could be avoided by the infant. 1938 BTA LEXIS 817">822 The Supreme Court, in interpreting somewhat similar provisions of section 302(d) of the Revenue Act of 1926, pointed out this very difference between a power to revoke and a condition which the law imposes. . It also held that a power to revoke, which is within the meaning of such provisions, must arise from the instrument creating the trust. . The same reasoning applies in the present case. Subsection (c) was repealed by section 511 of the Revenue Act of 1934, with the explanation by Congress that it was no longer necessary since it merely expressed a principle of law later well established by the decision in . Senate Report No. 558, 73d Cong., 2d. sess., p. 50; House Report No. 704, 73d Cong., 2d sess., p. 40. That is another indication that Congress did not intend to delay the tax on a transfer by an infant until the infant's right to avoid the transfer had lapsed since the Guggenheim case dealt with a power to revoke reserved in the trust deed. There is some language in the Guggenheim case which indicates that1938 BTA LEXIS 817">823 the gift tax in the Revenue Act of 1924 was intended to be laid on a transfer only after it was beyond recall. Yet, in the light of the Helmholz and Poor cases and of the statutory provision, we think the court must take the view that an unqualified gift by an infant is consummate when made and the gift here was made before the law imposing the tax became effective. Reviewed by the Board. Decision will be entered for the petitioner.DISNEY and KERN dissent. TURNER TURNER, concurring: I am unable to agree with that part of the majority opinion which discusses the effect of Helvering v. Helmholz,296 U.S. 93">296 U.S. 93, and White v. Poor,296 U.S. 98">296 U.S. 98. In my opinion the situation dealt with in Helvering v. Helmholz is in no way comparable to that involved in the instant case and the holding of the Court is not applicable here. There the trust instrument provided that the grantor should be entitled to a return of the property transferred in trust provided all of the beneficiaries agreed in writing that he should have it back. In this case the infant grantor alone and without regard to the desires or wishes of1938 BTA LEXIS 817">824 the beneficiaries had the power to 38 B.T.A. 871">874 revest in herself the title to the property transferred. A situation thus existed which was substantially and inherently different from that in Helvering v. Helmholz. As to White v. Poor, I am unable to find any basis for the conclusion that that case is authority for or lends support to any holding that section 501(c) of the Revenue Act of 1932, is inapplicable unless the grantor derives the power to revest from the written instrument creating the trust. In that connection the statute merely says that "where the power * * * is vested in the donor * * * the * * * termination of such power * * * shall be considered * * * a transfer * * * by gift * * *." There is nothing whatever to support the theory of the majority that the power must be reserved in the instrument of transfer. For other reasons stated in the majority opinion, however, I concur in the result. OPPER concurs in the above. Footnotes1. The situation is peculiar in that the acts and contracts of the infant are valid and binding except only in case the infant himself chooses to exercise his law given power to avoid them. Ed. Kasch and wife, et al.,; affd., ; ; DeVito v. Mechanicville,↩ 251 N.Y.Ap.Div. 514; Williston on Contracts, §§ 43, 105, 232.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625317/	PARKSIDE, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent BEACONCREST, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentParkside, Inc. v. CommissionerDocket Nos. 2885-71; 2886-71United States Tax CourtT.C. Memo 1975-14; 1975 Tax Ct. Memo LEXIS 359; 34 T.C.M. 54; T.C.M. (RIA) 750014; January 27, 1975, Filed Philip H. Long (an officer), for the petitioners. Robert T. Hollihan, for the respondent. HALL MEMORANDUM FINDINGS OF FACT AND OPINION HALL, Judge: Respondent determined deficiencies in the Federal income tax of petitioners Parkside, Inc. ("Parkside") and Beaconcrest, Inc. ("Beaconcrest") as follows: PARKSIDE, INC.BEACONCREST, INC.1966$ 3,975.25196710,615.659,260.7719688,593.458,806.60TOTAL$23,184.35$18,067.37 The two issues remaining for decision1975 Tax Ct. Memo LEXIS 359">362 are: (a) Whether petitioners are subject for the years in issue to the personal holding company tax imposed by section 541; 1 and (b) Whether in 1966, 1967 and 1968 all or any part of the compensation in excess of $1,800 per year paid by Beaconcrest to its president, Philip H. Long, constituted unreasonable compensation. FINDINGS OF FACT Some of the facts are stipulated and are accordingly found. Petitioners, Parkside, Inc. and Beaconcrest, Inc., are corporations organized and operating under the laws of the State of Washington. Each has its principal place of business in Bellevue, Washington. Petitioners filed their Federal income tax returns for the calendar years 1966 and 1967 with the district director of internal revenue, Tacoma, Washington. For 1968, returns were filed with the Internal Revenue Service Center, Ogden, Utah. Amended returns for all years in issue were filed by both petitioners with the Ogden Service Center. Both petitioners use the cash receipts and disbursements method of accounting. Since 1960 the stock of petitioners has been owned in equal1975 Tax Ct. Memo LEXIS 359">363 shares by three brothers and a sister, Philip H. Long, James Robert Long, Dwight Stanley Long, and Erma Long McKenzie ("shareholders"). The stock of Parkside was inherited by the shareholders from their father in 1960. Beaconcrest was formed on August 1, 1960 to receive part of the assets of Standard Homes, Inc., a corporation which had been organized by the shareholders' father to construct buildings for sale and/or rental and was owned by him at his death. Parkside's principal assets consisted of 26 duplex homes located in the Holman Road area of the City of Seattle. Beaconcrest's principal assets consisted of 21 duplexes located in the Beacon Hill area in the southern part of Seattle. In January 1960 Philip H. Long ("Long") left his job at Northwestern Mutual Insurance Company to become the president of each of the petitioners. He did not assume these roles eagerly, but did so only after extended discussions with his siblings and out of a sense of family responsibility. Long had little knowledge of his father's business prior to his father's death, although he was aware that his father had been experiencing serious financial difficulties. During the first months of his presidencies, 1975 Tax Ct. Memo LEXIS 359">364 Long made an intensive study of the corporations. He concluded that on liquidation Parkside would bring no more than $50,000, while Beaconcrest could be sold for between $50,000 and $100,000. These sums he found unacceptable. After discussions with the other shareholders, Long decided to retain the properties and rent them rather than liquidate the corporations. In 1960 Long undertook to fill what he regarded as gaps in his commercial education relating to corporate operations. In 1960 he spent six months studying rental and commercial properties in Seattle. Starting in April 1961 Philip took a twelve week course in real estate mechanics and salesmanship. Moreover, during 1962 Long took the professional real estate appraisal course given at the University of Washington, which qualified him to become a professional appraiser. Because of the poor financial position of petitioners, Long was very cost-conscious, cutting expenses wherever possible. Nonetheless, expenses continued to exceed receipts. It was continually necessary for him to raise additional funds to meet the petitioners' operating costs and obligations. Between 1960 and 1964 Beaconcrest's expenses and mortgage payments1975 Tax Ct. Memo LEXIS 359">365 exceeded its total receipts by between $20,000 and $25,000 and Parkside's expenses and mortgage payments exceeded its total receipts by more than $40,000. These deficits were financed in part by shareholder loans. Long decided that the properties would have to be disposed of rather than held unprofitably for rental indefinitely. By 1964 Long had determined that since neither the duplexes as a block nor the stock of the corporations would bring an acceptable price, he would endeavor to sell the duplexes individually. In order to avoid foreclosures and other problems which Long knew had always plagued his father in selling duplexes, he devised a unique set of criteria for potential purchasers. Long specified that purchasers on real estate contracts must be blue-collar workers, capable of making all repairs and maintaining the properties themselves. They also had to demonstrate an ability to rent the units not personally used without having to hire an agent. Further, the purchasers must intend to continue to hold a full-time job which would provide their main source of income. Long required that purchasers have good credit ratings, a history of steady employment, and be long-time residents1975 Tax Ct. Memo LEXIS 359">366 of the area. On August 23, 1964, Long placed a large advertisement in the Sunday Seattle Times on behalf of Parkside, which stated that 26 duplexes were for sale by the owner. Subsequent to the publication of the ad, Long contacted all tenants of the duplexes in an effort to interest them in purchasing them. He also attempted to sell duplexes to those who responded to the ad. These efforts were unsuccessful. Long then decided to employ professional real estate agents. On October 26, 1964, he listed the Parkside duplexes with the real estate firm of Ewing & Clark, Inc. An exclusive thirty day listing was given which was periodically extended. Later, after Long grew dissatified with Ewing & Clark, he engaged Metzgers' Realty, Inc., to sell the remaining duplexes, also utilizing an exclusive listing arrangement. In July 1965 Long gave Central Realty a ninety-day exclusive listing of the duplexes owned by Beaconcrest. These efforts did not produce the desired results. Before May 1965 only two duplexes were sold, and these were sold for substantially less than the original asking price. Therefore, Long modified his requirements, lowering both the downpayment and the monthly payment1975 Tax Ct. Memo LEXIS 359">367 requirements. To compensate for both concessions, he raised the asking price of each duplex by $1,000 to $2,000. Downpayments were as low as $375 for a duplex selling for $16,000 to $19,000. Initially, monthly payments for the Parkside duplexes were set at no higher than $135; later this figure was lowered to $100. Long set $100 as the monthly payment for all Beaconcrest duplexes sold on credit. Cash sales, of course, were never refused. All duplexes owned by both petitioners were mortgaged. When a duplex was sold on an installment contract, the mortgage was not assumed by the purchaser but remained a liability of the seller-corporation. The monthly amounts that the contract purchasers were required to pay were fixed by the contract of sale and were not increased when real estate taxes increased. Petitioners agreed to assume the additional tax payments along with the obligations to insure against fire. However, amounts so paid were passed on to the purchasers by extending the number of fixed payments. As president of Parkside and Beaconcrest, Long set the price and terms of each sale. He prepared and furnished the real estate brokerage firms with maps of all lots. Because the original1975 Tax Ct. Memo LEXIS 359">368 platting on which the Beaconcrest duplexes had been built was not followed, the preparation of the maps of these lots was especially arduous. Each sale of a duplex involved negotiations with the prospective purchaser. Initial negotiations for the seller corporation were carried out by the salesmen. Thereafter, the procedure would vary; sometimes Long would then personally enter into the negotiations, other times he would not. Once a formal offer to purchase was made, the purchaser signed an earnest money agreement specifying the duplex, the price and the terms. Long then decided whether or not to accept the offer or to make a counter-offer. Whenever the sales contract called for credit to be extended, Long made extensive inquiries to determine whether the purchaser was a good credit risk and whether he met Long's specifications. Long had an informal arrangement with two banks to obtain Dun & Bradstreet as well as Seattle Credit Bureau ratings on prospective buyers. Also, he personally determined how long the party had resided at the same Seattle address by consulting old phone books and city directories, and contacted the prospective purchaser's employer to determine how long he1975 Tax Ct. Memo LEXIS 359">369 had held his job. Long also interviewed each prospective purchaser to determine his level of personal commitment to the successful discharge of the purchase contract. Even after an earnest money agreement had been signed and extensive negotiations had been undertaken by Long, often an ultimate agreement was not reached. The first sale of the 47 duplexes occurred in January 1965. Thereafter, sales continued until the last duplex was sold in October 1966. The following is a schedule of all sales: Park-Beacon- Month and YearsidecrestTotalJanuary 196522May 196511June 196511September 196511October 196522December 196544January 196622February 1966112March 1966325April 19661910May 1966538June 1966314July 1966112August 196611October 196622TOTAL262147 By November 1, 1966, all duplexes of both Parkside and Beaconcrest had been sold. There were no foreclosures of any of these pieces of property during 1967 and 1968. All sales were made through brokers and required the payment of commissions. Parkside paid brokerage commissions1975 Tax Ct. Memo LEXIS 359">370 of $27,327.00 for the sale of its 26 duplexes; Beaconcrest paid $21,321.90 for the sale of its 21 duplexes. In most instances the downpayment received by the corporations was not sufficient to cover closing costs and commissions. Where this was the case, the petitioners signed notes obligating themselves to pay off the brokers over a period of time. Long believed that because major efforts were put forth by the brokers these payments were well justified and reasonable. All gains from the sale of the duplexes were reported (on the installment basis) in the petitioners' original Federal income tax returns as gains from the sale of section 1231 assets. 2 This treatment was never challenged by respondent. During the years in issue the petitioners received the following income, designated as interest on their Federal income tax returns, relating to real estate1975 Tax Ct. Memo LEXIS 359">371 contracts for the duplexes sold during the years 1965 and 1966: 196619671968Parkside$17,406.15$24,636.37$24,253.69Beaconcrest13,784.6712,865.98 Petitioners received no other personal holding company income during 1966, 1967 and 1968. In an effort to improve the cash flow position of the corporations, Long decided to take what he considered to be a minimal salary. The informal understanding among the shareholders was that Long would be better compensated once the corporations were in improved financial positions. During 1967 and 1968 the total compensation paid by Beaconcrest to Long was $7,300 and $7,200, respectively; 3 no salary was received from Parkside, which had a negative cash flow in 1967 and 1968. During these two years Long received no salary or compensation from any other sources. Allowing for a1975 Tax Ct. Memo LEXIS 359">372 15 percent fringe benefit factor, the prevailing yearly wage rates in 1968 for workers in the Seattle area in the following occupations were the following amounts: OccupationYearly Wageguards and watchmen$ 7,535janitors, porters andcleaners7,056helpers (maintenancetrades)7,535shipping clerks8,396truck drivers (citydelivery)10,286 Fringe benefits such as health, life insurance and pension coverage were typically provided to workers in the Seattle area at an average additional cost to the employer of 15 to 25 percent of the wages paid. Because of the poor cash flow of the petitioners and the necessity of making mortgage payments, Long closely monitored receipts. Six days a week he went to the post office, five miles from his home, to collect the real estate contract payments. He found that only about 20 percent of the monthly payments from the contracts were received when due; some were four to five months late. Long felt it incumbent upon him to keep abreast of economic conditions in Seattle. He made friends with certain members of financial institutions. He also studied financial publications and statistics at the Seattle Public Library1975 Tax Ct. Memo LEXIS 359">373 and the University of Washington library, and studied the Wall Street Journal and Fortune Magazine, to both of which he subscribed. These activities took an average of not less than five to six hours per week. All mortgage payments by Beaconcrest and Parkside were made by Long personally. Moreover, because of the precarious liquidity position of the corporations, he felt it necessary to establish and maintain certain business relationships. Several times a month Long would visit the managers and mortgage officers at certain banks and mortgage companies. Long felt that these contacts would be helpful if either corporation ever needed a loan on short notice. Those individuals who bought duplexes from petitioners were not, as purchasing criteria specified by Long would imply, sophisticated in the realm of business. Because of this, to insure against defaults Long would occasionally speak with them and offer business suggestions. Furthermore, when problems arose, the purchasers would often contact Long for advice or help. One of Long's corporate responsibilities was to inform the other shareholders of the condition of the corporations. Generally he telephoned the other shareholders,1975 Tax Ct. Memo LEXIS 359">374 but occasionally he visited them in Oregon or California. Since June 1964, Long has personally kept the corporate books and records. From 1960 to June 1964, they were kept by a professional bookkeeper, Ruth Hayden, who was paid $200 per month plus an occasional Christmas bonus. Merging the bookkeeper's responsibilities into those of Long was an economy measure. To cut out-of-pocket operating expenses further, Long moved the petitioners' office into his own house in or about July of 1964. Previously, an office had been rented in an office building at a cost of $144 per month. Long has never charged the corporations any rent for the use of the space. Other than Long, only three people were ever employed by petitioners. From August 1960 through November 1966, Beaconcrest employed Ruth Jensen who showed the duplexes to perspective renters. From January 1960 through December 1966, Parkside employed H. C. Rowan who showed the duplexes for rental, collected the monthly rents, and did most routine maintenance work. As described above, Ruth Hayden was employed as bookkeeper. All employees were directly supervised by Long. OPINION 1. Personal holding company tax.Respondent determined1975 Tax Ct. Memo LEXIS 359">375 that Parkside was a personal holding company (as defined in section 5424), subject to personal holding company tax (as provided in section 5415) upon its undistributed personal holding company income for the years 1966, 1967 and 1968. In addition, respondent determined that Beaconcrest was a personal holding company subject to the personal holding company tax for the years 1967 and 1968. 1975 Tax Ct. Memo LEXIS 359">376 Petitioners Parkside and Beaconcrest contend that they were not personal holding companies in the years in issue. It has been stipulated that petitioners met the stock-ownership test of section 542(a) (2), inasmuch as the stock of each petitioner was owned equally by the four shareholders. But petitioners contend they did not meet the adjusted ordinary gross income requirement of section 542(a) (1). Resolution of this issue rests upon the question of whether the 47 duplexes sold by petitioners were held by them for sale to customers in the ordinary course of their trade or business. During the years in issue petitioners received income from real estate contracts for duplexes sold by them during 1965 and 1966, which income was designated as "interest" on their Federal income tax returns. Petitioners contend that under section 543(b) (3)6 this interest is classified as "rents" for purposes of determining personal holding company status. Respondent agrees that if the interest is classified as "rents," petitioners are not personal holding companies. Under section 543(b) (3) the interest is "rents" only if the duplexes were held primarily for sale to customers in the ordinary course1975 Tax Ct. Memo LEXIS 359">377 of petitioners' trade or business. Whether petitioners are personal holding companies subject to personal holding company tax therefore depends on whether they were dealers in real estate during 1965 and 1966. Since this question turns on its individual and particular facts, prolonged comparison between the facts of this case and those of the many previously decided cases is not very helpful. The evaluation of petitioners' purpose in holding the duplexes cannot be limited to the time of sale, but must include consideration of the reasons for acquisition of the property and the purpose for holding it throughout the period from acquisition to sale. Municipal Bond1975 Tax Ct. Memo LEXIS 359">378 Corporation v. Commissioner,341 F.2d 683, 689 (C.A. 8, 1965), reversing 41 T.C. 20">41 T.C. 20 (1963). A dealer's intent to hold for sale must exist for some appreciable period before the actual sale; otherwise every sale would automatically fall into the dealer category. See McGah v. Commissioner,193 F.2d 662 (C.A. 9, 1952), reversing 15 T.C. 69">15 T.C. 69 (1950), on remand 17 T.C. 1458">17 T.C. 1458 (1952), reversed 210 F.2d 769 (1954). Relying in the main on the following facts, we conclude in this case that petitioners did not hold the duplexes primarily for sale to customers in the ordinary course of their trade or business. 1. The shareholders' interest in the property was acquired by inheritance. The Parkside shareholders acquired their stock directly from their father's estate; Beaconcrest was formed by the same shareholders to receive other assets from the shareholders' father's estate. The property owned by both corporations consisted of duplexes built by the deceased father. The duplexes were rented by the corporations while the shareholders considered and determined the best way to deal with them. Continued1975 Tax Ct. Memo LEXIS 359">379 rental proved to be a losing proposition. It was determined impractical and disadvantageous to sell either the stock of the corporations or the duplexes as a block, and so Philip Long, as president of the corporations, embarked upon a program of selling the duplexes individually. The overall picture is that the shareholders fell heir to rented property, duplexes, through the mechanism of holding shares in petitioners, Parkside and Beaconcrest, and after a brief and unsuccessful try at renting them, liquidated the property in the most economical and advantageous manner. The liquidation continued some two years, for the properties were difficult to dispose of, but the dominant liquidation motive continued from start to finish. No new properties were acquired nor was it ever contemplated that after these 47 duplexes had been sold there would be any continuation of sales activities. Generally, such a picture is not that of a dealer in real estate. Mackall v. United States,162 F. Supp. 522">162 F. Supp. 522 (E.D. Va., 1957); John Randolph Hopkins,15 T.C. 160">15 T.C. 160 (1950). See Garrett v. United States,120 F. Supp. 193">120 F. Supp. 193 (Ct. Cl., 1954). Even when it1975 Tax Ct. Memo LEXIS 359">380 is necessary to subdivide inherited property in order to sell it, the courts generally have found the taxpayer is not a dealer in real estate. Riedel v. Commissioner,261 F.2d 371 (C.A. 5, 1958), reversing and remanding a Memorandum Opinion of this Court; Yunker v. Commissioner,256 F.2d 130 (C.A. 6, 1958), reversing and remanding 26 T.C. 161">26 T.C. 161 (1956); Camp v. Murray,226 F.2d 931 (C.A. 4, 1955); Smith v. Dunn,224 F.2d 353 (C.A. 5, 1955); Estate of William D. Mundy,36 T.C. 703">36 T.C. 703 (1961). However, sufficient selling activities and large numbers of sales have in some cases been considered enough to turn a liquidation of inherited assets into the business of selling property. United States v. Winthrop,417 F.2d 905 (C.A. 5, 1969). Such, in our judgment, is not the situation here. 2. The property was held for rent prior to sale. Liquidation of investment property again generally does not cause the seller to be a dealer in real estate. Curtis Company v. Commissioner,232 F.2d 167 (C.A. 3, 1956), affirming in part, reversing1975 Tax Ct. Memo LEXIS 359">381 and remanding in part 23 T.C. 740">23 T.C. 740 (1955); Ross v. Commissioner,227 F.2d 265 (C.A. 5, 1955), reversing a Memorandum Opinion of this Court; Goldberg v. Commissioner,223 F.2d 709 (C.A. 5, 1955), reversing and remanding 22 T.C. 533">22 T.C. 533 (1954); Dillon v. Commissioner,213 F.2d 218 (C.A. 8, 1954), reversing a Memorandum Opinion of this Court. On the other hand, where the taxpayer is carrying on an active sales campaign in liquidating rental property, it is possible to be a dealer even though original acquisition of the property was for rental purposes. Murray v. Commissioner,238 F.2d 137 (C.A. 10, 1956), affirming a Memorandum Opinion of this Court; Pacific Homes, Inc. v. United States,230 F.2d 755 (C.A. 9, 1956); Home Co. v. Commissioner,212 F.2d 637 (C.A. 10, 1954), affirming a Memorandum Opinion of this Court. We do not find that Philip Long's sales activities or the volume of transactions are sufficient to make the petitioners dealers in real property. It is noteworthy that sales were carried on through real estate agents1975 Tax Ct. Memo LEXIS 359">382 rather than by employees of petitioners. See Dillon v. Commissioner,supra.3. The liquidation here was accomplished by piecemeal sales rather than a sale of the entire stock of the corporations or a sale of all the duplexes to one individual solely because it was the only economically feasible way to sell the property. See Ross v. Commissioner,supra;Palos Verdes Corp. v. United States,201 F.2d 256 (C.A. 9, 1952); 162 F. Supp. 522">Mackall v. United States,supra;Gordon, et al. v. United States,159 F. Supp. 360">159 F. Supp. 360 (Ct. Cl., 1958). 4. Petitioners acquired no other properties, but merely sold those received from the deceased father's estate. See Kent Industrial Corporation,25 T.C. 215">25 T.C. 215 (1955). 5. The property was sold "as is"; no subdivision activities or even improvements were involved. See Curtis Company v. Commissioner,supra.6. All gains from the sale of the duplexes were reported on the petitioners' original Federal income tax returns as gain from the sale of section 1231 assets. Section 1231 assets, of course, do not include1975 Tax Ct. Memo LEXIS 359">383 property held primarily for sale to customers in the ordinary course of their trade or business. We recognize that there are factors present which tend to characterize petitioners as being in the business of selling real estate, such as the fact that Philip Long was deeply involved in setting the criteria for potential buyers, and the rather large number of individual sales over a period of two years. However, viewed as a whole, we find that the preponderance of the evidence would not justify us in holding that petitioners had successfully sustained their burden of persuading us of the error of the respondent's determination. We conclude that the petitioners did not hold the duplexes primarily for sale to customers in the ordinary course of their trade or business. Petitioners also argue that they are not the type of corporation Congress had in mind when it passed the personal holding company provisions in 1934, and that they are precisely the kind of company Congress intended to exempt from personal holding company status when it amended the law to provide the "interest constituting rent" exception in section 403 of the Revenue Act of 1938. The Ways and Means report explained1975 Tax Ct. Memo LEXIS 359">384 the reason for this exemption as follows (H. Rept. No. 1860, 75th Cong., 3d Sess. (1938), 1939-1 C.B. (Pt. 2) 728, 765): In order to relieve from the surtax imposed by Title IA of the bill certain operating companies whose principal business consists in the development of real estate for sale, Section 403 makes a change in the treatment of certain types of interest as compared with the corresponding provision of the Revenue Act of 1936, as amended. This is done by including within the term "rents", as defined in subsection (g), interest on debts owed to the corporation, to the extent such debts represent the price for which real estate held primarily for sale to customers in the ordinary course of business was sold or exchanged by the corporation. This change will help those bona fide real estate operating companies which might otherwise find themselves subject to tax under Title IA of the bill in years in which, by reason of an inactive market for the sale of real estate, the greater part of their income is derived from interest on second mortgages on property previously sold by them and from rent from property leased pending its sale and the rents in themselves do1975 Tax Ct. Memo LEXIS 359">385 not constitute 50 per cent or more of gross income. In such cases rent and interest combined will usually exceed 50 per cent of the gross income. Under the proposed definition of "rents," such companies will not be classified as personal holding companies. First, we note that the legislative history talks in terms of "bona fide real estate operating companies." Petitioners were merely leasing companies. See 25 T.C. 215">Kent Industrial Corp.,supra. Second, we note that the rules prescribed by the personal holding company provisions are strictly mechanical, and apply even to those corporations that become personal holding companies accidentally without the slightest intent of reducing taxation.7 "Of course, all personal holding companies were not conceived in sin--many were organized for legitimate personal or business reasons; but Congress has made little distinction between the goats and the sheep." 8 The shareholders could have liquidated the petitioners and transferred their assets to a partnership. Unfortunately they did not, and the personal holding company provisions under the facts as we have found them impose the personal holding company tax on petitioners. 1975 Tax Ct. Memo LEXIS 359">386 2. Unreasonable compensation.Respondent contends that Long's salary of $7,300 in 1967 and $7,200 in 1968 paid by petitioner Beaconcrest is excessive. He disallowed all but $1,800 a year for each of the two years. Beaconcrest1975 Tax Ct. Memo LEXIS 359">387 claims it is entitled to deduct Long's salary for 1967 and 1968 under section 162(a)(1)9 because (1) the amounts paid were reasonable as compensation for services actually rendered by Long to Beaconcrest during those two years, and (2) in any event, they were reasonable for compensation for both past and present services rendered by Long. We find for petitioner on the second basis, although we acknowledge the question is a close one. The reasonableness of compensation is a factual determination, each case turning necessarily upon its particular facts and circumstances. Schneider & Co., Inc. v. Commissioner,500 F.2d 1481975 Tax Ct. Memo LEXIS 359">388 (C.A. 8, 1974) affirming a Memorandum Opinion of this Court; R. J. Nicoll Company,59 T.C. 37">59 T.C. 37, 59 T.C. 37">48 (1972); S. & B. Realty Co.,54 T.C. 863">54 T.C. 863, 54 T.C. 863">872 (1970). No one factor is dispositive. Mayson Mfg. Co. v. Commissioner,178 F.2d 115 (C.A. 6, 1949), reversing and remanding a Memorandum Opinion of this Court. The burden of proving that the compensation paid is reasonable is on the petitioner. Botany Mills v. United States,278 U.S. 282">278 U.S. 282 (1929). Where, as is the situation here, the corporation is controlled by the employee receiving the compensation, the transaction is subject to particularly close scrutiny. Dielectric Materials Co.,57 T.C. 587">57 T.C. 587, 57 T.C. 587">591 (1972). Petitioners offer no evidence of comparable salaries. However, a listing of the actual duties which Long performed for Beaconcrest refutes the claim of unreasonable compensation for past and present services performed.10Long educated himself regarding the area and kept abreast of current developments; he devised unusual and effective marketing techniques; he kept the books and records of the corporation; he negotiated contracts; he1975 Tax Ct. Memo LEXIS 359">389 prepared maps of the properties; he supervised the employees and advised the independent salesmen; he developed and maintained certain business contracts; he transferred the corporate headquarters into his own home; and he advised purchasers subsequent to sale in order to avoid default. Moreover, Long resigned an established position with what he felt to be a promising future in order to assume the management of petitioners and all the financial uncertainty inherent therein; he was entitled to some compensation for the reduction in position, the loss of security, and the foregone possibilities of advancement with his former employer. See Commercial Iron Works v. Commissioner,166 F.2d 221, 224 (C.A. 5, 1948), affirming a Memorandum Opinion of this Court. Finally, as president of Beaconcrest he assumed the ultimate responsibilities for the corporation's fate. The precise problem before this Court is not to determine exactly what amount would constitute1975 Tax Ct. Memo LEXIS 359">390 fair compensation for Long for the services rendered by him to Beaconcrest; we need merely decide whether or not the amounts received during the years in issue were unreasonable and excessive. The parties have stipulated that the effective yearly wage in 1968 in the Seattle area for guards and watchmen was $7,535; for janitors, porters and cleaners $7,056; for maintenance trade workers $7,535; for shipping clerks $8,396; and for city delivery truck drivers $10,286. Considering these statistics in unrelated jobs in the same area, and the duties undertaken by Long in his job, we find that the compensation paid to Long by Beaconcrest was not unreasonable and excessive. Decision will be entered under Rule 155.Footnotes1. All section references are to the Internal Revenue Code of 1954, as in effect in the years in issue.↩2. Section 1231 property is property used in the taxpayer's trade or business, which is depreciable or which is real property, has been held more than 6 months, and which is not inventory or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business. Section 1231(b) (1).↩3. From 1960 through 1966 Long received the following compensation as president of each of the petitioners. ↩ YearParksideBeaconcrest1960$5,500.00$ - 0 -19616,000.00 - 0 -19626,000.00375.001963500.007,000.001964200.004,300.001965200.004,800.001966 - 0 -6,300.004. 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) Adjusted ordinary gross income requirement.-- At least 60 percent of its adjusted ordinary gross income (as defined in section 543(b) (2)) for the taxable year is personal holding company income (as defined in section 543(a)), 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. * * ↩5. SEC. 541. IMPOSITION OF PERSONAL HOLDING COMPANY TAX. In addition to other taxes imposed by this chapter, there is hereby imposed for each taxable year on the undistributed personal holding company income (as defined in section 545) of every personal holding company (as defined in section 542↩) a personal holding company tax equal to 70 percent of the undistributed personal holding company income.6. Section 543(b) (3) provides in part that: "… [The] term 'rents' means compensation, however designated, for the use of, or right to use, property, and the interest on debts owed to the corporation, to the extent such debts represent the price for which real property held primarily for sale to customers in the ordinary course of its trade or business was sold or exchanged by the corporation↩; * * ." (Emphasis added.)7. "… [The] petitioner [urges that] the personal holding surtax was enacted to remedy the evil of the 'incorporated pocket book,' deliberately created to reduce the personal taxes of those who created them, and therefore, to impose the tax upon a corporation in petitioner's position is a perversion of the Congressional purpose… It is, however, abundantly clear that Congress, in correcting an evil, is not narrowly confined to the specific instances which suggested the remedy…. In enacting the very section being applied here, Congress was attempting to foreclose the defense, available under [the accumulated earnings tax] that the accumulation of profits was responsive to a legitimate business need." O'Sullivan Rubber Co. v. Commissioner,120 F.2d 845, 847-848↩ (C.A. 2, 1941). 8. Rudick, "Section 102 and Personal Holding Company. Provisions of the Internal Revenue Code," 49 Yale L. J. 171, 203↩ (1939).9. SEC. 162. TRADE OR BUSINESS EXPENSES. (a) In General.--There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including-- (1) A reasonable allowance for salaries or other compensation for personal services actually rendered; * * * *↩10. We are mindful that Long was paid his salary generally from the petitioner with the most money, first primarily from Parkside during 1960, 1961 and 1962, and then from Beaconcrest during 1963 through 1968.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625318/	Holmes Enterprises, Inc., Petitioner v. Commissioner of Internal Revenue, RespondentHolmes Enterprises, Inc. v. CommissionerDocket No. 9346-76United States Tax Court69 T.C. 114; 1977 U.S. Tax Ct. LEXIS 32; October 26, 1977, Filed 1977 U.S. Tax Ct. LEXIS 32">32 Decision will be entered under Rule 155. Petitioner is a corporation whose sole shareholder and president was arrested for transporting marijuana in petitioner's automobile. The automobile was seized and forfeited. Petitioner sought a deduction for the forfeiture as a business expense or a loss. Petitioner also sought deductions for the automobile's depreciation and operating expenses and for legal fees paid in an unsuccessful effort to prevent forfeiture. Held, forfeiture resulted in loss which was disallowed for public policy reasons. Also held, depreciation and operating expenses allowed for business use of automobile prior to seizure. Towner Leeper, for the petitioner.Charles N. Woodward, for the respondent. Tietjens, Judge. TIETJENS69 T.C. 114">114 OPINIONRespondent determined a deficiency of $ 660 in petitioner's Federal corporate income tax for the fiscal year ending August 31, 1973. The issues are (1) whether petitioner is entitled to a business expense or loss deduction for an automobile seized by and forfeited to the United States because of use in an illegal activity; (2) whether petitioner is allowed to deduct legal fees incurred in contesting the forfeiture of its asset; and (3) whether petitioner is allowed a depreciation deduction for the forfeited automobile.This case was fully stipulated pursuant to Rule 122, Tax Court Rules of Practice and Procedure. The stipulation1977 U.S. Tax Ct. LEXIS 32">34 of facts and attached exhibits are incorporated herein by reference.69 T.C. 114">115 Petitioner is a Texas corporation whose principal place of business is El Paso, Tex. Petitioner timely filed its Federal corporate income tax return for the fiscal year ending August 31, 1973, with the Internal Revenue Service Center in Austin, Tex.Petitioner is an active corporation engaged in the business of selling and servicing electric motors and related products. Jack E. Holmes (hereafter Holmes) is and was at all times relevant the sole owner and president of petitioner Holmes Enterprises, Inc. Petitioner is a substantial going concern with valuable inventories, receivables, realty, and other assets. Among those assets was a 1972 Jaguar sedan, model XJ-6. The Jaguar was purchased on October 8, 1971, for $ 8,600. Although the automobile was purchased and held in the petitioner's name, petitioner's employee Holmes used the car personally. Petitioner and respondent have stipulated that 25 percent of the car's use was personal, and we presume that 75 percent of the car's use was business.On October 11, 1972, Jack E. Holmes and two other individuals were arrested for possession of 189 pounds 1977 U.S. Tax Ct. LEXIS 32">35 (approximately 84.37 kilograms) of marijuana. When arrested, Holmes was using the Jaguar to transport his marijuana. He was indicted on one count of conspiracy to possess marijuana and one count of possession with intent to distribute. Holmes pleaded not guilty and was convicted by a jury on both counts. Initially he was sentenced to 5 years' imprisonment on each count with the suspension of one of the 5-year terms. The sentence was later reduced to 4 years' imprisonment to be served on weekends and a $ 5,000 fine.Because the Jaguar was used to transport marijuana in violation of Federal laws, it was seized and subjected to forfeiture proceedings under 49 U.S.C. secs. 781-788 (1970). Petitioner unsuccessfully contested the forfeiture, spending $ 3,000 on legal fees. On its Federal corporate income tax return, petitioner claimed as business expense deductions both its adjusted basis in the Jaguar, $ 4,711.42, and $ 3,000 in legal fees incurred in the unsuccessful defense of petitioner's property. Petitioner also claimed a depreciation deduction on its car in the amount of $ 2,355.71, which apparently reflects depreciation on the adjusted 1977 U.S. Tax Ct. LEXIS 32">36 basis of the car for the entire taxable year in issue.Petitioner contends that it has incurred a deductible expense or loss on the forfeiture of its automobile and in the amount of legal fees paid to defend title to the automobile. Petitioner also contends that it is entitled to prorate between corporate and 69 T.C. 114">116 personal use depreciation and operating expenses on the automobile. Respondent contends that the legal fees paid to defend petitioner's automobile are not ordinary and necessary business expenses but are in the nature of a capital expenditure, increasing the basis of the forfeited car. Thus the legal fees are deductible only to the extent that the basis of the Jaguar is deductible. With respect to the deduction of the automobile itself, respondent contends that the forfeiture is neither an ordinary and necessary business expense nor a loss. Specifically, the forfeited item is not a business expense item but a capital item; and it is a nondeductible loss because petitioner has failed to prove its inability to obtain reimbursement for the forfeiture from its employee Holmes. Alternatively, respondent argues that the forfeited Jaguar is nondeductible under section1977 U.S. Tax Ct. LEXIS 32">37 162(f) 1 or otherwise because its allowance would frustrate a sharply defined national policy against the sale or possession of marijuana.The cost of defending or perfecting title to business property is not deductible as a business expense. United States v. Hilton Hotels Corp., 397 U.S. 580">397 U.S. 580 (1970); sec. 1.263(a)-2(c), Income Tax Regs.; see sec. 263(a). Such costs are instead capitalized, increasing the basis of the property involved, and recovered either through the depreciation of that basis or by reducing the gain or increasing the loss realized upon sale of the property. See Brown v. Commissioner, 215 F.2d 697">215 F.2d 697 (5th Cir. 1954), affg. on this point 19 T.C. 87">19 T.C. 87 (1952). The legal fees of $ 3,000 deducted by petitioner should have been capitalized. They were paid to defend petitioner's title to the Jaguar in the forfeiture proceedings. 1977 U.S. Tax Ct. LEXIS 32">38 The extent to which petitioner's legal expenditures are recoverable therefore depends on the disposition of the underlying asset (the Jaguar) itself.We do not consider the forfeiture of property, albeit business property, to be an ordinary and necessary business expense. See Holt v. Commissioner, 69 T.C. 75">69 T.C. 75 (1977). See also Fuller v. Commissioner, 213 F.2d 102">213 F.2d 102 (10th Cir. 1954), affg. 20 T.C. 308">20 T.C. 308 (1953); Hopka v. United States, 195 F. Supp. 474">195 F. Supp. 474 (N.D. Iowa 1961). Rather, it is a loss. 69 T.C. 75">Holt v. Commissioner, supra; see 213 F.2d 102">Fuller v. Commissioner, supra; cf. Mazzei v. Commissioner, 61 T.C. 497">61 T.C. 49769 T.C. 114">117 (1974) (theft of cash in a scheme to counterfeit U.S. currency treated as a loss item); Richey v. Commissioner, 33 T.C. 272">33 T.C. 272 (1959) (same); Levy v. Commissioner, 30 T.C. 1315">30 T.C. 1315, 30 T.C. 1315">1330 (1958) (amount paid for rights to a story outline, which rights were subsequently abandoned, treated as a loss item). Whether the forfeiture1977 U.S. Tax Ct. LEXIS 32">39 in this case resulted in a loss within the meaning of section 165(a) and section 1231(a) is an interesting but unnecessary question; we consider the loss nondeductible for public policy reasons. 2Loss deductions are disallowed where the deduction would frustrate a sharply defined national or state policy. 213 F.2d 102">Fuller v. Commissioner, supra;69 T.C. 75">Holt v. Commissioner, supra;61 T.C. 497">Mazzei v. Commissioner, supra;33 T.C. 272">Richey v. Commissioner, supra. In 69 T.C. 75">Holt v. Commissioner, supra, the taxpayers sought to deduct as business expenses or losses properties forfeited under the provisions of 49 U.S.C. secs. 781-788 (1970). Like the automobile forfeited in this case, the properties in Holt had 1977 U.S. Tax Ct. LEXIS 32">40 been used by the taxpayer-husband to illegally transport marijuana. Although the properties forfeited were used in the taxpayer's stipulated trade or business of marijuana trafficking, we held them to be nondeductible losses. In so holding we found a sharply defined national policy against the possession and sale of marijuana. We need only add that our finding applies equally to the taxable year in issue here.Petitioner contends, however, that it is a separate, taxable entity, distinct from its employee Holmes. Thus, although the loss may be nondeductible for public policy reasons if realized by Holmes, there is no public policy reason to disallow the loss to petitioner who was an innocent party to the crime upon which the loss is founded. We recognize that petitioner is a separate, taxable entity. However, because Holmes is both petitioner's sole shareholder and president, we do not think petitioner is a wholly innocent bystander. Through Holmes, petitioner knew of and fully consented to the illegal use of its automobile. Cf. New Colonial Ice Co. v. Helvering, 292 U.S. 435">292 U.S. 435 (1934). We are not faced with a situation in which petitioner was unaware1977 U.S. Tax Ct. LEXIS 32">41 of the illegal and unauthorized use of its forfeited asset by its employee. Petitioner knew what was happening and made no 69 T.C. 114">118 efforts to prevent its employee from using the Jaguar for illegal purposes.Petitioner's reliance on Commissioner v. Tellier, 383 U.S. 687">383 U.S. 687 (1966), for the deductibility of the legal fees is misplaced. In Tellier, the taxpayer sought a business expense deduction for legal fees incurred in the unsuccessful defense of a criminal prosecution relating to his business. The Commissioner conceded that the fees were ordinary and necessary business expenses. The only question was whether the allowance of a deduction would frustrate public policy. The Supreme Court allowed the deduction because it is not against public policy to deduct legal fees as ordinary and necessary business expenses.The legal fees involved in this case are not ordinary and necessary business expenses, however. They are a capital expenditure which increased the basis of the property forfeited. Such expenditures are normally nondeductible without regard to public policy. See 397 U.S. 580">United States v. Hilton Hotels Corp., supra.1977 U.S. Tax Ct. LEXIS 32">42 And it would be improper to allow the deduction merely because it is not against public policy to employ an attorney to defend the title to property. We realize that because the Jaguar was forfeited, the legal fees will never be recovered. But neither will the rest of petitioner's adjusted basis in the Jaguar be recovered; and that basis surely reflects other expenditures, such as cost, that do not violate public policy. We disallow the loss not because the acquisition or preservation of the asset violates public policy but because the property was forfeited for its illegal use.Because we have found the forfeiture to result in a loss disallowed under section 165, we need not consider respondent's contention that the deductions should be disallowed under section 162(f).Finally, it must be decided whether and to what extent petitioner is allowed a deduction for depreciation and operating expenses of the forfeited automobile for the taxable year in issue. Respondent concedes that petitioner is entitled to depreciate the car for the period during which petitioner retained actual use of it. We agree. When the government seized petitioner's Jaguar, it was no longer available for1977 U.S. Tax Ct. LEXIS 32">43 petitioner's use. Hence the deductions claimed for depreciation and operating expenses of the Jaguar are allowable only while petitioner retained possession of the car. Cf. Algernon Blair, Inc. v. Commissioner, 29 T.C. 1205">29 T.C. 1205, 29 T.C. 1205">1221 (1958).69 T.C. 114">*119 Petitioner retained use of the Jaguar from September 1, 1972, to October 11, 1972. Because the business use of the automobile was 75 percent, that percentage of depreciation and operating expenses is allowable for the above period of time. See Rodgers Dairy Co. v. Commissioner, 14 T.C. 66">14 T.C. 66 (1950).Decision will be entered under Rule 155. Footnotes1. Unless otherwise stated, all statutory references refer to the Internal Revenue Code of 1954.↩2. We do note, however, that losses generally are nondeductible where reimbursement by insurance or otherwise is available. Sec. 165(a); sec. 1.165-1(a), Income Tax Regs.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625320/	ELIZABETH B. WALLACE, EXECUTRIX UNDER THE LAST WILL AND TESTAMENT OF EMMA A. MILLER, DECEASED, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Wallace v. CommissionerDocket Nos. 59414, 59970.United States Board of Tax Appeals27 B.T.A. 902; 1933 BTA LEXIS 1282; March 11, 1933, Promulgated 1933 BTA LEXIS 1282">1282 In 1920, the decedent transferred certain property to a trustee, to pay the income thereof to her during her life and upon her death to pay the corpus of the trust over to her daughter, "if she be living"; in the event the daughter predeceased the grantor, the property reverted to the grantor. Held, under New York law the daughter took a vested remainder by the execution of the trust instrument in 1920. Held, further, the death of the grantor in 1928 was not the generating source of definite accessions to the property rights of the survivor and there was no transfer of property from the dead to the living upon which to levy an estate tax. Cedric A. Major, Esq., for the petitioner. Eugene Smith, Esq., for the respondent. SMITH 27 B.T.A. 902">902 The Commissioner determined a deficiency of $58.14 in estate tax; the petitioner contests this determination and claims to have overpaid the estate tax. The only issue is whether the corpus of a certain trust was properly included in the decedent's gross estate. The facts were stipulated and these proceedings duly consolidated. FINDINGS OF FACT. The petitioner is the duly appointed executrix of the1933 BTA LEXIS 1282">1283 estate of Emma A. Miller, who died a resident of the City and State of New York on September 3, 1928. On June 7, 1920, the decedent executed a trust agreement which, in so far as material to these proceedings, is as follows: WHEREAS, the "Grantor," [Emma A. Miller], party of the first part hereto, desires to dispose of and create a trust of certain of her properties for the purposes hereinafter set forth, THIS INDENTURE WITNESSETH: In consideration of the premises and the mutual covenants herein contained, and other good and valuable consideration [s], and the sum of One Dollar to her in hand paid by the parties of the second part [Guaranty Trust Co. of New York], before the ensealing and delivery of these presents, the receipt whereof is hereby acknowledged, the party of the first part hereto has granted, conveyed, assigned, transferred, set over and delivered, and by these presents does grant, convey, assign, transfer, set over and deliver unto the parties of the second part, their successors and assigns, the following described securities: [List follows] together with all the estate and rights of the party of the first part thereto. TO HAVE AND TO HOLD all and1933 BTA LEXIS 1282">1284 singular the above-granted securities unto the said "Trustees," their successors and assigns, in trust nevertheless for and upon the following uses and purposes and subject to the terms, conditions, powers and agreements herein set forth. 27 B.T.A. 902">903 First. - To receive, hold, manage, use, invest and re-invest the same and every part thereof in the manner hereinafter specified, and to collect, recover and receive the issues, interest, income and profits thereof, hereafter called "income," and after deducting commissions of the "Trustees" as hereafter provided, and payment of any and all taxes, and legal expenses and other proper and necessary expenses in connection with the administration of the trust, to pay the same in semi-annual payments, or from time to time as they deem best and as soon as possible after the receipt of same, unto the "Grantor" for and during the term of her natural life. * * Third. - Upon the death of said "Grantor" the "Trustees" are hereby directed to and they shall pay over, assign, transfer and deliver the entire trust estate remaining undisposed of in their hands to "Grantor's" daughter. Elizabeth V. Bulen, if she be living, absolutely1933 BTA LEXIS 1282">1285 and forever. Fourth. - It is hereby mutually fully understood and agreed that if Elizabeth V. Bulen dies before the "Grantor," during the continuance of this trust, that the trust herein created then ceases and is of no further force or effect, and in such case the "Trustees" are then hereby authorized and directed to turn over to the "Grantor," freed from this trust, all of the principal and income of said trust, after deducting all commissions, as hereafter provided for, legal or other expenses or proper indebtedness incurred by said "Trustees." The petitioner, on or about August 29, 1929, filed with the collector of internal revenue for the third district of New York a return of Federal estate tax on Form 706, and on August 31, 1929, paid to the collector a tax in the sum of $4,063.76. The petitioner included in the decedent's gross estate the sum of $257,038.13 as the fair market value of the principal of the trust created by the decedent on June 7, 1920. The Commissioner later increased this value to $258,802.26. Under date of May 25, 1931, the Commissioner issued a 60-day letter to the petitioner, asserting a deficiency of $4,571.76, which, on the one hand, disallowed1933 BTA LEXIS 1282">1286 the credit claimed by petitioner in respect of taxes paid to New York State, and, on the other hand, eliminated from the gross estate the value of the above mentioned trust fund. Under date of July 23, 1931, the Commissioner issued a second 60-day letter to petitioner, asserting a deficiency of $58.14, which, on the one hand, allowed the credit in respect of the New York State taxes, but, on the other hand, included in the gross estate the increased value of the above mentioned trust fund, regarding which the letter contained the following explanation: This letter supersedes the Bureau sixty-day letter of May 25, 1931, and is issued for the purpose of including in the gross estate the trust fund created by the decedent under date of June 7, 1920, which in the opinion of the Bureau is subject to estate tax in view of the decision as rendered May 28, 1931, in the case of Sargent, Jr. v. White, Collector, in the United States Circuit Court of Appeals for the First Circuit. 27 B.T.A. 902">904 The parties have stipulated that if the trust fund, valued at $258,802.26, was correctly included in the decedent's gross estate there is a deficiency of $58.14; if it was not correctly included1933 BTA LEXIS 1282">1287 there has been an overpayment of $2,336.65, "which sum the taxpayer is entitled to recover back with interest as provided by law." OPINION. SMITH: The sole issue presented by these proceedings is whether the value of the trust fund is to be included in the decedent grantor's gross estate under section 302 of the Revenue Act of 1926 which, in so far as material hereto, is as follows: 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 - * * * (c) 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, except in case of a bona fide sale for an adequate and full consideration in money or money's worth. * * * The trust instrument here under consideration was irrevocable and created a life estate in the grantor (first clause), a remainder interest in the daughter (third clause), and a possibility of reversion in the grantor (fourth clause). The interest of the decedent in the property1933 BTA LEXIS 1282">1288 rights fixed by this trust instrument "must be determined by the laws of the place where the estate is to be administered." See Commissioner v. Jones, 62 Fed.(2d) 496, citing Crooks v. Harrelson,282 U.S. 55">282 U.S. 55. The decedent's estate was administered under the laws of the State of New York, where real property laws are applied in the determination of personal property rights. See Book 40, McKinney's Consolidated Laws of New York, Annotated, p. 16, et seq.; and see also note "Vested or contingent remainders of personal property," p. 54, Book 49, McKinney's, etc. Section 40 of the Real Property Law (Book 49, McKinney's, etc.), is as follows: When future estates are vested; when contingent. A future estate is either vested or contingent. It is vested, when there is a person in being, who would have an immediate right to the possession of the property, on the determination of all the intermediate or precedent estates. It is contingent while the person to whom or the event on which it is limited to take effect remains uncertain. The test of vesting applied by the New York courts has been stated as follows: If you can point to a man, 1933 BTA LEXIS 1282">1289 woman or child who, if the life estate should now cease, would, eo instanti et ipso facto, have an immediate right of possession, then the remainder is vested. 27 B.T.A. 902">905 See Moore v. Littel,41 N.Y. 66">41 N.Y. 66, and other cases cited on p. 55 of Book 49, McKinney's, etc.; and also Matter of Smith (1923), 205 A.D. 499; 200 N.Y.S. 538">200 N.Y.S. 538. The law of New York with respect to such estates was approved by the Supreme Court of the United States as early as Croxall v. Shererd, 5 Wall. (72 U.S.) 268, 287, wherein it was said: The struggle with the courts has always been for that construction which gives to the remainder a vested rather than a contingent character. A remainder is never held to be contingent when, consistently with the intention, it can be held to be vested. If an estate be granted for life to one person, and any number of remainders for life to others in succession, and finally a remainder in fee simple or fee tail, each of the grantees of a remainder for life takes at once a vested estate, although there be no probability, and scarcely a possibility, that it will ever as to most of them, vest in1933 BTA LEXIS 1282">1290 possession. Chancellor Kent says the definition of a vested remainder is thus fully and accurately expressed in the Revised Statutes of New York. It is, "when there is a person in being who would have an immediate right to the possession of the lands, upon the ceasing of the intermediate precedent estate." It is the present capacity to take effect in possession, if the precedent estate should determine, which distinguishes a vested from a contingent remainder. Where an estate is granted to one for life, and to such of his children as should be living after his death, a present right to the future possession vests at once in such as are living, subject to open and let in after-born children, and to be divested as to those who shall die without issue. A remainder, limited upon an estate tail, is held to be vested, though it be uncertain whether it will ever take effect in possession. * * * In Doe v. Considine, 6 Wall. (73 U.S.) 458, 474, 475, 476, is the following: A vested remainder is where a present interest passes to a certain and definite person, but to be enjoyed in futuro. There must be a particular estate to support it. The remainder1933 BTA LEXIS 1282">1291 must pass out of the grantor at the creation of the particular estate. It must vest in the grantee during the continuance of the estate, or eo instanti that it determines. A contingent remainder is where the estate in remainder is limited either to a dubious and uncertain person, or upon the happening of a dubious and uncertain event. * * The law will not construe a limitation in a will into an executory devise when it can take effect as a remainder, nor a remainder to be contingent when it can be taken to be vested. It is a rule of law that estates shall be held to vest at the earliest possible period, unless there be a clear manifestation of the intention of the testator to the contrary. Adverbs of time - as where, there, after, from, &c. - in a devise of a remainder, are construed to relate merely to the time of the enjoyment of the estate, and not the time of the vesting in interest. * * * "When a remainder is limited to a person in esse and ascertained, to take effect by express limitation, on the termination of the preceding particular estate, the remainder is unquestionably vested."27 B.T.A. 902">906 This rule is thus stated with more fulness1933 BTA LEXIS 1282">1292 by the Supreme Court of Massachusetts. "Where a remainder is limited to take effect in possession, if ever, immediately upon the determination of a particular estate, which estate is to determine by an event that must unavoidably happen by the efflux of time, the remainder vests in interest as soon as the remainder-man is in esse and ascertained, provided nothing but his own death before the determination of the particular estate, will prevent such remainder from vesting in possession; yet, if the estate is limited over to another in the event of the death of the remainder-man before the determination of the particular estate, his vested estate will be subject to be devested by that event, and the interest of the substituted remainder-man which was before either an executory devise or a contingent remainder, will, if he is in esse and ascertained, the immediately converted into a vested remainder." In 4th Kent's Commentaries, 282, it is said: "This has now become the settled technical construction of the language and the established English rule of construction." It is added: "It is the uncertainty of the right of enjoyment, and not the uncertainty of its actual1933 BTA LEXIS 1282">1293 enjoyment, which renders a remainder contingent. The present capacity of taking effect in possession - if the possession were to become vacant - distinguishes a vested from a contingent remainder, and not the certainty that the possession will ever become vacant while the remainder continues." Subsequent decisions of the Supreme Court have followed the above principles (see Cropley v. Cooper, 19 Wall. (85 U.S.) 167; McArthur v. Scott,113 U.S. 340">113 U.S. 340, 113 U.S. 340">378, 113 U.S. 340">379; Thaw v. Ritchie,136 U.S. 519">136 U.S. 519, 136 U.S. 519">546; and Johnson v. Washington Loan & Trust Co.,224 U.S. 224">224 U.S. 224, 224 U.S. 224">237, 224 U.S. 224">238), which were also followed by the lower Federal courts (see Pineland Club v. Robert,213 F. 545, 556; Aetna Life Inc. Co. v. Hoppin,214 F. 928, 933; Anderson v. Anderson,221 F. 871, 875. See also I Cooley's Blackstone, Book II, Chap. XI), p. 424, et seq.; III Thompson on Real Property, sections 2139, 2140, 2148. See also III Bouvier's Law Dictionary (Rawles Third Revision), p. 2869. This same question was considered at some length by the Supreme Court in 1933 BTA LEXIS 1282">1294 Coolidge v. Long,282 U.S. 582">282 U.S. 582, wherein the incidence of the Massachusetts succession tax upon certain remainder interests was involved. These remainder interests were created: By voluntary deeds of trust, [by which] a husband and wife transferred real and personal property, owned by them severally in certain proportions, to trustees, in trust to pay the income in those proportions to the settlors during their joint lives and then the entire income to the survivor of them, and upon the death of the survivor to divide the principal equally among the settlors' five sons, provided that, if any of the sons should predecease the survivor of the settlors, the share of that son should go to those entitled to take his intestate property under the statute of distribution in force at the death of such survivor. The deeds reserved no power of revocation, modification or termination prior to the death of the survivor of the settlors. * * * In holding that: By the deed of each grantor one-fifth of the remainder was vested in each of the sons, subject to be divested only by his death before the death of the 27 B.T.A. 902">907 survivor of the settlors. It was a grant in1933 BTA LEXIS 1282">1295 praesenti, to be possessed and enjoyed by the sons upon the death of such survivor. * * * And in further holding that the sons' interests were not subject to the succession tax, the court adverted to numerous decisions relating to remainder interests and, inter alia, said: By the deed of each grantor one-fifth of the remainder was immediately vested in each of the sons subject to be divested only by his death before the death of the survivor of the settlors. It was a grant in praesenti to be possessed and enjoyed by the sons upon the death of such survivor. Blanchard v. Blanchard,1 Allen 223">1 Allen 223. Clarke v. Fay,205 Mass. 228">205 Mass. 228. McArthur v. Scott,113 U.S. 340">113 U.S. 340, 113 U.S. 340">379, and cases cited. And see United States v. Fidelity Trust Co.,222 U.S. 158">222 U.S. 158. Henry v. United States,251 U.S. 393">251 U.S. 393. The provision for the payment of income to the settlors during their lives did not operate to postpone the vesting in the sons of the right of possession or enjoyment. The settlors divested themselves of all control over the principal; they had no power to revoke or modify the trust. Coolidge1933 BTA LEXIS 1282">1296 v. Loring, supra, 223. Upon the happening of the event specified without more, the trustees were bound to hand over the property to the beneficiaries. Neither the death of Mrs. Coolidge nor of her husband was a generating source of any right in the remaindermen. Knowlton v. Moore,178 U.S. 41">178 U.S. 41, 178 U.S. 41">56. Nothing moved from her or him or from the estates of either when she or he died. There was no transmission then. The rights of the remaindermen, including possession and enjoyment upon the termination of the trusts, were derived solely from the deeds. The situation would have been precisely the same if the possibility of divestment had been made to cease upon the death of a third person instead of upon the death of the survivor of the settlors. The succession, when the time came, did not depend upon any permission or grant of the Commonwealth. While the sons if occasion should arise might by appropriate suit require the trustees to account, it is to be borne in mind that the property was never in the custody of the law or of any court. Resort might be had to the law to enforce the rights that had vested. But the Commonwealth was powerless to condition1933 BTA LEXIS 1282">1297 possession or enjoyment of what had been conveyed to them by the deeds. Barnitz v. Beverly,163 U.S. 118">163 U.S. 118, and cases cited. The fact that each son was liable to be divested of the remainder by his own death before that of the survivor of the grantors does not render the succession incomplete. The vesting of actual possession and enjoyment depended upon an event which must inevitably happen by the efflux of time, and nothing but his failure to survive the settlors could prevent it. 1 Allen 223">Blanchard v. Blanchard, supra.Moore v. Lyons,25 Wend. 119">25 Wend. 119, 25 Wend. 119">144. Succession is effected as completely by a transfer of a life estate to one and remainder over to another as by a transfer in fee. Reinecke v. Northern Trust Co.,278 U.S. 339">278 U.S. 339, 278 U.S. 339">347-348. The recent case of Saltonstall v. Saltonstall,276 U.S. 260">276 U.S. 260, furnishes a good illustration of incomplete succession. There the remainder was liable at any time during the settlor's life to be divested through the exertion of the power of alteration and revocation that was reserved in the instrument creating the trust. 1933 BTA LEXIS 1282">1298 The decision sustaining a transfer tax went upon the ground that "the gift taxed is * * one which never passed to the beneficiaries beyond recall until the death of the donor. * * * A power of appointment reserved by the donor leaves the transfer, as to him, incomplete and subject to tax. * * * The beneficiary's acquisition of the property is equally incomplete whether the power be reserved to the donor or another." P. 271. See also Chase Nat. Bank v. United States,278 U.S. 327">278 U.S. 327, 278 U.S. 327">335, 278 U.S. 327">338. 27 B.T.A. 902">908 No Act of Congress has been held by this court to impose a tax upon possession and enjoyment, the right to which had fully vested prior to the enactment. By the trust instrument executed in 1920, Elizabeth V. Bulen, the grantor's daughter, was given "an immediate right to the possession" of the trust estate "upon the ceasing of the intermediate precedent estate," in which event she came into actual possession of the trust estate by reason of an event (the death of the grantor), "that must unavoidably happen by the efflux of time" and nothing but her "own death before the determination of the particular estate" could have prevented her right to the possession1933 BTA LEXIS 1282">1299 and thereby divesting her right by that event. In the light of the above authorities, we conclude that Elizabeth V. Bulen's interest in the trust propery vested as soon as the trust instrument was executed in 1920, and that the mere postponement of the "actual enjoyment" of the trust property did not render her remainder contingent. She took a vested remainder subject to being divested by her death prior to the death of the grantor, an event which did not happen. The respondent, in effect, contends that Elizabeth V. Bulen took only a contingent remainder, which ripened into a vested interest upon the death of the grantor in 1928, when the daughter for the first time acquired definite property rights from the decedent. In support of this contention the respondent cites Sargent v. White, 50 Fed.(2d) 410, affirming 46 Fed.(2d) 79; Klein v. United States,283 U.S. 231">283 U.S. 231; Chemical Bank & Trust Co. et al., Executors,25 B.T.A. 1153">25 B.T.A. 1153. While those cases are compatible with the respondent's position, they are distinguishable from the instant proceedings on their facts. 1933 BTA LEXIS 1282">1300 In Sargent v. White, supra,the District Court found that the decedent had "transferred to trustees in 1921 certain property to be held in trust during the joint lives of himself and his wife. On the death of either, the trust terminated and the survivor took the property." The report of that case indicates that the court considered Remick and his wife as joint tenants and that "Remick's death had, as was said in 281 U.S. 497">Tyler v. United States, supra, [281 U.S. 497">281 U.S. 497], 'the effect of passing to the survivor substantial rights, in respect of the property, theretofore never enjoyed by such survivor. * * Thus the death of one of the parties to the tenancy became the "generating source" of important and definite accessions to the property rights of the other.'" However, the District Court's decision was based on Commissioner v. Morsman, 44 Fed.(2d) 902, which was reversed by the Supreme Court in Morsman v. Burnet,283 U.S. 784">283 U.S. 784. In affirming the District Court, the Circuit Court of Appeals for the First Circuit quoted from the trust instrument as follows: 27 B.T.A. 902">909 * * If I survive my wife, Mary H. Remick, 1933 BTA LEXIS 1282">1301 then upon the decease of my said wife, Mary H. Remick, said trust shall cease and the Trustees shall pay over, transfer, deliver and convey the Trust Estate absolutely free and discharged of every trust to me, said Frank W. Remick. If, however, my said wife, Mary H. Remick, survives me, then the Trustees shall upon my death pay over, transfer, deliver and convey the trust estate absolutely free and discharged of every trust to my said wife, Mary H. Remick. The Circuit Court held that: It was clearly the intent of the decedent that the trust funds should not become absolutely vested during his life, * * Upon his death and as a result, the entire trust funds then passed to his wife. See Klein v. United States,51 S. Ct. 398, 75 L. Ed., decided by the Supreme Court April 13, 1931, which differs from this case to this extent that the grantor by deed transferred a life estate in some real property directly to his wife, expressly reserving to himself the fee, which, or as in this case the absolute title to the trust funds, passed to the wife at his death in case she survived him. In 283 U.S. 231">Klein v. United States, supra, the Supreme Court quoted the clauses1933 BTA LEXIS 1282">1302 of the deed there under consideration and said: The two clauses of the deed are quite distinct - the first conveys a life estate; the second deals with the remainder. The life estate is granted with an express reservation of the fee, which is to "remain vested in said grantor" in the event that the grantee "shall die prior to the decease of said grantor." By the second clause the grantee takes the fee in the event - "and in that case only" - that she shall survive the grantor. It follows that only a life estate immediately was vested. The remainder was retained by the grantor; and whether that ever would become vested in the grantee depended upon the condition precedent that the death of the grantor happen before that of the grantee. The grant of the remainder, therefore, was contingent. See 2 Washburn, Real Property (4th Ed.) pp. 547, 548, 559, par. 1. The decisions of the Supreme Court of Illinois, the state where the deed was made and the property lies, support this conclusion. Haward, et al. v. Peavey,128 Ill. 430">128 Ill. 430, 128 Ill. 430">439, 21 N.E. 503">21 N.E. 503, 15 Am. St. Rep. 120; 1933 BTA LEXIS 1282">1303 Baley v. Strahan,314 Ill. 213">314 Ill. 213, 314 Ill. 213">217, 145 N.E. 359">145 N.E. 359. * * * Nothing is to be gained by multiplying words in respect of the various niceties of the art of conveyancing or the law of contingent and vested remainders. It is perfectly plain that the death of the grantor was the indispensable and intended event which brought the larger estate into being for the grantee and effected its transmission from the dead to the living, thus satisfying the terms of the taxing act and justifying the tax imposed. Compare Tyler v. United States,281 U.S. 497">281 U.S. 497, 50 S. Ct. 356 * * * In 25 B.T.A. 1153">Chemical Bank & Trust Co. et al., Executors, supra, the grantor gave to his estranged wife a life estate or until the trust was terminated in accordance with its provisions, after which the trustees were to convey the property to the grantor, but if he was not living upon the termination of the trust the property was to go to his children. The property was included in the husband's gross estate on the ground that his children did not take a vested remainder interest in the trust property. It is obvious that the husband by 27 B.T.A. 902">910 the instrument had the right1933 BTA LEXIS 1282">1304 to the remainder or reversion of the trust property upon the termination of the life estate and that the children merely had an interest contingent upon their outliving their father. The children, though in esse at the creation of the trust estate, had no immediate right to possession upon the termination of the particular estate; so long as the grantor lived that "immediate right to possession" was vested in him, subject to divesting by his death, an event which eo instanti gave to the children a vested interest in the corpus, theretofore the children had a mere contingent interest. By the terms of the instruments involved in the cases relied upon by the respondent, the rights to the property included in the particular decedent's gross estate could not and did not vest absolutely in the grantee until the grantor's death - which was the "generating source of important and definite accessions to the property rights of the survivor." In each, the grantor reserved the remainder interest in the property; the grantee's interest did not ripen into a vested interest until the death of the grantor; and in the Chemical Bank & Trust Co. case the grantor was the only person 1933 BTA LEXIS 1282">1305 in esse who had the immediate right to the possession of the trust property upon the termination of the precedent estate. By the terms of the instrument involved in the instant proceedings the grantor took a life estate, the grantee took a vested remainder - subject to be divested by her death prior to the death of the grantor, who retained a mere possibility of reversion. The law and decisions of the courts of New York (referred to above), "the state where the deed was made and the property lies, support this conclusion." Cf. 283 U.S. 231">Klein v. United States, supra, p. 232. In Reinecke v. Northern Trust Co.,278 U.S. 339">278 U.S. 339, the Government argued that: * * the transfers of the remainder interests were all subject to the tax because, * * * they were "intended to take effect in possession or enjoyment at or after his [the grantor's] death." The court pointed out that even if the grantor had made himself the trustee: * * * the transfer would not for that reason have been incomplete, The shifting of the economic interest in the trust property which was the subject of the tax was thus complete as soon as the trust was made. His power to recall the property1933 BTA LEXIS 1282">1306 and of control over it for his own benefit then ceased and as the trusts were not made in contemplation of death, the reserved powers [of management] do not serve to distinguish them from any other gift inter vivos not subject to the tax. In holding that the trust property in the Reinecke v. Northern Trust Co. case was not subject to Federal estate tax, the Supreme Court said: 27 B.T.A. 902">911 In its plan and scope the tax is one imposed on transfers at death or made in contemplation of death and is measured by the value at death of the interest which is transferred. * * * One may freely give his property to another by absolute gift without subjecting himself or his estate to a tax, but we are asked to say that this statute means that he may not make a gift inter vivos, equally absolute and complete, without subjecting it to a tax if the gift takes the form of a life estate in one with remainder over to another at or after the donor's death. It would require plain and compelling language to justify so incongruous a result and we think it is wanting in the present statute. * * * In the light of the general purpose of the statute and the language of section 4011933 BTA LEXIS 1282">1307 explicitly imposing the tax on net estates of decedents, we think it at least doubtful whether the trusts or interests in a trust intended to be reached by the phrase in section 402(c) "to take effect in possession or enjoyment at or after his death," include any others than those passing from the possession, enjoyment or control of the donor at his death and so taxable as transfers at death under section 401. That doubt must be resolved in favor of the taxpayer. * * 278 U.S. 339">Reinecke v. Northern Trust Co., supra, was followed in May v. Heiner,281 U.S. 238">281 U.S. 238; wherein it was held that property transferred to a trustee with "a life estate in one with remainder over to another at or after the donor's death" was not to be included in the donor's gross estate. In the May case the Supreme Court pointed out that: * * * At the death of Mrs. May [the donor] no interest in the property held under the trust deed passed from her to the living; title thereto had been definitely fixed by the trust deed. The interest therein which she possessed immediately prior to her death was obliterated by that event. 1933 BTA LEXIS 1282">1308 281 U.S. 238">May v. Heiner, supra, was followed per curiam in Burnet v. Northern Trust Co.,283 U.S. 783">283 U.S. 783; McCormick v. Burnet,283 U.S. 784">283 U.S. 784; and 283 U.S. 784">Morsman v. Burnet, supra. These per curiam decisions affirm the Board's decisions reported at 9 B.T.A. 96">9 B.T.A. 96; 13 B.T.A. 423">13 B.T.A. 423; and 14 B.T.A. 108">14 B.T.A. 108, respectively. In the McCormick case, as in the instant proceedings, there was a possibility of the trust property reverting to the grantor in the event that the beneficiaries predeceased her. That event did not happen and apparently made no difference in the Supreme Court's decision, although some point was made of this possibility of reversion before the Circuit Court of Appeals which reversed the Board, 43 Fed.(2d) 277, and which in turn was reversed by the Supreme Court. On March 3, 1931 (the day following the announcement of the above per curiam decisions), Congress amended section 302(c) by passing House Joint Resolution 529, which is as follows: Resolved, etc., that the first sentence of subdivision (c) of section 302, of the revenue act of 1926, is1933 BTA LEXIS 1282">1309 amended to read as follows: (c) 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, including a transfer under which the transferor has retained for his life or any period 27 B.T.A. 902">912 not ending before his death (1) the possession or enjoyment of or the income from the property, or (2) the right 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's worth. In proposing this resolution in the House, Mr. Hawley, Chairman of the Ways and Means Committee, said: Mr. Speaker and gentlemen, the Supreme Court yesterday handed down a decision to the effect that if a person creates a trust of his property and provides that, during his lifetime, he shall enjoy the benefits of it, and when it is distributed after his death it goes to his heirs - the Supreme Court held that it goes to his heirs free of any estate tax. This resolution is to provide that hereafter such shall not be the law. This decision will cost1933 BTA LEXIS 1282">1310 the Treasury of the United States $25,000,000. That is, it will necessitate refunds in that amount. The Treasury does not know how many such trusts will be found before Congress meets again, but the opinion is that a great many will be, and it will take a very large sum from the Treasury unless this corrective legislation is enacted. * * * Yesterday afternoon the Supreme Court of the United States handed down decisions in three cases - Burnet against Northern Trust Co., Morsman against Burnet, and McCormick against Burnet - in which the court held that where an owner of property had made a transfer in trust reserving the income of the property, or the right to dispose of the income therefrom, to himself for his life, with remainder to others after his death, the value of the property should not be included in the estate of the donor for purposes of Federal estate tax upon his death. * * * It had generally been considered that this provision of the statute covered cases such as those referred to above. The Treasury Department had so construed the statute since the first Federal estate tax law in 1916 and its regulations so provide. If, for example, the owner of property1933 BTA LEXIS 1282">1311 transferred the title to his house to a trustee for the benefit of his children after his death, but in the meantime reserved the use, income, and enjoyment of the house to himself during his own lifetime, it was supposed that the value of the property at the date of his death should be included in his estate for purposes of estate tax. Under the decisions rendered yesterday the property would not be included in computing the Federal estate tax. It is entirely apparent that if this situation is permitted to continue, the Federal estate tax will be seriously affected. Entirely apart from the refunds that may be expected to result, it is to be anticipated that many persons will proceed to execute trusts or other varieties of transfers under which they will be enabled to escape the estate tax upon their property. It is of the greatest importance therefore that this situation be corrected and that this obvious opportunity for tax avoidance be removed. It is for that purpose that the joint resolution is proposed. Similar statements were made in the Senate by Senator Smoot, Chairman of the Finance Committee, in presenting this joint resolution. See pages 7017 and 6933 of Volume1933 BTA LEXIS 1282">1312 74 of the Congressional Record, Seventy-First Congress, Third Session. Thus, Congress undertook, without retroactive application, "to stop up the gap" and prevent trust estates (such as the one now before the Board) 27 B.T.A. 902">913 from escaping the incidence of the estate tax; however, this amendment not being retroactive has been applied only to transfers "made after 10:30 P.M. * * March 3, 1931." See Treasury Decision 4314; see also Charles H. W. Foster et al., Executors,26 B.T.A. 708">26 B.T.A. 708. There is no contention in the instant proceedings that the transfer made by the decedent in 1920 was made in contemplation of death. Elizabeth V. Bulen's interest in the trust property vested upon the execution of the trust instrument in 1920, and the death of the grantor was not the generating source of definite accession to the survivor's property rights but merely the obliteration of the decedent's life estate, upon which event the daughter came into possession of property, to which her rights had been fixed and vested upon the execution of the trust instrument in 1920. There was no transfer from the dead to the living upon which to levy the estate tax. The value of the trust1933 BTA LEXIS 1282">*1313 property was incorrectly included in the decedent's gross estate. 281 U.S. 238">May v. Heiner, supra;283 U.S. 784">McCormick v. Burnet, supra;Nanaline H. Duke et al., Executors,23 B.T.A. 1104">23 B.T.A. 1104; affd., 62 Fed.(2d) 1057; Stephen Peabody et al., Executors,24 B.T.A. 787">24 B.T.A. 787. Cf. 26 B.T.A. 708">Charles H. W. Foster et al., Executors, supra.Reviewed by the Board. Judgment will be entered for the petitioner.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625323/	MARTIN F. TIERNAN, TRUSTEE, MARTIN F. TIERNAN TRUST FOR MARTIN T., CHARLES W., JOHN W., ANN C. AND MARY E. TIERNAN, PETITIONER, ET AL., 1v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Tiernan v. CommissionerDocket Nos. 83167, 83169, 83171, 83173, 83175, 83177, 84276, 84277, 84278, 84279, 84291, 84292, 84293, 84294.United States Board of Tax Appeals37 B.T.A. 1048; 1938 BTA LEXIS 949; June 14, 1938, Promulgated 1938 BTA LEXIS 949">949 1. The income of a trust which in the trustee's discretion might be used for the support of the grantor's children but was not so used, is not taxable to the grantor. E. E. Black,36 B.T.A. 346">36 B.T.A. 346. 2. A mother, under no duty to support her children, is not taxable on the income of a trust created by her which might be but was not used for their support. Commissioner v. Yeiser, 75 Fed.(2d) 956. 3. A trust instrument, the language of which indicates that a separate trust was intended for each beneficiary and under which the trustee kept separate accounts for each, created separate trusts, the income of which is to be separately computed and taxed. United States Trust Co. of New York v. Commissioner,296 U.S. 481">296 U.S. 481. Henry P. Molloy, Esq., and Melville J. France, Esq., for the petitioners. Frank M. Thompson, Jr., Esq., and Jesse F. Gregory, Esq., for the respondent. STERNHAGEN 37 B.T.A. 1048">1049 The Commissioner determined the following deficiencies in petitioners' income taxes for 1932 and 1933: DeficiencyPetitionerDocket19321933Martin F. Tiernan84291, 84276$122,706.00$179,026.27Purcell C. Tiernan84294, 842795,795.546,416.77Charles F. Wallace84293, 84278115,941.44161,116.68Florence M. Wallace84292, 842777,189.115,121.31Martin F. Tiernan, trustee8316728,338.96Purcell C. Tiernan and Martin F. Tiernan, trustees8316985,206.10Fidelity Union Trust Co., trustee831711,691.57Charles F. Wallace, trustee8317347,844.65Florence M. Wallace and Charles F. Wallace, trustees8317556,640.98Fidelity Union Trust Co., trustee831771,700.901938 BTA LEXIS 949">950 The individuals assail the Commissioner's inclusion in their respective incomes of the incomes of trusts which they severally created for the benefit of their respective children. The trustees assail the Commissioner's determination that each of the trust instruments under which they respectively acted created a single trust, and contend on the contrary that a separate trust for each child beneficiary resulted from each of the several instruments. FINDINGS OF FACT. Martin F. Tiernan and Purcell C. Tiernan, residents of Essex Fells, New Jersey, are husband and wife and the parents of five children: Martin T., born June 20, 1917; Charles W., born August 2, 1918; John W., born March 4, 1922; Ann C., born December 2, 1924; and Mary E., born October 28, 1926. Charles F. Wallace and Florence M. Wallace, residents of Westfield, New Jersey, are husband and wife and the parents of three children: Jane Murray, born June 27, 1915, and married in October 1937; Barbara Stewart, born October 12, 1920; and Elizabeth Glover, born June 25, 1922. The Fidelity Union Trust Co. is a New Jersey corporation, with principal office at Newark, New Jersey. 1. On December 24, 1931, Martin F. Tiernan, 1938 BTA LEXIS 949">951 as grantor, executed a trust instrument (herein called instrument 1), transferring to himself as trustee specified securities, which, by section 2 of the instrument he was to divide: 2. * * * into five (5) equal parts, and to hold one of said parts IN TRUST for each of the five children of the Grantor, * * * which several five Trusts shall be known by the names of the said five children, and to continue to hold 37 B.T.A. 1048">1050 the principal of each of said Trusts throughout the lifetime of the survivor of said five children unless any of them shall be terminated prior thereto in whole or in part in accordance with the provisions of this instrument * . The trustee was vested with ample powers to manage, sell, and invest "each of said Trust Funds and the securities thereof, and to collect the gross income therefrom." By subsection 2(a) he was directed to: (a) * * apply the net income of each Trust so far as it may be deemed advisable and necessary, to the education and support of the child of the Grantor for whom each of said Trusts has been created, and income not so required shall be by the Trustee invested and added to the corpus * * , and if such child should die then1938 BTA LEXIS 949">952 it shall be applied in the same manner to the issue of such child per stirpes; By subsection 2(b), upon the grantor's death the trustee was to pay to the wife, if surviving, such part of the net income "of each and all of the said Trust Funds" as she should request for life, applying the balance to the education and support of each child. Subsections 2(c)-(e) provide that upon the wife's death the trustee shall hold "the principal of each Trust" throughout the lifetime of the survivor of the children, and in case a child die without issue, shall add the principal of his trust fund in equal shares "to the other existing Trust Funds created hereunder." (d) Upon the death of the last survivor of the children of the Grantor the undistributed portion of the several Trusts then existing shall be distributed in equal shares to the then living grandchildren of the Grantor, * * * or to the issue of deceased grandchildren per stirpes. If at any time "during the period of the several Trusts herein created" the income of the grantor's wife should fall below $20,000 a year, the trustee was directed to pay her the amount of the deficiency from the income, or if necessary, from the principal, 1938 BTA LEXIS 949">953 "of the several Trusts" proportionately, and if she should be living after January 1, 1939, "in any event ten percent (10%) of the income of each of said Trusts." 7. * * This Trust Agreement with respect to each of the Trusts herein created is irrevocable, except as herein provided. No amendment in this agreement with respect to any trust created thereby shall be made prior to January 1st, 1940, and thereafter during the year 1940 any amendment may be made by the Grantor, but only with the written consent annexed hereto of a beneficiary who has a substantial adverse interest in the income of the Trust in which the amendment is to be made * * . No amendment or change of any kind whatsover shall in any event be made by which the Grantor shall acquire or receive any interest of any kind whatsoever in either the principal or income of any Trust created hereby. Other provisions relate to management and name the Fidelity Union Trust Co. as successor trustee upon the death of the grantor-trustee. On the same date Charles F. Wallace, as grantor, transferred to himself as trustee specified securities for like purposes by a trust 37 B.T.A. 1048">1051 instrument (herein called instrument1938 BTA LEXIS 949">954 2) identical in substance and in language except for the persons named. Separate accounts under the names of the several beneficiaries were set up and maintained on the respective books and records of Tiernan and Wallace in their administrations as trustees and since January 6, 1933, the Fidelity Union Trust Co. has acted as the custodian of the securities held by the trustees and has kept them in eight separate folders under the respective names of the beneficiaries. Both trustees filed separate fiduciary and income tax returns for 1932 and 1933 for each of the children named in his respective trust instrument and paid the tax reported due. For 1933 Tiernan paid $592.23 as tax on each of the five incomes reported by him as trustee. Wallace paid $5,167.11 as tax on each of the three reported by him. The Commissioner treated the groups of five incomes and three incomes so reported as each received by a single entity. Under this theory he computed an income tax liability of $28,338.96 against Tiernan as trustee, all of which he determined as a deficiency in tax for 1933, and an income tax liability of $47,844.65 against Wallace as trustee, all of which he determined as a deficiency1938 BTA LEXIS 949">955 in tax for 1933. 2. On December 24, 1931, Martin F. Tiernan executed a second trust instrument (herein called instrument 3), subscribed by himself as grantor and by himself and his wife as trustees, transferring to the trustees specified securities in the same terms and for the same purposes as set forth in instrument 1, except that in lieu of the provisions of subsections 2(c)-(e) therein the "trustee" was empowered at discretion during the grantor's life to distribute to a child at his majority any part of the child's principal fund, and after the grantor's death the wife was so empowered to distribute one-half of the principal when the child should reach 30 years of age and the other half when he should reach 35. Any undistributed principal could be passed by the child's will or, failing a will, would go to his legal successors. On the same date Charles F. Wallace, as grantor, transferred specified securities to himself and wife as trustees by an instrument (herein called instrument 4) identical in substance and in language with instrument 3, except for the persons named. Separate accounts under the names of the several beneficiaries were set up and maintained on the1938 BTA LEXIS 949">956 trustees' respective books and since January 6, 1933, the Fidelity Union Trust Co., as custodian, has kept the trusts' securities in separate folders under the respective names of the eight beneficiaries. The trustees filed separate fiduciary and income tax returns for 1932 and 1933 for each of the children named in their respective trust instruments, and paid the tax shown. For 1933 Tiernan reported and paid a tax of $4,061.90 on each of the 37 B.T.A. 1048">1052 five income tax returns filed by him, and Wallace reported and paid a tax of $6,673.68 on each of the three filed by him. The Commissioner treated the groups of five incomes and three incomes so reported as each received by a single entity. Under this theory he computed an income tax liability of $85,206.10 against Tiernan and wife, as trustees, all of which he determined as a deficiency for 1933, and an income tax liability of $56,640.98 against Wallace and wife as trustees, all of which he determined as a deficiency for 1933. 3. In 1932 and 1933 Tiernan, as trustee under instrument 1, received incomes of $89,408.10 and $109,630.47, respectively, and he and his wife, as trustees under instrument 3, received incomes of $159,481.551938 BTA LEXIS 949">957 and $224,797.89, respectively. No part of the 1932 incomes was used in 1932 for the education or support of Tiernan's wife and children, and no part of the 1933 incomes was so used in 1933. A part of the incomes was invested in 1932, but the major portion was held in cash. Investments during 1933 reduced the cash balances in each child's fund under each instrument to slightly over $1,000. In determining Tiernan's individual income taxes for 1932 and 1933, the Commissioner included in income the respective amounts of income received under the two trust instruments in those years. In 1932 and 1933 Wallace, as trustee under instrument 2, received incomes of $115,433.64 and $151,805.62, respectively, and he and his wife, as trustees under instrument 4, received incomes of $118,397.81 and $167,914.27, respectively. No part of the 1932 incomes was used in 1932 for the education or support of Wallace's wife and children, and no part of the 1933 incomes was so used in 1933. A part of the incomes was invested in 1932, but the major portion was held in cash. Investments during 1933 reduced the cash balances in each child's fund under instrument 2 to $1,324 and under instrument 4 to1938 BTA LEXIS 949">958 $733. In determining Wallace's individual income taxes for 1932 and 1933, the Commissioner included in income the respective amounts of income received under the two trust instruments in those years. 4. On June 1, 1932, Purcell C. Tiernan, as grantor, executed a trust instrument (herein called instrument 5), transferring to the Fidelity Union Trust Co., as trustee, an undivided one-half interest in specified patents and royalties, which had been assigned to her by Martin F. Tiernan on December 24, 1921. Section 2 and subsection 2(a) of this instrument were substantially identical in words and substance with the divisions of instrument 1, so numbered. By subsection 2(b) the trustee was directed to pay to the grantor's husband, Martin F. Tiernan, at his request such part of the net income "of each of said Trust Funds" as should be required to make his annual income from all sources $25,000. By subsection 2(c) the trustee was empowered during the life of the grantor to distribute principal to any child at majority if the trustee thought him capable of 37 B.T.A. 1048">1053 managing the investment, and after the death of the grantor and her husband to distribute one-half of the principal1938 BTA LEXIS 949">959 when the child should reach 35 years and one-half when he should reach 40, provided that the child was deemed competent to manage. Otherwise, by subsection 2(d), the principal was to be held and distributed to the child's legatees or legal successors. Other provisions of the instrument are similar to those of instrument 1. On June 1, 1932, Florence M. Wallace, as grantor, executed a trust instrument (herein called instrument 6), transferring to the Fidelity Union Trust Co., as Trustee, an individed one-half interest in specified patents and royalties, which had been assigned to her by Charles F. Wallace on December 24, 1921. This instrument was identical in substance and in language with instrument 5, except for the persons named. The Fidelity Union Trust Co. has acted as trustee under instruments 5 and 6 since their execution. It entered in its cash accounts a separate account of the transactions for each of the beneficiaries, and in its securities ledger a separate record of the securities held for the benefit of each of the beneficiaries. It filed separate fiduciary and income tax returns for 1932 and 1933 for each of the children named in the trust instruments, and paid1938 BTA LEXIS 949">960 the tax shown. For 1933 $113.20 was so paid as tax under each of the five returns filed for a Tiernan beneficiary and $277.68 under each of the three filed for a Wallace beneficiary. The Commissioner treated the groups of five incomes and three incomes so reported as each received by a single entity. Under this theory he computed an income tax liability of $1,691.57 against the Fidelity Union Trust Co. as trustee under instrument 5, and $1,700.90 against it as trustee under instrument 6, and determined these amounts as deficiencies in tax for 1933. 5. In 1932 and 1933 the Fidelity Union Trust Co., as trustee under instrument 5, received incomes of $17,793.58 and $19,325.53, respectively. No part of the 1932 income was used in 1932 for the education or support of the children of Purcell C. Tiernan, and no part of the 1933 income was so used in 1933. Investments of income reduced the cash balance in the fund of each child to $2,516 at the end of 1932, and to $134 at the end of 1933. In determining the individual income taxes of Purcell C. Tiernan for 1932 and 1933, the Commissioner included in her income the respective amounts of income received by the trustee under instrument1938 BTA LEXIS 949">961 5 in those years. In 1932 and 1933 the Fidelity Union Trust Co., as trustee under instrument 6, received incomes of $17,796.74 and $19,356.43, respectively. No part of the 1932 income was used in 1932 for the education or support of the children of Florence M. Wallace, and no part of the 1933 income was so used in 1933. Investments of income reduced 37 B.T.A. 1048">1054 the cash balance in the fund of each child to $3,835 at the end of 1932, and $232.76 or less at the end of 1933. In determining the individual income taxes of Florence M. Wallace for 1932 and 1933, the Commissioner included in her income the respective amounts of income received by the trustee under instrument 6 in those years. OPINION. STERNHAGEN: All fourteen of these proceedings arise from several methods used by the Commissioner in taxing the income of the six trusts described in the findings. No argument has been made in behalf of the Commissioner, either orally or by written brief, attempting to support any of the determinations made. In eight of the proceedings the individual grantors of the trusts assail for each year, 1932 and 1933, the Commissioner's treatment of the trust incomes as if they were individually1938 BTA LEXIS 949">962 their own and taxable to them. In the remaining six proceedings the trustees assail the Commissioner's determination that each trust instrument sets up a single trust the income of which is taxable as a single lump sum instead of separate trusts for the several beneficiaries the incomes of which are taxable separately. 1. Although the four trusts established by Tiernan and by Wallace were for the benefit of their children in one case and of their children and wives in another, there was no power of revocation and no provision whereby under any circumstances either the corpus or the income could be revested in the grantor, hence there is no foundation for the application of section 166 or 167, Revenue Act of 1932. There is in each trust instrument a provision under which the trustee may in his discretion use the income for the education and support of the grantor's child, but it appears that in fact no such use was made of the income and that in fact the grantor was not relieved of any parental duty or obligation to maintain a child. The income was in fact accumulated and invested by the trustee. The wives in the taxable years in question actually received nothing from the trustees1938 BTA LEXIS 949">963 either by way of maintenance or otherwise. Thus the circumstances in evidence take the case entirely outside the scope of , and similar cases, 1 and bring it within , holding that the income of the trust is not under such circumstances taxable to the grantor. 2. In the four proceedings of the two wives, Purcell C. Tiernan and Florence M. Wallace, there is in addition to the reasons supporting the contentions of the husbands, the added reason that under New Jersey law, which governs the two families in question, there is no duty of a 37 B.T.A. 1048">1055 mother to support a child during the life of the father. 2 The Commissioner's determination as to the wives is likewise reversed. ; 1938 BTA LEXIS 949">964 ; cf. . 3. There is in each of the trust instruments language which unmistakably indicates that a separate trust was intended to be and was actually set up for each child beneficiary. In section 2 and subsection 2(a) appear words, "to hold one of said parts in trust for each of the five children"; "which several five trusts shall be known by the names of the said five children"; "the principal of each of the said trusts", etc. In conformity with this clear language, each trustee was careful to keep the principal and the income which he held for each child in an account separate from all the rest. Thus the situation is entirely similar1938 BTA LEXIS 949">965 to that in , in which the Supreme Court held that separate trusts were to be recognized for the several beneficiaries and the income of each separately computed and taxed. Upon this authority the Commissioner is held to have erred in determining the deficiencies of the trustees as if there were but six trusts, one under each instrument. It results, from the authorities cited, that upon all the issues raised the petitioners' contentions are sustained and the Commissioner's determinations are reversed. Judgments will be entered under Rule 50.Footnotes1. Proceedings of the following petitioners are consolidated herewith: Purcell C. Tiernan and Martin F. Tiernan, Trustees, Martin F. Tiernan Trust for Martin T., Charles W., John W., Ann C. and Mary E. Tiernan; Fidelity Union Trust Company, Trustee, Purcell C. Tiernan Trust for Martin T., Charles W., John W., Ann C. and Mary E. Tiernan; Charles F. Wallace, Trustee, Charles F. Wallace Trust for Jane M., Barbara S. and Elizabeth G. Wallace; Florence M. Wallace and Charles F. Wallace, Trustees, Charles F. Wallace Trust for Jane M., Barbara S. and Elizabeth G. Wallace; Fidelity Union Trust Company, Trustee, Florence M. Wallace Trust for Jane M., Barbara S and Elizabeth G. Wallace; Martin F. Tiernan; Florence M. Wallace; Charles F. Wallace; Purcell C. Tiernan. ↩1. ; ; ; . ↩2. ; ; affd., ; ; ; ; ; ; ; ; . ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625324/	Fotochrome, Inc. (Successor by Merger to Fotochrome Color Corp.), et al. 1 Petitioners v. Commissioner of Internal Revenue, RespondentFotochrome, Inc. v. CommissionerDocket Nos. 1077-68 -- 1084-68United States Tax Court57 T.C. 842; 1972 U.S. Tax Ct. LEXIS 157; March 23, 1972, Filed 1972 U.S. Tax Ct. LEXIS 157">157 The Tax Court is not deprived of jurisdiction where a petitioner files in bankruptcy subsequent to the filing of his petition for the redetermination of his taxes with the Tax Court. In such cases the jurisdiction of the Tax Court and the bankruptcy court to redetermine the deficiency is concurrent. Morris A. Kaplan, for the petitioners.Rufus H. Leonard, Jr., and Donald W. Geerhart, for the respondent. Sterrett, Judge. STERRETT57 T.C. 842">843 OPINIONRespondent has filed a motion to calendar these consolidated cases for trial. Essentially the motion raises the question of whether this Court has jurisdiction to proceed to a determination of these cases.Respondent sent seven different statutory notices, each dated December 8, 1967, to Fotochrome, Inc., determining deficiencies in the income taxes of the following corporations for the years indicated:Taxable yearTaxpayerendedDocket No.Fotochrome Color Corp3/31/601077-68Regal Distributors, Inc3/31/601078-68Fame Foto, Inc12/31/591079-68Melrose Photo Service, Inc6/1/60 to1080-689/30/60Lord Film Corp4/30/601081-68Fore Foto, Inc12/31/591082-68Chroma Color Corp4/30/601083-68Fotochrome is the successor by merger to all the above-named corporations. A statutory notice also dated December 8, 1967, was sent to the individual petitioners herein, Frank Nadaline, Jr., and Malvina Nadaline (docket No. 1084-68). Petitions were filed for all docket1972 U.S. Tax Ct. LEXIS 157">160 numbers herein on March 7, 1968. On October 21, 1968, this Court granted respondent's motion to consolidate the individual and all the aforelisted corporate cases for trial.It is alleged by respondent that Frank Nadaline, Jr., is a substantial stockholder in all the corporations here involved, and that he is deeply inmeshed in the operations of these corporations. Respondent's theory of the case is that certain claimed business expenses of the corporations should be disallowed, and that as a result Frank should be charged with constructive dividends. This view of the case led respondent to seek a consolidation.On March 26, 1970, Fotochrome filed a petition with the District Court for the Eastern District of New York for an arrangement under chapter XI of the Bankruptcy Act, 11 U.S.C. sec. 701 et seq. An order continuing the debtor, Fotochrome, in possession was entered by the referee in bankruptcy on March 27, 1970. Paragraph (5) of that order stated as follows:That until the further order of this Court, all creditors of the debtor, including their agents, servants and employees and any Marshal of the City of New 57 T.C. 842">844 York and Sheriff1972 U.S. Tax Ct. LEXIS 157">161 of the State of New York, acting in their behalf or in the furtherance of their claims, be and they are hereby restrained and enjoined from commencing or continuing any actions, suits, arbitrations, or the enforcement of any claim in any Court against this debtor or taking any further steps or proceedings except before this Court.Pursuant to section 6871(a), I.R.C. 1954, 2 respondent, on May 27, 1970, made immediate assessments of the income tax deficiencies asserted in docket Nos. 1077-68 through 1083-68 against the various corporations. A timely proof of claim for the asserted deficiencies was filed in the bankruptcy proceeding on February 23, 1971. Fotochrome filed with the bankruptcy court objections to the allowance of the proof of claim on July 8, 1971. The United States, on September 23, 1971, filed a motion for adjournment of the hearing on Fotochrome's objections to the proof of claim until the correctness of the deficiencies asserted against the various corporations could be determined by the Tax Court. The referee in bankruptcy denied this motion in an order dated December 23, 1971. The referee's decision in support of the order recites that the motion for adjournment1972 U.S. Tax Ct. LEXIS 157">162 "shall be treated as an application to modify the restraining provisions of the order of March 27, 1970 so as to permit proceeding in the Tax Court instead of having a determination in this Court on the debtor's objection to the allowance of the claim." The decision by the referee concludes that, as a consequence of the respondent's filing a proof of claim, the bankruptcy court was vested "with paramount jurisdiction to determine its validity."Respondent properly agrees that the bankruptcy court acquired jurisdiction to determine Fotochrome's tax liability for the years in issue upon the filing of a proof of claim by respondent. Nonetheless the claim is made by respondent that the Tax Court, having acquired jurisdiction to redetermine Fotochrome's tax liabilities for the years in issue prior to the filing of the chapter XI petition by Fotochrome, did not lose jurisdiction upon the filing of the proof of claim. We must1972 U.S. Tax Ct. LEXIS 157">163 agree with respondent that the jurisdiction of the Tax Court and the bankruptcy court under these circumstances is concurrent.Early in its history this Court, then the Board of Tax Appeals, considered the question of whether it lost jurisdiction to redetermine a deficiency in taxes where the taxpayer filed in bankruptcy after having petitioned this Court for a redetermination of his taxes. In the case of Plains Buying and Selling Association, 5 B.T.A. 1147">5 B.T.A. 1147 (1927), we had 57 T.C. 842">845 under consideration section 282(b), Revenue Act of 1926, ch. 27, 44 Stat. (Part 2) 9, 62, which is materially the same as section 6871(b). 3 See S. Rept. No. 1622, 83d Cong., 2d Sess, p. 598 (1954), (1954 Code); Comas, Inc., 23 T.C. 8">23 T.C. 8 (1954), (1939 Code); Missouri Pacific Railroad Co., 30 B.T.A. 587">30 B.T.A. 587 (1934), (Revenue Act of 1932). An exhaustive exposition and examination of the legislative history of section 6871(b)'s progenitor was made by the Board. See also H. Rept. No. 356, 69th Cong., 1st Sess. (1926), 1939-1 C.B. (Part 2) 373. This legislative history shows beyond peradventure1972 U.S. Tax Ct. LEXIS 157">164 that Congress intended this Court and a bankruptcy court to have concurrent jurisdiction to redetermine a deficiency in taxes asserted by the Commissioner where a taxpayer petitioned this tribunal for such redetermination prior to filing in bankruptcy.1972 U.S. Tax Ct. LEXIS 157">165 Petitioners rest their opposition to respondent's motion on section 2a (2A) of the Bankruptcy Act, 11 U.S.C. sec. 11(2A). Inferentially, petitioners would also have reliance on sections 2a(15), 11(a), and 314 of the Bankruptcy Act, 11 U.S.C. secs. 11a(15), 29(a), 714. None of these provisions warrant our denying respondent's motion to calendar for trial.The equivalent of section 2a(2A) 4 Bankruptcy Act, 11 U.S.C. sec. 11a(2A), appeared in the Bankruptcy Act of 1898 as part of section 64a. 5 Ch. 541, sec. 64(a), 30 Stat. 563. Thus the provision preceded section 57 T.C. 842">846 282(b), Revenue Act of 1926, which established the rule of concurrent Tax Court-bankruptcy court jurisdiction in cases such as the instant. The language empowering the bankruptcy court to make determinations on tax questions was made the second proviso of section 64b(4), Bankruptcy Act, by the Chandler Act in 1938. Ch. 575, sec. 1, 52 Stat. 874. This change was made without comment by Congress in spite of the Bankruptcy Act being extensively revised. Thus the change must have been clerical rather than1972 U.S. Tax Ct. LEXIS 157">166 substantive. See H. Rept. No. 1409, to accompany H.R. 8046 (Pub. L. No. 696), 75th Cong., 1st Sess., pp. 15, 56, 88 (1937). There matters rested until 1966 when section 2a(2A) was added to the Bankruptcy Act and the second proviso of section 64b(4), as written in 1938, was deleted. Act of July 5, 1966, Pub. L. 89-496, 80 Stat. 270, 271. Speaking of this change Congress said:Your committee also agrees with the amendment in the bills which, in effect, moves the provision relating to the statutory authority of bankruptcy courts to hear and determine tax disputes from the section of the Bankruptcy Act relating to the priority of unsecured tax claims to the provision of the act relating to the jurisdiction of the bankruptcy courts. This committee understands that this amendment makes no change in present law under which a bankruptcy court cannot adjudicate the merits of any claim, including a Federal tax claim, which has not been asserted in the bankruptcy proceeding by the filing of a proof of claim. [S. Rept. No. 999, 89th Cong., 2d Sess. (1966), 1966-2 C.B. 750.]There is nothing in the history of section 2a(2A) of the Bankruptcy Act which indicates1972 U.S. Tax Ct. LEXIS 157">167 Congress meant to abrogate the concurrent jurisdiction established by section 6871.1972 U.S. Tax Ct. LEXIS 157">168 Section 314 6 of the Bankruptcy Act, 11 U.S.C. sec. 714, is, in all respects here material, similar to section 77(j) of the Bankruptcy Act, 11 U.S.C. sec. 205(j), formerly 77(l), which we considered in 30 B.T.A. 587">Missouri Pacific Railroad Co., supra at 589. There it was found that section 77(j) did not alter the rule of concurrent jurisdiction. So it follows that section 314 does not either.Respondent asserts that section 11(a), 7 Bankruptcy Act, 11 U.S.C. sec. 291972 U.S. Tax Ct. LEXIS 157">169 (a), is inapplicable because the taxes here in issue are not dischargeable. Under section 17a(1), Bankruptcy Act, 11 U.S.C. sec. 35(a)(1), taxes "legally due and owing * * within three years preceding bankruptcy" are dischargeable. The provision for discharge 57 T.C. 842">847 of taxes was made in 1966 by Pub. L. 89-496, supra. The emerging rule appears to be that "legally due and owing," in the case of Federal taxes has reference to the proper filing date for the bankrupt's tax return. In re Able Roofing & Sheet Metal Co., 425 F.2d 699, 701 (C.A. 5, 1970); In re Kopf, 299 F. Supp. 182">299 F. Supp. 182, 299 F. Supp. 182">187 (E.D. N.Y. 1969). The latest year under consideration in present case ended in September 1960. But, whatever the proper rule for determining when taxes are legally due and owing, we find nothing in the history of the legislation adding the discharge for taxes provision which indicates an intent to limit the concurrent jurisdiction provided by section 6871. H. Rept. No. 687, 89th Cong., 1st Sess. (1965), 1966-2 C.B. 770; S. Rept. No. 999, 89th Cong., 2d Sess. (1966), 1966-2 C.B. 743.1972 U.S. Tax Ct. LEXIS 157">170 The quick answer to any assertion that section 2a(15) 8 of the Bankruptcy Act, 11 U.S.C. sec. 11(a)(15), limits the concurrent jurisdiction of this Court where a petitioner has subsequently filed in bankruptcy is that section 2a(15), like the essence of 2a(2A), has been in the Bankruptcy Act since 1898. Ch. 541, sec. 2a(15), 30 Stat. 546; and sec. 282 (b), Revenue Act of 1926, was enacted thereafter. In 30 B.T.A. 587">Missouri Pacific Railroad Co., supra, we had before us an order of a bankruptcy court containing language staying all suits against the debtor just as the above-quoted paragraph (5) of the referee's March 27, 1970, order enjoined suits against the debtor. 1972 U.S. Tax Ct. LEXIS 157">171 The referee's December 23, 1971, order is but a reassertion of his March 27, 1970, order. Such general injunctive language did not prevent us from exercising our concurrent jurisdiction in Missouri Pacific Railroad Co. and so it does not here.The jurisdiction of this Court is to redetermine deficiencies in taxes asserted by the Commissioner under subtitle A and B, and chapter 42 of the Internal Revenue Code of 1954. Secs. 6212, 6213, and 7442. In exercising this jurisdiction we do not pretend to allow or disallow a claim against a debtor's estate based on a deficiency in taxes or to discharge taxes as a bankruptcy court might. As we have said on another occasion:the Tax Court was1972 U.S. Tax Ct. LEXIS 157">172 set up by the Congress as a tribunal possessed of special competence in tax matters, and, as such, should not forbear to decide issues properly before it. [James H. S. Ellis, 14 T.C. 484">14 T.C. 484, 14 T.C. 484">487 (1950).]In cases of concurrent jurisdiction the court which first reaches the case for trial may then proceed to a final decision without interruption and the doctrine of res adjudicata will apply to the result. Ohio Steel Foundry Co. v. United States, 38 F.2d 144, 149, 150 (Ct. 57 T.C. 842">848 Cl. 1930), 23 T.C. 8">Comas, Inc., supra at 10-11. We have not been shown that the bankruptcy court has calendared the deficiencies asserted against Fotochrome for determination.Respondent's motion to calendar these cases for trial is granted, andAppropriate orders will be issued. Footnotes1. Cases of the following petitioners are consolidated herewith: Fotochrome, Inc. (Successor by Merger to Regal Distributors, Inc.), docket No. 1078-68; Fotochrome, Inc. (Successor by Merger to Fame Foto, Inc.), docket No. 1079-68; Fotochrome, Inc. (Successor by Merger to Melrose Photo Service, Inc.), docket No. 1080-68; Fotochrome, Inc. (Successor by Merger to Lord Film Corp.), docket No. 1081-68; Fotochrome, Inc. (Successor by Merger to Fore Foto, Inc.), docket No. 1082-68; Fotochrome, Inc. (Successor by Merger to Chroma Color Corp.), docket No. 1083-68; and Frank Nadaline, Jr., and Malvina Nadaline, docket No. 1084-68.↩2. All statutory references are to the Internal Revenue Code of 1954 unless otherwise indicated.↩3. SEC. 6871. CLAIMS FOR INCOME, ESTATE, AND GIFT TAXES IN BANKRUPTCY AND RECEIVERSHIP PROCEEDINGS.(b) Claim Filed Despite Pendency of Tax Court Proceedings. -- In the case of a tax imposed by subtitle A or B claims for the deficiency and such interest, additional amounts, and additions to the tax may be presented, for adjudication in accordance with law, to the court before which the bankruptcy or receivership proceeding is pending, despite the pendency of proceedings for the redetermination of the deficiency in pursuance of a petition to the Tax Court; but no petition for any such redetermination shall be filed with the Tax Court after the adjudication of bankruptcy, the filing or (where approval is required by the Bankruptcy Act) the approval of a petition of, or the approval of a petition against, any taxpayer in any other bankruptcy proceeding, or the appointment of the receiver.↩4. Sec. 2. Creation of courts of bankruptcy and their jurisdiction.(a) The courts of the United States * * are hereby created courts of bankruptcy and are hereby invested, * * * with such jurisdiction at law and in equity as will enable them to exercise original jurisdiction in proceedings under this title * * * to --* * * (2A) Hear and determine, or cause to be heard and determined, any question arising as to the amount or legality of any unpaid tax, whether or not previously assessed, which has not prior to bankruptcy been contested before and adjudicated by a judicial or administrative tribunal of competent jurisdiction, and in respect to any tax, whether or not paid, when any such question has been contested and adjudicated by a judicial or administrative tribunal of competent jurisdiction and the time for appeal or review has not expired, to authorize the receiver or the trustee to prosecute such appeal or review;↩5. The court shall order the trustee to pay all taxes legally due and owing by the bankrupt to the United States, State, county, district, or municipality in advance of the payment of dividends to creditors, and upon filing the receipts of the proper public officers for such payment he shall be credited with the amount thereof, and in case any question arises as to the amount or legality of any such tax the same shall be heard and determined by the court.↩6. Sec. 314. Stay of actions.The court may, in addition to the relief provided by section 29↩ of this title and elsewhere under this chapter, enjoin or stay until final decree the commencement or continuation of suits other than suits to enforce liens upon the property of a debtor, and may, upon notice and for cause shown, enjoin or stay until final decree any act or the commencement or continuation or any proceeding to enforce any lien upon the property of a debtor.7. Sec. 11. Suits by and against bankrupts.(a) A suit which is founded upon a claim from which a discharge would be a release, and which is pending against a person at the time of the filing of a petition by or against him, shall be stayed until an adjudication or the dismissal of the petition; * *↩8. This section empowers a bankruptcy court to:"Make such orders, issue such process, and enter such judgments, in addition to those specifically provided for, as may be necessary for the enforcement of the provisions of this title: Provided, however↩, That an injunction to restrain a court may be issued by the judge only;"	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625325/	J. E. BIGGS, SR., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Biggs v. CommissionerDocket No. 15255.United States Board of Tax Appeals15 B.T.A. 1092; 1929 BTA LEXIS 2728; March 26, 1929, Promulgated 1929 BTA LEXIS 2728">2728 Petitioner, his wife and two sons, with four others, formed a partnership which operated a coal mine during the taxable years. Held, that there should be included as income taxable to petitioner only the share of partnership net earnings that did not belong to others. E. L. Greever, Esq., for the petitioner. Paul L. Peyton, Esq., for the respondent. LANSDON 15 B.T.A. 1092">1092 The respondent has determined and assessed additional income and profits taxes for the years 1920 and 1921 in the respective amounts of $6,074.48 and $76.90. In due course petitioner filed a bond to stay collection, and instituted this proceeding for a redetermination of his liability for such taxes, alleging that respondent has erroneously included in his gross income certain amounts which were distributed to his wife and two sons by a partnership engaged in the coal mining business. FINDINGS OF FACT. The petitioner is an individual residing at Bramwell, W. Va. For many years prior to the taxable years he had been a successful operator of outcrop coal mines in West Virginia. In January, 1920, at the suggestion of one Jairus Collins, petitioner entered into negotiations1929 BTA LEXIS 2728">2729 with the Buckeye Coal & Coke Co. for a sublease of certain outcrop coal property. An oral lease was obtained on a royalty basis and through Collins, who was manager of the Louisville Coal & Coke Co., which owned the property adjoining that of the Buckeye Co., an arrangement was made to load and ship the coal over a track owned by the former concern. Soon after the above arrangements had been completed petitioner and Collins determined to take in their respective families, since coal prices were high and the enterprise promised to be highly profitable, and in January, 1920, the Norwest Fuel Co. was organized as a copartnership, the parties to the oral agreement being petitioner, Mary J. Biggs, Frank C. Biggs, Edwin Biggs, Jairus Collins, Jairus Collins, Jr., E. E. Hartsook, and H. J. Hartsook. The money needed for the business was borrowed from the Commercial Bank of Bluefield, W. Va., in which Collins was a stockholder, 15 B.T.A. 1092">1093 on the partnership note indorsed by petitioner, Jairus Collins, Sr., and E. E. Hartsook, dated January 16, 1920, in the amount of $2,500. This note was paid on May 15, 1920, and a second note given in the amount of $1,500, which was paid on July 3, 1920. 1929 BTA LEXIS 2728">2730 On June 12, 1920, the previous oral partnership agreement was reduced to writing, as follows: ARTICLES OF AGREEMENT, made the 12th day of June, 1920, between J. E. Biggs, Mary E. Biggs, Frank C. Biggs, Edwin Biggs, Jairus Collins, Jairus Collins, Jr., E. E. Hartsook and H. J. Hartsook, all of Bramwell, mercer County, West Virginia, as follows: The parties above named have agreed to become partners in business for the purpose of conducting and operating the business of coal mining, and, by these presents, do agree to be partners together under the firm name of Norwest Fuel Company, in the business of mining shipping and marketing coal at and from the village of Goodwill, in Mercer County and State of West Virginia, and doing all other acts pertaining thereto, their partnership to be retroactive to and to be in effect and to continue for the period of five years from that date or until all of the coal under lease from the Buckeye Coal & Coke Company, a West Virginia corporation, to the said partnership may have been mined, be that sooner or later than the expiration of five years. And it is agreed and understood by and between the parties hereto that J. E. Biggs, one of the partners1929 BTA LEXIS 2728">2731 herein, shall have active charge of the production of coal and that he shall be paid a salary commensurate with his services, which amount shall be considered as a part of the expense of doing business; and it is agreed and understood that E. E. Hartsook, another of the partners herein, shall have charge of and be responsible for the sale of the coal mined and sold under this contract of partnership and that he shall handle and be responsible for all money received and disbursed in the conduct of the business and that he shall render proper accounting to the other partners named herein at stated intervals or whenever required so to do by any or all of them of all funds received and disbursed, and it is agreed by the said partners that there shall be had and kept at all times during the continuance of this partnership just and accurate books of account, wherein shall be kept an accurate record of all business transactions conducted by the partnership or any of the partners, which said books of account shall be accessible to any or all of the partners at any and all times. And it is also agreed and understood that any and all profits accruing to this partnership as well as any and all1929 BTA LEXIS 2728">2732 losses and expenses sustained by this partnership shall be divided among the partners in the following proportion: J. E. Biggs23 per cent.Mary J. Biggs23 per cent.F. C. Biggs2 per cent.Edwin Biggs2 per cent.Jairus Collins12 1/2 per cent.Jairus Collins, Jr12 1/2 per cent.E. E. Hartsook12 1/2 per cent.H. J. Hartsook12 1/2 per cent.And the said partners hereby mutually agree to and with each other that during the said partnership neither of them shall or will endorse any note or otherwise become surety for any person or persons whomsoever without the consent of the others of said partnership. In witness whereof the undersigned have affixed their signatures and seals, this 12th day of June, 1920. Eight copies executed. 15 B.T.A. 1092">1094 Mary J. Biggs is the wife of petitioner. F. C. and Edwin Biggs are his sons. Edwin Biggs became nineteen years of age on February 12, 1920. Petitioner acted as manager of the Norwest Fuel Co.; E. E. Hartsook, who was Collins' secretary, kept the accounts and sold the coal; F. C. Biggs, except for a period of about two months when he was in a mining school at Morgantown, was in charge of the actual1929 BTA LEXIS 2728">2733 mining operations. Preparations for mining coal were started in January or February, 1920. The first coal was shipped in April or May, 1920. Profits were first distributed on July 3, 1920, such distribution being in accordance with the percentages set out in the written partnership agreement. The net income of the Norwest Fuel Co. for 1920 and 1921 was $92,812.64 and $10,861.33, respectively. Each of the parties received and has returned and paid taxes on his distributive share of the partnership earnings. The respondent has determined that 50 per cent of the net earnings of the Norwest Fuel Co. for each of the years, which amount includes the distributive shares under the partnership agreement of petitioner's wife and his two sons, constituted income taxable to the petitioner. OPINION. LANSDON: We are concerned here with the single issue whether certain income from an alleged partnership is taxable to the petitioner alone, or to him, his wife and his two sons. The respondent net income of the Norwest Fuel Co. for 1920 and 1921, contending as the basis for such action that Mary J. Biggs, F. C. Biggs and Edwin Biggs were not in fact and in law partners in the Norwest1929 BTA LEXIS 2728">2734 Fuel Co. and that the agreement of partnership, in so far as it relates to petitioner and his family, amounted to nothing more than a gift of income by petitioner to his wife and two sons. We are convinced from the evidence that a bona fide partnership was entered into in January, 1920, between petitioner, Mary J. Biggs, Frank C. Biggs, Edwin Biggs, Jairus Collins, Jarius Collins, Jr., E. E. Hartsook, and H. J. Hartsook. The parties intended and agreed to form a partnership and agreed to share the profits and losses. As the respondent points out, petitioner's wife and two sons contributed no property to the partnership and of the three only Frank contributed services. None of the partners, however, contributed property to the partnership. The capital needed in the conduct of the business was borrowed on the partnership note which was, in effect, a contribution by each party to the agreement of partnership. Edwin Biggs was 19 years of age when the partnership agreement was executed. His infancy was a factor which enabled him 15 B.T.A. 1092">1095 to disaffirm his obligations and agreements. It was a personal privilege, however, and, having elected to abide by the partnership contract, 1929 BTA LEXIS 2728">2735 his position is that of any responsible person. ; . The respondent alleges that in West Virginia a partnership between husband and wife is void. In a recent comprehensive and much cited opinion, ; ; L.R.A., 1917 D, 440, the supreme court of that State has clearly defined the status of a partnership between husband and wife. In its opinion the court states: On more than one occasion, it has been declared that the husband and wife cannot contract with one another, and that the statute has not altered the common law in this respect. ; ; ; ; ; 1929 BTA LEXIS 2728">2736 . * * The legislative action thus disclosed indicates intention not to disturb the common-law rule as to contracts between husband and wife. * * * The disability of the husband and wife to contract with one another, though absolute in the legal forum, is purely technical. Their contracts are enforceable in equity, if just and fair. They are denied a legal status to the end and purpose that they may be always within the power of the chancellor for enforcement, annulment, or modification, as the equities of the situation require. The ban under which such contracts fall is only partial. They are not wholly bad, nor are they prohibited by positive law. They are merely unenforceable in courts of law, or by strict legal process. In the broad sense of the law, including the equity jurisprudence as well as the legal, they are valid. * * * Cf. ; ; 1929 BTA LEXIS 2728">2737 ; ; ; Schouler on Marrriage, Divorce and Domestic Relations (6th Ed.), p. 549. In the instant proceeding the respondent has included as income taxable to petitioner the shares of the partnership net earnings distributed to his wife and two sons, under the terms of the agreement. In the Bolyard case, supra, the court points out that the husband is under disability as to his wife's property. At page 530 it is stated: * * The common-law rule places the husband as well as the wife under disability as to contracts made directly between them. He could no more bind himself to her by his contract than she could bind herself to him in such manner. Nothing in the statute discloses intention to emancipate him from this disability. On the contrary, the effect of the statute is to diminish his power respecting his wife's property and enlarge hers. * * * The purpose of the Married Woman's Act in West Virginia is to protect her property. Mary J. Biggs has actually participated in conducting a partnership business which resulted in large profits1929 BTA LEXIS 2728">2738 15 B.T.A. 1092">1096 and she will be protected in her share thereof even against creditors of her husband. ; ; . In 13 R.C.L. 1370, this question is discussed as follows: On the other hand, the rule denying the right to form such a partnership is intended for the protection of the wife's separate property, to prevent her from entering into such engagements with her husband that her separate property may be taken from her in satisfaction of his debts; the purpose of the rule is, not to work a loss to the wife, but to prevent it, and therefore, where a husband and wife have conducted a partnership business which has resulted in large profits, she will be protected in her share thereof even as against creditors of her husband. In an action against the partnership the petitioner could not have recovered the share of his wife and children in the partnership earnings. His wife received the profits accruing to her as a partner, made income-tax reports accordingly, and paid the tax. We are of the opinion that the respondent erred in including as petitioner's1929 BTA LEXIS 2728">*2739 income that part of the partnership net earnings which belonged to others. Cf. ; ; ; ; ; . 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/4625326/	KATHLEEN S. SIMPSON AND GEORGE T. SIMPSON, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentSimpson v. Comm'rDocket No. 26619-11.United States Tax Court141 T.C. 331; 2013 U.S. Tax Ct. LEXIS 30; 141 T.C. No. 10; October 28, 2013, Filed2013 U.S. Tax Ct. LEXIS 30">30 Decision will be entered under Rule 155.P-W sued E, her employer, for employment discrimination under California's Fair Employment and Housing Act (FEHA), claiming, among other things, that she was entitled to compensatory damages for, among other things, physical injuries. After the State court dismissed all but one claim alleged in the suit, P-W's attorney concluded that P-W would not be able to extract a settlement from E on the basis of the one remaining FEHA claim. P-W's attorney learned, however, that P-W was eligible for workers' compensation benefits under California's workers' compensation laws. On that basis alone, P-W and E engaged in settlement discussions and eventually entered into a settlement agreement by which P-W released E from "each and every claim" she might have against E, "including, but not limited to, claims asserted in" the FEHA lawsuit; the settlement agreement did not specifically mention P-W's possible workers' compensation claims. Neither P-W nor E submitted the settlement agreement to the California Workers' Compensation Appeals Board (WCAB) for the approval required under California's workers' compensation laws. Ten percent of the settlement award was 2013 U.S. Tax Ct. LEXIS 30">31 attributable to P-W's personal physical injuries and physical sickness.Held: None of the settlement payment P-W received is excludable from Ps' gross income under I.R.C. sec. 104(a)(1) because P-W did not obtain the requisite approval from the WCAB required by the State's workers' compensation laws.Held, further, 10% of P-W's settlement award is excludable from Ps' gross income under I.R.C. sec. 104(a)(2) and the newly amended regulations under that section, which exclude damages from income as long as recovery is for personal physical injuries or physical sickness even if recovery is under a statute that does not provide for a broad range of remedies and even if the injury is not defined as a tort under State or common law.Held, further, the portion of the settlement award allocated to attorney's fees and court costs is deductible under I.R.C. sec. 62(a)(20).Elizabeth L. Riles and David C. Anton, for petitioners.Matthew D. Carlson, for respondent.LARO, Judge.LARO141 T.C. 331">332 LARO, Judge: Respondent determined a Federal income tax deficiency of $73,407 for 2009 and an accuracy-related penalty under section 6662(a) of $14,681.1 Petitioners, while residing in California, timely petitioned this Court 2013 U.S. Tax Ct. LEXIS 30">32 to redetermine respondent's determination. Following respondent's concession that petitioners are not liable for the accuracy-related penalty, we decide: (1) whether any portion of $250,0002 petitioners received in 2009 in settlement of a dispute with Sears, Roebuck & Co. (Sears) is excludable from their gross income under section 104(a)(1) or (2). We hold it is not excludable under section 104(a)(1) but excludable under section 104(a)(2) to the extent set out in this Opinion; (2) whether section 62(a)(20) allows petitioners to deduct $152,000 of attorney's fees and court costs as an above-the-line deduction. We hold it does.FINDINGS OF FACTThe parties filed with the Court a stipulation of facts and related exhibits. Those facts and exhibits are incorporated in this Opinion by this reference. We find the 2013 U.S. Tax Ct. LEXIS 30">33 facts accordingly.Ms. Simpson started working for Sears in 1972 and performed various jobs such as data retrieval, project management, compensation management, and human resources. In 141 T.C. 331">333 the latter part of the 1990s Ms. Simpson began taking on more responsibilities and was promoted to manager of a small store in Prescott, Arizona, a position she held for about 18 months. Subsequently, she was promoted to a district-level position as a merchandise manager assisting the stores to purchase and assort hardware and lawn and garden merchandise. Two years after that, in October 2000 Ms. Simpson was transferred to manage another Sears store in Fairfield, California.The Fairfield store was much larger than the Prescott store, e.g., the Fairfield store had three times the sales volume and a fuller assortment of merchandise than the Prescott store. In addition, Ms. Simpson knew that the Fairfield store was a problem store in that the prior store manager and prior numerous management and staff were terminated and almost the entire staff had less than one year of management experience.Because of the problems at the store and the need to provide relief to the staff, Ms. Simpson had to work long hours, 2013 U.S. Tax Ct. LEXIS 30">34 sometimes 50 to 60 hours a week in addition to her three-hour daily commute. In addition, Ms. Simpson had to fill in for some of her sales managers and engage in strenuous physical activities such as receiving, unpacking, and stocking merchandise, moving garments from racks, and ripping plastic. The physical exertion resulted in injuries to her shoulders, to her left knee, and to her neck. Ms. Simpson became exhausted, lost 25 pounds, and considered committing suicide. She sought counselors and physicians for treatment and was ultimately diagnosed with clinical depression, irritable bowel syndrome, and fibromyalgia.In March 2002 Ms. Simpson approached Sears' district human resources manager, Nancy Mallory, and informed her of the diagnoses and the physical problems Ms. Simpson was experiencing. Ms. Simpson also told Ms. Mallory that her sickness was work related and that on the advice of her doctor, she wanted to transfer to another position. Ms. Simpson fully expected Ms. Mallory to refer the issue to management and to provide a reasonable solution.Ms. Mallory never informed anyone within Sears of the information Ms. Simpson provided in the March 2002 meeting. Nor did Ms. Mallory 2013 U.S. Tax Ct. LEXIS 30">35 tell anyone that Ms. Simpson 141 T.C. 331">334 had requested a transfer because of her work-related clinical depression and physical illness.After not hearing back from Ms. Mallory about her complaints, Ms. Simpson spoke to Sears' district manager in June of the same year and advised him of the diagnoses. Ms. Simpson also explained to the district manager that her clinical depression and physical sickness were work related and requested that she be transferred to another position. Sears never transferred Ms. Simpson to another position. In August 2002, Sears terminated Ms. Simpson's employment. No one at Sears ever provided Ms. Simpson with a California Workers' Compensation Claim Form or with information about filing such a claim.Ms. Simpson continued to suffer from depression and work-related physical injuries after her termination, and she remained unemployed for one year. She was then able to secure a retail position with a home improvement retail chain where she had to quit after a month because of the limitations imposed by her mental and physical problems. She eventually secured employment with the State of California in a human resources position and remains employed there today.After termination 2013 U.S. Tax Ct. LEXIS 30">36 of her employment with Sears, Ms. Simpson retained David Anton to file a lawsuit against Sears under California's Fair Employment and Housing Act (FEHA). The first amended complaint alleged in the first cause of action a claim for employment discrimination on the basis of gender, age, and harassment in violation of Cal. Gov't Code sec. 12940(a), (j) and (k) (West 2011). The first cause of action claimed that Ms. Simpson experienced lost wages, lost employment benefits, emotional distress, and mental pain and suffering. The second cause of action alleged retaliation in employment in violation of Cal. Gov't Code sec. 12940(h) and claimed Ms. Simpson experienced lost wages, lost employment benefits, emotional distress, and mental pain and suffering resulting in physical injury.The third cause of action alleged two claims. One claim under Cal. Gov't Code sec. 12940(m) alleged that Sears failed to provide a reasonable accommodation of a job transfer for Ms. Simpson after learning of her work-related mental disability. The other claim under Cal. Gov't Code sec. 12940(n) alleged that Sears failed to engage in an interactive process 141 T.C. 331">335 with Ms. Simpson when it learned that Ms. Simpson had a work-related 2013 U.S. Tax Ct. LEXIS 30">37 mental disability, was receiving treatment, and had asked to be transferred to another position because of the disability. The third cause of action alleged that Ms. Simpson suffered lost wages and employment benefits, emotional distress, mental pain and suffering, and physical injury. Ms. Simpson sought economic damages (e.g., back and future pay), noneconomic damages (e.g., compensatory damages for emotional distress), punitive damages, interest, attorney's fees and costs, and appropriate injunctive relief.Sears filed a summary judgment and adjudication motion that was heard in May 2009. The State court granted Sears' motion on the first and second causes of action. As to the third cause of action, the State court granted Sears' motion on the claim under Cal. Gov't Code sec. 12940(m) but allowed the claim under Cal. Gov't Code sec. 12940(n) to go forward. In reaching its decisions, the State court found Ms. Simpson could not prove that Sears had fired her for reasons other than poor job performance or that her transfer to another position within Sears would have been a reasonable accommodation.Ms. Simpson and Sears later engaged in settlement discussions. Mr. Anton concluded that 2013 U.S. Tax Ct. LEXIS 30">38 as a result of the State court's findings, Ms. Simpson would not be able to claim damages for lost wages or emotional distress on the basis of Sears' failure to engage in an interactive process required under Cal. Gov't Code sec. 12940(n).3 However, Mr. Anton's research led him to conclude that Sears' failure to give Ms. Simpson a California Workers' Compensation Claim Form and a notice of potential eligibility for benefits that were required under California's workers' compensation laws, seeCal. Lab. Code secs. 5400-5413 (West 2011), violated Sears' legal obligations under those laws.Mr. Anton relayed his conclusion to Sears' counsel and asserted that Ms. Simpson would have been entitled to certain workers' compensation benefits, including benefits for temporary disabilities and permanent disabilities resulting 141 T.C. 331">336 from work-related injuries, if she had filed such a claim.4 Mr. Anton believed these workers' compensation benefits were the only damages available to Ms. Simpson, and he formulated a settlement proposal on that basis alone. He hypothesized 2013 U.S. Tax Ct. LEXIS 30">39 the weekly temporary disability benefits that Ms. Simpson would be entitled to receive under California's workers' compensation laws (approximately $500) as well as an additional 25% penalty that could be imposed on Sears for failing to advise Ms. Simpson of potential workers' compensation eligibility and benefits, as the amount of temporary disability benefits owing to Ms. Simpson. Mr. Anton referenced the Schedule for Rating Permanent Disabilities issued under California workers' compensation laws as the amount of permanent disability award Ms. Simpson would be entitled to receive. These two amounts formed the sole basis of a settlement agreement that Ms. Simpson and Sears later entered into in June 2009 as to Ms. Simpson's lawsuit against Sears.In exchange for the release, Sears agreed to pay under the settlement agreement $12,500 to Ms. Simpson as to her claim for lost wages and employment benefits; $98,000 to Ms. Simpson as to her claims for "emotional distress, physical and mental 2013 U.S. Tax Ct. LEXIS 30">40 disability"; and $152,000 to Mr. Anton for attorney's fees and court costs. Mr. Anton understood that the $98,000 was intended to compromise Ms. Simpson's claim for workers' compensation benefits for "emotional distress and physical and mental disabilities" that she suffered from work-related injuries, i.e., clinical depression, irritable bowel syndrome, and fibromyalgia, while working for Sears, and he attributed 10% to 20% of the $98,000 to the work-related physical illness and disabilities Ms. Simpson suffered. The settlement agreement provides that California laws govern the contract and states thatSIMPSON expressly waives, releases and forever discharges the Company from each and every claim, whether known or unknown that SIMPSON has, had, or might have, arising out of, or related to, any events occurring up to the date this Agreement is fully executed, including, but not limited to, claims asserted in * * * [the FEHA lawsuit]. SIMPSON also promises that she will not seek any further compensation 141 T.C. 331">337 for any other claimed damages, costs or attorneys' fees in connection with the matters encompassed in this Agreement. [Emphasis added.]Ms. Simpson never filed a workers' compensation 2013 U.S. Tax Ct. LEXIS 30">41 claim, and Sears and Ms. Simpson never submitted the settlement agreement to the California Workers' Compensation Appeals Board (WCAB) for the approval required under Cal. Lab. Code sec. 5001 (West 2011). Mr. Anton was not aware of the approval requirement.Petitioners timely filed their 2009 Federal income tax return with the assistance of H&R Block. The 2009 return reported as income the $12,500 payment that Sears made to Ms. Simpson for lost wages and employment benefits. The 2009 return did not report anything else from the settlement. Petitioners attached to the 2009 return a letter dated March 18, 2010, from Mr. Anton, explaining the nature of the $250,000 proceeds reported in petitioners' Form 1099-MISC, Miscellaneous Income, received from Sears and why petitioners were not reporting any portion of it. The letter stated the following:The listed amount includes amounts that were paid to my office for attorney's fees and costs, which my office is reporting as income, in the amount of $113,985.60, for a net to Ms. Simpson from the $250,000.00 of $136,014.40. Due to the nature of the claim that was settled, although I am not Ms. Simpson's tax adviser, I understand that the settlement 2013 U.S. Tax Ct. LEXIS 30">42 proceeds should not be considered taxable. * * ** * * [On the summary judgment and adjudication motion, the] Judge found that there was evidence that the Human Resources Manager failed to take any action or interact with anyone at the company as a result of the information that Ms. Simpson was sick and disabled as a result, and failed to advise the direct managers over Ms. Simpson of the illness and resulting disability. The Human Resources Manager should have considered placing Ms. Simpson on Workers' Compensation disability leave, or on Short Term Disability leave, but did not do so.The settlement was entirely based upon the claim that Ms. Simpson became ill due to work, became disabled due to the severity of that illness, and Ms. Simpson should have been accommodated by being provided Workers' Compensation or Short Term Disability Leave, but was not. It is our understanding that a lawsuit settlement based on illness and disability from work are non-taxable settlement proceeds to the injured taxpayer.141 T.C. 331">338 On April 25, 2011, respondent issued to petitioners a notice of deficiency in which he determined that petitioners failed to report the $250,000 settlement proceeds as income. In response, 2013 U.S. Tax Ct. LEXIS 30">43 petitioners filed the instant petition.OPINIONGross income includes all income from whatever source derived, sec. 61(a); Commissioner v. Glenshaw Glass Co., 348 U.S. 426">348 U.S. 426, 348 U.S. 426">429, 75 S. Ct. 473">75 S. Ct. 473, 99 L. Ed. 483">99 L. Ed. 483, 1955-1 C.B. 207 (1955), unless specifically excluded. Under section 104(a)(1), "amounts received under workmen's compensation acts" to compensate for personal injuries or sickness are excluded from income. Section 104(a)(2) excludes from income the amount of any damages (other than punitive damages) received (by suit or agreement) on account of personal physical injuries or physical sickness.Adjusted gross income means gross income less certain enumerated deductions. Sec. 62(a). One of these deductions is a deduction for attorney's fees and court costs paid by, or on behalf of, a taxpayer in connection with any action involving a claim of unlawful discrimination. Sec. 62(a)(20).Petitioners argue primarily that the entire settlement amount in issue, $250,000, is excludable from gross income under section 104(a)(1) as an amount received under California's workers' compensation laws. Petitioners argue alternatively that (1) up to 20% of the $98,000 settlement figure allocated to "emotional distress and physical and mental disabilities" 2013 U.S. Tax Ct. LEXIS 30">44 is excludable from gross income under section 104(a)(2) as an amount received on account of personal physical injuries and physical sickness and that (2) petitioners are entitled to deduct under section 62(a)(20) $152,000 allocated to attorney's fees and court costs in connection with Ms. Simpson's FEHA action involving unlawful discrimination claims.I. Burden of proofThe Commissioner's determinations in a notice of deficiency are generally presumed correct, and a taxpayer bears the burden of proving those determinations are erroneous. Rule 142(a); Welch v. Helvering, 290 U.S. 111">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, 1933-2 C.B. 112 (1933). It is well established that statutory exclusions, such as those provided in section 104, are to be narrowly construed, see 141 T.C. 331">339 Commissioner v. Schleier, 515 U.S. 323">515 U.S. 323, 515 U.S. 323">328, 115 S. Ct. 2159">115 S. Ct. 2159, 132 L. Ed. 2d 294">132 L. Ed. 2d 294 (1995), and that taxpayers generally bear the burden of proving that they fall squarely within the requirements for any exclusion from gross income, Forste v. Commissioner, T.C. Memo. 2003-103, 85 T.C.M. 1146">85 T.C.M. 1146, 1151 (2003).At trial, petitioners conceded that the burden of proof falls on them. In their posttrial brief, however, petitioners for the first time request the Court to shift the burden of proof to respondent under section 7491(a).52013 U.S. Tax Ct. LEXIS 30">45 We find that petitioners conceded this issue at trial and that their request made in the posttrial brief to shift the burden of proof to respondent prejudices respondent and is untimely. See Dunne v. Commissioner, T.C. Memo 2008-63, 95 T.C.M. 1236">95 T.C.M. 1236, 1240 (2008); Smith v. Commissioner, T.C. Memo 2007-368, 94 T.C.M. 574">94 T.C.M. 574, 581 (2007), aff'd, 364 Fed. Appx. 317">364 Fed. Appx. 317 (9th Cir. 2009); Deihl v. Commissioner, T.C. Memo 2005-287, 90 T.C.M. 579">90 T.C.M. 579, 584 (2005). At a minimum, respondent has not been afforded an opportunity to test petitioners' allegations, either by cross-examination or by producing evidence, that petitioners have complied with the substantiation and recordkeeping requirements under section 7491(a)(2).II. Exclusion from incomeGross income does not include "amounts received under workmen's compensation acts as compensation for personal injuries or sickness" as well as "the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical 2013 U.S. Tax Ct. LEXIS 30">46 injuries or physical sickness". Sec. 104(a)(1) and (2). When a taxpayer receives a payment under a settlement agreement, as is the case here, the nature of the claim that was the actual basis for settlement guides our determination of whether such payments are excludable from income. See United States v. Burke, 504 U.S. 229">504 U.S. 229, 504 U.S. 229">237, 112 S. Ct. 1867">112 S. Ct. 1867, 119 L. Ed. 2d 34">119 L. Ed. 2d 34 (1992). Whether a settlement is achieved through a judgment or by a compromise agreement, the question to be asked is "In lieu of what were the damages 141 T.C. 331">340 awarded?" Fono v. Commissioner, 79 T.C. 680">79 T.C. 680, 79 T.C. 680">692 (1982), aff'd without published opinion, 749 F.2d 37">749 F.2d 37 (9th Cir. 1984).6A. Sears' intentWhat Ms. Simpson and Sears intended to compromise through 2013 U.S. Tax Ct. LEXIS 30">47 the settlement agreement is a question of fact, see Bagley v. Commissioner, 105 T.C. 396">105 T.C. 396, 105 T.C. 396">406 (1995), aff'd, 121 F.3d 393">121 F.3d 393 (8th Cir. 1997), determined by reference to the express language of the agreement, Knuckles v. Commissioner, 349 F.2d 610">349 F.2d 610, 349 F.2d 610">613 (10th Cir. 1965), aff'gT.C. Memo. 1964-33. If we cannot find evidence of the parties' express intent in the settlement agreement specifying the purpose of the compensation, we look to the payor's intent. Rivera v. Baker West, Inc., 430 F.3d 1253">430 F.3d 1253, 430 F.3d 1253">1257 (9th Cir. 2005); Knuckles v. Commissioner, 349 F.2d 610">349 F.2d at 613; see also Fono v. Commissioner, 79 T.C. 680">79 T.C. 696 (stating that payee's belief as to reasons for payment is relevant evidence although ultimate inquiry is into payor's reasons for payment); cf. Commissioner v. Duberstein, 363 U.S. 278">363 U.S. 278, 363 U.S. 278">285-286, 80 S. Ct. 1190">80 S. Ct. 1190, 4 L. Ed. 2d 1218">4 L. Ed. 2d 1218 (1960) (stating that transferor's intention is most crucial consideration in determining whether payment is gift). Under California law, which governs the interpretation of Ms. Simpson's settlement agreement with Sears, we must consider all credible evidence to determine whether the language of the agreement is fairly susceptible of more than one interpretation, and if it is, we must consider extrinsic 2013 U.S. Tax Ct. LEXIS 30">48 evidence relevant to prove which one of these meanings reflects the intent of the contracting parties. Pac. Gas & Elec. Co. v. G.W. Thomas Drayage & Rigging Co., 69 Cal. 2d 33">69 Cal. 2d 33, 69 Cal. 2d 33">39-40, 69 Cal. Rptr. 561">69 Cal. Rptr. 561, 442 P.2d 641">442 P.2d 641 (1968).The settlement agreement is ambiguous as to whether it was made to settle Ms. Simpson's FEHA claims, her workers' compensation claims, or both. The preamble of the agreement broadly states that Sears and Ms. Simpson desired to resolve all claims Ms. Simpson raised or could have raised in the 141 T.C. 331">341 FEHA lawsuit as well as "any other matters involving SIMPSON's former employment relationship with * * * [Sears]", but it falls short of expressly including Ms. Simpson's workers' compensation claim. Indeed, the settlement agreement includes multiple references to the FEHA lawsuit but does not mention Ms. Simpson's potential workers' compensation claims at all. But we also accept Mr. Anton's credible testimony that he had advised Sears' counsel that his client was eligible to make such claims. In the light of this fact, the broad and inclusive general release in the settlement agreement ought to place Ms. Simpson's workers' compensation claims under the settlement agreement although the agreement itself does 2013 U.S. Tax Ct. LEXIS 30">49 not state so expressly.Ambiguity also arises where California's workers' compensation laws specifically require that any compromise agreement to settle such workers' compensation claims be submitted to the WCAB for approval, and the parties did not do so here. From this fact one may infer that the parties, who were represented by presumably competent counsel, did not contemplate any potential workers' compensation claim. See Steller v. Sears, Roebuck & Co., 189 Cal. App. 4th 175">189 Cal. App. 4th 175, 189 Cal. App. 4th 175">182, 116 Cal. Rptr. 3d 824">116 Cal. Rptr. 3d 824 (Ct. App. 2010). Because extrinsic evidence before us exposes a latent ambiguity in Ms. Simpson's settlement agreement with Sears, we must consider extrinsic evidence to determine the parties' intent. See 189 Cal. App. 4th 175">id. at 183 (finding ambiguity in settlement agreement and concluding on extrinsic evidence that settlement encompassed workers' compensation claim and disability discrimination claim).We find Ms. Simpson and Mr. Anton to be generally credible. Ms. Simpson testified that she believed the settlement agreement was made to settle her one remaining FEHA claim (i.e., Sears' failure to engage in an interactive process under Cal. Gov't Code sec. 12940(n)) and her workers' compensation claims. Mr. Anton testified 2013 U.S. Tax Ct. LEXIS 30">50 that he saw no damage potential on the basis of the one remaining claim in the FEHA lawsuit and concluded that he could extract a settlement from Sears only on the basis of Ms. Simpson's entitlement to workers' compensation benefits. Mr. Anton also testified credibly that the $98,000 amount was determined by reference to the disability benefits provided under California's workers' compensation laws for the "emotional distress, physical and mental disability" that Ms. Simpson suffered while 141 T.C. 331">342 employed at Sears. He further testified credibly that 10% to 20% of the $98,000 portion of the settlement amount was attributable to personal physical injuries (other than emotional distress). Viewing the entire record before us, we find that Sears and Ms. Simpson intended to settle her workers' compensation claims and that a portion of the settlement was made to compensate her for her work-related personal physical injuries and sickness.B. Section 104(a)(1)The intent of the parties to a settlement of a workers' compensation claim does not necessarily mean that the payment is excludable under section 104(a)(1), however.72013 U.S. Tax Ct. LEXIS 30">52 Section 104(a)(1) excludes from gross income amounts received by an employee 2013 U.S. Tax Ct. LEXIS 30">51 under a workers' compensation act or under a statute in the nature of a workers' compensation act that provides compensation to employees for occupational personal injuries or sickness. Sec. 1.104-1(b), Income Tax Regs. To qualify for the exclusion, a taxpayer must show that she received her benefits under a statute or a regulation. Rutter v. Commissioner, 760 F.2d 466">760 F.2d 466, 760 F.2d 466">468 (2d Cir. 1985), aff'gT.C. Memo. 1984-525 (1984). In other words, unless payments are made pursuant to "'a rule of general applicability promulgated by a public agency to govern conduct within the agency's jurisdiction'", a taxpayer cannot exclude the payments from gross income under section 104(a)(1). Wallace v. United States, 139 F.3d 1165">139 F.3d 1165, 139 F.3d 1165">1167 (7th Cir. 1998) (quoting Rutter v. Commissioner, 760 F.2d 466">760 F.2d at 468). Thus, for Ms. Simpson's settlement payment to be an amount "received under workmen's compensation acts," the settlement agreement must comply with the statutory requirements to be valid under California's workers' compensation laws and not go beyond the scope of such laws.8California's workers' compensation laws set up a strict regime for parties to validly settle a workers' compensation 141 T.C. 331">343 claim under those laws. The laws provide a rule of general applicability requiring that the WCAB approve any release of or agreement to compromise an employer's liability for workers' compensation benefits before the agreement or release could become valid. Cal. Lab. Code sec. 5001. The same laws also require that the parties file the signed release or compromise agreement with the WCAB for the board to enter the award based on the release or compromise agreement. Id. sec. 5002. Petitioners have acknowledged that they never submitted the settlement agreement in issue to WCAB for approval, nor did they obtain the required approval from the board. Mr. Anton apparently was not aware of these requirements under Cal. Lab. Code secs. 5001 and 5002.Because the settlement agreement 2013 U.S. Tax Ct. LEXIS 30">53 fails to meet the express requirement of California's workers' compensation laws to obtain approval from the WCAB, any payments received under the agreement cannot be payments received under or pursuant to the State's workers' compensation act. The aggregate payments of $250,000 petitioners received under the settlement agreement are merely payments made under a private contract, cf. Rutter v. Commissioner, 760 F.2d 466">760 F.2d at 468, that has no force or effect under California's workers' compensation laws, see Steller, 189 Cal. App. 4th 175">189 Cal. App. 4th at 181-182; Raischell & Cottrell, Inc. v. Workmen's Comp. Appeals Bd., 249 Cal. App. 2d 991">249 Cal. App. 2d 991, 249 Cal. App. 2d 991">997, 58 Cal. Rptr. 159">58 Cal. Rptr. 159 (Ct. App. 1967).A recent California State court decision informs our conclusion. The State court in Steller was confronted with facts very similar to those here. There, an employee sued her employer for disability discrimination and was simultaneously pursuing a workers' compensation claim against her employer. Steller, 189 Cal. App. 4th 175">189 Cal. App. 4th at 178. The parties entered into an agreement to settle all of the employee's claims that arose from the lawsuit and related to her employment; the settlement agreement did not expressly mention the pending workers' compensation 2013 U.S. Tax Ct. LEXIS 30">54 action. 189 Cal. App. 4th 175">Id. at 179. The trial court entered a judgment in the disability discrimination action according to the terms of the compromise agreement. Id. The record did not show that the parties were aware of the approval requirement or contemplated obtaining the WCAB's approval. 189 Cal. App. 4th 175">Id. at 181.141 T.C. 331">344 On appeal, the California Court of Appeal construed the judgment as encompassing both the disability discrimination and workers' compensation claims. 189 Cal. App. 4th 175">Id. at 180. But citing Cal. Lab. Code sec. 5001, the court stated that "'the effect of the section, by its clear wording, is to make every compromise invalid until it is approved by [the WCAB].'" Id. (alteration in original) (quoting Chavez v. Indus. Accident Comm'n, 49 Cal. 2d 701">49 Cal. 2d 701, 49 Cal. 2d 701">702, 321 P.2d 449">321 P.2d 449 (1958)). The Court of Appeal thus held that a compromise agreement seeking to settle both a civil action and a related workers' compensation claim must be deemed to have been conditioned on the WCAB's approval. 189 Cal. App. 4th 175">Id. at 181. Until parties to a settlement obtain such approval, any compromise and release of workers' compensation liability is invalid. Id.; see also Raischell & Cottrell, Inc., 249 Cal. App. 2d 991">249 Cal. App. 2d at 997.Thus, the settlement agreement between Sears and Ms. Simpson 2013 U.S. Tax Ct. LEXIS 30">55 is not a valid agreement to settle her workers' compensation claims because the parties failed to obtain the requisite approval from the WCAB. Because neither Sears nor Ms. Simpson has taken the crucial step to submit the settlement agreement for the WCAB's approval, any payments received under the settlement are not "amounts received under workers' compensation acts". See Forste v. Commissioner, 85 T.C.M. 1146">85 T.C.M. (CCH) at 1152 n.15.C. Section 104(a)(2)We now turn to petitioners' alternative claim that 10% to 20% of the $98,000 received under the settlement agreement is excludable under section 104(a)(2) as an amount received "on account of personal physical injuries or physical sickness."1. Section 104(a)(2) regulationsThe Supreme Court has held that for a recovery to be excludable under section 104(a)(2), a taxpayer must "demonstrate that the underlying cause of action giving rise to the recovery is 'based upon tort or tort type rights'; * * * [in addition], the taxpayer must show that the damages were received 'on account of personal injuries or sickness.'"9141 T.C. 331">345 Commissioner v. Schleier, 515 U.S. 323">515 U.S. at 337. The requirement that recovery be based on a tortlike action was rooted in the former regulations, 2013 U.S. Tax Ct. LEXIS 30">56 seesec. 1.104-1(c), Income Tax Regs., before amendment by T.D. 9573, 2012-12 I.R.B. 498 (former regulations), which for the first time "formally * * * linked identification of a personal injury for purposes of §104(a)(2) to traditional tort principles".102013 U.S. Tax Ct. LEXIS 30">57 Burke, 504 U.S. 229">504 U.S. at 234; see alsoT.D. 6500, 25 Fed. Reg. 11402, 11490 (Nov. 26, 1960).Fifteen years after Congress amended section 104(a)(2) in 1996 to state that the section applies to personal injuries and sickness that are physical, the Secretary amended the regulations and abandoned the "based upon tort or tort type rights" requirement so long as recovery is for personal physical injuries or physical sickness even if recovery is under a statute that does not provide for a broad range of tort remedies. Seesec. 1.104-1(c), Income Tax Regs.112013 U.S. Tax Ct. LEXIS 30">58 141 T.C. 331">346 We have said that "[s]ettlement amounts which are paid to settle workers' compensation claims are not excludable from gross income under section 104(a)(2) * * [because] claims for workers' compensation do not necessarily involve tort or tort type rights." Forste v. Commissioner, 85 T.C.M. 1146">85 T.C.M. (CCH) at 1155 ("A worker's compensation claim is not itself a tort or tort type cause of action since its elements involve fixed awards and since it is based on no-fault principles."). Hence, absent a change in the law that applied in this case, the result here would seem to flow from our statement in Forste.122013 U.S. Tax Ct. LEXIS 30">59 2013 U.S. Tax Ct. LEXIS 30">60 Such a change in law, however, appears in the new regulations which have dispensed with the "based upon tort or tort type rights" requirement outlined in Burke and its progeny.The parties do not dispute the validity of the new regulations, and in the setting at hand we apply them as written.13 In other words, under the applicable regulations, even if payments under a settlement of a workers' compensation claim are not excludable under section 104(a)(1) because they fail to be "amounts received under workmen's compensation acts", some or all of the payments may nonetheless be 141 T.C. 331">347 excluded from gross income under section 104(a)(2) if the taxpayer can show the portion of the workers' compensation claim that is predicated on the taxpayer's personal physical injuries or physical sickness. As we elaborate below, we find that a portion of the settlement amount was to compensate Ms. Simpson for her personal physical injuries and physical sickness.2. Amount attributable to personal physical injuries or physical sicknessOn 2013 U.S. Tax Ct. LEXIS 30">61 the basis of admissible and credible extrinsic evidence, we have found that Sears and Ms. Simpson intended to settle her potential workers' compensation claims. The record has also established that she suffered physical personal injuries and sickness forming part of the basis of her workers' compensation claims. Viewing the entire record, we conclude that the settlement of Ms. Simpson's workers' compensation claims had elements intended to compensate those physical personal injuries and sickness. Because the record before us "is not susceptible of any precisely accurate determination" of the extent to which the settlement was attributable to Ms. Simpson's personal physical injuries and sickness, we use our best judgment and find that 10% of the settlement payment of $98,000 was made on account of those physical injuries and physical sickness (other than emotional distress). See generally Eisler v. Commissioner, 59 T.C. 634">59 T.C. 634, 59 T.C. 634">641 (1973). As we stated before, when a precise determination cannot be made, "the most that can be expected of us is the exercise of our best judgment based upon the entire record." Id. This we have endeavored to do. Accordingly, we conclude 10% of Ms. Simpson's 2013 U.S. Tax Ct. LEXIS 30">62 settlement payment of $98,000 is excludable from gross income under section 104(a)(2).III. Deduction for attorney's fees and court costsBecause we have concluded that the settlement amount was not received under a workers' compensation act, we now have to decide whether $152,000 of the settlement amount allocated to attorney's fees and court costs is deductible under section 62(a)(20).Section 62(a)(20) allows an above-the-line deduction for attorney's fees and court costs paid by, or on behalf of, a taxpayer141 T.C. 331">348 in connection with any action involving an unlawful discrimination claim. See alsosec. 62(e) (defining "unlawful discrimination"). The amount of a deduction under this section cannot exceed the amount includible in the taxpayer's gross income for the taxable year on account of a judgment or settlement resulting from such claim. Sec. 62(a)(20) (last sentence).At trial respondent conceded that petitioners were entitled to deduct under section 62(a)(20) a portion of the settlement amount allocated to attorney's fees and court costs.14 On brief, respondent argues that petitioners can deduct only $113,985.60 because Mr. Anton represented to respondent that this was what he received. 2013 U.S. Tax Ct. LEXIS 30">63 Petitioners maintain the entire $152,000 is deductible because Mr. Anton used $38,014.40 of the $152,000 to reimburse petitioners for the court costs that they paid over the years of the litigation.Deductions are a matter of legislative grace, and a taxpayer bears the burden of producing sufficient evidence to substantiate any allowable deduction 2013 U.S. Tax Ct. LEXIS 30">64 under the Code. Sec. 1.6001-1; Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79">503 U.S. 79, 503 U.S. 79">84, 112 S. Ct. 1039">112 S. Ct. 1039, 117 L. Ed. 2d 226">117 L. Ed. 2d 226 (1992); sec. 1.6001-1(a), Income Tax Regs. Under the familiar Cohan rule, where a taxpayer is able to demonstrate that she has paid or incurred a deductible expense but cannot substantiate the precise amount, the Court may estimate the amount of the expense if the taxpayer produces credible evidence providing a reasonable basis for the Court to do so. Cohan v. Commissioner, 39 F.2d 540">39 F.2d 540, 39 F.2d 540">544 (2d Cir. 1930); Vanicek v. Commissioner, 85 T.C. 731">85 T.C. 731, 85 T.C. 731">743 (1985).Mr. Anton testified credibly at trial that $38,014.40 was paid to reimburse petitioners for the court costs relating to Ms. Simpson's unlawful discrimination suit. In other words, 141 T.C. 331">349 Mr. Anton's testimony shows that petitioners paid $38,014.40 in court costs and $113,985.60 in attorney's fees. The settlement agreement that Ms. Simpson and Sears negotiated at arm's length corroborates Mr. Anton's testimony. In sum, the credible evidence on this issue provides a reasonable basis for us to conclude that petitioners paid $152,000 in attorney's fees and court costs. Accordingly, they are entitled to deduct this amount under section 62(a)(20).Any arguments 2013 U.S. Tax Ct. LEXIS 30">65 not discussed in this Opinion are irrelevant, moot, or lacking in merit.To reflect the foregoing,Decision will be entered under Rule 155.Footnotes1. Unless otherwise indicated, section references are to the Internal Revenue Code (Code) in effect for the year in issue, and Rule references are to the Tax Court Rules of Practice and Procedure.↩2. The actual settlement amount was $262,500, which included $12,500 for lost wages and benefits. Petitioners included the $12,500 in their gross income for 2009, and the $12,500 is not at issue.↩3. We do not express any opinion as to whether Mr. Anton's assessment was supported by the facts and the law underlying Ms. Simpson's FEHA claims.↩4. Mr. Anton had initially argued for vocational retraining benefits in addition to temporary disability and permanent disability benefits but did not include these benefits in the final settlement value.↩5. Neither the petition nor petitioners' pretrial brief asked the Court to shift the burden of proof to respondent under sec. 7491(a)↩.6. United States v. Burke, 504 U.S. 229">504 U.S. 229, 112 S. Ct. 1867">112 S. Ct. 1867, 119 L. Ed. 2d 34">119 L. Ed. 2d 34 (1992), and Fono v. Commissioner, 79 T.C. 680">79 T.C. 680 (1982), aff'd without published opinion, 749 F.2d 37">749 F.2d 37 (9th Cir. 1984), deal with agreements to settle personal injuries claims in the context of sec. 104(a)(2). While sec. 104(a)(1) does not explicitly mention settlement, we find it helpful here to look to cases like Burke and Fono to determine whether a settlement for a workers' compensation claim sanctioned by a State's workers' compensation laws can be excludable under section 104(a)(1)↩.7. It is conceivable that under certain statutory regime, parties may privately settle a workers' compensation claim pursuant to a statute without State action. These are not the facts of this case, and we need not discuss hypotheticals.8. For example, compensation received for an occupational injury or sickness in excess of the amount provided in the applicable workers' compensation act is not excludable. Sec. 1.104-1(b), Income Tax Regs.↩9. In 1996 Congress amended sec. 104(a)(2) by adding the requirement that any amount received must be on account of personal injuries that are physical or sickness that is physical. Small Business Job Protection Act of 1996, Pub. L. No. 104-188, sec. 1605, 110 Stat. at 1838↩.10. The former regulations read as follows:Section 104(a)(2) excludes from gross income the amount of any damages received (whether by suit or agreement) on account of personal injuries or sickness. The term 'damages received (whether by suit or agreement)' means an amount received (other than workmen's compensation) through prosecution of a legal suit or action based upon tort or tort type rights, or through a settlement agreement entered into in lieu of such prosecution.Current sec. 1.104-1(c)(3), Income Tax Regs., "applies to damages paid pursuant to a written binding agreement, court decree, or mediation award entered into or issued after September 13, 1995, and received after January 23, 2012. Taxpayers also may apply these final regulations to damages paid pursuant to a written binding agreement, court decree, or mediation award entered into or issued after September 13, 1995, and received after August 20, 1996."11. The preamble of the amended regulations, T.D. 9573, 2012-12 I.R.B. 498, states:Before the 1996 amendment, the section 104(a)(2) exclusion was not limited to damages for physical injuries or sickness. The tort-type rights test was intended to distinguish damages for personal injuries from, for example, damages for breach of contract. Since that time, however, Commissioner v. Schleier, 515 U.S. 323">515 U.S. 323, 115 S. Ct. 2159">115 S. Ct. 2159, 132 L. Ed. 2d 294">132 L. Ed. 2d 294 (1995), has interpreted the statutory "on account of" test to exclude only damages directly linked to "personal" injuries or sickness. Furthermore, under the 1996 Act, only damages for personal physical injuries or physical sickness are excludable. These legislative and judicial developments have eliminated the need to base the section 104(a)(2)↩ exclusion on tort cause of action and remedy concepts.12. As Mr. Anton's testimony shows, the workers' compensation claim that formed the basis of Ms. Simpson's eventual settlement with Sears provided only the types of fixed and limited benefits that were incongruous with traditional tort or tort type damages. Permanent disability benefits under California laws, which underlaid a portion of the settlement amount, are intended to compensate an injured worker for her diminished earning capacity resulting from her work-related injuries. Gamble v. Workers' Comp. Appeals Bd., 143 Cal. App. 4th 71">143 Cal. App. 4th 71, 143 Cal. App. 4th 71">80, 49 Cal. Rptr. 3d 36">49 Cal. Rptr. 3d 36 (Ct. App. 2006). Similarly, temporary disability benefits under California laws, which formed the remaining portion of Ms. Simpson's settlement, seek to provide an injured employee interim wage replacement assistance during the period she is healing. 143 Cal. App. 4th 71">Id. at 79-80. Thus, the remedial scheme under the California laws does not appear to compensate an injured employee for tortlike personal injuries that are broad in scope. But it instead appears to address narrowly and exclusively "'legal injuries of an economic character'", Commissioner v. Schleier, 515 U.S. 323">515 U.S. at 335 (quoting Burke, 504 U.S. 229">504 U.S. at 238-239), because it aims only to restore the injured employee to the economic position that the State has deemed she would have occupied absent the disability or disabilities the occupational injuries have caused.13. The new regulations may be applied retroactively at the desire of the taxpayer. Sec. 1.104-1(c)(3), Income Tax Regs.↩ The new regulations are favorable to petitioners, and we thus apply the regulations retroactively to their benefit.14. It appears to be factually inconsistent for petitioners to maintain, on the one hand, that the $250,000 was includible in their gross income "on account of a judgment or settlement * * * resulting from * * * [an unlawful discrimination claim]" and on the other hand, that Ms. Simpson and Sears intended to allocate the entire settlement value to Ms. Simpson's workers' compensation claims and nothing to the employment discrimination suit. If none of the $250,000 was allocable to the unlawful discrimination suit and if Sears would not have entered into the settlement agreement but for Ms. Simpson's workers' compensation claims, it would appear that none of the attorney's fees and court costs are deductible under sec. 62(a)(20)↩ by virtue of the last sentence of that section. But because respondent has conceded this issue, we need not address it.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4512662/	IN THE COURT OF APPEALS OF IOWA No. 19-0706 Filed March 4, 2020 STATE OF IOWA, Plaintiff-Appellee, vs. ALICIA MARIE RIOS, Defendant-Appellant. ________________________________________________________________ Appeal from the Iowa District Court for Fayette County, Linda M. Fangman, Judge. Defendant appeals her conviction of murder in the first degree. AFFIRMED. Martha J. Lucey, State Appellate Defender, and Bradley M. Bender, Assistant Appellate Defender, for appellant. Thomas J. Miller, Attorney General, and Darrel Mullins and Denise Timmons, Assistant Attorneys General, for appellee. Considered by Mullins, P.J., Schumacher, J., and Danilson, S.J.* Senior judge assigned by order pursuant to Iowa Code section 602.9206 (2020). 2 DANILSON, Senior Judge. Alicia Rios appeals her conviction of murder in the first degree. She claims she received ineffective assistance because defense counsel permitted her to plead guilty when there was not a sufficient factual basis for her plea. We find there is sufficient evidence in the minutes of testimony to show Rios acted with malice aforethought and manifested an extreme indifference to human life. We conclude Rios has not shown she received ineffective assistance of counsel and affirm her conviction. I. Background Facts & Proceedings According to the minutes of evidence, Rios was the mother of L.R., born in 2018. Rios told Scott Reger, a special agent with the Iowa Division of Criminal Investigation, that on August 21, 2018, when L.R. was about five weeks old, “she became frustrated with [the child’s] crying and then threw [the child] down, striking her head on a coffee table and then the floor.” After a 911 call, officers arrived at the scene to find L.R. was having difficulty breathing and was unresponsive. Medical personnel observed “multiple areas of bruising on [the child’s] chest and abdomen, as well as other areas of bruising on [the child’s] body including bilateral eyelid swelling and bruising.” Dr. Barbara Knox stated the child “was suffering multiple skull fractures, subdural hemorrhaging, cerebral edema, [and e]xtensive bilateral retinal hemorrhages.” Dr. Paul Stanton and Dr. James Stadler stated the child’s injuries were “consistent with abusive head trauma.” Also, Dr. Scott Hagen stated the child’s condition “was not consistent with non-accidental trauma.” 3 Rios told Amanda Palm, a physician’s assistant, Rios’s two-year-old son was playing with a toy near L.R., who was in a car seat. She stated the older child “bounced onto the child.” Rios stated L.R. cried after this but was limp, so she called 911. Palm believed the child’s injuries were consistent with non-accidental trauma. Dr. Geralyn Zuercher stated the child’s injuries were not consistent with those that would result from a toy being dropped on her head. The child died as a result of her injuries. Rios was charged with murder in the first degree, in violation of Iowa Code section 707.2(1)(e) (2018), based on a theory she killed L.R. while committing child endangerment, in violation of section 726.6(1)(b), or while committing assault, in violation of section 708.1. In addition, Rios was charged with child endangerment resulting in death, in violation of section 726.6(1)(b) and (4). Rios entered into a plea agreement in which she agreed to enter an Alford plea to first-degree murder and the State agreed to dismiss the charge of child endangerment.1 Rios told the court it could rely on the minutes of evidence to help establish a factual basis for the offense. She also agreed the witnesses listed by the State would testify in accordance with the minutes, and this would provide substantial evidence to show she committed first-degree murder. The court found there was a factual basis for Rios’s guilty plea. The court determined the plea was knowingly and intelligently entered, and was voluntary. Rios was sentenced to life in prison. She now appeals. 1 In an Alford plea, a defendant pleads guilty to a crime without admitting to the underlying facts of the offense. State v. Rodriguez, 804 N.W.2d 844, 847 n.1 (Iowa 2011) (citing North Carolina v. Alford, 400 U.S. 25, 32 (1970)). In this type of plea, a defendant consents to the imposition of a sentence without admitting guilt. Id. 4 II. Ineffective Assistance Rios claims she received ineffective assistance because defense counsel failed to file a motion in arrest of judgment to challenge her guilty plea. She states there was not an adequate factual basis for the plea. Rios asserts there is no evidence in the record to show she acted with malice aforethought. She also asserts there is insufficient evidence to show she intentionally committed a wrongful act or exhibited an extreme indifference to human life. Rios asks to have her guilty plea vacated and the case remanded for further proceedings. We conduct a de novo review of claims of ineffective assistance of counsel. State v. Maxwell, 743 N.W.2d 185, 195 (Iowa 2008). To establish a claim of ineffective assistance of counsel, a defendant must prove: (1) counsel failed to perform an essential duty and (2) prejudice resulted. Id. A defendant’s failure to prove either element by a preponderance of the evidence is fatal to a claim of ineffective assistance. See State v. Polly, 657 N.W.2d 462, 465 (Iowa 2003). “It is a responsibility of defense counsel to ensure that a client does not plead guilty to a charge for which there is no objective factual basis.” State v. Finney, 834 N.W.2d 46, 54 (Iowa 2013). We examine the entire record to determine if there is a factual basis for a defendant’s guilty plea. Id. at 62. “Our cases do not require that the district court have before it evidence that the crime was committed beyond a reasonable doubt, but only that there be a factual basis to support the charge.” Id. A sufficient factual basis may be found in the minutes of evidence. Id. For first-degree murder, the State was required to show: 5 [The defendant] shook, struck, and/or assaulted the child; the child was under age fourteen; the child died as a result of being shaken, struck, or assaulted by [the defendant]; [the defendant] acted with malice aforethought; [the defendant] was committing the offense of child endangerment or assault; and the child’s death occurred under circumstances showing an extreme indifference to human life. State v. Trowbridge, No. 12-2272, 2014 WL 955404, at 3 (Iowa Ct. App. Mar. 12 2014) (citing Iowa Code §§ 707.1, .2(5)); see also State v. Blanchard, No. 09-0871, 2010 WL 2089222, at 3 (Iowa Ct. App. May 26, 2010) (listing elements of offense). A. Rios claims there is not a sufficient factual basis for the element that she manifested an extreme indifference to human life. See Iowa Code § 707.2(5). “The ‘extreme indifference’ element stands apart from, and in addition to, the element of malice.” State v. Thompson, 570 N.W.2d 765, 769 (Iowa 1997). “No further elaboration—by reference to risk of danger or recklessness—adds in a meaningful way to the words themselves.” Id. “We agree that the phrase ‘manifesting an extreme indifference to human life,’ when considered in the context of a killing of a child with malice, sufficiently describes the aggravating circumstance elevating the act from second-degree to first-degree murder so as to need no further or other explanation.” Id. at 768. We previously found, “intentionally shaking and striking the head of a five- day-old child manifests extreme indifference or callousness to human life.” Blanchard, 2010 WL 2089222, at 4. In this case, Rios manifested extreme indifference to human life by throwing L.R. down, striking the child’s head on the coffee table and floor. We conclude there is a sufficient factual basis in the record on the element of “manifesting an extreme indifference to human life.” See Iowa Code § 707.2(5). 6 B. Rios claims there is not sufficient evidence to show she acted with malice aforethought, which is necessary under both alternatives in Iowa Code section 707.2(1)(e). “Malice aforethought is a fixed purpose or design to do physical harm to another that exists before the act is committed. It does not have to exist for any particular length of time.” State v. Myers, 653 N.W.2d 574, 579 (Iowa 2002). Malice is a state of mind and is usually proven by circumstantial evidence. State v. Newell, 710 N.W.2d 6, 21 (Iowa 2006). In State v. Rhode, 503 N.W.2d 27, 39 (Iowa Ct. App. 1993), we found malice could be inferred from the circumstantial evidence that the defendant “intentionally slammed [a child’s] head against a hard, flat surface causing a severe head injury.” Accord State v. Porter, No. 12-0170, 2013 WL 2146543, at 5 (Iowa Ct. App. May 15, 2013) (inferring malice from defendant’s violent shaking of child, resulting in death); Blanchard, 2010 WL 2089222, at 4 (finding malice could be inferred from the death of a child caused by defendant intentionally shaking and striking the head of the child). Rios told the district court it could rely on the minutes of evidence to establish a factual basis for her guilty plea. The minutes provide that Special Agent Reger would testify Rios told him: That she was at home in the morning that day with her two-year-old son, [B.R.] and [L.R.], while her husband, Abrahan Rios, and her mother, Dawn Fernette, were both at work. That [L.R.] was fine the night before and fine that morning of August 21, 2018 while her husband and mother were at work. That she became frustrated with [L.R.] and [B.R.] crying and then threw [L.R.] down, striking her head on a coffee table and then the floor. That [L.R.] had been healthy and happy the days prior and that [L.R.] had eaten earlier that morning. That she was the only person with [L.R.] and her son after her husband went to work. 7 Due to Rios’s action striking the child’s head on the coffee table and the floor, the child had “multiple areas of bruising on [her] chest and abdomen, as well as other areas of bruising on [her] body including bilateral eyelid swelling and bruising.” The child suffered multiple skull fractures, subdural hemorrhaging, cerebral edema, and extensive bilateral retinal hemorrhages. As in Rhode, 503 N.W.2d at 39, we infer malice aforethought from the circumstantial evidence Rios “intentionally slammed [a child’s] head against a hard, flat surface causing a severe head injury.” Rios stated she had become frustrated because the child was crying and threw the child down, striking her head on the coffee table and floor. We find there is a factual basis in the record to support the element of malice aforethought. C. We conclude Rios has not shown she received ineffective assistance because defense counsel permitted her to plead guilty when there was an inadequate factual basis for her plea. For the same reasons, counsel was not ineffective for failing to file a motion in arrest of judgement. We affirm Rios’s conviction of first-degree murder. AFFIRMED.	01-04-2023	03-04-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625353/	WALTER E. AND WILMA KUHN, ET AL., 1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Kuhn v. CommissionerDocket Nos. 7731-79, 704-80, 705-80.United States Tax CourtT.C. Memo 1981-207; 1981 Tax Ct. Memo LEXIS 541; 41 T.C.M. (CCH) 1372; T.C.M. (RIA) 81207; April 27, 1981. Walter E. Kuhn, pro se. William P. Hardeman, for the respondent. DAWSONMEMORANDUM OPINION DAWSON, Judge: In these cases respondent determined the following deficiencies in petitioners' Federal income taxes and additions to tax: Addition to TaxPetitionersDkt. No.YearDeficiencySec. 6651(a)Sec. 6653(a) 2Walter E. andWilma Kuhn7731-791975$ 3,166.88$ 158.34Walter E. Kuhn704-80197613,777.20$ 3,444.30688.8619771,980.00495.0099.00Wilma E. Kuhn705-80197613,777.203,444.30688.8619771,980.00495.0099.00The adjustments made in the notice of deficiency542 mailed to petitioners on March 6, 1979, with respect to the year 1975 and the separate notices of deficiencies mailed to them on November 19, 1979, with respect to the years 1976 and 1977, relate to capital gains; rental income and expenses; interest income; additional income determined by the bank deposits method; disallowance of itemized deductions; and the negligence and failure to file penalties. Timely petitions were filed with this Court in all three cases. Petitioners were legal residents of Cerrillos, New Mexico, when they filed their petitions in these cases. Notices setting the cases for trial at Albuquerque, New Mexico, on March 30, 1981, were mailed to petitioners on December 24, 1980, informing them to be present and prepared to try their cases. On March 24, 1981, the petitioners filed in each case a "Motion to Dismiss for Want of Jurisdiction," stating as follows: 1. That this Court does have jurisdiction over the parties involved. 2. That this Court has no jurisdiction over questions of law and cannot render the relief sought. a. The issues involved in the above captioned matters are substantive issues of law and not disputes of fact. b. That until543 the issues of law have been judicially determined, there can be no fact to dispute. 3. That Petitioners have taken the necessary steps to initiate litigation in the United States District Court in an action for refund. 4. That Petitioners decline to make further prosecution for reasons stated above. When the cases were called for trial on March 30, 1981, the petitioners were present and argued in support of their motions to dismiss for lack of jurisdiction. Respondent opposed the motions. For reasons stated in the record the Court denied the petitioners' motions. The contention that this Court lacks jurisdiction of these cases is without merit. Where, as here, a taxpayer receives a notice of income tax deficiencies and files a timely petition with the United States Tax Court, he gives the Court exclusive jurisdiction. Section 6512(a). The mere filing of the petition in the Tax Court is enough to deprive a United States District Court of jurisdiction for years as to which the petition was filed. See United States v. Wolf, 238 F.2d 447">238 F.2d 447 (9th Cir. 1956); Brooks v. Driscoll, 114 F.2d 426 (3d Cir. 1940). It is significant that it is the544 taxpayer's action in filing a valid petition in the Tax Court, under circumstances which give the Court jurisdiction, and not any action taken by the Court, that bars a subsequent suit. Elbert v. Johnson, 164 F.2d 421">164 F.2d 421, 424 (2d Cir. 1947). As we said in Dorl v. Commissioner, 57 T.C. 720">57 T.C. 720, 722 (1972), affd. 507 F.2d 406">507 F.2d 406 (2d Cir. 1974): It is now a settled principle that a taxpayer may not unilaterally oust the Tax Court from jurisdiction which, once invoked, remains unimpaired until it decides the controversy. See Main-Hammond Land Trust, 17 T.C. 942">17 T.C. 942, 956 (1951), affd. 200 F.2d 308">200 F.2d 308 (C.A. 6, 1952); United States v. Shepard's Estate196 F. Supp. 281">196 F. Supp. 281, 284 (N.D. N.Y. 1961), affirmed as modified on other issues 319 F.2d 699">319 F.2d 699 (C.A. 2, 1963); and Nash Miami Motors, Inc. v. Commissioner, 358 F.2d 636">358 F.2d 636 (C.A. 5, 1966), affirming a Memorandum Opinion of this Court. See also Burns, Stix Friedman & Co., Inc. v. Commissioner, 57 T.C. 392">57 T.C. 392 (1971); Bowser, Sr. v. Commissioner, 78-1 USTC par. 9102, 40 AFTR 2d 77-5531 (3d Cir. 1977). The Court545 of Appeals for the Fourth Circuit said in an unpublished per curiam opinion (609 F.2d 505">609 F.2d 505) dated October 5, 1979, affirming an order and decision of this Court in Bowser, Jr. v. Commissioner, docket No. 5544-75: On appeal Bowser attacks the constitutional authority of the Tax Court to adjudicate his tax liability. The constitutionality of the Tax Court has been explicitly sustained in a number of decisions. See, e.g., Melton v. Kurtz, 575 F.2d 547 (5th Cir. 1978); Nash Miami Motors, Inc. v. Commissioner, 358 F.2d 636">358 F.2d 636 (5th Cir.), cert. denied, 385 U.S. 918 (1966); Martin v. Commissioner, 358 F.2d 63">358 F.2d 63 (7th Cir.), cert. denied, 385 U.S. 920">385 U.S. 920 (1966); Willmut Gas & Oil Co. v. Fly, 322 F.2d 301">322 F.2d 301 (5th Cir. 1963), cert. denied, 375 U.S. 984 (1964). SeealsoAmos v. Commissioner, 360 F.2d 358">360 F.2d 358 (4th Cir. 1965). Furthermore, in 1969 Congress altered the status of the Tax Court from that of an "independent agency in the Executive Branch of Government" to a "court of record" established under Article I of the Constitution546 of the United States.The authority of Congress to establish specialized courts or courts of limited jurisdiction outside the authority of Article III of the Constitution has long been recognized. SeeWilliams v. United States, 289 U.S. 553 (1933); Ex parte Bakelite Corp., 279 U.S. 438">279 U.S. 438 (1929). Accordingly, we hold that this Court has jurisdiction over the disposition of these cases. After denying their motions, the Court asked the petitioners if they intended to offer any evidence to show errors in the adjustments made by respondent in the notices of deficiencies. They declined, and thus failed to produce any evidence. Whereupon respondent's counsel orally moved to dismiss the cases for the petitioners' failure to properly prosecute. The issues are factual and the burden of proof is on the petitioners. Welch v. Helvering, 290 U.S. 111">290 U.S. 111 (1933); Rule 142(a), Tax Court Rules of Practice and Procedure. Because they declined to present any evidence to support the assignments of errors alleged in their petitions we will grant respondent's oral motion to dismiss each case for lack of prosecution. We also sustain respondent's547 determination on the ground that the petitioners, although offered the opportunity to do so, did not present any evidence on the substantive issues, and therefore they have failed to carry their burden of proof. Orders and Decisions will be entered. Footnotes1. Cases of the following petitioners are consolidated herewith: Walter E. Kuhn, docket No. 704-80; Wilma E. Kuhn, docket No. 705-80.↩2. All section references are to the Internal Revenue Code of 1954, as amended and in effect during the years in issue.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4477053/	OPINION. Raum, Judge: 1. Petitioners contend that they are entitled to business deductions in each of the taxable years equivalent to the $2,000 monthly payments decedent received from Ellington. They argue that the decedent was personally acquainted with many prominent persons and executives of many of America’s largest corporations; that a man in his position was expected to entertain on a lavish scale; that the decedent had expenses other than those charged to the Ellington account which were entered in his regular books; that the funds in the Ellington account were not included in the regular, books kept by decedent but were handled in a separate checking account; that although checks were drawn on the Ellington account for items which might be considered personal, reimbursements or other deposits were made to take care of them; and that the disallowance by the respondent of all the amounts charged to the Ellington account was purely arbitrary. The petitioners had the burden of proving that they were entitled to business deductions for the taxable years in addition to those allowed by the respondent. Decedent filed an individual’income tax return for 1947. Petitioners submitted no evidence from which we can find that he was entitled to any business deductions, in addition to those already allowed by the respondent, because of any expenditures made from the $8,000 received from Ellington during that year. For the years 1948 to 1951, inclusive, decedent and his wife claimed business deductions in their returns for those years ranging from $15,754.60 to $20,013. Additional deductions were claimed for contributions and miscellaneous items. Respondent allowed all of the business deductions claimed in these returns. Petitioners made no attempt to prove that any expenditures made from the Ellington account for business purposes were not included in the business deductions allowed for the taxable years. They introduced in evidence bank ledger sheets, checks drawn against the Ellington account, and a detailed schedule showing the number, payee, and amount of the checks charged against it. Decedent’s secretary testified by deposition and was asked to explain the nature of the various expenditures made from the account. She was able to explain the purpose of some of the expenditures from the names of the payees appearing on the checks. Her explanation of many of these expenditures indicated that they were of a personal nature. As to others that may have been of a business nature, such as auto expenses, office expenses, etc., there was no convincing evidence that such items had not been included in the amounts claimed in the returns and allowed by the respondent as business deductions in each of the taxable years. In a few instances the account was reimbursed for charges of a personal nature, such as for furnishings for apartment, but in most instances where the personal nature of withdrawals was established, there does not appear to have been any reimbursement. The witness had no knowledge of the nature of many of the expenditures or of the purpose for which the decedent expended the substantial amount of cash withdrawals he made from the account each year. The rental of the New York apartment, which was used as living quarters by decedent and his wife, was not a business expense even though it may have been used at times for entertainment of business guests. Where entertainment expenses are proximately related to a taxpayer’s business, they may be deductible, but the general statements made by petitioners’ witnesses with respect to entertainment for business purposes do not convince us that to the extent that such expenses were properly deductible they were not already included in the deductions claimed and allowed by the respondent in each of the taxable years. After a careful consideration of the evidence, we hold that the petitioners have not proved that the respondent erred in failing to allow additional business deductions for the taxable years because of expenditures made from the Ellington account. 2. The second issue relates to the gains derived by the decedent in 1949 and 1950 upon the redemption of the class A and class B preferred stock of Ellington. Each of these blocks of stock was purchased by decedent at the nominal amount of $25, and each was redeemed at $50,000 as originally contemplated. Petitioners contend that the difference, $49,975, represents capital gain during each of the years 1949 and 1950, whereas the Commissioner takes the position that the profit in fact consists of earnings derived by the decedent from Ellington which are taxable as ordinary income rather than as capital gain. We think that the facts in this case abundantly support the conclusion that these were not bona fide capital transactions, and that they were merely a device for compensating the decedent in part for his services in connection with bringing in and maintaining the Cities Service account for Ellington. It is important in this connection to read the entire letter of September 10, 1947, set forth above in our findings. That letter constituted the basic agreement between the decedent and Ellington. It plainly shows that the financial advantages spelled out therein for decedent’s benefit were intended as compensation to him for his efforts in connection with the Cities Service account; and that such rewards were predicated upon a minimum annual revenue of $212,000 from the Cities Service account. Indeed it was clearly indicated that if such revenue were not received and not replaced by other accounts there would be an appropriate downward revision of the amounts obtainable by decedent on account of the preferred stock. The preferred stock itself was sold to the decedent at a nominal cost of 5 cents a share, although redemption was to be at the rate of $100 a share. The two blocks of preferred stock involved — class A and class B — were unique. No other shares of class A or class B preferred stock were issued to anyone else. Dividends were not payable upon such stock, and the shares were kept in escrow. It is all too plain that such stock was tailored for a special purpose, namely, to provide the vehicle for paying additional compensation to the decedent in 1949 and 1950, and that the issuance and redemption of the preferred stock were merely a sham. The various cases cited by petitioners dealing with stock options are not pertinent to the facts involved herein. The amounts in controversy here were in truth and in fact compensatory in nature and were not mere capital gains. Nor do we accept petitioners’ alternative contention that the amounts were income in 1947 rather than in 1949 and 1950. The decedent’s rights in relation to the stock and payments ripened only with the passage of time and the receipt of the anticipated revenue from the Cities Service account. The payments to the decedent were in fact made in 1949 and 1950, as originally planned. He was on the cash basis, and, in any event, his rights thereto did not accrue until the time of payment. We hold that the amounts in question were ordinary income and were chargeable to the decedent in 1949 and 1950. 3. Petitioner Caroline Aylesworth contends that she is not individually liable for any of the deficiencies found to be due for the taxable years 1948 to 1951, inclusive, because her signature on the returns filed for those years was procured by fraud and duress. In petitions filed in these proceedings on April 3,1953, with respect to the years 1948 and 1949, and on September 9, 1954, with respect to the years 1950 and 1951, Caroline Aylesworth alleges that she married the decedent on July 1, 1945, that beginning with January 1, 1946, he inflicted intolerable cruelty upon her; that this cruelty continued up to and including 1952; that she was in constant fear of the decedent and by reason of such cruelty and fear, she was compelled by him to sign the returns filed for the years 1948 to 1951, inclusive; that the signing was not her free act; and that her signatures on the returns were procured by force and duress. Caroline Aylesworth testified at the trial. From her testimony it appears that at times during the years she was married to the decedent he drank alcoholic beverages to excess and then when intoxicated he abused, mistreated, and threatened her. Just how often this occurred is not clear. Nor is it clear that he indulged in any such conduct at times other than when he was intoxicated. Some specific instances of abuse and mistreatment mentioned by her had no connection with the filing of any of the joint income tax returns. Beginning in 1948 the split income provisions were enacted into law thereby enabling married couples to obtain favorable tax treatment by filing joint returns. Plainly, the decedent’s desire to file joint returns beginning with 1948 was with a purpose to take advantage of the new law. Mrs. Aylesworth’s testimony, however, indicated a reluctance on her part to sign the returns because the returns reported a “salary” paid to her. Such “salary” was in fact paid to her, but since she performed no services therefor she resented being designated as an employee of her husband and felt that it was done to humiliate her. The reporting of such salary had no effect taxwise on the joint returns because, to the extent that it was ascribed as income to Mrs. Aylesworth, there was a corresponding deduction with respect to the decedent’s business expenses, and the two items would thus neutralize each other. The record contains evidence suggesting numerous ugly incidents which occurred between the Aylesworths. In connection with the 1948 return she testified: He told me if I did not sign it, that I would be very, very sori-y. He told me that he would destroy my father. He told me that he would mutilate my face, and when I told him I would divorce him rather than sign it, he said, “You haven’t got a chance. I will go to Bruce Bromley and see — I will go anywhere, to everyone, and your word against Merlin Aylesworth’s will never stand.” And I think he was probably right. She testified that when she signed the 1949 return she was “just a wreck” and was still being threatened. She made no similar statement as to the threats made or the state of her mind when she signed the 1950 return, except that, in response to a question whether the signing of that return was “a free act on * * * [her] part,” she replied, “It was not.” In connection with the 1951 return, the evidence discloses a tempestuous episode in the evening of April 8, 1952, when the decedent had much to say about his wife’s failure to sign the returns. The decedent was then very inebriated. He was abusive, he tore her clothes, and pulled her hair so severely that some came out. She, on the other hand, countered with a hat pin, and summoned police assistance. The following morning, April 9, 1952, she went to decedent’s office and signed the 1951 return on his secretary’s desk and in her presence. She did not see the decedent that morning or at any time thereafter until August 1952 at a hospital a short time prior to his death. We cannot hold that Mrs. Aylesworth’s signature on the 1948-1951 joint returns must be treated as a nullity. There is no evidence that she filed any separate returns on her own behalf for any of those years, notwithstanding that, at least for the year 1951, she realized $17,500 in income as capital gain. She continued to live with the decedent and indeed contributed her own property and funds towards the construction of their Connecticut home, after the alleged coercive acts during some of the years had taken place. Moreover, she began to consult legal counsel as early as 1949 about her marital difficulties. The filing of joint returns resulted in a substantially reduced tax burden for the couple as a result of the split income provisions, and we should be very slow to conclude that the signature of the wife is to be regarded as having been obtained by fraud or duress. We are not convinced on the evidence before us that her signature was not voluntary, regardless of her reluctance to sign and regardless of the domestic frays that may have occurred at about the time. We are of the opinion that when she in fact signed the returns they were her voluntary, although perhaps distasteful, acts. So far as we know she never undertook to disavow her signature on any of the returns within a reasonable time so that the Government might promptly have proceeded against the husband for increased tax by reason of the higher brackets that would be applicable to his individual return; and, as noted above, she filed no separate return of her own, particularly for the year 1951. We find and hold that her signature on each return in question was not procured by duress or fraud, and that section 51 (b) of the Internal Revenue Code of 1939 providing for joint and several liability of the spouses on a joint return is applicable here. 4. The final issue relates to the respondent’s disallowance of a portion of the amounts claimed in the joint returns as deductions for traveling and entertainment expenses for 1947, for contributions for the taxable years 1947 to 1951, inclusive, for a loss by theft in 1949, and for sales tax for 1951. The respondent’s determination was based upon the petitioners’ failure to substantiate the expenditures claimed to the extent of the disallowances. Decedent’s secretary testified that the figures shown in the returns for the deductions claimed were given to her by the decedent. The loss by theft will be hereinafter considered. As to the other items, no convincing evidence was introduced to substantiate the deductions claimed in the returns and to establish that the respondent erred in disallowing a portion of them. In these circumstances we must hold that the petitioners have not sustained their burden of proving that the respondent’s disallowance of a portion of the deductions claimed was erroneous. In the 1949 return a loss from theft of a fitch cape in the amount of $600 was claimed as a deduction. Caroline Aylesworth testified that she purchased this cape with her own money in 1945 or 1946 for $500 and that it was in very good condition when it was stolen on December 24, 1949. She was unable to explain why a loss of $600 was claimed in the 1949 return for a cape that cost $500. The respondent disallowed $250 of the amount claimed. In view of the fact that the cape was 3 or 4 years old at the time it was stolen, we think his action was reasonable and it is approved. Decisions will be entered, for the respondent.	01-04-2023	01-16-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625356/	JERRY W. AND JEANNETTE MULDER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentMulder v. CommissionerDocket No. 33637-85.United States Tax CourtT.C. Memo 1987-363; 1987 Tax Ct. Memo LEXIS 363; 53 T.C.M. (CCH) 1429; T.C.M. (RIA) 87363; July 23, 1987; Reversed and Remanded September 19, 1988 Merle R. Flagg, for the petitioners. William P. Hardeman, for the respondent. SCOTT MEMORANDUM OPINION SCOTT, Judge: On January 27, 1986, respondent filed a motion to dismiss the above-entitled case for lack of jurisdiction on the ground that the petition was not filed within 90 days after the date of the mailing of the notice of deficiency and on March 10, 1986, petitioners filed a motion to dismiss for lack of jurisdiction on the ground that the notice of deficiency was not mailed to petitioner's last known address. Both motions were heard in Dallas, Texas on June 4, 1986. There was an evidentiary hearing consisting of a stipulation of facts, oral testimony and exhibits. The record shows that petitioners resided in Duncanville, 364 Texas at the time of the filing of their petition in this case. Respondent on May 4, 1984 mailed to petitioner, Jerry W. Mulder, by certified mail, a notice of deficiency addressed to Jerry W. Mulder (petitioner) at 4545 Mint Way, Dallas, Texas 75236 (the Mint Way address). As of December 31, 1980 petitioner resided at 703 Timer Trail Drive, Duncanville, Texas 75137 (the Timber Trail address) and still resided at that address at the time of the hearing on these motions. Petitioner's return for the calendar year 1980 was filed on June 19, 1981. The return was timely filed pursuant to an extension previously received for late filing of the return. Petitioner's 1980 return was prepared on his behalf by a Certified Public Accountant, John H. Eads (Mr. Eads). Mr. Eads' address in Dallas, Texas was shown underneath his signature on this return. The address shown on petitioner's 1980 return was the Mint Way address. The Mint Way address was the address of a partnership, Red Top Foods, which in 1980 was owned by petitioner and his parents. Petitioner's return reported income of $ 40,992 from Red Top Foods. Respondent in his notice of deficiency determined a deficiency in petitioner's365 income tax in the amount of $ 9,116. This determination resulted from a disallowance by respondent of a $ 20,000 loss claimed by petitioner from Control Tech. Limited and a disallowance of contributions of $ 8,253 described as "contributions K-1." In early 1983, petitioner and his parents sold the business located at 4545 Mint Way to two other individuals who were friends of petitioner's parents. Neither petitioner nor his parents notified the post office of any change of address from the Mint Way address. Petitioner's mother and sometimes petitioner himself would go by the Mint Way address regularly and pick up mail addressed to petitioner or to his parents. Petitioner regularly received mail addressed to him at Mint Way up through sometime in 1984. Petitioner's mother was still picking up mail at the Mint Way address in May of 1984 and some mail was received there late in 1984 by petitioner and his parents and picked up by petitioner or his mother. A document addressed to petitioners at the Mint Way address was returned to respondent's Salt lake City office undelivered on January 17, 1984 with the notation on the envelope "Returned to Writer -- Moved, Left No Address." A366 letter dated February 17, 1984 transmitting a Form 872-A for the calendar year 1980 was mailed from respondent's Salt Lake City office to petitioners at the Mint Way address and was returned undelivered on February 28, 1984 with a notation "Moved -- Left No Address From 75211." The returned letter of February 17, 1984 was returned to the administrative file with respect to petitioner's 1980 income tax on April 11, 1984 in San Francisco. A representative of respondent in Salt Lake City prepared the statutory notice of deficiency dated May 4, 1984 for the calendar year 1980 which was addressed to petitioners at the Mint Way address. The statutory notice was mailed from respondent's San Francisco office on May 4, 1984 by certified mail. Mr. Eads filed, on behalf of petitioners, a Form 4868 for the calendar year 1983 requesting an extension of time for filing petitioners' income tax return for the calendar year 1983. This form was signed by Mr. Eads on April 12, 1984. This form showed petitioners' address as 703 Timber Trail, Duncanville, Texas 75137. This was the first document filed with respondent by or on behalf of petitioner showing the Timber Trail address as petitioner's367 address. However, that address had been shown on some documents filed by petitioner in purchasing a partnership interest in R&D Limited Partnership and International Oil Recovery Systems. The statutory notice of deficiency that was mailed to petitioner on May 4, 1984 was prepared on respondent's Form 5278 on or prior to March 27, 1984 since the initialed copy of the notice bears initials of the preparer under that date. The procedure in respondent's office is to have the preparer of a statutory notice check for the proper address of a taxpayer before preparing the initial draft of the notice, which is then sent forward to be reviewed by other persons in the office where the notice is prepared and finally signed on behalf of respondent by a person authorized to sign such a notice. Therefore, the check for an address is made by the preparer from 60 to 90 days prior to the date of the mailing of the notice. It is customary for the preparer of a notice to check the computer master file under the social security number of the individual to whom the notice is addressed to obtain the last address of that person at the time the notice is prepared. Generally, the reviewer of a statutory368 notice does not make a check of the address to which the notice is to be sent. When a new address is received for an individual and put into respondent's master computer it takes at least 23 working days from the date the new address is received for it to be placed into the master computer file to show as the address of the individual who has sent in the new address. When a new address comes in for an individual on a subsequently filed tax return or a request for extension of time to file a return it is placed in respondent's master computer. The statutory notice of deficiency mailed by respondent to petitioner on May 4, 1984 was not returned to respondent. Under date of October 15, 1984 a Statement of Tax and Interest Due was addressed to petitioners at the Timber Trail address. When petitioner received the notice dated October 15, 1984, Statement of Tax and Interest Due, from respondent's Ogden, Utah Service Center, he turned it over to Mr. Eads, who responded to the statement. On December 17, 1984 respondent's Ogden representative responded to Mr. Eads' letter by letter to petitioner at the Timber Trail address. There was other correspondence between respondent's representatives369 and Mr. Eads on behalf of petitioner with respect to the statement of petitioner's tax liability for the year 1980. In February, 1985 petitioner received a letter addressed to his Timber Trail address from a representative of respondent's Ogden, Utah office stating that a statutory notice of deficiency was mailed to petitioner on May 4, 1984 and not returned. This letter did not enclose a copy of the notice of deficiency. Mr. Eads also responded to this letter on behalf of petitioner. Under date of August 12, 1985 petitioner received from a representative of respondent at the Timber Trail address a handwritten notice to which was attached a copy of the statutory notice of deficiency mailed to petitioner on May 4, 1984. The petition in this case was filed September 3, 1985. It is respondent's position that a notice of deficiency was mailed to petitioner by certified mail at his last known address on May 4, 1984 and that no petition was filed from this notice within 90 days after the date of its mailing. Petitioner does not claim to have filed the petition within 90 days of May 4, 1984, but contends that the petition was filed within 3 weeks after he actually received a copy of370 the notice of deficiency which had been mailed to him at the Mint Way address on May 4, 1984. It is petitioner's position that the notice of deficiency was not mailed to him at his last known address since respondent should have used more diligence in checking for his address. Petitioner takes the position that after two items addressed to him at the Mint Way address were returned, it was incumbent on respondent to have contacted his accountant or checked in the Dallas or Duncanville directory for a different address for him. Petitioner does not contend that at any time he directly furnished respondent with an address different from the Mint Way address until the filing of the request for extension of time to file his 1983 return in April 1984. Petitioner does contend that since respondent was investigating partnerships in which he had an interest, respondent should have procured the partnership agreement he had signed to have found the Timber Trail address. A taxpayer's last known address has been stated to be his last permanent address or legal residence known to respondent or the last known temporary address of a definite duration to which he has directed respondent to send371 communications. , affd. . We further stated in that case that the relevant inquiry is as to the Commissioner's knowledge rather than as to what may in fact be the taxpayer's current address. It is, of course, clear under the provisions of section 6212(b)(1) 1 that a notice of deficiency is sufficient if it is mailed to the taxpayer's last known address. In order for this Court to have jurisdiction to hear a case it is necessary that a valid statutory notice of deficiency be mailed to petitioner at his last known address and a timely petition be filed from that notice with this Court. It is therefore clear that we lack jurisdiction in this case. If respondent did mail the notice to petitioner's last known address the petition is untimely and if respondent did not mail the notice to petitioner's last known address there is no valid statutory notice under section 6212(b)(1). The burden is on petitioner372 to show that he did provide respondent with clear and concise notification of his last known address. There are many cases discussing what is clear and concise notification. We have held in a number of cases that the mere showing of a different address on a return or other document for a subsequent year is not sufficient notification to respondent of a change of address. . However, a number of cases hold that where a subsequent address has appeared on a later filed document it is incumbent on respondent to use due diligence to determine if the address shown on petitioner's return for the year for which the notice is being sent is petitioner's last known address. Petitioner never specifically furnished respondent his Timber Trail address until sometime after April 12, 1984 when he filed a request for an extension of time to file his 1983 return. Even then he made no specific reference to his 1980 return. Since petitioner never furnished respondent with a specific notification of any change in his address until mid-April 1984, we must determine whether respondent should have been more diligent in attempting to ascertain373 an address different from the one appearing on petitioner's 1980 return before he sent the statutory notice. There had been some documents returned to respondent's Salt Lake City office addressed to petitioner at the Mint Way address prior to the issuance of the statutory notice. However, these documents gave no different address for petitioner. Because the case was being worked on in both respondent's Ogden, Utah and San Francisco offices, the returned envelope did not actually find its way into the petitioner's 1980 administrative file until after the time that an address check would normally have been made by the preparer of the statutory notice. However, it is also clear that a further check of respondent's computer file after the documents were returned would not have turned up an address for petitioner other than the Mint Way address until after May 4, 1984, the date the notice was mailed. The record shows that the statutory notice was actually prepared prior to the time petitioner submitted a request for extension of time to file his 1983 return in mid-April 1984. Considering all the facts in this case, we conclude that there has been no showing that respondent did not use374 due diligence in attempting to find petitioner's last known address. Furthermore, in this case there is responsibility on petitioner. Although the record is silent as to the address shown on petitioner's returns for 1981 and 1982, assuming returns were filed for those years, it is clear that no address other than the Mint Way address was used if such returns were filed, since there is no claim by petitioner of any document filed with respondent showing an address other than the Mint Way address prior to the filing in mid-April of the request for extension of time. Also, it is clear in the record that in the spring of 1983 the business at the Mint Way address was sold by petitioner and his parents. Instead of leaving a forwarding address they opted to have an informal system of picking mail up at that address. Why two documents from the Internal Revenue Service were not picked up there is unclear in the record. Petitioner testified that he received other mail addressed to him at the Mint Way address until after the end of May 1984. The record shows that the statutory notice was not returned to respondent, which leads to the presumption that it was delivered to the Mint Way address. 375 Why petitioner did not actually receive it is unexplained in the record. The testimony is that petitioner's mother was picking mail up at the Mint Way address after the date that the statutory notice would normally have been received at that address. Whether the persons running the business at the Mint Way address merely failed to give it to petitioner's mother, or petitioner's mother obtained it and failed to give it to petitioner, does not show from the record. Petitioner's mother did testify that she gave petitioner the mail she picked up for him at the Mint Way address. There was no testimony by the individuals who were running the business at the Mint Way address in 1984 as to their diligence in delivering all mail they received there for petitioner or his parents to petitioner or petitioner's mother. There is no showing in the record that any representative of respondent ever saw the partnership agreements signed by petitioner giving the Timber Trail address. There is some showing that respondent was investigating these partnerships but this is far from a showing that respondent saw every agreement signed by any participant. Petitioner actually lived at the Timber Trail*376 address at the time his 1980 return was filed, but chose to use the Mint Way business address on his return. Respondent was not only justified in concluding that the Mint Way address used on the return was the address to which petitioner wished mail to be sent, but would not have been justified in assuming petitioner wished his mail sent to some other address. We hold that respondent did properly mail the statutory notice of deficiency to petitioners' last known address and that the petition in this case was not filed within 90 days after the mailing of that notice. We, therefore, grant respondent's motion to dismiss for lack of jurisdiction and deny petitioner's motion. An appropriate order will be entered.Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954, as amended and in effect during the years here in issue. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625357/	APPEAL OF ROBERT H. McCORMICK ET AL. 1McCormick v. CommissionerDocket No. 1605.United States Board of Tax Appeals2 B.T.A. 430; 1925 BTA LEXIS 2406; September 7, 1925, Decided Submitted June 10, 1925. 2406 A reasonable allowance for exhaustion, wear and tear, including a reasonable allowance for obsolescence, determined with reference to two office buildings in the business district of Chicago. William B. Hale, Esq., for the taxpayers. Robert A. Littleton, Esq., for the Commissioner. 430 Before IVINS, MORRIS, and LOVE. These seven appeals were heard together upon eight depositions taken in Chicago, exhibits and argument. The Commissioner disallowed depreciation as taken upon the return of the trustee for an estate in which the several taxpayers were entitled to distributive shares and increased their respective incomes, with determinations of deficiencies in taxes as follows: Robert H. McCormick$343.24L. Hamilton McCormick5,022.74Henrietta McCormick Williams179.52Elizabeth D. McCormick208.38Phoebe McCormick Ayer207.07Henrietta McCormick-Goodhart5,035.01Mildred D. McCormick201.20From the evidence submitted the Board makes the following FINDINGS OF FACT. The taxpayers are individuals who in the year 1919 were beneficiaries of the income under a trust for 20 years created pursuant to the will of Leander2407 J. McCormick, who died February 20, 1900. The McCormick Building and the Lumber Exchange Building, both situated in Chicago, were constructed by the trustees of the estate and were owned in fee by them in 1919. The McCormick Building, located on the northwest corner of Michigan Avenue and Van Buren Street, was constructed in 1910-1911 at a cost of $3,272,818.92. It is a store and office building, built 431 on caisson foundations, of steel and concrete, with granite and brick facings. It is 20 stories high, running to a total height of 260 feet, which was the building limit by city ordinance at the time of erection. Present ordinances permit a greater height through set-backs and tower construction. The ground floor is occupied by retail stores. The ceiling of that story is 20 feet high, of the second story 13 feet, and all stories above that 10 feet 6 inches high. The first story is excessively high and has been reduced 4 feet by the present tenants to meet their needs. Modern construction would permit 21 stores instead of 20 within the same height limit. All of the offices on the Michigan Avenue side are 40 feet deep, which is wasteful of space, being much deeper2408 than in more modern structures. The building is fireproof. There are 11 elevators. Its original design of the floors above the first was for occupancy by tenants requiring extensive office space. Some of such tenants have recently vacated to take space in other buildings. One occupied two entire floors and the space has not been filled. On account of the lack of demand for space of that character the rental basis per square foot has been dropped from $3.75 to slightly under $3. The land on which the building stands extends 192 feet on Michigan Avenue and 171 feet on Van Buren Street. The building is located in the southern extremity of the business or loop district of Chicago. The natural development of Chicago is toward the north. The net rentals of the McCormick Building (without deduction for depreciation) have been: 1913$376,162.851914400,263.211915432,140.391916410,432.741917474,184.261918475,019.881919$455,236.081920440,178.441921547,485.891922688,382.361923792,208.46The Lumber Exchange Building, located on the southeast corner of La Salle and Madison Streets, was completed in 1915 at a cost of $1,392,772.59. 2409 In 1919 it was 200 feet in height and had 16 stories. Five additional stories were added in 1924, making the height at present 260 feet. It is built on caisson foundations, of steel and con crete superstructure, and has an outside finish of brick and terra cotta. It is an office building in the business or loop district. There are few unrented offices. It is 135 feet on La Salle Street and 100 feet on Madison Street. The net rentals (without deduction for depreciation) have been: 1916$93,767.601917147,696.411918156,213.761919147,173.051920$153,831.041921165,942.111922221,952.691923248,148.44432 During the Chicago fire of 1871 the entire business district was destroyed. Since that time many buildings in the district have been torn down to make way for more modern structures, even though the buildings were making a return upon the original investment. In many instances a third building now stands on land which was swept by the fire. The general tendency has been for newly constructed buildings to cover more land than that occupied by the demolished structure. Consolidation of ownership and larger and higher buildings2410 with resulting economies in operation and increased rental space have occurred in many instances of new construction. Within the district bounded by Lake Street on the north, Wells Street on the west, Michigan Avenue on the east, and Van Buren Street on the south (including south of Van Buren Street and north of Congress Street between State Street and Michigan Avenue), 877 buildings existing in 1891 were reduced to 793 buildings in 1904. In 1922 there were 639 buildings, and in 1925 596 buildings, a total decrease of 271 buildings between 1891 and 1925, or a 32.36 per cent decrease. The building history of Chicago in this business district has shown few buildings remaining after 35 years from construction and that buildings that had not reached the final condition of physical depreciation or exhaustion had become obsolete from an economic standpoint and were replaced by larger, higher, and more modern structures. From the competent testimony of eight credible witnesses produced by the taxpayer, and with no conflicting or rebutting evidence introduced by the Commissioner, we find the probable useful economic life of both of the buildings here involved to be 40 years from the*2411 respective dates of their construction, and that a reasonable allowance for exhaustion, wear and tear, including a reasonable allowance for obsolescence, is 2 1/2 per cent upon their respective costs. The determinations of deficiencies by the Commissioner were based upon an allowance at the rate of 1 1/2 per cent. From those determinations the taxpayers duly appealed to this Board. DECISION. The deficiencies determined by the Commissioner are disallowed. ARUNDELL not participating. Footnotes1. The following were heard with the above-named appeal and are decided herewith: Appeals of L. Hamilton McCormick, No. 1606; Henrietta McCormick Williams, No. 1607; Elizabeth D. McCormick, No. 1608; Phoebe McCormick Ayer, No. 1609; Henrietta McCormick-Goodhart, No. 1610; and Mildred D. McCormick, No. 1611. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625359/	F. T. Bedford v. Commissioner.Bedford v. CommissionerDocket No. 112750.United States Tax Court1944 Tax Ct. Memo LEXIS 286; 3 T.C.M. (CCH) 374; T.C.M. (RIA) 44123; April 17, 1944286 Holt S. McKinney, Esq., 122 E. 42nd St., New York, N. Y., for the petitioner. Ellyne E. Strickland, Esq., for the respondent. HARRON Supplemental Memorandum Opinion HARRON, Judge: Originally, a findings of fact and opinion was promulgated in this proceeding on December 22, 1943 (2 T.C. 1189">2 T.C. 1189). As stated therein, the question presented was whether petitioner, as an income beneficiary of certain trusts, was taxable upon the value of the new preferred stock of the Bush Terminal Co. (hereinafter called Terminal Co.) received by the trusts during the taxable year in connection with a reorganization of the Terminal Co. under section 77 (B) of the National Bankruptcy Act. The determination of the question depended upon whether the stock eas received as part of a non-taxable exchange under section 112 (b) (3) of the Internal Revenue Code. In our original opinion, it was held that the receipt of the new preferred stock of the Terminal Co. was not the receipt of securities of a corporation a party to a reorganization within section 112 (b) (3) and that the stipulated value of the new securities was taxable gain to petitioner. The Revenue Act of 1943 was enacted 287 by Congress on February 25, 1944. On February 26, 1944 and March 1, 1944, petitioner lodged with this Court motions for reconsideration of the issue in the light of section 121 of the Revenue Act of 1943. On March 2, 1944, petitioner's motions were granted. [The Facts] For convenience, the facts will be briefly restated here. Petitioner was one of the named beneficiaries of five trusts. Each trust owned certain shares of 7 percent cumulative preferred stock of the Bush Terminal Buildings Co. (hereinafter called Buildings Co.). The dividends on this perferred stock and the payment of its par value in the event of dissolution were unconditionally guaranteed by the Terminal Co. The dividends became in arrears in 1933, and in that year the Terminal Co. was placed in the hands of receivers. On April 21, 1937, the Terminal Co. and the Buildings Co. were both reorganized under section 77(B) of the National Bankruptcy Act. In the reorganization of the Buildings Co. its preferred stockholders received new preferred stock of that company, generally similar to the old preferred stock, but having voting rights and without guarantee of dividends. In the reorganization proceedings of the 288 Terminal Co. the preferred stockholders of the Buildings Co. had filed claims in connection with the guarantee of their stock but the validity of such claims was questioned by the trustee for the Terminal Co. In the plan for the reorganization of the Terminal Co., however, it was provided that all claims of the preferred stockholders of the Buildings Co. against the Terminal Co. based upon the guaranty would be satisfied by the issuance to such stockholders of one share of new Terminal Co. 6 percent cumulative preferred stock for each five shares of Buildings Co. preferred stock. Thereupon and pursuant to the plan, the preferred stockholders of the Buildings Co. relinquished their claims against the Terminal Co. and received new preferred stock of the Terminal Co. in lieu of that company's guaranty of the Building Co.'s old preferred stock. Under these facts, it was held that each company was reorganized under its own plan and that the trusts received new preferred stock of the Terminal Co. as a general creditor of that company. It was further held that the Terminal Co. was not a party to the reorganization of the Buildings Co. and that the receipt of the new preferred stock by the289 trusts was not part of a tax-free exchange under section 112 (b) (3) of the Code. Petitioner now contends that sections 121 (a) and (b) 1 of the Revenue Act of 1943 require a different result. Petitioner relies particularly upon section 121 (b) which, as material to this proceeding, provides that no gain or loss shall be recognized by security holders of a corporation reorganized under section 77 (B) of the National Bankruptcy Act pursuant to a plan of reorganization approved by the court whereby stock or securities of the corporation are relinquished or extinguished in consideration of the acquisition solely of stock or securities in a corporation organized or made use of to effectuate the plan of reorganization. This section, however, is inapplicable to the facts of this proceeding. Although the trusts received new stock of the Terminal Co., that stock was not received in consideration of the relinquishment or extinguishment of stock or securities of the Terminal Co. The new stock was received solely in consideration of the extinguishment of the trusts' right to enforce the contractual obligation of the Terminal Co.'s guaranty. That right, however, cannot be considered a "security" 290 within the meaning of the statute. See Le-Tulle v. Scofield, 308 U.S. 415">308 U.S. 415; Helvering v. Tyng and Helvering v. Buchsbaum, 308 U.S. 527">308 U.S. 527; Pinellas Ice & Cold Storage Co. v. Commissioner, 287 U.S. 462">287 U.S. 462; Lloyd-Smith v. Commissioner, 116 Fed. (2d) 642; L. & E. Stirn, Inc. v. Commissioner, 107 Fed. (2d) 390; Cortland Specialty Co. v. Commissioner, 60 Fed. (2d) 937 "security" within the contemplation of the statute means permanent or semi-permanent long-term obligations. Commissioner v. Sisto Financial Corporation, 139 Fed. (2d) 253. It does not mean a contingent contractual obligation. Here, the obligation of the Terminal Co. was contingent and, in fact, was contested by the trustee for the company. Accordingly, it is held that the transaction does not come within the non-recognition of gain or loss provisions of the Code, and it is therefore necessary to determine petitioner's gain or loss on the transaction. Cf. Commissioner v. Sisto Financial Corporation, supra.291 292 The parties have stipulated that the fair market value of the new preferred stock of the Terminal Co. received by the trusts was $16,170 of which $3,370.42 was attributable to petitioner. In his notice of deficiency, respondent has taxed the full amount of $3,370.42 to petitioner, apparently on the theory that there was no cost basis attributable to the guaranty. At the hearing the only evidence introduced by petitioner with reference to cost basis was the cost of the old Buildings Co. preferred stock. No evidence was introduced allocating any part of that cost basis to the guaranty of the Terminal Co. Under the circumstances, respondent's determination must be sustained. No decision has been entered in this proceeding. Under the opinion promulgated on December 22, 1943, and under this supplemental memorandum opinion the income tax liability must be recomputed under Rule 50. On January 31, 1944, respondent filed his recomputation of the tax. Petitioner has not filed a recomputation of the tax and has not acquiesced in respondent's recomputation to date. Respondent's recomputation has been placed upon the day calendar of April 26, 1944, for hearing. Under separate order, that hearing293 is continued until May 3, 1944, before which date petitioner should file his recomputation or acquiescence in respondent's recomputation. Decision will be entered under Rule 50. Footnotes1. SEC. 121. REORGANIZATION OF CERTAIN INSOLVENT CORPORATIONS. (a) Nonrecognition of Gain or Loss on Certain Reorganizations. - Section 112 (b) (relating to recognition of gain or loss upon certain exchanges) is amended by inserting at the end thereof the following: "(10) Gain or loss not recognized on reorganization of corporations in certain receivership and bankruptcy proceedings. - No gain or loss shall be recognized if property of a corporation (other than a railroad corporation, as defined in section 77m of the National Bankruptcy Act, as amended) is transferred, in a taxable year of such corporation beginning after December 31, 1933, in pursuance of an order of the court having jurisdiction of such corporation - "(A) in a receivership, foreclosure, or similar proceeding, or "(B) in a proceeding under section 77B or Chapter X of the National Bankruptcy Act, as amended. to another corporation organized or made use of to effectuate a plan of reorganization approved by the court in such proceeding, in exchange solely for stock or securities in such other corporation." (b) Recognition of Gain or Loss of Security Holders in Connection With Certain Corporate Reorganizations. - Section 112 (relating to recognition of gain or loss) is amended by inserting at the end thereof the following: "(1) Exchanges by Security Holders in Connection With Certain Corporate Reorganizations. - "(1) General Rule. - No gain or loss shall be recognized upon an exchange consisting of the relinquishment or extinguishment of stock or securities in a corporation the plan of reorganization of which is approved by the court in a proceeding described in subsection (b) (10), in consideration of the acquisition solely of stock or securities in a corporation organized or made use of to effectuate such plan of reorganization. "(2) Exchange occurring in taxable years beginning prior to January 1, 1943. - If the exchange occurred in a taxable year of the person acquiring such stock or securities beginning prior to January 1, 1943, then, under regulations prescribed by the Commissioner with the approval of the Secretary, gain or loss shall be recognized or not recognized - "(A) to the extent that it was recognized or not recognized in the final determination of the tax of such person for such taxable year, if such tax was finally determined prior to the ninetieth day after the date of the enactment of the Revenue Act of 1943; or "(B) in cases to which subparagraph (A) is not applicable, to the extent that it would be recognized or not recognized under the latest treatment of such exchange by such person prior to December 15, 1943, in connection with his tax liability for such taxable year."↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625360/	APPEAL OF THE KOLYNOS CO.Kolynos Co. v. CommissionerDocket No. 4130.United States Board of Tax Appeals4 B.T.A. 520; 1926 BTA LEXIS 2267; July 29, 1926, Decided 2267 The petitioner and Kolynos, Inc., were affiliated during the fiscal years ended August 31, 1917, 1918, and 1919, respectively. K. N. Parkinson, Esq., and S. C. Morehouse, Esq., for the petitioner. E. C. Lake, Esq., for the Commissioner. LANSDON 520 Before STERNHAGEN, LANSDON, and ARUNDELL. In this appeal the Commissioner asserts a deficiency in the income and profits taxes of the petitioner for the fiscal year ended August 31, 1920, in the amount of $10,619.75. The deficiency arises from the refusal of the Commissioner to permit The Kolynos Co. and Kolynos, Inc., to make a consolidated return for the fiscal year ended August 31, 1920, and from certain deductions from the invested capital of the petitioner for the same year. FINDINGS OF FACT. 1. The petitioner is a Connecticut corporation organized in 1908 to manufacture and sell Kolynos dental cream. The formula for this preparation was developed by Newell S. Jenkins, who had been a successful practitioner of dentistry in Europe and the United States since about the year 1866. 521 2. The organizers and original stockholders of the petitioner were Newell S. Jenkins; 2268 his wife, Clara Elizabeth Jenkins; his son, Leonard A. Jenkins; Calvert Townley, Henry E. Hosley, and Herbert W. Carter, who were close friends of the Jenkins family, and Klewe & Co., Inc., a corporation of which Newell S. Jenkins was the only beneficial owner of stock. The stock originally allotted to this corporation was all transferred to Newell S. Jenkins and Leonard A. Jenkins in 1910. 3. In 1911 the stockholders of the Kolynos Co. organized Kolynos, Inc., under the laws of Connecticut, for the sole purpose of distributing Kolynos products outside of continental North America, and especially within Great Britain and her dependencies. On account of the exigencies of the World War the two companies established a factory in Great Britain for the manufacture of their products. 4. In any years 1917, 1918, and 1920, the stock of the two corporations was owned and held as follows: Kolynos, Inc.The Kolynos Co.Per centPer cent1917.Newell S. Jenkins40.40.Leonard A. Jenkins5.110.Clara E. Jenkins6.2.Henry E. Hosley15.130.Calvert Townley10.8.Herbert W. Carter9.110.James D. Lockhead2.7Charles S. DeForest8.William E. Gilbert4.100.100.1918.Newell S. Jenkins40.41.3Leonard A. Jenkins5.110.5Clara E. Jenkins6.2.1Henry E. Hosley15.131.1Calvert Townley10.10.Herbert W. Carter9.1James D. Lockhead2.71.8Charles S. DeForest8.1.8William E. Gilbert4.1.4100.100.1920.Newell S. Jenkins40.41.3Leonard A. Jenkins5.110.5Clara E. Jenkins6.2.1Henry E. Hosley15.131.1Calvert Townley1.2.6Clifford C. Townley4.53.7Donald C. Townley4.53.7James D. Lockhead2.71.8Charles S. DeForest8.1.8William E. Gilbert4.1.4Edith J. Carter9.1100.100.2269 522 5. James D. Lockhead was manager of the New York office of the petitioner; William E. Gilbert was a close friend of the Jenkins family; Clifford C. and Donald C. Townley are sons of Calvert Townley, to whom their father gave the stock standing in their names, with the verbal understanding that he retained the right to vote and sell the same; Edith J. Carter is the widow of Herbert J. Carter, an original incorporator of each company, from whom she inherited her shares in both concerns. Financial necessity forced Mrs. Carter to sell her shares in The Kolynos Co. to other shareholders of this corporation. 6. Kolynos, Inc., was organized and, until its absorption by the parent company subsequent to the taxable year, was always conducted as a subsidiary of The Kolynos Co. Except as indicated above, the stockholders of the two corporations were identical in the year involved in this appeal. They had the same officers and were operated as single business unit. The parent company directly, or by the stock subscription of its shareholders, financed all the operations of the subsidiary and at all times, from 1911 to 1922, exercised complete control over it. No dissenting2270 vote was ever cast at any of the directors' or stockholders' meetings of the company. 7. The petitioner made a separate income and profits-tax return for its fiscal year ended August 31, 1917, but thereafter filed a consolidated return for both corporations. It made a similar consolidated return for its fiscal year ended August 31, 1918. The Commissioner allowed affiliation for both such years, and settlement of taxes was so made. In September, 1924, after the statute of limitations contained in section 250(d) of the Revenue Act of 1918 had run, the Commissioner reaudited the returns for the fiscal years ended August 31, 1917 and 1918, and held that the companies were not entitled to file a consolidated return for either of such years. He thereupon determined deficiencies for each year in the amounts that would have been due the Government if the statute had not run against their collection, and deducted such amounts from the invested capital of the petitioner for the year 1920. OPINION. LANSDON: The two issues in this proceeding are: (1) Whether the petitioner and Kolynos, Inc., were entitled to make consolidated returns for the fiscal year ended August 31, 1920; and2271 (2) whether the Commissioner erred in reducing the invested capital of The Kolynos Co. for the fiscal year ended August 31, 1920, in the amounts which he determined should have been paid as income and profits taxes for the fiscal years ended August 31, 1917 and 1918. The facts are not in dispute. After the incorporation of Kolynos, Inc., the two corporations were closely associated and operated as 523 a single business. The officials and directors of the two were the same persons. Except as disclosed in the findings of fact, above, the stockholders were the same. The shareholders who owned stock in one and not in the other were closely drawn together by ties of blood, friendship, and interest. We are of the opinion that during the fiscal years 1917, 1918, and 1920, respectively, The Kolynos Co. and Kolynos, Inc., met all the conditions required as a basis for affiliation by section 240(b) of the Revenue Act of 1918 and section 1331(a) and (b) of the Revenue Act of 1921, and were entitled to file consolidated returns for each of such years. 2272 ; ; ; . Having determined that the petitioner and Kolynos, Inc., were entitled to make consolidated returns for the fiscal years ended, respectively, at August 31, 1917 and 1918, it follows that the additional taxes asserted by the Commissioner were erroneously determined, and that the amount of such taxes may not be deducted from the invested capital of the taxpayer for the fiscal year ended August 31, 1920. Order of redetermination will be entered on 10 days' notice, under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625362/	Moses Mitnick (Also Known as Eddie Lewis), Petitioner, v. Commissioner of Internal Revenue, RespondentMitnick v. CommissionerDocket No. 16971United States Tax Court13 T.C. 1; 1949 U.S. Tax Ct. LEXIS 136; July 5, 1949, Promulgated 136 Decision will be entered for respondent. Upon the facts, held (1) petitioner has not established that he had any "home" within the meaning of section 23 (a) (1) (A), Internal Revenue Code, and his traveling expenses for the years 1942, 1943, and 1944, therefore, were personal expenses and not deductible, and (2) petitioner has not sustained his burden of proof as to other expenses for which he claimed deductions for those years. Lewis G. Lebish, Esq., for the petitioner.Whitfield J. Collins, Esq., for the respondent. Hill, Judge. HILL 1 Respondent determined deficiencies in petitioner's income tax for the years 1943 and 1944 in the respective137 amounts of $ 893.84 and $ 274.90. Respondent made certain adjustments in petitioner's income for the year 1942, but, due to the forgiveness feature of the Current Tax Payment Act of 1943, deficiencies were determined only for the years 1943 and 1944. The basic question is whether petitioner should be permitted deductions for alleged traveling, entertainment, and other business expenses, and for contributions and payments of taxes during the years involved.FINDINGS OF FACT.During 1942, 1943, and 1944 petitioner was a nonresident alien, doing business in this country. His tax returns for those years were filed with the collector of internal revenue for the third district of New York.Petitioner was a citizen of Canada during the years involved. From 1923 to 1939 petitioner spent most of his time in Paris, France. In 1939 he left Paris and came to the United States to manage theatrical companies. He remained in the United States from that time until 1946. He did not visit or live in Canada between 1939 and the 2 end of 1944. From time to time petitioner gave money to his brother, who lived in Canada, whenever the latter visited this country. During part of 1942 and 1943138 petitioner maintained an apartment in New York City. In 1944 he spent most of his time on the west coast.During 1943 and 1944 petitioner was a theatrical or company manager of certain shows. His duties consisted of collecting the money for the shows, arranging for transportation of personnel and all equipment used by the company, paying the personnel, and taking care of other details connected with the shows. The companies which he managed during the years involved were comprised, on the average, of six or seven people.In 1942 petitioner was with a show which traveled over the United States for approximately 34 weeks. In 1943 the show which he managed traveled for 43 weeks. Four or 5 of those weeks were spent in New York City. In that year he was employed by Clifford Fisher of New York City and W. F. F. B. Corporation of San Francisco, California. In 1944 the show he managed traveled for a period of 17 weeks.In 1943 the show of which petitioner was manager traveled to the following cities:Dayton, Ohio.Minneapolis, Minn.St. Louis, Mo.Louisville, Ky.St. Paul, Minn.Detroit, Mich.Indianapolis, Ind.Des Moines, Iowa.Cincinnati, Ohio.Davidson, Ark.Sioux Falls, S. Dak.Philadelphia, Pa.Milwaukee, Wis.Omaha, Nebr.Washington, D. C.Madison, Wis.Kansas City, Mo.139 Petitioner was paid a salary by his employer as manager of the show and in addition was allowed an expense account.In his capacity as manager petitioner incurred certain expenses for meals, hotels, taxi fares, tips, telephone calls, secretarial help and entertainment.In his tax return for 1942 petitioner claimed deductions as follows:Contributions$ 200Taxes755Other deductions:Hotel and meals at $ 60 weekly$ 2,040Transportation310Tips to porters, bell boys and stage hands250Entertainment4503,050Of these amounts, respondent disallowed $ 100 for contributions and $ 75 for taxes for lack of substantiation. In addition, respondent disallowed the entire amount of $ 3,050, because it was expended for "personal living expenses." Petitioner claimed a deduction for travel and 3 entertainment expenses in 1943 in the amount of $ 2,580 and in 1944 in the amount of $ 1,120, $ 1,020 being for traveling expenses and $ 100 for entertainment. Respondent disallowed such deductions "because they are personal expenses and are not deductible for Federal income tax purposes."During the years here involved petitioner had no permanent place140 of residence and no business headquarters.OPINION.Respondent contends petitioner should not be allowed any deductions for the expenditures involved for the reasons (1) that petitioner has not established any "home" within the meaning of section 23 (a) (1) (A) of the Internal Revenue Code, 1 and, therefore, disbursements that he made while on the road with the shows were personal expenses and not deductible (sec. 24(a)); and (2) that he has failed to sustain his burden of proof with respect to the amount of the deductions claimed. Petitioner claims that he has proved both a home within the meaning of section 23 (a) (1) (A) and the incurrence of the expenses which he claimed as deductions during the years in question.141 In Mort L. Bixler, 5 B. T. A. 1181, 1184, we said that a taxpayer's "home" as that term is used in the statute, 2 was his "place of business, employment, or post or station at which he is employed." That definition was cited with approval in Walter M. Priddy, 43 B. T. A. 18, 31.Petitioner claims that Canada was his home during the years involved and that he was "in a travel status and is entitled to claim traveling and living expenses in connection with his trade or business within the United States." He had lived in Paris from 1923 until 1939, when he came to the United States for the purpose heretofore stated. The evidence is vague as to whether he ever lived in Canada after 1923, but it is definite that he never visited Canada from 1939 until after 1944 and that his business headquarters were never there. He claims that he paid rent142 to his brother, who lived in Montreal, Canada, the mode of payment being amounts given to his brother whenever he visited petitioner in the United States. The amounts of such payments or how often they were made are not disclosed by the record. We can not conclude from that evidence that petitioner has established a "home" in Canada for the years involved.4 Neither can we find from the record that he had a permanent or principal place of employment within the United States. The only evidence pertaining to any headquarters in this country was his testimony that he never submitted an expense account while in New York City and that he maintained an apartment part time in that city during the taxable years 1942 and 1943, and the listing of Clifford Fisher of New York City as his employer during the taxable year 1943. There is no showing in the record, however, of how much time he spent in New York City, except that he was there three or four weeks in 1943. We do not believe that those facts prove a permanent headquarters or principal place of business for the years involved, particularly in view of the fact that petitioner apparently never considered New York City his headquarters, 143 for he has not alleged that it or any other place, except Montreal, Canada, was his "home" during such period.Hence, the evidence is not sufficient to justify any of petitioner's expenditures involved as traveling expenses while away from home in pursuit of a trade or business; his home being, so far as the record shows, wherever a particular show he managed happened to be. The traveling expenses, therefore, were personal expenses and not deductible. Sec. 24 (a), I. R. C. See Charles E. Duncan, 17 B. T. A. 1088, distinguished in Charles G. Gustafson, 3 T.C. 998">3 T. C. 998.Moreover, we can not say from the facts that respondent's disallowance of the entertainment and other business expenses was error. The only evidence presented concerning the amounts of such expenditures was petitioner's estimation. Moreover, he was given an expense account. The amount of that account or for what he was reimbursed can not be adequately ascertained from the record. It might be that the expense account was more than sufficient to cover any of his disbursements for entertainment or other business expenses. In this respect the case at bar differs*144 from Cohan v. Commissioner, 39 Fed. (2d) 540. Petitioner has failed to overcome the prima facie correctness attaching to respondent's determination with respect to those items.The pleadings also raised the issue of deductibility of $ 100 for contributions and taxes of $ 75 allegedly paid by petitioner during the taxable year 1942. Respondent disallowed those deductions for "lack of substantiation." Petitioner presented no proof whatsoever concerning those amounts at the hearing, and respondent's disallowance of those items, therefore, will not be disturbed.It follows that respondent did not err in his determination.Decision will be entered for respondent. Footnotes1. See section 213, Internal Revenue Code, and section 29.213-1 (b) of Regulations 111, which provide for the allowable deductions in the case of a nonresident alien individual. If a nonresident alien is engaged in a trade or business within the United States, he may have deductions for ordinary and necessary business expenses under section 23 (a) (1) (A)↩ of the code.2. Section 214 (a) (1) of the Revenue Act of 1921, which was later incorporated in the code as section 23 (a) (1) (A)↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625364/	Richard Jiu and Theodora G. Jiu v. Commissioner.Jiu v. CommissionerDocket No. 4039-70 SCUnited States Tax CourtT.C. Memo 1971-48; 1971 Tax Ct. Memo LEXIS 283; 30 T.C.M. (CCH) 220; T.C.M. (RIA) 71048; March 23, 1971, Filed. Richard Jiu, pro se, 2009 Upland St. San Pedro, Calif. Melvern Stein, for the respondent. JOHNSTON Memorandum Findings of Fact and Opinion JOHNSTON, Commissioner: The respondent determined a deficiency in petitioners' Federal income tax for 1968 in the amount of $146.46. The issue for decision is whether petitioners are entitled to a medical expense deduction under section 213(a) of the Internal Revenue Code284 of 1954. 1Some of the facts have been stipulated and are so found. Petitioners resided in San Pedro, California when they filed their petition in this case. During the taxable year petitioners paid medical expenses of the parents of Mrs. Jiu in the amount of $503. Ping Y. Gin and Tom See Gin, the father and mother of Mrs. Jiu, were subject to a multiple support agreement of their twelve children under which one of Mrs. Jiu's brothers was designated as the person entitled to claim the dependency exemptions for the parents for the taxable year. Petitioners did not supply over one-half of the support of Mr. and Mrs. Gin. In fact, petitioner estimated that the payment of $503 of medical expenses represented less than ten percent of the total support provided for Mr. and Mrs. Gin. Petitioners concede that Mr. and Mrs. Gin do not qualify as their dependents for the taxable year under the provisions of sections 151 and 152. Petitioner contends that any person who, but for the fact that he did not contribute over half the support, would have been entitled to claim an individual as a dependent for a285 taxable year can consider such individual as his dependent under section 213. This contention is without merit. To be entitled to deduct medical expenses for a dependent where a multiple support agreement is filed, the taxpayer claiming the deduction must be the person designated in the multiple support agreement as the person entitled to claim the dependent. Section 1.213-1(a)(3)(i), Income Tax Regs. See Litchfield v. Commissioner, 330 F. 2d 509 (C.A. 1, 1964) affirming 40 T.C. 967">40 T.C. 967 (1963). Accordingly, the medical expenses paid by petitioners for their parents are not deductible by them. Reviewed and adopted as the report of the Small Tax Case Division. Decision will be entered under Rule 50. Footnotes1. All statutory references are to the Internal Revenue Code of 1954.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625367/	LEO KUBIK, TRANSFEREE, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentKubik v. CommissionerDocket No. 5960-68.United States Tax CourtT.C. Memo 1974-62; 1974 Tax Ct. Memo LEXIS 257; 33 T.C.M. (CCH) 302; T.C.M. (RIA) 74062; March 12, 1974, Filed. 257 1. Held: Missouri Valley Distributors, Inc., a valid taxable entity, must include in income certain amounts paid to it or on its behalf by a lessee pursuant to the terms of a ground lease. 2. Held: A portion of each of the underpayments of tax that Missouri Valley Distributors, Inc. was required to show on its Federal income tax returns for each of the taxable years in issue was due to fraud. 3.Held: Petitioner is liable as a transferee of the assets of Missouri Valley Distributors, Inc. for the deficiencies determined by respondent. 4. Held: The statutory period for assessment and collection of the liability of the petitioner as a transferee has not expired. Truman Clare, for the petitioner. Robert J. Murray, for the respondent. WILESMEMORANDUM FINDINGS OF FACT AND OPINION WILES, Judge: Respondent determined that petitioner is liable as the transferee of the assets of Missouri Valley Distributors, Inc. (sometimes referred to as the corporation) 259 pursuant to section 6901. 1 Petitioner's alleged liability relates to the following deficiencies that respondent has determined in the corporation's income tax: YearDeficiencyAddition to Tax Section 6653(b) 1960$6,984.32$3,492.1619616,321.153,160.58The issues for decision are: (1) whether certain amounts paid to or on behalf of Missouri Valley Distributors, Inc., by Manhattan Corporation, pursuant to the terms of a ground lease, are includable in the income of Missouri Valley Distributors, Inc. for the years in issue; (2) whether a portion of each of the underpayments of tax that Missouri Valley Distributors, Inc., was required to report on its Federal income tax returns for each of the taxable years in issue was due to fraud; (3) whether petitioner is liable as a transferee of the assets of Missouri Valley Distributors, Inc., for the deficiencies determined by respondent; and (4) whether the statutory period for assessment and collection of the liability of the petitioner as a transferee of the corporation has expired. 260 FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. Leo Kubik was a resident of Carter Lake, Iowa, at the time he filed his petition in this proceeding. Missouri Valley Distributors, Inc., incorporated under the laws of the State of Iowa on June 3, 1957, did not file Federal corporate income tax returns for each of the taxable years 1960 and 1961. Petitioner was the president, treasurer, and sole owner of the transferor, which was incorporated for the purpose of operating a bottle club. Payment of an annual membership fee entitled a member to bring a bottle of liquor to the club premises and socialize with other members. The bottle club was operated in a building that was known as the Shrangi-La Club and that had been constructed prior to the formation of the corporation. Although the Shrangi-La Club was located on real estate in the State of Nebraska, the corporation was incorporated under Iowa law in order to create diversity of citizenship with law enforcement personnel of the State of Nebraska. It was thereby intended that disputes arising between the newly formed corporation and Nebraska law enforcement personnel would be subject to261 the jurisdiction of a Federal district court. In an attempt to resolve one such dispute, Missouri Valley Distributors, Inc. filed a civil action in its own name to enjoin the padlocking of the club. In 1959 the charter of Missouri Valley Distributors, Inc. was cancelled by the State of Iowa for failure to file an annual report, but was reinstated on June 10, 1960. On April 10, 1962, the charter was again cancelled by the State of Iowa for failure to file an annual report. On August 4, 1960, Missouri Valley Distributors, Inc. agreed to lease certain real estate situated in the City of Omaha, Douglas County, Nebraska, to the Manhattan Corporation for a term of ninety-nine years at a monthly rental of $850. The lessee agreed to pay as advance rentals certain liens on the real estate in order to clear title, certain attorney's fees, a real estate commission and an amount of cash. During the taxable years 1960 and 1961 Manhattan Corporation made advance rental payments to or on behalf of Missouri Valley Distributors, Inc. in the amounts of $24,875.59 and $21,379.66, respectively, in order to pay the outstanding liens on the real estate in issue. Advance rental payments in the262 total amount of $10,000 were also paid to Warren C. Schrempp, who represented Missouri Valley Distributors, Inc. as an attorney and agent in negotiating the lease. A portion of this amount was retained by Schrempp as compensation for services and the remainder was disposed of by him to or for the benefit of the petitioner. On February 6, 1967, Missouri Valley Distributors, Inc. transferred the real estate in issue to petitioner. The corporation received no consideration from petitioner for the transfer of this real estate, which was the transferor's only asset at that time and which had a fair market value of at least $200,000. Two buildings had previously been located on the property but, pursuant to the terms of the lease, had been relocated to other property belonging to the petitioner. On September 25, 1968, respondent sent to petitioner, by certified mail, a notice of transferee liability in which it was determined that for its taxable years 1960 and 1961, Missouri Valley Distributors, Inc. was liable for deficiencies in income tax in the amount of $19,958.21, including additions to tax under section 6653(b), plus interest as provided by law. No part of this deficiency263 or the statutory interest has been paid, and the entire amount is still outstanding. By reason of the transfer of the real estate in issue to petitioner, the transferor was rendered, and is, insolvent and without assets with which to pay the deficiencies in income tax and additions to the tax due for the taxable years 1960 and 1961, plus statutory interest thereon. Because of the insolvency of the transferor from approximately February 6, 1967 to the present, any further efforts by respondent to collect from the transferor the deficiency in income tax and additions to the tax due from the transferor would be a useless gesture. On June 3, 1964, Special Agent Robert Collins and Revenue Agent David Crossan met with petitioner and his accountant, Edward Milder. At that meeting, petitioner stated that he knew Federal corporate returns were required to be filed and that he had discussed this matter with his attorney, Warren C. Schrempp, about a dozen times. Petitioner also stated at that meeting that he had engaged Edward Milder to prepare only his personal returns and that he had informed Edward Milder that the corporate returns would be filed by Warren C. Schrempp. On March 19, 1965, Special264 Agent Collins, Revenue Agent Crossan and Group Supervisor Bud Cronk met with petitioner. Petitioner repeated the statements he had made at the June 3, 1964 meeting, but admitted that Warren C. Schrempp never had had access to the books and records of Missouri Valley Distributors, Inc. Petitioner stated that he had kept those records but could not produce them because they were lost, stolen or not available. Petitioner did not elaborate regarding the alleged thefts. Special Agent Collins attempted to determine whether the alleged thefts had in fact occurred by contacting the various local police departments. He was able to verify only one theft. The local newspaper account of this theft reported the items that petitioner had listed as missing; however, records of Missouri Valley Distributors, Inc. were not included in that list. The petitioner also told Revenue Agent Crossan at various times that the records in issue were possibly burned in a fire either at the Jet Drive-In, a business of petitioner, or at the Shangri-La Club. A fire at the Jet Drive-In occurred on May 13, 1962. A fire at the Shrangri-La Club occurred in 1969 or 1970. Warren C. Schrempp testified at trial265 that he never maintained the books and records of Missouri Valley Distributors, Inc. He also stated that he had never discussed with petitioner the filing of corporate returns. The petitioner testified at trial that he never had discussed the filing of corporate returns with Warren C. Schrempp. He testified that Edward Milder kept the records of Missouri Valley Distributors, Inc. and that a procedure had been established whereby Edward Milder would pick up these records about every three months. Petitioner also testified that he had asked Edward Milder if Missouri Valley Distributors, Inc. was required to pay taxes if all its income had been paid out as expenses. The petitioner testified that Edward Milder told him he wouldn't have to pay taxes if the corporation didn't have any profits. During the month of December 1972, the petitioner and his wife, Regina M. Kubik, litigated Civil No. 3-884-W in the United States District Court for the Southern District of Iowa. That suit was for refund of personal income taxes plus additions to the tax that they had paid for the taxable years 1960, 1961 and 1963. In that proceeding, the court determined as a matter of law that Missouri266 Valley Distributors, Inc. was a corporation for tax purposes during the taxable years 1960 and 1961. The determination of the court in Civil Docket No. 3-884-W has now become final. On August 11, 1966, petitioner as president and responsible officer of the transferor was charged in two counts of an indictment with willful failure to file corporate income tax returns for the transferor for the taxable years 1960 and 1961 in violation of section 7203. On November 8, 1967, petitioner entered a plea of nolo contendere to each count of the indictment referred to in the preceding requested finding, and on March 21, 1968, he was sentenced to pay a fine of $1,000 on each of the two counts or a total of $2,000. OPINION The first issue is whether the advance rentals paid to Missouri Valley Distributors, Inc. are includable in its gross income. The burden of proof with regard to this issue is on the petitioner. Initially, petitioner argued that these payments were not includable in the gross income of Missouri Valley Distributors, Inc. because that corporation was not a valid corporation for tax purposes. Petitioner asserts that the corporation was a "shell" corporation, that it never267 functioned in a business capacity, and the petitioner was the real business operator. We do not agree with petitioner's argument. The corporation operated a bottle club, held title to real estate, leased real estate, received payments in its own name and prosecuted a civil action. We find that these business activities were of such a substantial nature that the corporation's validity as a separate entity must be recognized. Moline Properties, Inc. v. Commissioner, 319 U.S. 436">319 U.S. 436 (1943); Paymer v. Commissioner, 150 F.2d 334">150 F.2d 334 (C.A. 2, 1945). Furthermore, we conclude that the petitioner is collaterally estopped from denying the corporate existence of the transferor for the years in issue. When a suit is brought on a cause of action distinct from any action previously litigated, the doctrine of collateral estoppel will be invoked to prevent the relitigation of those matters in issue or points controverted, the determination of which was essential to the prior finding or verdict. Commissioner v. Sunnen, 333 U.S. 591">333 U.S. 591 (1948); Harold S. Divine, 59 T.C. 152">59 T.C. 152 (1972),268 on appeal (C.A. 2, May 4, 1973). The doctrine is normally applicable when the issues and the parties in the two actions are the same. American Range Lines, Inc., 17 T.C. 764">17 T.C. 764 (1951), remanded on other issues 200 F.2d 844">200 F.2d 844 (C.A. 2, 1952). The petitioner is the same individual who commenced the prior civil suit for refund of taxes paid. The respondent is a party in privity with the United States of America, the defendant in that refund suit. The taxable years in issue are the same as those in issue in the refund suit. The determination by the district court that Missouri Valley Distributors, Inc. was a corporation for tax purposes was essential to the rendering of a final judgment in that case. The prior judicial determination has become final by reason of the petitioner's decision not to appeal that judgment. Accordingly, we conclude that the elements necessary to invoke the doctrine of collateral estoppel are present in the instant controversy. Citing Ruben v. Commissioner, 97 F.2d 926">97 F.2d 926 (C.A. 8, 1938), petitioner further argues that the advance rentals do not constitute gross income to petitioner because they were used to pay debts or269 obligations of Missouri Valley Distributors, Inc. Petitioner's argument is misguided. The issue is not whether the payments in issue are income to petitioner, but rather whether they are income to Missouri Valley Distributors, Inc. We hold that petitioner has failed to meet his burden of proof and that these payments are includable in the gross income of Missouri Valley Distributors, Inc. Section 61(a) (5); section 1.61-8(b), Income Tax Regs., and Renwick v. United States, 87 F.2d 123">87 F.2d 123 (C.A. 7, 1936). The next issue for decision is whether a portion of each of the underpayments of tax that Missouri Valley Distributors, Inc. was required to show on its return was due to fraud. Section 6653(b) provides that fifty percent of the underpayment of tax shall be added to the tax if any part of the underpayment is due to fraud. The issue of fraud is one of fact to be determined upon a consideration of the entire record. Anson Beaver, 55 T.C. 85">55 T.C. 85 (1970). Respondent bears the burden of proving fraud by clear and convincing evidence. Arlette Coat Co., 14 T.C. 751">14 T.C. 751 (1950);270 Abraham J. Muste, 35 T.C. 913">35 T.C. 913 (1961). The addition to tax for fraud may be imposed when there has been a willful attempt to evade tax by means of a willful failure to file returns. Such a willful attempt to evade tax may be found from any conduct calculated to mislead or conceal. Anson Beaver, supra, and cases cited therein. Although willful failure to file does not in itself establish liability for additions to tax on account of fraud, such failure may properly be considered in connection with other facts in determining whether any deficiency or underpayment of tax is due to fraud. Anson Beaver, supra.Upon a careful consideration of the entire record, we conclude that the respondent has proved fraud with intent to evade tax with regard to the taxable years in issue. As evidenced by his admissions to respondent's agents, the petitioner was aware of his responsibility to file Federal corporate income tax returns on behalf of his wholly owned corporation. Nonetheless, he failed to file returns for the corporation for the years 1960 and 1961271 and made no attempt to fulfill his responsibilities before his delinquency was discovered by representatives of the respondent. Furthermore, we find that petitioner's statements and conduct during meetings with respondent's agents and his testimony during the trial were calculated to mislead or conceal. During the trial petitioner demonstrated a tendency to respond to questions of his own counsel but to forget answers to questions propounded by the respondent. Petitioner has made several contradictory statements regarding whom he had engaged to prepare returns for the corporation. At the June 3, 1964 meeting with representatives of the respondent, petitioner, accompanied by his accountant, stated that he had engaged his attorney to prepare the corporate returns and that he had discussed this matter with his attorney about a dozen times. At trial, however, petitioner's attorney testified that he had never discussed the filing of corporate returns with the petitioner. Even petitioner admitted, at the meeting of March 19, 1965, that his attorney never had access to the corporate books and records. Furthermore, petitioner testified at trial that he had asked his accountant to272 prepare those returns and that the accountant picked up the records of the corporation about every three months. Petitioner testified that he had been told by his accountant that the corporation would not have to pay taxes if it had not made a profit during the years in issue. Petitioner apparently contends that this statement by his accountant and his reliance thereon constitutes a sufficient explanation of why he failed to file returns.In view of petitioner's statement to revenue agents that he was aware of his obligation to file corporate returns, we do not believe that petitioner's alleged reliance on his accountant's statement regarding liability for tax is sufficient excuse for failing to file such returns. Petitioner also failed to produce the corporate books and records of Missouri Valley Distributors, Inc. to respondent's agents for their examination. Failure to supply requested records to internal revenue agents is a factor to be considered in determining whether the penalty for fraud should be assessed. Millikin v. Commissioner, 298 F.2d 830">298 F.2d 830 (C.A. 4, 1962), 273 affirming a Memorandum Opinion of this Court. Petitioner's explanation for not supplying the requested records was that they had been stolen or burned. We are not persuaded by petitioner's explanation. Special Agent Collins was able to verify only one theft. At the time of that theft, however, petitioner failed to report that any corporate books and records had been stolen. The record establishes that fires occurred at two of petitioner's businesses, the Jet Drive-In and the Shangri-La Club. The fire at the Shangri-La Club, the location at which we possibly would expect records of the Missouri Valley Distributors, Inc. to be stored, did not occur until several years after the respondent's agents requested certain records. Assuming that the records had been kept at the Jet Drive-In, the records that might have been destroyed by fire in any event would have related to a maximum three month time period, in view of petitioner's testimony that his accountant picked up the records in issue every three months. The third issue for decision is whether petitioner is liable as a transferee for the assessed deficiencies, additions to tax and interest pursuant to section 6901. 274 The respondent has the burden of proving transferee liability. Section 6902(a). Whether a transferee is liable at law or equity for the transferor's unpaid tax is governed by state law. Commissioner v. Stern, 357 U.S. 39">357 U.S. 39 (1958). With regard to the diversion of corporate funds, the provisions of Iowa Code Annotated, section 491.41 (1949) provide as follows: The diversion of the funds of the corporation to other objects than those mentioned in its articles and in the notice published, if any person be injured thereby, and the payment of dividends which leaves insufficient funds to meet the liabilities thereof, shall be such fraud as will subject those guilty thereof to the penalties of section 491.40; and such dividends, or their equivalent, in the hands of stockholders, shall be subject to such liabilities. * * [Emphasis added.] This provision is operative with regard to a corporation's liability for taxes. Manning v. Ottumwa Auto Co., 210 Iowa 1182">210 Iowa 1182, 232 N.W. 501">232 N.W. 501 (1930).275 In that case, the Supreme Court of Iowa said: The statute of this state [the predecessor of section 491.41] prohibits the diversion of corporate funds to other things than those mentioned in its articles, and it is a well-settled rule of the common law that stockholders of a corporation cannot divide its property or assets among themselves without first paying the corporate debts. * * By transferring its only asset to the petitioner, its sole owner, Missouri Valley Distributors, Inc. thereby rendered itself insolvent without having discharged its Federal income tax liability. Because the value of the property transferred to petitioner exceeded the amount of the transferor's liability, we conclude that the petitioner is liable as a transferee for the full amount of the unpaid taxes. Furthermore, we hold that the petitioner is liable for the penalties imposed pursuant to section 6653(b) and for interest pursuant to section 6601. Leo L. Lowy, 35 T.C. 393">35 T.C. 393 (1960); Estate of Samuel Stein, 37 T.C. 945">37 T.C. 945 (1962). The final issue for decision is whether the statutory period for assessment and collection of the deficiencies due from the petitioner as a*276 transferee has expired. Section 6901(c) provides that the statutory period in the case of an initial transferee is one year after the expiration of the period of limitation for assessment against the transferor. Because the transferor failed to file income tax returns for the years in issue and because part of the underpayments of tax were due to fraud, the tax may be assessed against the transferor at any time. Section 6501(c). Accordingly, the statutory period with regard to the petitioner-transferee has not expired. Decision will be entered for the respondent. Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as in effect during the tax years in issue, unless otherwise indicated. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625370/	Jean Renoir and Dido Freire Renoir, Petitioners, v. Commissioner of Internal Revenue, RespondentRenoir v. CommissionerDocket No. 87205United States Tax Court37 T.C. 1180; 1962 U.S. Tax Ct. LEXIS 163; March 30, 1962, Filed 163 Decision will be entered under Rule 50. Petitioners received in 1956 and 1957 earned income from sources outside the United States attributable to an 18-month period ending in 1956. Held, the amount of such income excludible from gross income in 1956 is a fraction of $ 20,000 based upon the number of days of the 18-month period contained in the taxable year, and no amount is excludible in 1957. Sec. 911(a)(2), I.R.C. 1954. J. Everett Blum, Esq., for the petitioners.Douglas W. Argue, Esq., for the respondent. Bruce, Judge. BRUCE 1180 OPINION.The respondent determined deficiencies for the calendar years 1956 and 1957 in the respective amounts of $ 9,318.37 and $ 2,441.19. The sole issue for decision is the extent to which amounts received in the taxable years for personal services performed in France are excludible from taxable income. All the facts are stipulated and are found accordingly.The petitioners, husband and wife, were residents and domiciled in California during the years at issue. They filed joint Federal income 1181 tax returns for the calendar years 1956 and 1957 with the director of internal revenue at Los Angeles. These returns were prepared on165 the cash receipts and disbursements basis.The petitioners were continuously in Europe from October 1, 1953, to July 15, 1956. Jean performed personal services as a motion-picture director and writer in France during this period. Dido performed no services in connection with the income received in 1956 and 1957.Jean received in partial payment for services performed in France the amounts of $ 35,000 in 1956 and $ 10,000 in 1957.The petitioners, on their returns for 1956 and 1957, reported receipt of the salary items but excluded them from taxable income as being exempt under article 10 of the tax treaty between the United States and France, and also under section 911(a)(2) of the Internal Revenue Code of 1954.The respondent determined that none of the salary received by the petitioners in 1957 was excludible and that the amount received in 1956 was excludible only to the extent of $ 10,794.52. Respondent now concedes that the correct amount excludible in 1956 is $ 12,732.24.The parties on brief do not discuss the tax convention between the United States and France and we consider that any argument thereunder has been abandoned. Neither party has discussed the possibility of166 a right to exclusion pursuant to section 911(a)(1) of the 1954 Code. The sole argument is based upon section 911(a)(2). 1167 It is undisputed that the amounts received in 1956 and 1957 constitute earned income, attributable to a period of 18 consecutive months while the petitioners were in Europe, that the income was from sources outside the United States, and that Jean was present in a foreign country or countries for at least 510 days in the 18-month period. The parties disagree as to the interpretation of the last part of paragraph (2), which limits the amount excludible.1182 The petitioners contend, first, that by virtue of the community property laws of California they are entitled each to exclude up to $ 20,000 of the income received in each of the taxable years, and second, that the respondent erred in limiting the amount excludible in 1956 and denying any exclusion in 1957 instead of treating the amounts received as excludible entirely from gross income.They contend that under the community property laws of California, each of them is entitled to one-half of the earnings, and each is entitled to an exclusion of that half entirely since it does not exceed $ 20,000 in either 1956 or 1957. They cite Rev. Rul. 55-246, 1 C.B. 92">1955-1 C.B. 92. This ruling states168 that --If * * * the physical presence requirements of section 911(a)(2) of the Internal Revenue Code of 1954 are met by the spouse who earns the income and the income qualifies as earned income within the meaning of section 911(b) of the Code, such income subject to any limitations of the applicable section of the Code is exempt from taxation on the individual income tax returns of the husband and wife filing separate returns in a community property State regardless of whether the other spouse meets the requirements specified in section 911(a) of the Code. * * ** * * the wife may exclude from gross income on her separate return her share of the income earned by her husband without the United States which is excludable from gross income under the applicable provisions of section 911(a) of the Code. However, with respect to that portion of the earned income of the husband which is not exempt under the provisions of 911(a) of the Code, the wife must include in gross income on her separate return her share of such earned income.The foregoing ruling does not help the petitioners. For one thing they filed joint returns for the taxable years, while the ruling relates to a husband169 and wife who file separate returns. More important is the fact that the $ 20,000 figure stated in section 911(a)(2) is a limitation on the amount of income received in the taxable year which was earned in the 18-month period and which may be excluded. The limitation applies to the income, not to the individual taxpayer. The ruling states that "such income subject to any limitations of the applicable section of the Code is exempt," and states that the wife must include in her gross income her share of "that portion of the earned income of the husband which is not exempt." (Emphasis supplied.) The interpretation urged by the petitioners would favor taxpayers in community property States. Without a clear-cut statutory mandate, we would not attribute to the Congress an intention to authorize a double exclusion of such income for taxpayers in community property States as compared with other taxpayers. Cf. John E. Ross, 37 T.C. 445">37 T.C. 445 (1961).The petitioners further contend that the respondent erred because the time of receipt of this income is immaterial. They refer to section 116(a)(2) of the Internal Revenue Code of 1939 from which section170 1183 911(a)(2) of the Code of 1954 is derived, and the regulations relating thereto. Under these regulations the time of payment was not material so long as the income was attributable to a period of foreign residence. Regs. 118, sec. 39.116-1(b). 2 The provisions of section 116 (a)(2), I.R.C. 1939, as they existed before 1953, contained no limitation upon the amount excludible. The $ 20,000 limitation on the amount excludible was provided by an amendment contained in Pub. L. No. 287, 83d Cong., 1st Sess., referred to as the Technical Changes Act, 67 Stat. 615 (1953). This amendment added the last two sentences and applies to taxable years beginning after 1952. Until this amendment the time of receipt of the income was immaterial. It is still immaterial in determining whether the income is from sources outside the United States or is attributable to an 18-month period. But, since the amount excludible depends upon how much of the taxable year in which the income is received is within the 18-month period which includes 510 days of presence in foreign countries, the year of receipt is obviously material in computing that amount. The "taxable year" means, in this case, 171 the calendar year upon the basis of which the taxable income is computed. Sec. 7701(a)(23), I.R.C. 1954. In this case, as to the taxable year 1956 there was no 18-month period during which Renoir was physically present 510 days in foreign countries and which includes the entire year 1956. Therefore, the entire $ 20,000 exclusion is not available to the petitioners. The 18-month period which includes the largest part of 1956 and yet includes 510 days of physical presence in foreign countries is that adopted by the respondent on brief and apparently includes 233/366 of 1956. This is the period most favorable to the petitioners. There is no period of 18 consecutive months during which Renoir was physically present 510 days in foreign countries and which includes any part of the taxable 1184 year 1957. Hence, there is no allowable exclusion for 1957. The petitioners argue that the respondent's determination is contrary to the earlier regulations which have acquired the force and effect of law. We do not agree that it is contrary to such regulations. But assuming that it is contrary, the determination is in accord with the statute, and if the regulations are inconsistent172 the statute must prevail.173 The present regulations, Income Tax Regulations, section 1.911-1 (b)(2)(ii), interpreting section 911(a)(2) of the Code of 1954, are consistent with the determination of the respondent in this case and contain an example of the method of computation used herein.The respondent's determination with respect to the year 1957 is sustained. We further hold that the petitioners are not entitled to an exclusion greater than $ 12,732.24 for 1956. Certain adjustments have been conceded and others stipulated, depending upon the resolution of the principal issue.Decision will be entered under Rule 50. Footnotes1. SEC. 911. EARNED INCOME FROM SOURCES WITHOUT THE UNITED STATES.(a) General Rule. -- The following items shall not be included in gross income and shall be exempt from taxation under this subtitle: * * (2) Presence in foreign country for 17 months. -- In the case of an individual citizen of the United States, who during any period of 18 consecutive months is present in a foreign country or countries during at least 510 full days in such period, amounts received from sources without the United States (except amounts paid by the United States or an agency thereof) if such amounts constitute earned income (as defined in subsection (b)) attributable to such period; but such individual shall not be allowed as a deduction from his gross income any deductions (other than those allowed by section 151, relating to personal exemptions) properly allocable to or chargeable against amounts excluded from gross income under this paragraph. If the 18-month period includes the entire taxable year, the amount excluded under this paragraph for such taxable year shall not exceed $ 20,000. If the 18-month period does not include the entire taxable year, the amount excluded under this paragraph for such taxable year shall not exceed an amount which bears the same ratio to $ 20,000 as the number of days in the part of the taxable year within the 18-month period bears to the total number of days in such year.↩2. Sec. 39.116-1. Earned income from sources without the United States. -- * * (b) Presence in a foreign country. (1) Amounts constituting earned income as defined in section 116(a)(3) shall be excluded from gross income in the case of an individual citizen of the United States who during any period of 18 consecutive months is present in a foreign country or countries during a total of at least 510 full days, if such amounts are (i) from sources without the United States, (ii) attributable to such period, and (iii) not paid by the United States or any agency or instrumentality thereof. If attributable to a period of 18 consecutive months in respect of which the citizen qualifies for the exemption from tax thus provided, the amounts shall be excluded from gross income irrespective of when they are received.(2) For taxable years ending before January 1, 1953, there is no limitation upon the amount which may be excluded from gross income pursuant to subparagraph (1). For taxable years ending after December 31, 1952, but only with respect to amounts received after such date, the amount excluded from gross income under the provisions of section 116(a)(2)↩ shall not exceed $ 20,000 if the 18-month period includes the entire taxable year. If the 18-month period does not include the entire taxable year, the amount excluded from gross income under such section for such taxable year shall not exceed an amount which bears the same ratio to $ 20,000 as the number of days in the part of the taxable year within the 18-month period bears to the total number of days in such year. * *	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625371/	Wesley J. Rogers v. Commissioner. Estate of Dorothy H. Rogers, Deceased, Wesley J. Rogers, Administrator, and Wesley J. Rogers, individually v. Commissioner.Rogers v. CommissionerDocket Nos. 84596, 84597.United States Tax CourtT.C. Memo 1961-291; 1961 Tax Ct. Memo LEXIS 56; 20 T.C.M. (CCH) 1515; T.C.M. (RIA) 61291; October 24, 196156 Petitioner, a member of the Kentucky bar, owned and operated a variety store. In 1953 the lessor of the store's premises canceled the lease and petitioner ceased to operate the store. The fixtures were sold and its merchandise inventory placed in storage. Petitioner attempted to sell the merchandise in bulk and finally did so in 1958. For the years 1955, 1956 and 1957 petitioner reported losses resulting from the estimated decrease in value of the inventory while in storage. Respondent disallowed the losses. Held, the losses claimed were correctly disallowed. Held, further, expenditures for law library and bar association dues were not deductible in addition to standard deduction as petitioner was a full time employee. Lee S. Jones, Esq., Kentucky Home Life Bldg., Louisville, Ky., for the petitioners. Vernon R. Balmes, Esq., for the respondent. MULRONEY Memorandum Findings of Fact and Opinion MULRONEY, Judge: The respondent determined deficiencies in petitioners' income tax as follows: DocketYearPetitionerNo.Amount1955Estate of Dorothy H. Rogers, Deceased, Wesley J.Rogers, Administrator, and Wesley J. Rogers,individually84597$ 530.471956Estate of Dorothy H. Rogers, Deceased, Wesley J.Rogers, Administrator, and Wesley J. Rogers,individually84597525.491957Wesley J. Rogers845961,078.1157 The questions for decision are (1) whether petitioner is entitled to losses for the years 1955, 1956 and 1957 in the amounts of $2,833.45, $2,550.11 and $4,730.26, respectively, for the decrease in value of an inventory of variety store merchandise; and (2) whether petitioner is entitled to deduct miscellaneous expenses of $109.40 in 1955. Findings of Fact Petitioner Wesley J. Rogers is an individual who resides in Louisville, Kentucky. He and his wife, Dorothy H. Rogers, filed joint income tax returns for the taxable years 1955 and 1956 and petitioner filed an individual income tax return for the year 1957 with the district director of internal revenue at Louisville. 1In about 1944 petitioner and his wife purchased a variety store in Jefferson Village, Indiana, and thereafter conducted the business. Dorothy did most of the buying for the store and acquired a sizable inventory. The store was located on rented premises and in about March 1953 the lessor gave notice for them to vacate. An auction was held but only the fixtures and a small amount of the merchandise inventory58 were sold. The remaining inventory of merchandise was moved into storage until a location could be found to set up the business again. In about June 1953 petitioner inventoried the remaining merchandise at cost or market and arrived at a value for the inventory of $15,111.76. The merchandise consisted of pictures, notions, ribbons, yarns, hardware, piece goods, chinaware, jewelry, fountain pens, ladies' handbags, luggage, ties, shoestrings, nylon hosiery, baby merchandise, ladies' wear, school items, stationery, greeting cards and kindred items usually found in a variety store. Attempts were made from time to time by both petitioner and his wife to sell the merchandise in bulk during the years in question, but no purchasers could be found. In May 1957 it was removed to an auction house and was sold in 1958 for about $775. Petitioner carried the merchandise inventory on Schedule C 2 of his tax returns for all of the years through 1957. For each of the years from 1953 through 1957 he decreased the ending inventory on the assumption that the market value of the stored merchandise was decreasing by about 20 or 25 percent a year. The inventory figures thus arrived at were as follows: 59 1955 opening inventory, $11,333.82; 1955 ending inventory, $8,500.37; 1956 ending inventory, $5,950.26; 1957 ending inventory, $1,220. The difference between the opening and ending inventory in each year ($2,833.45 in 1955, $2,550.11 in 1956 and $4,730.26 in 1957) was reported on petitioners' tax returns as a loss from the variety store business. In addition to these sums, petitioner claimed costs for storing and repairing the merchandise. Respondent, in the determination of deficiency, disallowed the losses to the extent of the depreciation in inventory because it did "not constitute an allowable loss" and allowed the storage and repair charges. Petitioner has been a member of the Kentucky bar since about 1926 and has engaged in the practice of law from time to time since 1929. During 1955 he was employed on the legal staff of the DuPont Company in Charlestown, Indiana. He was sent to a tax school by the company to enable him to advise its employees and he appeared in Indiana and Kentucky courts in litigation dealing with DuPont employees' wages and salaries. The company required that petitioner be a member60 of the Kentucky Bar Association and attend the American Bar Association regional convention in Cincinnati, Ohio, in 1955. In his 1955 tax return petitioner claimed $109.40 as a deduction for amounts spent for expenses of maintaining law library and bar association dues. Respondent disallowed this amount in its entirety. Opinion Petitioner took deductions for the three years in question for unrealized merchandise inventory losses. Respondent's disallowance of the deductions casts the burden on petitioner to substantiate the losses. There is authority for the proposition that a taxpayer, engaged in a going business in which inventories are used, may, in computing the income from the business, write down his closing inventory to reflect the obsolescence of inventory items that occurred in that year. American Manganese Steel Co., 7 B.T.A. 659">7 B.T.A. 659; Dunn Manufacturing Co., 14 B.T.A. 225">14 B.T.A. 225; C-O-Two Fire Equipment Co., 22 T.C. 124">22 T.C. 124 (reversed as to the year obsolescence occurred, 219 F. 2d 57). However, in all such cases specific proof is required61 as to obsolescence of designated articles before the write-down is permitted. The necessity or even the propriety of using inventories in reporting income when no sales of inventory items were made is not readily apparent to us. Petitioner, since 1953, merely held the stock of variety store merchandise in storage. During the first year or so he endeavored to find another store but the record shows that by 1955 he was merely trying to sell the merchandise in bulk. Inventories are used to determine aggregate gain or loss from voluminous continuing selling transactions of inventory items. Petitioner owned the same property (stock of merchandise) at the beginning and at the end of the three year period here involved. If the value of some or all of it went down during said years, petitioner can take no unrealized losses merely because in a prior year it was once the subject of inventory. Petitioner's ownership of this property and his holding it for sale had no effect at all upon his income (beyond expenses for storage, which respondent allowed) 3 because it was held intact and not sold during said years. 62 Even if it be thought such an unrealized inventory loss could ever be taken by one who merely holds the inventory during the years in question for sale in bulk, petitioner's evidence falls far short of establishing such loss. Viewing the evidence in this case in the light most favorable to the petitioner, there is nothing but the opinion of petitioner, his brother, and an auctioneer that an inventory of variety store merchandise would decrease in value about 20 to 25 percent a year. Such evidence would be wholly useless to justify an inventory write-down by the operator of a going variety store business. Certain it is petitioner would be in no better position by reason of the fact that he was not engaged in the business of selling individual items during the years he contends obsolescence occurred. We hold petitioner has not shown error in respondent's disallowance of the so-called inventory losses during the years in question. The only other issue raised by the petitioner involves respondent's disallowance of petitioner's deductions for expenditures in 1955 of $109.40 for his law library and bar association dues. In his petition he states the expenditures were to maintain his63 professional standing "for the purpose and with the intention at any time to re-engage exclusively in the practice of" law. Petitioner was a full time employee of DuPont Company. He elected to take the standard deduction. The expenses were not deductible in addition to the standard deduction. Henry G. Owen, 23 T.C. 377">23 T.C. 377. Decisions will be entered for the respondent. Footnotes1. Dorothy H. Rogers died in December 1956 and petitioner was appointed administrator of her estate.↩2. Form 1040: Schedule C: Profit (or loss) from Business or Profession.↩3. Petitioner took a deduction in 1957 of $4,856.76 as a loss resulting from the depreciation of inventory. Respondent disallowed $4,730.26 of the claimed deduction. The difference, or $126.50, was the amount petitioner established as storage and repair expense.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625373/	John Dempsey Raiford and Roberta Raiford v. Commissioner.Raiford v. CommissionerDocket No. 821-65.United States Tax CourtT.C. Memo 1966-201; 1966 Tax Ct. Memo LEXIS 83; 25 T.C.M. (CCH) 1036; T.C.M. (RIA) 66201; September 15, 1966John Dempsey Raiford, pro se, 18 Voyage St., Venice, Calif. Morley H. White, for the respondent. WITHEYMemorandum Findings of Fact and Opinion WITHEY, Judge: A deficiency has been determined by respondent in the income tax of petitioners for the taxable year 1962 in the amount of $442.14. The issue to be decided is whether respondent correctly disallowed petitioners' dependency deductions taken in their income tax return for that year relating to Jacqueline and Gwendolyn Davis, two minor nieces of petitioner John Dempsey Raiford, under a multiple support agreement. In their return petitioners claimed an additional dependency deduction for Marshall Mhoon which they concede was not proper and which concession will be given effect under Rule84 50. Findings of Fact All stipulated facts are so found. Petitioners who are husband and wife filed their joint income tax return for 1962 with the district director at Los Angeles, California. Petitioner (hereinafter meaning John Dempsey Raiford) in his 1962 return treated Gwendolyn and Jacqueline Davis, his minor nieces aged 9 and 10, respectively, as his dependents and claimed a dependency deduction for each. He had theretofore entered into a valid multiple support agreement regarding the two minors with his mother, Minnie Mhoon Miller, and the children's father, Knowledge N. Davis, who was during such year a member of the Armed Forces of the United States. As an Armed Forces member the father contributed $104.90 per month for the support of his mother, Minnie Mhoon Miller, and three children, including Gwendolyn and Jacqueline. The Government's contribution to the father's allotment was $44.90 per month, the remaining $60 being taken from the father's pay. The two nieces and their minor brother lived during 1962 in the home of their grandmother, Minnie Mhoon Miller, in Memphis, Tennessee, together with petitioner's sister, Mattie Withers. The grandmother was not gainfully85 employed during that year. It is stipulated that petitioner contributed $45 during the year toward the support of each niece. In addition, we find that he contributed $211.84 in clothing purchased for each niece during the year. Mattie Withers was employed during 1962 and contributed an average of $7.50 per week toward the support of the household. The monthly rent of the home was $48.50. The cost of utilities was $13.50 per month. The average weekly grocery bill for the household was $16 per week. Neither the nieces' grandmother nor their father claimed them or either of them as a dependent for the taxable year 1962. The total cost of support for each of petitioner's nieces during 1962 was $649.54. No one person furnished more than half such total support. Of the total cost of such support for each niece, petitioner furnished $256.84, or in excess of 10 percent thereof. Opinion In order that a dependency deduction be allowed under a multiple support agreement, the taxpayer must show under section 152(c) of the Internal Revenue Code of 19541 that no one person contributed more than half the total yearly cost of support of the claimed dependent, 86 that except for the requirement of contribution of more than 50 percent of total support, each person contributing to the support of a claimed dependent could legally have been entitled to claim the dependency deduction, that the taxpayer claiming the deduction furnished in excess of 10 percent of such total support, and that each person who contributed more than 10 percent of such support has agreed in writing that he will not claim such person as a dependent for the involved year. 87 It is stipulated that a valid multiple support agreement exists between petitioner, his mother Minnie Mhoon Miller, and his brother Knowledge N. Davis. This leaves only two issues to be decided. The preliminary issue is whether any one person contributed more than half the support for either of petitioner's nieces during 1962. This issue is disposed of in our findings by mathematical computation. We have found the total support furnished each child to have been $649.54. The evidence indicates that neither the petitioner, the children's father, their grandmother, nor Mattie Withers contributed more than half of this amount to their support. Ten percent of the total cost of the support for each child is $64.95. Our findings are that petitioner contributed $256.84 to the support of each niece. We therefore find that he has complied with the controlling law, has sustained his burden of proof, and is entitled to claim Jacqueline and Gwendolyn Davis as dependents for the taxable year 1962. Decision will be entered under Rule 50. Footnotes1. SEC. 152. DEPENDENT DEFINED. * * *(c) Multiple Support Agreements. - For purposes of subsection (a), over half of the support of an individual for a calendar year shall be treated as received from the taxpayer if - (1) no one person contributed over half of such support; (2) over half of such support was received from persons each of whom, but for the fact that he did not contribute over half of such support, would have been entitled to claim such individual as a dependent for a taxable year beginning in such calendar year; (3) the taxpayer contributed over 10 percent of such support; and (4) each person described in paragraph (2) (other than the taxpayer) who contributed over 10 percent of such support files a written declaration (in such manner and form as the Secretary or his delegate may by regulations prescribe) that he will not claim such individual as a dependent for any taxable year beginning in such calendar year.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625374/	APPEALS OF W. WILEY WAHL AND HENRY WAHL.Wahl v. CommissionerDocket Nos. 2004 and 2292.United States Board of Tax Appeals2 B.T.A. 1106; 1925 BTA LEXIS 2149; October 30, 1925, Decided Submitted June 11, 1925. 2149 Frank I. Ford, Esq., for the taxpayer. Ward Loveless, Esq., for the Commissioner. 1106 Before GRAUPNER, TRAMMELL, and PHILLIPS. These appeals involve determinations of deficiencies in income and profits taxes for the year 1917 in the amounts of $5,109.47 and $5,710.13, respectively. The deficiencies arose from the fact that the Commissioner proposed to assess the profits tax imposed by section 201 of the Revenue Act of 1917 upon the income arising from the business of the taxpayers, rather than by assessing the tax under the provisions of section 209 of the Revenue Act of 1917. The petitions allege that the income of the taxpayers arose by virtue of their employment and was compensation for services rendered rather than income arising from a trade or business. It is also alleged that error was made by the Commissioner in disallowing a deduction of $5,000 as to each taxpayer on account of money borrowed during the taxable year. At the hearing, however, counsel for taxpayers stated that the only question involved was whether the income is subject to the 8 per cent profits tax under section 209 or to profits tax at the rate prescribed in section2150 201. The appeals were consolidated for the purpose of taking testimony, and it was stipulated that the testimony offered should be used in the determination of both. 1107 FINDINGS OF FACT. The taxpayers were engaged in farming during 1917. They rented approximately 1,000 acres of land from their uncle, J. R. Hulen. They operated the business under the name of Wahl Brothers. The two brothers, also during 1917, rented certain land from their mother on which to carry on a portion of their farming operations. They also borrowed $5,000 from their father. The plows and other farm implements used belonged to either their father or their uncle. The horses, mules, and wagons located on that part of the farm belonging to the father of the taxpayers belonged to him and not to the taxpayers. During 1917 the taxpayers repaid to their father the $5,000 which had been advanced on account of expenses necessary to operate the ranch. Money in excess of this $5,000 was loaned by the father of the two taxpayers for the purpose of financing the purchase of seed in 1916, which was paid back after the harvest of the 1917 crop. In 1915 a tractor was purchased by the taxpayers*2151 at a cost of $4,675, for the purpose of operating the ranch. This tractor was purchased with money borrowed from their uncle, J. R. Hulen, and was paid back to Hulen after the harvest in 1917. On January 1, 1917, the taxpayers each had $588.98 in the bank. In January, 1917, the taxpayers each owed $2,337.50, one-half of the cost of the tractor which had been purchased. In carrying on the farming operations during the taxable year, the following expenses were incurred and paid by the taxpayers: Labor$7,211.67Sacks and twine3,469.59Insurance317.44Threshing2,617.10Interest517.50Total14,233.30DECISION. The deficiencies, if any, should be computed under section 209 of the Revenue Act of 1917. Final determination will be settled on 15 days' notice, under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625376/	Portable Industries, Inc., Petitioner, v. Commissioner of Internal Revenue, RespondentPortable Industries, Inc. v. CommissionerDocket No. 38640United States Tax Court24 T.C. 571; 1955 U.S. Tax Ct. LEXIS 147; June 30, 1955, Filed 147 Decision will be entered under Rule 50. 1. Petitioner gave X corporation a license under which petitioner received royalties. A separate so-called service agreement was executed which provided that X would pay petitioner $ 30,000 per year for 2 years for petitioner's services in improving the patented devices and expanding their use. In each taxable year, X paid petitioner $ 30,000. The question is whether all or part of the $ 30,000 constituted personal holding company income. Held, that a portion represented personal holding company income; a portion was compensation for services rendered; the total amount of personal holding company income received in each taxable year was as large as the prescribed percentages in section 501 (a) (1) and petitioner was a personal holding company.2. Petitioner failed to file personal holding company returns for its fiscal years 1949 and 1950. Held, on the facts, petitioner's failure to file such returns was due to reasonable cause and not due to willful neglect. I. W. Sharp, Esq., for the petitioner.Stanley W. Ozark, Esq., for the respondent. Harron, Judge. HARRON 571 The Commissioner determined deficiencies for the taxable years ended March 31, 1949 and 1950, in personal holding company surtaxes under section 500 of the 1939 Code, and in additions to tax under section 291 (a) as follows:YearDeficiencySec. 291 (a)March 31, 1949$ 45,176.99$ 11,294.25March 31, 195055,883.8813,970.97The questions are whether petitioner was a personal holding company within section 501 (a) of the 149 1939 Code, subject to surtax under section 500, in either or both of the taxable years, and whether petitioner's failure to file a personal holding company surtax return was due either to reasonable cause or to willful neglect. The parties are in agreement with respect to several adjustments determined by the respondent.FINDINGS OF FACT.The facts which have been stipulated are found according to the stipulation. The stipulation of facts, together with the annexed exhibits, is incorporated herein by reference.572 Petitioner was incorporated on February 6, 1948, under the laws of the State of Ohio. Its principal office is located at 12117 Berea Road, Cleveland, Ohio. Petitioner's books of account have been kept and its income tax returns have been prepared and filed on an accrual basis. Petitioner filed its income tax returns for the fiscal years ended March 31, 1949 and 1950, with the collector of internal revenue for the eighteenth district of Ohio, at Cleveland, Ohio. The returns showed liability for income tax in the following amounts which were duly paid on or before their due dates:For the year ended March 31, 1949$ 33,619.90For the year ended March 31, 195040,281.36150 On February 24, 1947, the Stemco Corporation, hereinafter referred to as Stemco, was incorporated under the laws of Ohio for the purpose of engaging in the manufacture and sale of explosive-operated tools, among other things. Soon thereafter, it began to assemble and sell explosive-operated tools under patents or applications for patents owned by an engineer named Stanley Temple.On October 1, 1947, Jesse E. Williams, president of Stemco, purchased Temple's patent rights and applications for patents for $ 24,155. Stemco continued to sell the explosive-operated tools under these patents and applications for patents. Stemco had not paid royalties to Temple for the use of these inventions, and did not pay royalties to Williams after he had acquired them from Temple.Stemco did not manufacture the devices it sold. The component parts were ordered from various manufacturers, and Stemco assembled, packaged, sold, and shipped the finished product.In 1947, several claims were asserted against Stemco for personal injuries growing out of the use of Stemco's products. In addition, Stemco was unable to obtain adequate liability insurance coverage. Williams desired to protect himself and151 his family from any personal injury claims which might otherwise be asserted against him as owner of the patents. Accordingly, he organized petitioner on February 6, 1948, for the purpose of holding and licensing the patent rights he had acquired from Temple and such other patent rights as might be secured by virtue of engineering and development work which he intended petitioner would perform. Williams preferred that a new corporation, rather than Stemco, should hold the patents and perform the developmental work, inasmuch as there existed a possibility that personal injury judgment creditors might gain control of Stemco's assets.Petitioner's stock consisted of 250 shares of no-par common stock of which 248 shares, or 99.2 per cent, were owned by Williams throughout the years in controversy. During the years 1948 through 1950, Williams 573 also owned 248 shares of the 250 outstanding shares of Stemco's no-par common stock. Williams was the president and a director of each corporation.During the calendar and fiscal years 1948 and 1949, the principal offices of both corporations were located at the same place. The books of petitioner and Stemco were kept in the same office152 and by the same person during the years in question.On April 2, 1948, Williams transferred to petitioner for $ 150,000 the ownership of the patent rights and applications he had acquired from Temple. On the same day, the board of directors of each corporation authorized the execution of two agreements between the corporations.The following is found in the minutes of a meeting on April 2, 1948, of petitioner's board of directors:It was then regularly resolved that the president and secretary be authorized to enter into a contract with Stemco Corporation by the terms of which Stemco Corporation would be granted an exclusive license to manufacture and sell powder-operated tools, studs, pins and accessories within the United States, its territories and dependencies for a term of ten (10) years, Stemco Corporation to pay Portable Industries, Inc. a royalty of ten (10%) per cent of the manufacturer's net sales up to a total of One Million Dollars and five (5%) per cent on manufacturer's net sales thereafter.It was also regularly resolved that the president and secretary be authorized to contract with Stemco Corporation for the rendering of engineering, development and research services153 to Stemco Corporation to improve the safety, use and sales appeal of the tools and the accessories; said engineering services to be done in cooperation with the Employees of Stemco Corporation and Stemco Corporation to charge Portable Industries for any and all amounts expended by Stemco Corporation in connection with the research and development covered by such agreement.The following is found in the minutes of a meeting on April 2, 1948, of the board of directors of Stemco Corporation:Mr. Williams presented to the board a copy of the agreement which had been prepared. The terms of this agreement were thoroughly discussed after which it was regularly resolved that the officers be authorized to execute such agreements on the part of the company, one agreement calling for employing Portable Industries, Inc. as sales and development engineer at a fee of $ 30,000 per year for a two year period, to work in cooperation with Stemco Corporation in designing and developing a safer, more effective and more saleable tool and appliances, and providing that Stemco Corporation be reimbursed by Portable Industries for any materials, labor and engineering and for a prorata portion consumed in154 such research and developing work by any of Stemco's employees; the other agreement providing for an exclusive right to manufacture the tool and accessories within the United States for a ten year period at a royalty of ten (10%) per cent on the first million dollars net sales and five (5%) per cent thereafter, with a minimum royalty of $ 25,000.00 per year.The two agreements were executed as of April 2, 1948.574 The exclusive license agreement between petitioner, as licensor, and Stemco Corporation, as licensee, contained the following provisions:(1) Licensor hereby grants to Licensee under any patent or patents that may be issued upon the applications aforesaid and and [sic] under all patents relating thereto which may be owned or controlled by Licensor during the period of this agreement shall remain in effect an exclusive license to manufacture, use and sell powder-operated tools, studs, pins and accessories, and any and all developments and improvements thereon within the United States, its territories and dependencies.(2) Said license shall continue in effect for a term of ten (10) years unless sooner terminated under the provisions hereof.(3) It is the essence155 of this agreement that Licensor shall furnish to Licensee engineering research, development and other services, not only to enable licensee to use the inventions aforesaid and obtain the best results therefrom but to considerably improve said inventions; to overcome any and all dangers in the use of said tools and accessories; to improve the effectiveness and expand the uses for said tools and accessories; to improve the efficiency, effectiveness and quality of said tool by metallurgic and other scientific and engineering research.For the services so to be rendered by Licensor to Licensee, Licensor shall be compensated in accordance with separate agreement entered into by and between the parties and the entering into of said separate agreement for said services and the consideration therein expressed is a part of the inducement to Licensor to enter into this agreement.(4) Licensee agrees to pay Licensor, in addition to the payment for services as above set forth, a sum equal to ten (10%) per cent of Licensee's net sales as a royalty upon the first million ($ 1,000,000.00) dollars of such net sales and five (5%) per cent of licensee's net sales above said figure, annually.The 156 license agreement is incorporated herein by reference.The second agreement executed by petitioner and Stemco Corporation on April 2, 1948, was a service agreement which contained the following provisions:(1) Portable agrees to use its best efforts, technical knowledge and skill to continuously improve the tools, studs, pins and accessories therefor above referred to, and to furnish engineering, research, development and other service to Stemco in order to improve said inventions, to overcome any dangers connected with the use of such; to improve the efficiency and expand the uses of said tools and accessories and to aid in sales engineering.(2) Stemco agrees to pay to Portable for said services the sum of Thirty Thousand ($ 30,000.00) Dollars per year during the life of this agreement.(3) It is understood and agreed that certain engineering and technical employees of Stemco Corporation will assist Portable's officers and engineers in such research and development to an extent which does not interfere with the needs of Stemco. For such services Stemco shall be reimbursed by Portable upon the presentation of invoices for the time actually spent by such employees upon Portable's 157 business. In no event shall Portable be held liable for any claims for any product liability or defect.This agreement shall continue in full force and effect for a period of two years from the date hereof, and shall be renewable for a like period upon such terms as shall be agreed to by the parties.The service agreement is incorporated herein by reference.575 On April 2, 1948, when petitioner and Stemco entered into the exclusive license and service agreements, the basic invention required substantial improvement and development to render the devices less hazardous and to enlarge their utility. At this time, petitioner owned no facilities and employed no engineers. Stemco employed engineers, Rowland J. Kopf, Frank Svekric, Rudy Witt, and Stanley Temple, who were familiar with the devices and the problems involved in their use. In the year ending March 31, 1949, petitioner reimbursed Stemco $ 15,066.86 for the time devoted by these engineers to what Williams considered as petitioner's activities. These engineers were paid by Stemco and remained employees of Stemco during the periods for which Stemco was reimbursed by petitioner. During the year ending March 31, 1949, 158 the only engineers employed by petitioner were Evor S. Kerr, a naval engineering officer, who was paid a retainer of $ 400 for the 4 months from December 1, 1948, to March 31, 1949, and Kopf and Svekric, who were employed for the month of March 1949, at salaries of $ 500 and $ 350, respectively. Williams received an annual salary from petitioner of $ 6,000.The work performed by the engineers in the year ending March 31, 1949, consisted primarily of designing a safer and more efficient tool and developing a line of accessories to enhance the use of the tool. This developmental work was performed for petitioner, which obtained the property rights to all innovations. For the $ 30,000 fee specified in the service agreement, Stemco received from petitioner the use of these new developments and improvements, and certain services, such as the training of Stemco's customers and salesmen, the investigation of accidents, and the preparation of sales, service, and price literature.In the year ending March 31, 1949, $ 20,000 of the $ 30,000 paid by Stemco to petitioner was paid for the use of the new accessories for and improvements to the original Temple device. Stemco paid $ 10,000 for159 the services it received in training customers and salesmen, investigating accidents, and preparing literature.In the year ending March 31, 1949, petitioner's gross income did not exceed $ 127,895.84. In this year, the petitioner received royalties from Stemco in the total amount of $ 116,482.98.More than 80 per cent of petitioner's grosss income for the year ending March 31, 1949, and more than 70 per cent of petitioner's gross income for the year ending March 31, 1950, consisted of personal holding company income.Petitioner was a personal holding company in the years ending March 31, 1949, and March 31, 1950.Petitioner did not file personal holding company surtax returns for the years ending March 31, 1949, or March 31, 1950. Petitioner's 576 failure to file the returns was due to reasonable cause and not due to willful neglect.OPINION.The issue to be decided is whether during the taxable years ended March 31, 1949, and March 31, 1950, petitioner was a personal holding company as defined by section 501 of the 1939 Code. Petitioner met the stock ownership requirement of section 501 (a) (2). The issue is restricted to whether the required percentage of gross income160 of petitioner in each taxable year was personal holding company income within sections 501 (a) (1) and 502. The required percentage would be at least 80 per cent for the year ended March 31, 1949, and the percentage for the year ended March 31, 1950, would be the same, unless petitioner should have been found to be a personal holding company with respect to the year ended March 31, 1949, in which event the required percentage for the year ended March 31, 1950, would be 70 per cent. The provisions of section 501 (a) (1) are set forth in the margin. 1161 The petitioner also admits that some of its income in each taxable year consisted of "royalties" (other than mineral, oil, or gas royalties), and interest. See sec. 502 of the 1939 Code. That is to say, apart from income in the amount of $ 30,000, the income which is in dispute, petitioner received royalties during the taxable year ended March 31, 1949, in an amount which was approximately 75.6 per cent of gross income. Also, during the taxable year ended March 31, 1950, petitioner received royalties in an amount which was approximately 75.6 per cent of gross income. If it is found that all or part of the $ 30,000 in dispute which was received during the year ended March 31, 1949, represented "royalties" under section 502, in an amount which would increase the admitted "personal holding company income" from 75.6 per cent to 80 per cent, then, of course, it must be held that petitioner was a personal holding company subject to the surtax in the year ended March 31, 1949. It will follow from that holding that petitioner was a personal holding company subject to the surtax in the succeeding year, the year ended March 31, 1950, because more than 70 per cent of its gross income for162 the latter year was admittedly from "royalties."577 From the foregoing it is clear that the issue to be decided relates to the fiscal year ended March 31, 1949.In the deficiency notice, the respondent stated his reason for his determination that there were deficiencies in personal holding company surtax in the following way:it is held that during the years ended March 31, 1949 and March 31, 1950, you were a "personal Holding Company" as defined in Section 501 (a) of the Internal Revenue Code and subject to the surtax imposed by Section 500 thereof.In its petition, the petitioner set forth among alleged facts upon which it would rely that on April 2, 1948, it entered into a "Service Agreement" with Stemco under which Stemco agreed to pay petitioner $ 30,000 per year for 2 years for engineering, research, development, and other services to be rendered by petitioner "to improve said inventions, to overcome any dangers connected with their use, and to improve the efficiency and expand the uses of said tools and accessories and to aid in sales engineering"; and that the alleged engineering service fees were not "personal holding company income."The respondent contends first163 that at least 80 per cent of petitioner's gross income for the taxable year ended March 31, 1949, was personal holding company income within the meaning of section 502 because the so-called service agreement between petitioner and its licensee, Stemco, lacked substance and was designed to avoid personal holding company surtax liability of petitioner by disguising royalties as engineering fees. He asserts that royalties include compensation for the use of not only the basic invention or patent but also any improvements and developments thereof; that the evidence as to the services petitioner claims it rendered to Stemco under the service agreement is that such services actually consisted of the use of improvements and developments of the basic invention or patent; and that the $ 30,000 specified in the service agreement was consideration for such use and, therefore, constituted additional royalties. Respondent relies upon Lane-Wells Co., 43 B. T. A. 463, affirmed as to this question 134 F.2d 977">134 F. 2d 977, certiorari denied 320 U.S. 741">320 U.S. 741; Warren Browne, Inc., 1056">14 T. C. 1056; Anton Dolenz, 41 B. T. A. 1091164 (acq. 1940-2 C. B. 2); Hugh Smith, Inc., 8 T. C. 660, affd. 173 F. 2d 224, certiorari denied 337 U.S. 918">337 U.S. 918; and Commissioner v. Affiliated Enterprises, Inc., 123 F.2d 665">123 F. 2d 665, certiorari denied 315 U.S. 812">315 U.S. 812.The evidence shows that prior to February 24, 1947, Stanley Temple had invented an explosive-operated device capable of driving metal studs and other fasteners into steel and concrete objects. On February 24, 1947, Williams organized Stemco to subcontract the manufacture of the component parts of the device under an informal arrangement with Temple, and to assemble the parts, and package and sell the completed product. On October 1, 1947, Williams personally purchased from Temple the patent rights and applications 578 covering the tool. In 1947, its first year of operation, Stemco earned $ 31,340.55, after provision for Federal income taxes. The device was comparatively new and proved extremely dangerous to its users. Safety improvements and the development of additional accessories were urgently required165 to reduce the hazards involved in the use of the device and to enlarge its utility. In addition, in 1947, a number of claims were asserted against Stemco for injuries allegedly resulting from the new device. Williams feared that claims would be asserted against him personally, as patent owner. On February 6, 1948, he organized petitioner. Throughout the years in question Williams owned 248 shares of each corporation's 250 outstanding shares of no-par common stock. On April 2, 1948, he conveyed his patent rights and applications to petitioner, intending that petitioner would also acquire all other patents subsequently obtained with respect to these tools. These patent rights were not conveyed to Stemco inasmuch as Stemco was experiencing considerable difficulty in obtaining liability insurance, and its assets were exposed to tort claims and judgments. On the same day, April 2, 1948, the two corporations entered into two agreements. In the first, or license agreement, petitioner granted to Stemco a 10-year exclusive license to manufacture, use, and sell within the United States any tools or accessories covered by any patent rights then owned by petitioner or which might be issued166 to petitioner in the future. Stemco agreed to pay petitioner annual royalties equal to 10 per cent of Stemco's net sales on the first million dollars of sales and 5 per cent of annual sales in excess of one million dollars. The second agreement, or service agreement, is the basis of this controversy. The service agreement was to last for 2 years, and provided that petitioner was to use "its best efforts, technical knowledge and skill to continuously improve the tools, studs, pins and accessories therefor," and to furnish "engineering, research, development and other service to Stemco," in return for which Stemco agreed to pay the sum of $ 30,000 per year. At this time petitioner had been in existence for less than 2 months, had no facilities, and employed no engineering or technical staff, with the possible exception of Williams, who was president of both corporations and who, although not a graduate engineer, claimed to have had considerable experience with engineering problems. Stemco, on the other hand, employed a staff of engineers who had been working on the devices for Stemco for more than 1 year. The Stemco engineering staff included Temple, the inventor. The service167 agreement contained the following provision relating to the assistance to be given to petitioner by Stemco:It is understood and agreed that certain engineering and technical employees of Stemco Corporation will assist Portable's officers and engineers in such research and development to an extent which does not interfere with the needs of Stemco. For such services Stemco shall be reimbursed by Portable upon the 579 presentation of invoices for the time actually spent by such employees upon Portable's business. In no event shall Portable be held liable for any claims for any product liability or defect.In the year ending March 31, 1949, Rowland J. Kopf, Rudy Witt, Frank Svekric, and Temple were engineers employed by Stemco. Pursuant to the paragraph of the service agreement quoted above, petitioner paid Stemco $ 15,066.86 for the portion of their working time which Williams considered as having been devoted to "Portable's business." During this year, petitioner employed the following engineers: Evor S. Kerr, a naval engineering officer, who was paid a retainer of $ 100 per month for 4 months beginning December 1948, and Kopf and Svekric, who were employed only during168 the month of March 1949, at a total salary of $ 850.One of petitioner's contentions is that engineers Kopf, Witt, Svekric, and Temple were part-time employees of petitioner during the year ending March 31, 1949, to the same extent that petitioner reimbursed Stemco for their assistance. The evidence does not support petitioner. These engineers were employed by Stemco before petitioner was organized, were always paid by Stemco, and continued to be so paid after the service agreement was executed. Neither the resolutions of the respective boards of directors which authorized the service agreement, nor the agreement itself purport to change the existing employer-employee relationships, but on the contrary, specifically classify as Stemco employees the engineering and technical personnel for whose services petitioner was required to reimburse Stemco.The status of these engineers as employees of Stemco pertains more, however, to the construction to be accorded the service agreement than to our primary inquiry concerning the nature of the benefits received by Stemco, in return for which the $ 30,000 was paid to petitioner.The evidence concerning the nature of the services purportedly169 rendered to Stemco consisted primarily of testimony and of an exhibit which Williams identified as "a record of many details of engineering and service work that was rendered by Portable Industries' personnel" up to September 29, 1949. The exhibit lists 42 descriptive phrases of "Details Completed and Completed Problems" accomplished by the engineers, and is incorporated herein by reference.Except for a few items such "Sales and Service Bulletins," "Accident records file up to date," "New type of Multigraph print forms," and "Dimensional and price catalogue," petitioner admits that each entry describes the completion of a design or redesign of a part of the device or of an accessory.580 The petitioner secured the patent applications for these improvements and new accessories, pursuant to Williams' plan to have petitioner own all patent rights touching on the devices invented by Temple, and to have Stemco perform the assembling and selling.We find from this evidence that the greatest part of the engineers' efforts were devoted to the most urgent problem created by the device, namely, the design or redesign of safer and more efficient parts for the tool and the development170 of accessories to enhance its use. We also find that this improvement and development was done for the benefit of petitioner, which was the patent holder.That petitioner itself considered that the improvement and development work was performed on its behalf, as the patent owner, is also indicated by its sworn protest to respondent, executed by Williams on May 1, 1951, in which the reimbursement to Stemco for the assistance of the Stemco engineers is characterized as "wages and salary payments paid or accrued by the taxpayer in connection with engineering, research and exploration of present and future products to be manufactured by whatever business organizations which may be interested in obtaining such rights from the taxpayer." (Emphasis supplied.)Stemco obtained the rights to incorporate the improvements and new accessories in the parts which it ordered from its subcontractors and in the finished product it sold. We find no merit in petitioner's contention that the improvement and development work on its inventions constituted "engineering services" to Stemco. We think it quite clear in this case that the engineering services involved in improving petitioner's patents171 were rendered to petitioner, as owner-licensor of the basic patents and of the improvements, and not to Stemco, which, as a licensee, obtained only the use of the new developments.The respondent properly determined that the principal benefit obtained by Stemco under the service agreement was the right to use petitioner's new accessories for, and improvements to, the basic Temple patents. It is concluded from all the evidence that $ 20,000 of the $ 30,000 paid by Stemco in the year ended March 31, 1949, was paid for the use of these new developments. This $ 20,000 constituted royalties. Lane-Wells Co., supra;Warren Browne, Inc., supra.The allocation of two-thirds of the total payment is amply supported by a consideration of the nature of the work accomplished by the engineers and of the urgent need for the development of safety features and accessories which existed at the time the service agreement was executed. On the other hand, the evidence, viewed in its most favorable aspect for the petitioner, namely, that certain services were rendered to Stemco by petitioner in the year ended March 31, 1949, nevertheless 581 172 fails to establish that Stemco paid any more than one-third of the $ 30,000 for such services. These services consisted of the training of Stemco customers and salesmen, the investigation of accidents purportedly caused by the devices, and the preparation of Stemco's sales, service, and price literature. When compared to the benefits obtained by Stemco from the use of the improvements developed for petitioner, it is apparent that these services accounted for but a small portion of the $ 30,000. It is concluded that Stemco paid $ 10,000 for these services during the year ended March 31, 1949. U.S. Universal Joints Co., 46 B. T. A. 11.The petitioner had gross income in the year ended March 31, 1949, in the amount of $ 127,895.84. It had personal holding company income, in the form of royalties from Stemco, in the total amount of $ 116,482.98, of which $ 96,482.98 was paid under the license agreement and $ 20,000 was paid under the service agreement. Petitioner's personal holding company income exceeded 80 per cent of its gross income, and, accordingly, it is concluded that petitioner was a personal holding company, under the provisions of section173 501 (a) of the 1939 Code, in the year ended March 31, 1949. Petitioner's personal holding company income in the year ended March 31, 1950, admittedly exceeded 70 per cent of its gross income, and, accordingly, petitioner was a personal holding company in the year ended March 31, 1950. See sec. 501 (a) (1) of the 1939 Code.The petitioner makes an alternative contention to its argument that the $ 30,000 was paid by Stemco for engineering services. The petitioner's argument is that a patent owner, while receiving royalties from a licensee, is under no obligation to the licensee to improve the patents or inventions, and that the $ 30,000 should be viewed as compensation or reimbursement paid by Stemco to induce petitioner to continue development of its patents and of the inventions on which they are based.Petitioner cites no authority to support this theory of a patent owner-licensee relationship. In any event, we do not think it applicable to the facts of this case. On April 2, 1948, petitioner had no facilities or technical employees and owned only patent rights which required substantial improvement. Williams desired petitioner to hold not only the Temple patents, but also 174 any related patent rights which subsequently would be acquired. We construe the service agreement not as an inducement for petitioner to act, but on the contrary, as substantially an arrangement for giving petitioner the use of Stemco's engineers and facilities, and the rights to whatever inventions would be developed by these engineers. That the service agreement was required primarily for petitioner's benefit is expressly revealed in the companion license agreement, which states that "the 582 entering into of said separate agreement for said services and the consideration therein expressed is a part of the inducement to Licensor to enter into this agreement." (Emphasis added.) We therefore reject petitioner's argument that the $ 30,000 fee specified in the service agreement was paid to induce it to improve its patent rights.We hold that respondent did not err in determining that the petitioner was liable for personal holding company surtax in the years ended March 31, 1949, and March 31, 1950. Because of our finding that $ 10,000 received by petitioner from Stemco in the year ended March 31, 1949, did not constitute personal holding company income, it will be necessary175 to recompute the deficiency in surtax for this year under Rule 50.In view of the conclusions reached, it is unnecessary to consider an alternative contention of the respondent.An additional problem is raised by petitioner's failure to file personal holding company returns for either of its fiscal years in controversy, as a consequence of which the Commissioner has determined additions to tax under section 291 (a) of the Code.Williams admitted that he had been a certified public accountant since 1935. The evidence indicates, however, that until 1940, he was controller of the Cleveland operations of an industrial manufacturing firm and from 1940 to 1948 general manager of their Cleveland plant. There is also uncontradicted testimony that Williams consulted with Jules Eshner, a Cleveland attorney, concerning whether petitioner was required to file a personal holding company return for each year in question. Eshner had been engaged in the practice of law in Cleveland for over 30 years and was admitted to practice before The Tax Court of the United States and before the Treasury Department. He was conversant with petitioner's operations, and advised Williams that petitioner was 176 not a personal holding company and that no additional return was required. The return for the year ending March 31, 1950, was prepared by a firm identified as certified public accountants, with whom Eshner testified he consulted at length concerning petitioner's status and the necessity for filing a personal holding company return. We find, on the basis of the foregoing, that the failure to file personal holding company returns for the years ending March 31, 1949, and March 31, 1950, was due to reasonable cause and not due to willful neglect. Haywood Lumber & Mining Co. v. Commissioner, 583 178 F.2d 769">178 F. 2d 769, reversing 12 T.C. 735">12 T. C. 735; O. Falk's Department Store, Inc., 20 T.C. 56">20 T. C. 56; Rev. Rul. 172, 1953 2 C. B. 226. Respondent's determination on this issue is disapproved.Decision will be entered under Rule 50. Footnotes1. SEC. 501. DEFINITION OF PERSONAL HOLDING COMPANY.(a) General Rule. -- For the purposes of this subchapter and chapter 1, the term "personal holding company" means any corporation if -- (1) Gross income requirement. -- At least 80 per centum of its gross income for the taxable year is personal holding company income as defined in section 502; but if the corporation is a personal holding company with respect to any taxable year beginning after December 31, 1936, then, for each subsequent taxable year, the minimum percentage shall be 70 per centum in lieu of 80 per centum * * *; and(2) Stock ownership requirement. -- At any time during the last half of the taxable year more than 50 per centum in value of its outstanding stock is owned, directly or indirectly by or for not more than five individuals.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625377/	The Danco Company, Petitioner, v. Commissioner of Internal Revenue, RespondentDanco Co. v. CommissionerDocket No. 19519United States Tax Court14 T.C. 276; 1950 U.S. Tax Ct. LEXIS 266; February 28, 1950, Promulgated 266 Decision will be entered for the respondent. Petitioner, an Ohio corporation organized in April, 1940, was engaged during the taxable years 1942 and 1943 in the business of fabricating sheet metal to customers' specifications. Petitioner duly filed applications for relief under section 722 (c) of the Internal Revenue Code in respect to the years 1942 and 1943, which applications have been disallowed by the Commissioner. Held, that a taxpayer seeking relief under section 722 (c) must demonstrate the inadequacy of its excess profits tax credit based upon invested capital by showing the existence of one of the qualifying features under section 722 (c) and by establishing a fair and just amount representing normal earnings for use as a constructive average base period net income. A taxpayer is not entitled to relief where, as here, it fails to produce evidence sufficient to support a reasonable determination of normal earnings. William C. Bracken, Esq., for the petitioner.Lawrence R. Bloomenthal, Esq., and Edwin L. Kahn, Esq., for the respondent. Arundell, Judge. ARUNDELL276 In the notice of deficiency, the respondent determined deficiencies in excess profits tax for the calendar years 1942 and 1943 in the amounts of $ 3,930.87 and $ 17,887.20, respectively, and in the same notice disallowed the petitioner's applications for relief and claims for refund of excess profits tax under section 722 (c) (1) and (c) ( 2) of the Internal Revenue Code.The only issue is whether the petitioner is entitled to refunds of excess profits tax of $ 7,026.32 for 1942 and $ 26,765.10 for 1943, representing the amounts actually paid by the petitioner in those years, under the provisions of section 722 (c) (1) or (c) ( 2) of the Internal Revenue Code.FINDINGS OF FACT.The petitioner is an Ohio corporation, with its principal office in Rocky River, Cuyahoga County, Ohio. Its Federal tax returns for the years 1942 and 1943 were filed with the collector of internal revenue for the eighteenth district of 268 Ohio, at Cleveland, Ohio.The petitioner was organized in April, 1940, with a paid-in capital of $ 5,000. During the years in question, petitioner was engaged in the business of manufacturing sheet metal products.The following persons were the petitioner's directors, and they all held offices and owned stock in petitioner, as set forth below: 277 SharesC. George Danielson, president40Peter B. Pierson, vice president20D. Edmund Evans, second vice president10Earl F. Danielson, secretary-treasurer20G. Wilmer Danielson (no office)10C. George Danielson (hereinafter referred to as Danielson) has been engaged in the sheet metal business since 1907, and in 1927 he, together with three other men, organized a company known as the Artisan Metal Works Co. (hereinafter sometimes referred to as Artisan). Danielson contributed $ 200 of Artisan's total capital of $ 1,500 and acted as one of its directors and as vice president of the company. He was in full charge of the plant and production, did all of its estimating, hired and fired its employees, and called upon customers with its salesman to obtain suitable sketches of the product desired.Danielson fixed the269 prices charged by Artisan for its products by use of a formula which consisted of the estimated cost of direct labor and material in the product, plus the cost of overhead fixed as 100 per cent of the estimated cost of direct labor, the total of which items constituted 80 per cent of the selling price, the remaining 20 per cent being the company's net profit. This formula was one generally accepted and used in the trade.In 1928 Danielson and another stockholder, J. F. Maynard, acquired all of the stock of Artisan, Danielson thereafter owning a one-third interest and Maynard a two-thirds interest in the business. Maynard was the president of Artisan and its general administrative head, and was in charge of the office and of buying and selling. Danielson's salary from Artisan ranged from $ 75 a week in 1933 to $ 80 a week in 1936. Danielson never received any dividends upon the stock he held in Artisan. In September, 1936, Danielson sold his stock interest in Artisan to Maynard and severed his connection with the company.Danielson returned to Artisan in 1938 and during the years 1938 and 1939 was employed as its shop superintendent at a salary of $ 80 per week. In 1939 Danielson270 left the employ of Artisan for the purpose of organizing the petitioner.It was necessary for the petitioner to have heavy machinery before it could commence business. Prior to the organization of the petitioner in April, 1940, Danielson purchased such machinery, which was mostly second-hand, and he contributed it to the petitioner, for which he received credit upon its formation. In 1940 the petitioner had $ 1,422.49 of used machinery and $ 1,696.09 of new machinery. The petitioner rented the buildings in which it conducted business operations.The petitioner thereafter engaged in the business of fabricating sheet metal to customers' specifications, commonly known as "custom 278 work." During 1942 and 1943, all of the petitioner's business was war work and it was necessary for the petitioner to obtain priorities for both material and equipment during those years.Following the establishment of the petitioner, Danielson communicated with various customers of Artisan, notifying them that he had organized the petitioner and requesting the opportunity to quote prices on their work. During the period from 1940 to 1943 petitioner was successful in obtaining work from approximately271 50 different customers.The principal products manufactured by the petitioner were metal cabinets for Army X-ray units. Petitioner's principal customer for such items was the Picker X-ray Corporation, a Cleveland concern engaged in the manufacture of medical and industrial X-ray equipment. During the years 1941 to 1943, inclusive, the total sales of petitioner, its sales to the Picker X-ray Corporation, and the percentage of the latter sales to total sales, were as follows:Sales toYearTotal salesPicker X-rayPercentageCorporationof total sales1941$ 58,689.45$ 49,74884.8%1942154,759.34135,17287.3%1943234,913.79206,30087.8%Approximately 90 per cent of the petitioner's sales to Picker during 1941 to 1943, inclusive, were cabinets for two Army X-ray units, one a field mobile unit and the other an air-flow unit developed for air transportation. The first models of the field unit cabinets were manufactured in 1940 and full production was reached by the end of 1941 or the first part of 1942. The air-flow unit was developed during 1942.In the development of its X-ray cabinets from 1940 to 1943, Picker received unusual cooperation from272 Danielson, who spent at least three days a week at the Picker plant working out the details for such units. The blueprints for the cabinets when first submitted were not complete enough to work from without consultations and revisions. Picker placed the orders for both the field mobile unit and the airflow units with the petitioner because of the cooperation it received from Danielson.During the years in question, the petitioner dropped from 12 to 15 of its other customers in order to fill the demands of the Picker Co. for its products. The petitioner employed at the peak of its operations 54 men, 12 of whom worked on machines. Petitioner obtained payment on its sales to Picker twice a month.The Picker Co. did business with Artisan during the years 1936 to 1939, and continued to do business with that company and other sheet 279 metal businesses during the taxable years involved. The business of Picker in 1942 and 1943 was four or five times its business in 1938 and 1939.Danielson had technical knowledge, designing experience, and extensive experience in manufacturing and production problems as they related to the sheet metal industry and the manufacturing of products273 to the customer's specifications. The qualifications and reputation of Danielson were valuable and helpful to the petitioner in securing business. During the years 1942 and 1943, the petitioner paid Danielson salaries of $ 10,105 and $ 11,520 per year, respectively.During the years 1936 to 1939, there were at least 10 firms in the Cleveland area doing sheet metal work to customers' specifications, all comparable in skill and ability to turn out the work. Three of these firms in the Cleveland area that did the same type of work as petitioner, except that they were equipped to handle bulkier products, were the Artisan Metal Works Co., the Overly-Hautz Co., and the Reister-Thesmacher Co.Every firm in the industry employed men of comparable skill, experience, and ability to perform the engineering services of their business. The firms were equally skilled and capable of turning out the work. During the war, including the years involved herein, all firms in this industry were engaged in war work.During the years 1936 to 1939 purchasers had no difficulty in getting orders for sheet metal work filled in the Cleveland area, as there were a number of companies in the business and materials274 and labor were available. During the years 1936 to 1939 purchasers placed their orders with producers on the basis of the price and quality of the product turned out. Price and quality were equally important.During the years 1942 and 1943 it was difficult for purchasers to have their orders for sheet metal work filled in the Cleveland area and, as a consequence, there was plenty of business for all sheet metal firms in the industry. This situation arose from the difficulty of obtaining sufficient labor and equipment for all the war business, and the fact that priorities were necessary to secure materials.The assets of petitioner for the years 1941, 1942, and 1943 were as follows:194119421943Cash$ 3,734.72$ 7,704.64$ 39,433.19Accounts receivable3,311.309,770.5213,946.57Inventories3,917.098,024.7613,739.18Furniture and fixtures186.06286.14640.07Machinery and equipment4,525.699,131.1910,907.02Truck275.001,427.25280 During the years 1940 to 1943, inclusive, the petitioner's capital, surplus, and the total thereof, were as follows:Total capitalSurplus at endand surplusYearCapitalof yearat end of year1940$ 5,000($ 767.04)$ 4,232.9619415,0002,636.46 7,636.4619425,0008,567.56 13,567.5619435,00020,124.50 25,124.50275 The petitioner's net sales, gross profit, expenses, and net income for the period from April 10, 1940, through December 31, 1940, and the years 1941, 1942, and 1943, as reflected by its income tax returns after adjustment by the respondent, were as follows:4-10-40 through12-31-40194119421943Net sales$ 18,379.57 $ 58,689.45$ 154,759.34$ 234,913.79Gross profit 4,284.63 16,234.8951,321.1198,948.79Total expenses4,958.57 11,367.7931,730.0739,244.34Net income(767.04)4,391.3018,311.6257,981.50The petitioner's net sales, gross profit, expenses, and net income for the period from April 10 through December 31, 1940, and the years 1941, 1942, and 1943, as reflected in a statement of profit and loss prepared from the petitioner's books and before adjustment by the respondent, were as follows:4-10-40 through12-31-40194119421943Net sales$ 18,379.57 $ 58,689.45$ 154,759.34$ 234,913.79Gross profit3,129.46 12,887.0043,269.6589,183.82Total expenses3,896.50 8,183.2024,583.0331,418.94Net income(767.04)4,703.8018,686.6257,764.88276 The capital, surplus, and earned surplus, the total thereof, sales, and gross profit of the Artisan Metal Works Co. for the years 1936 to 1939, inclusive, according to its annual financial statements, were as follows:Total capitalEarnedandYearCapitalSurplussurplussurplus1936$ 30,000$ 5,000$ 14,902.22$ 49,902.22193730,0005,00033,794.3868,794.38193830,0005,00046,016.8481,016.84193930,00015,50049,265.0894,765.08GrossMachineryYearSalesprofitaccount1936$ 247,068.19$ 67,524.59$ 8,950.891937304,530.2188,458.758,148.721938226,930.2173,425.808,373.541939314,221.85102,409.4112,532.43281 During the years 1936 to 1939, the Artisan Metal Works Co. operated at from 85 to 90 per cent of capacity and employed approximately 45 men.The sales, gross profit, and percentage of gross profit to sales for one company in the petitioner's industry for the years 1936 to 1939, inclusive, were as follows:193619371938Sales$ 71,920$ 98,847$ 107,455Gross profit25,32730,57234,255Percentage35.22%30.93%31.88%Average for1939base periodSales$ 158,904Gross profit55,213Percentage34.25%33.20%277 The respondent computed petitioner's invested capital for 1942 as $ 8,410.49 and allowed 8 per cent of this amount or $ 672.84 as its excess profits credit for that year. In 1943 the respondent determined petitioner's invested capital as $ 13,567.56, of which amount he allowed $ 1,085.40, or 8 per cent of invested capital, as petitioner's excess profits credit.Respondent determined in the notice of deficiency that the petitioner's correct excess profits tax liability for the year ended December 31, 1942, was $ 10,957.19. Of this amount, petitioner paid the sum of $ 7,026.32 prior to the issuance of the notice of deficiency, the remaining amount of $ 3,930.87 being determined by the respondent as a deficiency. The respondent determined petitioner's excess profits tax liability for the year ended December 31, 1943, as $ 44,652.30, of which amount petitioner paid $ 26,765.10 prior to the issuance of the notice of deficiency. The remaining amount of $ 17,887.20 respondent has determined as a deficiency for 1943.In the same notice respondent disallowed applications for relief under section 722 of the Internal Revenue Code which were filed within the time prescribed by law in respect278 to the taxable years 1942 and 1943.OPINION.In this proceeding, the petitioner challenges the deficiencies in excess profits tax determined by the respondent for the taxable years 1942 and 1943 on the ground that under the provisions of section 722 (c) of the Internal Revenue Code it is entitled to refunds in the amounts of $ 7,026.32, with interest, and $ 26,765.10, with interest, representing excess profits taxes paid in the years 1942 and 1943, respectively.282 Generally speaking, section 722 (c)1 provides that the tax shall be considered excessive and discriminatory where a taxpayer is not entitled to use the excess profits credit based on income under section 713 if it can be shown that the excess profits credit based on invested capital is an inadequate standard because --(1) the business of the taxpayer is of a class in which intangible assets not includible in invested capital under section 718 make important contributions to income,(2) the business of the taxpayer is of a class in which capital is not an important income-producing factor, or(3) the invested capital of the taxpayer is abnormally low.279 The existence of one of the qualifying conditions specified in the statute is not sufficient to establish a taxpayer's right to relief under section 722 (c), for the reason that the condition may not result in the invested capital method being an inadequate standard for the determination of the excess profits credit or because it may be more than outweighed by other unusual war conditions operating to the taxpayer's advantage during the taxable years. Therefore, the taxpayer must demonstrate the inadequacy of its excess profits credit based on invested capital by showing that the inadequacy results from one of the above factors and by establishing within the framework of section 722 (a)2280 a fair and just amount representing normal earnings to be used as a constructive average base period net income. 3281 283 Petitioner contends that its excess profits credit based upon invested capital for each of the years 1942 and 1943 was an inadequate standard, due to the existence of the conditions or factors described in subsections (1) and (2) of section 722 (c). Specifically, petitioner submits that its business was of a class in which intangible assets not includible in equity invested capital under section 718 made important contributions to income, and that its business was of a class in which capital was not an important income-producing factor.The petitioner argues that C. George Danielson had valuable contacts with the trade prior to its organization; that he had special technical skill and ability and a comprehensive knowledge of the problems of production; and that he had an established reputation for ability and performance in connection with work under his supervision. Petitioner's view that these characteristics of Danielson constituted intangible assets contributing to its income is based upon the conclusion that Danielson's contacts and reputation in the trade were material factors in the customers' decisions to place orders with the petitioner. Petitioner further contends282 that, since Danielson was its organizer, principal stockholder, president, and manager in full charge of its production and policies, the petitioner started business in 1940 with an established good will.Respondent, on the contrary, argues that the only intangible assets that the statute contemplates are such assets as are owned by the petitioner, and that Danielson's contacts were purely personal to him and could never become petitioner's property, and that for the use of his contacts and experience Danielson was fully compensated by the petitioner.It is true that Danielson's contacts, reputation, skill, and personal characteristics did not become the property of petitioner and that, 284 within the meaning of section 718, 4 their value, whatever it might be, was not includible in the petitioner's equity invested capital. Indeed, it has long been held that "Ability, skill, experience, acquaintanceship, or other personal characteristics or qualifications [of an officer or employee] do not constitute good will as an item of property; nor do they exist in such form that they could be the subject of transfer." See Providence Mill Supply Co., 2 B. T. A. 791;283 Northwestern Steel & Iron Corporation, 6 B. T. A. 119; Amalgamated Products Co., 12 B. T. A. 659; Wickes Boiler Co., 15 B. T. A. 1118; D. K. MacDonald, 3 T. C. 720, 727; John Q. Shunk, 10 T. C. 293, 303.284 However, section 722 (c) (1) is concerned with intangible assets that are not includible in invested capital under section 718 which nevertheless make important contributions to income, and the immediate question is whether the attributes and qualifications of Danielson as found to exist do in fact constitute such intangible assets within the meaning of this subsection. There is no requirement in section 722 (c) (1) that the intangible assets must be owned by the corporation. 5 The statute merely requires that the intangible assets must make important contributions to the corporation's income.285 A recent pronouncement of the Excess Profits Tax Council fully supports this view. E. P. C. 36, 1949-1 C. B. 137. In that case a partnership consisting of two individuals opened a restaurant in New England in 1928 and another restaurant on the Gulf Coast in 1936, both of which enjoyed a national reputation. In 1941 the two partners and another individual organized a corporation to operate a restaurant in a South Atlantic resort city. The new restaurant was designed and operated on the same plan and with the same name, decorations, menus, and recipes as the restaurants of the partnership. The corporation paid nothing to the partnership for the use of the name, recipes, and menus. The determination of the Excess Profits Tax Council was as follows:285 In E. P. C. 35 (1949-1 C. B. 134), the Council held that ownership of the intangible asset, in a strict legal sense is not required by section 722 (c) (1). The asset here involved is, in fact, the reputation, or good will, of the partnership which the taxpayer is using by permission of the partnership. Also involved are the recipes of the partnership, which might be compared286 with secret formulas of a manufacturer. It is therefore held that the K Corporation's business is of a class in which intangible assets not includible in invested capital make important contributions to income.The entire testimony in the instant case compels the conclusion that Danielson's contacts in the trade were responsible for the immediate flow of business to petitioner. A number of witnesses testified that it was his association with the enterprise and his ability and cooperativeness that caused them to place their orders with this new company. The petitioner was not simply manufacturing and selling an article. In conducting a customs business, it was performing a service in accordance with the specifications outlined by its customers. Danielson's contacts and reputation in this type of business immediately provided the petitioner with the benefit of good will of considerable value, albeit, as we have said, such good will did not constitute an intangible asset includible in its equity invested capital under section 718. That section 35.722-4 (a) of Regulations 112 also recognizes this situation as a qualifying factor under section 722 (c) (1) will appear from the following287 statement:* * * Corporation M commenced business in 1940. Its business was of a class which required little invested capital but necessitated the establishment of contacts with the trade in which it would obtain its customers. It lost money during its first two years of operation, but by 1942 had built up patronage and showed a considerable profit. If its invested capital was very small, its excess profits credit based on invested capital would be an inadequate standard for determining excess profits, and the corporation would be entitled to file a claim for relief under section 722 for the year 1942 and subsequent years.In our opinion, the personal contacts and attributes of Danielson resulted in petitioner having the benefit of an established good will that made important contributions to its income during the taxable years in question within the meaning of section 722 (c) (1), although such good will was not includible in its equity invested capital within the meaning of section 718.Petitioner's second contention, based upon section 722 (c) (2), is that its business was "of a class in which capital is not an important income-producing factor." The parties have not cited nor288 have we been able to discover any prior decision involving the interpretation of section 722 (c) (2).Petitioner argues that "Capital is not an important income producing factor" if "the business is of a type showing a high return on invested capital." In support of this position, petitioner points to 286 the following language of the Report of the Senate Committee on Finance (S. Rept. No. 1631, 77th Cong., 2d sess., p. 203):Under existing law, a taxpayer not entitled to use the excess profits credit based on income is not entitled to relief. This places in a disadvantageous competitive position corporations commencing business after January 1, 1940, as well as other corporations deprived of such credit if the business is of a type showing a high return on invested capital, or if for some reason peculiar to the corporation, the invested capital is unusually low. [Italics supplied.]In further support of its position, petitioner points to the very low excess profits credit allowed to it based on the invested capital formula and the very high percentage of its profits and net income to its invested capital.Respondent, on the contrary, takes the position that the word "important" 289 as used in section 722 (c) (2) is to be interpreted in the same manner as "material" in section 725, having to do with personal service corporations. See E. P. C. 35, 1949-1 C. B. 134; Gus Grissmann Co., 10 T. C. 499; Graham Flying Service, 8 T. C. 557; affd., 167 Fed. (2d) 91; certiorari denied, 335 U.S. 817">335 U.S. 817; Fairfax Mutual Wood Products Co., 5 T. C. 1279; Atlanta-Southern Dental College v. Commissioner, 50 Fed. (2d) 34.We are of the opinion that capital should be regarded as "not important" within the meaning of section 722 (c) (2), where the taxpayer's business is of a class in which the normal profit is so greatly in excess of the normal return on invested capital of 8 per cent recognized by the statute that the large discrepancy between such profit and such normal return clearly indicates that the invested capital method is inadequate as a basis for determining its excess profits credit.In determining whether a taxpayer's business is of a class in which capital is not290 an important income-producing factor, all material facts bearing upon the petitioner's business operations must be considered and substantiation may be sought in the form of evidence of the experiences of other firms engaged in the same type of business in the same locality. Our views in this respect are in accordance with those expressed by the Excess Profits Tax Council in its definition of "class" as set out in E. P. C. 35, supra:The provision that taxpayer's business must be "of a class" does not imply that there be a division of businesses into trades or industries, or that any other separation into specified groups is required. Here, the word "class" is used in the sense of type, character, or nature, rather than with any requirement that businesses must be segregated into classes. If the nature of the taxpayer's business function, the character of its organization, or the methods it employs in operation are such that intangible assets of the character in question make important contributions to income, it is considered that it falls within the purview of the statute. 6291 287 The record shows that the petitioner's net income for 1941 was over 100 per cent of its combined capital and surplus at the beginning of 1941; that its net income for 1942 was approximately 240 per cent of its total capital and surplus at the beginning of 1942; and that its net income for 1943 was approximately 425 per cent of its total capital and surplus at the beginning of 1943. Although we have no evidence of the net income of comparable firms during the excess profits tax years, the record shows that, during the years 1936, 1937, and 1939, Artisan realized gross profits considerably in excess of its total capital and surplus. (Cf. E. P. C. 37, 1949-1 C. B. 138.)It is also undisputed that the formula used generally in the trade during the base period years was designed to yield net earnings equal to 20 per cent of sales. Under this formula, the cost of direct labor and material to be used in the product was estimated, to which was added overhead fixed at 100 per cent of the estimated cost of direct labor, the total of which items constituted 80 per cent of the selling price, the remaining 20 per cent being the company's net profit.It is292 clear that the petitioner's business was of a class in which capital was not such an "important income-producing factor" as to warrant limiting its normal profits to 8 per cent on its invested capital as contemplated by the statute as a normal return for corporations whose excess profits credit would be determined on the basis of invested capital. Moreover, petitioner's competitors who were in existence during the base period years possessed, at the time of the imposition of the excess profits tax, an election to compute their excess profits credit on the basis of invested capital or on the basis of average income, and, being members of an industry in which a high return on invested capital was characteristic, they were able to obtain a larger excess profits credit by the use of the average income method. Our conclusion that the petitioner has met the requirements of qualification under section 722 (c) (2) alleviates this inequity and permits the petitioner to obtain the relief to which it can show itself to be entitled.As we have previously pointed out, the mere existence of the qualifying features of section 722 (c) does not establish a taxpayer's right to relief. The petitioner293 must further demonstrate the inadequacy of its excess profits credit based upon invested capital by establishing under section 722 (a) a fair and just amount representing normal earnings to be used as a constructive average base period net income. Cf. Lamar Creamery Co., 8 T. C. 928; Irwin B. Schwabe Co., 12 T.C. 606">12 T. C. 606.The petitioner states that its constructive average base period net income should be computed on the basis of the general formula which was commonly used by Artisan and other companies from 1936 to 1939 to fix the sales price of custom work. Thus, the petitioner contends that 20 per cent of its net sales in 1942 and 1943 fairly represents a constructive average base period net income to be used in 288 computing its excess profits credit for each year. It makes no effort to establish what its own sales, gross profits, administrative costs, or net income could reasonably have been expected to be during the base period years. In our opinion, a fair and just amount representing petitioner's normal earnings can not be established under the method proposed.The inherent fallacies in the petitioner's contentions294 are obvious. It is abundantly clear that by "constructive average base period net income" section 722 (a) contemplates that a taxpayer's normal earnings over the base period years will be expressed as a fixed amount and not as a percentage to be applied to sales from year to year as proposed by the petitioner. See secs. 713 and 722 (d), I. R. C. Under the system the petitioner suggests, it is inevitable that a different constructive "average" base period net income must be determined for each taxable year, a result clearly not contemplated by the statute. Moreover, such a system would bring about inequities between taxpayers as great as those sought to be corrected by section 722 (c). An unfair tax advantage would be gained by the petitioner if it were allowed, in computing its excess profits credit, to use as its normal earnings 20 per cent of its 1942 and 1943 sales, whereas those of its competitors who were in existence during the base period years would be limited to the same percentage of their sales as for prewar years.The petitioner's proposed computations are also in conflict with section 722 (a), which provides that in determining the constructive average base period295 net income, no regard shall be had to events or conditions affecting the taxpayer, the industry of which it is a member, or the taxpayer generally occurring or existing after December 31, 1939, except that under section 722 (c) the nature of the taxpayer and the character of its business may be considered to the extent necessary to establish its normal earnings. In our opinion, the exception as to evidence of the nature and character of the taxpayer's business does not sanction the petitioner's use of its actual sales after December 31, 1939, in the manner proposed by the petitioner for the computation of a constructive average base period net income. 7296 Although section 35.722-4 (c) of Regulations 112 recognizes the fact that no exact criteria can be prescribed for the computation of the constructive average base period net income of a taxpayer under section 722 (c), we feel that the taxpayer seeking relief must be prepared to submit the facts from which this Court may reasonably determine 289 with some degree of accuracy the probable amount of its normal earnings for use as a constructive average base period net income.In the instant case we find it impossible to fix the relative position of the petitioner in its industry for the reason that there is no evidence of the experiences of comparable firms during the taxable years from which we might make an analysis such as suggested in the regulations. 8 There is no satisfactory evidence of competitive conditions as they existed in the industry during the base period years, the demand for custom work during the base period years, or the extent to which business in the industry increased during the excess profits years due to war conditions. No testimony was offered in respect to what share of the total available business existing during the base period years petitioner could297 reasonably have been expected to capture, or the volume of business it could have attained by the close of the base period had it commenced business during the base period.298 The record contains figures representing the total capital and surplus, sales, and gross profits of Artisan and the sales and gross profits of another unidentified company during the base period years. However, there is no evidence relative to the standing of these firms in the industry, the detail of their operating techniques, the net income realized, or any factual basis upon which a valid comparison of the petitioner may be made.At the hearing of the instant case, an accountant for the petitioner and an economist for the respondent apparently reached a tentative agreement in respect to some of the needed facts. Petitioner's counsel, however, objected to the proposed stipulation and the information contained therein never became a part of the record in this case. Petitioner's objection was based on his contention that the data as to one of the comparables was inaccurate and that the net income of the comparable concerns considered in the stipulation was not a fair measure of their earnings due to the large salaries paid to officer-stockholders during the base period years.290 As we have previously stated, it is the design of the statute that a taxpayer must demonstrate299 the inadequacy of its excess profits credit by establishing a fair and just amount representing normal earnings for use as a constructive average base period net income in addition to showing the existence of the qualifying factors listed in subsections (1), (2), and (3) of section 722 (c). Although the record as a whole convinces us that petitioner could have successfully entered the industry during the base period years and realized some earnings, it is our opinion that the petitioner's failure to provide sufficient evidence from which its normal earnings could be reasonably determined defeats its contention that its excess profits credit based upon invested capital constitutes an "inadequate standard for determining excess profits" within the meaning of section 722 (c).The petitioner has not contested various adjustments made by the respondent in his determination of deficiencies for both years, but bases its appeal herein solely upon the respondent's rejection of its application for refunds under section 722 (c). As the petitioner has failed to establish its right to such refunds, the respondent's determination as set out in the notice of deficiency is sustained.Decision300 will be entered for the respondent. Footnotes. The discrepancy between gross profit and the sum of total expenses and net income↩ is due to minor adjustments made by respondent not material to the issue herein.1. SEC. 722. GENERAL RELIEF -- CONSTRUCTIVE AVERAGE BASE PERIOD NET INCOME. * * (c) Invested Capital Corporations, Etc. -- The tax computed under this subchapter (without the benefit of this section) shall be considered to be excessive and discriminatory in the case of a taxpayer, not entitled to use the excess profits credit based on income pursuant to section 713, if the excess profits credit based on invested capital is an inadequate standard for determining excess profits, because -- (1) the business of the taxpayer is of a class in which intangible assets not includible in invested capital under section 718 make important contributions to income,(2) the business of the taxpayer is of a class in which capital is not an important income-producing factor, or(3) the invested capital of the taxpayer is abnormally low.↩In such case for the purposes of this subchapter, such taxpayer shall be considered to be entitled to use the excess profits credit based on income, using the constructive average base period net income determined under subsection (a). * 2. SEC. 722. GENERAL RELIEF -- CONSTRUCTIVE AVERAGE BASE PERIOD NET INCOME.(a) General Rule. -- In any case in which the taxpayer establishes that the tax computed under this subchapter (without the benefit of this section) results in an excessive and discriminatory tax and establishes what would be a fair and just amount representing normal earnings to be used as a constructive average base period net income for the purposes of an excess profits tax based upon a comparison of normal earnings and earnings during an excess profits tax period, the tax shall be determined by using such constructive average base period net income in lieu of the average base period net income otherwise determined under this subchapter. In determining such constructive average base period net income, no regard shall be had to events or conditions affecting the taxpayer, the industry of which it is a member, or taxpayers generally occurring or existing after December 31, 1939, except that, in the cases described in the last sentence of section 722 (b) (4) and in section 722 (c), regard shall be had to the change in the character of the business under section 722 (b) (4) or the nature of the taxpayer and the character of its business under section 722 (c)↩ to the extent necessary to establish the normal earnings to be used as the constructive average base period net income.3. The bulletin on section 722, part I (D) states:"The mere presence of a factor under section 722 (b), or the existence of the situation under section 722 (c), is not a sufficient qualification for relief. Relief is based upon an inadequacy of the actual average base period net income or the excess profits credit based on invested capital shown to exist as a result of such factor or situation. This inadequacy will obtain if the actual average base period net income is less than the constructive average base period net income determined under section 722, or if (in the section 722 (c) cases) the excess profits credit based on invested capital is less than the excess profits credit based upon the constructive average base period net income. Section 722 is an integrated and unified provision which cannot be broken up into two parts, one of which makes a taxpayer eligible for relief (sections 722 (b) and 722 (c)), and another of which provides for the determination of the amount of relief (section 722 (a)). There can be no valid contention that a taxpayer is eligible for relief under one portion of section 722↩ but is denied a constructive average base period net income under another portion of the section."4. SEC. 718. EQUITY INVESTED CAPITAL.(a) Definition. -- The equity invested capital for any day of any taxable year shall be determined as of the beginning of such day and shall be the sum of the following amounts, reduced as provided in subsection (b) --(1) Money Paid In. -- Money previously paid in for stock, or as paid-in surplus, or as a contribution to capital;(2) Property Paid In. -- Property (other than money) previously paid in (regardless of the time paid in) for stock, or as paid-in surplus, or as a contribution to capital. Such property shall be included in an amount equal to its basis (unadjusted) for determining loss upon sale or exchange. * * ↩5. E. P. C. 35, 1949-1 C. B. 134, 135, states:"The taxpayer's rights in the intangible asset, whether legal title, equitable title, license or privilege of use, or any other, must be such that the income contributed by the intangible is properly includible in the taxpayer's income. It is not sufficient if taxpayer is merely the assignee of the income of the intangible. The contribution of the intangible asset to income, while it may be direct or indirect, must be important in the sense that it is significant in relation to the taxpayer's total income."↩6. E. P. C. 35 also states:"The words 'class' and 'important,' as used in section 722 (c) (2), have the same general meaning as in section 722 (c) (1)↩."7. The bulletin on section 722 (part VII, par. E, pp. 136-137) states:" * * no significance can be attached to the actual rate of development or earnings of a taxpayer that began business subsequent to the end of the base period. Constructive normal earnings can never be based on post-1939 circumstances. The constructive normal earnings of a taxpayer under section 722 (c)↩ are the earnings it would have obtained from normal operations during a period of normal conditions for general business."8. Regulations 112, section 35.722-4 (c), reads in part as follows:"* * * In the case of a taxpayer commencing business after December 31, 1939, it is necessary to examine the type of business engaged in, the relationship between its profits and invested capital, its profits and sales, and the profits and invested capital and profits and sales of comparable concerns, the earning capacity of the taxpayer, the character and experience of the management, the nature of the competition encountered, and all other factors pertinent in constructing normal earnings. The mere fact that earnings after December 31, 1939, exceed the amount of the excess profits credit based on invested capital is not of itself an indication that the taxpayer is of a class which shows a higher than average return upon capital or that its invested capital is abnormally low. Therefore any facts or conclusions derived with respect to the period after December 31, 1939, shall be related to the base period; or, if the base period does not represent a period of normal earnings for the type of business exemplified by the taxpayer, to another period of average normal earnings; and in either case the taxpayer must establish that it would satisfy the provisions and conditions of section 722 (c)↩ and of this section for such period." (Italics supplied.)	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625378/	THE L. A. WELLS CONSTRUCTION COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.L. A. Wells Constr. Co. v. CommissionerDocket No. 102554.United States Board of Tax Appeals46 B.T.A. 302; 1942 BTA LEXIS 880; February 11, 1942, Promulgated 880 1. The petitioner is a contractor and files its income tax returns on the calendar year basis. Some contracts are begun and completed within the taxable years. Others are begun in one taxable year and completed in the next. In keeping its books and filing its income tax returns, it computes income on the basis of completed contracts. Held, that it may not take a deduction in the taxable year 1937, as a reserve for loss, of an amount estimated as the loss sustained in that year on a contract begun in that year and completed in 1938. 2. In 1937 petitioner purchased for $200 a dredge that had been lying on the bottom of Lake Erie for three months and expended $9,480.73 in raising the dredge and putting it into serviceable condition. Of the amount so expended, $7,537.35 was deducted by the petitioner on its return as business expense. Petitioner now concedes that $7,414.54 representing the cost of raising the dredge and rearranging and rebuilding the house part thereof was not a business expense, but does contend that the remaining $2,066.19 expended in reconditioning and restoring the hull and the motor to the condition they were in at the time the dredge was sunk is deductible. 881 Held, that the deduction so claimed does not represent an ordinary and necessary business expense within the meaning of the statute and is not allowable. Meyer A. Cook, Esq., and Frank W. Koral, Esq., for the petitioner. W. W. Kerr, Esq., for the respondent. TURNER 302 The Commissioner determined a deficiency of $20,019.59 in the petitioner's income tax and of $1,703.97 in its excess profits tax for 1937. The only questions for decision are whether the petitioner is entitled to deduct (1) $61,031.40 as a reserve for loss on a construction contract begun by it in 1937 and completed in 1938, and (2) $2,066.19 as a business expense. FINDINGS OF FACT. The petitioner is a Delaware corporation, with its principal office in Cleveland, Ohio. It filed its income tax return for 1937 on the 303 calendar year basis, with the collector of internal revenue for the eighteenth district of Ohio. Since 1926 the petitioner has been engaged principally in marine construction work embracing dredging, the building of breakwaters, and the performance of subaqueous work of all kinds, and filed its income tax returns on the calendar year882 basis. During this period the petitioner has undertaken on an average of from 45 to 50 projects annually. Prior to 1935 all projects begun during a given year were completed within that year. In 1935 it began 1 project which was not completed until the succeeding year. In 1936 it began 4 projects which were completed in 1937. In 1937 it began 2 projects which were completed in 1938. So far as disclosed none of the contracts under which projects were begun in one year and completed in the following year contemplated or required a period in excess of 12 months for completion. One of the projects begun in 1937 and completed in 1938 was the construction of an intercepting sewer and sewage treatment project at Buffalo, New York, sometimes referred to as the Buffalo project. The contract for the project was with the Buffalo Sewer Authority, sometimes referred to as the authority, and was awarded to the petitioner under competitive bidding. The contract was approved on August 14, 1937. It provided for the completion of the project in 225 consecutive calendar days from the date of notice by the authority to proceed with the work, unless such period should later be extended by the883 authority. The specifications and contract contemplated completion of the project as a whole, and that was petitioner's understanding in submitting its bid. The project was shown, however, in 17 separate items, and as to 4 payment was to be made on the lump sum basis, while as to the others payment was to be made at a unit price. At the time the petitioner entered into the contract it was estimated that the total amount to be received for the completion of the project would be $382,249.02, and the performance bond given by the petitioner to the authority was for that amount. The petitioner began work on the Buffalo project on August 16, 1937, and completed it on or about July 10, 1938. Under the contract the petitioner received monthly payments from the authority based on progress estimates made by the engineers for the authority, which in turn were predicated upon the work done and materials furnished. Only 90 percent of the amount of the monthly progress estimates was currently payable or paid to the petitioner, the remaining 10 percent being retained until the completion of the contract and subject to forfeiture in event of its nonfulfillment. During November 1937, the884 petitioner encountered subsurface difficulties which 304 resulted in greater labor and material costs than it originally had anticipated. At the time the petitioner prepared its bid it estimated labor costs of $99,000 for the entire project. By December 31, 1937, the progress estimates made by the authority's engineers indicated that the project was 46.96 percent completed and totaled $182,189.62. By that time the petitioner's labor costs had amounted to $100,349.18 and its total costs to $244,369.30, or $62,179.68 in excess of the total of progress estimates. After it had encountered the unanticipated difficulties petitioner filed complaints with the authority as the work progressed, in order to lay a basis for a formal claim if it should later decide to make a claim for compensation in excess of that provided for in the contract. Under the existing contract, however, the responsibility for judging the sufficiency of its estimates of costs and conditions affecting the execution of the project rested entirely on the petitioner. No formal claim for additional compensation was filed in 1937, but in 1938, when the work was completed, the petitioner did file with the authority885 formal claim for compensation beyond that provided in the contract to cover the unanticipated costs it incurred in completing the project. Labor costs alone for the entire job amounted to $222,177.93. In final settlement the authority, without the contract so providing, paid the petitioner approximately $24,000 in addition to the $382,249.02 originally estimated to be paid under the contract. The petitioner's loss on the project after making allowance for the receipt of the $24,000 was $95,343.26. On or after December 31, 1937, the petitioner debited an account on its books designated "Cost of Jobs - Miscellaneous" with an amount of $61,031.40, with the following explanation: Buffalo Sewer Authority Job in progress as of Dec. 31, 1937 - Cost$244,369.30Estimates allowed on 46.96% of project completed to Dec. 21, 1937182,189.62Cost is 134% of estimates allowed.Completed contract price is 382,249.02 Continued loss at 134% would cost 512,213.68 to complete causing a loss of 129,964.66.46.96% of 129,964.66 represents known loss as of Dec. 31, 1937.In its income tax return for 1937 the petitioner deducted as a reserve for loss on the contract the $61,031.40, 886 computed in the foregoing manner. In determining the deficiency the respondent disallowed the deduction on the ground that the loss was not evidenced by a closed and completed transaction. With respect to projects begun in one year and completed in the subsequent year, even though on a unit price basis, it has been the practice of the petitioner to enter currently on its books the receipts from such projects and the expenditures incurred thereon, but under the method of accounting employed by it the profit or loss on such 305 projects was not reflected in its income until the year of completion of the projects. It has been the practice of the petitioner in filing its income tax returns to report in the year of completion the gain or loss resulting from projects begun in the preceding year and completed in the current taxable year. In conformity with that practice the petitioner, in filing its 1937 return, completely ignored the Buffalo project so far as income and expenditures were concerned except to deduct as a reserve the $61,031.40. In its income tax return for 1938 the petitioner showed the total receipts and the total expenses of the Buffalo project and from the887 expenses subtracted the $61,031.40 taken in its 1937 return, thereby taking as a loss in 1938 on the project the difference between $95,343.26, loss actually sustained, and $61,031.40, deducted as a reserve in 1937, or the amount of $34,311.86. After thus taking the $34,311.86 as a loss the petitioner reported a loss in 1938 of about $20,000. In 1937 the petitioner purchased for $200 from a salvage association representing certain underwriters a 12-inch suction dredge called the "Gala Water." At the time the petitioner purchased the dredge it was on the bottom of Lake Erie and under about 30 feet of water, where it had been for about three months. In negotiating the purchase of the dredge the petitioner estimated that an expenditure of about $2,500 would be required to raise the dredge and put the motor in a serviceable condition, and that an expenditure of about $2,000 would be required to rebuild the house part of the dredge and to do certain other things necessary to make the dredge usable. The petitioner had never before undertaken the raising of a dredge and did not have much experience in activities relating thereto. The actual cost to the petitioner of raising the dredge888 and putting it in usuable condition was $9,480.73, of which $1,914.54 represented the cost of rearranging and rebuilding the house. Of the $9,480.73 expended on or in connection with the raising of the dredge, the petitioner treated the $1,914.54 on its books as representing additions and betterments and therefore a capital expenditure. Of the remainder, it treated $7,537.35 as an expense and deducted that amount in its income tax return for 1937 as repairs to dredge. The record is silent as to the treatment accorded $28.84 representing the balance of the $9,480.73. In determining the deficiency the respondent disallowed the $7,537.35 as a deduction on the ground that it constituted a capital expenditure. OPINION. TURNER: The petitioner contends that it kept its books and filed its income tax returns on the accrual basis; that the Buffalo contract, which did not contemplate or require in excess of twelve months for 306 completion, was not a "long-term" contract as defined by the respondent's regulations, and that therefore the deduction of $61,031.40 taken in its 1937 return as a reserve for loss should be allowed in order to clearly reflect its income. The respondent889 contends that, since the petitioner has consistently reported its taxable income from contracts begun in one year and completed in the following year on the completed contract basis, and since the Buffalo project was not completed until 1938, the allowance of the deduction sought by the petitioner would result in a distortion of its taxable income for both 1937 and 1938. The evidence shows that the first of the petitioner's contracts on which work was begun in one year and completed in the following year was in 1935. So far as disclosed, none of petitioner's contracts of that type covered a period in excess of twelve months from beginning until completion. The testimony of its secretary-treasurer, who had charge of its books, shows that under the petitioner's method of accounting for and reporting income from such contracts it was its practice to report the income received and the costs incurred with respect to specific projects in its return for the year of completion. Such a practice contradicts the petitioner's contention that it kept its books and filed its returns on the accrual basis. For as we said in 890 ; affd., : * * * When, as here, the specific project accounts have been withheld from profit and loss until the completion of the project and this in disregard of and intervening annual period, it can not be said that the taxpayer's accounting method is one of the annual accrual of net income. From the evidence it is apparent that the petitioner accounted for and reported its income by the completed contract method. So far as disclosed, the respondent has consistently accepted such method as correctly reflecting the petitioner's income and, we think, properly so. ;; affd., ; ; ; affirmed on this point, ; certiorari denied, ; . With respect to the Buffalo project the petitioner, under the guise of a reserve for loss, seeks to depart from its established practice of accounting for891 and reporting income and to deduct in its 1937 return an amount representing a prorated portion of its total estimated loss on the project. Where, as here, the method of accounting employed by the taxpayer clearly reflects income, to permit such departure would not result in the petitioner's net income being computed "in accordance with the method of accounting regularly employed in keeping the books of such taxpayer", as is required by the statute. 307 Sec. 41, Revenue Act of 1936. The allowance of such departure would, as respondent contends, result in a distortion of income for both 1937 and 1938. We are of the opinion that the action of the respondent with respect to this issue is correct, and it is therefore sustained. The petitioner contends that the decisions in the H. Stanley Bent, Alfred E. Badgley, Russell G. Finn, Executor, and Fort Pitt Bridge Works cases, supra, cited by respondent, were predicated on article 36 of Regulations 45, relating to the 1918 Act, and did not specifically define "long-term contracts"; that article 42-4 of Regulations 94, relating to the 1936 Act, which is applicable892 here, defines "long-term contracts" as "building, installation, or construction contracts covering a period in excess of one year"; that the Buffalo contract did not cover a period in excess of one year and that to hold as applicable here the completed-contract method of reporting income involved in said decisions and specifically provided for in article 42-4(b) of Regulations 94, would nullify the obvious intent of the regulation as disclosed in the definition of long term contracts. It is true that the decisions in the cases mentioned, except the Badgley case, involved taxable years controlled by the Revenue Act of 1918. However, the D. L. Wheelock case involved years controlled by the 1918 and 1921 Acts and the Badgley case involved years controlled by the Revenue Acts of 1921, 1924 and 1926. The regulations under all acts since the Act of 1918 contain the same definition of long term contracts as appears in article 42-4 of Regulations 94. The rule in the above mentioned cases is grounded not on the length of time covered by the contracts, but on the taxpayer's method of keeping books and reporting income, and, as we said in the Bent case, "The fact that some893 of the contracts were performed within a year and some took longer creates no inconsistency in the method and does not detract from a clear reflection of income." The petitioner has consistently reported the income from the various projects in the year in which the particular project was completed and there is nothing in the facts to indicate that such method consistently followed does not clearly reflect income, and certainly there is no justification for according the Buffalo project any different treatment from that accorded to other contracts begun in one year and completed the year after. The petitioner has alleged that the respondent erred in disallowing the deduction of $7,537.35 taken as repairs to the dredge, Gala Water. The petitioner now concedes that $5,500 of the amount in question represented cost of raising the dredge and is not deductible. It is contended that the remaining amount of $2,066.19 is deductible because expended in reconditioning and restoring the hull and the 308 motor to the condition they were in prior to the time the dredge sank, citing 894 . Assuming, as petitioner contends, that $2,066.19 was expended for the purpose alleged, the Zimmern case is not authority for the allowance of the deduction claimed. In that case the taxpayer owned and was using in its business a coal barge which sank during a storm in 1918. The court held that an expenditure made by the taxpayer in 1920 for restoring the barge to the condition it was in at the time it sank was an ordinary and necessary expense and therefore deductible for the year in which made. The facts in the instant case are materially different. Here the petitioner purchased a dredge which had been lying on the bottom of Lake Erie for three months and was in an unusuable condition. It was for the dredge in that location and in that condition that the petitioner paid $200. Without further expenditures the dredge would have continued in the same location and in the same condition. Clearly what the petitioner had after making the expenditures here involved was not a sunken dredge in its then useless condition, but one that was afloat and serviceable. So far as disclosed, the expenditures made by the petitioner*895 gave the dredge a useful life of many years beyond the taxable year. Under these circumstances we are unable to hold that the portion, now claimed, of the amount deducted by the petitioner constituted an allowable deduction. Cf. . The situation here presented is entirely different from that of a taxppayer who repairs damage which has occurred to property owned and being used by him and who after such repairs has no greater asset than he originally owned. Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625379/	All-Steel Equipment Inc., Petitioner v. Commissioner of Internal Revenue, RespondentAll-Steel Equipment, Inc. v. CommissionerDocket No. 2805-66United States Tax Court54 T.C. 1749; 1970 U.S. Tax Ct. LEXIS 60; September 30, 1970, Filed 60 Decision will be entered under Rule 50. The petitioner consistently valued its inventory by use of the prime cost method including in inventory only the cost of direct labor and materials. The respondent determined that such method did not clearly reflect the petitioner's income and that its inventory should be valued by use of the full absorption method. Held (1) the petitioner's method of accounting did not clearly reflect its income; and (2) the respondent did not abuse his discretion in requiring the petitioner to value its inventory by use of the full absorption method. Arthur E. Bryan, Jr., Don S. Harnack, and James M. Roche, for the petitioner.Nelson E. Shafer, for the respondent. Simpson, Judge. Quealy, J., did not participate in the consideration and disposition of this case. SIMPSON1749 The respondent determined deficiencies in the petitioner's income taxes of $ 212,842.90 for the taxable year 1962 and $ 36,547.03 for the taxable year 1963. Some of the issues have been settled, and the only question remaining for decision is whether the respondent erred in revaluing the petitioner's opening and closing inventories to include therein an allocable portion of indirect manufacturing expenses.FINDINGS OF FACTSome of the facts have been stipulated, and those facts are so found.The petitioner is an Illinois corporation which had its principal office in Montgomery, Ill., 63 at the time its petition was filed in this case. The general method of accounting employed by the petitioner in keeping its books and records and preparing its Federal income tax returns is and has been the accrual method. It timely filed its 1962 and 1963 Federal income tax returns with the district director of internal revenue, Chicago, Ill.The petitioner is engaged in the metal fabricating business. It was incorporated and commenced business in 1912. Initially, its product lines consisted of electrical cutout boxes and shop tote boxes. Over 1750 the years, the petitioner's business has expanded both as to volume and product lines. In 1962 and 1963, the petitioner's business consisted generally of the manufacture and sale of metal office furniture. The office furniture lines included office desks, credenzas, bookcases, chairs, storage cabinets, filing cabinets, and lockers.In computing its income for financial reporting and Federal income tax purposes, the petitioner has used inventories at least since 1928. Its inventories have consistently been valued by use of a "prime cost" method and reflect only direct labor and materials, but no manufacturing overhead. It64 had been audited by the respondent for all years since 1916, except for the years 1928 and 1951, and its use of the prime cost method for valuing its inventories was not challenged until the issuance of the notice of deficiency with respect to 1962 and 1963.The petitioner's books have been audited by reputable independent accounting firms since 1933. None of the reports issued as a result of such audits concluded that the use of prime costing prevented the petitioner's financial statements from fairly presenting its financial condition and the results of its operations. The reports for the years 1959 through 1965 indicate that the accounting firm then conducting the audits, Peat, Marwick, Mitchell & Co., felt that the use of the prime costing method of valuing inventories was not in accordance with generally accepted accounting principles, but that its application by the petitioner did not result in any significant accounting error. Each of the reports before us disclose that the petitioner included no overhead items in its inventory valuation.For the year 1962, the books and records and the tax return of the petitioner showed an opening inventory of $ 3,734,480.16 and a closing65 inventory of $ 3,631,037.08. For the year 1963, its opening inventory was $ 3,631,037.08, and its closing inventory was $ 4,491,806.26. The respondent in his notice of deficiency determined that the use of the prime cost method for valuing such inventories did not clearly reflect the petitioner's income for such years. He determined that the costs of such inventories should include an allocable portion of all manufacturing expenses. To compute the portion of such expenses allocable to closing inventories, he first ascertained the amount of direct labor included in the cost of goods produced during the year. He then computed the amount of indirect manufacturing expense that should be allocated to the production of goods. The amount of such indirect expense was divided by the amount of such direct labor to determine the "Overhead Ratio." Such ratio was then applied to the amount of direct labor cost included in the inventory on hand at the end of the year, and such result was added to the costs of such inventory. As a 1751 result of these computations, he increased the costs of the closing inventory for 1962 by $ 494,637.99 and the closing inventory for 1963 by $ 604,450.78. 66 In his determination, the respondent included in the manufacturing expenses to be allocated to the costs of inventory some items which he now concedes should have been totally or partially excluded. These items appeared in the petitioner's manufacturing ledger, but the respondent now concedes that they are properly allocable to general overhead, selling, warehousing, or other nonmanufacturing activities.OPINIONGross income, in a merchandising or manufacturing business, means total sales less cost of goods sold. Sec. 1.61-3(a), Income Tax Regs. The cost of goods sold during a year is determined by subtracting the cost of inventory on hand at the end of the year from the total of the cost of inventory on hand at the beginning of the year and the cost incurred during the year in acquiring new inventory. 1 Schedule A, Form 1120. The cost of inventory on hand at the end of a year becomes the cost of opening inventory for the next succeeding year. Thus, if an expense is properly allocable to the costs of acquiring the inventory on hand at the end of the year, it is not deductible in the year it is incurred; in effect, the expense is deferred until the year in which such inventory67 is sold. On the other hand, if the expense is not considered part of inventory cost, it ordinarily is currently deductible in accordance with the general method of accounting of the taxpayer. In this case, we have an interesting question of whether certain overhead expenses are currently deductible or whether such expenses should be allocated to inventories and deferred until a later year.The initial question to be decided is whether any change should be made in the petitioner's method of valuing its inventory. The respondent contends that, since the petitioner's method of valuing inventory, which included only the cost of direct labor and materials, was not in accordance with either generally accepted68 accounting principles or applicable Income Tax Regulations, the use of such method did not clearly reflect income, and therefore, he is authorized to require the use of a different method. On the other hand, the petitioner's position is that, irrespective of whether its method of valuing inventory conforms, in the abstract, to the general principles of accounting 1752 and to the Income Tax Regulations, such method has been consistently used, has not resulted in any material errors, and therefore clearly reflected income for the years 1962 and 1963. Accordingly, the petitioner contends that under section 446 of the Internal Revenue Code of 1954, 2 the respondent was not authorized to change its method of accounting. See Glenn v. Kentucky Color & Chemical Co., 186 F. 2d 975 (C.A. 6, 1951); Fort Howard Paper Co., 49 T.C. 275 (1967); Sam W. Emerson Co., 37 T.C. 1063">37 T.C. 1063 (1962).69 Section 446 (a) and (b) provides:(a) General Rule. -- Taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books.(b) Exceptions. -- If no method of accounting has been regularly used by the taxpayer, or if the method used does not clearly reflect income, the computation of taxable income shall be made under such method as, in the opinion of the Secretary or his delegate, does clearly reflect income.Section 471 provides:Whenever in the opinion of the Secretary or his delegate the use of inventories is necessary in order clearly to determine the income of any taxpayer, inventories shall be taken by such taxpayer on such basis as the Secretary or his delegate 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.First, it is quite clear that the petitioner's method of valuing its inventory, the prime cost method, does not, in the abstract, clearly reflect income.Prime costing is not considered a generally accepted accounting principle for purposes of commercial accounting. Although we heard some70 testimony that prime costing was an acceptable method of accounting for the cost of inventory at the time the petitioner commenced to use such method, the first official pronouncement on the question by the American Institute of Certified Public Accountants was published in 1947 and is now contained in Accounting Research Bull. No. 43 (1961). In part, it provides: "It should * * be recognized that the exclusion of all overheads from inventory costs does not constitute an accepted accounting procedure." A.R.B. No. 43, p. 29. This provision of A.R.B. No. 43 was reexamined by the AICPA in 1964 and 1965 and was not modified in any way. AICPA, Opinions of the Accounting Principles Board 6 (1965). A principal purpose of the A.R.B.'s was to encourage some degree of uniformity in accounting practices, and they constitute the most authoritative statement of generally accepted accounting principles. A.R.B. No. 43, p. 8. Additionally, other accounting authorities appear to agree that 1753 prime costing is not a proper method of valuing inventories. American Accounting Association, Accounting and Reporting Standards for Corporate Financial Statements, 1957 Revision; Finney & Miller, 71 Principles of Accounting, Intermediate, 227 (5th ed. 1958).Moreover, the use of the prime cost method is contrary to the Income Tax Regulations. Section 1.471-3(c) provides:Cost means:* * * (c) In the case of merchandise produced by the taxpayer since the beginning of the taxable year, (1) the cost of raw materials and supplies entering into or consumed in connection with the product, (2) expenditures for direct labor, (3) indirect expenses incident to and necessary for the production of the particular article, including in such indirect expenses a reasonable proportion of management expenses, but not including any cost of selling or return on capital, whether by way of interest or profit.Similar provisions have been included in the regulations since 1918. Regs. 45, art. 1583 (2); Photo-Sonics, Inc., 42 T.C. 926">42 T.C. 926, 934 (1964), affd. 357 F. 2d 656 (C.A. 9, 1966). Although the regulations are not definite as to which indirect manufacturing expenses must be included in the costs of inventories, they state unequivocally that some portion of such expenses must be allocated to inventories.When the question of the use of the72 prime cost method has come before the courts, its use has been disapproved. Photo-Sonics, Inc. v. Commissioner, 357 F. 2d 656 (C.A. 9, 1966), affirming 42 T.C. 926">42 T.C. 926 (1964); Dearborn Gage Co., 48 T.C. 190">48 T.C. 190 (1967); Frank G. Wikstrom & Sons, Inc., 20 T.C. 359">20 T.C. 359 (1953). See also Fort Howard Paper Co., supra.Thus, in the light of the unequivocal position of the AICPA, the regulations, and the court precedents, prime costing, in the abstract, must be recognized as an erroneous method for valuing inventories.Next, we turn to the argument on which the petitioner relies heavily. It argues that as a practical matter, the prime cost method clearly reflects its income since it has consistently used such method over many years and its taxable income computed under such method does not materially differ from its taxable income resulting from the use of the method proposed by the respondent. In support of such argument, the petitioner has produced certain accountants' reports and has called expert witnesses whose professional stature is impressive73 and who testified that under the circumstances of this case the petitioner's method would clearly reflect its income for purposes of commercial accounting. In addition, the petitioner argues that its position is supported by the Income Tax Regulations and the legal precedents. The case has been thoroughly and exceptionally well prepared, but after considerable deliberation, we have concluded that the petitioner's position is unacceptable.1754 The petitioner relies on the fact that since 1933, it has been audited yearly by independent public accounting firms. So far as we can tell, none of the reports resulting from such audits has taken serious exception to the petitioner's method of costing inventories. Most of the reports state unqualifiedly that the financial statements of the petitioner fairly reflect its financial condition and the results of its operations, in conformity with generally accepted accounting principles. Some of the reports, which state the same general conclusion, specifically note the conservative method by which the petitioner valued inventory, but state that such valuation did not materially affect income. Other reports indicate that the petitioner's74 method of valuing inventory was not in accordance with generally accepted accounting principles. However, such reports do not specifically disapprove the petitioner's valuation method and we have concluded that the accountants believed that even though the petitioner departed from generally accepted accounting principles, such departure did not prevent the petitioner's financial statement from fairly reflecting the results of operations. All of the reports available to us for examination disclose in some way that the petitioner included only direct labor and materials in inventory cost.In addition to the accountants' reports, the petitioner's expert witnesses testified that its method of accounting clearly reflected income. None of these witnesses, however, stated that prime costing was a generally accepted accounting procedure. Rather, their testimony was posited on the belief that no material distortion of income resulted from prime costing in the facts of this case. With respect to the matter of materiality, the petitioner has provided us with a table, reproduced below, showing the effect on its net income for the years 1954 through 1967 by applying the method of inventory75 valuation used by the respondent in his determination.Respondent's proposedCalendar yearmethod of costing inventoryOpeningClosing1954$ 167,197.42$ 223,862.641955223,862.64193,090.951956193,090.95210,950.431957210,950.43344,673.071958344,673.07441,315.131959441,315.13320,110.961960320,110.96487,442.261961487,442.26522,859.201962522,859.20493,611.831963493,611.83604,450.781964604,450.78501,171.181965501,171.18508,000.131966508,000.13715,558.411967715,558.41863,537.67Form 1120Effect ontaxableCalendar yearincome ofincome asPercentAll-Steelreported bychangeAll-Steel1954$ 56,665.22 $ 1,507,363.543.76 1955(30,771.69)2,735,777.69(1.12)195617,859.48 4,226,135.060.42 1957133,722.64 2,913,885.574.59 195896,642.06 2,444,283.633.95 1959(121,204.17) 4,088,541.88(2.96)1960167,331.30 3,277,497.545.11 196135,416.94 3,008,140.681.18 1962(29,247.37)3,348,839.72(0.87)1963110,838.95 3,358,663.523.30 1964(103,279.60)3,917,807.82(2.64)19656,828.95 5,634,029.100.12 1966207,558.28 5,222,067.053.97 1967147,979.26 3,472,962.190.43 76 1755 The evidence suggests that, insofar as commercial accounting standards are concerned, an item which distorts net income by less than 5 percent is not material. According to the AICPA, such an item need not be treated in accordance with generally accepted accounting principles:9. The committee [Committee on Accounting Procedure of the AICPA] contemplates that its opinions will have application only to items material and significant in the relative circumstances. It considers that items of little or no consequence may be dealt with as expediency may suggest. * * * [A.R.B. No. 43, p. 9]Although we accept the fact that the petitioner's method of accounting fairly reflected the results of its operations for commercial accounting purposes, we do not think its departure from applicable generally accepted accounting principles and tax regulations can be justified for tax purposes on the argument that the errors were not material. Since it is clear that prime costing is not a generally accepted accounting procedure, the opinions of public accountants adduced in favor of the petitioner's position must rest on the accounting doctrine of materiality. Such doctrine finds broad77 application in commercial accounting, but we do not think it may appropriately be extended to the law of taxation in cases in which the taxpayer's method of accounting is clearly erroneous.It has been stated that the primary function of commercial accounting is "the extraction and presentation of the essence of the financial experience of businesses, so that decisions affecting the present and the future may be taken in light of the past." May, Financial Accounting vii (1943). As opposed to this rather broad function of commercial accounting, the purpose of tax accounting is limited to providing an income figure on which to compute tax. An error in the treatment of an item for commercial accounting purposes will probably be harmless if the general statement of financial condition is substantially correct. However, any error in the treatment of an item which changes taxable income will cause a corresponding error in tax computation. For tax purposes, there is no rule excusing a taxpayer from paying deficiencies which are relatively immaterial. Moreover, the doctrine of materiality in commercial accounting does not have the same significance it would have if applied to tax controversies. 78 Accounting Research Bulletin No. 43 states at page 23 that:It is important that the amounts at which current assets are stated be supplemented by information which reveals, * * * for the various classifications of inventory items, the basis upon which their amounts are stated and, where practicable, indication of the method of determining the cost -- e.g., average cost, first-in first-out, last-in first-out, etc.1756 Thus, in this case, each accountant's report of the petitioner which has been introduced in evidence recites at some point, in some manner, that only the costs of direct labor and materials are reflected in inventory. Such disclosure, for commercial accounting purposes, minimizes any harm that may be done by incorrectly computing the cost of inventory. See also AICPA, Opinions of the Accounting Principles Board 6, app. A (1965). However, for tax purposes, such disclosure has no ameliorative effect since taxes will still be computed on an incorrect computation of income. Accordingly, we have concluded that the application of the materiality doctrine is inappropriate in this case, even though such doctrine might lead a public accountant to believe that79 the petitioner's method of accounting clearly reflected income. We wish to stress the point that our conclusion with respect to materiality is limited to cases in which the method of accounting in issue complies with neither applicable tax regulations nor generally accepted accounting procedures; we express no view on other situations.The petitioner next argues that the factors of consistency and materiality have been given significance in tax regulations and case law, and that such regulations and law require us to find that its method of accounting did clearly reflect income. The petitioner points out that it has used prime costing since at least 1928; that although it has been regularly audited by the respondent, no deficiencies have been asserted with respect to its method of costing inventories until the years in issue; and that the divergence between its net income as reported for the years 1953 through 1967 and the income it would have reported under the respondent's method of accounting is for all years except 1960 less than 5 percent. Conceding all these facts, we do not believe that the regulations and the cases relied on by the petitioner support its position.Section80 1.471-2(b), Income Tax Regs., states:(b) It follows, therefore, that inventory rules cannot be uniform but must give effect to trade customs which come within the scope of the best accounting practice in the particular trade or business. In order clearly to reflect income, the inventory practice of a taxpayer should be consistent from year to year, and greater weight is to be given to consistency than to any particular method of inventorying or basis of valuation so long as the method or basis used is substantially in accord with §§ 1.471-1 through 1.471-9. * * [Emphasis supplied.]Frequently, there are several acceptable methods of accounting for an item of income or expense. The regulations make clear that the accounting practice once adopted should be followed consistently, but the italicized portion of the regulations also makes clear that the significance of consistent use is limited to the situation in which the method chosen is acceptable. This interpretation of the 1757 regulations is also consistent with decided cases. In Fort Howard Paper Co., supra, the Court approved of the taxpayer's method of accounting for the expenses81 of self-constructed assets in which it did not include any portion of manufacturing overhead. However, the Court emphasized that such method was an acceptable method of treating such expenses and was not inconsistent with any regulation. The Court distinguished Photo-Sonics, Inc., supra, and Dearborn Gage Co., supra, in which it was held that the consistent use of an erroneous method did not justify its continued use. See also Sam W. Emerson Co., supra;Geometric Stamping Co., 26 T.C. 301 (1956). We have found no case in which consistency caused the Court to conclude that an erroneous method of accounting should be approved as clearly reflecting income.Nor is the petitioner on any firmer ground with respect to its argument on materiality. First, it should be recognized that the amounts in dispute are substantial, even though they constitute only a small percentage of the petitioner's income. The parties agree that if the petitioner's method of accounting is changed, section 481 is applicable; consequently, although only the taxable years 1962 and 1963 are in82 issue, the adjustment for 1962 in effect picks up the income not reported for the years subsequent to 1953 due to the use of an improper method of accounting. The respondent's adjustment for 1962 was $ 327,440.55, and although that amount will have to be recomputed as a result of our decision, it illustrates the significance of the amount in dispute.Moreover, the objective of the method of valuing inventories is to assign to such inventories the cost of their production; thus, in a later year when the inventories are sold, the income resulting therefrom may be offset by the costs of producing such goods. The use of an improper method for valuing inventories involves the risk of distorting income by failing to offset against the income from the sale of the inventories the expenses properly attributable thereto. For a year in which the inventory expands, the use of the prime cost method results in an understatement of income; whereas, its use causes an overstatement of income when there is a decrease in the inventory. For example, according to the table presented by the petitioner, the use of the prime cost method caused an understatement of income for 10 of the 14 years and an83 overstatement of income in only 4 of the years. That table also shows that, even though the prime cost method was used consistently, the errors resulting from its use were not eliminated. What is more, the continued use of an erroneous method involves the risk that it will produce a much greater error in a later year, especially if the petitioner's business should increase significantly.1758 We have already stated our reasons for concluding that the accountants' attitude toward mistakes considered immaterial by them is not acceptable for tax purposes. Furthermore, there is no legal basis for permitting the petitioner to continue to use an erroneous method merely because of the smallness of the amounts of income not reported in the years before us; and there is surely no basis for holding that the petitioner may continue to use such method until a year in which it does result in the underreporting of larger amounts of income. None of the cases cited by the petitioner convinces us of error in this judgment. Glenn v. Kentucky Color & Chemical Co., supra;Broida, Stone & Thomas, Inc. v. United States, 204 F. Supp. 841">204 F. Supp. 841 (N.D.W. Va. 1962),84 affirmed per curiam 309 F. 2d 486 (C.A. 4, 1962); Michael Drazen, 34 T.C. 1070">34 T.C. 1070 (1960); National Builders, Inc., 12 T.C. 852">12 T.C. 852 (1949). At most, such cases indicate that materiality will be considered a factor in situations involving permissible alternative methods.Since we have found that the petitioner's method of accounting did not clearly reflect its income, we reach the question of what adjustments to the petitioner's accounting method should be made. The petitioner takes the position that if its method of costing inventory is found not to clearly reflect income, we should not impose the adjustments sought by the respondent, but rather should make an independent determination as to the method of costing inventory "conforming as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting the income." Sec. 471. The petitioner recognizes that it has a heavy burden of proof in matters involving the respondent's judgment as to accounting methods, but it contends that errors in the respondent's determination, and expert testimony introduced at the trial, 85 indicate that the determination was erroneous and that we should fashion a method of accounting for inventory consistent with the evidence before us.First, the petitioner points out that the respondent now concedes some errors in his determination. In determining the deficiency, the respondent included in the cost of inventory virtually all of the accounts contained in the petitioner's manufacturing ledger. In this manner, it was the respondent's intention to effectuate what may be referred to as the full absorption method of costing. Full absorption costing is the most expansive method of valuing inventories. As expressed by expert witnesses for the petitioner and the respondent, such method includes in inventory all costs incurred by a business by reason of the fact that it is a manufacturing business. However, as the petitioner points out, and as the respondent on brief agrees, certain items included in inventory for purposes of the deficiency determination are not properly includable in inventory even under full absorption 1759 costing. These errors appear to result from the respondent's initial view that all items in the petitioner's manufacturing ledger related 86 to its manufacturing operations. The respondent now concedes that such is not the case, and proposes to eliminate from inventory all items in the manufacturing ledger which his expert witness stated to be not includable under full absorption costing. In addition, the respondent has determined, apparently for administrative reasons, that he does not desire at this time to have the Court consider the includability in inventory of profit-sharing plan contributions; and accordingly, he has conceded the deductibility of this item.Secondly, the petitioner contends that the respondent also erred in his determination by requiring the inclusion of certain costs in inventory even though the current deductibility of such costs is expressly authorized by the Code and regulations. The expenditures referred to by the petitioner involve costs incurred for repairs, taxes, losses, and research and experiment. We agree with the petitioner that such expenditures are currently deductible and are excludable from inventory costs.Deductions for taxes, losses, and research and experiment are expressly authorized in the year the taxes are paid or accrued, the losses are sustained, or the research and87 experimental expenditures are paid or incurred. Secs. 164, 165, 174. Neither the statutory provisions nor the regulations indicate in any way that such deductions are limited to current expenses as distinguished from capital expenditures for the acquisition of capital assets or inventory. To the contrary, it has been held that deductions expressly granted by statute are not to be deferred even though they relate to inventory or capital items. Montreal Mining Co., 2 T.C. 688 (1943); Spring Valley Water Co., 5 B.T.A. 660">5 B.T.A. 660 (1926); Pacific Coast Redwood Co., 5 B.T.A. 423 (1926). See also Joe W. Stout, 31 T.C. 1199 (1959), affirmed and modified on other issues sub nom. Rogers v. Commissioner, 281 F. 2d 233 (C.A. 4, 1960). Cf. sec. 266; Rev. Rul. 141, 2 C.B. 101">1953-2 C.B. 101. Moreover, section 174 expressly states that research and experimental expenditures may be treated "as expenses which are not chargeable to capital account." Although Frank G. Wikstrom & Sons, Inc., 20 T.C. 359 (1953),88 held that taxes were not currently deductible but must be included in the costs of inventory, it appears that the issue was not fully presented to and considered by the Court, and accordingly, in the light of the other precedents, we do not consider that case to be controlling.The treatment of expenditures for repairs presents a somewhat different question since there is no statutory provision expressly allowing their deduction. Whether such expenditures are currently deductible or must be capitalized depends upon whether they are ordinary 1760 and necessary expenses deductible under section 162, whether they are capital expenditures expressly made nondeductible by section 263, or whether they are part of the costs of production of goods to be taken into consideration in computing gross income under section 61. Section 1.162-4, Income Tax Regs., provides:Sec. 1.162-4. RepairsThe cost of incidental repairs which neither materially add to the value of the property nor appreciably prolong its life, but keep it in an ordinarily efficient operating condition, may be deducted as an expense, provided the cost of acquisition or production or the gain or loss basis of the taxpayer's89 plant, equipment, or other property, as the case may be, is not increased by the amount of such expenditures. Repairs in the nature of replacements, to the extent that they arrest deterioration and appreciably prolong the life of the property, shall either be capitalized and depreciated in accordance with section 167 or charged against the depreciation reserve if such an account is kept.By this provision, the regulations take the position that incidental repairs may be treated as ordinary and necessary expenses deductible under section 162; they need not be capitalized. It therefore seems appropriate to conclude that they need not be treated as part of the costs of acquiring an inventory.The petitioner's final attack upon the determination is based upon expert testimony to the effect that the respondent's method of costing inventory was not in accordance with the regulations and sound accounting practices. Under section 471, the Income Tax Regulations provide that the method of valuing an inventory shall "conform as nearly as may be to the best accounting practice in the trade or business." Sec. 1.471-2(a)(1). The petitioner called three expert witnesses to testify as to what90 method of valuing inventory would, in their opinion, constitute the best accounting practice for the petitioner. Although these witnesses were not completely unanimous in their treatment of each item of inventory cost, they all excluded most of the indirect expenses included by the respondent in his determination. The petitioner argues that since the question calls for the opinion of accountants, its expert testimony must be given substantial weight. On the other hand, the petitioner points out that although the single expert called on to testify by the respondent expressed his general preference for the full absorption method of costing, at no time was he asked, nor did he testify, as to whether such method was best for this taxpayer in its trade or business.Although the respondent has admitted that he made some mistakes in the determination, and although we have found that additional items should not have been treated as part of the costs of the inventories, we do not agree that we should disregard the method of accounting proposed by the respondent.1761 The wording of sections 446(b) and 471 makes clear that, in matters of accounting methods, the respondent is invested91 with broad discretion. If a taxpayer's method of accounting does not clearly reflect income, the respondent may compute income "under such method as, in * * * [his] opinion * * , does clearly reflect income." Sec. 446(b). More specifically, section 471 provides that "inventories shall be taken * * on such basis as the Secretary or his delegate 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." (Emphasis supplied.) These provisions have been a part of our tax law for many years, and they have been interpreted as imposing an extremely heavy burden of proof on taxpayers challenging the respondent's determinations -- the Supreme Court has gone so far as to require a showing that such determinations are "plainly arbitrary." Lucas v. Structural Steel Co., 281 U.S. 264">281 U.S. 264 (1930). See also Photo-Sonics, Inc. v. Commissioner, supra; Finance & Guaranty Co. v. Commissioner, 50 F. 2d 1061 (C.A. 4, 1931), affirming 19 B.T.A. 1313">19 B.T.A. 1313 (1930); Commissioner v. Joseph E. Seagram & Sons, Inc., 394 F. 2d 73892 (C.A. 2, 1968), reversing 46 T.C. 698">46 T.C. 698 (1966). Thus, it appears to be a longstanding and well-established policy of our tax system that since we have found the petitioner's method of accounting does not clearly reflect income, we should accept the method proposed by the respondent, unless it is shown that such method is arbitrary -- we are not to fashion a different method merely because it may appeal to our sense of equity.The petitioner's expert witnesses testified that in their opinion the best method of accounting for the petitioner's business would result from excluding from inventory certain specified items included by the respondent, in addition to the erroneous items. In fact, by excluding such additional items, the petitioner would include in inventory only very few items which were not included under its prime costing method. The testimony convinces us that there is a wide range of permissible variations in the method of inventory costing, and the selection of an individual method is largely a matter of judgment by the involved accountant. Although the petitioner's experts gave their views in response to the question of which method of inventory93 costing would be best for the petitioner in light of the facts of this case, the experts did not point out any specific facts about the petitioner's business which led them to conclude that a method of costing, more conservative than the full absorption method, would be generally regarded by accountants as the most appropriate method for the petitioner. After reviewing their testimony, it appears that they were merely expressing their general preference for more conservative 1762 methods. Such testimony falls far short of showing that the application of the full absorption method to the petitioner's business is arbitrary or unreasonable.The full absorption method has been accepted by the AICPA, and the respondent's expert stated it to be his preferred method. One of the petitioner's experts confirmed the fact that the absorption method was clearly a generally accepted accounting practice, and even went so far as to state that the more conservative method of costing favored by him was not as clearly generally accepted. We have concluded that the expert accounting testimony is not sufficient to carry the petitioner's heavy burden of proving that the respondent's determination94 is incorrect because of the use of the absorption method.Nor do we think the respondent's inclusion in the petitioner's inventory of the erroneous items is grounds for disregarding his determination and for constructing a whole new method of inventory costing. We can clearly discern the general approach adopted by the respondent in computing the petitioner's opening and closing inventory, and we have found that approach, the full absorption method, to be in accordance with law. Therefore, we do not think the inclusion of the erroneous items renders the respondent's general approach arbitrary. Cf. Foster v. Commissioner, 391 F. 2d 727 (C.A. 4, 1968), modifying a Memorandum Opinion of this Court; M. Pauline Casey, 38 T.C. 357">38 T.C. 357 (1962). The erroneous items can be discerned with relative clarity and can therefore be omitted from inventory valuation in the Rule 50 computation.Though the petitioner has produced impressive expert testimony, we have concluded that under the law, we must accept the respondent's method, subject to some modifications. Courts in the past have expressed their reluctance to formulate methods 95 of accounting. Brown v. Helvering, 291 U.S. 193">291 U.S. 193 (1934); Harden v. Commissioner, 223 F. 2d 418 (C.A. 10, 1955), reversing 21 T.C. 781">21 T.C. 781 (1954); Fort Pitt Brewing Co. v. Commissioner, 210 F. 2d 6 (C.A. 3, 1954), affirming 20 T.C. 1">20 T.C. 1 (1953), certiorari denied 347 U.S. 989">347 U.S. 989 (1954). As we have seen, there is a broad range of permissible alternative methods and expert accountants frequently disagree as to which method is most appropriate in a given situation. If distinguished members of the accounting profession cannot agree on the best method of accounting in a given situation, courts should not undertake to make such a choice except in the most obvious cases. In the instant case, it is clear that the method of costing inventories employed by the petitioner is unacceptable; it is also clear that the general method adopted by the respondent is, if not a favored approach, at least one which is generally accepted. 1763 In these circumstances, both the words of the statute and the prior cases direct us96 to accept the method proposed by the respondent.The petitioner also argues that in his determination, the respondent has incorrectly interpreted and applied the provision of the regulations which requires inventory costs to include "indirect expenses incident to and necessary for * * production." Sec. 1.471-3(c), Income Tax Regs. The petitioner's experts were of the opinion that the "incidental" test requires the exclusion from inventory costs of those expenditures which do not vary as a result of variations in production. Such an interpretation of the regulations would effect a method of costing sometimes known as direct costing. Although the use of such a method may be permitted under certain circumstances (cf. Geometric Stamping Co., 26 T.C. 301">26 T.C. 301 (1956)), such interpretation is not required by the words of the regulations. Obviously, expenditures which are necessary for the production of inventory need not vary with the quantity of inventory produced. For example, the quality control account, one of the overhead items included in inventory by the respondent, has been identified as a fixed cost which does not vary with production; yet, it is97 clear that such expenditures are necessary to the manufacturing operation. Similarly, we do not think that expenditures "incident" to production excludes fixed costs. "Incident" is defined by Webster's Third New International Dictionary as "occurring or likely to occur esp. as a minor consequence or accompaniment * * dependent on or appertaining to another thing." Surely such a definition does not imply an occurrence which necessarily varies in accordance with another occurrence. Furthermore, the effect of adopting the petitioner's position would be to foreclose the use of absorption costing in inventory valuation. However, such a method of costing has already been judicially approved; nothing convinces us that we should ignore such prior adjudication. Photo-Sonics, Inc., supra.The question now becomes which of the items included in the petitioner's inventory by the respondent's determination should be excluded from inventory cost in the Rule 50 computation. We have already concluded that items representing repairs, taxes, losses, and research expenditures are currently deductible and should be excluded from inventory cost.In addition to these98 accounts, it is clear that certain other accounts are not, under any proper interpretation of absorption costing, includable in inventory. Both the expert witness called by the respondent and one of the experts called by the petitioner enumerated several of such accounts. However, the petitioner's expert was of the opinion that several of the accounts included in inventory by the respondent's 1764 expert should be excluded. We have already stated our views with respect to the burden of proof in cases involving disputes over accounting methods. Accounting procedures are frequently a matter of judgment, and when, as in this case, the petitioner's method of accounting does not clearly reflect income, we will accept the respondent's proposed alternative unless it is demonstrably incorrect. The respondent's witness testified that the includability of an item in inventory under full absorption costing depends on whether such item was incurred because the business was a manufacturing business rather than a merchandising one. The petitioner's expert basically agreed with this test, even though he disagreed, to some extent, in applying such test. We have reviewed the disputed 99 items and, based on the testimony and argument in this case, we cannot conclude that the judgment of the respondent's expert was unreasonable.To avoid uncertainty in the Rule 50 computation, we will enumerate those items which are excludable from inventory either because they are expressly made currently deductible or because they are not manufacturing expenses. As we indicate, some of the items should only be partially excluded from inventory. In some instances, the parties will be required to make an allocation on the basis of the petitioner's books and records; in other instances, we have estimated the proper allocation rate. Cohan v. Commissioner, 39 F. 2d 540 (C.A. 2, 1930). If no allocation is indicated, the entire account is to be excluded from inventory. Account 5101 -- General Superintendent (exclude 10 percent, based on portion of time devoted to sales matter)Account 5101 -- Paint General Foreman (exclude 10 percent based on portion of time devoted to research and experiment)Account 5111 -- Maintenance Foremen (exclude 20 percent, based on portion of time devoted to maintenance of nonplant areas)Account 5111 -- Receiving Foreman100 (exclude 25 percent, based on portion of time devoted to receiving nonmanufacturing materials)Account 5111 -- Assistant Receiving ForemanAccount 5111 -- Janitor Foremen (exclude portion not attributable to plant areas -- allocate on basis of proportion of plant areas to nonplant areas)Account 5121 -- Production Planning (exclude portion of expenditures devoted to planning as opposed to scheduling functions)Account 5121 -- Paint Processing (exclude 50 percent, based on portion of time devoted to research and experiment)1765 Account 5121 -- Superintendent's Office (exclude 15 percent of nurses' salaries, based on portion of time devoted to office employees)Account 5121 -- Plant Engineering (exclude 80 percent, based on time devoted to nonplant activities)Account 5121 -- Shipping ExpeditingAccount 5121 -- Stock and Storage (exclude 25 percent, based on time devoted to office supplies)Account 5131 -- Overtime Premium (exclude portion attributable to excludable basic compensation of Account 5121 employees)Account 5141 -- Administrative (exclude 50 percent, based on portion of time devoted to nonproduction matters)Account 5141 -- Miscellaneous (exclude in same proportion101 as Account 5501)Account 5151 -- Receiving (exclude 20 percent, based on time attributable to nonproduction material)Account 5151 -- Try Out New DiesAccount 5151 -- Janitor Work Factory (exclude portion attributable to maintenance of nonplant facilities -- allocate on basis of proportion of plant areas to nonplant areas)Account 5161 -- Time Clerks (exclude portion allocable to processing time cards of shipping and warehouse personnel -- allocate on basis of proportion of number of such personnel to number of personnel whose salary is included in inventory)Account 5171 -- Rework LaborAccount 5181 -- Spoiled MaterialAccount 5301 -- Die Grinding and Repairs -- Material and Outside ServicesAccount 5311 -- Die Grinding and Repairs -- LaborAccount 5321 -- Repairs to Buildings, Roads, and Grounds -- Materials and Outside ServiceAccount 5331 -- Repairs to Buildings, Roads, and GroundsAccount 5341 -- Repairs to Machinery and Equipment -- Materials and Outside ServicesAccount 5351 -- Repairs to Machinery and Equipment -- LaborAccount 5361 -- Automobiles and Trucks (exclude 50 percent, based on use for mail and light deliveries)Account 5401 -- Casualty Insurance (exclude portion102 attributable to finished goods inventory -- allocate on basis of proportion of cost of finished goods inventory to costs of raw materials, work in process, and plant facilities)1766 Account 5421 -- Property TaxesAccount 5501 -- Workmen's Compensation and Liability Insurance (exclude in same proportion as covered employee's basic compensation is excluded from inventory)Account 5511 -- Payroll Taxes (exclude State and local taxes only)Account 5541 -- Profit SharingAccount 5551 -- Group Insurance (exclude in same proportion as covered employee's basic compensation is excluded from inventory)Account 5731 -- Rubbish Removal (exclude 40 percent, based on portion of expense attributable to nonplant facilities)Account 5741 -- Water (exclude 20 percent, based on portion of expense not attributable to plant operation)Account 5751 -- Watchmen Service (exclude 20 percent, based on portion of expense not attributable to plant facilities)Account 5761 -- Janitorial Service (exclude on same basis as Account 5151 -- Janitor Work Factory)Account 5771 -- Interplant Trucking (exclude 75 percent, based on portion of expense not attributable to work in process)Account 5951 -- Manufacturing*103 Method LaboratoryAccount 5961 -- Illinois Sales TaxAccount 5981 -- Christmas Checks (exclude on basis of same proportion by which recipients' basic compensation is excluded from inventory)The petitioner did not dispute the section 481 adjustment proposed in the deficiency notice. However, since we have not wholly accepted the respondent's determination, certain modifications of the section 481 adjustment will be necessary. We assume that the parties will be able to agree on appropriate modifications in the Rule 50 computation.Decision will be entered under Rule 50. Footnotes1. Inventory may be valued at either cost or the lesser of cost or market. Sec. 1.471-2(c), Income Tax Regs.↩ No issue has been raised with respect to the latter method of inventory valuation, and for the sake of simplicity, we assume that the value of the inventories in this case is based upon the costs thereof.2. All statutory references are to the Internal Revenue Code of 1954.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625380/	J. EARL MORGAN, EXECUTOR OF THE ESTATE OF ELIZABETH S. MORGAN, DECEASED, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Morgan v. CommissionerDocket No. 82771.United States Board of Tax Appeals36 B.T.A. 588; 1937 BTA LEXIS 687; September 30, 1937, Promulgated 687 Decedent, a resident of the State of Wisconsin, and the donee of two powers of appointment, died May 3, 1933. The powers were created by decedent's father, a resident also of the State of Wisconsin. The instruments creating the powers provided that the income from the properties was to be paid to decedent for life, remainder "to such person or persons as she may appoint by her last will and testament" or, in case she failed to exercise the powers, "to her issue surviving." Decedent exercised the powers by will in favor of her husband. Held, under the applicable law of the State of Wisconsin, the powers were "general", and the property passing thereunder is includable in decedent's gross estate under section 302(f) of the Revenue Act of 1926, as amended by section 803(b) of the Revenue Act of 1932. A. M. Kracke, Esq., for the petitioner. H. F. Noneman, Esq., and Frank T. Horner, Esq., for the respondent. ARUNDELL589 OPINION. ARUNDELL: Petitioner seeks the redetermination of a $43,977.93 deficiency in estate tax. All the issues, except one, have been agreed upon by stipulation and effect will be given thereto under Rule 50. The688 issue remaining is whether two certain powers of appointment were "general" as determined by respondent, or "special" as contended for by petitioner. The parties filed a stipulation of facts which we incorporate herein by reference and briefly summarize only those facts which are material to a clear understanding of the issue we are to decide. The decedent, Elizabeth S. Morgan, died testate May 3, 1933, a citizen of the United States and a resident of the State of Wisconsin, and petitioner is the duly appointed executor of her last will and testament. Isaac Stephenson, decedent's father, died testate on March 15, 1918. He was also a citizen of the United States and a resident of the State of Wisconsin. By his last will and testament and several codicils thereto, he conveyed certain property in trust for the benefit of his children. The children were to receive the income annually and a certain portion of the principal at the end of four, eight, and twelve years after his death, and the entire remaining principal at the end of sixteen years after his death, provided they were living at the end of each of the four stated periods. The trust estate was divided into nine parts, 689 part numbered five being conveyed in trust for decedent's benefit as follows: ITEM FIFTEEN: I direct said trustees to pay to my daughter Elizabeth S. Morgan annually the net annual income from part numbered five (5) into which my trustees shall have divided my estate * * . I give, devise and bequeath to the appointee or appointees of my daughter Elizabeth S. Morgan by her last will and testament all property of any nature and kind in the hands of my said trustees at the time of her death constituting said part five (5) * . The trust further provided that, should decedent die without exercising the power, then whatever portion of the principal remained should go to her issue, and, in the event of her death without issue, then such remaining portion of the principal should be equally divided and distributed among the other remaining parts into which the estate was divided. 590 On May 12, 1917, Isaac Stephenson executed a deed of trust reading in part as follows: 7. After my death and during the continuance of the trust hereby created, said Trustees shall pay annually to my daughter ELIZABETH S. MORGAN the net annual income from said part numbered five (5). 690 If my daughter Elizabeth S. Morgan shall be living at the time of the termination of this trust, said Trustees shall transfer to her all property then in their possession constituting said part five (5). If my daugher Elizabeth S. Morgan shall die prior to the termination of said trust, then said Trustees shall pay annually the net annual income from said part five (5) to such person or persons as she may appoint by her last will and testament duly admitted to probate, and at the termination of this trust said Trustees shall transfer the property then in their possession constituting said part five (5) to such person or persons as she may appoint in the manner aforesaid. If my daughter Elizabeth S. Morgan, dying as aforesaid, should fail to make such appointment * * then and in any such event the annual income from said part five (5), * * * shall be paid annually by said Trustees to her issue surviving * * * and at the termination of said trust, said Trustees shall transfer all the property then in their possession, constituting said part five (5), * * * to the then surviving issue of my said daughter * * . During her life decedent received the distributions payable to691 her at the end of the fourth, eighth, and twelfth years after the death of her father, as provided for in his will, but she did not receive the distribution payable to her at the end of the sixteenth year, owing to the fact that she only lived fifteen years, one month, and eighteen days after her father's death. By her last will and testament decedent exercised the power of appointment under her father's will as to that portion of the property which she would have received at the end of the sixteen years after her father's death, had she lived, and she also exercised the power of appointment given her by her father's deed of trust, the appointments being in the following words: TWENTY-SECOND: Under the last will and testament of my father * * * I do hereby nominate, constitute, authorize and appoint my husband, J. Earl Morgan * * . TWENTY-THIRD: Under the Deed of Trust dated May 12, 1917, * * I do hereby appoint my husband, J. Earl Morgan * * . The respondent determined that both powers which decedent exercised by will were "general" powers of appointment; that the value of the property passing under such powers was $41,212.82 and $325,613.51, respectively; and that692 these values should be included in decedent's gross estate under section 302(f) of the Revenue Act of 1926, as amended by section 803(b) of the Revenue Act of 1932. Petitioner contends that the two powers in question were "special" powers, rather than "general" powers, as was determined by the 591 respondent. Petitioner does not question the respondent's determination of the value of the property passing under the powers. Section 302(f) of the Revenue Act of 1926, as amended by section 803(b) of the Revenue Act of 1932, provides in part as follows: SEC. 302. The value of the gross estate of the decedent shall be determined by including the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated * * * * * (f) To the extent of any property passing under a general power of appointment exercised by the decedent (1) by will * * . It has been held that in determining the nature and effect of powers we look to the law of the state having jurisdiction, ; 693 . In this case the powers were created while the donor was a resident of Wisconsin; the donee was a resident of that state; the property affected is in that state, and the estate of the deceased donee is being administered in the courts of that state. The statutes of Wisconsin in force when the powers herein were created and when they were exercised define general and special powers as follows: 232.05 General power. A power is general when it authorizes the alienation in fee, by means of a conveyance, will or charge of the lands embraced in the power, to any alienee whatever. 232.06 Special power. A power is special: (1) When the person or class of persons to whom the disposition of the lands under the power to be made are designated. (2) When the power authorizes the alienation by means of a conveyance, will, or charge of a particular estate or interest less than a fee. These provisions are held by the Wisconsin Supreme Court to apply to both real and personal property. 694 ; ; ; . The two powers here appear to us to come squarely within the above definition of general powers. Each of them "authorizes the alienation in fee, by means of a * * will * * * to any alienee whatever." They do not contain the specified elements that mark special powers. They do not designate the person or class that may be appointed (232.06(1)); they do not limit the estate that may be alienated to a particular estate or an interest less than a fee (232.06 (2)). Consequently, it is our opinion that these powers, fitting exactly as they do in the statutory definition of general powers, must be held to be general powers under the law of Wisconsin. In , the Supreme Court of Wisconsin states that the Wisconsin statute on powers being "derived by adoption from New York, should have the same interpretation here as 592 there * ." The statutes of the two states are almost identical. See sec. 134, Real Property Law, McKinney's Consolidated Laws of New York. The courts695 of New York have construed powers such as are under consideration in this case to be general powers. In the case of ; , there was a testamentary trust to pay the income to the testator's son for life and then to distribute the corpus to the son's appointees designated by will. The power to appoint was exercised and the court held that "it was a general power exercised by will." On similar facts in ; , it was held that the power was "a general power of appointment without limitation." An early New York case, ; , uses almost literally the language of the Wisconsin statute in defining a general power. The definition is, "It is general where it authorizes the alienation in fee by means of a conveyance, will, or charge of the lands embraced in the power to any alienee whatever." These holdings of the New York courts applying their similar statute afford substantial support for our view that the powers in this case are general powers. 696 The case of , is said by petitioner to be authority for holding these powers to be special powers. In that case there was a testamentary trust to pay the income to plaintiff's mother for life, then to the plaintiff for life with a power of appointment as to the corpus, to be exercised by will. In a suit brought by the donee of the power the two main questions presented were, first, whether the power of appointment was valid, and, second, if the power was valid, whether it gave the donee complete and absolute title in the property. Under the second point the theory of the plaintiff was that there was a merger of her life estate and of her power of appointment. On the first point the court held the power to be valid. In discussing the second point the court said in part: Neither is the power a general power, as defined in section 232.05, but is a special power under subdivision (2), § 232.06, because it embraces an interest less than a fee. The petitioner points to the quoted language in support of the contention that the powers in this case are special powers. We do not so read the opinion of the court. The chief concern697 of the court was to determine whether the power was one that the Wisconsin statute describes as "an absolute power of disposition." Sec. 232.08. The court held that it was not such a power and consequently there was no merger of estates. As we read the opinion, the court did not have squarely presented to it the question of whether the power was general or special, and its statement as above quoted is dictum. The Cawker case appears to be the only one reported to date that at *593 all purports to touch upon the question here involved. In view of the fact that the precise question we have was not before the Wisconsin court in the Cawker case, we think the quoted words should not be taken as decisive, especially as they appear to be out of harmony with the decisions of the New York courts construing their similar statute. Considering the powers in this case in the light of the language of the Wisconsin statute and the decisions of the New York courts above cited, we hold, as set out above, that the powers were general and that the property passing thereunder is includable in gross estate. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625381/	WILLIAM C. MILLAR AND BARBARA S. MILLAR, ET AL., 1 Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent Millar v. CommissionerDocket Nos. 27794-81, 27795-81, 27921-81, 27962-81, 1303-82, 13485-82.United States Tax CourtT.C. Memo 1986-592; 1986 Tax Ct. Memo LEXIS 12; 52 T.C.M. (CCH) 1200; T.C.M. (RIA) 86592; December 22, 1986. Howard K. Schwartz and Patrick John Gray, Jr., for the petitioners. Beth L. Williams, for the respondent. CLAPPMEMORANDUM FINDINGS OF FACT AND OPINION CLAPP, Judge: In these consolidated cases, respondent determined the following deficiencies in, and additions to, petitioners' Federal income taxes: Addition to TaxDocket No.Taxable YearDeficiencySec. 6651(a)(1) 227794-811976$2,872.0027795-811976760.0019776,819.00197813,061.4427921-811976775.0019778,681.3219782,178.4227962-8119761,615.0019779,672.3519787,330.101303-8219762,050.38197715,339.8913485-821976460.00$115.0019777,593.00612.00197817,761.004,440.00The issues for decision are: (1) Whether14 the activities of Hybrid Vehicle Limited Partnership with respect to a patent license constitute activities engaged in for profit; (2) Whether Hybrid Vehicle Limited Partnership placed the patent license in service during the years in issue; (3) Whether the $2,130,000 nonrecourse debt executed by Hybrid Vehicle Limited Partnership pursuant to its exclusive license with Patent Systems, Inc. is includible in the depreciable basis of the patent license; (4) Whether the $335,000 recourse debt executed by Hybrid Vehicle Limited Partnership is a bona fide indebtedness of the Partnership; (5) Whether, if Hybrid Vehicle Limited Partnership used the patent license in a trade or business and its value exceeds the $2,500,000 license fee, the allowance for depreciation is limited to royalties actually paid during the years in issue; (6) Whether legal fees of $4,500 paid to Leo H. Angelos and Gerald Schneider in 1976 constitute non-amortizable organization or syndication fees pursuant to sections 709(a) and 263; (7) Whether Hybrid Vehicle Limited Partnership may claim interest deductions in 1977 and 1978; and, (8) Whether petitioners Leo H. Angelos and Carey Angelos are liable for15 additions to tax pursuant to section 6651(a)(1) for failure to timely file their individual income tax returns for the years 1976, 1977 and 1978. FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulation of facts and attached exhibits are incorporated herein by this reference. BackgroundAt the time of the filing of their petitions, petitioners at docket Nos. 27794-81, 27795-81, 27921-81, 27962-81, and 13485-82, resided in Ann Arbor, Michigan. At the time of filing of the petition at docket No. 1303-82, Sophia Wilseck, as personal representative for the estate of Francis S. Wilseck, resided in Utica, Michigan. Each of the petitioners filed their respective returns for the years in issue utilizing the cash receipts and disbursements method of accounting. The returns of petitioners Leo and Carey Angelos and the following due dates and filing dates. Taxable YearDue Date 3Filing Date19764/15/7712/22/78 19776/15/781/03/7919786/15/799/27/7916 During the years in issue, petitioner Robert Tisch was a sales manager for the general agency of the Equitable Life Assurance Society of the United States, for which petitioner William Millar was a general agent. During the years in issue, petitioner Sotirios Roumanis was engaged in business as a restaurant owner and manager. From 1976 until the date of his death in 1978, petitioner Francis Wilseck was engaged in the construction business as a general contractor. Before and during the years in issue, petitioner Leo Angelos was licensed to practice law in the state of Michigan and maintained a law office in Ann Arbor, Michigan. United States Patent No. 3,792,327 (the "patent") was issued to Lindsey Waldorf ("Waldorf") on February 12, 1974. The patent was issued for a hybrid electrical vehicle drive, a drive utilizing both an electric motor and a traditional combustion engine. As of the time of trial, the specific hybrid vehicle design concept described in the patent had never been physically tested in any manner. No prototype or working model of the vehicle had ever been built. No computer simulation of the vehicle had ever occurred, nor had physical models of the drive components17 been constructed. The PartnershipHybrid Vehicle Limited Partnership (the "Partnership") was organized on December 30, 1976, under the laws of the state of Michigan by the filing of a Limited Partnership Agreement. The partnership adopted the cash receipts and disbursements method of accounting for its 1976, 1977 and 1978 taxable years. At all times relevant herein, Leo H. Angelos ("Angelos") was the sole general partner of the Partnership and held a 10 percent interest therein. During the years in issue, the limited partners held the following percentage interests in the Partnership: Limited PartnerPercentage InterestAlex G. Karras19.38%Dennis Serras13.85 William Millar13.85 Francis Wilseck13.85 Tom G. Vance8.31Robert R. Tisch6.92Sotirios Roumanis6.92Barry A. Breakey6.92The amount of cash invested by each of the limited partners was as follows: Limited Partner19761977197819791980TotalAlex G. Karras$ 7,000$ 0 $15,812$ 0 10,748$ 33,560Dennis Serras5,0000 10,5005,0002,00022,500William Millar5,0000 13,12513,1250 31,250Frances Wilseck5,0000 13,1250 0 18,125Tom G. Vance3,0000 6,9370 4,61314,550Robert R. Tisch2,5000 4 6,5626,5630 15,625Sotirios Roumanis2,5005 6,0001502,0000 10,650Barry A. Breakey2,5000 4,5000 0 7,000$32,500$6,000$70,711$26,688$17,361$153,26018 As of 1976, Angelos had no background in patent law or in the licensing of patents. Angelos had no scientific, technical or engineering experience and had no experience in the fields of automotive engineering, automotive marketing, electrical or mechanical engineering or electronics. On December 6, 1976, Angelos contacted Jerold I. Schneider of the law firm of Cullen, Settle, Sloman & Cantor, specializing in patent law, and requested him to investigate the validity and enforceability of the patent and make a full report and evaluation of the patent. Schneider's report concluded that the patent was valid and that the fair market value of a proposed 7 year exclusive license of the patent was in the range of $1,100,000 to $11,300,000. The report valued the patent license by: (1) identifying 8 levels of market penetration over the 7 year life of the proposed patent license;19 (2) using the above to estimate the number of vehicles that would be manufactured during the 7 years period utilizing the patent's drive concept; (3) estimating a single figure for the total per vehicle wholesale cost of the components in these vehicles which would be covered by the patent; and (4) for each level of market penetration, multiplying the number of vehicles sold by the cost of the patented component parts, and multiplying this figure by royalty percentages ranging from one-half percent to five percent. Based on the above figures, the report determined the fair market value of the patent license by treating it as falling within the range of income streams which might be produced by the patent license. The report did not discount the potential streams of income in order to determine the fair market value of the patent license. Nor did the report attempt to predict the likelihood of any particular stream of income being realized. The report also ignored the possibility that the purchaser of the license would realize zero income from the license. The report stated that this possibility was ignored because "every patent license is subject to this risk and hence the fair20 market value of every patent would be zero." Prior to seeking this report, Angelos did not inquire into Schneider's qualifications for making market projections or determining the fair market value of patents or patent licenses. Nor did Angelos consult with an engineer regarding the patent, or the hybrid vehicle concept generally. The Patent LicensePatent Systems, Inc., (PSI") was a Michigan corporation incorporated on December 15, 1976. Eugene Hanlon ("Hanlon") was the president and sole officer of PSI during all periods in issue. Hanlon was a lawyer in Ann Arbor and a business associate of Angelos in other matters. On December 15, 1976, 6 Hanlon, on behalf of PSI, and Angelos, on behalf of the Partnership, executed an agreement conferring upon the Partnership the exclusive worldwide rights to exploitation of the patent, for a period of seven years. PSI was identified in the agreement as the owner of the patent by assignment and warranted that it owned title to the patent free and clear of all encumbrances. PSI had acquired the patent in exchange for its agreement to pay to Waldorf 95 percent of any income received by it from exploitation of the patent. 21 The stated consideration due from the Partnership was $2,500,000. Payment was to be made as follows: (1) $35,000 cash paid at closing; (2) $335,000 paid by promissory note, such amount to be paid in full before December 1, 1981, and bearing interest on the unpaid balance at an annual rate of 7 percent; 7 and (3) the balance of $2,130,000 paid with a nonrecourse promissory note payable out of 30 percent of the gross income received by the Partnership from the sale or license of its interest in the patent. The nonrecourse note had a 7-year term and the unpaid balance was to earn interest at 7 percent per annum. The agreement further provided that the Partnership would grant PSI a security interest in all property of the Partnership to secure its indebtedness to PSI and would execute any documents necessary to record such security interest. 22 The license agreement also provided an option for the Partnership to renew the license on a non-exclusive basis upon the expiration of the 7-year period. In order to exercise the option, the Partnership would be required to pay PSI a renewal fee equal to the greater of 3 percent of the income received by the Partnership from exploitation of the patent during the original term of the license, or $50,000. The term of the renewal period was to be the remaining life of the patent and, upon exercise of the option, the maturity date of the nonrecourse note would be extended until the end of the renewal term. In addition, if during the renewal period the total cumulative royalties received by the Partnership from the date of the execution of the licensing agreement exceeded $10,000,000, the Partnership would be required to pay PSI 50 percent of all income received from exploitation of the patent thereafter. Investment DescriptionPotential investors in the Partnership were given a document entitled "Patent License Investment Description 1976." The document purported not to be a prospectus or an offer. The cover sheet of the document stated that interests would be offered on23 a private basis only and at the sole discretion of the general partner. The purpose of the Partnership was identified as being the purchase of an exclusive license to the inventions claimed in the patent. The document briefly described the hybrid vehicle design which was the subject of the patent and also enumerated the advantages which the "Inventor believes the Hybrid Vehicle will offer * * * over present motor vehicles." The document gave no independent analysis or verification of these advantages. The terms of the license agreement was set out in the investment description. The license being granted was described as an exclusive license for a period of 7 years covering the rights to make, use and sell commercial products and to sublicense the patent. The investment description did not, however, identify any plans for utilizing the patent for production or sublicensing, nor did it identify a source of capital which the Partnership could use to accomplish such production or sublicensing. A section of the investment description headed "Economic Risk Factors" stated that the investment was highly speculative and that the receipt of any royalties by the Partnership could not24 be predicted with any certainty. This section of the document reiterated the inventor's beliefs about the advantages of the hybrid vehicle design and then stated that, in light of the economic and regulatory conditions at the time, "there would appear to be a substantial market for [these] vehicles * * if the inventors beliefs prove to be correct and accurate." The remainder of the economic risk section enumerated some of the specific risk factors of investment as follows: (1) the patent, while issued, had not been judicially tested; (2) a prototype had not been completed, no firm commitment had been obtained for the construction of a prototype, and even if a prototype were constructed, there was no assurance that it would operate in a satisfactory manner or that consumers would accept a hybrid vehicle; (3) no revenue would be received by the Partnership with respect to the construction of a prototype; (4) many large and well financed companies had already committed substantial resources to research and development programs which might produce vehicles directly competitive with any vehicle produced from the patent; and (5) no assurances could be given that substantial revenue25 would be produced during the life of the license or that the substantial additional investment required to exercise the option to extend the term of the license would seem economically justified at the time the option became exercisable. The investment description stated that the Partnership would have a $2,500,000 depreciable tax basis in the license and would be able to use straight-line depreciation over 7 years. This would give the Partnership a deduction of $357,142 per year. The investment description warned, however, that if the patent license was not extended, "recapture" of the depreciation deductions could occur at the end of the 7-year period to the extent that the principal on the nonrecourse note remained unpaid. The investment description also stated that the renewal option was structured to give each investor the choice of renewing his share of the option. In a portion of the investment description dealing with the challenges the Internal Revenue Service might make to the Partnership's tax deductions, the document stated that one such challenge might be that the fair market value of the patent license was insufficient to support the depreciation deductions. The26 document then stated: The question then becomes what is the fair market value of the license. Of course, the nature of the license interest is such that it is very difficult to ascertain "true fair market value." Since the definition of fair market value is "the price to be paid by a willing buyer to a willing seller," and since its [sic] fair to conclude that there is a willing buyer and seller in this transaction, presumptively the price paid (the $2,500,000) should be the fair market value. In no other portion of the document was it alleged that the $2,500,000 purchase price was in fact the fair market value of the patent license. Nor did the investment description explain how this price had been chosen. Potential investors in the Partnership also received a single page document containing the following schedule: INVESTMENTBalanceCashInterestPrincipalNote19768 40,00035,000365,0001977100,00025,55074,450290,5501978100,00020,33879,662210,8881979100,00014,76285,238125,6501980100,0008,79591,20534,44519819 33,8562,41134,445473,85610 400,000TAX DEDUCTIONSTaxBeneficiaryDepreciationInterestTotalat 50%197629,67129,67114,8351977357,14225,550382,692191,3461978357,14220,338377,530188,7651979357,14214,762371,904185,9521980357,1428,795365,937182,9681981357,1422,411359,553179,7761982357,142357,142178,5711983327,381327,381163,6901,285,903 27 Renegotiation of the LicenseDuring the years 1976 through 1981, the payments made by the Partnership to PSI and the payments which the Partnership was required to make to PSI pursuant to the installment note executed by Angelos were as follows: YearPayments MadePayments Reguired1976$22,500.00$ 35,000.0019775,000.00100,000.00197873,150.00100,000.00197929,687.50100,000.00198020,000.00100,000.0019811,000.0036,856.00$151,337.50$471,856.00Beginning in early 1978, Angelos, the limited partners, and PSI began receiving letters from Waldorf and Howard K. Schwartz, an attorney representing Waldorf, complaining of the Partnership being in arrears on the installment note and threatening to bring suit to collect. These letters also stated that if Waldorf was forced to28 foreclose on the Partnership, recapture of the depreciation deductions taken by the Partnership would occur. In response, Angelos began encouraging the limited partners to pay in amounts which were due the Partnership. In August and September of 1979, a set of agreements was executed in settlement of the dispute between Waldorf, PSI and the Partnership. One of the agreements substituted a corporation named Patent Licensing International, Ltd. ("PLI") into the position of PSI with respect to Waldorf and the Partnership. This agreement was executed by Schwartz as president of PLI and Hanlon as president of PSI. PSI assigned all of its rights in the patent to PLI and also assigned all of its rights and delegated all of its duties with respect to its agreements with Waldorf and the Partnership to PLI. A second agreement executed between the Partnership and PLI altered the terms of the agreement originally executed between the Partnership and PSI. This agreement amended the earlier agreement as follows: (1) the original purchase price of $2,500,000 was decreased to $2,332,000, of which $35,000 was stated to have been paid at the time of the execution of the 1976 agreement; (2) $475,00029 of accrued and unpaid interest was stated to be owing on the promissory notes given in connection with the 1976 agreement; (3) upon execution of the 1979 agreement, the Partnership was to pay to PLI an amount equal to the difference between $168,000 and the amount paid by the Partnership prior to the date of the 1979 agreement, exclusive of the $35,000 down payment; 11 (4) the balance owing of $2,604,000 12 (principal and interest) was to be paid with a new promissory note earning interest at 7 percent per annum on the unpaid balance and payable out of 70 percent of the income received by the Partnership from exploitation of the patent; (5) the term of the exclusive license was extended to the life of the patent; and (6) if the total amount due on the promissory note was paid in full during the extended term of the license, the Partnership was to pay PLI 50 percent of the income it derived from the patent thereafter. 30 The payment which was to be made by the Partnership upon the execution of the agreement with PLI was not made. Further, the $2,604,000 promissory note was nonrecourse and no portion of it had been paid as of the time of trial. Operation of the PartnershipFrom its inception in 1976 until at least the time of trial, the Partnership owned no property and had no assets other than its interest in the patent license. Nor did it have any capital which could be used to develop the invention. The Partnership did not maintain any formal offices and had no employees. The address used by the Partnership on its returns for 1976 and 1977 was the site of the law office of Angelos during those years. During the years 1976 to 1980, the Partnership did not sell, license, or market the hybrid vehicle design claimed in the patent. The Partnership made no formal offers to anyone to sublicense the patent and received no offers from anyone expressing an interest in sublicensing the patent or acquiring rights to use the invention. No advertisements or similar published matter pertaining to the invention claimed in the patent have ever been printed or placed by the Partnership. The Partnership31 has not paid or incurred any expenditures with respect to the patent license or the invention, except for the expenditures made to acquire the patent license. The Partnership made no significant expenditures and incurred no significant expenses to: (1) develop a prototype of the invention; (2) market, sublicense, or sell the invention; (3) develop a working model of the invention; or (4) interest any other person or entity in developing the invention. No estimate of the cost of manufacturing vehicles in production quantities utilizing the invention or of the price at which such vehicles could be sold has ever been made by or on behalf of the Partnership. The Partnership has paid no royalties to PSI or any other party. The Partnership has never realized any income or royalties from the patent license or from any other source. It reported zero receipts and zero gross income on each of its returns for 1976 through 1980. Trafalger LimitedTrafalger, Ltd. ("Trafalger") was a Michigan corporation incorporated on April 8, 1977. At all times relevant, Howard K. Schwartz was the president and a 76 percent shareholder of Trafalger. Waldorf owned 24 percent of the capital stock32 of Trafalgar and was its only other shareholder. Neither the Partnership nor any of its partners held any interest in Trafalger. Jet Propulsion Laboratory ("JPL"), under a subcontract with the United States Department of Energy, issued a solicitation for contract bids for Phase I of a "near term hybrid vehicle" on November 18, 1977. Trafalger submitted a three-volume proposal to JPL in March 1978, entitled "Proposal No. HI-2-8275, Phase I of a Near Term Hybrid Passenger Vehicle." Waldorf was the principal author of the proposal. Trafalger was notified in May 1978 that JPL had rejected the proposal. At no time has there been a written agreement, a written contract, or a memorandum or writing evidencing an oral agreement between Trafalger and the Partnership, or any partner therein, with respect to the patent or any license of the patent. OPINION As a preliminary matter, petitioners have raised the argument that respondent's deficiency determination is arbitrary and capricious and should not be accorded the normal presumption of correctness. Petitioners base this argument on one of respondent's alternative grounds, stated in the notices of deficiency, for the disallowance33 of the Partnership's losses. In the notices of deficiency respondent, as one of several alternatives, disallowed the Partnership's claimed deductions because of a failure of petitioners to prove that "The underlying theory set forth in the patent was a viable alternative for propelling a vehicle and, therefore, had marketability." Petitioners argue that in order for the United States Patent Office to issue a patent it must determine that the invention described in the patent application will work. Further, petitioners argue that respondent's determination that the invention is not "viable" is in effect a determination that the patent is invalid. Petitioners conclude that because respondent does not have standing to challenge the validity of a patent 13, his determination in this case is arbitrary and capricious. Respondent's determination clearly goes to the marketability of the patent and not to its validity as a matter of patent law. As petitioners have not claimed that the United States Patent Office must determine that a patent will be marketable prior to its issuance, we will34 not interpret respondent's determination as going to the validity of the patent. Accordingly, we do not accept petitioners' argument that the notices of deficiency are arbitrary and capricious. DepreciationIn order for the Partnership to be entitled to the claimed amortization of the cost of the patent license, petitioners must prove that they acquired a patent license which was used in a trade or business or held for the production of income. Sec. 167(a); Rule 142(a). A partnership's activities constitute a trade or business if the partnership is engaged in the activities with the predominant purpose and intention of making a profit. Flowers v. Commissioner,80 T.C. 914">80 T.C. 914, 931 (1983); Siegel v. Commissioner,78 T.C. 659">78 T.C. 659, 698 (1982). While the partnership's profit making expectations need not necessarily be reasonable, its profit objective must be in good faith. Flowers v. Commissioner,supra;Allen v. Commissioner,72 T.C. 28">72 T.C. 28, 33 (1979). The existence or absence of the requisite profit objective is determined35 at the partnership level. Brannen v. Commissioner,78 T.C. 471">78 T.C. 471, 505 (1982), affd. 722 F.2d 695">722 F.2d 695 (11th Cir. 1984). The determination is to be made based on a consideration of all the facts and circumstances. Flowers v. Commissioner,supra at 931-932. Greater weight, however, should be placed upon objective facts than mere statements of intent. Brannen v. Commissioner,supra at 506. Section 1.183-2(b), Income Tax Regs., lists some of the factors which should be considered in determining whether an activity is engaged in for profit. The list is not intended to be exclusive and the weight given any particular factor may very depending on the circumstances. These factors include: (1) the manner in which the taxpayer carries on the activity; (2) the expertise of the taxpayer or his advisors; (3) the time and effort expended by the taxpayer in carrying on the activity; (4) the expectations that assets used in the activity may appreciate in value; (5) the success of the taxpayer in carrying on other similar or dissimilar activities; (6) the taxpayer's history of income or losses with36 respect to the activity; (7) the amount of occasional profits, if any, which are earned; (8) the financial status of the taxpayer; and (9) whether elements of personal pleasure or recreation are involved. In this case, the Partnership's activities consisted of little more than the purchase of the patent license. Following the purchase of the license the Partnership engaged in no activities other than the general partner's unsuccessful attempts to prod the limited partners into making the contributions to the Partnership which were needed to pay the Partnership's recourse obligations to PSI and his renegotiation of the licensing agreement when it became apparent that the Partnership would not meet its obligations to PSI. The Partnership made no attempts to exploit the patent in a profitable manner. Nor did the Partnership have any resources with which to exploit the patent. Angelos had no background in the fields of automotive engineering, automotive marketing, electrical or mechanical engineering, or electronics. Nor did Angelos have any background in patent law or in the licensing of patents. Angelos allegedly relied on the expertise of Waldorf as to technical matters and on37 Schneider as to matters relating to patent law and the value of the patent. With respect to Angelos' reliance on Waldorf, we note that with respect to negotiation for the license, Waldorf was a party with economic interests adverse to those of the Partnership. Almost all of the payments to be made to PSI were to be paid over to Waldorf. As such, Angelos' reliance on Waldorf as a technical advisor would not be reasonable during the negotiation for the license. Further, there is little evidence in the record to suggest that Angelos actually sought technical advice from Waldorf. Angelos' reliance on advice from Schneider, beyond the report which Angelos sought from Schneider, is similarly unproven. As to Schneider's report, we find its utility as a basis upon which to make economic decisions to be questionable. The report equated potential income stream with fair market value. Further, while suggesting a potential range of income streams varying by more than a factor of 10, it gave no predictions of the likelihood of any particular level of income being realized. We find it difficult to accept that any prudent businessman would place his reliance on this report, especially where38 the background and qualifications of the preparer were not investigated. Once the purchase of the patent license had been completed Angelos expended almost no time in the exploitation of the patent. The activities of the Partnership were negligible once the purchase was completed. Angelos testified that the books and records of the Partnership consisted of a checking account. He also stated, in explaining why the Partnership did not need an office, that "This was a project that occupied a file drawer for me." The record clearly shows that Angelos' activities were minimal with respect to the patent and the Partnership in general. Based on the above considerations alone we find that the Partnership clearly did not purchase the patent license for use in a trade or business or for the production of income. The alleged purchase price of $2,500,000 was established to achieve desired tax benefits. The terms of the Partnership agreement and the terms of the purchase agreement were designed not to create economic profits but to create amortization deductions in the amount of $2,500,000 over 7 years while allowing the recapture of these deductions to be postponed for an additional 1039 years (the remaining life of the patent). Accordingly, we hold that petitioners are not entitled to the claimed amortization deductions in any of the years in issue. 14Legal FeesPetitioners have conceded that there is no evidence in the record to demonstrate the purpose behind the legal fees allegedly paid to Angelos and that, therefore, those amounts are not properly deductible by the Partnership. Petitioners have also conceded that the amounts paid to Jerold I. Schneider were start up costs of the Partnership. Because of our holding that the Partnership was not engaged in an activity for profit, the deduction of such amounts are not allowable whether or not they are subject to the provisions of section 709. Secs. 165(c), 212. InterestAlso at issue is whether the Partnership may claim interest deductions for the years 1977 and 1978. As a preliminary matter, respondent asserts, and petitioners concede, that the Partnership should properly have been on the cash receipts and disbursements method of accounting40 during the years in issue and therefore the Partnership was not entitled to deduct amounts representing accrued but unpaid interest. Thus, we need only resolve the proper treatment of amounts actually paid during the years in issue. The amounts actually paid by the Partnership pursuant to the licensing agreement during the years in issue were as follows: YearPayments Made1976$22,500.0019775,000.00197873,150.00$100,650.00The burden of proof is upon petitioners to establish the character of these payments. Rule 142(a). Respondent points out that the licensing agreement required that the Partnership pay a down payment in the amount of $35,000 and that the renegotiation and settlement agreement stated that this amount had been paid. There is insufficient proof in the record to establish that the first $35,000 of payments made by the Partnership were other than the down payment required by the licensing agreement. We therefore narrow our consideration to the characterization of $18,091 claimed by the Partnership in 1978 as an interest deduction. Respondent has challenged the Partnership's entitlement to the interest deductions on the grounds41 that (1) the debt upon which the payments were made was not a bona fide debt and (2) the petitioners failed to establish the character of the payments. The parties agree that the payments made by the Partnership were not made pursuant to the nonrecourse debt of the Partnership. Clearly, all such amounts were either the down payment on the purchase or payments made pursuant to the recourse debt. After reviewing the facts of this case, we are convinced that the recourse debt of the Partnership was not a bona fide debt. The recourse debt was an obligation to a corporation which was controlled by a business associate of Angelos. Even though the Partnership was in arrears on payments owed to PSI during all of the years in issue, there is no evidence in the record to indicate that Hanlon, as president of PSI, ever attempted to enforce the debt against the Partnership.At the end of 1978, the Partnership was over $130,000 in arrears on its payments owed to PSI. In addition, while Waldorf may have had some right to enforce the debt as a third party beneficiary, Waldorf's efforts to do so were minimal. The evidence shows that Waldorf did little more than have his attorney, who was extensively42 involved in many aspects of the transaction, write letters threatening to bring suit to enforce the obligation and forceclose on the patent license, thereby triggering recapture of the Partnership's deductions. When the Partnership proved unresponsive to these letters, Waldorf agreed to renegotiate the deal rather than attempting to enforce the obligation. The renegotiated agreement effectively released the Partnership from its liability to pay $167,000 of the $335,000 originally agreed to be paid by installment note. Further, while the renegotiated agreement called for the Partnership to pay $80,162.50 on the execution of the agreement, the Partnership failed to pay this amount at that time. As of the end of 1981, $51,662.50 of this amount had still not been paid by the Partnership. Petitioners have clearly failed to show that the debt in question was treated as a bona fide debt by the parties. Accordingly, petitioner's interest deduction for the year 1978 is not allowable. Late Filing AdditionsThe final issue for decision is whether petitioners Leo H. Angelos and Carey Angelos are liable for additions to tax pursuant to section 6651(a)(1) for failure to timely file43 their individual income tax returns for the years 1976, 1977 and 1978. Section 6651(a)(1) provides that a taxpayer who fails to file a return which is timely is subject to an addition to tax of 5 percent of the amount required to be shown as tax on the return for each month the return is overdue. The addition to tax is limited to a maximum of 25 percent. The addition is not applicable, however, if the taxpayer can demonstrate that the delay in filing the return is due to reasonable cause and not due to willful neglect. The returns of petitioners Leo and Carey Angelos had the following due dates and filling dates: Taxable YearDue DateFiling DateMonths Late 1519764/15/7712/22/782119776/15/781/03/79719786/15/799/27/794Petitioners have offered no evidence tending to show that their delays in filing were due to reasonable cause and not due to willful neglect. Petitioners44 have also not briefed the issue. Accordingly, we hold that petitioners are subject to the additions to tax as determined by respondent. Decisions will be entered for the respondent.Footnotes1. Cases of the following petitioners are consolidated herewith: Robert R. Tisch and Jennifer S. Tisch, docket No. 27795-81; Sotirios Roumanis, docket No. 27921-81; Dennis Serras, docket No. 27962-81; Estate of Francis Wilseck, Deceased, a/k/a Frank Wilseck, Sophia Wilseck, Personal Representative, docket No. 1303-82; Leo H. Angelos and Carey A. Angelos, docket No. 13485-82.↩2. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954, as amended and in effect during the years in issue.↩3. Respondent has conceded that the due dates of the 1977 and 1978 returns were extended to the listed dates.↩4. The stipulated exhibit identifying the amounts paid into the partnership indicates that this amount was not deposited to the partnership's bank account. This amount was deposited to Angelos' private bank account as a partial repayment of a loan made by him to the partnership. ↩5. See supra,↩ Note 4.6. This was 15 days before the Partnership was organized.↩7. The promissory note actually executed by Angelos on behalf of the Partnership was in the face amount of $400,000. This amount included the $35,000 down payment, but the additional amount of $30,000 is unexplained. The amount of the nonrecourse note was not decreased by this amount. The parties have attached little relevance to this discrepancy.↩8. The reason for this figure being $5,000 larger than the sum of the principal and interest is unexplained. ↩9. This figure should apparently be $36,856, the sum of the principal and interest to be paid in 1981. ↩10. This figure matches the principal amount stated in the promissory note rather than the amount stated in the licensing agreement.↩11. As of September 18, 1979, the date this agreement was executed, the Partnership had made total payments to PSI, in excess of the $35,000 down payment, of $87,387.50. Therefore, the Partnership should have paid an amount on closing of $80,162.50 ($168,000.00 - $87,837.50). ↩12. This was calculated as follows: ↩Adjusted Purchase Price$2,332,000 Plus: Accrued and unpaid interest475,000 Less: Closing and prior note payments(168,000)Less: Down payment( 35,000)$2,604,000 13. See Differential Steel Car Co. v. Commissioner,T.C. Memo 1966-65">T.C. Memo 1966-65↩.14. Our disposition of this issue makes it unnecessary to deal with any of the issues relating to the Partnership's amortization of the patent license.↩15. In determining the number of months late which a return has been filed, a fraction of a month is treated as an additional month. Sec. 6651(a)(1)↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625351/	Richard N. and Juanita D. Newbre v. Commissioner.Newbre v. CommissionerDocket No. 406-70SC.United States Tax CourtT.C. Memo 1971-165; 1971 Tax Ct. Memo LEXIS 169; 30 T.C.M. 705; T.C.M. (RIA) 71165; July 15, 1971, Filed Richard N. Newbre, pro se, 527 N. Cherokee Ave., Los Angeles, Calif. Stephen W. Simpson, for the respondent. SACKS Memorandum Findings of Fact and Opinion SACKS, Commissioner: Respondent determined a deficiency in petitioners' Federal income tax for the year 1967 in the amount of $411.25. Three issues are presented for our decision: (1) Whether petitioners may deduct a claimed loss of $2,645 arising from the sale of their former residence located in Boise, Idaho in 1967, under the provisions of section 165(c)(2), Internal Revenue Code of 1954; 1 (2) Whether1971 Tax Ct. Memo LEXIS 169">171 petitioners are entitled to deduct depreciation in the amount of $1,050 with respect to this former residence under the provisions of section 167(a) and the regulations thereunder; and (3) Whether petitioners are entitled to deduct "closing costs" and "commissions" paid incident to the sale of their former home as maintenance expenses under section 212(2). Findings of Fact Some of the facts have been stipulated and are so found. Petitioners are husband and wife whose residence at the time they filed their petition herein was in Los Angeles, California. Petitioners timely filed their 1967 joint Federal income tax return with the district director of internal revenue at Los Angeles, California. Petitioner Richard N. Newbre (herein called petitioner) was employed as a real estate manager by Albertsons, Inc., during the period in issue. He was requested by his employer to move from Portland, Oregon, to Boise, Idaho, to complete a short assignment he believed would last no longer than six weeks. It was anticipated that after this six week period, petitioner would be moved to Los1971 Tax Ct. Memo LEXIS 169">172 Angeles. Due to a change of circumstance, petitioner agreed to extend his stay in Boise, Idaho, and rented a home there. After approximately six months petitioner and his family had to vacate their rented home. Petitioners then purchased a home in Boise in which they resided until they moved to Los Angeles, California in March of 1967. Prior to relocating in Boise, petitioner had an understanding with Albertsons, Inc., that he would in time be transferred to Los Angeles. However, when petitioners purchased their home in Boise, they were unaware of exactly how much longer they would be required to remain there. Despite the indefiniteness of the duration of their stay in Boise, petitioners decided to purchase a home there so they would have a suitable place to live. They also expected that, when they left Boise, the house could be resold at a profit. The residence which they purchased was acquired at a total cost of $29,739. Of this amount, $3,500 represented the cost of the land on which the home was located. After moving to Los Angeles, petitioners offered their residence for sale at a price of $32,500 through a realtor in Boise. Petitioners received two offers to rent their property1971 Tax Ct. Memo LEXIS 169">173 but rejected these because they had no desire to be bothered with owning a piece of property so far removed from Los Angeles. The property was finally sold in August of 1967 for $29,000. Petitioners received net proceeds from this sale of $27,094, after deductions for commissions of $1,740, and closing costs of $166. Opinion We are asked to make two determinations in this proceeding. First, we are asked to decide whether petitioners have suffered a 706 loss on the sale of their Boise residence in a transaction entered into for profit under section 165(c)(2). 2 Second, we are requested, by way of amended petition, to determine whether petitioners held their Boise residence for the production of income under the provisions of sections 167(a)(2)3 and 212(2). 4 For the reasons set forth below we have found that petitioners neither suffered a loss in a transaction entered into for profit nor held the subject property for the production of income within the meaning of the applicable statutory provisions. 1971 Tax Ct. Memo LEXIS 169">174 The resolution of this controversy requires us to ascertain the purposes or intentions of the petitioners in connection with the holding and subsequent sale of their Boise residence. In the Court Reviewed case of Frank A. Newcombe, 54 T.C. 1298">54 T.C. 1298 (1970), this Court assiduously chartered the course it will follow in deciding when residential property has been converted to property held for the production of income. We have attempted to apply these same criteria to the instant facts. We have also considered the question of whether the residential property here involved was otherwise appropriated to income-producing purposes within the meaning of section 1.165-9, 5 Income Tax Regs.1971 Tax Ct. Memo LEXIS 169">175 Petitioners occupied their Boise property for at least two years as their personal residence. After abandoning it as their residence in March of 1967, petitioners permitted the house to remain vacant until it was finally sold in August of 1967. During this interim period petitioners rejected two offers to rent the house, indicating they were only interested in selling the property. These facts, without more, appear to us to be devoid of any indication that petitioners in some way "otherwise appropriated to income-producing purposes" their former residence. See Edward N. Wilson, 49 T.C. 406">49 T.C. 406, 49 T.C. 406">415 (1968), reversed and remanded on other grounds, 412 F.2d 314 (C.A. 6, 1969); Andrew F. McBride, Jr., 50 T.C. 1">50 T.C. 1 (1968), Acq. 1969-1 C.B. 21; Gerald Melone, 45 T.C. 501">45 T.C. 501 (1966); Harold K. Meyer, 34 T.C. 528">34 T.C. 528 (1960); Warren Leslie, Sr., 6 T.C. 488">6 T.C. 488 (1946); Rumsey v. Commissioner, 82 F.2d 158 (C.A. 2, 1936), cert. denied 299 U.S. 552">299 U.S. 552; Morgan v. Commissioner, 76 F.2d 390 (C.A. 5, 1935), cert. denied 296 U.S. 601">296 U.S. 601; 5 Mertens, Law of Federal Income1971 Tax Ct. Memo LEXIS 169">176 Taxation (Malone Rev.) sec. 28.78. To the contrary, we are persuaded here that petitioners were primarily seeking to recoup their investment from the Boise residence. Although petitioners may have anticipated a future profit from the ultimate sale of their residence when they acquired it, this profit was no more than the appreciation in value which was expected to accrue during their occupancy of the property as a residence. As we stated in 54 T.C. 1298">Frank A. Newcombe, supra, at page 1302: The placing of the property on the market for immediate sale, at or shortly after the time of its abandonment as a residence, will ordinarily be strong evidence that a taxpayer is not holding the property for postconversion appreciation in value. Under such circumstances, only a most exceptional situation will permit a finding that the statutory requirement has been satisfied. See also Gilbert Wilkes, 17 T.C. 865">17 T.C. 865 (1951). 707 Neither are we convinced that petitioners held their Boise residence for the production of income during 1967. Petitioners' only action here was to offer1971 Tax Ct. Memo LEXIS 169">177 the Boise house for sale immediately upon its abandonment as a residence. Without further affirmative evidence of a conversion of this property to income producing use, we see no rational basis upon which to conclude such a conversion occurred at the time the property was abandoned as a residence. See Jones v. Commissioner, 152 F.2d 392 (C.A. 9, 1945), affirming per curiam a Memorandum Opinion of this Court; William C. Horrmann, 17 T.C. 903">17 T.C. 903 (1951); Charles F. Neave, 17 T.C. 1237">17 T.C. 1237 (1952); 54 T.C. 1298">Frank A. Newcombe, supra; 4 A Mertens, Law of Federal Income Taxation (Riordan Revision), sec. 25A.08. Petitioners urge that their case should be governed by the decision in Commissioner v. Hulet P. Smith, 397 F.2d 804 (C.A. 9, 1968) affirming per curiam a Memorandum Opinion of this Court. In that case, under what appears to have been somewhat similar circumstances, it was held that depreciation and maintenance expenses were properly deductible on the ground that the residence there was held for the production of income while being offered for sale. While certain facts are analogous, we are faced here with different issues on1971 Tax Ct. Memo LEXIS 169">178 two points as well as an argument not previously considered by this Court with respect to the deduction of depreciation where residential property is held only for sale. In Smith no claim for a loss deduction under section 165(c)(2) was made and no consideration was accorded to this point by either the Tax Court or the Circuit Court. Also, the maintenance costs at issue in the Smith case represented actual maintenance and repair work expenses and were not composed of real estate commissions and "closing costs" which are offsets against the proceeds of sale received upon the disposition of real property, Irma Jones Hunt, 47 B.T.A. 829">47 B.T.A. 829 (1942); Mrs. E. A. Giffin, 19 B.T.A. 1243">19 B.T.A. 1243 (1930), rather than section 212(2) deductions. Lastly, the depreciation deduction claimed by petitioners arises in a different posture than in Smith. In that case the government did not contest in the Tax Court that the salvage value of the property in question was greater than zero. In the case before us respondent now argues that even if the subject property is found to have been held for the production of income, since it is only held for the production of income by way of a sale, 1971 Tax Ct. Memo LEXIS 169">179 no deduction for depreciation is allowable since the property has no reasonably ascertainable useful life and has a salvage value at least equal to its fair market value as of the date converted to income-producing use. These arguments have substantial appeal. Since the residence in question is held solely for immediate sale, its useful life cannot be accurately determined. Moreover, at the time the residence is ostensibly converted to income-producing property held only for sale its estimated salvage value cannot be less than its fair market value as of the date of conversion since that is presumably the amount that will be realized upon its sale. See Fasan, "Maintenance and Depreciation Deductions for a Personal Residence Offered for Sale." 25 Tax Law Review 269, 278 (1970). In affirming the decision in the Smith case, the Circuit Court has indicated that unusual circumstances present in the case were of some significance. No such unusual circumstances are present in this proceeding. Further, as we stated in 54 T.C. 1298">Newcombe, supra, at page 1303: We hold that, during the taxable year 1966, petitioners did not hold the Pine Bluff residence for the production1971 Tax Ct. Memo LEXIS 169">180 of income. In so holding, we recognize that our decision in Hulet P. Smith, supra, reaches a contrary result on similar facts. But our statement in that case that the issue was a "question" of "law" is belied by the affirmance by the Ninth Circuit on the ground that "we are not persuaded that the Tax Court's factual finding and its consequent conclusions are clearly wrong" and the statement that "the Government makes a strong case for reversal." See 397 F. 2d at 804. We therefore consider that case inapposite and of little precedential value. Accordingly, we do not regard the holding of the Court of Appeals for the Ninth Circuit in the Smith case to be controlling since the position taken by that Court is not so clear as to require the application of our decision in Jack E. Golsen, 54 T.C. 742">54 T.C. 742 (1970) on appeal (C.A. 10, May 4, 1970), wherein we indicated that henceforth we would uniformly follow the position of the Circuit Court to which appeal would normally lie. Kent Homes, Inc., 55 T.C. 820">55 T.C. 820, 708 830-831 (1971), on appeal (C.A. 10, May 24, 1971). Reviewed and adopted as the report of the Small Tax Case Division. 1971 Tax Ct. Memo LEXIS 169">181 Decision will be entered for the respondent. Footnotes1. All statutory references are to the Internal Revenue Code of 1954 unless otherwise indicated.↩2. SEC. 165. LOSSES. (c) Limitation on Losses of Individuals. -in the case of an individual, the deduction under subsection (a) shall be limited to - * * (2) Losses incurred in any transaction entered into for profit, though not connected with a trade or business; * * * ↩3. 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) - * * * (2) of property held for the production of income. ↩4. SEC. 212. EXPENSES FOR PRODUCTION OF INCOME. In the case of an individual, there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year - * * * (2) for the management, conservation, or maintenance of property held for the production of income; * * *↩5. § 1.165-9 Sale of residential property. (a) Losses not allowed. A loss sustained on the sale of residential property purchased or constructed by the taxpayer for use as his personal residence and so used by him up to the time of the sale is not deductible under section 165(a). (b) Property converted from personal use. (1) If property purchased or constructed by the taxpayer for use as his personal residence is, prior to its sale, rented or otherwise appropriated to income-producing purposes and is used for such purposes up to the time of its sale, a loss sustained on the sale of the property shall be allowed as a deduction under section 165(a)↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625352/	CONTINENTAL SCREEN CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Continental Screen Co. v. CommissionerDocket No. 30350.United States Board of Tax Appeals19 B.T.A. 1095; 1930 BTA LEXIS 2254; May 26, 1930, Promulgated 1930 BTA LEXIS 2254">2254 In 1924 the petitioner was served with a notice of complaint by the Federal Trade Commission, in which violation of the Sherman Act by the petitioner was alleged and a date set for hearing before the Commission. The petitioner employed eminent counsel to defend it against such charge. On October 14, 1925, the Commission entered an order dismissing the complaint. The petitioner paid bills as rendered by its attorneys for services in 1925 and 1926 in the amounts of $40,000 and $15,000, respectively. Held that the amounts paid as attorneys' fees were deductible from gross income as ordinary and necessary expenses in the carrying on of its business. H. A. Mihills, C.P.A., for the petitioner. A. H. Murray, Esq., for the respondent. SMITH 19 B.T.A. 1095">1095 This is a proceeding for the redetermination of deficiencies in income tax for 1925, and for the fiscal period January 1 to July 31, 1926, of $5,199.99 and $2,025, respectively. The petitioner alleges that the respondent erred in disallowing as deductions from gross income in its return for the calendar year 1925, and in its return for the fiscal period January 1 to July 31, 1926, of $40,000 and $15,000, 1930 BTA LEXIS 2254">2255 respectively, paid for attorneys' fees in presenting its case before the Federal Trade Commission. FINDINGS OF FACT. The petitioner is a Michigan corporation with its principal office at Detroit. It was organized in 1905, for the purpose of manufacturing screen doors and kindred products by four or five large woodworking concerns located in different parts of the United States. The purpose of the organization was the desire of these separate companies to have a common distribution point for their products so that they would have agencies and distribution facilities and factories in all parts of the country. In 1920 the Federal Trade Commission 19 B.T.A. 1095">1096 began investigating its practices, charges having been made against it that it was operating in violation of the Sherman Anti-Trust Law. The petitioner was able to convince the Commission in 1922 that the charges that had been made against it were unfounded. Investigators of the Federal Trade Commission continued, however, to investigate the practices of the petitioner and several different examiners came to its offices in 1922 and 1923 for the purpose of obtaining data. On December 29, 1924, the petitioner was served1930 BTA LEXIS 2254">2256 with a notice of complaint by the Federal Trade Commission that it was operating in violation of the Sherman Anti-Trust Act and a date was set for hearing before the Commission. The petitioner viewed the complaint with much concern as, in the opinion of the officers, it might mean the dissolution of the petitioner's business, which it had taken 20 years or more to develop. A meeting of the board of directors of the petitioner was immediately called and it was decided to employ three different firms of attorneys to represent it before the Federal Trade Commission. These attorneys obtained a continuance for the date of hearing and prepared voluminous data to submit to the Commission. The petitioner was accorded a hearing before the Board of Review of the Federal Trade Commission in May, 1925, at which counsel presented data and moved that the complaint be dismissed as not being proven. After careful consideration the Commission, on October 14, 1925, entered an order dismissing its complaint against the petitioner. Within the year 1925 two firms of attorneys rendered bills against the petitioner for services performed in the amount of $40,000, which bills were paid by the petitioner1930 BTA LEXIS 2254">2257 in 1925. The third firm of attorneys submitted its bill for services rendered in January, 1926, which bill was immediatetly paid by the petitioner in the amount of $15,000. These fees were paid solely for services in representing the petitioner before the Federal Trade Commission. In its income-tax returns for the calendar year 1925, and for the fiscal period January 1 to July 31, 1926, petitioner claimed as deductions from gross income $40,000 and $15,000, respectively, representing fees paid to its attorneys. These deductions were disallowed by the Commissioner in the determination of the deficiencies and the deficiencies result solely from such disallowances. OPINION. SMITH: The single question presented by this proceeding is whether attorneys' fees paid by the petitioner in the calendar year 1925, and in the fiscal period January 1 to July 31, 1926, for services performed by the attorneys in representing it before the Federal Trade Commission, are ordinary and necessary expenses deductible from gross 19 B.T.A. 1095">1097 income within the meaning of section 234(a)(1) of the Revenue Act of 1926, which permits a corporation to deduct from gross income, among other items, "All1930 BTA LEXIS 2254">2258 the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business * * ." At the hearing of this proceeding counsel for the respondent stated that the disallowances by the respondent were based upon several decisions of the Board. He stated: * * In the first place, we are relying upon the F. Myer and Company case, reported in 4 B.T.A., at page 481, which involves expenses incurred in connection with defending a suit for an alleged patent infringement, and defending of an action for an accounting in receivership as set forth in the O'Day Investment Company, reported in 13 B.T.A., at 1230, and defending an action for partnership accounting, as set forth in the Kornhauser case, reported in 48 Supreme Court, 219, or where the act alleged to have been committed is illegal, such as perjury, for instance, in the Sarah Backer case, reported in 1 B.T.A., at page 214, or a conspiracy to defraud as set forth in the appeal of 1930 BTA LEXIS 2254">2259 John Stephens,2 B.T.A. 724">2 B.T.A. 724, or violation of the anti-trust laws of the State of Ohio as set forth in the appeal of the Columbus Bread Company,4 B.T.A. 1126">4 B.T.A. 1126, and in those cases, the Board has consistently refused to allow expenses incurred in defense of the act as an ordinary and necessary business expense. We have carefully examined the cases cited and are of the opinion that the decisions of the Board which have disallowed the deduction of attorneys' fees as ordinary and necessary expenses are not in point. In the first place, it is to be noted that in the present proceeding no suit had been brought against the petitioner for an injunction to restrain it from continuing its practices or for the dissolution of the corporation. The Federal Trade Commission, upon imperfect information, raised a question as to whether the petitioner was not violating the Sherman Anti-Trust Law. It was perfectly proper for the petitioner to present its case before the Federal Trade Commission. The counsel fees were paid for services in connection with the presentation of the petitioner's case. After obtaining the full facts the Federal Trade Commission dismissed1930 BTA LEXIS 2254">2260 its complaint against the petitioner. This must be interpreted to mean that the petitioner was found to the satisfaction of the Commission not to be operating in violation of the Sherman Anti-Trust Law. It was permitted to continue its practices. The expense of employing the attorneys was incurred in the course of its business operations. In Kornhauser v. United States,276 U.S. 145">276 U.S. 145, it was stated: In the Appeal of F. Meyer & Brother Co.,4 B.T.A. 481">4 B.T.A. 481, the Board of Tax Appeals held that a legal expenditure made in defending a suit for an accounting and damages resulting from an alleged patent infringement was deductible as a business expense. The basis of these holdings seems to be that where a suit or action against a taxpayer is directly connected with, or, as otherwise stated (Appeal of Backer,1 B.T.A. 214">1 B.T.A. 214, 1 B.T.A. 214">216), proximately resulted from, his business, the expense incurred is a business expense within the meaning of section 214(a), 19 B.T.A. 1095">1098 subd. 1, of the act. These rulings seem to us to be sound and the principle upon which they rest covers the present case. * * Similarly, in this case we are of the opinion1930 BTA LEXIS 2254">*2261 that the attorneys' fees paid proximately resulted from the conduct of petitioner's business. They were ordinary and necessary expenses of conducting the business and as such are legal deductions from gross income. Judgment will be entered for the petitioner.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625327/	Harry R. and Joan E. Hoglander v. Commissioner.Hoglander v. CommissionerDocket No. 3678-70 SC.United States Tax CourtT.C. Memo 1971-113; 1971 Tax Ct. Memo LEXIS 221; 30 T.C.M. 483; T.C.M. (RIA) 71113; May 18, 1971, Filed Harry R. Hoglander, pro se, Atlantic Ave. , North Hampton, N.H.Edward DeFranceschi, for the respondent. INGOLIAMemorandum Findings of Fact and Opinion INGOLIA, Commissioner: Respondent determined a deficiency in the petitioners' Federal income tax for the year 1968 of $326.26. Although the statutory notice of deficiency contained several adjustments, the only issue before the Court is whether the petitioners are entitled to exclude sick pay from their income in the amount of $662.50. Since the petitioner-wife, Joan E. Hoglander, is involved herein only because she joined in the filing of the Federal tax return, the word "petitioner" will refer hereinafter to the petitioner-husband, Harry R. Hoglander. Findings of Fact Some of the facts are stipulated and they are so found. The1971 Tax Ct. Memo LEXIS 221">222 petitioners, husband and wife, were residents of North Hampton, New Hampshire, at the time the petition herein was filed. They filed their Federal income tax return for the year 1968 with the District Director at North Hampton, New Hampshire. During the year 1968 the petitioner was employed as an international airlines pilot by Trans World Airlines. Under his contract with the company, the petitioner was on call for duty seven days a week, although, because of his seniority, he was the holder of a regularly scheduled "bid run". On February 10, 1968, the petitioner dislocated his shoulder in a skiing accident. His next scheduled bid run was to be flown on February 24, 1968. He was unable to fly that run because of his injury and did not return to work until March 14, 1968. The petitioner's contract with Trans World provided for a wage continuation plan should the petitioner be unable to work due to injury or sickness. Under the plan, a pilot holding a bid run is entitled to sick leave "on the first day he is unable to report for scheduled duty". The petitioner was paid $415.24 for his absence from duty from February 24 through March 1 and $647.29 for his absence from duty from March1971 Tax Ct. Memo LEXIS 221">223 2 through March 12. In 1968 the petitioner received $25,789.40 from Trans World for his services. While the record indicates that the payments were based on an hourly rate, it is unclear as to whether they were paid biweekly, semi-monthly, or monthly. Opinion Section 105(d) of the Internal Revenue Code of 1954 provides that: "(d) Wage Continuation Plans. - Gross income does not include amounts referred to in subsection (a) if such amounts constitute wages or payments in lieu of wages for a period during which the employee is absent from work on account of personal injuries or sickness; but this subsection shall not apply to the extent that such amounts exceed a weekly rate of $100. The preceding sentence shall not apply to amounts attributable to the first 30 calendar days in such period, if such amounts are at a rate which exceeds 75 percent of the regular weekly rate of wages of the employee (as determined under regulations prescribed by the Secretary or his delegate). If amounts attributable to the first 30 calendar days in such period are at a rate which does not exceed 75 percent of the regular weekly rate of wages of the employee, the first sentence1971 Tax Ct. Memo LEXIS 221">224 of this subsection (1) shall not apply to the extent that such amounts exceed a weekly rate of $75, and (2) shall not apply to amounts attributable to the first 7 calendar days in such period unless the employee is hospitalized on account of personal injuries or sickness for at least one day during such period. If such amounts are not paid on the basis of a weekly pay period, the Secretary or his delegate shall by regulations prescribe the method of determining the weekly rate at which such amounts are paid." The respondent agrees that the petitioner has met the basic requirements of section 105(d) in that he was injured, was absent from work because of the injury, and received payments under a wage continuation plan. However, the respondent argues that the petitioner was not absent from work over 30 days and received sick pay at a rate which exceeds 75 percent of the employee's regular weekly rate of wages. We cannot agree with the respondent. He reaches his result by reasoning that 485 because the wage continuation plan does not entitle the petitioner to sick leave pay until he misses the "bid run", the petitioner was not "absent from work" until the date of that run, or1971 Tax Ct. Memo LEXIS 221">225 February 24, 1968. Then he calculates the petitioner was absent a period of 19 days (February 24 through March 13). By using the 19-day figure to compute the petitioner's weekly rate of sick pay under the regulations (Regs. 1.105-4(e)(6)(ii)(e)) he arrives at a figure of $392.49, which exceeds 75 percent (or $372.64) of the petitioner's weekly rate of wages which he finds to be $496.85. We think it is wrong to equate the method of payment set forth in a wage continuation plan with a determination of when an employee is "absent from work" under section 105(d). It is clear to the Court that the petitioner in this case was injured on February 10, 1968. At that time he was "on call" under his contract with his employer and he was "absent from work" within the meaning of the term as used in section 105(d). His situation ws analogous to that of a member of the Armed Forces who had no assigned duties but stood ready for duty. Regs 1.105-4(a)(5). Since the petitioner was "absent from work" from February 10 until March 14, he was absent from work for a period of 32 days, not 19 days as the respondent asserts. Also, the petitioner's rate of sick pay under the wage continuation plan did not1971 Tax Ct. Memo LEXIS 221">*226 exceed 75 percent of his weekly rate of wages. As we have found, the petitioner received a total of $1,062.53 in sick pay. Under the regulations (Regs. 1.105-4(e)(6) (ii)(e)) this translates to a weekly rate of sick pay of $233.04 (annual rate 52; annual rate = daily rate X 365; daly rate = $1,062.53 32). The weekly rate of sick pay is well below 75 percent of the petitioner's weekly rate of wages of $495.95 ($25,789.40 52), as computed under the applicable regulations. Regs. 1.105-4(e)(5) (iv)(e). In view of the above, the petitioner is entitled to a sick pay exclusion for amounts paid him under the wage continuation plan limited to a $75 per week limitation for the first 30 days and at a rate of $100 per week for any period thereafter. Reviewed and adopted as the report of the Small Tax Case Division. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625328/	APPEAL OF MARKET SUPPLY CO.Market Supply Co. v. CommissionerDocket No. 5381.United States Board of Tax Appeals3 B.T.A. 841; 1926 BTA LEXIS 2536; February 18, 1926, Decided Submitted December 12, 1925. 1926 BTA LEXIS 2536">2536 Taxpayer purchased the business, the store location, and the right to use the name of its competitor during the period of two years. Held, that the amount paid in excess of the inventory of merchandise and equipment can not be written off and claimed as a deduction from gross income over the two years during which the right to use the competitor's name continued. John J. Barry, C.P.A., for the taxpayer. Thomas P. Dudley, Jr., Esq., for the Commissioner. JAMES3 B.T.A. 841">841 Before JAMES, LITTLETON, SMITH, and TRUSSELL. This is an appeal from the determination of a deficiency in income and profits tax for the year 1918 in the sum of $7,400.65. Only so much of the deficiency is in controversy as results from the disallowance of a certain deduction of $6,000 from gross income, which the Commissioner determined to be a capital expenditure. FINDINGS OF FACT. 1. The taxpayer is a Massachusetts corporation with its principal place of business at Boston. 2. During the year 1918 the taxpayer corporation occupied the place of business at 67 Long Wharf, Boston. As a war measure, the United States Government required the erection of gates to1926 BTA LEXIS 2536">2537 the wharves and only permitted persons to enter who had proper credentials. As this interfered with the business of the taxpayer, it sought another location, which resulted in the purchase of the business of M. J. Gallagher & Co., a competitor. On account of the favorable location, existing contracts, good will, and an agreement not to enter into the same business, and the use of the trade name, the taxpayer paid $6,000, in addition to the inventory value of the machinery, merchandise, etc., so acquired. There was no lease to the new premises and the tenants occupied the premises as tenants at will. However, no tenant had ever been ejected to give preference to others. The pertinent parts of the bill of sale are as follows: Know all men by these presents that I, Martin J. Gallagher of Arlington in the County of Middlesex and Commonwealth of Massachusetts, in consideration of one dollar and other valuable consideration to me paid by the Market Supply Company, a corporation duly established under the laws of said Commonwealth, and having a usual place of business in Boston, Suffolk County, Massachusetts, the receipt whereof is hereby acknowledged, do hereby sell, assign, transfer1926 BTA LEXIS 2536">2538 and set over unto said Market Supply Company, all of 3 B.T.A. 841">842 the goods, wares, merchandise, machinery, stock in trade, fixtures and furniture used by me in the business of dealer in market supplies, market boxes, shooks, nails, paper, etc., under the name of M. J. Gallagher & Co., at No. 24 Mercantile Street in said Boston, and in the storehouse at 20 Fulton place in said Boston, and now situated on said premises on Mercantile Street occupied by me in connection with said business or in said storehouse and including also all goods now in transit, and the horse, wagon and harness used by me in said business, together also with the good will of said business, and all of my right, title and interest as tenant of said premises. And I do further assign to said Market Supply Company, all contracts which I have for delivery of shook to me, the said Market Supply Company to assume payment on all shook delivered to it under said contract, and to pay to the parties entitled thereto for all goods now in transit and sold by the bill of sale, and to hold me harmless from any liability on account of shook contracted for by me, but delivered to said Market Supply Company; and I agree with1926 BTA LEXIS 2536">2539 said Market Supply Company to deliver to it all bills of lading received by me, or made out to me, for shipments of shook as aforesaid, and to deliver to said Market Supply Company all necessary or appropriate orders or endorsements to secure delivery to said Market Supply Company by the railroad or carrier of all shook shipped to or consigned to me. * * * And for the considerations aforesaid, I do further covenant and agree with said Market Supply Company, and its successors and assigns that I will not either directly or indirectly (except as a stockholder in said Market Supply Company) engage in or become financially interested in, or permit or allow my name to be used in connection with any business of the kind or character formerly conducted by me as aforesaid, for a period of ten years from the date hereof, in either the State of Maine or Massachusetts, and I further covenant and agree not to do any act or thing to injure or affect the grant of good will of said business herein made. It is further understood and agreed that said Market Supply Company shall have the right to use the name of M. J. Gallagher or M. J. Gallagher & Co., in connection with the business herein1926 BTA LEXIS 2536">2540 transferred, whether at the same location or elsewhere, for a period of two years from the date hereof, and at all times whether within said two years period or not, shall have the right to use the name of M. J. Gallagher & Co., in connection with its own name, when used with appropriate words indicating that the Market Supply Company is successor to M. J. Gallagher & Co., or has succeeded to the business formerly conducted by M. J. Gallagher & Co.3. The taxpayer claims the $6,000 as a business expense, deductible from gross income. The Commissioner treated the amount as a capital expenditure. DECISION. The deficiency should be computed in accordance with the following opinion. Final determination will be settled on 15 days' notice, pursuant to Rule 50. OPINION. JAMES: For some years prior to 1918 the taxpayer had been engaged in the mercantile business, occupying a store on what is 3 B.T.A. 841">843 known as "Long Wharf," at Boston, Mass. Prior to June, 1918, the United States Government, as a war measure, required the erection of gates at the entrance to the wharf and permitted no one to enter without proper credentials. This so interfered with the taxpayer's business1926 BTA LEXIS 2536">2541 that it found it necessary either to secure a new store location or practically to suspend operations. In seeking a new location, the taxpayer found that it could, and it finally did on June 17, 1917, purchase the business and the right to the store location of one of its competitors. In making such purchase, the competitor's stock of merchandise and equipment was inventoried and valued, and the taxpayer paid such inventory value, plus the sum of $6,000, and accepted from said competitor a bill of sale in the form and language set forth in the foregoing findings of fact. It appears from the foregoing bill of sale that the taxpayer acquired the right to occupy a store location as a tenant at will, the merchandise of the seller, his contracts, the good will of his business, the right to use the vendor's name in connection with its business for a period of two years, and the abstention of the vendor from engaging in a like business for a period of 10 years. The benefits accruing to the taxpayer appear to be the benefit of continuing in business unembarrassed by war regulations, the retention of its own customers, the acquisition of the customers of Gallagher, the abstention of Gallagher1926 BTA LEXIS 2536">2542 from business, and the right to use Gallagher's name for two years. It is impossible under the evidence to separate the consideration paid for these various rights, some of which are presumably of permanent benefit to the taxpayer. It might be conceded that the tenancy in Gallagher's location was of little permanent value. It might be conceded that the use of Gallagher's name would also be of temporary benefit, but the acquisition of Gallagher's business and customers, and the abstention of Gallagher from further engaging in business for a period so long as to take him practically permanently out of the field of competitors were benefits difficult to estimate at all, and the duration of which it is particularly difficult to estimate. Certainly, it can not be said that the benefit flowing from these provisions of the contract is limited, as claimed by the taxpayer, to the period of two years during which it was permitted to hold itself out as the successor to M. J. Gallagher & Co. We are, therefore, of the opinion that the amount paid in excess of inventory value of merchandise was a capital expenditure of such indefinite duration that it can not properly be said to exhaust over1926 BTA LEXIS 2536">*2543 any particular period, and no deduction for such exhaustion may be allowed, unless or until a definite loss can be and is established. TRUSSELL dissents.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625329/	E. M. GREEN AND WIFE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Green v. CommissionerDocket No. 28983.United States Board of Tax Appeals11 B.T.A. 278; 1928 BTA LEXIS 3836; March 28, 1928, Promulgated 1928 BTA LEXIS 3836">3836 Under the evidence, held that a part of the deficiency for each of the years involved was due to fraud with intent to evade tax. George M. Stanton, Esq., for the petitioners. A. S. Lisenby, Esq., and J. E. Marshall, Esq., for the respondent. TRAMMELL 11 B.T.A. 278">278 TRAMMELL: This is a proceeding for the redetermination of deficiencies in income tax for the years 1924 and 1925 in the amounts of $675.45 and $4,600.44, including a 50 per cent penalty in accordance with section 275(b) of the Revenue Act of 1924 and the Revenue Act of 1926. It is alleged by the petitioners that the respondent was in error in increasing the net income shown on the original returns for the years involved. While this proceeding was not consolidated with the proceeding in the case of E. M. Green, Docket No. 28981 [ante, 185], it was agreed that the testimony introduced in that proceeding be considered as testimony in this case. The facts relating to the business carried on by the petitioner Green for the years involved herein are the same as those relating to the previous years which are involved in the proceeding, Docket No. 28981, and without repeating1928 BTA LEXIS 3836">3837 the findings of fact which we made in that proceeding, reference is made thereto. The petitioner Green testified that he had deducted on his return $1,250 representing the cost of a load of whiskey, but we are not advised whether this was disallowed by the respondent, nor do we know for which year this deduction was claimed. The only difference between the two proceedings, in so far as it is material here, is that for the taxable years involved the petitioners 11 B.T.A. 278">279 did make and file income-tax returns and employed counsel to prepare them. The petitioner Green had no records except his bank book and deposit books to deliver to his counsel upon which to base the return, but orally advised him with respect to deductions which he claimed and other transactions. The testimony relating thereto, however, is so indefinite and uncertain that we are unable to determine therefrom that the Commissioner's determination was erroneous. It appears, however, that Green did not turn over to his counsel complete information with respect to his income in that he omitted to furnish him information as to deposits in the First National Bank of Cincinnati, and other facts which indicate1928 BTA LEXIS 3836">*3838 to our mind that a part of the deficiencies due for the years involved was due to fraud and with intent to evade tax. The 50 per cent penalty provided in section 275(b) was included in the deficiency and is approved. Judgment will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625330/	Estate of Sidney M. Spiegel, Deceased, Sidney M. Spiegel, Jr., Katherine J. Spiegel and Robert Michels, Executors v. Commissioner.Estate of Sidney M. Spiegel v. CommissionerDocket No. 1662.United States Tax Court1945 Tax Ct. Memo LEXIS 287; 4 T.C.M. 256; T.C.M. (RIA) 45075; February 24, 1945Harry Thom, Esq., 231 S. La Salle St., Chicago, Ill., for the petitioners. Harold H. Hart, Esq., for the respondent. STERNHAGEN The Commissioner determined a deficiency of $454,788.58 in estate tax. The only question is whether the value of the corpus of a trust created by the decedent during his lifetime is includable in gross estate under Section 811 (c), Internal Revenue Code. Findings of Fact The petitioners are the executors of the estate of Sidney M. Spiegel, who was born August 16, 1872, and died testate on December 19, 1940. The executors filed the estate tax return in Chicago, Illinois. The decedent left him surviving two daughters, Katherine J. Spiegel, born March 1, 1897, and Julia S. Michels, born1945 Tax Ct. Memo LEXIS 287">288 March 7, 1907, a son, Sidney M. Spiegel, Jr., born August 8, 1904, and three grandchildren, Robert Michels, Jr., born August 21, 1930, Helen Katherine Michels, born November 17, 1936, and Sydney Ann Michels, born November 4, 1938. On January 2, 1920, the decedent made an agreement by which he, transferred in consideration of one dollar and other considerations, to Modie J. Spiegel and Sidney M. Spiegel, as trustees, 625 shares of Spiegel's House Furnishing Company, and 750 shares of Spiegel May Stern Company, in trust, for the uses and purposes and upon the terms and conditions in part as follows: "1: The said Trustees, and the survivor of them, or any successor trustee, shall have full, absolute and complete power to hold, manage and control said shares and every part thereof; to sell, exchange, transfer or otherwise dispose of the same, or any part thereof, and to invest and reinvest the proceeds derived from any such sale or sales, or other disposition of said shares, or any part thereof, during the continuance of this trust. While said shares of stock, or any substitutes therefor, are held by said Trustees, or the survivor of them, or any successor Trustee, if any corporation1945 Tax Ct. Memo LEXIS 287">289 whose stock or other securities are held by said Trustees should require any action of any kind to be taken, said Trustees, and the survivor and any successor trustee, shall have the same right to take any action which may be required of any stockholder or holder of any securities of any such corporation as if said Trustees, and the survivor and any successor held such shares or said securities in their own individual names and were the sole owners thereof. "2: The Trustees, and the survivor of them, and any successor trustee, shall collect and receive all income derived therefrom, or from any substitutes therefor, and shall during the life of myself, said Sidney M. Spiegel, divide said net income into three (3) equal parts, and pay or use one of said parts of said income to or for the maintenance, support and education of each of my three (3) children, Katherine J. Spiegel, Sidney M. Spiegel, Jr. and Julia K. Spiegel, - such income to be distributed at convenient intervals each year. In the event that any of my said, three (3) children shall die prior to my death, then the share of such income to which such deceased one of said three (3) children would have been entitled shall go1945 Tax Ct. Memo LEXIS 287">290 to the child or children of such deceased child of mine, in equal parts, and if there be no such child or children of any such deceased child of mine, then such income shall be divided equally among the survivors of said three (3) children of mine, and their descendants, per stirpes and not per capita. "3: Upon my death, the said Trustees, and the survivor of them, or any successor Trustee, shall divide said trust fund, and any accumulated income thereon then in the hands of said Trustee, equally among my said three (3) children, and if any of my said children shall have died, leaving any child or children surviving, then the child or children of such deceased child of mine shall receive the share of said trust fund to which its or their parent would have been entitled, and if any of my said three (3) children shall have died without leaving any child or children him or her surviving, then the share to which such deceased child of mine would have been entitled shall go to my remaining children, and the descendants of any deceased child of mine per stirpes and not per capita." * * * * The property was delivered to and accepted by the trustees on the date of the trust agreement. 1945 Tax Ct. Memo LEXIS 287">291 Until the death of the grantor, the income of the trust was distributed to or for the benefit of the grantor's three children. The estate tax return showed a net taxable estate of $841,042.81 for the basic tax and a net taxable estate of $901,042.81 for the additional tax, the executors having elected to value the property as of one year from the date of death under Section 811 (j) of the Internal Revenue Code. The tax shown on the return was $180,404.41 and was paid on March 19, 1942. No part of the corpus held by the trustees was included in the gross estate shown on the return. In recomputing the estate tax the Commissioner included in gross estate $1,140,606.30, the fair market value of the entire trust corpus, and accumulated income held by the trustees on December 19, 1940, the agreed date for the purposes of Section 811 (j), Internal Revenue Code, of the distribution of the property to the three beneficiaries. Following the death of the grantor the entire corpus and accumulated income were distributed equally to his three children. The transfers of the property to the above trust on January 2, 1920, were not made in contemplation1945 Tax Ct. Memo LEXIS 287">292 of death. The value, computed on the basis of the mortality table and on the basis of the assumed interest rate prescribed in the Treasury Regulations applicable to federal estate taxes, of the right of a person aged 68 years to receive $1.00 on the date of death of the one last to die of six other persons, aged 44, 36, 34, 10, 4 and 2 years, provided said person aged 68 years would survive all of the six other persons, is.00007384. The probability, computed on the basis of the mortality table prescribed by Treasury Regulations applicable to federal estate taxes, that a person aged 68 years will survive six other persons of the ages of 44, 36, 34, 10, 4 and 2 years is.00015635. The value, computed on the basis of the mortality table and on the basis of the assumed interest rate prescribed in the Treasury Regulations applicable to federal estate taxes, of the right of a person aged 47 years to receive $1.00 on the date of the death of the one last to die of three other persons aged 13, 15 and 23 years is.00390. The probability, computed on the basis of the mortality table prescribed in Treasury Regulations applicable to federal estate taxes, that a person aged 47 years will survive1945 Tax Ct. Memo LEXIS 287">*293 three other persons of the ages of 13, 15 and 23 years is.01612. The petitioners are entitled to a deduction from gross estate of $20,000 for executors' fees allowed by the Probate Court of Cook County and paid. Memorandum Opinion STERNHAGEN, Judge: The decedent had created an irrevocable trust in 1920, the income of which was distributable from that time forth to his children and the corpus was to be distributed to the children when he died. He died in 1940. The Commissioner, citinginternal Revenue Code, Section 811 (c), has included the corpus in the decedent's gross estate. We are of opinion that this determination of the Commissioner must be reversed, on the authority of Reinecke v. Northern Trust Co., 278 U.S. 339">278 U.S. 339; Commissioner v. Estate of Flora W. Lasker, 141 Fed. (2d) 889. The decedent in creating the trust retained no "string or tie" amounting to a possibility of reversion, and hence the doctrine of Helvering v. Hallock, 309 U.S. 106">309 U.S. 106, and numerous decisions deriving from it, are not in point. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625334/	ESTATE OF ALBERT E. GARCIA, DECEASED, ELOIS GARCIA, EXECUTRIX, and ORA GARCIA, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentEstate of Garcia v. CommissionerDocket No. 2344-74.United States Tax CourtT.C. Memo 1976-70; 1976 Tax Ct. Memo LEXIS 331; 35 T.C.M. 318; T.C.M. (RIA) 760070; March 9, 1976, Filed Herbert Finkelstein, for the petitioners. Charles N. Woodward, for the respondent. SCOTT MEMORANDUM FINDINGS OF FACT AND OPINION SCOTT, Judge: Respondent determined deficiencies in Federal income tax and additions to the tax of Albert E. Garcia and Ora Garcia for the years and in the amounts as follows: Addition to Tax UnderIncome TaxSectionSection Tax Year EndedDeficiency6653(a)6651(a)December 31, 1969$8,682.39$ 482.78$ 2,170.60December 31, 19703,480.07174.00696.01December 31, 19714,614.86230.7401976 Tax Ct. Memo LEXIS 331">332 Albert E. Garcia died on December 27, 1974, and on January 28, 1975, Elois Garcia was appointed executrix of his estate by the Probate Court of Harris County, Texas. The amount of the tax liability of the Garcias for the years here in issue having been disposed of by agreement of the parties, the only issues remaining for decision are: (1) Whether petitioners have shown that the failure of the Garcias to file timely income tax returns for the calendar years 1969 and 1970 was due to reasonable cause and not to willful neglect so as to relieve them of the addition to tax provided for under section 6651(a), I.R.C. 1954, 1 and (2) whether petitioners have shown that no part of their underpayment in tax for the calendar years 1969, 1970 and 1971 is due to negligence or intentional disregard of rules and regulations so as to show that they are not liable for the additions to tax provided for by section 6653(a). FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. Albert E. and Ora Garcia (hereinafter referred to as petitioners) were legal residents of Houston, 1976 Tax Ct. Memo LEXIS 331">333 Texas at the time of the filing of their petition in this case. Petitioners filed a joint Federal income tax return for the calendar year 1969 with the District Director of Internal Revenue, Austin, Texas on April 16, 1971. They filed a joint Federal income tax return for the calendar year 1970 with the District Director of Internal Revenue, Austin, Texas on September 2, 1971, and timely filed a joint Federal income tax return for the calendar year 1971 with the same District Director. 2Beginning sometime prior to the calendar year1976 Tax Ct. Memo LEXIS 331">334 1969, Mr. Garcia began to purchase cigarette vending machines, phonograph machines, pool and other game type machines to place in business locations operated by other persons. By 1969 this was the full-time business of Mr. Garcia. During the years 1969, 1970 and 1971, he had approximately 100 juke boxes, pool and other game machines and approximately 50 cigarette machines placed in between 50 and 70 different locations. The machines were operated by coin. When a collector would go to the business establishment where the machines were located, he would take a collection book and when the coins were taken from the juke boxes and game machines the amount of cash in the machines would be entered on the collection slip. Half of the amount taken from the machines would be paid to the owner of the establishment where the machines were located and the other half retained by Mr. Garcia. The collection slips were in duplicate. The original would generally be left with the owner of the establishment and the carbon copy retained by the collector. The collection slips were unnumbered. The same system was used with respect to the amounts taken from the cigarette machines except that the amount1976 Tax Ct. Memo LEXIS 331">335 paid from the cash taken from these machines to the owner of the establishment where the machines were located would be between 3 and 5 cents a pack of cigarettes. However, sometimes Mr. Garcia would retain all of the cash collected from cigarette machines and periodically a check would be issued to the owner of the establishment where the cigarette machines were located for the amount due him. Most of the expenses of Mr. Garcia's business were paid by checks. These expenses included payment for cigarettes, for machine repair and for labor. During the years here at issue, petitioners were making payments on machines acquired in prior years and were acquiring additional machines. All of their acquisitions were made under an installment type contract requiring payment of carrying charges and interest. From time to time, either Mr. Garcia or the now Mrs. Elois Garcia, who began working with him in 1969, would take the carbon copies retained from the collection books and canceled checks to Mr. Roy R. Williams, who was the sole proprietor of Accurate Bookkeeping & Tax Service. Mr. Williams is an accountant who had operated the accurate Bookkeeping & Tax Service firm for a number of1976 Tax Ct. Memo LEXIS 331">336 years prior to 1968 when Mr. Garcia first came to him. Mr. Williams would attempt to explain to Mr. Garcia the need for complete receipts and records of payments. Mr. Garcia did not have available all records with respect to his acquisition of machines and the carrying charges and interest paid with respect to those acquisitions. Sometime in 1969, Mr. Garcia became ill with a heart condition and was hospitalized from time to time. Thereafter, the now Mrs. Elois Garcia would bring over records to Mr. Williams' firm, and when asked for additional records, would attempt to get them. Petitioners' income tax returns for the calendar years 1969 and 1970 were prepared by an accountant in Mr. Williams' firm. The return for 1969 reported taxable income and the return for 1970 reported a loss. It was the practice in Mr. Williams' firm to call a client after the return was prepared and have the client pick up the return together with an instruction sheet telling the client where to sign the return and where to mail it after having signed it. It was Mr. Williams' invariable custom to have each client's return prepared prior to its due date. Petitioners' Federal income tax return for the1976 Tax Ct. Memo LEXIS 331">337 calendar year 1968 was investigated by an Internal Revenue agent beginning sometime in 1970. Since questions arose about the adequacy of petitioners' records during the course of this investigation, Mr. Williams advised petitioners to consult a lawyer. The lawyer consulted with respect to the investigation of petitioners' 1968 tax liability prepared their 1971 Federal tax return. This return reported a loss. OPINION Section 6012(a) requires every person having a specified amount of gross income to file a Federal income tax return, and section 6072(a) prescribes the time for filing of returns by individuals who report their income on the calendar year basis as the 15th day of April following the close of the calendar year. Section 6651(a) provides for an addition to tax for failure to timely file a return unless such failure is due to reasonable cause and not to willful neglect. Petitioners filed their tax returns on the calendar year basis. However, their return for the calendar year 1969 was filed over a year late and their return for the calendar year 1970 was filed over 4-1/2 months late. No evidence was presented of the reason for the late filing. The only witnesses in this1976 Tax Ct. Memo LEXIS 331">338 case were Mrs. Elois Garcia, the executrix of the estate of Mr. Garcia but not a party to the returns for the years here involved, and the accountant who prepared the returns of petitioners for the years 1969 and 1970. Mrs. Elois Garcia did not know why petitioners' returns for 1969 and 1970 were not timely filed. The accountant testified that he had prepared the returns and delivered them either to Mr. Garcia or to someone Mr. Garcia sent to pick up the returns prior to the date the returns were due to be filed. He further testified that he attached to the returns he had prepared a note indicating the date by which the returns should be filed, where they should be filed, and where petitioners should sign the returns. Since the returns were filed late and respondent determined that there was due from petitioners an addition to tax because of such late filing, petitioners are liable for this addition to tax unless they are able to show reasonable cause for the late filing. Paula Construction Company,58 T.C. 1055">58 T.C. 1055, 58 T.C. 1055">1061 (1972), affd. without published opinion 474 F.2d 1345 (5th Cir. 1973); Robert L. Bunnel,50 T.C. 837">50 T.C. 837, 50 T.C. 837">843 (1968); 1976 Tax Ct. Memo LEXIS 331">339 Logan Construction Company v. Commissioner,365 F.2d 846, 853 (5th Cir. 1966), affirming a Memorandum Opinion of this Court. In the instant case there is a total lack of evidence of the reason for the late filing of the 1969 and 1970 returns. Mr. Garcia is dead and for reasons not shown in the record Mrs. Ora Garcia did not testify. Understandably, Mrs. Elois Garcia who did testify did not know why petitioners' returns were filed late. She did testify that petitioners relied on an accountant to prepare their returns. Even if this had been proven to be a fact and it had been shown that the accountant negligently failed to timely prepare the returns, petitioners would not have shown reasonable cause for their failure to timely file their returns. Logan Construction Company,supra, at 854. However, Mrs. Elois Garcia did not know whether the accountant prepared the returns in time for them to be filed before their due date and the accountant unequivocably testified that he did prepare them and deliver them to petitioners prior to the time they were due to be filed. On the basis of the facts in this record, we sustain respondent's additions to tax under1976 Tax Ct. Memo LEXIS 331">340 section 6651(a) for failure of petitioners to timely file their returns for 1969 and 1970. Section 6653(a) provides that if any part of any underpayment of tax is due to negligence or intentional disregard of rules and regulations there shall be added to the tax an amount equal to 5 percent of the underpayment. Where respondent has determined an addition to tax under section 6653(a), the taxpayer has the burden of showing that no part of the underpayment was due to negligence or intentional disregard of rules and regulations. Mark Bixby,58 T.C. 757">58 T.C. 757, 58 T.C. 757">791-792 (1972), and cases there cited. The failure of a taxpayer to keep adequate books and records from which his tax liability may be computed is generally negligence of a type contemplated by section 6653(a). Estate of James Max Harrison,62 T.C. 524">62 T.C. 524, 62 T.C. 524">536 (1974). The facts here show that petitioners' records were inadequate to permit a proper computation of their tax liability. The customer collection books did not contain numbered pages and the indication from the record is that not all the collection slips were retained by petitioners. The record shows not only that petitioners did not have adequate1976 Tax Ct. Memo LEXIS 331">341 records of receipts but that they did not maintain adequate records of their expenditures or adequate records for a proper computation of depreciation on their equipment. Not only does this record fail to show the reasons for petitioners' inadequate records but the testimony of the accountant who prepared petitioners' returns indicates that he was constantly urging petitioner to keep more satisfactory records. On the basis of this record we sustain respondent's determination of an addition to tax under section 6653(a). Because of a reduction in petitioners' tax liability as determined by respondent for each year by agreement of the parties and the fact that the addition to tax is based upon the amount of the underpayment of tax, Decision will be entered under Rule 155.Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as amended.↩2. The copies of the returns for the calendar years 1970 and 1971, which are stipulated exhibits in evidence, at the top show Albert E. and Elois Garcia with a line drawn through the name "Elois" and the name "Ora" written above. The first signature on each of these returns is "Albert E. Garcia" and the second signature under the space designated "Spouse's signature" is "Elois Garcia." However, since the parties have stipulated that these are returns of Albert E. and Ora Garcia and the deficiency notice is addressed to Albert E. and Ora Garcia, and the petition filed in the name of Albert E. and Ora Garcia, we will accept the parties' stipulation.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625335/	PERKIN-ELMER CORPORATION AND SUBSIDIARIES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentPerkin-Elmer Corp. v. CommissionerDocket No. 28860-89United States Tax CourtT.C. Memo 1993-414; 1993 Tax Ct. Memo LEXIS 424; 66 T.C.M. 634; September 8, 1993, Filed 1993 Tax Ct. Memo LEXIS 424">424 For petitioner: Robert J. Cunningham, James M. O'Brien, Mark A. Oates, Fred G. D'Amato, and Debra F. Novack. For respondent: Victoria W. Fernandez, Christine Halphen, George H. Soba, and William J. Gregg. TANNENWALDTANNENWALDMEMORANDUM FINDINGS OF FACT AND OPINION TANNENWALD, Judge: Respondent determined deficiencies in the Federal income taxes of petitioner, The Perkin-Elmer Corp. (P-E) and consolidated subsidiaries, as follows: Taxable Year EndedDeficiencyJuly 31, 1975$ 1,277,967 July 31, 19761,439,257July 31, 19772,334,572July 31, 19781,970,301July 31, 19793,001,785July 31, 19804,248,794July 31, 198111,864,674The issues relating to section 482, the subject of this opinion, have been severed from certain other issues. 1 The issues presently before us for decision are: (1) Whether respondent's allocations of gross income to P-E under section 482 were arbitrary, capricious, or unreasonable; (2) whether the prices P-E paid for finished products to a wholly owned subsidiary operating in Puerto Rico were arm's-length amounts; (3) whether the prices the subsidiary paid to P-E for parts that went into the finished products were arm's-length amounts; 1993 Tax Ct. Memo LEXIS 424">425 (4) whether the royalties the subsidiary paid to P-E on sales of the finished products to P-E were arm's-length amounts; and (5) for prices or royalties that were not arm's length, what the arm's-length amounts are. In addition to finished products, which needed no further manufacturing work, the subsidiary sold so-called component products to P-E. The parties settled the section 482 implications of these component products prior to trial. FINDINGS OF FACT Some of the facts have been stipulated. The seven stipulations of fact, together with their accompanying exhibits, are incorporated by this reference. I. Introductory BackgroundA. The P-E OrganizationThe principal office of P-E was located at all relevant times in Norwalk, Connecticut. P-E and affiliated subsidiaries filed consolidated Federal income 1993 Tax Ct. Memo LEXIS 424">426 tax returns. Perkin-Elmer Caribbean Corp. (PECC), a wholly owned subsidiary of P-E operating in Mayaguez, Puerto Rico, did not join in the consolidated returns. On its returns for the taxable years ended July 31, 1975 and 1976, PECC excluded gross income by invoking section 931. On its 1977 return, PECC elected under section 936(e) to claim a credit against its income tax liability, which election was in effect through 1981. During the years in issue, 1975 through 1981, the worldwide operations of P-E and its subsidiaries were organized into five operating groups, each of which was responsible for the research, manufacturing, sales, and servicing of its products. 2 The five product areas were analytical instruments, optical systems, computer systems, flame spray equipment and materials, and military avionics. The Instrument Group, responsible for analytical instruments, included the following units with manufacturing operations: (1) The P-E Instrument Division, of which PECC was a part for management and accounting purposes, headquartered in Norwalk, Connecticut; (2) the Coleman Instruments Division, located in Illinois; (3) Perkin-Elmer Ltd. (P-E Ltd.), a United Kingdom corporation; 1993 Tax Ct. Memo LEXIS 424">427 and (4) Bodenseewerk Perkin-Elmer & Co., GmbH (Bodenseewerk), a West German corporation. P-E Ltd. and Bodenseewerk each had its own purchasing, engineering, manufacturing, marketing, and sales departments. B. The Analytical Instrument Industry1. ProductsAnalytical instruments are used to analyze samples of solids, liquids, and gases to obtain quantitative or qualitative information, including details of the chemical structures of the samples. An instrument called a spectrophotometer, with atomic absorption (AA) and infrared (IR) as common varieties, 1993 Tax Ct. Memo LEXIS 424">428 uses light as the means of analysis. An AA spectrophotometer is generally used to determine the concentrations of metallic elements in liquid samples. Typically, the sample burns in a flame and converts into atoms that float in the flame. A light source, usually a hollow cathode lamp (HC lamp), emits the characteristic wavelength of the element being measured, copper for example. The copper atoms in the sample, and only the copper atoms, absorb the copper light, and the remainder of the light strikes a detector. The proportion of the copper light absorbed by the atomized sample reveals the concentration of copper atoms in the sample. An HC lamp is cylindrical in shape with a plastic plug-in base. Much of its length is glass, which sometimes mates at the end with a quartz window. The glass bulb contains a filler gas, usually neon. Although this lamp typically has only a single-element cathode useful in measuring that element alone, multi-element HC lamps have existed since the 1960s. The useful life of an HC lamp, which eventually burns out and needs replacement in regular use, is substantially shorter than the spectrophotometer itself, causing HC lamps to be referred to 1993 Tax Ct. Memo LEXIS 424">429 sometimes as consumables. An alternative light source for some elements is an electrodeless discharge lamp (ED lamp), which offers greater intensity and longer life and sometimes offers better sensitivity. Among the major accessories for a flame-burner AA spectrophotometer is a furnace atomizer, which greatly enhances the analytical sensitivity of the instrument by atomizing samples in a furnace rather than a flame. Another AA accessory, a background corrector, minimizes the effects of undesirable background absorption and scatter; it is generally sold already installed in the instrument rather than as a later add-on. A third major AA accessory, an ED lamp power supply, is a separate power source for ED lamps. An IR spectrophotometer identifies molecules in a sample and determines their structure and concentration. A beam of invisible, IR light containing a spectrum of wavelengths passes through the sample, which absorbs the many wavelengths in varying degrees. A chart recorder graphically depicts the amount of energy absorbed at the several wavelengths, beam intensity versus wavelength. This graphical "fingerprint" is then compared to those of standard samples with known compositions. 1993 Tax Ct. Memo LEXIS 424">430 2. Instrument UsersThe primary users of analytical instruments during the period in issue were industrial, university, and governmental laboratories engaged in sophisticated analyses in areas such as research and product testing. A low price was normally not the main consideration for an instrument purchaser. Instead, factors such as a company's technical reputation in the product line, its servicing reputation, the instrument specifications, and product reliability were usually more important than price. However, because of the functional and design similarities among competitors' products in the low-priced realm, purchasers of low-priced instruments were primarily concerned with price and reliability. Overall, instrument users purchased more than half of their nonconsumable accessories from the same manufacturer that had supplied them with the associated instrument. 3 A customer generally wanted to deal with a supplier that could provide both the desired type of instrument and the associated accessories, thus entailing a single purchase order and a single warranty. In addition to convenience, other important considerations to accessory customers were quality and compatibility. 1993 Tax Ct. Memo LEXIS 424">431 Instrument users preferred to purchase consumables in general from supply houses, with little worry about compatibility, in part because they perceived supply houses as considerably less expensive than instrument companies. However, instrument users were much more likely than not to purchase lamps from the same instrument company that had supplied the associated instrument. When purchasing accessories or consumables, customers tended to value a low price somewhat less than they valued quality and delivery time, but price was not unimportant. A typical laboratory with one or more AA spectrophotometers might have several working HC lamps covering different elements, and users changed HC lamps themselves, without the need for service assistance. As with lamps1993 Tax Ct. Memo LEXIS 424">432 in general, an instrument user had a strong tendency to buy HC lamps from the instrument supplier, both at the time of instrument purchase and subsequently. Nonetheless, various sources of competition existed in the form of supply houses, other instrument manufacturers, and HC lamp makers that did not also manufacture instruments. Price was ordinarily not the main consideration for an HC lamp purchaser, but major price differences caused shifts to lower priced suppliers. HC lamps of different sizes among competitors were not a major problem for purchasers because instrument manufacturers and supply houses sold lamp adaptors that accommodated the differences. Worldwide sales of analytical instruments, which were approximately $ 1.25 billion in calendar 1977, grew at a compounded annual rate exceeding 10 percent from the late 1960s to the late 1970s. By 1975, the basic AA and IR technologies were mature and widely known. 3. P-EThere were a few full-line manufacturers in the analytical instrument industry and many small firms with strengths in selected product areas. P-E, one of the full-line manufacturers, was a leader in the industry in the United States and worldwide. 1993 Tax Ct. Memo LEXIS 424">433 Principal reasons for this position were its broad line of instruments, its continual introduction of new products and incorporation of new technology, and its strong customer support and service organization. P-E had a reputation for high quality products, and its desired "high quality, high technology" image discouraged it from seeking to meet the often lower instrument prices of competitors. In the spectroscopy area, which included the AA and IR product lines, instrument users in 1981 rated P-E the best of four major manufacturers on many nonprice factors, including technical reputation, completeness of product lines, product reliability, and service speed. P-E was the worldwide leader in the AA instrument market, holding about a 40-percent market share of units sold overall and about a 60-percent share of units sold in the United States. Its two main competitors taken together did not closely approach the P-E market share. Within the AA market in 1975, however, the P-E position was relatively much weaker in the low-priced market segment (below a $ 6,000 price) than in any of the higher priced segments. Despite its strong worldwide position in the AA area, P-E had a market1993 Tax Ct. Memo LEXIS 424">434 share below 5 percent in Japan, a country with at least 10 percent of the worldwide AA market. The AA product line was the most successful and profitable for the Instrument Division at P-E. Instrument Division annual unit sales of AA instruments were about 25 percent higher in 1980 than in fiscal 1974, and dollar sales in the AA product line had nearly doubled. The nature of the industry was such that the P-E AA instruments often reached their sales peaks only 2 or 3 years after introduction, followed by a gradual decline in the absence of significant improvements or modifications. P-E's generally high pricing relative to its competitors sometimes created pricing "umbrellas" under which competitors could sell comparable AA instruments profitably. Nonetheless, the P-E reaction to heightened competition, in the AA and other product lines, was more likely to take the form of increased marketing efforts or accelerated product improvements than published price reductions or systematic discounting. At the low-priced end of the AA product line, the P-E pricing was generally close to that of competitors but still often higher. Marketed under the "Intensitron" trademark, P-EHC lamps1993 Tax Ct. Memo LEXIS 424">435 were physically larger than those of competitors, with capacity for more filler gas and potential for longer life. P-E experienced quality problems with some of its HC lamps in about 1976, which competitors exploited. Specifically, unwanted hydrogen was appearing in the lamps because of a failure of the epoxy that sealed the quartz window to the bulb, leading P-E to switch to an improved, yet more expensive, graded seal. P-E completed the conversion in early calendar 1980. P-E also sold ED lamps, which were technologically superior to competitors' products in the mid-1970s. A P-E ED lamp, which was directly interchangeable with Intensitron HC lamps, required a separate power supply, and P-E voided the ED lamp warranty if the user operated the lamp with other than a P-E power supply. Between 1976 and 1980, P-E's dollar volume of AA lamp sales, meaning HC lamps and ED lamps combined, increased nearly 50 percent. P-E management always viewed AA lamp sales as very profitable. P-E, with about a 50-percent market share, was also the worldwide leader in the IR instrument market and, by 1977, dominated both the domestic and export markets for instruments priced over $ 7,000. Market1993 Tax Ct. Memo LEXIS 424">436 surveys by the periodical Analytical Chemistry in 1980 and 1981, as with AA instruments, showed P-E well ahead of its competitors in terms of IR quality, delivery/availability, and servicing. The weakest P-E market segment, as in the AA product line, was at the low-priced end. II. The P-E Instrument DivisionA. Product DepartmentsThe Product Departments, each headed by a product manager and staffed in part with specialized chemists, were responsible for the technical marketing of the products manufactured, or purchased and resold, by the Instrument Division. Each Product Department handled a distinct product line, such as AA, IR, gas chromatography, or fluorescence, and within the AA product line, management regarded spectrophotometers, lamps, furnace atomizers, and accessories as separate sublines. The Product Departments performed much of the customer training that took place in Connecticut and also developed marketing support materials, including periodic newsletters and occasional studies on the analysis of samples. Successful product development depended on constant interaction between the Product Departments and the sales organization, the latter often being1993 Tax Ct. Memo LEXIS 424">437 more immediately conscious of customer needs. The Product Departments also interacted with the service organization, which, in addition to identifying problems and recommending changes in the products, made suggestions for the improvement of instruction manuals and other user documentation. Product managers held periodic product support meetings at which the participants discussed engineering, manufacturing, quality, and field problems. Annually, each Product Department contributed to the preparation of a detailed written "Summary of Project Status and Plans" (SP2 report), which described by product line, both for the recent past and as projected, financial results, products, markets, competitors, and marketing strategies. The SP2 reports sometimes noted the tendency of an HC lamp user to purchase from its AA instrument supplier, while also noting that pricing and other factors, such as quality and delivery time, could override this inclination. The SP2 report prepared in 1977 described P-E ED lamps as "definitely superior in quality" to the competition, while Intensitron lamps, as a technical matter, were "at least the equivalent of any competitive" HC lamps. B. Engineering1993 Tax Ct. Memo LEXIS 424">438 The Engineering department had two principal responsibilities: product development research, which included feasibility studies and product improvements, and so-called continued engineering. Engineering determined the cost and time frame for proposed products and generally sent a product, whether an instrument or an accessory, through several development phases. After exploratory research, Engineering prepared a working "breadboard" that the Product Department evaluated on a preliminary basis. Engineering then built a few prototypes for testing by Engineering itself and perhaps a customer or two. Later, Engineering released and then worked with Manufacturing to refine detail, assembly, and test drawings, and at some point Engineering and the Manufacturing department prepared technical documentation that reflected the original design of the product and manufacturing know-how. The continued engineering function, which supported a product after it entered commercial production, dealt with design problems that arose during either manufacture or customer use. One of the duties of a continued engineer was involvement in approving engineering change notices, which revised or updated1993 Tax Ct. Memo LEXIS 424">439 specifications shown in blueprints and other engineering documents. During 1975 through 1981, the Instrument Division spent over $ 40 million on research and development, with approximately one-third of the total relating to the AA and IR product lines. C. ManufacturingThe Manufacturing department was responsible for the building and final testing of instruments, accessories, and lamps. A P-E internal report prepared sometime before July 1980 described the relationship between parts and the finished instruments: From a manufacturing point of view, the products can be characterized as follows. There are 2,000 to 3,000 parts per instrument. The [Instrument] Division sells many models, all with fairly low volume; for instance, the highest-volume product has sales of 750 units per year. Due to the existence of 7 different product lines, there is low commonality of parts. Thus, total parts-on-file number roughly 96,000. Of these, 60% are purchased (mostly electronic components) and 40% are manufactured in-house.The functional sections within Manufacturing included sheet metal, the machine shop, raw board, painting, electrical assembly, preassembly, final assembly1993 Tax Ct. Memo LEXIS 424">440 and test, lamps, and packing and shipping. The raw board section made printed circuit boards, and the machine shop and sheet metal sections produced various types of other parts with the help of computer-controlled machines. The production process for a P-E instrument typically involved the combining of several subassemblies that were themselves each made up of many parts. The final assembly and test section was important largely because of its position at the end of the manufacturing process. In this section, workers assembled optical, electrical, and mechanical parts and subassemblies into completed products, which were then tested to ensure that they met specifications. The final test technicians, who were among the most skilled employees in Manufacturing, had to have an understanding of the complete instrument and an ability to detect and correct problems. HC lamp manufacturing required precise control of materials and conditions, with an emphasis on avoiding contamination. During the manufacturing process, the lamps underwent parts inspection, cathode fabrication, glass lathing, electrical assembly, preassembly, final assembly, vacuum pumping, and testing. This process, 1993 Tax Ct. Memo LEXIS 424">441 which involved relatively few parts but certain specialized equipment, was much different than the manufacturing process for instruments. During the years in issue, the Instrument Division manufactured about 30 HC lamp models in Norwalk, and the manufacturing equipment maintained in Norwalk was capable of producing any HC lamp model that P-E sold. The Instrument Division did not purchase any finished HC lamps from unrelated suppliers. D. Quality AssuranceQuality Assurance was independent of Manufacturing, in part to avoid conflicts of interest, and the Quality Assurance manager reported to the general manager of the Instrument Division. Quality Assurance involvement was widespread. This department assisted in the selection of parts suppliers and also communicated with and visited suppliers if problems arose in the field. The inspection section inspected samples of purchased materials and parts and also sampled work-in-process from Manufacturing sections. Quality Assurance ran tests during the preproduction phases of new product development, and it audited manufactured finished products and those purchased from others for resale. Because assembly and test specifications1993 Tax Ct. Memo LEXIS 424">442 did not cover all possible problems, Quality Assurance performed tests that differed from those performed by the Manufacturing final test technicians. As a general rule, defective instruments and accessories were not scrapped in their entirety; defective parts within instruments and accessories were sometimes reworked rather than scrapped. E. Manufacturing Staff Functions1. Production PlanningThe Instrument Division planned its production on a model-by-model basis. Each Product Department prepared an annual sales forecast, subject to monthly revision, based on input from sales personnel. These annual forecasts served as the foundations for manufacturing and operating budgets. Forecasting and production planning were especially important because the cumulative production lead time for a typical instrument was much longer than the desired delivery time of 4 to 8 weeks following a customer order. In 1964, the Instrument Division began using the Material Requirements Planning system (MRP system), a software program and computer system designed to improve operational control of the manufacturing process, especially inventories. This was an ordering and scheduling system1993 Tax Ct. Memo LEXIS 424">443 that constructed a manufacturing plan from sales data, production history, and shipping schedules. Cataloged in the system was a wide variety of information, including sales and cost data, lead times, purchasing information, bills of materials, job status reports, and complete histories of products. As specific output, the MRP system, which included in its coverage HC lamps, generated at least monthly suggestions to production planners for issuing work orders to the factory or purchase orders to vendors. The production planners could adjust the suggestions based on their reviews of forecasts and inventories. In one way or another, the MRP system interacted with virtually all areas of Instrument Division activities, including the Purchasing department, Engineering, the service organization, and the final assembly and test section of Manufacturing. Analytical instrument manufacturers ordinarily built some portion of their production in direct response to customer orders rather than as inventory. The Instrument Division used this technique in Norwalk for some of its AA products that had many variations, but did not use it for the more standardized IR product line. 2. Purchasing1993 Tax Ct. Memo LEXIS 424">444 The Instrument Division maintained a Purchasing department, with 12 or 13 employees, to ensure timely supplies of materials and parts. The expenses associated with Purchasing, not including amounts paid for purchased items, totaled approximately $ 3.1 million from 1975 through 1981. Purchasing ultimately selected almost all of the Instrument Division vendors, although the selection process could involve Engineering, Quality Assurance, and manufacturing engineers. Engineering was familiar with specialized vendors and sometimes specified them for certain parts. Quality Assurance surveyed potential vendors, as did the manufacturing engineers, and also kept files and history cards as a record of vendor quality. For mechanical parts, as contrasted with electronics, Purchasing usually acted alone in selecting vendors. Purchasing maintained a qualified vendor list, which was proprietary information but not unlike what other instrument manufacturers compiled, and an "approved component list" of the most reliable sources for basic electronic parts. The Purchasing buyers, most of whom had college degrees, usually served at least a few years as parts expediters before becoming buyers. 1993 Tax Ct. Memo LEXIS 424">445 Initial training for buyers consisted of a 12-week purchasing and procurement course, and training available thereafter included technical seminars conducted by vendors, internal monthly meetings, negotiation seminars, and trade school enrollment. Some Purchasing personnel read technical bulletins and trade journals and maintained contacts with account executives of major vendors. The more senior buyers in Purchasing were responsible for purchasing hard-to-locate items and so-called complex and highly complex items, which were made to P-E specifications. For the complex and highly complex parts, the buyer provided the vendor with specialized engineering drawings that the buyer had reviewed with Engineering. Parts that were difficult to manufacture usually necessitated in-person negotiations, which the buyer often attended with representatives from Quality Assurance and the manufacturing engineering function. The two supervisory purchasing agents in Purchasing became directly involved in production planning by attending planning/shortage meetings twice a week. By 1975, the MRP system enabled Purchasing to be much more effective in scheduling and rescheduling delivery dates on1993 Tax Ct. Memo LEXIS 424">446 purchase orders. Interfacing with the MRP system was a computerized purchasing system, with a vendor historical file base, that generated reports and purchase orders. The purchasing process for mechanical parts began when Purchasing received a requisition form from the production people specifying a part number, quantity, and required delivery date. If P-E had at some previous time manufactured the part itself, the requisition form would indicate the P-E manufacturing standard cost. Assuming adequate lead time, which was not always the case, Purchasing was supposed to pay an outside vendor no more than this standard cost. These outside purchases of parts that had also been manufactured by P-E were recorded in inventory account 2403 of the P-E general ledger. The electronics specialists in Purchasing, unlike the mechanical specialists, rarely used account 2403. Petitioner engaged the public accounting firm of Arthur Andersen & Co. (Arthur Andersen) to make calculations and render opinions concerning various accounting matters. After adjusting for items such as consignment transactions and purchases requiring additional work by P-E, Arthur Andersen determined that the account1993 Tax Ct. Memo LEXIS 424">447 2403 data from March 1978 through July 1980 showed aggregate actual purchased costs below aggregate manufacturing standard costs by 19.6 percent in 1978 and 2.1 percent in 1979, and purchased costs above standard costs by 8.2 percent in 1980; the summed purchased costs over the full period were 11.5 percent below the summed standard costs. The costs recorded in account 2403 during this period represented less than 1 percent of the Instrument Division cost of sales. III. P-E Distribution ActivitiesThe P-E marketing and sales organization for analytical instruments was superior to most or all of its competitors for the AA and IR product lines. The Instrument Division sold its products to end users in the United States through the U.S. Sales and Service Division (USSD) of the Instrument Group, which had offices throughout the country. For foreign distribution, apart from some direct sales to unrelated foreign customers, the Instrument Division sold either to foreign subsidiaries of P-E or to Perkin-Elmer International, Inc. (P-E International), both of which resold to unrelated foreign distributors or dealers. P-E International, a domestic corporation wholly owned by P-E, 1993 Tax Ct. Memo LEXIS 424">448 joined in the P-E consolidated income tax returns. The Instrument Division used these same channels to distribute the products purchased on an original equipment manufacturer (OEM) basis. OEM products were those manufactured by others, then purchased by P-E and resold under the P-E name and trademarks. The USSD sales organization had sales engineers and product specialists among its over 300 employees. A product specialist was a chemist who provided technical assistance to users in a particular product line. Located in regional offices and at the Norwalk headquarters, the product specialists conducted most of the training for Instrument Division customers, and a training course was free with the purchase of an AA spectrophotometer. Sales laboratories located around the United States enabled customers to learn how to operate instruments while testing their own samples. The P-E marketing and sales approach for analytical instrumentation involved customer visits and technical literature, and management thought it important to maintain a full range of products in order to be able to satisfy all of a customer's needs. USSD salespeople, in visits with existing and prospective customers, 1993 Tax Ct. Memo LEXIS 424">449 determined their analytical requirements, helped them prepare product proposals, sometimes arranged for demonstrations at sales laboratories, prepared product quotations, and ultimately took orders. Compensated by commission, the salespeople generally exerted more effort on the higher priced products, which coincided with management's philosophy to avoid overselling low-priced instruments to the detriment of higher priced units. Technical literature, normally prepared by the Product Departments, was either product specific or more general in nature. Product-specific literature consisted mainly of data sheets, which described detailed specifications, and product brochures. The data sheets and brochures were more elaborate for the more complex and expensive products in the AA and IR lines, and brochures were generally not prepared specifically for accessories or HC lamps. Major accessories, however, often had a short data sheet. More general technical literature, such as customer newsletters and original or reprinted journal articles, illustrated various applications of analytical techniques, sometimes with the use of a specific product. All AA instruments sold by P-E came with1993 Tax Ct. Memo LEXIS 424">450 a 1-year newsletter subscription and a "cookbook" describing over 400 analyses. There was a similar cookbook for the furnace atomizer AA accessory. The advertising department in USSD placed ads in professional publications such as technical and trade journals, prepared mailings, and organized exhibitions and workshops. Some ads covered specific instrument models, others covered a product line, and still others promoted the P-E corporate image. Trade show exhibitions were an important promotional method in the analytical instrument industry, and P-E was a regular participant. The Instrument Division usually displayed its newest products at trade shows, but sometimes used extra space to exhibit best sellers; both categories at times included lower to mid-priced instruments. P-E often marketed its instruments and accessories together. An instrument brochure frequently included a section highlighting available accessories, and at times P-E offered price incentives on AA and IR accessories for a package instrument/accessory deal. In the AA product line overall, P-E did not widely advertise its accessories. The AA product line included some accessories that customers avoided because1993 Tax Ct. Memo LEXIS 424">451 of perceived high prices, and, because of development resources diverted elsewhere in the mid-1970s, some accessories lost their competitive edges technologically. At least some of the AA accessories, however, faced no outside competition. The IR accessory business for P-E, which tended to follow the IR instrument business, was very profitable in the mid-1970s. This encouraged competition and prompted P-E to offer discounts and other customer incentives such as generous trade-in allowances. For most of the period in issue, the sale of HC lamps was little more than an order-taking activity for P-E salespeople, like that of catalog salespeople. Although the annual SP2 reports sometimes urged or predicted increased marketing efforts, P-E did not attempt aggressive promotion and advertising until about 1980. P-E informational brochures, however, did mention that Intensitron HC lamps were "particularly notable for brightness, stability, and long life" and were "designed specifically for best atomic absorption performance, and combine long, usable lifetimes with high intensity and stability." The catalog of a large supply house that sold HC lamps manufactured by Westinghouse described1993 Tax Ct. Memo LEXIS 424">452 these lamps as "Spectral tubes designed for high spectral output, excellent stability, low noise and long operating life; providing the analyst with higher precision, sensitivity and detectability." Also a part of USSD was the service department, with personnel spread among field offices, regional offices, and the Norwalk headquarters. Service engineers installed all AA and IR instruments sold by USSD, and they also performed warranty and maintenance work. An instrument user could easily install HC lamps, however, without service assistance. Although outside service contracts were an option for users, P-E tended to service its own instruments, and, for its nonwarranty service work, its activities were generally profitable. A 1-year warranty covered the instruments and accessories sold by the Instrument Division. HC lamps had a 2-year spectra-emission warranty and a 6-month intensity warranty. Use of competitors' HC lamps in a P-E instrument did not void the P-E instrument warranty. IV. PECCA. OriginDuring 1968 and 1969, Instrument Group management was exploring the possibility of adding a Puerto Rican operation, in part because of capacity constraints in Norwalk. 1993 Tax Ct. Memo LEXIS 424">453 In May of 1970, Gaynor Kelley (Kelley), the head of Manufacturing, made a presentation to the P-E board of directors recommending that P-E establish a manufacturing operation in a leased facility in Mayaguez, Puerto Rico. According to Kelley's written proposal, the Instrument Division intended the new facility to perform assembly operations on specified finished products and component products, all using parts, supplies, and subassemblies provided by the Instrument Division. The proposal stated that the Instrument Division would transfer all the necessary parts at standard cost plus 10 percent and would purchase all the finished products at a 25-percent discount off list price. At least for the early years, Kelley envisioned the new operation selling its entire output to P-E. The proposal emphasized various tax exemptions and income tax savings available in Puerto Rico. Among the other favorable factors Kelley mentioned were a high unemployment rate relative to the United States and a low wage rate relative to Norwalk. He assumed a 25-percent increase in productivity over comparable Instrument Division operations in the United States. Following Kelley's presentation, the board1993 Tax Ct. Memo LEXIS 424">454 of directors approved a manufacturing operation in Puerto Rico and authorized the creation of a wholly owned subsidiary. PECC filed its certificate of incorporation with the State of Delaware in June 1970, and operations commenced at the Mayaguez facility in early October. In December 1970, the government of Puerto Rico granted applicant PECC a 15-year industrial tax exemption applicable to various specified products. In its application dated in July 1970, PECC described its marketing outlets as follows: "Sole purchaser of products manufactured by Applicant will be The Perkin-Elmer Corporation of Norwalk, Connecticut, which enjoys a worldwide market." B. Licensing and Distribution AgreementsP-E and PECC entered into a General Licensing Agreement dated as of October 1, 1970, by the terms of which P-E granted PECC an exclusive right to manufacture in Puerto Rico and a nonexclusive right to use and sell worldwide the instruments and accessories to be identified in specific licenses. P-E also agreed to furnish PECC with all design and manufacturing information, including any then still to be developed, associated with any licensed products. PECC agreed to pay royalties on1993 Tax Ct. Memo LEXIS 424">455 the products based upon the "Net Sales Price", defined as "the net amount billed and payable for * * * [licensed products] excluding import duties, insurance, transportation costs, taxes which are separately billed and normal trade discounts." In practice, P-E and PECC interpreted this definition to mean the amount PECC billed P-E rather than the amount P-E billed upon resale. The specified term of this agreement was until the expiration of the last license entered into pursuant to the agreement. The General Licensing Agreement was very similar in form and content to agreements of July 1966 between P-E and subsidiaries P-E Ltd. and Bodenseewerk, except that the 1966 agreements were cross-licensing agreements covering P-E's role as both a licensor and a licensee. As part of the P-E agreements with P-E Ltd. and Bodenseewerk, the parties licensed specific AA and IR instruments for a 6-percent royalty and a Model F-11 gas chromatography instrument for a 7-percent royalty. In its "intersite" licensing arrangements with subsidiaries, the P-E policy was to reduce the royalty rate by half if, for a particular licensed product, the parts sold by the licensor to the licensee represented1993 Tax Ct. Memo LEXIS 424">456 more than 35 percent of the licensor's manufacturing cost for the finished product. A 1968 internal P-E memorandum described the 35-percent crossover point for a so-called partial versus a so-called complete transfer as based on an "arbitrary assumption". Although neither the General Licensing Agreement nor the specific licenses with PECC manifested this intersite policy, P-E incorporated it into the 1966 agreements with P-E Ltd. and Bodenseewerk by means of 1968 amendments. The General Licensing Agreement did state that P-E would reduce the royalty if PECC caused a "major redesign" of a product, but PECC never made any changes that met this classification. The first license that P-E and PECC entered into pursuant to the General Licensing Agreement was also dated as of October 1, 1970, and had a term of 10 years. This license identified HC lamps, the Model 700 series IR spectrophotometers, and four models of AA spectrophotometers as licensed products subject to a royalty rate of 3 percent. It also identified a Model F-11 gas chromatography instrument as subject to a royalty rate of 3.5 percent. The parties intended the PECC royalty payments to cover engineering technical assistance1993 Tax Ct. Memo LEXIS 424">457 but not other technical assistance. P-E and PECC entered into no more written licenses until one dated as of October 1, 1980, again for a term of 10 years. This license identified various finished products as subject to a 3-percent royalty. In May of 1971, representatives of P-E and PECC executed a Distributor Agreement in which P-E agreed to act as a worldwide distributor for PECC. The agreement did not explicitly state that P-E would be an exclusive distributor. P-E was obligated to purchase from PECC, f.o.b. Mayaguez, only the quantities it ordered and at the prices specified in then current price lists and schedules. PECC was to sell and deliver products subject to the terms and conditions of its standard sales order. The agreement did not specify ordering lead time, and payment terms were to be as "mutually agreed". The agreement was to continue in effect for at least 1 year and thereafter indefinitely until either party gave 90 days' written notice of termination. C. Products and SalesPECC never sold or otherwise distributed its finished products to any unrelated party. Although alternative distribution arrangements, at least on a small scale, were considered, 1993 Tax Ct. Memo LEXIS 424">458 PECC sold and shipped all of these products to P-E. The PECC finished products were AA spectrophotometers and accessories, HC lamps, IR spectrophotometers and accessories, and gas chromatography accessories. The AA and IR instruments were generally low priced, high volume, and easy to use relative to the other P-E instruments in these two product lines. The PECC finished product sales totaled $ 74,012,133 from 1975 through 1981. 4 As percentages of this total, instrument sales (including autobalances and furnace atomizers) were approximately 45 percent, HC lamp sales were 30 percent, and accessory sales were 25 percent. 51993 Tax Ct. Memo LEXIS 424">459 PECC recorded gross profit margins of 30.2 percent for instruments, 62.7 percent for HC lamps, and 55.4 percent for accessories. 6PECC generally produced the lowest priced AA spectrophotometers then offered for sale by the Instrument Division, plus one or two models from adjoining low-priced or mid-priced segments. Except for Models 560 and 2380, which had customer list prices in the neighborhood of $ 12,000, all of the PECC AA spectrophotometers had published prices between $ 4,000 and $ 10,000. PECC also produced heated graphite furnace atomizers, Models HGA 2100 and HGA 2200, with list prices between $ 4,000 and $ 5,000. Another major AA accessory that PECC produced was the autobalance, Models AD-2 and AM-2, used to weigh solid samples to be analyzed with a furnace atomizer. The list price of the Model AD-2 1993 Tax Ct. Memo LEXIS 424">460 averaged about $ 3,500. PECC recorded sales of AA instruments, HGA furnaces, and autobalances as follows: AA ProductYears ProducedSalesModel 1031975-1977$ 453,661 Model 1071975-1977797,700HGA furnace1975-19796,348,729Model 3601976293,513Model 3701976-1977784,125AM-2 autobalance1976-197898,409AD-2 autobalance1976-1979975,326Model 3721977-1979755,507Model 2721978-19801,348,200Model 2801979-19801,163,246Model 3801979-19803,301,340Model 5601980534,660Model 22801980-19811,885,261Model 23801980-19815,964,078Total $ 24,703,755In 1975, the P-E market share in units for its low-priced AA instruments, Models 103 and 107, was only 26 percent in the United States and, because of P-E's relatively high overseas pricing, 13 percent worldwide. Orders for these models were already in a state of decline because of the competition, including that from P-E's own lower mid-priced instruments. The Models 103 and 107 lacked reliability and the key features offered by competitors, rendering them unattractive to both users and the sales force. P-E discontinued these models in 1977. The Models 360 and 370, introduced in 19741993 Tax Ct. Memo LEXIS 424">461 and 1975, respectively, were in the lower mid-priced market segment in 1975, where P-E had a 56-percent U.S. market share and a 40-percent worldwide share. Management forecast a drop of about 12 percent in unit volume for 1976, but, mainly because of a desirable upward shift in the P-E product mix, the actual drop was 33 percent. In 1977, when P-E discontinued these models, the drop in unit volume was again 33 percent. Because of pricing pressure from competitors, the Model 372, introduced in 1977, was priced overseas at or below domestic prices. Management viewed this model as offering more for the user's money than competitors' products. Customer response was excellent, and unit orders in 1978 exceeded the forecast. In 1979, when P-E introduced the replacement Model 380, unit sales decreased substantially from 1978, primarily because of severe competition from the new products offered by Varian/Techtron. In 1979, the Model 560 also confronted Varian/Techtron competition, which prompted P-E to offer a free background corrector valued at about $ 1,500 with the instrument, which in turn greatly increased sales. The Model 2380 replaced the Models 380 and 560 in 1980, and, according1993 Tax Ct. Memo LEXIS 424">462 to the SP2 report covering that year, "demonstrated itself to be a real winner." The Model 272, which replaced the Models 103 and 107, was P-E's only single-beam AA instrument in 1978. Although management viewed it as a very good value for its low price, USSD sales engineers preferred to push higher priced models, and it sold overseas at domestic prices or less. P-E replaced the Model 272 with the Model 280 in 1979, which was in turn replaced in 1980 by the Model 2280, still a single-beam instrument. The Model 2280 encountered severe price competition in Europe. Nonetheless, unit sales of P-E single-beam instruments increased 25 percent in 1980. P-E modified the HGA 2100 to create the HGA 2200 in March 1977. The market for furnace atomizers was very competitive and price sensitive, but P-E began to take control in the late 1970s because of superior products, especially the replacement models for the PECC-produced furnaces. P-E replaced the HGA-2200 in March 1979. In the medium-priced market for nonrecording electronic microbalances, which the P-E autobalances shared with only one major competitor, P-E had over half of the market through 1976. P-E salespeople, however, showed1993 Tax Ct. Memo LEXIS 424">463 little interest in selling autobalances. The first IR spectrophotometer produced by PECC was the Model 700, beginning in 1971. From 1975 through 1981, PECC produced successor products in the Model 700 series, which generally had customer list prices between $ 4,000 and $ 8,000. In 1981, PECC began production of the Model 1300 series, with list prices between $ 8,000 and $ 13,000. PECC recorded sales of IR instruments as follows: IR InstrumentYears ProducedSalesModels 710, 710B1975-1981$ 2,584,804Models 727, 727B1975-19813,198,855Models 735, 735B1975-19811,906,588Model 13101981113,530Model 13201981152,950Model 13301981483,000Total $ 8,439,727The Model 700 series instruments, P-E's lowest priced IR spectrophotometers, had become technically reliable by 1975, and the sales force was comfortable selling them. However, the P-E market share did not approach that of Beckman Instrument Co. in this low-priced segment, and the SP2 report for 1976 characterized these products as "extremely old" and the "only weak link in the [IR instrument] chain". P-E introduced the Model 1300 series in 1981 and within a few months discontinued selling the instruments1993 Tax Ct. Memo LEXIS 424">464 replaced, Models 727B and 735B. The Model 710B remained as P-E's lowest priced IR spectrophotometer. Even after the exclusion of autobalances and HGA furnaces, see supra note 5 and p. 31, most of the PECC accessory dollar volume, which was nearly $ 19 million in total, was in the AA product line. The highest dollar volume accessory was the ED lamp power supply, with sales of $ 4.8 million. Other PECC AA accessories generated another $ 7.9 million in sales. The PECC sales of IR and gas chromatography accessories were $ 5.1 million. In 1980 alone, PECC produced at least 30 accessories with differing part numbers. The P-E weighted average resale price of a PECC accessory sold to an unrelated party, after all applicable discounts, was $ 294 in 1980 and $ 341 in 1981. Only a few of these accessories had unit selling prices well below $ 200, but the range was from less than $ 40 for AA burner chambers and lamp brackets to over $ 2,600 for a sophisticated ED lamp power supply. PECC also built over 50 types of HC lamps with differing cathodes, some of them multi-element. The customer list price for most models was between $ 125 and $ 300, and P-E offered discounts of 10 and 1993 Tax Ct. Memo LEXIS 424">465 20 percent for volume purchases of 7 and 12 lamps, respectively. The HC lamp adaptor sold by P-E, which accommodated the smaller HC lamps of competitors, had an average list price of about $ 100; a similar adaptor was available from a large supply house in 1981 for $ 70. D. OperationsPECC, which conducted its operations in a facility leased from the Puerto Rican government, owned the machinery, equipment, and tooling, most of which it purchased from P-E. PECC grew from 7 employees in October 1970 to 93 in 1980. Most employees had high school educations, with many having electronics or other technical training but none having an engineering degree. PECC experienced low employee turnover and, generally, was at least as efficient as Norwalk in terms of labor hours for transferred products. The general manager at PECC reported directly to the head of Manufacturing. In the early 1970s, when P-E sent parts to PECC for a newly transferred finished product, it also sent various types of documentation, including a set of blueprints and detailed part drawings. At least one person at PECC, the general manager, was capable of interpreting this technical documentation, and the blueprints1993 Tax Ct. Memo LEXIS 424">466 were sometimes used to troubleshoot products during the final assembly and test stage. Later parts shipments for an already transferred finished product occasionally included engineering change notices and documents affected by the changes. Sometime during the years in issue, PECC began updating its prints based on the change notices instead of continuing to receive new prints. Other documentation sent to PECC by P-E included assembly drawings, assembly and test specifications, and operations sheets describing in some detail how to assemble the product. The Instrument Assembly and Test department at PECC used a progressive production line, consisting of various stations, to combine subassemblies and other parts into instruments and accessories. In addition to the final assembly operations, completion of an instrument involved optical alignment, final testing, and quality checks. Optical alignment took 2 to 4 hours, and final testing averaged about 15 hours. Production of accessories was similar to, but generally less complex than, production of instruments. For the instruments and accessories worked on by PECC, the final assembly and test function was similar to that at P-E. 1993 Tax Ct. Memo LEXIS 424">467 PECC established an HC lamp production area in 1971. Cathode fabrication involved either the mixing and compressing of metal powders, followed by oven heating, or the induction heating of pellets; the resulting metal slug was then lathed into shape. Later, glass lathing joined the outside bulb to the stem and assembly. The lamp at some point was filled with an inert gas and then purged of the gas, with several repetitions, and a vacuum system came into play during the final stages of production. As a test of the completed HC lamp, its intensity was checked while in use in an AA instrument. PECC incurred both scrap and rework costs during production. Although production problems usually did not result in the scrapping of an entire instrument or accessory, defective HC lamps were scrapped. If Quality Assurance in Norwalk discovered major defects in PECC finished products, they were reworked in Norwalk; P-E charged the associated labor costs to PECC. The PECC production volume was neither constant nor assured, which at least once caused PECC to lay off some employees. PECC production scheduling depended heavily on in-hand customer orders at P-E, and, as noted, customer demand1993 Tax Ct. Memo LEXIS 424">468 for a given instrument model commonly peaked 2 to 3 years after introduction and then declined. Another influence on an uncertain production volume was the refusal of Instrument Division management to transfer production to PECC if the move would cause a loss of jobs in Norwalk. A mitigating factor for PECC, however, was the requirement of the Puerto Rican government that PECC maintain a specified minimum level of employment, with which management strived to comply. In addition to uncertain production volume, PECC had no guarantee of a minimum gross margin on a product. For example, the PECC >costs of sales for HGA furnaces exceeded net sales revenue in both 1978 and 1979, resulting in negative gross margins. E. Parts and Parts KitsPECC purchased from P-E substantially all of the parts required for its finished products. These parts included electrical items such as capacitors, resistors, transistors, and transformers, and mechanical items such as sheet metal parts, castings, machined parts, plastic parts, and optics. Essentially all of these individual parts were either standardized, off-the-shelf items readily available from third parties, often by catalog order, or1993 Tax Ct. Memo LEXIS 424">469 they could be custom-made by, for example, machine shops or sheet metal shops. P-E sold many parts to PECC that had been purchased from suppliers and then shipped without any application of P-E direct labor. Although PECC itself sometimes produced electrical or mechanical subassemblies that went into its finished products, in other cases P-E produced subassemblies before shipping parts to PECC. For the parts to which P-E applied direct labor manufacturing and finishing operations, examples of such operations were: (1) Manufacturing of printed circuit boards; (2) machining, including lathe work on steel tubing and copper rods; (3) injection molding of plastic parts; (4) sheet metal work; (5) manufacturing of optical parts; and (6) for HC lamps, manufacturing of graded seal bulbs, cathode holders, and lamp bases. The P-E standard costs for these types of parts often approximated or exceeded the cost if purchased from outside suppliers. However, P-E rarely contracted out to others the specific parts it manufactured and sold to PECC; very few of the parts that Arthur Andersen analyzed in account 2403, see supra pp. 20-21, were identical to any of those that P-E sold to PECC. 1993 Tax Ct. Memo LEXIS 424">470 For each of its finished products, P-E maintained a computerized listing of the parts necessary for its manufacture. For cost accounting, invoicing, and shipping purposes, certain listed groupings of parts, known as "parts kits", were each assigned a unique part number with the prefix "031". In addition to meaning a listed grouping of parts, "parts kit" could refer to the physical parts themselves. In this latter sense, however, "kit" was a misnomer because the parts in a given parts kit were not packaged in an individual grouping for shipment. There was no market for physical parts kits as such, and P-E did not sell them in the ordinary course of business to unrelated parties. A complicated product could have several parts kits in its comprehensive parts listing, and often a parts kit was one of the listed parts in a higher level parts kit. The dual ED lamp power supply, for example, had seven parts kit listings, some of which were embedded in one or more of the others. A parts kit also sometimes included parts without an 031 prefix that, like parts kits, were composites of several other parts. The parts kit system enabled PECC to streamline its ordering of parts for a particular1993 Tax Ct. Memo LEXIS 424">471 finished product, and, when there were embedded parts kits, PECC ordered the high-level one. When P-E billed PECC for the parts, the invoice listed only the part number and price of the high-level parts kit. The invoice did not list embedded parts kits and other parts that comprised the high-level parts kit. For ease of inventory retrieval and shipping, P-E first resorted and consolidated the listings of constituent parts in the parts kits ordered by PECC, in part number order, on an "8080" listing. The parts were then drawn from inventory against the 8080 listing. When the parts arrived at the PECC receiving area, in up to 40 boxes, the PECC receiving personnel unpacked the shipping crates, visually inspected and counted the parts, documented any damages, and then routed the parts to the appropriate work centers. Missing and backordered parts were included in subsequent shipments. PECC did not keep an inventory of spare parts and thus was dependent upon P-E to supply replacements for defective parts discovered during production. This lack of inventory could lead to the stoppage of a production line while awaiting the replacement parts. Arthur Andersen calculated the P-E1993 Tax Ct. Memo LEXIS 424">472 inventory carrying cost for parts sold to PECC as $ 1.8 million during the period in issue, based on a cost of capital of 37 percent. The bank prime interest rate during this time, which averaged 10.58 percent, closely approximated the P-E cost of short-term borrowing. F. Relationship and Interaction with P-E1. Sales and Royalty TransactionsFor the parts it sold to PECC, P-E charged its standard cost plus 21 percent through 1978 and standard cost plus 13.12 percent thereafter. The P-E standard cost included incoming freight and inspection. For the 7-year period in issue, PECC bought parts for finished products at $ 4.6 million over the P-E standard cost of $ 27.8 million, for an average markup of over 16 percent. The P-E invoices for parts stated that the parts were f.o.b. P-E, and PECC paid the freight to Mayaguez. Through August 1977, PECC sold its finished products to P-E at a discount of 25 percent off the P-EU.S. list price on the date P-E issued its purchase order. Beginning in September 1977 and continuing through 1981, the discount was 30 percent. 7PECC invoiced P-E at the time of shipment to P-E. 1993 Tax Ct. Memo LEXIS 424">473 PECC paid royalties to P-E based on the prices PECC charged P-E for the finished products, which, as noted, were 25 or 30 percent below the P-EU.S. list prices. The royalty rate was 3 percent. 8 From 1975 through 1980, PECC paid royalties on several products, including all accessories it sold to P-E, that were not identified in the 1970 licensing agreements with P-E. 2. Intercompany AccountP-E and PECC used an intercompany account to record transactions between them. Amounts owed by PECC for administrative services, parts purchases, royalties, and other intercompany charges were netted against amounts owed to PECC by P-E. P-E, which was the net debtor in this arrangement, made cash payments to PECC to reduce its intercompany payable balance. As determined by Arthur Andersen, the P-E intercompany payables were outstanding for an average of 77 days. The PECC invoices, however, 1993 Tax Ct. Memo LEXIS 424">474 called for payment by P-E on finished products within 30 days. 3. Norwalk Support GroupThe Norwalk Support Group, organized in August 1974 and based in Connecticut, consisted of two to five employees who monitored the PECC activity and provided continual manufacturing engineering, production planning and scheduling, and other support services. The salaries, employee benefits, and allocable overhead expenses of the Norwalk Support Group members were included in the PECC general and administrative overhead. The manufacturing engineering function in the Norwalk Support Group identified finished products with potential for transfer to PECC, collected and sometimes prepared necessary technical documentation, developed training programs for the PECC employees, assisted in the acquisition or repair of capital equipment, and monitored the quality of PECC instruments. The production planners in the Norwalk Support Group used the MRP system in scheduling the PECC production. See supra pp. 17-18. Other specific responsibilities included preparing the purchase orders and sales orders for parts and finished product transfers between P-E and PECC, determining the parts necessary1993 Tax Ct. Memo LEXIS 424">475 for the manufacture of new products, and expediting parts through Purchasing. With the assistance of the MRP system, the production planners released a parts kit to PECC by issuing a PECC purchase order to P-E; simultaneously, they issued a P-E purchase order to PECC for the purchase of the associated finished product. PECC production generally corresponded closely to customer orders, in the sense that a customer order for the finished product was in hand at P-E over 80 percent of the time when PECC placed a purchase order for parts. An order was almost always in hand at the time PECC completed a finished product for shipment to P-E. 4. OtherAs part of its regular activities and with no special effort, Purchasing in Norwalk acquired the outside parts needed for the PECC finished products. A small scale purchasing operation at PECC, which would have required three or four people, would have been largely a duplication of Norwalk cost and effort. An on-site PECC purchasing department, however, obviously would have been closer to parts suppliers, machine shops, and sheet metal shops that were available in Puerto Rico. Although PECC sometimes recommended process changes to1993 Tax Ct. Memo LEXIS 424">476 P-E that could affect the operations sheets, PECC had no research and development facilities or personnel and no engineering department. Quality Assurance in Norwalk audited PECC finished products and performed tests that differed from those performed by the PECC final test personnel. PECC also lacked marketing, sales, and service functions, and among the P-E activities with which PECC had no involvement were preparation of application studies, customer training and support, and customer billing. P-E also handled all of the registration requirements for PECC products with Federal regulators. Training for PECC employees often involved Norwalk personnel, whether the Norwalk Support Group or others. Sometimes a PECC employee spent training time in Norwalk, and sometimes a Norwalk technician or engineer traveled to PECC. P-E charged PECC for at least some training expenses every year, but the charges did not include training costs incurred by Engineering personnel. P-E performed several functions in distributing PECC finished products: marketing and sales, installation, customer training and support, and service. PECC products were never advertised under that name. Depending 1993 Tax Ct. Memo LEXIS 424">477 on its nature, a PECC finished product was the technical marketing responsibility of the AA, the IR, or the gas chromatography Product Department. Although P-E provided the same high level of customer support and service for the AA and IR instruments produced by PECC, the USSD salespeople typically did little except respond to telephone inquiries and take telephone orders. Nonetheless, the salespeople were familiar with the characteristics and specifications of these instruments, partly through memoranda disseminated by the Product Departments. PECC did not provide a warranty on the finished products sold to P-E, nor did it reimburse P-E for product defects discovered by users. For the period 1976 through 1981, Arthur Andersen determined that USSD installation and warranty expense was 3.1 percent of P-E's total net sales of PECC finished products to unrelated parties, while billable and contract service income net of associated expenses was 2.7 percent of those sales. 91993 Tax Ct. Memo LEXIS 424">478 5. P-E Resale of PECC Finished ProductsThe Instrument Division resold the PECC finished products under the P-E name and trademarks through the same sales channels it used for its other products. Like Instrument Division products in general, a large portion of PECC finished products went into foreign markets. Arthur Andersen, which assumed a 30-percent discount from domestic list prices for all years, see supra note 7, concluded that during the period in issue P-E earned an average 31.1 - percent gross margin on resales to unrelated parties of the PECC finished products. The high was 32.4 percent in 1980 and 1981, and the low was 29.7 percent in 1979. By type of finished product, the average gross margins were 31.5 percent for instruments (ranging from 29.7 to 33.9 annually), 32.0 percent for accessories (ranging from 29.9 to 35.6 annually), and 29.5 percent for HC lamps (ranging from 27.8 to 30.4 annually). In 1980 and 1981, the spread between the highest and lowest margin product groups was over five percentage points. According to these calculations, resales in foreign markets were over one-third of the total resales to unrelated parties. For the PECC finished1993 Tax Ct. Memo LEXIS 424">479 products that P-E resold to unrelated parties in 1980 and 1981, the consolidated gross margins by product category were as follows: 19801981Instruments61.4%62.4%HC lamps70.2%71.0%Accessories73.8%72.8%These gross margin figures are a function of the P-E net sales revenue and the combined standard costs of P-E and PECC. Higher gross margins for HC lamps and accessories were typical even when P-E alone manufactured and sold these products. As determined by Arthur Andersen, P-E held the PECC finished products in inventory for an average of 27 days before shipment to customers. The holding period was 20 days for instruments and 33 days for HC lamps and accessories. V. Potential Comparable TransactionsA. Finished Products1. Spectra-Physics and P-EAn integrator is an electronic data handling accessory that analyzes measurements made by a gas chromatography instrument. During the years in issue, the Instrument Division purchased and resold integrators manufactured by Spectra-Physics, Inc. (Spectra-Physics). The annual agreements establishing the terms and conditions treated P-E as a nonexclusive, worldwide OEM dealer (see supra p. 1993 Tax Ct. Memo LEXIS 424">480 21 for "OEM" definition) for integrators, associated accessories, replacement parts, and supplies. The agreements sometimes set forth an annual delivery schedule listing the number of units per quarter and always included a provision requiring 90 days' notice for P-E schedule changes or shipping requirements. For fiscal 1976, as specified in the agreement dated July 31, 1975, the price charged by Spectra-Physics to P-E was to be a 32-percent discount from the P-E domestic list price if P-E accepted delivery of at least 300 units. The lowest discount was 26 percent for delivery of 100 to 249 units. The discount for supplies and accessories coincided with the applicable integrator discount. The express payment terms were net 30 days from the date of the Spectra-Physics invoice. The agreement also stated that Spectra-Physics would make personnel available to provide product or service training, upon request, up to 10 days in each of Europe and the United States, with both parties bearing their own expenses. The parties later amended the July 1975 agreement, effective for shipments made after October 28, 1975. Under the revised agreement, the maximum discount, again for 300 units1993 Tax Ct. Memo LEXIS 424">481 or more, was 30.5 percent off the Spectra-Physics domestic list price. The agreement for fiscal 1977 was substantially the same as that of the previous year as amended. There was, however, no provision covering training. In addition, the new agreement included a warranty that Spectra-Physics would repair free of charge all integrators rejected by P-E within 30 days of the shipment date. The parties also agreed on the applicable charge for nonwarranty repair work performed by Spectra-Physics. The fiscal 1978 agreement lowered the delivered quantity to 250 to qualify for the maximum 30.5-percent discount, but was otherwise substantially the same as the preceding agreement. The agreement covering June 1980 through May 1981 specified: (1) A 200-unit delivered quantity to qualify for the maximum discount of 28.5 percent; (2) exact prices rather than the normal integrator discount for several parts, accessories, and supplies; and (3) an intricate method for determining the Spectra-Physics repair charge for nonwarranty work. Spectra-Physics painted the integrators in P-E colors, which enabled P-E to resell them without further manufacture. P-E resold them as the Model 1 computing1993 Tax Ct. Memo LEXIS 424">482 integrator and the Model 2 calculating integrator, at list prices ranging from $ 2,300 to over $ 5,000. Under the nonexclusive annual agreements, P-E sold these products in competition with those sold by Spectra-Physics through other channels. A 1976 internal P-E memorandum referred to the "awful experience" of customers rejecting attempts to sell at higher prices than those of Spectra-Physics, and P-E generally sold at prices no higher than what Spectra-Physics charged users. Spectra-Physics provided some service training and documentation to P-E but only limited marketing support, such as brochures. In 1975, the gas chromatography Product Department conducted seminars for the product specialists and prepared and distributed its own brochures. The Model 1 product brochure stated that the integrator would be "installed and working in minutes", and neither integrator product brochure mentioned customer training, a newsletter, or an applications cookbook. In accordance with the annual agreements, Spectra-Physics provided a free operator's instruction manual with each unit shipped. P-E resales for both models peaked in 1977 when they were becoming obsolete, and by this time P-E1993 Tax Ct. Memo LEXIS 424">483 had already begun to institute major price cuts. For those Spectra-Physics integrators resold to unrelated parties, Arthur Andersen calculated P-E's average gross margin on over $ 6 million in sales as 34.1 percent. Arthur Andersen also concluded that: (1) P-E paid Spectra-Physics an average of 50 days after the invoice date during 1978 through 1981; (2) P-E held the integrators in inventory an average of 34 days from date of receipt until shipment to customers; and (3) during 1976 through 1981, USSD installation and warranty expenses for the integrators averaged 4.5 percent of net sales to unrelated parties, with billable and contract service income net of associated expenses equal to 3.0 percent. 2. Hitachi and P-EP-E began selling fluorescence instruments in 1968. The largest selling instrument of one of P-E's major competitors had been in existence for over 10 years by 1975 when the worldwide fluorescence market outside of Japan was about $ 14 million in sales. Over $ 10 million of this market was instruments priced below $ 9,000, a segment in which the P-E market share was less than 10 percent. However, because its market share exceeded 50 percent for instruments1993 Tax Ct. Memo LEXIS 424">484 priced above $ 9,000, P-E had over 30 percent of the market in the $ 3,000-to-$ 16,000 price range. Although the P-E share of the mid-priced market did not increase in succeeding years, its annual sales in the fluorescence product line more than doubled between 1975 and 1979. The geographical breakdown for the entire fluorescence market in 1979, which was very similar to that of AA spectrophotometers, was 45 percent United States, 35 percent Europe, 10 percent Japan, and 10 percent other. On August 1, 1971, P-E and Hitachi, Ltd. (Hitachi), a Japanese corporation, entered into a sales agreement under which P-E agreed to use its best efforts to distribute various scientific instruments, related accessories, supplies, and spare parts manufactured by Hitachi, including fluorescence products. As amended and extended from time to time, the agreement was in effect throughout the years in issue. The P-E distribution rights for fluorescence instruments, which generally covered North and South America and western Europe, were with minor exceptions exclusive under the agreement. The Hitachi prices to P-E, f.o.b. Japan, were to be determined in advance by mutual agreement, subject to changes1993 Tax Ct. Memo LEXIS 424">485 by Hitachi after appropriate notice to P-E. P-E was obligated to make payments within 30 days after receipt of the products. The sales agreement, which did not specify an ordering lead time, stated that Hitachi would sell and ship products subject to "the terms and conditions of its standard sales order". P-E was to use its best efforts to advertise the products, and Hitachi agreed to provide literature, specifications, and manuals at P-E's request to assist in the preparation of advertising. P-E agreed to submit its advertising material for preapproval by Hitachi if performance or operation was mentioned. Hitachi agreed to submit its own planned advertising copy to P-E for comment. Hitachi warranted that its products were free from defects in material and workmanship and met applicable specifications for the shorter of 12 months after delivery to P-E or 16 months after shipment from the Hitachi factory. For product defects covered by the warranty, if repairable by P-E, Hitachi was to send free replacement parts for installation at P-E expense. The fluorescence Product Department bore responsibility for the Hitachi fluorescence instruments, which were sold under the P-E name1993 Tax Ct. Memo LEXIS 424">486 and trademarks by P-E salespeople, installed by P-E service technicians, and backed by a P-E warranty. These instruments, which had customer prices generally between $ 3,000 and $ 15,000, were similar in technical complexity to the instruments produced by PECC. P-E used essentially the same marketing and selling techniques for fluorescence products as it did for the AA and IR product lines. The P-E standard cost for Hitachi instruments included freight from Japan and U.S. customs duties. As determined by Arthur Andersen, P-E purchased over $ 3 million of fluorescence instruments from Hitachi during the years in issue, earning an average gross margin on resale to unrelated parties of 36.2 percent. At times, actual margins fell short of projections because of unfavorable currency exchange rates and unanticipated increased costs. Arthur Andersen further concluded that in 1979 P-E paid Hitachi on average 19 days prior to receipt of an instrument, and, after receipt, held the instrument in inventory for an average of 76 days before shipping to the customer. 3. Analect and P-EDuring calendar 1981, P-E entered into an OEM agreement (see supra p. 21 for "OEM" definition) 1993 Tax Ct. Memo LEXIS 424">487 with the Analect Instruments Division of Laser Precision Corp. (Analect), covering the P-E purchase, for nonexclusive worldwide resale, of the Analect Model FX-6200 spectrophotometer and accessories. The FX-6200 was a Fourier Transform IR (FTIR) instrument, nondispersive in nature as opposed to the dispersive technology in P-E and PECCIR instruments. 10 In the United States, the FTIR market was over 20 percent of the entire IR market. As sold to users by Analect, the FX-6200 had a relatively low price for an FTIR instrument, in the range of $ 30,000 to $ 35,000. Analect held about a 20-percent share of the low-priced FTIR market. At the time the parties negotiated the agreement, P-E was selling no IR products employing the nondispersive technology. Management saw purchasing the FX-6200 as a quick entry into the low-priced segment of the FTIR market while awaiting the completed1993 Tax Ct. Memo LEXIS 424">488 development of a P-E product. Management also believed that gaining this foothold would facilitate the later marketing of the product developed by P-E. The P-E product development process had begun a few years earlier. By the end of calendar 1979, P-E management was well aware of the fundamental advantages of the FTIR nondispersive technology, which had the potential to improve cost effectiveness and operating convenience, partly through a tremendous reduction in analysis time. A P-E study group recommended the initiation of a project to develop an FTIR instrument, to be ready for shipping in January 1983. Most in the industry believed that FTIR was an emerging dominant technology that would render dispersive techniques largely obsolete. The failure of P-E to offer an FTIR product to customers, which caused it to lose IR market share during 1980, threatened its reputation as the world leader in the IR area according to the SP2 reports prepared in 1980 and 1981. Upon receipt of the FX-6200 from Analect, P-E performed no additional manufacturing work on it. However, as provided in the OEM agreement, P-E did not purchase the Analect control and display terminal for the instrument. 1993 Tax Ct. Memo LEXIS 424">489 Instead, P-E combined the FX-6200 with its own data station, essentially a computer, for sale under the P-E name and trademarks as the Model 1500 or Model 1550 system, depending on the data station. The P-E data stations, which had substantially greater capabilities than the relatively primitive Analect control and display terminal, required special applications software, which P-E provided. Analect intended the integrated P-E system to enter a higher priced market segment, thus bypassing direct competition with Analect. The OEM agreement stated that the price per unit to P-E would be 30 percent off the Analect domestic list price at the time of ordering. Analect did not have a separate list price for its control and display terminal, but, for purposes of its discounting arrangement with P-E, it adjusted the list price of the complete FX-6200 system (based on proportionate standard costs) to exclude the terminal. Accessories and spare parts were subject to the same 30-percent discount, and the accessories that P-E purchased included items that had Analect list prices of $ 3,500 and up. The agreement allowed P-E 45 days from delivery to pay for the products. Analect agreed 1993 Tax Ct. Memo LEXIS 424">490 to provide both software assistance for the merging of the P-E data station and the FX-6200 and "reasonable technical support" for up to 12 months. In actuality, Analect provided marketing assistance, complete service documentation and training, user's manuals, and the contemplated assistance in interfacing software. The technical support, for which there was no separate compensation, also included visits by Analect personnel to the P-E facilities and visits by P-E personnel to the Analect facilities. The IR Product Department was responsible for the technical marketing of the Models 1500 and 1550, including the preparation of brochures and data sheets, the conducting of seminars, and the performance of application studies. Analect warranted that its products would be free of defects for 1 year from shipment. The recourse for P-E was to send a defective product to the Analect plant, freight prepaid, where Analect would decide whether to repair or replace it. Analect was to bear the return freight charges. In accordance with their agreement, P-E paid Analect $ 250,000 up front for an option to enter into a license in January 1982. By the terms of this license, P-E was to have1993 Tax Ct. Memo LEXIS 424">491 the exclusive right, except for Analect itself, to use Analect manufacturing information in making and selling the FX-6200 worldwide. P-E exercised the option in January 1982, at which time it paid an agreed upon royalty of $ 1,000,000. P-E never used this licensed technology to manufacture the FX-6200. P-E did not make FX-6200 purchases after calendar 1984. From fiscal 1982 through fiscal 1985, as calculated by Arthur Andersen, P-E sold 70 of the FTIR systems to unrelated parties for over $ 2.7 million, earning an average gross margin of 25.2 percent. The P-E list prices ranged from about $ 35,000 for a basic version of the Model 1500 to over $ 80,000 for a sophisticated version of the Model 1550. For the three largest selling versions of these systems, the list prices of the P-E additions to the FX-6200 (i.e., data station, software applications package, and sometimes a printer) ranged from one-fourth to one-half of the P-E list price for the entire integrated system. According to Arthur Andersen: (1) P-E paid Analect, on average, 35 days after the Analect invoice date; (2) P-E held the FX-6200 in inventory for an average of 39 days after receipt until shipment to a customer; 1993 Tax Ct. Memo LEXIS 424">492 and (3) USSD incurred warranty and installation expenses that amounted to 8.7 percent of net sales to unrelated parties, while billable and contract service income net of associated expenses was 1.5 percent. 4. P-E and Scientific ProductsThe Scientific Products Division of American Hospital Supply Corp. (Scientific Products) was a large, nationwide distributor of laboratory instruments, equipment, and supplies. Its catalog in the early 1980s listed over 70,000 items from over 900 manufacturers. During the period in issue, Scientific Products purchased for resale approximately $ 23.3 million of instruments, accessories, and repair parts from the Coleman Instruments Division of P-E (hereinafter Coleman), reselling them nonexclusively under the Coleman name and trademark. Most of Coleman's remaining $ 12.2 million in sales went to other unrelated U.S. dealers, but some went through USSD. Among the analytical instruments handled by Scientific Products were Coleman ultraviolet-visible (UV-VIS) spectrophotometers. The Coleman products sold to Scientific Products were less sophisticated than the PECC finished products, thus entailing less technical support by the distributor. 1993 Tax Ct. Memo LEXIS 424">493 Scientific Products employed over 400 sales representatives, over 200 service people, and about 35 technical specialists. Although both Scientific Products and USSD salespeople visited customers, a Scientific Products salesperson generally had responsibility for a broader range of products and had less specialized training. The technical specialists, who were similar in background to P-E product specialists, were trained and salaried technicians or chemists who presented technical information to the customers and provided demonstrations of the more complicated Scientific Products instrumentation, which included the Coleman instruments. Coleman trained the technical specialists responsible for its products and provided telephone assistance thereafter. Coleman also trained and conducted seminars for users of its instruments. Among its marketing activities, Scientific Products participated in trade shows and seminars, advertised in journals, and prepared selling materials such as catalogs and mailings. Coleman, in addition to providing Scientific Products with marketing information such as applications brochures, data sheets, and instrument photographs, reviewed advertising copy1993 Tax Ct. Memo LEXIS 424">494 prepared by Scientific Products. P-E personnel also sometimes exhibited Coleman products at trade shows displaying Instrument Group products. The service personnel at Scientific Products did some installation work but spent most of their time performing warranty or billable service. Coleman trained those responsible for maintaining and servicing its products. Coleman also supplied instruction manuals and maintenance manuals. Scientific Products generally took responsibility for the relatively high labor portion of warranty costs, and Coleman agreed to supply free replacements for defective parts. Scientific Products contracted to purchase Coleman instruments and accessories at a discount of 33 percent off the Coleman list prices, provided that the total list price of the order was at least $ 10,000. Smaller orders had a lower discount, but Scientific Products usually attained the maximum 33 percent. Scientific Products recorded an average resale margin of 23.6 percent on Coleman products for calendar years 1975 through 1978. 5. P-E and Foreign DistributorsThe Instrument Division sold all of its product types, including those in the AA, IR, and gas chromatography product1993 Tax Ct. Memo LEXIS 424">495 lines, to P-E International, which in turn sold to over 100 independent foreign distributors or dealers. The discounts provided to the foreign distributors generally ranged from 10 to 20 percent off the P-E export list prices, which were higher than the domestic list prices. A given foreign distributor received the same discount on instruments and ancillary products within a product line, except that some distributors received a special 33-percent discount on the autobalance accessory. 6. Accessory ResalesP-E purchased a variety of products for resale from unrelated parties, including accessories, consumable supplies, and replacement and repair parts. In the AA and IR lines, P-E generally did not actively market these products. The consumable supplies and replacement parts consisted of items such as chart paper, recorder pens, and graphite tubes. An inch-long graphite tube, designed to hold a sample while heating in a graphite furnace, sometimes needed replacement daily in heavy use. P-E's AA price lists offered several types. P-E neither sold nor quoted prices for individual tubes, and the price lists showed sets of 5, 10, 20, and 50 per box, depending on the specific1993 Tax Ct. Memo LEXIS 424">496 tube type. During 1980 and 1981, the published prices for 50-count boxes were from $ 450 to $ 970; for 20-count boxes, from $ 315 to $ 425; for 10-count boxes, from $ 120 to $ 205; and for 5-count boxes, from $ 70 to $ 84. During these years, P-E purchased from unrelated parties and resold to unrelated parties only one type of graphite tube for which the boxed price, in this case a box of 50, exceeded $ 200; the list price, $ 500 in September 1979, rose to $ 675 by June 1981. Graphite tube vendors did not aggressively pursue sales directly to instrument users until after 1981, when the tubes became widely available through distributors and catalogs. The P-E computerized sales database for 1980 and 1981 included detailed information by product line on P-E resales to unrelated parties of noninstrument products purchased from many vendors around the world. The weighted average gross margins on those products with an average unit selling price above $ 200 were as follows: Product Line1980 Gross Margin1981 Gross MarginAA 58.5%62.4%IR 37.8%43.9%Gas chromatography36.8%37.3%Graphite tubes comprised over 85 percent of the net sales volume of the over-$ 1993 Tax Ct. Memo LEXIS 424">497 200 products in the AA line. Because of their relatively high gross margins, factoring out the graphite tubes would lower the AA gross margins to 41.1 percent in 1980 and 49.5 percent in 1981. For the products other than graphite tubes, taken collectively without product line distinction, the 1980 gross margin would be 37.7 percent and the 1981 gross margin would be 41.5 percent. 7. Deuterium Arc LampsA deuterium arc lamp, an essential part of a deuterium background corrector for AA spectrophotometers, provides a source of light that passes through the sample area alternately with the HC lamp or ED lamp. For more sophisticated AA instruments, a UV-VIS background corrector has both a deuterium lamp and a tungsten-halide lamp. P-E offered deuterium background correctors for most of its AA instruments at list prices between $ 1,000 and $ 2,000, and UV-VIS background correctors were priced $ 350 to $ 500 higher. Deuterium lamps for use in background correctors had list prices between $ 200 and $ 400. P-E exerted no marketing and selling efforts to speak of for AA deuterium lamps. Deuterium lamps are also a source of ultraviolet radiation in UV-VIS spectrophotometers, which1993 Tax Ct. Memo LEXIS 424">498 were marketed by the fluorescence Product Department and Coleman. Initially installed at the factory, the lamp is an integral part of the UV-VIS instrument rather than part of an accessory. In this setting, a tungsten lamp provides the visible light source, and the instrument design incorporates a lever that conveniently moves one or the other lamp, tungsten or deuterium, into the light path without danger of radiation to the user. A February 1980 P-E price list indicated prices for replacement deuterium lamps in UV-VIS spectrophotometers ranging from $ 235 to $ 305. For both AA and UV-VIS instruments from 1975 through 1981, a deuterium lamp was not changed or removed unless it failed. The lamp was considered a consumable item because it had a finite life and needed replacement when it burned out, typically every 1 or 2 years for an AA instrument. Replacement installation required a partial disassembly of the instrument, electrical hook-up, and optical adjustment of the new lamp. Optical adjustment, performed with the instrument turned on, was potentially dangerous because of the heat and ultraviolet light emitted. There were also possible electrical hazards involved. Replacement1993 Tax Ct. Memo LEXIS 424">499 of a deuterium lamp took about 20 minutes, compared to less than 5 minutes for an HC lamp. An instrument user normally did not buy additional deuterium lamps when purchasing the associated AA instrument. The P-E price lists recommended service installation, which cost extra, for the deuterium lamps used in deuterium background correctors. The price lists did not mention service installation for either deuterium lamps used in UV-VIS background correctors or deuterium lamp assemblies used in certain deuterium background correctors. In fact, a 1975 pamphlet on the Model 360 and 370 spectrophotometers touted "Easy access" to the deuterium lamp assembly in the optional deuterium background corrector, with a lamp mount "designed to provide for easy interchange and quick, accurate alignment." Service installation was the general recommendation for deuterium lamps in UV-VIS spectrophotometers. Instrument manufacturers were available to replace deuterium lamps, as were independent service companies, but deuterium lamp manufacturers rarely offered service installation. Sometimes a user did not know specifically that a deuterium lamp needed replacing, instead recognizing only that the 1993 Tax Ct. Memo LEXIS 424">500 instrument was not performing properly. When this situation arose, the user tended to buy a replacement lamp from a service person, who often worked for the instrument manufacturer, and to have that service person install the lamp during the service call. P-E did not manufacture deuterium lamps and instead purchased them from unrelated parties, mostly or exclusively GTE-Sylvania (Sylvania). The SP2 report prepared in 1978 stated: "We are considering shifting over to the engineering of our own deuterium arc lamp. These lamps are sold in tremendous quantities and are no end of trouble to ourselves and to our customers." P-E had purchased lamps from Sylvania for many years with no formal agreement and continued to do so during the years in issue based on purchase orders. The payment terms were net 30 days. The Sylvania lamps, which came to P-E with a warranty of 500 hours, bore the P-E name and part number. They were standard lamps that Sylvania adapted to P-E specifications communicated through Purchasing or Engineering. P-E did not provide its own warranty to customers. P-E purchased over 1,000 deuterium lamps from Sylvania in a typical month, including those for Coleman. 1993 Tax Ct. Memo LEXIS 424">501 For 1979, Arthur Andersen concluded that 48 percent of the P-E purchases went into OEM production, 39 percent went directly to customers, and the remainder went to the service organization. Sylvania considered P-E an OEM customer, which was Sylvania's target market for these lamps, rather than a distributor. Although Sylvania maintained a distributor price list, it sold perhaps 20 lamps annually to any particular distributor. This low distributor volume was intentional because Sylvania had concerns about product liability arising from ultraviolet radiation and electrical hazards. The OEM prices charged by Sylvania to P-E were up to 50 percent below the list prices to distributors. P-E earned an average gross margin of 63.1 percent on the resale to unrelated parties of replacement deuterium lamps and lamp assemblies used in AA background correctors. The net sales of those items for which the price lists recommended service installation were 48 percent of the total in 1980 and 41 percent in 1981. The net sales of AA deuterium lamps and assemblies for 1980 and 1981 combined were less than 4 percent of the P-E net sales of PECCHC lamps. Arthur Andersen determined that in 1979, 1993 Tax Ct. Memo LEXIS 424">502 for those AA deuterium lamps and assemblies that were sold to customers outside of the service organization, P-E held them in inventory for an average of 113 days. B. PartsOn August 22, 1977, Coleman granted a license to Sao Paulo Laboratorio, Ltda. (Sao Paulo), an unrelated Brazilian dealer, to assemble and sell the Coleman Model 295 and Junior III spectrophotometers in Brazil. Because of a 100-percent Brazilian import duty at the time on finished instruments, Coleman had not been able to compete with local manufacturers. To avoid the import duties, Coleman and Sao Paulo intended the Coleman instruments to be assembled sufficiently in Brazil to warrant an "Assembled in Brazil" label. The license agreement required Sao Paulo to purchase all of the subassemblies from Coleman and to sell the instruments under the P-E name. Coleman was to provide, at no charge, assembly drawings, specifications, testing and calibration data, and training at P-E facilities. Sao Paulo was not obligated to pay a royalty. The two licensed models, which were less sophisticated than the instruments assembled by PECC, were small instruments that Coleman sold in the United States through Scientific1993 Tax Ct. Memo LEXIS 424">503 Products and other dealers. Upon arrival in Brazil, the subassemblies were almost completed instruments in terms of the finishing work left. Thus, the Sao Paulo final assembly and test operations, covering 2 to 4 hours per instrument, were relatively simple and straightforward compared to what PECC did. In setting the prices for the subassemblies sold to Sao Paulo, Coleman began with the export list price for the finished instrument, then subtracted a 33-percent dealer discount, and finally reduced the price for labor to be performed on the subassemblies. Based on 1981 sales and cost data, the subassembly price to Sao Paulo represented a markup over Coleman standard cost of 59 percent for the Junior III and 44 percent for the Model 295; for sales of finished instruments by Coleman to customers, independent of Sao Paulo, the markup over standard cost was 62 percent for the Junior III and 50 percent for the Model 295. Sao Paulo was able to sell the Coleman instruments at unusually high prices because of the import duties that deterred outside competition. C. Royalties1. In GeneralFrom the mid-1950s through 1981, P-E entered into over 100 licensing arrangements with1993 Tax Ct. Memo LEXIS 424">504 unrelated parties involving analytical instruments and associated technology. Hitachi manufactured, sold, and serviced analytical instruments while also engaging in research and development. See supra p. 50. In 1960, P-E and Hitachi entered into a 10-year agreement for the organization and operation of a jointly owned Japanese corporation called Hitachi Perkin-Elmer, Ltd. (HIPE). HIPE was to be an intermediary for the exchange of product and technical information and for the planning and coordination of engineering, manufacturing, and sales. The agreement stated that P-E and Hitachi would enter into license and technical assistance agreements with HIPE to provide for the manufacture of each other's products. In the ensuing years, the three parties entered into various technical exchange and licensing agreements. In connection with these agreements, P-E and Hitachi agreed to provide each other with all available technical information relating to the subject products. While the agreements recognized Hitachi as the progenitor and licensor of certain technological principles, such as liquid chromatography, they recognized P-E as the progenitor and licensor of AA technology. 1993 Tax Ct. Memo LEXIS 424">505 In 1965, the parties entered into a supplemental technical exchange agreement that specified ranges of reasonable royalties. The royalty was: (1) 6 to 7.5 percent for a licensed product specifically designed by the licensor; (2) 2 to 4 percent for a licensed product designed by the licensee but employing concepts, techniques, or technical information of the licensor; or (3) for jointly developed products, some point in between ranges (1) and (2). In order to permit more effective direct communication between P-E and Hitachi, HIPE ceased acting as a liaison in 1970. In 1971, P-E and Hitachi directly entered into a comprehensive license agreement, whereby P-E granted Hitachi the exclusive right to use P-E technical information and patents to manufacture in Japan and a few nearby areas products from P-E's AA, IR, and gas chromatography product lines. The agreement required P-E to convey or make available all design and manufacturing information relating to the licensed products and, upon request, to send a technical expert to Japan for up to a cumulative 30 days during the term of the agreement, with travel expenses payable by Hitachi. P-E also granted Hitachi the nonexclusive 1993 Tax Ct. Memo LEXIS 424">506 right to sell these products in Japan and several other countries in Europe and Asia. The products covered by the license included all of the instruments, accessories, and HC lamps produced under the licensing arrangement between P-E and PECC. Hitachi, which did not purchase parts kits from P-E for the instruments licensed, agreed to pay a 7.5-percent royalty on most of the licensed products, computed on the Hitachi "Net Sales Price". The "Net Sales Price" was defined generally as the price charged to "customers", with this exception: In the case of sales by * * [Hitachi] to a subsidiary thereof or to an individual, corporation, partnership or association which is so closely associated to * * * [Hitachi] as to prevent arms length [sic] bargaining, the Net Sales Price shall be deemed to be that charged by * * * [Hitachi] for similar products sold in the same period to customers not thus closely associated.In October 1977, P-E licensed the manufacture and sale of its "diff3" instrument, a blood analyzer, to Coulter Electronics, Inc. (Coulter). The agreed royalty percentage of 7 percent, which decreased over time, was based on the "Net Selling Price", defined as "either1993 Tax Ct. Memo LEXIS 424">507 the actual price at which the article is sold by Licensee, f.o.b. Licensee's plant and shall not include taxes, freight and insurance, or the fair market value of the article when otherwise shipped for placement at a customer's site." The agreement, which explicitly defined "Licensee" to include any affiliate of Coulter, stated that only one royalty was payable for a particular instrument. P-E and Coulter subsequently disagreed about the royalty computation base and exchanged correspondence over several months. Coulter contended that it could sell the diff3 to affiliated resellers at a price less than that applicable to the end users, yet pay one royalty based on the lesser price. P-E maintained that Coulter was liable for royalties based on the price received by Coulter or an affiliate for the first sale in the chain to an unrelated party. In an internal memorandum assessing the P-E litigating position in February 1982, P-E counsel mentioned without elaboration or specific support that it was "customary practice in patent licensing" to give effect to third-party sales in royalty computations while disregarding intermediate sales between affiliates. However, counsel also pointed1993 Tax Ct. Memo LEXIS 424">508 out in the memorandum that, regardless of custom, a licensor and a licensee could agree on some other computation base. The Coulter position ultimately prevailed. 2. HC LampsBy written agreement dated August 18, 1977, S & J Juniper & Co. (Juniper), an English manufacturer of HC lamps with a primary market in Europe, granted a license to manufacture and sell HC lamps to Instrument Laboratory, Inc. (Instrument Lab), an unrelated U.S. instrument manufacturer. Instrument Lab acquired the exclusive right to manufacture and sell the licensed HC lamps in the United States, except that Juniper retained the right to sell through its existing agents and dealers. Instrument Lab was also authorized to sell the licensed HC lamps elsewhere worldwide, nonexclusively. Prior to this licensing arrangement, Instrument Lab bought finished HC lamps from Westinghouse, earning a 35- to 40-percent gross margin on resales. Juniper agreed to and did provide Instrument Lab with complete HC lamp technical documentation and know-how. Juniper agreed to train Instrument Lab employees in England at the expense of Instrument Lab and to provide any other assistance requested by Instrument Lab, including1993 Tax Ct. Memo LEXIS 424">509 visits by Juniper personnel, again generally at the expense of Instrument Lab. Juniper actually did provide training over a 1-year period to Instrument Lab employees and also assisted Instrument Lab in the acquisition and construction of the special equipment necessary to the manufacturing of HC lamps. Instrument Lab agreed to pay a 2-percent royalty for 10 years based on the invoice price of the first sale following manufacture, whether or not the purchaser was related to Instrument Lab. It also agreed to pay # 25,000 as technical assistance fees and # 35,000 as nonrefundable advance royalties, the latter being in addition to the 2-percent royalty. At the end of 10 years, Instrument Lab was entitled to continue using the Juniper know-how without any further consideration. Instrument Lab purchased its sheet metal, machine shop, and plastic base parts for HC lamp production from unrelated vendors, but fabricated a few parts itself. It did not purchase anything resembling parts kits from Juniper. The HC lamps covered by the license, which were usable in P-E instruments with the help of an adaptor, were similar to those produced by PECC. D. ARCFrom 1973 through the years1993 Tax Ct. Memo LEXIS 424">510 in issue, the P-E Optical Group manufactured microlithography equipment called the Micralign projection mask alignment system. This Micralign system, a revolutionary innovation for the production of semiconductor chips, used optics to project and etch a circuitry design onto the light-sensitive surface of a silicon wafer. The light source was a mercury capillary lamp specifically designed for the Micralign system. When introduced in 1973, the Micralign system was priced at $ 95,000, and, early on, P-E had trouble meeting the heavy demand for the system. Later models, in the early 1980s, were priced at about $ 500,000. When P-E was developing its Micralign equipment, management sought out a source for curved mercury capillary lamps because the common straight lamp, readily available, was unworkable. Advanced Radiation Corp. (ARC) had been organized in 1971 as a two-person enterprise. The president of ARC, Raymond Paquette, who eventually accumulated 10 or 11 patents relating to arc lamps, had a reputation for producing quality mercury capillary lamps largely from his prior work at another company. Hearing of the P-E need, he sent a few unsolicited sample lamps to P-E that incorporated1993 Tax Ct. Memo LEXIS 424">511 a technique for heating and uniformly bending straight capillary tubing. After talking to several companies, P-E settled on ARC as its supplier of unbased lamps, in part because of anticipated flexibility, cooperation, and low prices. ARC disclosed its heating and bending technique to P-E during the P-E vendor selection process, after which P-E improved on a part of the technique and provided ARC with equipment. Beginning in about 1972, P-E began purchasing curved unbased lamps from ARC by means of purchase orders. After a P-E employee spent a few weeks learning the manufacturing process at ARC, P-E set up its own lamp manufacturing facility. P-E nonetheless continued to purchase unbased lamps from ARC at the request of a major customer who wanted P-E to maintain a second source. P-E occasionally asked ARC personnel for advice concerning the manufacture of mercury lamps. By 1975, P-E held a patent on its mercury lamp mounting base, which precisely positioned the lamp upon installation and allowed for quick, easy, and precise replacement. Effective in May 1977, P-E and ARC entered into a Patent and Technology License Agreement. Under this agreement, P-E licensed both its patent1993 Tax Ct. Memo LEXIS 424">512 and its engineering and manufacturing technology so that ARC could manufacture, assemble, and sell based lamps worldwide on a nonexclusive basis directly to Micralign users. P-E also agreed to provide ARC employees with free training at mutually agreeable times. During the course of its fiscal years ending on January 31 in 1976 through 1982, ARC sold unbased Micralign lamps to P-E from 1976 to 1980, based Micralign lamps to P-E from 1979 on, and based Micralign lamps to others from 1978 on. From 1976 to 1981, the ARC annual unit sales of the lamps increased from 2,050 to 44,234, and annual net sales after adjustment for discounts increased from under $ 50,000 to almost $ 3 million. Between April 1975 and January 1982, ARC had Micralign lamp net sales, based and unbased, of nearly $ 9 million. ARC, which did not maintain a finished goods inventory and instead built lamps to specific customer orders, provided a warranty on the based lamps it sold to P-E and to others. It performed its own purchasing and manufacturing functions, including the testing of lamps it sold to P-E and to third parties. Although ARC had commissioned salespeople, they did not concentrate on the Micralign1993 Tax Ct. Memo LEXIS 424">513 lamps, which were marketed partly by word-of-mouth among Micralign system users. VI. Notice of DeficiencyAs the foundation for a section 482 allocation of income in the notice of deficiency, respondent treated PECC as a consignment "contract assembler" for P-E. Respondent applied a cost-plus method by setting the arm's-length PECC profits equal to a fixed percentage of its adjusted operating costs, which were in turn equal to: (1) the PECC recorded costs, less (2) the PECC recorded costs for royalties and materials paid to P-E or Bodenseewerk, plus (3) the PECC estimated location savings. The notice of deficiency, as it related specifically to the PECC finished products, allocated income of $ 29,299,836 to P-E for the 7-year period in issue. Prior to trial, respondent formally abandoned the contract assembler theory and its associated cost-plus methodology. OPINION I. IntroductionFrom 1975 through 1981, PECC, a wholly owned subsidiary of P-E located in Mayaguez, Puerto Rico, built analytical instruments, HC lamps, and accessories. P-E sold PECC substantially all of the parts for the products at a price equal to the P-E standard cost for the parts plus a markup, 1993 Tax Ct. Memo LEXIS 424">514 21 percent through 1978 and 13.12 percent thereafter. PECC sold the finished products to P-E at a 25-percent discount from the P-E domestic list prices through August 1977 and a 30-percent discount thereafter. PECC also paid royalties to P-E representing 3 percent of the amounts billed to P-E for the finished products. Section 482 authorizes respondent to allocate gross income, deductions, credits, or allowances between two related corporations if the allocations are necessary either to prevent evasion of taxes or clearly to reflect the income of the corporations. The applicable standard is arm's-length dealing between taxpayers unrelated by ownership or control. Sec. 1.482-1(b)(1), Income Tax Regs. A business purpose for an arrangement or a set of transactions does not by itself insulate a taxpayer from a section 482 allocation. Bausch & Lomb, Inc. v. Commissioner, 92 T.C. 525">92 T.C. 525, 92 T.C. 525">582 (1989), affd. 933 F.2d 1084">933 F.2d 1084 (2d Cir. 1991). Petitioner has conceded that respondent is entitled to make income allocations from PECC to P-E to conform to a 30-percent discount from domestic list prices for all years. See supra note 1993 Tax Ct. Memo LEXIS 424">515 7. After this adjustment, which affects the intercompany finished product sales and the royalties derived therefrom, petitioner contends that the three transactions between P-E and PECC -- sale of parts, sale of finished products, and royalties -- were arm's length in amount, thereby precluding additional adjustments. Respondent's primary trial position is that none of the three transactions was arm's length within the meaning of section 482, thus necessitating income allocations to P-E of $ 6,221,911 on the sale of parts and $ 17,131,821 on the sale of finished products. After an allocation of $ 1,110,341 away from P-E for royalties, see infra p. 152, respondent's total income allocation to P-E is $ 22,243,391. Respondent's alternative trial position, which differs only in the amount of the parts adjustment, leads to a total income allocation to P-E of $ 29,290,304. Although the period in issue spans 7 taxable years and the PECC product mix varied considerably from year to year, the parties generally have been content to work with categories of finished products no narrower than instruments, accessories, and HC lamps, and to avoid making distinctions from year to year. To1993 Tax Ct. Memo LEXIS 424">516 the extent feasible, we have sought to respect the parties' simplified approach. II. Preliminary MattersRule 151(e)(3) requires that the parties' briefs set forth proposed findings of fact based on the evidence. Petitioner's proposed findings include many drawn directly from the conclusions on various accounting matters appearing in the Arthur Andersen written reports. In her reply brief, respondent objects to many of these proposed findings on the ground that the underlying business records are not in evidence, a point repeated in respondent's proposed findings and argument. The four Arthur Andersen written reports are similar in format. After describing the questions posed by petitioner's counsel, they detail the assumptions, information sources (including business records), and procedures used to arrive at the conclusions. Petitioner does not dispute that much of the underlying information is not in evidence. We find unpersuasive respondent's approach to our use of the Arthur Andersen reports. Neither at trial, nor on brief, has respondent cast her objections in the form of a challenge to the admissibility of the reports into evidence -- reports which had been 1993 Tax Ct. Memo LEXIS 424">517 furnished to respondent weeks before trial. Nor did respondent object, at trial, to any particulars of the testimony of the Arthur Andersen representatives, Robert G. Kutsenda and Gary E. Holdren, on the ground which now forms the basis of her objections. Consequently, we see no need to analyze the impact of rules 103(a)(1) (dealing with objections to admissibility) and 703 (dealing with the permissible bases of expert opinions) of the Federal Rules of Evidence, which are applicable to proceedings in this Court (sec. 7453 and Rule 143(a)), although it would appear that those rules of evidence offer little support for respondent's position. Under the foregoing circumstances, respondent's wholesale attack on the reports is unwarranted. III. Arbitrary, Capricious, or UnreasonableWhen the Commissioner has determined deficiencies based on section 482, the taxpayer bears the burden of showing that the allocations are arbitrary, capricious, or unreasonable. Sundstrand Corp. v. Commissioner, 96 T.C. 226">96 T.C. 226, 96 T.C. 226">353 (1991); Eli Lilly & Co. v. Commissioner, 84 T.C. 996">84 T.C. 996, 84 T.C. 996">1131 (1985), affd. on this issue, revd. in part, and remanded1993 Tax Ct. Memo LEXIS 424">518 856 F.2d 855">856 F.2d 855, 856 F.2d 855">860 (7th Cir. 1988). We must sustain the allocations absent a showing of respondent's abuse of discretion. Bausch & Lomb, Inc. v. Commissioner, 92 T.C. 525">92 T.C. 525, 92 T.C. 525">582 (1989), affd. 933 F.2d 1084">933 F.2d 1084 (2d Cir. 1991); G.D. Searle & Co. v. Commissioner, 88 T.C. 252">88 T.C. 252, 88 T.C. 252">358 (1987). Respondent based the notice of deficiency on a characterization of PECC as a consignment contract assembler. See supra p. 73. Prior to trial, respondent formally abandoned the contract assembler theory and its associated cost-plus methodology, adopting instead a position that respects the PECC status as a licensed manufacturer. Petitioner, while acknowledging that alternative positions do not result in per se arbitrariness of a deficiency notice determination, nonetheless contends that respondent's abandonment of both the factual and legal bases underlying the notice causes the determinations therein to be arbitrary, capricious, and unreasonable. In contrast to petitioner's position that the resolution of this matter was a foregone conclusion before trial, respondent argues that we 1993 Tax Ct. Memo LEXIS 424">519 must take account of her experts' testimony presented at trial in making our determination. Here, respondent abandoned a theory before trial that, in similar cases, we have rejected after a trial on the merits. E.g., Sundstrand Corp. v. Commissioner, supra at 357-358; Bausch & Lomb, Inc. v. Commissioner, 92 T.C. 525">92 T.C. 583-584; Eli Lilly & Co. v. Commissioner, 84 T.C. 1132-1133. In these circumstances, we hold that petitioner has met its burden of showing respondent's allocations to be arbitrary, capricious, or unreasonable. This holding, however, does not relieve petitioner of its burden of proving that the transactions between P-E and PECC meet the arm's-length standard; if it fails to do so, the Court must decide the proper allocations of income between P-E and PECC. Sundstrand Corp. v. Commissioner, supra at 354; Eli Lilly & Co. v. Commissioner, 856 F.2d at 860, 872. The task thus thrust upon us is, to put it mildly, frustrating. In this case, as in other significant section 482 cases before the Court in recent years, each party has spent most of the time attacking1993 Tax Ct. Memo LEXIS 424">520 the other party's allocation formula rather than establishing the soundness of its or her own formula. In pursuing this path, an unduly long and unnecessarily complicated trial record has been created, replete with bickerings between counsel over unimportant and often irrelevant evidentiary questions and a continuance of the "play your cards close to the chest" attitude of petitioner's counsel and the lack of focus on the part of respondent's counsel exhibited during the discovery process. Both of these elements seemingly reflect a strategy of telling the judge as little as possible. Thus, in the final analysis, the Court is left to its own devices without the usual anchor of decision, namely that, if the taxpayer fails to carry its burden of proof, the deficiency is sustained. The Court must find a formula, without the benefit of sufficient help from the parties as to what that formula might be. In a section 482 case, this task usually requires the Court to find a middle ground -- a task which it has disavowed, in other contexts, see Buffalo Tool & Die Mfg. Co. v. Commissioner, 74 T.C. 441">74 T.C. 441 (1980), and one which is most difficult to perform in light1993 Tax Ct. Memo LEXIS 424">521 of the Court's inevitable lack of knowledge of the realities of the workings of a specific industry and of the business world generally, including particularly the international competitive atmosphere which those realities reflect. It is against this background that we now turn to finding precise answers based on an imprecise record. IV. PECC Sales of Finished ProductsA. BackgroundSection 1.482-2(e), Income Tax Regs., describes allocation methods intended to reflect an arm's-length price for tangible property sales between a related buyer and seller. Such sales between related parties are called "controlled sales". Sec. 1.482-2(e)(1)(i), Income Tax Regs. "Uncontrolled sales", used for comparison purposes, are sales in which the buyer and seller are not related. Sec. 1.482-2(e)(2)(ii), Income Tax Regs. The three allocation methods described in detail are the comparable uncontrolled price method, the resale price method, and the cost plus method, in that order of priority. Sec. 1.482-2(e)(2), (3), and (4), Income Tax Regs.Under the comparable uncontrolled price method, the arm's-length price of a controlled sale between related parties is equal to the price 1993 Tax Ct. Memo LEXIS 424">522 paid in comparable uncontrolled sales, as adjusted. Sec. 1.482-2(e)(2)(i), Income Tax Regs. Uncontrolled sales are comparable, and adjustments are permissible, if the physical property and circumstances involved are so nearly identical to the controlled sale that any differences both can be reflected by a reasonable number of adjustments to the price of the uncontrolled sales and have a definite and reasonably ascertainable effect on price. Sec. 1.482-2(e)(2)(ii), Income Tax Regs. Petitioner and respondent agree that there are no comparable uncontrolled sales available for applying the comparable uncontrolled price method to finished product sales from PECC to P-E. We will return to this method, however, in our consideration of the parts transactions. See infra p. 145. The next method in priority under the regulations is the resale price method, which generally applies only if there are no comparable uncontrolled sales and if: (1) An applicable resale price is available; (2) the reseller has not added more than an insubstantial amount of value by physically altering the property before resale; and (3) the reseller has not added more than an insubstantial amount of value 1993 Tax Ct. Memo LEXIS 424">523 by the use of intangible property. Sec. 1.482-2(e)(3)(ii) and (iii), Income Tax Regs.Under the resale price method, the arm's-length price of a controlled sale is equal to the applicable resale price reduced by an appropriate markup percentage, with adjustments. Sec. 1.482-2(e)(3)(i), Income Tax Regs. The applicable resale price is ordinarily the price at which the buyer resells the property in an uncontrolled sale. Sec. 1.482-2(e)(3)(iv), Income Tax Regs. The appropriate markup percentage is the gross profit percentage, relative to sales, earned by a reseller on property that is both purchased and resold in an uncontrolled transaction, if the resale is sufficiently similar to the resale that follows the controlled sale. Sec. 1.482-2(e)(3)(vi), Income Tax Regs.Close physical similarity of the products in the compared sales is not required, but characteristics important to the similarity of resales are: (1) The type of product; (2) the functions performed by the reseller; (3) the intangible property, such as patents and trademarks, used by the reseller; and (4) the geographic market in which the reseller performs its functions. Id. Adjustments should reflect material 1993 Tax Ct. Memo LEXIS 424">524 differences between the uncontrolled resale used to calculate the appropriate markup percentage and the resale that follows the controlled sale. Sec. 1.482-2(e)(3)(ix), Income Tax Regs. These are differences in functions or circumstances that have a definite and reasonably ascertainable effect on price. Id.The parties agree that the resale price method applies to the sale of finished products by PECC to P-E. As petitioner applies it, this method establishes that the transfer price between PECC and P-E, 30 percent off P-E domestic list prices after petitioner's concession (see supra note 7), was arm's length; this would entail no adjustment to P-E income other than the concession. Respondent, on the other hand, maintains that of her total income allocation to P-E under section 482, $ 17.1 million results from application of this method to the finished products. In reaching this adjustment, respondent uses purportedly arm's-length gross margins for P-E resales of 32.7 percent for instruments, 57.2 percent for HC lamps, and 57.6 percent for accessories. B. Resale Price Method and Product AggregationAlthough the parties agree on the applicability of the resale price1993 Tax Ct. Memo LEXIS 424">525 method, they have a fundamental disagreement about whether that method should be applied to the finished products as a whole or to instruments, accessories, and HC lamps separately. Petitioner contends that the finished products should be aggregated, characterizing respondent's contrary position as a "hypothetical and theoretical disaggregation". Petitioner emphasizes that manufacturers generally granted uniform resale discounts (i.e., uniform discounts from list prices) to unrelated distributors and that a particular resale discount translated into a similar gross margin upon resale by the distributor. As part of the agreement between P-E and Spectra-Physics, the same contractual discount generally applied to the primary product, which was an integrator, and the associated accessories. In the agreement between P-E and Analect, the same discount applied to the FX-6200 and its accessories. The discount that Coleman provided to Scientific Products varied by order volume but did not vary between instruments and accessories. Finally, for products distributed in foreign markets, P-E International normally granted a uniform discount to a particular foreign distributor on instruments, 1993 Tax Ct. Memo LEXIS 424">526 accessories, and HC lamps. Given these discount congruences, petitioner argues that we should not attempt to determine three separate margin percentages for the finished product categories. We disagree. One obvious difficulty with petitioner's position is that Spectra-Physics and Analect did not sell HC lamps to P-E, nor apparently did Coleman sell them to Scientific Products, yet HC lamps were 30 percent of the PECC output. The relationship of the accessories to the instruments in these transactions causes at least three further obstacles to our adopting an aggregation approach. First, the accessories involved in the Spectra-Physics and Analect transactions were only those directly associated with the primary product. Walter Doyle (Doyle), the president of Laser Precision Corp. who testified about the Analect transaction, stated that there was no reason for different discounts because the systems were typically sold as "packages" consisting of an instrument and one or more accessories. There was similar testimony about the Coleman products sold to Scientific Products. PECC, in contrast, sold accessories to P-E that were not limited to use with the PECC instruments. As one1993 Tax Ct. Memo LEXIS 424">527 example, PECC sold gas chromatography accessories but did not sell any gas chromatography instruments. Second, since the anticipated accessory or replacement part volume was relatively small for the Spectra-Physics and Analect transactions, there would be little apparent incentive to bother with differing discounts. It does not necessarily follow, however, that uniform discounts in this type of situation would stay uniform as the situation changed to one in which the secondary products were a more important part of the deal. The secondary products that PECC sold to P-E, accessories and HC lamps, were over half of the PECC sales volume. Third, the only two accessories that Doyle could specifically recall selling to P-E had Analect list prices of $ 3,500 and up, which places them near or in the PECC instrument price range. That these accessories had the same discount as the FX-6200 instrument says little about whether the PECC accessories and HC lamps, with average prices to users below $ 400, should have the same discount as the PECC instruments. For the foreign distributors, the generally uniform discounts provided by P-E were in the 10- to 20-percent range, well below the 301993 Tax Ct. Memo LEXIS 424">528 percent advocated by petitioner as arm's length. In addition, petitioner's principal expert witness in economics, Dr. William J. Baumol, emphasized in his initial report that the foreign distributor transactions were not directly comparable to those between PECC and P-E. In these circumstances, we do not find the discount uniformity meaningful. Even if we agreed with petitioner that PECC would have granted an arm's-length distributor a uniform discount on instruments, accessories, and HC lamps, that point is merely a first step. The applicable regulations revolve around the appropriate markup percentage earned by the distributor, not the percentage discount arrangement for transfers between manufacturer and distributor. Sec. 1.482-2(e)(3)(i), (vi), Income Tax Regs. Petitioner attempts to bridge this gap by arguing that, in actual market transactions, a given discount translates into a similar margin upon resale by the distributor, at least if there are competitive products in the market. The P-E resales of PECC finished products arguably support this relationship in view of the small difference between the 30-percent discount to P-E and its overall 31.1-percent resale margin1993 Tax Ct. Memo LEXIS 424">529 as calculated by Arthur Andersen. See supra pp. 45-46. Nonetheless, the connection between discounts and corresponding resale margins is typically not an especially close one, judging by the transactions in the record. The P-E discount for Spectra-Physics products did not exceed 30.5 percent, except for 32 percent during the initial 3 months of the first year, yet Arthur Andersen determined a P-E overall resale margin of 34.1 percent. For Coleman sales to Scientific Products, which usually entailed a discount of 33 percent, the recorded resale margin was only 23.6 percent. Even the seemingly close connection for PECC finished products does not hold up under closer scrutiny. Over the course of the years in issue, as calculated by Arthur Andersen, P-E's annual resale margin for instruments varied by over four percentage points and for accessories by over five. Within a particular year, the spread between product categories sometimes exceeded five percentage points. See supra p. 46. There are several reasons why, for a specific sale and subsequent resale, the distributor's resale margin could differ from the resale discount provided by the manufacturer. For one, the1993 Tax Ct. Memo LEXIS 424">530 distributor's resale list price could differ from the manufacturer's list price, which served as the discount reference point in the Spectra-Physics, Analect, and Scientific Products transactions. As a factor applicable to P-E and PECC, their discount was computed against the P-E domestic list price for the product. The export price list differed from the domestic price list, and P-E resold many PECC products in foreign markets. The peculiarities of the foreign markets also sometimes necessitated special pricing, such as that for the Model 372 and 272 AA instruments assembled by PECC. Furthermore, P-E sales into foreign markets through P-E International were not directly to users; this different level of the market imparts further strain on the connection between resale discounts and resale margins. Even for a domestic sale, volume discounts and other customer incentives such as package deals were not unheard of. Any of these factors, or others, could have had a disproportionate effect on the resale margins of the three types of finished products. On a different tack, petitioner argues that imposing separate resale margins by product category treats P-E as something more than1993 Tax Ct. Memo LEXIS 424">531 a mere distributor of PECC finished products, citing Bausch & Lomb, Inc. v. Commissioner, 92 T.C. 525">92 T.C. 525 (1989), affd. 933 F.2d 1084">933 F.2d 1084 (2d Cir. 1991). In Bausch & Lomb, we described the assumptions used by the Commissioner's economics expert in his determination of an arm's-length price for contact lenses purchased by a domestic corporation from an Irish subsidiary. The expert reduced his estimate of the arm's-length price in part because the domestic corporation had sales and research functions to support, which would require it to pay a lesser amount for the lenses than a distributor not so encumbered with other functions. In rejecting the expert's conclusions, we did not find it significant that the domestic corporation engaged in functions other than distribution. Bausch & Lomb, Inc. v. Commissioner, 92 T.C. 525">92 T.C. 589. Petitioner, who acknowledges that manufacturers earned varying profit margins on instruments, accessories, and HC lamps, appears to argue that separate treatment of the finished product categories is tantamount to injecting the P-E manufacturing function into an analysis that1993 Tax Ct. Memo LEXIS 424">532 should be limited to distribution activities. In Bausch & Lomb, however, we did not confront a similar product aggregation issue. We instead declined to consider activities other than distribution in our derivation of a comparable uncontrolled price for soft contact lenses, which were considered a fungible commodity. Id. Here, our resolution of the aggregation issue is independent of how the P-E manufacturing activities or margins differed across product categories. We also do not agree with petitioner that disaggregation is grounded in abstract economic principles, nor that it creates an unreasonable degree of economic sophistication that precludes practical application. Instruments, accessories, and HC lamps are fundamentally different functionally, with the potential for differing and predictable influences on their respective resale margins, including the "captive" tendencies we discuss below. See infra p. 113. Indeed, within the AA product line that comprised 80 percent of the PECC output, P-E management considered spectrophotometers, lamps, furnace atomizers, and accessories to be distinct sublines. Petitioner itself acknowledges on brief, in a different 1993 Tax Ct. Memo LEXIS 424">533 context, that "The SP2 Reports regarded HCLs [HC lamps] as a major product line." The P-E accounting systems and records were sophisticated enough to track the three product categories separately, and the voluminous stipulated exhibits in the record include many financial documents with precisely this tripartite breakdown, including the original PECC financial statements. Dr. Baumol, petitioner's expert in economics, did not aid petitioner's cause on this matter. Although Dr. Thomas Horst, respondent's expert in economics, clearly stated his preference for separate product categories in his original report, Dr. Baumol did not comment specifically on this point in his rebuttal report. At trial, Dr. Baumol testified that generally "the more one can disaggregate, the better" and proceeded to explain why the resale margins on HC lamps and accessories might very well differ from an instrument margin. Moreover, although petitioner on brief invokes case law speaking of abstract economic principles, degrees of economic sophistication, and perfectly competitive markets in the economic sense, counsel for petitioner never asked Dr. Baumol about these concepts at trial, nor do they appear 1993 Tax Ct. Memo LEXIS 424">534 in his written reports. We conclude that the resale price method is appropriately applied not to the PECC finished products as a whole, but instead to the separate categories of instruments, accessories, and HC lamps. C. InstrumentsOf respondent's proposed income allocation to P-E of $ 17.1 million derived from the resale price method as applied to finished products, less than $ 400,000 is attributable to instruments. This relatively small amount follows from a coupling of Dr. Horst's conclusions that P-E earned an actual resale margin on PECC instruments of 31.9 percent for the period in issue and that P-E at arm's length should have earned a margin of 32.7 percent. Respondent's choice as the most reliable comparable transaction for instruments under the resale price method is the P-E resale of Hitachi fluorescence instruments. Petitioner recommends instead, for the finished products as a whole, the P-E transactions with Spectra-Physics, Analect, and Scientific Products, in that order. The parties themselves recognize that none of the proposed comparable transactions is close to an ideal fit. An expert adjusted the resale margin of his proposed comparable upward if he1993 Tax Ct. Memo LEXIS 424">535 quantified a circumstance either favorable to the distributor or unfavorable to the manufacturer compared to the P-E dealings with PECC. Similarly, he adjusted the resale margin downward if he quantified a circumstance either unfavorable to the distributor or favorable to the manufacturer compared to the P-E dealings with PECC. Generally, an expert supporting the comparability of a particular uncontrolled resale mentioned some differences without attempted quantification, often on the rationale that quantification was not feasible or that the associated adjustments were in a favorable direction and thus unnecessary to quantify. The other side often countered with more unquantified adjustments. Because the overall similarity sought in the resale price method relates to the probable effect upon the markup percentage of any differences in characteristics, sec. 1.482-2(e)(3)(vi), Income Tax Regs., these circumstances undermined the proposed comparables. Another general shortcoming in the proposed comparable transactions is that AA (atomic absorption) instruments dominated the PECC production, yet neither party offers a comparable from this product line. Each of the Instrument Division1993 Tax Ct. Memo LEXIS 424">536 product lines had its own distinct Product Department, and, despite similar marketing programs among the Product Departments, the markets themselves were not the same. As illustrated by the annual SP2 reports, see supra p. 13, product lines at any given time could differ in several respects, including total market size, rate of market growth, P-E market share, P-E product and customer mix, completeness of P-E line, and number and identities of major competitors. Because of the parties' mutually broad approaches to the issues in this case and the record as conformingly developed, we cannot easily evaluate and even less easily quantify product line differences. Based on the evidentiary record and the parties' arguments, we discuss the proposed comparable transactions in descending order of value, in our view, to our ultimate determination of the appropriate resale margin for instruments. 1. Hitachi and P-ESimilarities between P-E's resale of PECC instruments and resale of Hitachi fluorescence instruments include the price range and technical complexity of the instruments, the use of the P-E name and trademarks upon resale, installation and warranty provided by P-E, an1993 Tax Ct. Memo LEXIS 424">537 established analytical technology, and exclusive distribution of the products by P-E. See supra pp. 50-52. Petitioner and respondent agree, coincidentally in view of their differing computation methods, that P-E earned an average margin of 36.2 percent on resales of the Hitachi instruments to unrelated parties. From this starting point, Dr. Horst made a financing adjustment for differences in payment practices between the Hitachi/P-E and PECC/P-E transactions. The period relevant to this adjustment was the time between the P-E cash outflow (payment to the manufacturer) and the P-E cash inflow (payment received from the customer). 11Dr. Horst accepted the Arthur Andersen conclusion that a detrimental1993 Tax Ct. Memo LEXIS 424">538 95 days elapsed between P-E's prepayment to Hitachi and P-E's shipment of the instrument to a customer. See supra p. 52. He computed the comparable period for the PECC transaction, using as inputs a 4-day shipping period from PECC to P-E, the 20-day inventory holding period at P-E determined by Arthur Andersen, see supra p. 46, and a 50-day period between PECC's shipment to P-E and P-E's payment to PECC. The resulting time between P-E's shipment to its customer and its later payment to PECC was a beneficial 26 days (i.e., 50 minus 20 minus 4). Combining P-E's 95-day detriment in the Hitachi transaction, where P-E was in effect a lender, with its 26-day benefit in the PECC transaction, where P-E was in effect a borrower, meant that the Hitachi transaction was 121 days worse for P-E from a cash flow standpoint. Dr. Horst applied the P-E short-term cost of borrowing, 10.58 percent, to this 121 days, which caused him to reduce the unadjusted Hitachi resale margin of 36.2 percent by 3.5 percentage points. 12 This left an adjusted margin of 32.7 percent. 1993 Tax Ct. Memo LEXIS 424">539 Petitioner disapproves of Dr. Horst's use of the P-E short-term borrowing rate of 10.58 percent rather than the 37-percent estimate of the P-E weighted average cost of capital offered by Dr. Sanford J. Grossman, petitioner's other economics expert. According to Dr. Grossman: (1) The annual cost of capital can be defined as the before-tax earnings level that a firm must earn to provide its shareholders and creditors with their required rates of return; (2) P-E must offer a rate of return that rewards the shareholders of its common stock for the risk associated with fluctuations in P-E's value, and, on a before-tax basis, this rate of return ranged from 34 percent in 1975 to over 50 percent in 1981; and (3) the required return on debt for the P-E creditors, with the long-term component based on the AAA-rated bond yield, ranged from under 7 percent in 1977 to over 13 percent in 1981. Weighting the equity and debt required returns by their respective proportions of the P-E capitalization, with the equity generally comprising over 90 percent, Dr. Grossman arrived at the 37-percent overall figure. We do not question the accuracy of this computation, but we do have reservations about1993 Tax Ct. Memo LEXIS 424">540 its applicability to the circumstances surrounding the P-E and PECC dealings. In light of our ultimate conclusion regarding the appropriate resale margin for instruments, see infra pp. 110-111, we find it unnecessary to resolve this point definitively. As described, Dr. Horst assumed a period of 50 days between PECC's shipment to P-E and P-E's payment to PECC, rather than the 77 days calculated by Arthur Andersen. See supra p. 42. Without disputing the Arthur Andersen calculation, Dr. Horst justified his use of 50 days as "a reasonable estimate of payment practices when parties are dealing at arm's length". Incorporating the 77-day period into Dr. Horst's calculations would result in an adjusted resale margin of 31.9 percent. Respondent asserts that this adjustment for credit terms should be limited either to the 50-day estimate of Dr. Horst or, better yet, to the contractual terms between P-E and PECC. Because the Distributor Agreement lacked a provision specifying payment terms, respondent derives the contractual terms from PECC invoices calling for P-E to pay within 30 days of the PECC shipment. In Eli Lilly & Co. v. Commissioner, 84 T.C. 996">84 T.C. 996, 84 T.C. 996">1171, 84 T.C. 996">1179 (1985),1993 Tax Ct. Memo LEXIS 424">541 affd. in part, revd. in part, and remanded 856 F.2d 855">856 F.2d 855 (7th Cir. 1988), we made an adjustment for contractual payment terms as part of our application of the comparable uncontrolled price method. We did not, however, refer to any extended payment practices, in fact noting that the taxpayer in practice used the full contractual payment period. Eli Lilly & Co. v. Commissioner, 84 T.C. 1171. Even assuming that the PECC invoices set the contractual payment terms, P-E's actual payment practice with PECC strikes us as the appropriate benchmark for this adjustment. A focus on actual practice is consistent with the treatment of another point arising out of the distribution arrangement, the exclusivity of the P-E distribution rights. Although the Distributor Agreement did not state that P-E would be PECC's exclusive distributor, respondent, petitioner, and the experts have treated P-E as such for comparability purposes. As another example of deference to actual practices, respondent has not sought to apply a different legal analysis under section 482 for those many PECC finished products omitted from the 1970 licensing agreements. 1993 Tax Ct. Memo LEXIS 424">542 See supra pp. 41-42. Further, we are not impressed with respondent's argument that section 936, relating to Puerto Rico and the possessions tax credit, caused P-E to prefer that late payments to PECC appear in adjustments to the transfer price rather than as a separate interest charge. Cf. Eli Lilly & Co. v. Commissioner, 84 T.C. 1179. Petitioner suggests another downward adjustment to the P-E resale margin on Hitachi instruments, this time to account for P-E's short lead time for ordering from PECC as compared to a 6-month lead time in dealing with Hitachi. In this regard, petitioner's industry expert, Herbert L. Kahn, testified that a distributor would accept a reduction of two percentage points or more in its resale margin for the relative flexibility afforded by PECC. The sales agreement between P-E and Hitachi was vague about ordering, however, stating that Hitachi would sell and ship products subject to the terms and conditions of its standard sales order. The record does not contain such a sales order, and petitioner relies instead on a single transaction for which the P-E purchase order showed an order date of December 4, 1978, 1993 Tax Ct. Memo LEXIS 424">543 and a "ship to arrive" date of June 30, 1979. Because we are not persuaded that Hitachi required a 6-month lead time, no adjustment therefor is warranted. We turn now to the purported differences between the fluorescence and AA product lines. Dr. Baumol characterized the fluorescence market as relatively new and small, requiring the P-E salesperson to sell both the technique and the P-E product and to seek correspondingly higher compensation from the manufacturer in the form of a higher discount. He contrasted this situation with PECC products that had supposedly captured a major share of the low-cost instrument market by 1975. However, Dr. Baumol expressly disclaimed expertise concerning the analytical instrument industry, and the record does not support his vague descriptions of the fluorescence market and the PECC market share. Nor does it necessarily follow that a relatively new and small market requires more selling effort, especially if the growth rate is substantial, as it apparently was in the fluorescence area. In this regard, petitioner's industry expert, Mr. Kahn, characterized fluorescence as "a very rapidly moving market". Interestingly, respondent makes an argument1993 Tax Ct. Memo LEXIS 424">544 similar to that of Dr. Baumol about P-E's relative market dominance in the AA and IR (infrared) areas as compared to fluorescence. Instead of support for a higher discount, however, respondent sees this as indicative of lesser competition in the AA and IR markets, enabling P-E to achieve better margins than in the more competitive fluorescence market. Like Dr. Baumol, however, respondent overlooks the pertinent point of comparison in emphasizing P-E's overall positions in the AA and IR markets, rather than its much less dominant position in the low-priced segment occupied by the PECC instruments. Finally, respondent on brief suggests several other circumstances that supposedly require upward adjustment to the P-E resale margin on the Hitachi instruments in order to create true comparability. Dr. Horst did not specifically quantify any of these upward adjustments, although he mentioned some, nor does respondent on brief. Although we cannot readily quantify the effect, nor say for certain that P-E availed itself of these benefits, we do agree with respondent that Hitachi agreed to provide P-E with promotional support and free replacement parts under warranty, neither of which PECC1993 Tax Ct. Memo LEXIS 424">545 provided to P-E. 2. Spectra-Physics and P-EAlthough the resale price method is not always suited to situations in which the reseller adds product value by means of intangible property, petitioner maintains that P-E added the same such value to the products of PECC, Spectra-Physics, and Analect, thereby negating any comparability problem. See sec. 1.482-2(e)(3)(ii)(d), (iii), Income Tax Regs. Dr. Horst took a similar position in support of the Hitachi transaction as a resale comparable. Like the PECC finished products, P-E sold Hitachi, Spectra-Physics, and Analect products under the P-E name and trademarks through the P-E marketing and sales organization. Petitioner's first preference as a comparable resale transaction is Spectra-Physics, whose integrators, according to Arthur Andersen, generated a 34.1-percent margin to P-E on resales to unrelated parties. See supra pp. 47-50. Dr. Baumol pointed out several differences from the PECC arrangement with P-E, all of which he saw as favorable to Spectra-Physics relative to PECC: (1) Spectra-Physics granted its maximum discount only if P-E reached a threshold quantity level; (2) P-E had to commit to an annual delivery 1993 Tax Ct. Memo LEXIS 424">546 schedule; (3) P-E had to notify Spectra-Physics of scheduling changes 90 days before delivery; (4) P-E paid its invoices after only 50 days rather than the 77 days for PECC; (5) Spectra-Physics could compete with P-E on sales of the integrators; (6) the Spectra-Physics integrators entailed higher P-E net service costs; and (7) Spectra-Physics was not required to purchase parts from P-E, at a substantial markup, for inclusion in the finished products. Dr. Baumol believed that all of these differences, for comparability purposes, exerted downward pressure on the 34.1-percent Spectra-Physics margin, but he quantified only two. First, using Dr. Sanford's 37-percent estimate of the P-E weighted average cost of capital, Dr. Baumol concluded that the 27-day difference in payment practices translated into a reduction of 1.9 percentage points in the resale margin. 13 For Dr. Baumol's second quantified adjustment, he adopted the Arthur Andersen calculation concerning the P-E net service costs, which resulted in a further margin reduction of 1.1 percentage points. 14 Dr. Horst agreed with Dr. Baumol that an adjustment for differences in service costs was appropriate. After accounting for1993 Tax Ct. Memo LEXIS 424">547 these two factors, Dr. Baumol's adjusted resale margin for Spectra-Physics integrators stood at 31.1 percent. Substituting the P-E cost of short-term borrowing, 10.58 percent, into Dr. Baumol's calculation of the difference in payment practices results in an adjusted resale margin of 32.5 percent rather than 31.1 percent. Concerning one of Dr. Baumol's unquantified factors, the P-E status as a nonexclusive distributor for Spectra-Physics, both he and Dr. Horst recognized that P-E was in effect an exclusive distributor for PECC, but they disagreed about whether exclusivity tends to increase or decrease a resale margin. In Dr. Baumol's view, a distributor would accept a smaller discount1993 Tax Ct. Memo LEXIS 424">548 from the manufacturer if the manufacturer agreed not to sell the same product to others, the rationale being that the distributor, protected from direct competition, could make sales with less effort. The smaller discount under this theory leads to a smaller resale margin. In Dr. Horst's view, on the other hand, a lack of direct competition enables the distributor to sell at a higher price, thereby earning a higher resale margin. Mr. Kahn agreed with Dr. Baumol's point about reduced selling effort and Dr. Horst's point about more distributor price control, concluding that these were benefits to the distributor for which it would sacrifice approximately three percentage points of discount. In our view, however, the resale margin effect of an exclusive arrangement versus a nonexclusive arrangement, in the circumstances before us, is unsuited to generalizations like those advanced by the experts. Based on the P-E attempt to price the integrators higher than Spectra-Physics, which was unsuccessful because of the latter's competing presence, we recognize that P-E probably would have priced the integrators higher in an exclusive arrangement. This does not by itself, however, prove1993 Tax Ct. Memo LEXIS 424">549 Dr. Horst's point. Even he acknowledged as a general proposition that the presence of third-party competitors' products could limit pricing freedom. Because the low-priced market segments that included the PECC instruments were price sensitive and not dominated by P-E, we do not believe that the Spectra-Physics pricing implications transfer readily to the PECC instruments. Even if we assume that P-E had some measure of pricing freedom with the PECC instruments, Dr. Horst's position faces another obstacle. In attempting to reconcile his view with that of Dr. Baumol, Dr. Horst agreed that a manufacturer would probably seek and get a higher price from the distributor in an exclusive arrangement. He recognized that, if this were so, the price charged by the distributor to the user would have to increase even more (in terms of the percent increase) than the price charged by the manufacturer to the distributor, in order for a higher resale margin percentage to result. Thus, even if we accept that a distributor would charge a higher price in an exclusive arrangement, it is by no means certain that a higher resale margin percentage would result. We are also not persuaded that, as Dr. 1993 Tax Ct. Memo LEXIS 424">550 Baumol suggests, a rational manufacturer would necessarily seek a smaller discount percentage off the distributor's price in a state of lessened competition from an exclusive arrangement. If the distributor set a higher price while the discount percentage stayed the same, the manufacturer would still reap a proportionate share of the increased price. For example, at an unchanging discount of 30 percent, 70 percent of the distributor's price increase would be additional revenue to the manufacturer. Considering the effects in the opposite direction, moving from exclusive to nonexclusive, Dr. Baumol testified that if PECC had sold some of its products directly to customers, then P-E, if at arm's length, would have demanded a higher discount to compensate for the more difficult selling task it faced. In actuality, however, P-E exerted relatively little effort in selling the PECC instruments, with salespeople often acting merely as passive order takers. Given that P-E did not try to exploit its exclusivity with aggressive selling, it is not as clear to us, as it was to Dr. Baumol, that a nonexclusive, arm's-length P-E would increase its selling efforts and thus need or demand more1993 Tax Ct. Memo LEXIS 424">551 compensation. In sum, we do not believe that the resale margin effect of exclusive versus nonexclusive distribution arrangements is as straightforward as suggested by the experts, nor do we believe that they have adequately accounted for the particular circumstances of this case. We therefore agree with Dr. Horst's more general proposition that the uncertainty surrounding this factor undermines the comparability of the Spectra-Physics transaction. Of the remaining four factors that Dr. Baumol cited as relatively favorable to Spectra-Physics, we see none that necessarily affects the P-E resale margin on PECC instruments. As to a required minimum order level to reach the maximum discount percentage, a stipulated exhibit indicates that P-E regularly exceeded that level, suggesting that the contracting parties contemplated high order levels that rendered the lower discounts largely meaningless. 15 The agreed annual delivery schedule, which the allowance for 90-day rescheduling largely mitigated, in context appears to have been merely a guideline, not a binding obligation that Spectra-Physics would have cared to enforce. Concerning the Spectra-Physics freedom to purchase parts from1993 Tax Ct. Memo LEXIS 424">552 other than P-E, our conclusion below that PECC did not pay more than an arm's-length amount for its parts negates this purported distinction. See infra p. 152. Finally, the access of the Norwalk Support Group to the sophisticated MRP system, coupled with P-E's provision of necessary parts to PECC, potentially offsets to a great extent what would otherwise be a risk disparity with Spectra-Physics, which had 90 days' notice of P-E scheduling requirements. Respondent argues that the Spectra-Physics transaction is not comparable, or at least its resale margin must be adjusted upward to become comparable, because the integrators exhibited price sensitivity, showed a clear obsolescence trend, and needed limited sales support. These circumstances, according to respondent, contrast with the price premiums commanded by P-E's quality AA and IR1993 Tax Ct. Memo LEXIS 424">553 products. However, although in general P-E maintained a high pricing policy and enjoyed a reputation for high quality, the pricing policy became somewhat muted for the relatively low-priced PECC instruments. Because of functional similarity among competitors, price was more important to users at the low-priced end than for higher priced instruments, and the P-E prices on PECC instruments were usually at least close to those of competitors. Admittedly, the Spectra-Physics integrators had obsolescence problems that adversely affected margins, but obsolescence was also not uncommon among the PECC instruments. Sales of an AA instrument model at P-E generally peaked after only 2 or 3 years, and PECC did not always begin production of an instrument model at its marketable inception. See supra pp. 31-34. Spectra-Physics did agree to provide some benefits to P-E that PECC did not provide, such as service training, but respondent's suggested differences in marketing support and in the P-E distribution activities seem insignificant, largely because PECC instruments themselves entailed little in the way of distribution activities. 3. Analect and P-EPetitioner's second choice1993 Tax Ct. Memo LEXIS 424">554 as a comparable transaction under the resale price method is the P-E resale of Analect FX-6200 FTIR instruments, which P-E sold in combination with its own data stations as the Models 1500 and 1550. See supra pp. 52-56. P-E purchased the instruments during fiscal 1982 through 1985 at a 30-percent discount from the Analect list price, and Arthur Andersen concluded that P-E earned a resale margin of 25.2 percent on the Model 1500 and 1550 systems. Petitioner contends that any necessary adjustments to arrive at true comparability would reduce the unadjusted resale margin and, accordingly, that the already low margin is corroborative evidence that the P-E resale margin on PECC instruments as calculated by Arthur Andersen, 31.5 percent, was arm's length. The only such adjustment quantified by Dr. Baumol, of three percentage points, was for the 42-day difference between P-E payments to PECC (77 days after invoice) and P-E payments to Analect (35 days). As with the Spectra-Physics integrators, P-E sold the FX-6200 instruments while the manufacturer continued to sell them itself. The record, however, is not clear about the actual degree of direct competition. On the one hand, Gaynor1993 Tax Ct. Memo LEXIS 424">555 Kelley of P-E testified that P-E faced some bothersome competition from Analect. On the other hand, Analect intended the integrated P-E system to enter a higher priced market segment, thus avoiding direct competition. Assuming that the Analect intentions played out in practice, thus creating in effect a largely exclusive arrangement like that between P-E and PECC, several other factors cumulatively cause us to conclude that this is not an appropriate comparable transaction. The Analect FX-6200 became part of P-E's IR product line, making this transaction the first we have discussed that involved a product line for which PECC produced instruments. However, the P-E list prices for the Models 1500 and 1550, beginning at $ 35,000, were well above the mainly under-$ 10,000 prices for the PECC instruments. This huge price discrepancy is indicative of the relative complexity of the instruments, and what follows from more complexity is usually more costly technical support provided by the distributor to the user. Petitioner's industry expert, Mr. Kahn, attempted to downplay the complexity difference, but his testimony on this point was vague and unpersuasive. Dr. Baumol did not mention1993 Tax Ct. Memo LEXIS 424">556 prices in his discussion of the Analect instruments in his original written report, but, elsewhere in that report, he acknowledged the relationship between complexity and technical support. At trial, Dr. Baumol stated generally that price is a legitimate comparability factor. More to the point, he admitted that the Analect price disparity "certainly casts very severe doubt on the comparability". Furthermore, at the time P-E entered into the agreement with Analect, management, which was well aware of the advantages of the nondispersive technology, had already authorized development of a P-E product. Lack of a nondispersive product had caused a loss of P-E market share in 1980 and had threatened its status as the world leader in the IR area. Management perceived purchasing the FX-6200 from Analect as an expeditious way to enter the market, which would provide a foothold for the later marketing of the P-E product under development. These considerations may have caused P-E to sell at a lower price than it otherwise would have, which would afford a degree of reconciliation of Gaynor Kelley's testimony and the Analect intentions regarding competition. Cf. sec. 1.482-2(e)(2)(iv), 1993 Tax Ct. Memo LEXIS 424">557 Income Tax Regs. (relevant circumstance in comparable uncontrolled price method is low pricing for primary purpose of establishing or maintaining a market for a product). Analect also provided P-E with marketing assistance, service documentation and training, other technical support, and warranty coverage, none of which PECC provided to P-E. Dr. Baumol admitted at trial that the presence of technical assistance and warranty coverage would affect the conclusions he drew in his original report, but he did not attempt to estimate the effect. He also did not raise the Arthur Andersen net service figures as a possible offset. See supra p. 56. We are left with several possible adjustments moving in different directions, with little in the way of quantitative guidance. Finally, the Model 1500 and 1550 systems included P-E components, such as data stations and applications software, that comprised significant portions of the total value, thus possibly distorting the resale margin. Petitioner points out that certain PECC finished products were also packaged together with P-E products for resale, but petitioner has not given us a basis upon which we could conclude that this practice1993 Tax Ct. Memo LEXIS 424">558 was widespread, as it was with the Analect instruments. To overcome the possible margin-distorting effects of combined P-E and Analect components, Arthur Andersen computed a P-E resale margin of 17 percent that supposedly isolated the Analect-sourced products. Nonetheless, we need not address respondent's arguments concerning possible methodological errors in this calculation. Petitioner does not refer to this calculation on brief, and we deem it abandoned. 4. Coleman and Scientific ProductsColeman sold various items to Scientific Products, usually at a 33-percent discount from Coleman list prices, for which Scientific Products recorded an average resale margin of 23.6 percent. See supra pp. 56-58. This margin lies well below the resale margin that Arthur Andersen concluded P-E earned on PECC instruments, 31.5 percent, which petitioner maintains was arm's length. Unlike the PECC relationship with P-E and the three potential comparable transactions already discussed, the distributor in this transaction, Scientific Products, resold the products under the manufacturer's name and trademarks rather than its own. The P-E name and trademarks were valuable marketing intangibles1993 Tax Ct. Memo LEXIS 424">559 that should be accounted for somehow under the resale price method as applied to the PECC instruments. See sec. 1.482-2(e)(3)(vi)(c), Income Tax Regs. We have no way on this record, however, to quantify the value of these intangibles. The uncertainty on this important matter alone greatly undermines any purported comparability. Cf. sec. 1.482-2(e)(2)(ii), Example (2), Income Tax Regs. (difference in trademarks under comparable uncontrolled price method normally renders uncontrolled sale noncomparable). Moreover, although P-E and Scientific Products had similar distribution organizations structurally, and Scientific Products performed similar distribution functions to those of P-E, we are not satisfied that Scientific Products performed them as well or to the same extent. Indeed, Dr. Baumol suggested two factors relating to reseller functions as exerting upward pressure on the Scientific Products resale margin for comparability purposes. See sec. 1.482-2(e)(3)(vi)(b), Income Tax Regs. First, the relative simplicity of the Coleman instruments compared to the PECC instruments meant less costly technical support. Second, Coleman bore a portion of the warranty 1993 Tax Ct. Memo LEXIS 424">560 costs for the instruments it sold to Scientific Products. Other Coleman assistance that relieved Scientific Products of some measure of distribution functions included: (1) Training and seminars for the instrument users; (2) technical training and ongoing assistance for Scientific Products personnel; and (3) detailed product and marketing information. Understandably, the resale price method regulations strongly encourage the use of comparable transactions that involve the same reseller as in the related-party transaction. Sec. 1.482-2(e)(3)(vii), Income Tax Regs. Petitioner here, however, does not suggest how we might attempt to quantify necessary adjustments to the Scientific Products resale margin. With such notable differences to account for, and no discernible way to account for them, we attach minimal significance to this transaction. 5. ConclusionNeither party has provided a proposed instrument comparable sufficiently similar to the P-E resale of PECC instruments, in and of itself, to satisfy the resale price method in section 1.482-2(e)(3), Income Tax Regs. Consequently, we must undertake an evaluation of the arm's-length price for PECC instruments sold to P-E 1993 Tax Ct. Memo LEXIS 424">561 based on the entire record in respect of the various transactions offered as comparables by the parties. We continue to focus on what the regulations call an appropriate markup percentage and what we have often referred to as a resale margin. See sec. 1.482-2(e)(3)(i), (vi), Income Tax Regs. Respondent has not specifically contested the accuracy or reliability of the Arthur Andersen determination that P-E earned a resale margin of 31.5 percent on PECC instruments sold to unrelated parties, so we accept that figure as our reference point. See supra p. 46. Accordingly, the question before us is whether 31.5 percent was an arm's-length resale margin. With primary reliance on the Hitachi transaction, which was the least controversial proposed comparable, and somewhat lesser reliance on the Spectra-Physics transaction, we are satisfied that the P-E resale margin of 31.5 percent on PECC instruments was not lower than arm's length. After considering the more readily quantifiable adjustments surrounding the Hitachi and Spectra-Physics transactions, we were left with adjusted resale margins of 31.9 percent and 32.5 percent, respectively, even after incorporating respondent's preference1993 Tax Ct. Memo LEXIS 424">562 for the short-term borrowing rate in the time-value-of-money aspects. See supra pp. 94, 99. We do not mean to suggest that further adjustments to the Hitachi and Spectra-Physics margins would not have been appropriate had we been furnished with more complete information or more easily quantified factors. However, on the record before us, and in light of the parties' broad approach in terms of product groupings and combined taxable years, we are satisfied that the prices charged for instruments by PECC to P-E fall within the range of permissible levels under section 482. Cf. U.S. Steel Corp. v. Commissioner, 617 F.2d 942">617 F.2d 942, 617 F.2d 942">950 (2d Cir. 1980), revg. T.C. Memo. 1977-140 and T.C. Memo. 1977-290; Bausch & Lomb, Inc. v. Commissioner, 92 T.C. 525">92 T.C. 525, 92 T.C. 525">592-593 (1989), affd. 933 F.2d 1084">933 F.2d 1084 (2d Cir. 1991). Accordingly, we hold that respondent may not allocate income to P-E based on the prices it paid PECC for instruments, except for the stipulated allocation to account for petitioner's concession that a 30-percent discount should have applied in all1993 Tax Ct. Memo LEXIS 424">563 years. See supra note 7. D. HC LampsPetitioner advanced the Spectra-Physics, Analect, and Scientific Products transactions as comparables under the resale price method for PECC finished products as a whole. Because these three transactions have a closer connection to instruments than to HC lamps or accessories, and because we did not find them comparable even for instruments, we will not consider them again in our analysis of the noninstrument PECC products. Respondent contends that the P-E resale of Sylvania deuterium lamps, after appropriate downward adjustment to the resale margin, was comparable to the P-E resale of HC lamps produced by PECC. See supra pp. 61-64. Under respondent's primary trial position, $ 9.0 million of the total income allocation to P-E of $ 22.2 million is attributable to HC lamps. Petitioner disputes the comparability of the deuterium lamps on the ground that identifiable differences caused P-E systematically to earn higher resale margins on deuterium lamps than on HC lamps. 161993 Tax Ct. Memo LEXIS 424">564 According to Dr. Horst's calculations, P-E earned a margin of 63.1 percent on its resale of deuterium lamps, a figure that petitioner does not contest. Much like he did for the P-E resale of Hitachi fluorescence instruments, Dr. Horst made a financing adjustment to account for the Arthur Andersen conclusions that P-E held deuterium lamps in inventory for 113 days and HC lamps for only 33 days. See supra p. 46. Applying the P-E cost of short-term borrowing of 10.58 percent, he reduced the deuterium lamp margin by 2.3 percentage points. He further reduced the margin, by 3.6 percentage points, to account for the volume discounts customers could get for purchasing several HC lamps at a time. His adjusted resale margin for deuterium lamps, which respondent argues should apply to the HC lamps produced by PECC, was 57.2 percent. The parties argue about the comparability of deuterium lamps in three principal areas. One is the technical and functional characteristics of each type of lamp. A second area is the nature and extent of the functions performed by the distributor, P-E. Finally, the parties contest the "captive" nature, or lack thereof, of HC lamps and deuterium lamps1993 Tax Ct. Memo LEXIS 424">565 as they relate to instruments. Dr. Horst raised this last topic in his initial written report, describing a captive product (e.g., razor blades) as one that a customer tends to buy, largely because of the value of a company's name or goodwill, from the same company that sold the customer the principal product (e.g., a razor). This tendency, as described by Dr. Horst, frequently leads to high markups on the captive product. Dr. Baumol agreed with Dr. Horst's general description of the principle. 17Under the resale price method, one of the important characteristics in determining which resales are most similar for comparability purposes is the type of property involved. Sec. 1993 Tax Ct. Memo LEXIS 424">566 1.482-2(e)(3)(vi)(a), Income Tax Regs. On the subject of technical and functional characteristics, respondent's industry expert, Dr. Nelson L. Alpert, observed in his initial report that both types of lamps are radiation sources of limited useful life in instruments, that they are of comparable complexity, and that P-E sold both in moderately high quantities. There is no question that both lamps were radiation sources of limited useful life that P-E resold at similar prices. Further, petitioner's industry expert, Mr. Kahn, who responded in his rebuttal report to Dr. Alpert, did not rebut Dr. Alpert's statement that the lamps were of similar technical complexity, instead merely stating that HC lamps for various elements differed in technical respects from one another. Nonetheless, it is beyond dispute that the specific functions of the two lamps differed. Neither party suggests that a deuterium lamp could substitute for an HC lamp in an AA spectrophotometer, nor that an HC lamp could substitute for a deuterium lamp in an AA background corrector or in a UV-VIS spectrophotometer. In addition, a notable difference in use was that an instrument user might temporarily remove and1993 Tax Ct. Memo LEXIS 424">567 reinstall various functioning HC lamps in order to measure different elements, yet a deuterium lamp would only be removed upon failure after some necessary disassembly of the instrument. Section 1.482-2(e)(3)(vi)(a), Income Tax Regs., provides examples of acceptable product categories for comparability purposes, listing specifically machine tools, men's furnishings, and small household appliances. From a technical, functional, and use standpoint, HC lamps and deuterium lamps appear at least as closely related as common items within these categories. Because petitioner has not described the probable effect upon the markup percentage of the differences in technical specifications, functions, and use characteristics, we are not prepared to disqualify deuterium lamps as a comparable based on these differences alone. The second broad point of contention between the parties is the nature and extent of the functions performed by P-E in distributing the two types of lamps. See sec. 1.482-2(e)(3)(vi)(b), Income Tax Regs. As we view the evidence, the P-E distribution activities were not substantial for either lamp, and we see no distribution factor that we would expect to have1993 Tax Ct. Memo LEXIS 424">568 a material effect on a resale margin, with the possible exception of warranty costs. P-E bore the entire warranty expense on HC lamps; the deuterium lamps had more limited warranty exposure because of the Sylvania 500-hour warranty to P-E and because P-E did not give its own warranty to customers. HC lamps required little P-E effort and expense in the areas of installation, customer training, and servicing. For deuterium lamps, there was no such thing as initial installation for the replacement market, nor is there evidence that P-E provided any customer training to users already accustomed to the instruments and accessories that contained those lamps. P-E did perform service installation for some portion of the replacement deuterium lamps, but there was a separate charge for this to the customer. In the marketing and sales area, advertising was not a factor for HC lamps most of the time, and the P-E salespeople acted for the most part as mere order takers. The deuterium lamps also did not involve marketing and sales efforts by P-E personnel. P-E held deuterium lamps in inventory over three times as long as it held HC lamps, and we agree with Dr. Baumol that, other things being1993 Tax Ct. Memo LEXIS 424">569 equal, a distributor would require a higher resale margin as compensation for this extra burden. However, Dr. Baumol did not estimate the quantitative effect of this factor, and it is therefore unclear to what extent he believed that Dr. Horst's financing adjustment based on inventory holding periods failed to address this point. See supra p. 112. Another important characteristic in determining which resales are most similar for comparability purposes is the effect on price of any intangible property used by the reseller. Sec. 1.482-2(e)(3)(vi)(c), Income Tax Regs. Respondent, who considers the captive product phenomenon a marketing intangible in this regard, argues that HC lamps and deuterium lamps were equally captive in relation to their associated P-E instruments. Petitioner counters that deuterium lamps were captive, but that HC lamps were much less so, if at all. As sometimes noted in the P-E SP2 reports, a customer tended to purchase HC lamps from its instrument supplier. An Instrument Lab employee testified about Instrument Lab customers to the same effect. More generally, a P-E market study conducted in 1981 confirmed the existence of this tendency for lamps1993 Tax Ct. Memo LEXIS 424">570 as a whole, that is, not just P-E lamps and not just HC lamps. Respondent, while recognizing that P-E HC lamps were not captive products in the strict sense of one-of-a-kind replacement parts, offers several explanations for their generally captive nature in order to give us a sense of the similarity to deuterium lamps. It does makes sense, as respondent suggests, that convenience and compatibility concerns would push a customer toward purchasing HC lamps from the instrument supplier at the time of the instrument purchase, especially in view of the relatively low HC lamp prices compared to AA spectrophotometer prices. Convenience and compatibility, however, go only so far. The convenience rationale at the time of the instrument purchase would not apply to the same extent for replacement lamps purchased later, and the presence of inexpensive and widely available lamp adaptors would seemingly allay compatibility concerns. P-E itself apparently did not try to exploit these concerns. P-E included lamp adaptors in its published price lists, and, when customers used competitors' HC lamps, P-E did not void its instrument warranty. In terms of the competitive environment, respondent1993 Tax Ct. Memo LEXIS 424">571 argues that customer loyalty to the instrument supplier derived in part from limited alternative sources for HC lamps. We are confident from this record, however, that someone seeking an HC lamp had several alternative suppliers from which to choose, including other instrument manufacturers, and that a lack of suppliers was not a major contributing factor to customer loyalty. Moreover, someone seeking an HC lamp sometimes had another lamp option. P-E itself successfully sold ED lamps that were superior to the corresponding HC lamps for certain elements and applications. We also disagree with respondent that P-E cultivated strong customer loyalty through promotion of a superior product. We read the P-E promotion language for HC lamps as standard product puffing; it differs little from how a supply house catalog described WestinghouseHC lamps. See supra pp. 24-25. As to actual quality, many Intensitron HC lamps suffered quality problems from unwanted hydrogen for much of the period in issue. Further, the SP2 report prepared in 1977, without regard to the hydrogen problem, described those lamps as no more than "at least the equivalent" of competitive products. The same 1993 Tax Ct. Memo LEXIS 424">572 report immodestly described the P-E ED lamps as "definitely superior". In any event, superior P-E quality would not explain why the captive tendencies of HC lamps apparently extended across the industry; clearly, not everyone was offering superior quality. In addition to suggesting reasons for the captive nature of HC lamps, respondent rationalizes the higher pricing assumed to follow from a captive product by arguing that price was relatively unimportant to consumables purchasers when compared with factors such as quality and delivery time. Although price may have been subordinate to other considerations for consumables in general, customers did not consider price unimportant and, further, consumables include products other than HC lamps. See supra p. 8 and note 3. Moreover, for HC lamps in particular, P-E management noted in the SP2 reports that customer preferences shifted to alternative sources if pricing varied too much between suppliers. Management demonstrated its recognition of customer price consciousness by offering published volume discounts on HC lamps. Petitioner seeks to distance deuterium lamps from HC lamps by arguing that the former were much more captive1993 Tax Ct. Memo LEXIS 424">573 than the latter. Unlike HC lamps, which were often purchased separately either with AA instruments or as later add-ons, customers purchased deuterium lamps only as replacements for failed lamps that originated as integral parts of AA background correctors or UV-VIS spectrophotometers. Although replacement parts have something of a captive aura about them to begin with, petitioner emphasizes the circumstances surrounding replacement, with reliance on its industry expert, Mr. Kahn. In his rebuttal report, Mr. Kahn concluded that "as a practical matter, the overwhelming majority of customers have no choice but to purchase necessary replacement * * [deuterium] lamps from the instrument manufacturer and to have the instrument manufacturer's service people install them", a situation ripe for high markups. The major premises leading up to this conclusion were that, first, the complexity and danger of installing the lamps discouraged all but a very few users from doing it themselves, and second, deuterium lamp manufacturers almost never provided installation services. Mr. Kahn added in his trial testimony that a user typically would not even know that a deuterium lamp had failed until1993 Tax Ct. Memo LEXIS 424">574 so informed by a service person diagnosing an unidentified problem. Mr. Kahn's view that instrument users rarely installed their own replacement deuterium lamps strikes us as an exaggeration lacking independent support in the record. Even assuming that the reluctance of Sylvania to sell to distributors extended to other lamp manufacturers, this would not preclude users from purchasing the lamps from instrument manufacturers, which was the Sylvania target market, for self-installation or for service company installation. Indeed, this was apparently the case at P-E in the AA product line. In analyzing deuterium lamps from the P-E records, Arthur Andersen determined that three-fourths of the lamps that did not become components in the production of instruments and accessories went directly to users rather than to the service organization. See supra pp. 63-64. P-E also promoted at least one spectrophotometer model as having easy access to the deuterium lamp in the background corrector, and P-E's AA price lists, which recommended service installation for only some deuterium lamps and assemblies, required service installation for none. From a competition standpoint, petitioner1993 Tax Ct. Memo LEXIS 424">575 claims that an absence of market competition characterized deuterium lamps, thus enabling P-E to earn an abnormally high resale margin. The deuterium lamp manufacturers, says petitioner, declined to compete with instrument manufacturers because of product liability exposure, the small size of the market, and the high cost of maintaining a service organization. Given the inadequate picture of the competitive setting in the record before us, we find none of these points persuasive. We further note that petitioner has not suggested that only P-E deuterium lamps were compatible with P-E instruments. Although Sylvania was indeed concerned about its product liability exposure, this feeling was apparently not universal. P-E, for example, sold some models of deuterium lamps without even recommending service installation. As to the size of the market, it was certainly small compared to the HC lamp market but not small in an absolute sense. In fact, P-E at one time considered engineering its own deuterium lamps, in part because they sold "in tremendous quantities". Concerning the purported high cost of a service organization, we are not convinced that a service organization was necessary. 1993 Tax Ct. Memo LEXIS 424">576 Although some of petitioner's arguments have not impressed us, we are nonetheless unwilling to conclude, as respondent would have us do, that the P-E resale of deuterium lamps was comparable to the P-E resale of HC lamps purchased from PECC. Both lamps exhibited captive tendencies, but the differing and uncertain circumstances preclude us from making quantifiable adjustments to the P-E deuterium lamp resale margin. Differences suggesting that the arm's-length resale margin for deuterium lamps should have been higher than the arm's-length HC lamp margin include: (1) Customers bought HC lamps at the time of the instrument purchase and later both to expand the elements analyzed and to replace failed lamps, while deuterium lamps as sold by P-E were only replacement products; (2) the HC lamp market had many competitors, while competition in the deuterium lamp market is unclear from this record; (3) service people did not install or replace HC lamps, while they at least sometimes replaced deuterium lamps; and (4) a typical instrument user purchased HC lamps much more frequently, and at a higher aggregate cost, than deuterium lamps. We therefore do not adopt respondent's recommendation1993 Tax Ct. Memo LEXIS 424">577 of a 57.2-percent resale margin. Instead, we turn to the entire record to determine the arm's-length price for HC lamps sold to P-E by PECC. Regardless of the specific reasons, which remain somewhat elusive to us, customers had a definite inclination to purchase HC lamps from their instrument suppliers, who we believe would reasonably seek to exploit the tendency through higher resale margins than they earned on the instruments. Consequently, the starting point for the HC lamp resale margin is 31.5 percent, which we have accepted as an arm's-length margin for the P-E resale of PECC instruments. See supra pp. 110-111. Frank Boes, a division general manager for Instrument Lab during the years in issue, testified that for the HC lamps Instrument Lab purchased from Westinghouse prior to the agreement with Juniper, see supra p. 69, Instrument Lab earned a margin on resale "in the range of 35 or 40 percent". Respondent elicited this testimony on cross-examination, and it appears to be the foundation of petitioner's argument on brief that dealings between Westinghouse and Instrument Lab offer an appropriate resale margin for HC lamps. However, petitioner's counsel did not 1993 Tax Ct. Memo LEXIS 424">578 ask the witness to elaborate on the circumstances surrounding this arrangement, nor was he asked for a more definitive percentage. Thus, we are left with no explanation of how the circumstances of this arrangement differed from those of the PECC and P-E dealings. We assign the adverse consequences of this gap in the record to petitioner, whose inexactitude is of its own making. See Sundstrand Corp. v. Commissioner, 96 T.C. 226">96 T.C. 226, 96 T.C. 226">375 (1991); Eli Lilly & Co. v. Commissioner, 84 T.C. 996">84 T.C. 996, 84 T.C. 996">1148, 84 T.C. 996">1167, 84 T.C. 996">1180 (1985), affd. in part, revd. in part, and remanded 856 F.2d 855">856 F.2d 855 (7th Cir. 1988); Cohan v. Commissioner, 39 F.2d 540">39 F.2d 540, 39 F.2d 540">543-544 (2d Cir. 1930). Under the foregoing circumstances, we are not prepared to adopt a resale margin below 40 percent. At the same time, we find no basis in the record for adopting a figure in excess of 40 percent but less than the 57.2 percent advocated by respondent, which we have rejected. In short, using our best judgment on the record before us, we conclude that 40 percent constitutes an arm's-length resale margin for HC lamps. The starting1993 Tax Ct. Memo LEXIS 424">579 point for the corresponding income allocation to P-E is the PECC net sales of HC lamps to P-E, after accounting for petitioner's concession regarding a constant 30-percent discount. See supra note 7. The arm's-length price for these sales is equal to the applicable resale price reduced by the appropriate resale margin. Sec. 1.482-2(e)(3)(i), (iv), (vi), Income Tax Regs. The applicable resale price shall be calculated by the parties for each year by increasing the PECC net sales base by the actual P-E resale margin for that year on sales to unrelated parties, as determined by Arthur Andersen. See supra pp. 45-46. This applicable resale price, which will represent total P-E resales to unrelated and related parties, shall then be reduced by the arm's-length resale margin determined by the Court, 40 percent. To the extent that the actual PECC net sales exceed the arm's-length price, gross income is allocated to P-E. E. AccessoriesRespondent proposes an income allocation to P-E of $ 7.8 million to account for the arm's-length pricing of accessories between PECC and P-E. See supra pp. 59-61. Respondent bases this allocation on a purported comparable resale margin1993 Tax Ct. Memo LEXIS 424">580 of 57.6 percent, which Dr. Horst derived largely from the P-E 1980 and 1981 computerized sales database. In his original report, Dr. Horst had calculated a lower comparable resale margin. As the most comparable resale transactions under the resale price method, he had targeted the P-E sales of all accessories purchased from unrelated suppliers in each of the three product lines covered by PECC accessories. He had found the gross margins for those sales, by product line and by year, in the P-E accounting records under categories called "Resale Hitachi" and "Resale Other". After weighting the resale margins by product line and by year based on PECC standard costs, he had arrived at a weighted average resale margin of 53.2 percent applicable to all PECC-assembled accessories. In his subsequent supplemental report, Dr. Horst adopted the recommendations of petitioner's accounting experts that the 1980 and 1981 sales database was preferable to the accounting records he had used originally. He also agreed to factor out those products that P-E resold at unit prices not exceeding $ 200. Weighting the percentages from the table in part V.A.6. of our findings, see supra p. 60, by 1993 Tax Ct. Memo LEXIS 424">581 the P-E resales of PECC accessories to unrelated parties in each product line, he computed separate resale margins for 1980 and 1981, made adjustments to account for 1975 through 1979, and ultimately arrived at his proposed comparable resale margin of 57.6 percent for the entire period in issue. Petitioner's principal objection to the Horst methodology is his failure to factor out the substantial effect of the graphite tubes. Because the graphite tubes comprised over 85 percent of the over-$ 200 net sales for AA accessories resold by P-E in 1980 and 1981, and because Dr. Horst's weighting factor favored the AA product line, the graphite tubes went a long way toward determining Dr. Horst's 57.6-percent resale margin. Indeed, applying Dr. Horst's methodology without the graphite tubes results in a 44-percent resale margin. Petitioner's rationale for excluding the purportedly captive graphite tubes is that, with a price per tube below $ 25, this was a relatively inexpensive, consumable item that was similar to many items within the low-priced ($ 200 or less) accessory category that Dr. Horst voluntarily disregarded in reaching his 57.6-percent margin. P-E never sold graphite tubes1993 Tax Ct. Memo LEXIS 424">582 singly, however, leading respondent to argue that a 50-count box is a legitimate over-$ 200 product. As support for inclusion of the graphite tubes and for the overall comparability of the Resale Other and Resale Hitachi categories, respondent cites section 1.482-2(e)(1)(iv), Income Tax Regs. This provision permits the application of an appropriate arm's-length pricing method to product lines or other groupings, including those derived from reasonable statistical sampling techniques, if it is impractical to apply the method to each product. Because PECC assembled accessories with 30 different part numbers in 1980 alone, some sort of grouping method presumably cannot be avoided. Respondent maintains that Dr. Horst applied a reasonable statistical sampling technique and that excluding graphite tubes is inconsistent with the statistical principle that the "law of numbers" eliminates distortions caused by specific items. Further, argues respondent, venturing into an evaluation of one product in the group undermines the very reason the regulations permit grouping, which is the impracticality of examining every product and sale. We disagree. Dr. Horst merely adopted categories established1993 Tax Ct. Memo LEXIS 424">583 by the P-E accounting records and then eliminated those products priced at $ 200 or less. Respondent does not attempt to describe the specific factors that made the Resale Other and Resale Hitachi transactions comparable to the P-E resale of PECC accessories. Instead, respondent states broadly that these "Resale" transactions involved the P-E resale of accessories in the same three product lines as the accessories produced by PECC. We do not view these circumstances as reflecting the application of a statistical sampling method. Admittedly, a so-called law of numbers, which we interpret as grounded in a large sample size, may tend to even out distortions among items when no one item is weighted disproportionately. We fail to see, however, how any such principle could operate effectively in a weighted-average situation where one item comprises 85 percent of the total in the heaviest of three weighted categories. Moreover, respondent's argument that delving into the details of the sample undermines the grouping rationale is out of place. Dr. Horst himself willingly eliminated from the sample those products selling for under $ 200, even though PECC sold some products in that price1993 Tax Ct. Memo LEXIS 424">584 range to P-E. Respondent does not contend that PECC itself manufactured graphite tubes, nor that graphite tubes were comparable to any specific accessory that PECC produced, nor that PECC packaged any of its products for resale in similar bulk quantities. Given these circumstances and the extreme influence that the graphite tubes had on the derivation of Dr. Horst's 57.6-percent margin, we do not believe that the graphite tubes are an appropriate element in the P-E accessory grouping. After elimination of the graphite tubes, we still cannot conclude that Dr. Horst's sample is comparable to the P-E resale of PECC accessories. In this regard, section 1.482-2(e)(3)(vi) and (ix), Income Tax Regs., requires consideration of factors such as reseller functions and product types, with adjustments made for material differences between the controlled and uncontrolled transactions. Certainly, section 1.482-2(e)(1)(iv), Income Tax Regs., which authorizes product groupings, implicitly relaxes some of the normally strict constraints on comparability. Nonetheless, we do not believe that respondent's vague comparability rationale here passes muster. From the record as it stands, however, we1993 Tax Ct. Memo LEXIS 424">585 do think that a captive product premium, which Dr. Horst took into account, applies to the PECC accessories resold by P-E. Generally, because of concerns with quality and compatibility, for example, an instrument customer would more likely than not purchase an accessory from the instrument manufacturer without great concern about price. P-E encouraged the tendency by often marketing instruments and accessories together. As with HC lamps, however, P-E's potential pricing flexibility had its limits. The SP2 reports disclosed that customers avoided some AA accessories because of high prices and that others lost their competitive edges technologically in the mid-1970s. P-E also sometimes offered package deals and other customer incentives. We know little specifically about the facts and circumstances surrounding the resale of PECC accessories. Respondent mentions the ED lamp power supply, PECC's largest volume accessory, as one that faced no competition and thus had a high degree of captivity. 18 However, although this product probably faced little competition (because of the strict ED lamp warranty, see supra p. 11) in the minds of P-E's ED lamp owners, P-E was not the only1993 Tax Ct. Memo LEXIS 424">586 ED lamp seller. Because P-E's ED lamps were directly interchangeable with Intensitron HC lamps, P-E instrument customers presumably could buy their ED lamps and power supplies elsewhere, just as they could their HC lamps. In the circumstances confronting us, our best judgment leads us back to the 1980 and 1981 sales database used by Dr. Horst, which involved a wide variety of vendors. For adjustments, we will ignore the products with unit prices not exceeding $ 200 because both parties accepted this restriction, and we will disregard the graphite tubes. In addition, we will not weight the product line margins by the PECC accessory output, in part because elimination1993 Tax Ct. Memo LEXIS 424">587 of the graphite tubes makes the AA accessory figures from the sales database much smaller, and associated margins potentially less reliable, than the other two product lines. Combining the sales and cost of sales for all three product lines in the 1980 and 1981 sales database, before computing the resale margin, results in a resale margin of approximately 40 percent. Again using our best judgment, we hold that 40 percent is the arm's-length margin for the P-E resale of the accessories that PECC produced during the years in issue. The starting point for the corresponding income allocation to P-E is the PECC net sales of accessories to P-E, after accounting for petitioner's concession regarding a constant 30-percent discount. See supra note 7. The applicable resale price shall be calculated by the parties for each year by increasing the PECC net sales base by the actual P-E resale margin for that year on sales to unrelated parties, as determined by Arthur Andersen. See supra pp. 45-46. This applicable resale price, which will represent total P-E resales to unrelated and related parties, shall then be reduced by the arm's-length resale margin determined by the Court, 401993 Tax Ct. Memo LEXIS 424">588 percent. To the extent that the actual PECC net sales exceed the arm's-length price, gross income is allocated to P-E. V. P-E Sales of PartsFor the parts it sold to PECC, P-E charged its standard cost plus 21 percent through 1978 and standard cost plus 13.12 percent thereafter. Of the total income allocation to P-E of $ 22.2 million under respondent's primary trial position, $ 6.2 million is attributable to a parts adjustment based on markups over standard cost of 40.2 percent for instrument parts, 50.2 percent for HC lamp parts, and 28.5 percent for accessory parts. The parties' point of divergence on how to calculate an arm's-length price for the parts is whether the parts are properly analyzed as individual parts or as parts kits. Respondent takes the position that a parts kit is a "single economic unit" in the form of an unassembled and untested finished product rather than a random collection of unrelated parts. A parts kit is not susceptible to analysis under the comparable uncontrolled price method, according to respondent, because the only uncontrolled sale of parts kits in the record was from Coleman to Sao Paulo, and those spectrophotometers were less complicated1993 Tax Ct. Memo LEXIS 424">589 than the instruments produced by PECC. See supra pp. 64-66. Nor does the resale price method apply, says respondent, leaving the next method in priority under the regulations, the cost plus method. Petitioner, in contrast, views a parts kit not as a single economic unit but as a collection of individual parts, each of which fits neatly into a generalized view of the comparable uncontrolled price method. A. Respondent's PositionUnder the cost plus method, the arm's-length price of a controlled sale is the cost of producing the property as increased by the appropriate gross profit percentage, plus or minus adjustments. Sec. 1.482-2(e)(4)(i), Income Tax Regs. The appropriate gross profit percentage is the gross profit percentage relative to costs earned by a seller on the uncontrolled sales of property that are most similar to the controlled sale. Sec. 1.482-2(e)(4)(iii), Income Tax Regs. Characteristics important to the similarity of the sales include the functions performed by the seller, examples being contract manufacturing, product assembly, selling activity, processing, servicing, and delivering. Sec. 1.482-2(e)(4)(iii)(b), Income Tax Regs. When the most similar1993 Tax Ct. Memo LEXIS 424">590 sales used to derive the appropriate gross profit percentage differ in any material respect from the controlled sale, the arm's-length price must be adjusted to reflect the differences. Sec. 1.482-2(e)(4)(v), Income Tax Regs. The differences must have a definite and reasonably ascertainable effect on price. Id.Respondent's recommended approach to the pricing of parts kits, which follows Dr. Horst's analysis, is novel and complex. According to respondent, the appropriate P-E markup on a parts kit is the corresponding markup that P-E achieved on sales of the associated finished product when produced in Norwalk. The foundation of this position is the purported comparability of a parts kit and the finished product into which the parts kit was assembled. A parts kit and a finished product were obviously much different in terms of both physical appearance and functional readiness, but respondent believes that a parts kit embodied the same manufacturing intangibles, such as product design and manufacturing know-how, as the finished product itself. 191993 Tax Ct. Memo LEXIS 424">591 Although we here describe only the Horst methodology for pricing parts that went into instruments, the methodology was similar for accessories and HC lamps. Dr. Horst's first step was to calculate a representative gross margin for select Norwalk instruments. Because P-E usually stopped manufacturing an instrument after its transfer to PECC for production, he and Dr. Alpert, respondent's industry expert, selected from the instruments that P-E continued to manufacture in Norwalk the ones judged most closely comparable to the instruments produced by PECC. Dr. Horst then computed the gross margins that P-E earned on the Norwalk instruments, grouped the instruments by product line and year, and ultimately arrived at a weighted average gross margin of 52.0 percent. In keeping with the nature of these initial steps, he described this as the Comparable Norwalk Products method. Dr. Horst treated the gross margin of an instrument manufactured in Norwalk as a summed combination of a distribution or resale margin and a so-called manufacturing margin. To isolate the manufacturing margin, he subtracted his previously determined resale margin of 32.7 percent (the Hitachi fluorescence comparable, 1993 Tax Ct. Memo LEXIS 424">592 see supra pp. 92-93) from the total gross margin of 52.0 percent, leaving a manufacturing margin of 19.3 percent. Because the cost plus method involves a markup over cost, he converted the manufacturing margin as a percentage of sales to a 40.2-percent markup over manufacturing costs. 20 Finally, he applied the 40.2-percent manufacturing markup applicable to Norwalk instruments to the P-E standard cost of the instrument parts kits it sold to PECC. Stated summarily, Dr. Horst attributed the P-E manufacturing markup on a finished product manufactured in Norwalk to the parts that P-E sold to PECC for the production of a similar product in Mayaguez. If the PECC production costs were the same as the P-E production costs for the similar product, this1993 Tax Ct. Memo LEXIS 424">593 method in effect also attributed the P-E manufacturing markup to the PECC labor and overhead, a situation that causes petitioner to characterize this as an impermissible formulary apportionment of total manufacturing profit based on respective P-E and PECC direct costs. If the PECC production costs exceeded those of P-E, however, then the PECC profit on its labor and overhead would be a smaller percentage than the P-E manufacturing markup applicable to the finished products and the parts. Similarly, if the PECC production costs were less than those of P-E, then the PECC profit on its labor and overhead would be a larger percentage than the P-E manufacturing markup applicable to the finished products and parts. Dr. Horst advanced an alternative approach to parts kit pricing denominated the Proportionate Profits method, which is the foundation of respondent's secondary trial position. For certain models of AA spectrophotometers built at both Norwalk and PECC during the same year, or built at Norwalk one year and at PECC the next, Dr. Horst determined that the total gross margins were approximately the same for the two locations. 21 This led him to conclude that the P-E and PECC1993 Tax Ct. Memo LEXIS 424">594 consolidated gross margin on a PECC-produced instrument was a reliable estimate of what the P-E gross margin would have been had it continued to manufacture the instrument in Norwalk. To implement the Proportionate Profits analysis through a simple procedure, Dr. Horst began with the consolidated gross margins of the instruments actually produced by PECC and in effect split the consolidated manufacturing profit in direct proportion to the respective P-E and PECC manufacturing costs, with the PECC costs including only labor and overhead. For example, P-E in 1980 made resales of PECC instruments totaling $ 11,367,863, according to Dr. Horst. He derived this amount by grossing up PECC's actual sales to P-E, $ 7,570,997, to account for the 33.4-percent resale margin he drew from the 1980 sales database. The P-E standard cost for the instrument1993 Tax Ct. Memo LEXIS 424">595 parts it sold to PECC, including all purchased material, was $ 3,738,902, and the PECC standard cost for its labor and overhead was $ 445,965, for a cost total of $ 4,184,867. Dr. Horst calculated the consolidated gross margin as the difference between resales and cost, $ 7,182,996, divided by resales, $ 11,367,863, or 63.2 percent. This 63.2 percent became the total gross margin that corresponded to the 52.0 percent used in the Comparable Norwalk Products method. From this point on, beginning with the subtraction of the 32.7-percent resale margin based on the Hitachi proposed comparable, the computational steps in the two methods were the same. Unlike the Comparable Norwalk Products approach, in which the derived manufacturing markup on costs was constant from year to year in each finished product category, these percentages varied in the Proportionate Profits method. In addition, for the 7-year period overall, the percentages were higher under the Proportionate Profits method: 67.3 percent for instruments, 78.2 percent for HC lamps, and 46.4 percent for accessories. Compare supra p. 130. This method leads respondent to a P-E income allocation for all PECC finished product1993 Tax Ct. Memo LEXIS 424">596 parts of $ 13.3 million, more than double the $ 6.2 million resulting from the Comparable Norwalk Products analysis. Despite the higher Proportionate Profits income allocation, respondent treats it as a secondary trial position on the rationale that it effects a profit split that is subordinate under the section 482 regulations to the Comparable Norwalk Products cost plus approach. See sec. 1.482-2(e)(1)(iii), Income Tax Regs.A key underpinning of respondent's parts analyses, as earlier noted, is that a parts kit was a single economic unit, in the form of an unassembled and untested finished product, rather than a random collection of unrelated parts. From a theoretical perspective, we cannot fault respondent for attempting to incorporate the "coherent grouping" of a parts kit into an analysis of the appropriate arm's-length price for parts. After all, except for occasional backordered or replacement parts, the parts kit system was how P-E and PECC communicated. With their distinctive part number prefixes, the parts kits streamlined both the PECC ordering and the P-E billing. Concerning another of respondent's premises, we do not disagree that a parts kit, when viewed as such, 1993 Tax Ct. Memo LEXIS 424">597 embodied what respondent has characterized as manufacturing intangibles. During the product development process, in designing and bringing to production a particular instrument, P-E did not start with a box of random parts and seek to build the best possible product from those parts. Instead, P-E sought to design an instrument with desired characteristics or specifications, and only after completion of the finished product did P-E know and fully document the composition and specifications of the necessary parts. When viewed this way, the parts were an output of the product development process rather than an input. Because PECC received the parts in the form of a parts kit that matched exactly the composition and specifications of the parts needed to produce the finished product, PECC indeed benefited from the so-called manufacturing intangibles of the finished product. Despite our acceptance of some of Dr. Horst's important conceptual and theoretical premises, we nonetheless decline to adopt either of his approaches to the arm's-length pricing of parts. Because no outside market existed for the parts kits as such, determining the appropriate markup under the Comparable Norwalk1993 Tax Ct. Memo LEXIS 424">598 Products cost plus analysis involves practical difficulties and unsupported assumptions that we cannot ignore. The Proportionate Profits method generally has the same shortcomings. As Dr. Horst openly acknowledged at trial, he backed into the appropriate percentage markup on parts (i.e., his manufacturing markup) rather than deriving that markup directly from a comparable transaction. The percentage he did compute directly under the Comparable Norwalk Products approach was the total gross margin, including a distribution or resale margin, on the P-E sale of a Norwalk finished product. See supra p. 133. A concern we have with this indirect approach is its extreme sensitivity, leaving little room for error; small differences in the directly computed percentage become large differences in the "appropriate gross profit percentage" that serves as the "plus" in the cost plus method. See sec. 1.482-2(e)(4)(i), (iii), Income Tax Regs.For example, Dr. Horst began the Comparable Norwalk Products method for instrument parts with P-E's total gross margin of 52.0 percent on finished instruments, which became a 40.2-percent markup over manufacturing costs. See supra pp- 133-134. 1993 Tax Ct. Memo LEXIS 424">599 The Proportionate Profits approach to instrument parts began with a total gross margin of 59.6 percent for the 7 years taken together, which evolved, under the same computational steps as the Comparable Norwalk Products method, into a 67.3-percent manufacturing markup. Thus, less than 8 percentage points of difference in total margin blossomed into over 27 percentage points of difference in manufacturing markup. For HC lamps, similarly, less than 5 percentage points of difference in total margin became 28 percentage points of difference in manufacturing markup. These amplified differences caused respondent's income allocation to P-E for all parts to more than double, to the tune of an additional $ 7 million, under the Proportionate Profits analysis. Another problem with both of the Horst parts pricing methods is the seemingly simplistic allocation of the P-E manufacturing intangibles. Assuming that the PECC production costs were equal to the P-E production costs for the compared similar instruments, then the Comparable Norwalk Products method would have three profit percentages coinciding: the P-E manufacturing markup on the sale of the finished Norwalk instruments, the P-E 1993 Tax Ct. Memo LEXIS 424">600 markup on the instrument parts kits sold to PECC, and the PECC profit on the labor and overhead costs it applied to the parts kits. In effect, this scenario assumes, as does the Proportionate Profits method, that the amount of manufacturing intangibles utilized was a direct function of an entity's manufacturing costs. Apart from simplicity and convenience, we see no meaningful justification for this assumed direct relationship, and respondent's broad and vague definition of manufacturing intangibles does not aid our understanding. It is true, as argued by respondent, that if the PECC production costs were different than those of P-E, then the Comparable Norwalk Products method would in effect assign a higher or lower profit percentage to the PECC labor and overhead costs than the derived P-E markup percentage on the parts. See supra p. 134. While this imparts a degree of flexibility to the Comparable Norwalk Products method, which counters petitioner's "formularly apportionment" argument, it does not solve the valuation problem for the manufacturing intangibles. Respondent has failed to justify the mathematical relationships, or even the implicit connection, between PECC1993 Tax Ct. Memo LEXIS 424">601 efficiency and the use of manufacturing intangibles. If respective manufacturing costs are indeed an appropriate means of allocating manufacturing intangibles, then we would still be troubled by how respondent proposes to define the respective manufacturing costs. Under both of the Horst approaches, the P-E parts kit cost base, prior to markup, includes the cost of value added by P-E before shipment to PECC and the entire purchased material cost, which was not insubstantial. PECC was left with its value-added cost, which consisted of only labor and overhead. Respondent, in effect, treats PECC like a consignment contract assembler in this regard -- a position coinciding with that on which respondent based the deficiency notice and then abandoned before trial. See supra p. 73. Dr. Horst explained his rationale in his initial report: P-E incurred the costs of identifying qualified suppliers, negotiating purchase prices, inspecting incoming shipments, stocking and releasing inventory, and gathering parts into parts kits. That process required P-E to invest in parts inventory, inventory storage facilities and the MRP system. Because the process of acquiring and inventorying1993 Tax Ct. Memo LEXIS 424">602 purchased parts and materials was anything but routine, we conclude that P-E's costs of purchased parts and materials should be combined with its other manufacturing costs in applying the cost plus method.While citing examples such as the intercompany account, see supra p. 42, respondent adds that this total material allocation to P-E accurately reflects PECC's lack of risk. Unlike respondent, we see no risk implications in PECC's use of the intercompany account for its parts kit payments, largely because P-E was the net debtor in this arrangement. We agree with respondent, however, that PECC benefited in terms of reduced risk by committing to purchase a parts kit only when P-E simultaneously committed to purchase the associated finished product. This arrangement effectively relieved PECC from the burdens of maintaining a parts inventory and of perhaps buying parts that would never find their way into sold finished products. Nonetheless, PECC did retain some risk in connection with its parts kit purchases. For example, P-E invoiced the parts f.o.b. P-E, and PECC incurred both scrap and rework costs during production. On balance, we do not believe that the circumstances1993 Tax Ct. Memo LEXIS 424">603 warrant a 100-percent allocation of material costs to P-E for purposes of the cost plus method, even after consideration of the cost-oriented factors emphasized by Dr. Horst. Respondent urges us to consider one other proposed comparable transaction under the cost plus method if we reject the Comparable Norwalk Products approach. We obligingly, but briefly, address the Coleman transaction with Sao Paulo, in which Coleman marked up the parts it sold to Sao Paulo by an average 51.5 percent. 22 See supra pp. 64-66. 1993 Tax Ct. Memo LEXIS 424">604 Respondent concedes that the Coleman spectrophotometers sold by Sao Paulo were simpler than those assembled by PECC, thus rendering the Coleman parts kits noncomparable under the comparable uncontrolled price method. Although the cost plus method generally accommodates physically distinguishable products more readily than does the comparable uncontrolled price method, we cannot disregard meaningful distinctions even under the cost plus method. See sec. 1.482-2(e)(4)(iii), Income Tax Regs. Because respondent treats parts kits as imbued with intangibles such as technology, know-how, and an experienced engineering staff, the level of sophistication of the finished products makes a difference. Dr. Horst admitted that he lacked reliable information to quantify the effects of either technical complexity or Sao Paulo's right to use the P-E name in Brazil. We therefore decline to adopt this transaction as a cost plus comparable for parts. Because of the limited data and the circumstances detailed in our findings, we also do not find relevant the similarity between the Coleman markup on its parts kits and the markup on the associated finished instrument. See supra pp. 65-66. As1993 Tax Ct. Memo LEXIS 424">605 our final point concerning respondent's parts pricing adjustments, we note that respondent has failed to explain persuasively why royalties cannot adequately and more simply account for the manufacturing intangibles inherent in the parts kits. On this matter, respondent points to the P-E intersite licensing arrangements with subsidiaries, in which the P-E policy was to reduce the royalty rate by half if, for a particular licensed product, the parts sold by the licensor to the licensee represented more than 35 percent of the licensor's manufacturing cost for the finished product. See supra p. 28. Dr. Horst, who admitted that the royalty rate could in theory reflect the value of manufacturing intangibles embodied in the parts kits, thought the intersite royalty policy was consistent with his parts methodologies because the policy recognized a partial transfer of technology to the licensee rather than a complete transfer. He sought in his transfer pricing analysis to mirror the intent of P-E and PECC in entering into their licensing arrangement, which intent was, according to Dr. Horst and respondent, to reflect the value of manufacturing intangibles in the prices of the parts1993 Tax Ct. Memo LEXIS 424">606 kits. We do not attach the same importance that respondent does to the intersite royalty policy. Ordinarily, in an arm's-length analysis under section 482, we disregard transactions between the taxpayer and a related entity. Sundstrand Corp. v. Commissioner, 96 T.C. 226">96 T.C. 226, 96 T.C. 226">371-372 (1991); Eli Lilly & Co. v. Commissioner, 84 T.C. 996">84 T.C. 996, 84 T.C. 996">1143-1145 (1985), affd. in part, revd. in part, and remanded 856 F.2d 855">856 F.2d 855 (7th Cir. 1988). As far as we know, and as suggested by the name, the intersite policy only applies to such related entities. Even for Dr. Horst's seemingly limited purpose of setting the basic structure of a licensing arrangement, the intersite policy comes up short. A 1968 internal P-E memorandum described the 35-percent crossover point for a partial versus a complete transfer as based on an "arbitrary assumption". Consistent with this characterization, examples in the same document showed a 34-percent cost figure not affecting the royalty rate and a 36-percent figure causing a halving of that rate. More importantly, Dr. Horst did not reconcile his parts pricing analyses with the apparently1993 Tax Ct. Memo LEXIS 424">607 nonexistent parts pricing implications in the intersite royalty policy. The markup percentage on the transferred parts in the memorandum examples was a constant 10 percent before and after the royalty rate dropped. A 1969 internal memorandum on intersite transactions again illustrated a halved royalty rate accompanied by an unchanging parts markup. B. Petitioner's PositionPetitioner suggests a relatively straightforward approach to the arm's-length pricing of parts, which it argues comports with the comparable uncontrolled price method in section 1.482-2(e)(2), Income Tax Regs. See supra p. 80. Petitioner maintains that the arm's-length price of a parts kit is equal to the sum of the arm's-length prices of the individual parts, plus an upward level-of-the-market adjustment for the P-E purchasing, inventory, and freight forwarding activities. Even after a level-of-the-market adjustment, asserts petitioner, the markup PECC paid P-E over the P-E standard cost more than covered that adjustment. Petitioner accordingly argues that no section 482 income allocation attributable to parts is warranted. We begin with what we will call "manufactured" parts, to which, unlike1993 Tax Ct. Memo LEXIS 424">608 "purchased" parts, P-E applied at least some direct labor before shipment to PECC. The record is clear that all of the manufactured parts, including those with P-E specifications, were available from unrelated suppliers. Because the General Licensing Agreement granted PECC access to all of the technical documentation relating to its finished products, PECC in theory could have availed itself of these sources. 23 As to the cost of the manufactured parts, there was both general testimony and some more specifically directed toward account 2403, see supra pp. 20-21, supporting petitioner's position that these parts were available from outside suppliers at or below the P-E standard cost of manufacture. Section 1.482-2(e)(1)(iv), Income Tax Regs., permits the grouping of products in the determination of arm's-length prices in order to avoid the impracticalities1993 Tax Ct. Memo LEXIS 424">609 associated with a large number of products or transactions. Certainly, with the many thousands of parts implicated in this case, some form of grouping is necessary to apply the comparable uncontrolled price method. Moreover, the similarity in physical property and circumstances required by section 1.482-2(e)(2)(ii), Income Tax Regs., must not be read so strictly as to "threaten effective nullification of the * * * method of choice for testing transfers of tangible property between commonly controlled entities." Bausch & Lomb, Inc. v. Commissioner, 933 F.2d 1084">933 F.2d 1084, 933 F.2d 1084">1091 (2d Cir. 1991), affg. 92 T.C. 525">92 T.C. 525 (1989). Nonetheless, we conclude that petitioner has not met the requirements of the comparable uncontrolled price method. The regulations contemplate comparisons with actual transactions in the form of uncontrolled sales. See sec. 1.482-2(e)(2)(ii), Income Tax Regs. Only with actual transactions can the similarity of the "physical property and circumstances" be evaluated to determine both comparability and any necessary adjustments to the uncontrolled price. Id. Petitioner emphasizes the physical similarity of the general1993 Tax Ct. Memo LEXIS 424">610 types of parts P-E sold to PECC as compared to the general types of parts that witnesses testified were available outside at less than the P-E standard cost. However, petitioner fails to mention the word "circumstances" in this portion of its brief. Section 1.482-2(e)(2)(ii) and (iii), Income Tax Regs., lists as possible differences having an effect on price the quality of the product, the terms of sale, delivery, and payment, and the level of the market and the geographic market in which the sales take place. Petitioner's only venture into this area is to assert that the level of the market was not a differentiating factor: a parts manufacturer sold to an instrument manufacturer in both the controlled (P-E to PECC) and uncontrolled (unrelated supplier to P-E) sales. As another possible circumstance, however, one of P-E's experienced purchasing agents testified that the length of lead time affected the outside price to P-E. PECC could adjust to a relatively short lead time, and benefited in this regard from the P-E parts inventory, because it normally did not order parts until a customer order was in hand at P-E. Disregarding the circumstances, which perhaps could have been 1993 Tax Ct. Memo LEXIS 424">611 accounted for through statistical sampling of actual PECC parts or through more specific testimony, causes petitioner, in our view, to fail to come within the comparable uncontrolled price method. Without regard to differing circumstances, respondent challenges petitioner's assertion that the PECC parts were available from the outside at or below the P-E standard cost of manufacture, primarily by attacking account 2403. Recorded in account 2403 were outside purchases of parts that had also been manufactured by P-E at some time previously. See supra pp. 20-21. We agree that the conclusions drawn from this account are of limited value. Only the mechanical parts specialists in Purchasing regularly used account 2403, the purchases in the account represented only a small fraction of the Instrument Division cost of sales, and very few of the parts in the account were identical to parts that P-E sold to PECC. Respondent also correctly notes that P-E manufacturing reports on costs and hours showed P-E at least sometimes beginning to manufacture a part in-house with anticipated or resulting cost savings over its outside purchase price. Still, the evidence cited by respondent does1993 Tax Ct. Memo LEXIS 424">612 not effectively rebut or qualify the testimony cited by petitioner that manufactured parts of the types sold to PECC generally cost no more on the outside than the P-E standard cost. This testimony does not necessarily conflict with P-E's continuing to manufacture parts in circumstances such as when its variable manufacturing cost (i.e., excluding fixed overhead) was at or below the outside price; other circumstances might include desires to ensure availability when needed and to monitor quality more easily. Respondent has not demonstrated that potential suppliers were lacking for any major part category, nor has respondent given us other reason to think that petitioner's witnesses were wrong to a material degree in their generalizations. For purchased parts, which involved no P-E direct labor prior to shipment to PECC, petitioner again seeks to apply the comparable uncontrolled price method in section 1.482-2(e)(2), Income Tax Regs. See supra p. 80. Petitioner this time refers to more specific uncontrolled sales: before selling purchased parts to PECC, P-E acquired the very same parts from unrelated suppliers in arm's-length transactions. The only material difference between1993 Tax Ct. Memo LEXIS 424">613 the controlled and uncontrolled sales, according to petitioner, is that in the former P-E performed purchasing, inventory, and freight forwarding activities for PECC, suggesting the existence of different levels of the market. Petitioner contends that the $ 4.6-million excess over P-E standard cost that PECC paid for parts, see supra p. 41, far exceeded the market level price adjustment to which unrelated parties would have agreed. Despite the clear physical identity of the products involved in petitioner's controlled and uncontrolled sales, we must again reject petitioner's comparable uncontrolled price approach as ignoring potential differences in circumstances other than the level of the market. Petitioner, who did not offer third-party comparables at trial for the profit element in the services P-E performed for PECC, argues that P-E's 100-percent or more return on the cost of the services made the purchased parts prices to PECC more than arm's length. 24 Petitioner derives the cost of the P-E services by: (1) Allocating to PECC, based on sales, $ 424,000 of the Purchasing department expenses of $ 3.1 million, see supra p. 18; (2) adopting $ 1.8 million as P-E's maximum1993 Tax Ct. Memo LEXIS 424">614 inventory carrying cost for parts, based on an Arthur Andersen calculation, see supra p. 40; and (3) disregarding as de minimis the P-E costs to pull the parts from inventory and pack them for shipment. With a total P-E cost of less than $ 2.3 million under this analysis, the remaining $ 2.3 million of the excess that PECC paid over P-E standard cost was supposedly profit to P-E on these parts services. Respondent does not directly dispute petitioner's three cost premises, 1993 Tax Ct. Memo LEXIS 424">615 instead arguing that petitioner deceptively minimizes P-E's "valuable and complex" purchasing function, which allegedly included many intangibles. Respondent does not attempt to quantify this value, however, either in total or element by element. Some of the specific points mentioned by respondent are well-educated and highly trained buyers, continual interaction with other departments, a proprietary qualified vendor list, and a computerized purchasing system that interacted with the MRP system. See supra pp. 18-21. In our view, factors such as these were not material in effect. The education and training of the Purchasing buyers, for example, were presumably inherent to some extent (through salaries and training expenses) in the Purchasing expenses of $ 3.1 million, which petitioner allocated based on PECC sales. Further, although Purchasing did indeed interact with Quality Assurance, Engineering, and manufacturing engineers, the extent of that interaction does not appear from the evidence to have been substantial. Even the qualified vendor list, although proprietary in some sense, was apparently nothing special in the industry. C. ConclusionSection 1.482-2(e)(1)(i), 1993 Tax Ct. Memo LEXIS 424">616 Income Tax Regs., provides that an arm's-length price normally involves a profit to the seller. Although petitioner ignored this principle in applying its purported comparable uncontrolled price method to manufactured parts, we, having rejected the comparable uncontrolled price method for manufactured parts, will not. Accordingly, if we are to conclude that the parts prices overall were arm's length, the $ 4.6-million total markup over P-E standard cost, which petitioner associated entirely with purchased parts, now must cover the profit element to P-E on both manufactured and purchased parts. We lack a specific indication of respondent's position, however, concerning how much profit an arm's-length P-E would have earned on parts not imbued with so-called manufacturing intangibles. After consideration of the entire record, which is wanting on this matter through the fault of both parties, we conclude that the amounts PECC paid P-E for parts that went into finished products were arm's length. In so concluding, we reject petitioner's position that P-E received an excess over an arm's-length amount, which excess petitioner attempts to use as an offset to respondent's income allocations1993 Tax Ct. Memo LEXIS 424">617 in the finished product and royalty transactions. See supra p. 103; infra p. 162. VI. RoyaltiesPursuant to a licensing arrangement with P-E, PECC paid royalties on its finished product sales equal to 3 percent of the prices paid by P-E, which prices were either 25 or 30 percent below the P-E domestic list prices. See supra p. 41. Respondent's proposed royalty adjustment is actually a reverse income allocation, away from P-E, of $ 1.1 million. The royalty rates leading respondent to this allocation are 1.6 percent for instruments, 1.2 percent for HC lamps, and 3.8 percent for accessories. The royalty issue as presented to the Court for resolution is in an unusual posture. Petitioner maintains that the 3-percent royalty rate is equal to or higher than an arm's-length rate, yet it opposes respondent's use of Dr. Horst's overall lower rate. Respondent initially argues on brief that the 3-percent rate is "below market", then continues with reasons why it should be higher, and then adopts Dr. Horst's adjustments, which for instruments and HC lamps reduce the already "below market" rate. This strange situation, with petitioner appearing to favor a higher royalty1993 Tax Ct. Memo LEXIS 424">618 than respondent, is largely a result of the Horst parts pricing methods. Because respondent's parts and royalty allocations are interrelated, petitioner's arguments against respondent's downward royalty adjustments are, in effect, arguments against the Comparable Norwalk Products and Proportionate Profits methods for pricing parts. In the determination of an arm's-length royalty on the transfer of intangible property, the applicable standard is the amount that would have been paid by an unrelated party for the same intangible property under the same circumstances. Sec. 1.482-2(d)(2)(ii), Income Tax Regs. The best indicators of this amount are generally transfers by the same transferor to unrelated parties involving the same or similar intangible property under the same or similar circumstances. Id. If a sufficiently similar transaction involving an unrelated party is unavailable, the arm's-length amount is determined by evaluating various facts and circumstances. Sec. 1.482-2(d)(2)(iii), Income Tax Regs.The parties agree that the P-E license agreement with Hitachi from 1971 is sufficiently similar to the P-E and PECC licensing arrangement to serve as a comparable transaction1993 Tax Ct. Memo LEXIS 424">619 for instruments and accessories. See supra pp. 66-68. They also agree that the Juniper licensing arrangement with Instrument Lab is the best available comparable transaction for HC lamps. See supra pp. 69-70. They do not agree, however, about how the 7.5-percent rate paid by Hitachi and the 2-percent rate paid by Instrument Lab should be adjusted to account for differences from the P-E/PECC circumstances. We consider the HC lamps first. On the subject of the PECC royalty paid on HC lamps, Dr. Baumol stated in his original report that, under the terms of the Hitachi licensing agreement with P-E, HC lamps were subject to a royalty of 4 percent at most. He also described the overall comparability of the Juniper/Instrument Lab transaction. He calculated that adjusting the 2-percent royalty to account for the # 60,000 paid by Instrument Lab for advance royalties and technical assistance fees still left the resulting royalty below 3 percent. Petitioner, who adopts Dr. Baumol's one adjustment as the only material difference between the P-E/PECC license and the Juniper/Instrument Lab license, consequently argues that the 3-percent royalty paid by PECC on HC lamp sales was1993 Tax Ct. Memo LEXIS 424">620 an arm's-length amount. Respondent, in contrast, recommends a 4-percent royalty on HC lamps, for the reason that both Dr. Baumol and Dr. Horst supported this figure. Dr. Baumol, however, did not unequivocally adopt the 4-percent rate; indeed, his report stated that this was an "extremely conservative" ceiling amount, an assessment he repeated at trial. Moreover, although Dr. Baumol did not associate a 4-percent rate with the Juniper/Instrument Lab license, Dr. Horst in his supplemental report mistakenly "accepted Dr. Baumol's recommendation that the * * [HC lamp] royalty be set at 4 percent, based on the Juniper License Agreement." Respondent does not quantify any upward adjustments to the Juniper/Instrument Lab royalty rate of 2 percent and does not attempt to rebut Dr. Baumol's calculated effect for the # 60,000 payment. Further, contrary to respondent's thinking, we do not believe that Juniper necessarily had difficulty penetrating the U.S. market, nor do we believe that P-E necessarily provided substantially more ongoing HC lamp technical assistance to PECC than Juniper provided to Instrument Lab. In these circumstances, given respondent's acceptance of the Juniper/Instrument1993 Tax Ct. Memo LEXIS 424">621 Lab arrangement as a comparable transaction, we conclude that the arm's-length royalty rate for PECC sales of HC lamps is tentatively 3 percent, subject only to our consideration of Dr. Horst's technology adjustment below. As noted, the parties agree that the P-E license agreement with Hitachi is a comparable royalty transaction for instruments and accessories. In this agreement, P-E granted Hitachi the exclusive right, with geographical restrictions, to use P-E technical information and patents to manufacture products from P-E's AA, IR, and gas chromatography product lines. P-E also granted Hitachi the nonexclusive right to sell the products, again in a limited area. Dr. Horst quantified two adjustments to this 7.5-percent rate, one upward and one downward. Adopting the upward adjustment, respondent argues that the Hitachi royalty of 7.5 percent is not directly comparable to the PECC royalty situation because the Hitachi royalty was based on the arm's-length "retail price" charged to "ultimate customers", while PECC paid royalties to P-E based on the transfer price between them. To compensate, Dr. Horst increased the 7.5-percent royalty to account for his calculated arm's-length1993 Tax Ct. Memo LEXIS 424">622 margins on P-E's finished product resales, which he had derived separately for instruments (32.7 percent) and accessories (57.6 percent) as part of his resale price method analysis discussed earlier. 25 See supra pp. 92-93, 124-125. Petitioner does not agree that the Hitachi royalty percentage applied to prices charged to ultimate customers. Respondent relies heavily upon the definition of "Net Sales Price" in the Hitachi licensing agreement. This was, as a general rule, the price charged to "customers", except that -- In the case of sales by * * * [Hitachi] to a subsidiary thereof or to an individual, corporation, partnership or association which is so closely associated to * * * [Hitachi] as to prevent arms length [sic] bargaining, the Net Sales Price1993 Tax Ct. Memo LEXIS 424">623 shall be deemed to be that charged by * * [Hitachi] for similar products sold in the same period to customers not thus closely associated.Respondent's position appears to boil down to reading the word "customers" to mean instrument or accessory users. The agreement, however, nowhere defined this key term, and we do not have sufficient information to conclude that Hitachi planned to sell predominately or exclusively to users directly. On balance, we believe that "customers" reasonably could have a broader intended meaning that encompassed all those to whom Hitachi first sold the products, including intermediate distributors. 26Both respondent and petitioner refer to other licensing transactions as evidence of industry practice and thus what Hitachi and P-E intended in their agreement. Respondent emphasizes P-E's position in the dispute with1993 Tax Ct. Memo LEXIS 424">624 Coulter over the blood-analyzer royalty, in particular the memorandum statement of counsel that giving effect to the first third-party sale while disregarding intermediate sales between affiliates was "customary practice in patent licensing." See supra pp. 68-69. The memorandum, however, did not specifically support the proposition, nor was the proposition consistent with the Juniper/Instrument Lab license, which gave effect to sales to related parties. In addition, the memorandum acknowledged that an agreed arrangement could differ from custom. Finally, we note that respondent's interpretation was apparently not "customary" enough to avoid a prolonged and ultimately unsuccessful dispute with Coulter. In sum, we are not prepared to interpret "customers" in the Hitachi agreement as restrictively as respondent urges, and we have not been directed to evidence concerning the nature of the Hitachi distribution system for the P-E products. Without clear guidance from the other licensing transactions in the record, we reject respondent's proposed adjustment to the P-E/PECC royalty premised on differing royalty computation bases. Dr. Horst intended his second adjustment to the Hitachi1993 Tax Ct. Memo LEXIS 424">625 7.5-percent royalty, this one downward, to account for the relatively limited manufacturing technology used by PECC in its operations. P-E supplied parts kits to PECC, and, as already detailed (see supra pp. 131-145), Dr. Horst adjusted the prices of those parts kits to reflect the value of the P-E manufacturing intangibles therein. His specific methodology for the royalty technology adjustment, which he viewed as consistent with his parts kit pricing analyses, was to reduce the royalty by the percentage of the P-E and PECC consolidated standard cost represented by the P-E standard cost of parts kits. For sample year 1980, the P-E standard cost for instrument parts sold to PECC was $ 3,738,902 (or 89.3 percent) of the consolidated standard cost of $ 4,184,867, and the PECC standard cost for labor and overhead applied to those parts was $ 445,965 (or 10.7 percent). See supra pp. 135-136. Dr. Horst multiplied 10.7 percent by the 7.5-percent Hitachi rate to arrive at an adjusted royalty of 0.8 percent for instruments. Respondent adopts Dr. Horst's downward technology adjustment to the royalty rate only contingently, subject to our acceptance of one of the Horst parts pricing1993 Tax Ct. Memo LEXIS 424">626 analyses. Because we have declined to adopt either the Comparable Norwalk Products method or the Proportionate Profits method, and because petitioner does not approve of the Horst technology adjustment to the Hitachi royalty, we will disregard this downward adjustment. As an aside on this matter, given the nature and state of progress of the parts kits that PECC received from P-E, PECC plainly did not need or use P-E technical manufacturing documentation to the same extent that Hitachi did. Viewed from this narrow perspective, the PECC royalty and the Hitachi royalty arguably would be comparable only after adjusting for this difference through something similar to the Horst technology adjustment. However, although the record is unclear as to whether PECC actually received complete technical documentation for all of its licensed finished products, PECC clearly had a contractual right to it, just as Hitachi did. PECC would have needed that documentation to procure manufactured and purchased parts in the manner implicitly hypothesized in petitioner's parts pricing theory. See supra pp. 145-151. Because we have accepted the parts pricing result urged by petitioner, with the1993 Tax Ct. Memo LEXIS 424">627 exception of a purported excess over arm's-length parts prices, a technology adjustment indeed appears unwarranted. Respondent supplements Dr. Horst's adjustments to the Hitachi royalty rate with other arguments to at least counter any further downward pressure on the adjusted royalty. Limitations on the geographic area covered can be a factor in arriving at the amount of an arm's-length royalty, sec. 1.482-2(d)(2)(iii)(c), Income Tax Regs., and although P-E limited Hitachi to sales in Japan and a select list of other countries, P-E granted PECC the right to sell worldwide. PECC did not sell its finished products worldwide, however, and in fact sold only to P-E. As shown by Gaynor Kelley's presentation to the P-E board of directors and PECC's initial application for an industrial tax exemption, this had been the plan from the start. See supra p. 26. Granted that P-E exploited established worldwide markets which PECC automatically tapped into, we have already accounted for this valuable marketing intangible in determining the P-E arm's-length resale margins for the PECC finished products. As to respondent's other points, it is not at all clear from the evidence how much 1993 Tax Ct. Memo LEXIS 424">628 more technical assistance P-E provided to PECC than to Hitachi. Also, given the several countries other than Japan in which Hitachi could sell P-E products, the Hitachi royalty rate was not necessarily lower than otherwise because of P-E's failure effectively to penetrate the Japanese market. Petitioner, relying on Dr. Baumol, advocates different means to reduce the 7.5-percent Hitachi royalty and thereby render it comparable to the 3-percent PECC royalty that petitioner contends was arm's length. Dr. Baumol noted in his initial report that the Hitachi license was much broader in scope than the PECC license, in the sense that Hitachi could choose to manufacture and sell any or all of the low-priced PECC products plus many other higher priced P-E products. Petitioner accordingly characterizes the Hitachi royalty as including additional consideration for a valuable option on a broader range of intangibles. Dr. Baumol also observed that because Hitachi declined to manufacture the PECC products, this meant that Hitachi considered the opportunity worth something less than 7.5 percent. We are not persuaded. The notion that Hitachi perceived value in an "option", independent of the1993 Tax Ct. Memo LEXIS 424">629 intangibles actually used, is speculative. Although we have available some information concerning the pre-1971 dealings between P-E and Hitachi, we do not know what P-E products Hitachi planned to manufacture in 1971, nor what products P-E thought or hoped Hitachi would manufacture. Regarding the Hitachi decision not to manufacture PECC products, it may well be true that Hitachi in some sense valued the opportunity at less than 7.5 percent, but this point standing alone is not meaningful. For any number of legitimate business reasons, Hitachi could have decided that it would not manufacture and sell a particular P-E product in exchange for even a nominal royalty. Without knowing those reasons, we cannot evaluate the possible adjustment effect on the 7.5-percent royalty rate. Petitioner's final suggested rationale for adjusting the Hitachi royalty downward, and the only one that Dr. Baumol attempted to quantify, relates to the markup over P-E standard cost that PECC paid for parts. See supra p. 41. In his initial report, Dr. Baumol divided the $ 4.6-million parts markup by the approximately $ 75 million in PECC finished product sales, concluding that PECC was paying P-E 1993 Tax Ct. Memo LEXIS 424">630 an implicit royalty over six percentage points higher than the recorded 3 percent. Petitioner, on brief, lowers the $ 4.6 million to $ 2 million because petitioner's parts pricing theory assumes that PECC paid some of the $ 4.6 million as arm's-length compensation for P-E parts-related services. See supra pp. 149-150. In essence, then, petitioner asks us to apply as an adjustment to the Hitachi royalty the portion of the $ 4.6-million parts markup that is not necessary to justify arm's-length parts prices. We have held, however, that the P-E parts prices to PECC were arm's length in the aggregate. There is no excess available for a royalty adjustment. See supra p. 152. In conclusion, we hold that the arm's-length royalty rates applicable to PECC sales of finished products to P-E are 7.5 percent for instruments and accessories and 3 percent for HC lamps. VII. Petitioner's Cost Plus MethodIn the notice of deficiency, respondent treated PECC as a consignment contract assembler and applied a cost plus method to determine the appropriate PECC profits. See supra p. 73. As petitioner views it, the notice of deficiency approach restricted PECC to a return for1993 Tax Ct. Memo LEXIS 424">631 its manufacturing function alone, without any return for its licensed intangibles. This approach, petitioner argues, establishes a ceiling for the income allocations derived from respondent's trial positions, which do ostensibly allow for a return on the licensed intangibles. Petitioner contends that respondent's notice of deficiency erred in four respects in applying the cost plus method, and that correcting these errors results in an income allocation to P-E roughly consistent with petitioner's trial position. According to petitioner, respondent in the notice: (1) Improperly excluded from the PECC cost base the cost of the materials that PECC purchased from P-E; (2) ignored a good portion of the location savings attributable to PECC; (3) incorrectly used operating profit markups rather than gross profit markups of 29 supposedly comparable electronics companies; and (4) erroneously assumed that the functions of the 29 companies were comparable to PECC's production of HC lamps. For purposes of their ceiling analysis, petitioner accepts the 29 electronics companies as comparable for the PECC instrument and accessory production. Petitioner's analysis raises a host of issues, most1993 Tax Ct. Memo LEXIS 424">632 of which we find unnecessary to address because of our holdings above that result in income allocations to P-E considerably less than called for under respondent's trial positions. However, because petitioner's "corrected" cost plus method undercuts even our income allocations to P-E, we will not entirely refrain from comment. Specifically, we address petitioner's asserted incomparability for the 29 electronics companies as relating to the PECCHC lamp production, and we also briefly address the applicable PECC cost base. Petitioner suggests that a much more appropriate comparable for valuing HC lamp manufacturing skills is ARC, which manufactured precision mercury capillary lamps for the Micralign system sold by the P-E Optical Group. See supra pp. 71-73. For these Micralign lamps, Arthur Andersen determined that ARC earned a gross profit markup on its cost of sales of approximately 200 percent for its 1976 through 1982 fiscal years. The effect of using ARC rather than the 29 electronics companies as an HC lamp comparable, according to petitioner, is an approximately $ 10-million reduction in the income allocation to P-E under the cost plus method in the deficiency notice. 1993 Tax Ct. Memo LEXIS 424">633 On this record, however, we do not believe that the Micralign lamps were comparable to the PECCHC lamps within the meaning of section 1.482-2(e)(4), Income Tax Regs., which details the cost plus method. Dr. Baumol thought that the ARC manufacture and sale of Micralign lamps was comparable to the PECC manufacture and sale of HC lamps in several respects. As examples of similar sophistication, he mentioned the products, the work forces, and the manufacturing technology. He also noted the similar sizes of the companies and their fast responses to orders. Petitioner cites as additional support for comparability the testimony of people involved in either the manufacture of HC lamps or the manufacture of Micralign lamps. From a technical perspective, however, Dr. Baumol by his own admission lacked industry expertise, and petitioner's cited testimony fails to establish the comparability link between the manufacturing processes for the two lamps. See sec. 1.482-2(e)(4)(iii)(b), Income Tax Regs. Indeed, although P-E was an established HC lamp manufacturer by 1972, it did not set up its own Micralign lamp manufacturing facility until it learned the manufacturing process from ARC. 1993 Tax Ct. Memo LEXIS 424">634 Moreover, the lamps were not even used in the same industries; the Micralign lamp was an integral component in very expensive equipment used to produce semiconductors. See sec. 1.482-2(e)(4)(iii)(a), Income Tax Regs. The technology flows between P-E and ARC, of indeterminate net effect, also preclude us from finding the two lamps comparable. P-E had a patent on the lamp mount that arguably enabled it to extract more profit from ARC, but ARC, for its part, had originally developed manufacturing know-how for the lamp itself and had transferred that know-how to P-E. Thereafter, ARC occasionally provided technical assistance. Finally, ARC's annual sales of Micralign lamps increased at a much higher rate than the PECC sales of HC lamps, indicating a large demand discrepancy with the potential for affecting relative profitability. As another of respondent's supposed errors in applying the cost plus method in the deficiency notice, petitioner argues that the PECC cost base should include the cost of the materials that PECC acquired from P-E. Whether petitioner is correct or not on this point, which we do not here decide, we need only note for present purposes that this argument appears1993 Tax Ct. Memo LEXIS 424">635 to detract from why petitioner chose to focus on the deficiency notice in the first place, which was to set a contract assembler ceiling on respondent's income allocations. Arguably, assigning the entire material cost to PECC weakens the contract assembler analog. VIII. Profit-Split MethodOne final word. Both parties submitted broad profit-split analyses, but only respondent sought sustenance for her position on this ground in her brief and then only as a check on the allocations she derived from the methods detailed in the section 482 regulations. Whatever benefit might have been supplied by a profit-split analysis, the calculations of the parties are not sufficiently grounded on basic facts to permit their use as a check on the conclusions we reach herein; there are significant differences between the parties, unresolvable on the record, in respect of the amounts of operating expenses, variable manufacturing profit, and location savings. Under these circumstances, we think it inappropriate to seek to develop such a check on our conclusions, particularly since, despite the difficulties we have encountered in reaching them, we are satisfied with the factual foundations1993 Tax Ct. Memo LEXIS 424">*636 upon which they rest. To reflect the foregoing, An appropriate order will be issued. Footnotes1. Statutory references are to the Internal Revenue Code as in effect for the years in issue. Unless otherwise indicated, Rule references are to the Tax Court Rules of Practice and Procedure.↩2. Unless otherwise clear from the context, our findings relate to the 7-year period in issue, and a reference to a year from 1975 to 1981 is to the P-E taxable year ending on July 31 of the referenced calendar year. For example, a reference to "1979" without more specificity is to the taxable year beginning August 1, 1978, and ending July 31, 1979; "October 1979", however, as an example of a more specific reference, means October of calendar year 1979.↩3. Consumables in this context are small items used directly with instruments, such as chart paper, lamps, columns, and bulbs. Although consumables could be thought of as a type of accessory, the term "accessory", as we use it, does not include consumables.↩4. An additional $ 26.1 million represented sales of component products, namely, printed circuit boards and mechanical and electromechanical assemblies. As earlier noted, the parties have settled the sec. 482 implications of the component products. See supra↩ p. 4.5. Although autobalances and furnaces are not instruments, they are similar to instruments in terms of price and technical complexity. The original PECC financial statements and the parties' adjusted, stipulated product line income statements group these items with instruments rather than accessories.↩6. Gross profit is equal to net sales revenue less cost of sales. The cost-of-sales components are material, labor, and overhead; operating expenses are not included. A gross profit margin, in percentage form, is the gross profit amount divided by net sales revenue and then multiplied by 100. For convenience, we sometimes refer simply to a "gross margin" or "margin", meaning a percentage gross profit margin.↩7. Petitioner has conceded that a 30-percent discount should have applied throughout the years in issue. The stipulated effect is $ 1,609,040 additional gross income to P-E because of the reduced transfer price and $ 45,160 less gross income to P-E because of a smaller royalty base.↩8. PECC never assembled the Model F-11 gas chromatograph, to which the 1970 licensing agreements assigned a 3.5-percent royalty.↩9. Unrelated party sales by P-E, in this and all other Arthur Andersen calculations, were those made indirectly through USSD and P-E International and those made directly to foreign third parties; sales to foreign subsidiaries were not included. All references herein to P-E unrelated party sales are to this definition.↩10. The dispersive and nondispersive technologies differ, in part, in the method used to produce wavelength spectra. See supra↩ p. 7.11. Both parties' experts assumed that the time between P-E's shipment to a customer and subsequent payment by that customer was the same for the Hitachi and PECC instruments. Accordingly, the relevant periods actually compared were from the time P-E paid the manufacturer to the time P-E shipped to the customer.↩12. The 3.5 percent resulted from 121/365 (the portion of the year) x 10.58 (the short-term borrowing rate).↩13. The 1.9 percent resulted from 27/365 (the portion of the year) x 37 (the Grossman cost of capital) x 0.7 (the 30-percent discount from list price).↩14. The 1.1 percent was the P-E net service cost for Spectra-Physics products (1.5 percent) less the P-E net service cost for PECC products (0.4 percent). See supra↩ p. 45.15. Respondent has objected to this exhibit as inadmissible hearsay. Because we use this exhibit solely against petitioner's interest, we need not decide the hearsay question.↩16. Petitioner also invokes the cost plus method as applied to the ARC Micralign lamps, but because petitioner raises this method in another context that we discuss in due course, we defer comment at this point. See infra↩ p. 164.17. When Dr. Horst described captive products and their pricing in his original report, he did so without reference to the possible influences of the competitive environment. Nonetheless, the parties consider competition part of the captive product analysis, as affecting the degree or the very existence of captivity, and we will do likewise.↩18. Respondent's reference to the purported market dominance of another major PECC product, the HGA furnace, is inappropriate here. Dr. Horst treated HGA furnaces and autobalances as instruments rather than accessories in his analysis, so any purported captive characteristics are irrelevant in the present accessory context. See also supra↩ note 5.19. Respondent uses "manufacturing intangibles" in a broad sense to mean elements of value, other than marketing intangibles, in finished products. As examples applicable to P-E finished products, respondent on brief lists, among other things, technology, know-how, an experienced engineering staff, a vertically integrated structure that allowed a cost-efficient operation, an ability to innovate and respond to market demands for new techniques, and an extensive purchasing, production planning, and inventory control system.↩20. With a total gross margin of 52.0 percent of sales, cost-of-sales elements made up the remaining 48.0 percent of sales. Dividing the 19.3-percent manufacturing margin on sales by the 48.0-percent cost of sales gives a manufacturing markup on costs of 40.2 percent.↩21. For the PECC products, the cost-of-sales components in the gross margin computation were the combined costs of P-E (for the parts kits) and PECC (for labor and overhead).↩22. Respondent actually interjects this position between the preferred Comparable Norwalk Products method and the subordinated Proportionate Profits method, presumably because its cost plus orientation takes precedence over the Proportionate Profits profit split under the applicable regulations. However, Dr. Horst did not incorporate the Coleman/Sao Paulo cost plus implications into his detailed schedules and computations. For convenience, we have accordingly referred to the Proportionate Profits method as the foundation of respondent's secondary, rather than tertiary, trial position. ↩23. We do not agree with respondent that the terms of the General Licensing Agreement necessarily precluded PECC from having parts manufactured outside of Puerto Rico.↩24. Sec. 1.482-2(b)(3), Income Tax Regs., relied upon by neither party, provides that an arm's-length charge for services between related parties is generally deemed equal to the costs or deductions incurred by the service provider. However, when a seller of tangible property renders ancillary services in connection with the sale, the effect of such services is accounted for under sec. 1.482-2(e), Income Tax Regs., which describes the comparable uncontrolled price, resale price, and cost plus methods. Sec. 1.482-2(b)(8), Income Tax Regs.↩25. Dr. Horst did not make this adjustment for HC lamps because the Juniper/Instrument Lab agreement applied the royalty percentage to the invoice price of the first sale following manufacture, whether or not the purchaser was related to Instrument Lab.↩26. We have used "customer" and "user" interchangeably throughout this opinion only for convenience; we do not mean to suggest that this was an industry-wide practice.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625336/	APPEAL OF CLIFFORD A. COOK, EXECUTOR OF THE WILL OF CHARLES A. CLAFLIN.Cook v. CommissionerDocket No. 1579.United States Board of Tax Appeals2 B.T.A. 126; 1925 BTA LEXIS 2536; June 23, 1925, Decided Submitted April 30, 1925. 1925 BTA LEXIS 2536">2536 Value of a fractional interest in real estate determined. Charles E. Haywood, Esq., for the taxpayer. L. C. Mitchell, Esq., for the Commissioner. GREEN 2 B.T.A. 126">126 Before GRAUPNER, LANSDON, and GREEN. This is an appeal from a deficiency in estate taxes in the sum of $1,736.90, which results from the Commissioner's conclusion that certain real estate had been undervalued in the estate-tax return. FINDINGS OF FACT. Charles A. Claflin died July 17, 1922, and in the same year the taxpayer was appointed executor of his estate. Among the assets of the estate was a nine-fourteenths interest in a Massachusetts trust. The property of the trust consisted of three buildings, known as the Grant Block, the Franklin & Manheim Building, and the Washington Block, all in Milford, Mass. The estate valued the nine-fourteenths interest at $100,890, and the Commissioner valued the same interest at $162,875.25. All of the witnesses related their testimony to the assessed valuations, but they were by no means in accord as to the percentage by which said valuation should be increased or decreased. Evidence as to sales of similar property in the vicinity was1925 BTA LEXIS 2536">2537 introduced and indicated a gradual increase in price, commencing several years prior to the death of the deceased. During this time the sales prices increased generally from below to above the assessed valuations. Numerous valuations of the three pieces of real estate have been made. Those which seem to merit our consideration most are as follows: Commissioner of Internal Revenue$210,000Taxpayer156,940Board of Assessors153,300William Clancy, witness for taxpayer157,8002 B.T.A. 126">127 In the light of all the evidence it appears that the valuations of the witness, Clancy, are the correct valuations. These valuations segregated as to buildings are as follows: The Grant Block$62,500Franklin & Manheim Building50,000Washington Block45,300The value of the nine-fourteenths interest in the three parcels of real estate is $101,442.85. DECISION. The deficiency should be computed in accordance with the following opinion. Final decision will be settled on consent or on 10 days' notice, in accordance with Rule 50. OPINION. GREEN: The evidence includes the taxpayer's valuation, the Commissioner's valuation, the appraisement1925 BTA LEXIS 2536">*2538 for the Massachusetts inheritance tax, the appraisement for local tax purposes, and the opinions of several witnesses, as well as evidence as to sales of like property. Certain witnesses testified that in their opinion a fractional interest in real estate, though that fraction be more than half, is worth less than the same fractional part of the total value. There is nothing in the record to indicate that there are in this case any special conditions which reduce the value of a fractional part, or that the value of the fractional part is less than the proportionate part of the value of the whole. From the evidence before us, we are of the opinion that the correct value of the nine-fourteenths interest in the trust held by the estate is $101,442.85.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625339/	CENTRAL AUTO EQUIPMENT CO., SUCCESSOR TO BITTEL-LEFTWICH SERVICE CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Central Auto Equipment Co. v. CommissionerDocket No. 10506.United States Board of Tax Appeals7 B.T.A. 1068; 1927 BTA LEXIS 3027; August 12, 1927, Promulgated 1927 BTA LEXIS 3027">3027 Taxpayer held not affiliated with the Bittel-Leftwich Tire Service Co. of St. Louis from January 1, 1918, to November 30, 1920, inclusive. Joseph P. Renard, Esq., for the petitioner. P. J. Rose, Esq., for the respondent. SMITH 7 B.T.A. 1068">1068 This is a proceeding for the redetermination of deficiencies in income and profits tax for the period July 1 to November 30, 1918, and for the fiscal years ended November 30, 1919, and November 30, 1920, aggregating $2,515.94. The proceeding is based upon the disallowance 7 B.T.A. 1068">1069 by the respondent of affiliation of the petitioner with the Bittel-Leftwich Tire Service Co. of St. Louis, from July 1, 1918, to November 30, 1920, inclusive. FINDINGS OF FACT. The Bittel-Leftwich Tire Service Co. of St. Louis, in order to extend its business in the State of Illinois, established a branch in Springfield, Ill., which it caused to be incorporated on September 20, 1915, under the name of Bittle-Leftwich Tire Service Co.The St. Louis company was engaged in business as dealers in automobile accessories, tires, tubes, vulcanizing Etc., and the branch established at Springfield, Ill., was engaged in the same1927 BTA LEXIS 3027">3028 business. On December 1, 1919, the name of the Illinois corporation was changed to Central Auto Equipment Co., which is the petitioner. In July, 1919, the name of the Missouri corporation was changed to the Lee Tire Service Co. The petitioner was organized with a capital stock of $10,000 divided into 100 shares of a par value of $100 each. This stock was issued as follows: SharesOwner:C. G. Bittel49B. O. Leftwich48A. Turner1Phil Stewart1Helen Murray1Total100At a meeting of the stockholders of the petitioner held November 8, 1917, it was voted to increase the authorized capital stock from 100 to 500 shares, par value $100 per share, and additional shares of stock were issued. There were 348 shares outstanding on November 30, 1918, as follows: OwnerDate of issueSharesA. R. KellerMar. 7, 19185F. W. WebbMar. 7, 191810A. TurnerMar. 27, 19185F. ReidelMay 15, 19185L. W. ShadeMay 15, 191810J. P. TurnerMay 15, 19182 1/2W. M. ChilesMay 25, 19183T. J. PrenticeJune 5, 19182 1/2J. R. HoltJune 5, 19182 1/2E. D. ConradJune 26, 19182 1/2C. B. ConradJune 26, 19182 1/2E. T. CrawfordJune 27, 19182 1/2J. T. WilcoxJuly 6, 19185J. W. SandersJuly 6, 19182 1/2R. Z. SandersJuly 6, 19182 1/2B. O. Leftwich, trusteeJuly 13, 1918260J. D. HeckJuly 17, 191810J. T. WilcoxJuly 25, 19185F. E. HaroldSept. 1, 19185D. L. GriffinDec. 23, 19182 1/2A. TurnerDec. 23, 19182 1/2Total3481927 BTA LEXIS 3027">3029 There were no substantial changes in stock ownership during 1919. The stock held by B. O. Leftwich, trustee, was transferred to A. Chouteau, trustee, and two additional shares were issued to others, 7 B.T.A. 1068">1070 making a total of 350 shares of stock outstanding at the end of 1919. There were a few minor changes in stock ownership during 1919 and the holdings of A. Chouteau, trustee, were reduced to 220 shares - 40 shares being returned as treasury stock. B. O. Leftwich and A. Chouteau were officers of the petitioner and were trustees for the Missouri corporation or its stockholders. The stock held by A. Turner and D. C. Griffin was merely for qualifying purposes and was within the custody and control of the officers of the corporation. The balance of the stockholders were not employees of the company and paid cash for their stock. Most of the minority stockholders voted their stock by proxy, naming A. Turner as their proxy, but the proxies in no wise contain authority in any way to control the stock of the person issuing a proxy nor did anyone other than the holders of the stock, except in the case of the trustee's stock, and in the case of the shares standing in the name1927 BTA LEXIS 3027">3030 of Griffin and Turner, have control over the stock owned by the individual stockholder. Proxies were given for each stockholders' meeting. Goods were sold by the Missouri company to the petitioner at cost plus from 2 to 5 per cent for handling charges, freight, drayage, insurance, etc. The Missouri corporation controlled the business policies of the petitioner in all its details. Checks of the petitioner were countersigned by an officer of the Missouri corporation who was also an officer of the petitioner. These checks had to be sent to St. Louis for signature and then were returned to the petitioner and mailed out. The petitioner filed a consolidated return with the Bittel-Leftwich Tire Service Co. of St. Louis, and with its successor, the Lee Tire Service Co., for the taxable periods under consideration herein. The respondent has computed deficiencies in tax upon the basis that the companies were not affiliated. OPINION. SMITH: The petitioner claims to be affiliated with the Bittel-Leftwich Tire Service Co. of St. Louis, Mo., which claim has been denied by the respondent. The only issue in this case is the affiliation or nonaffiliation of the companies during the1927 BTA LEXIS 3027">3031 taxable periods July 1, 1918, to November 30, 1918, and the fiscal years ended November 30, 1919, and November 30, 1920. The evidence shows that the two companies were in the same line of business; that the control of the business was under the guiding influence of representatives or nominees of the Missouri corporation. Separate books of account were kept by each company and the only evidence of intercompany relations is a purchasing arrangement 7 B.T.A. 1068">1071 whereby the petitioner secured its merchandise and supplies at cost to the Missouri corporation plus handling charges. The fact that the business policy and management were dictated by the Missouri corporation or its stockholders is not determinative of the issue; for the control of the business of a corporation is not control of the stock as contemplated by the statute. ; ; . In , it was stated: The fact of intercompany relations, or the absence of them, without the necessary1927 BTA LEXIS 3027">3032 stock ownership or control as provided in the statute, is not sufficient to permit or require affiliation. The stock ownership of the petitioner as presented in the evidence may be summarized as follows: Nov 30, 1918Nov 30, 1919Nov 30, 1920OwnerSharesPer centSharesPer centSharesPer centTrustee for the Missouri Company or its stockholders26075.826074.2822070.97Qualifying shares51.46102.86103.22Minority, owning no stock in Missouri company7822.748022.868025.81Total343100350100310100The ownership of stock by the trustee plus qualifying shares shown above does not of itself amount to "substantially all" the stock as required by the statute. ; ; . The minority stock in the petitioner was owned by investors who paid cash for their stock and acquired absolute ownership therein without any condition or agreement as to resale. They were not employees and were in no way connected with the Missouri1927 BTA LEXIS 3027">3033 corporation. The fact that the minority stockholders gave proxies for the voting of their stock is immaterial. As was stated in : The giving of proxy is not a relinquishment by the donor of any of the rights of ownership or control. In , it was stated relative to a minority interest that a feeling of helplessness does not indicate any control of stock. Although the question of affiliation or nonaffiliation of corporations is not to be determined solely on the basis of mathematical computations 7 B.T.A. 1068">1072 of stock holdings, , we think that it can not be said that the Missouri corporation owned directly or controlled through closely affiliated interests, or by a nominee or nominees, substantially all of the stock of the petitioner or that substantially all of the stock of the two corporations was owned or controlled by the same interests during the taxable periods involved herein. Judgment will be entered for the respondent.Considered by LITTLETON.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625340/	RICHARD S. PAULI AND FELICIA C. PAULI, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentPauli v. CommissionerDocket No. 5104-81United States Tax CourtT.C. Memo 1989-481; 1989 Tax Ct. Memo LEXIS 481; 58 T.C.M. 9; T.C.M. (RIA) 89481; September 5, 1989Alan E. Popkin and Ronald U. Lurie, for the petitioners. Henry T. Schafer and Larry N. Johnson, for the respondent. FAYMEMORANDUM OPINION FAY, Judge: This case was assigned to and heard by Special Trial Judge Daniel J. Dinan pursuant to section 7456(d) (redesignated as section 7443A(b) by the Tax Reform Act of 1986, Pub. L. 99-514, section 1556, 100 Stat. 2755) of the Code and Rule 180 et seq. 1 For convenience and clarity, the Findings of Fact and Conclusions of Law have been combined in the opinion. The Court agrees with and adopts his opinion, which is set forth below. 1989 Tax Ct. Memo LEXIS 481">482 OPINION OF THE SPECIAL TRIAL JUDGE DINAN, Special Trial Judge: Respondent determined deficiencies in petitioners' Federal income taxes and additions to tax as follows: Additions to TaxYearDeficiencySection 6653(b)1977$ 102,332$ 51,1661978600,233300,116On August 8, 1983, respondent filed an amended answer in which he claimed increased deficiencies and increased additions to tax as follows: DeficiencyIncrease in AdditionYearIncreaseTo Tax Sec. 6653(b)1977$ 194,570.57$ 97,285.271978254,616.54127,308.77Respondent's amended answer also asserted, in the alternative, an addition to tax under section 6653(a), should this Court decide that the addition to tax under section 6653(b) is inapplicable. On October 17, 1983, respondent filed a second amended answer in which he proposed to increase petitioners' income for 1977 by $ 38,300. Respondent also asserted a corresponding increase in the addition to tax under section 6653(b), or, in the alternative, under section 6653(a). After trial, joint supplemental stipulations of fact were filed which reflect various concessions made1989 Tax Ct. Memo LEXIS 481">483 by the parties. The parties agree that income tax deficiencies are due from petitioners for the taxable years 1977 and 1978 in the amounts of $ 74,391 and $ 101,790, respectively. The issues thus remaining for our decision are: (1) whether petitioners are liable for additions to tax under section 6653(b) for fraud; or (2) in the alternative, whether petitioners are liable for additions to tax under section 6653(a) for negligence or intentional disregard of rules and regulations. Some of the facts have been stipulated and are so found. The stipulations of fact, supplemental stipulations of fact, combined stipulations of fact, supplemental combined stipulations of fact and attached exhibits which were received in evidence are incorporated herein by this reference. Petitioners resided in Anchorage, Alaska, when they filed their petition in this case. They filed joint Federal income tax returns for the years 1977 and 1978. Dr. Pauli practiced full time as a dentist; Mrs. Pauli cared for their children and worked part time as a bookkeeper for the dental practice and other, "business" entities that Dr. Pauli established or caused to have established. Charles H. Bumpus (Bumpus) 1989 Tax Ct. Memo LEXIS 481">484 and Glen A. Huff (Huff) were business associates who lived in Anchorage, Alaska. In 1976, they met one Hiram Conley, a representative of the American Law Association (ALA) who informed them that they could reduce their income and estate tax liability through the use of foreign trust organizations (FTOs). He told them that the use of FTOs to reduce income and estate tax liabilities had been researched by one Karl Dahlstrom (Dahlstrom) and that he conducted seminars on the subject for members of the ALA. Bumpus and Huff joined ALA and attended a seminar given by Dahlstrom in Alaska. At that seminar, Dahlstrom explained the plan to reduce taxes through the use of FTOs. They also received a "tax package" consisting of, inter alia, excerpts from Federal and state tax cases and various tax commentaries. In 1976, Bumpus and Huff created a business trust organization called the American Tax Education Society (ATES) and became its co-trustees. ATES was used by Bumpus and Huff to market "tax package materials" and to provide those who purchased the tax package materials with advice and assistance relating to business trust organizations. Bumpus and Huff, as co-trustees of ATES, 1989 Tax Ct. Memo LEXIS 481">485 established an office and hired Wesley J. Milton, an accountant, to assist purchasers of the ATES tax package with any problems they might encounter after their purchases. In the Spring of 1977, Dr. Pauli, through his professional corporation, Richard S. Pauli, D.D.S., Inc. (the Corporation), paid $ 11,500 to ATES. The payment entitled him to (1) membership in ATEs and in ALA, (2) transportation from Alaska to Houston, Texas, to attend Dahlstrom's tax seminar, (3) transportation from Houston, Texas, to Belize, Central America, (4) assistance from ATES in establishing and maintaining business trust organizations and tax counseling from ATES officials, (5) the ATES tax package and forms pertaining to the establishment of business trusts, and (6) transportation to return to Alaska from Belize. At his seminars in Houston, Texas, Dahlstrom lectured those who attended on how to create foreign and domestic trust organizations in order to reduce their tax liabilities. In April 1977, Dr. Pauli attended a two-day, Dahlstrom Seminar in Houston, Texas. Dr. Pauli was impressed by Dahlstrom's presentation of the ALA/Dahlstrom plan. Dahlstrom informed those attending the seminar that he1989 Tax Ct. Memo LEXIS 481">486 had been implementing the plan for two years without encountering any problems from the implementation. Dr. Pauli was convinced that Dahlstrom had thoroughly researched the plan and that it was entirely legal. He then journeyed to Belize, Central America, in order to establish his FTOs. Dr. Pauli caused to have created 12 such trusts: Beaver Unlimited, Bentley Trust Company, Bering Trust Company, Caprice Trust Company, Courtly Company, Geneva Limited, Gulf Controllers, Hudson Trust Company, Knik Consultants, Monetary Opinions, Northern Business Services and Pacific Business Services. Belizian law required that the trust "creator" be a resident of Belize. The "creator" of Dr. Pauli's trusts in Belize was one Julian Thompson (Thompson). Under the terms of the various trust documents, Thompson had no rights or responsibilities, except to insure that the terms of the various trusts were carried out by the trustee. On the same day that the aforementioned 12 trusts were created by Thompson in Belize, Dr. Pauli was named, by Thompson, as trustee of the following trusts: Bentley Trust Company, Beaver Unlimited, Bering Trust Company and Gulf Controllers. Again, on the same day, Bentley1989 Tax Ct. Memo LEXIS 481">487 Trust Company was designated as trustee of: Caprice Trust Company and Courtly Company; Bering Trust Company was designated as trustee of Hudson Trust Company and Monetary Opinions; Beaver Unlimited was designated as trustee of Northern Business Services and Knik Consultants; Gulf Controllers was designated as trustee of Pacific Business Services and Geneva Limited. It is apparent, therefore, that Dr. Pauli, having followed the ALA/Dahlstrom plan, had complete control and dominion over the trusts established in Belize and was authorized in his sole discretion to distribute trust income to anyone, including himself. Upon returning to Anchorage from Belize, Dr. Pauli caused to have created three revocable living trusts: Pauli Trust A, Pauli Trust B and Pauli Trust C. Dr. Pauli considered each of the trusts A, B and C to be "grantor trusts" and that, consequently, any income earned by them would be returnable by him on his Federal income tax returns. Dr. Pauli also caused to have created two "domestic business trust organizations": Lakeside Investments (Lakeside) and LaTouche Dental Services (LaTouche). Again, Dr. Pauli exercised complete dominion and control over these two domestic1989 Tax Ct. Memo LEXIS 481">488 business trusts. Dr. Pauli transferred to Lakeside unimproved real estate, improved real estate, the assets of the Corporation's profit sharing trust, life insurance policies and cash. In June 1977, Dr. Pauli caused to have all of the operating assets of the Corporation transferred to La Touche. Dr. Pauli then operated his dental practice as a sole proprietorship. LaTouche conducted all of the nonprofessional operations of Dr. Pauli's dental practice. Dr. Pauli then paid LaTouche management fees for the management services it provided to him in his dental practice. Having placed in position the various entities recommended by the ALA/Dahlstrom plan to avoid taxes, Dr. Pauli then implemented the plan. Petitioners have fully conceded the ALA/Dahlstrom "loan-note-gift" plan was to avoid Federal taxes through the use of foreign and domestic "business trusts." The parties have stipulated that petitioners are liable for deficiencies in Federal income tax for the years 1977 and 1978 in the amounts of $ 74,391 and $ 101,790, respectively. Section 6653(b): Fraud. Section 6653(b) provides that if any part of any underpayment of tax required to be shown on a return is1989 Tax Ct. Memo LEXIS 481">489 due to fraud, there shall be added to the tax an amount equal to 50 percent of the underpayment. The Commissioner has the burden of proving, by clear and convincing evidence, that some part of the underpayment was due to fraud. Section 7454(a); Rule 142(b); , cert. denied ; , affd. without published opinion . The Commissioner will carry his burden if he shows that the taxpayer intended to evade taxes which he knew or believed that he owed, by conduct intended to conceal, mislead, or otherwise prevent the collection of such taxes. , cert. denied ; , affg. a Memorandum Opinion of this Court; , modified , affd. . The existence of fraud1989 Tax Ct. Memo LEXIS 481">490 is a question of fact to be resolved upon consideration of the entire record. . Fraud is never presumed, but rather must be established by affirmative evidence. . Circumstantial evidence is permitted where direct evidence of fraud is not available. ; ; ; . Fraud may properly be inferred where an entire course of conduct establishes the necessary intent. ; . The precise amount of underpayment resulting from fraud need not be proved. . The statute requires only a showing that "any part" of an underpayment results from fraud. However, the Commissioner must show fraud resulting in an underpayment for each taxable year in which1989 Tax Ct. Memo LEXIS 481">491 fraud has been asserted. At trial, respondent examined Dr. Pauli and called two other witnesses, Mr. Egan and Mr. Lawrence. Mr. Egan has been a CPA since 1970. He prepared petitioners' Federal income tax returns for the years 1975 and 1976 and the corporation's returns for the fiscal years ended March 31, 1976 and 1977. After Mr. Egan prepared petitioners 1976, Federal income tax return, Dr. Pauli informed Mr. Egan that he intended to use domestic and foreign trusts in the conduct of his professional services as an orthodonist. Having been informed by Dr. Pauli that he was using foreign business trusts in offering his professional services, Mr. Egan told Dr. Pauli that he and his firm had decided not to involve themselves with FTOs. Mr. Egan further informed Dr. Pauli that neither he nor his CPA firm were knowledgable about the structure or operation of FTOs. Mr. Egan concluded his testimony by stating that he had never advised Dr. Pauli as to the legality or illegality of the ALA/Dahlstrom plan. Mr. Egan, called by respondent as a witness, testified that he did not know whether the ALA/Dahlstrom plan was legal or illegal1989 Tax Ct. Memo LEXIS 481">492 when he was performing accounting services for petitioners and their professional corporation. Dr. Pauli testified on direct examination by respondent that, in the early spring of 1977, he met with a local Anchorage tax lawyer named William Lawrence. Dr. Pauli testified that he recalled meeting with Mr. Lawrence after work one day and spent about a half-hour with him. Dr. Pauli did not recall the specifics of his conversation with Mr. Lawrence but thought that he discussed the ALA/Dahlstrom plan with him. Dr. Pauli recalled that Mr. Lawrence had informed him that the ALA/Dahlstrom plan was interesting but that Dr. Pauli would be "chancing it." Respondent called Mr. Lawrence as an impeachment witness. Mr. Lawrence testified that Dr. Pauli was never a client of his and that he did not recall ever giving Dr. Pauli any legal advice about anything. In this case, respondent has failed to prove by clear and convincing evidence that some part of the underpayment for each year was due to fraud. Respondent has failed to show that petitioners intended to evade taxes through conduct designed to conceal, mislead, or otherwise prevent the collection of such taxes. ;1989 Tax Ct. Memo LEXIS 481">493 ; Beaver v. Commissioner, supra at 9293; . Petitioners were clearly misled when they involved themselves in the use of the complicated ALA/Dahlstrom business trust program. Dr. Pauli was educated to be a dentist. There is nothing in the record to indicate that Dr. Pauli was knowledgeable in tax matters and we conclude, as noted above, that he was misled into believing that the Dahlstrom Plans were acceptable. The use of foreign and domestic business trusts seemed to petitioners to be a legitimate method of reducing taxes. When petitioners began using the foreign business trusts to reduce their tax liability, the trusts seemed to be similar to corporations -- legal fictions with substantial tax benefits. Petitioners did not distinguish the theoretical tax law differences between the legitimacy of the use of the corporation to reduce taxes and the illegitimacy of the use of foreign business trusts to accomplish the same purpose. In both instances, petitioners signed legal documents and kept meticulous records detailing transactions between Dr. Pauli, 1989 Tax Ct. Memo LEXIS 481">494 his Corporation and his business trust organizations. Respondent's evidence at trial to sustain his burden of proving fraud by petitioners was threefold: (1) petitioners participated in the ALA/Dahlstrom plan to avoid taxes, (2) petitioners failed to produce records to the IRS during the audit of their returns, and (3) petitioners had unreported income during the years in issue and claimed deductions to which they were not entitled. Our reading of this record causes us to conclude that respondent's principal argument is that participation in the ALA/Dahlstrom plan to avoid taxes through the use of domestic and foreign trust organizations was, per se, evidence of fraud. We disagree. See . While Dr. Pauli's communications with respondent appear to us to have been adventuresome, we do not find it to be the type of conduct usually associated with the fraudulent concealment of records in order to evade tax. Finally, respondent points to various omissions of income and excess deductions attributable to petitioners as evidence of fraud. We have reviewed the record and have determined that most1989 Tax Ct. Memo LEXIS 481">495 of the alleged omissions from income and excess deductions result from adjustments made to petitioners' returns and the returns of their numerous trusts. We also note that in the stipulations of fact filed at the trial of this case, respondent agreed to allow petitioners unclaimed deductions on their 1977 and 1978 returns in the amounts of $ 44,799.71 and $ 20,545.81, respectively. Again, these adjustments resulted from other adjustments made to petitioners' "business trusts." No clear and convincing evidence of fraudulent intent by petitioners exists. Upon a review of the record in this case, we conclude that the underpayments of tax for the years in issue resulted from petitioners' mistaken belief as to the legal consequences of the various transactions involved. Accordingly, respondent has failed to prove fraud and we hold for petitioners on this issue. Negligence. Respondent pleaded alternatively in his amended answer and asserted the addition to tax for negligence under section 6653(a). As this issue was not raised in the notice of deficiency, it constitutes new matter upon which respondent bears the burden of proof. Rule 142(a). However, unlike the issue of1989 Tax Ct. Memo LEXIS 481">496 fraud where respondent's burden of proof must be carried by clear and convincing evidence, respondent's burden of proof on this addition to tax for negligence may be met by a preponderance of the evidence. Rule 142(a). Thus, respondent must introduce sufficient evidence to make a prima facie showing that petitioners' failure to pay their tax liability was due to negligence or intentional disregard of rules and regulations. . As we noted, supra, Dr. Pauli testified on direct examination by respondent that, in the early Spring of 1977, he recalled a meeting with a local Anchorage tax attorney named William Lawrence. Dr. Pauli recalled that Mr. Lawrence had informed him that the ALA/Dahlstrom Plan was interesting but that Dr. Pauli would be "chancing it." We believe that a reasonable and prudent man, having been informed by a tax attorney that he would be "chancing it" if he embarked upon a particular tax program, would have further consulted with knowledgeable tax attorneys about the validity or legality of the program. Dr. Pauli did not do so. Respondent has demonstrated to this Court that petitioners' deficiencies1989 Tax Ct. Memo LEXIS 481">497 in tax for the years 1977 and 1978 were due to negligence and we so find. Decision will be entered under Rule 155.Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended and in effect for the years in issue. All Rule references are to the Tax Court Rules of Practice and Procedure.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625343/	L. C. Bohart Plumbing & Heating Co., Inc., Petitioner v. Commissioner of Internal Revenue, RespondentL. C. Bohart Plumbing & Heating Co. v. CommissionerDocket No. 6871-73United States Tax Court64 T.C. 602; 1975 U.S. Tax Ct. LEXIS 109; July 21, 1975, Filed 1975 U.S. Tax Ct. LEXIS 109">109 Decision will be entered for the respondent. B Corp. adopted a plan of liquidation pursuant to which it distributed all of its assets to its sole shareholder within 24 months of adopting the plan. B Corp. did not designate any part of the distribution as a dividend. On its final Federal income tax return B Corp. did not identify itself as a personal holding company nor did it attach thereto Schedule PH which is required in the case of a personal holding company. In the following year an agent of the Internal Revenue Service tentatively determined that B Corp. was a personal holding company and had undistributed personal holding company income subject to tax. B Corp. thereupon filed an amended tax return accompanied by a Schedule PH, in which it claimed a dividends paid deduction in an amount equal to its tentatively determined undistributed personal holding company income. Held, B Corp. failed to designate such amount as a dividend within the time prescribed in the regulations pursuant to sec. 316(b)(2)(B)(ii), on account of which it is not entitled to a deduction for dividends paid but must include that amount in its undistributed personal holding company income. Clarence J. Ferrari, Jr., Edward M. Alvarez, and Kent E. Olsen, for the petitioner.Eugene H. Ciranni, for the respondent. Raum, Judge. RAUM64 T.C. 602">603 OPINIONThe Commissioner determined a deficiency of $ 19,611 in petitioner's Federal income tax for its taxable period ended February 28, 1969. Petitioner is a personal holding company, subject to the 70-percent tax imposed by section1975 U.S. Tax Ct. LEXIS 109">114 541, I.R.C. 1954, with respect to its undistributed personal holding company income. Under section 545, a personal holding company may reduce its undistributed personal holding company income by an amount equal to its dividends paid deduction, as described in section 561. At issue is whether, under section 316(b)(2)(B)(ii), the controlling definition of "dividend" for this purpose, a liquidated personal holding company may retroactively designate part of its liquidating distribution as a "dividend" after the expiration of the period fixed by applicable Treasury regulations for such designation. The facts have been stipulated.Petitioner L. C. Bohart Plumbing & Heating Co., Inc., is a California corporation which, at the time of filing its petition herein, had its principal office in Sunnyvale, Calif. Petitioner had been formed in 1955 for the purpose of engaging in the business of plumbing subcontracting which business was subsequently replaced by apartment house rentals. On September 11, 1968, petitioner's board of directors held a special meeting with petitioner's sole shareholder, Lewis C. Bohart (Bohart), at which time the directors adopted, with the approval of Bohart, resolutions1975 U.S. Tax Ct. LEXIS 109">115 authorizing the winding up and dissolution of petitioner. Among the various resolutions adopted in this regard were the following:Further Resolved that this corporation liquidate its assets in compliance with Internal Revenue Code § 337;* * Further Resolved that each shareholder, upon distribution to him of his proportionate part of the assets, shall be required to surrender his share certificates for cancellation and that such a distribution shall be in complete satisfaction of his rights as a shareholder of this corporation, * On October 3, 1968, petitioner filed with the District Director of Internal Revenue at San Francisco, Calif., a Form 966 (Return Of Information To Be Filed By Corporations Within 30 Days After Adoption Of Resolution Or Plan Of Dissolution, Or Complete Or Partial Liquidation). Petitioner did not indicate thereon in the 64 T.C. 602">604 space provided the existence of any amendment to its plan of dissolution.Between December 1, 1968, and February 28, 1969, petitioner distributed all of its assets to Bohart, its sole shareholder, as provided in its plan of liquidation. At that time petitioner did not designate any part of the distribution to Bohart as 1975 U.S. Tax Ct. LEXIS 109">116 a dividend, nor did it notify Bohart in writing that any part of the distribution was designated as a dividend. On its Federal income tax return, Form 1120, for the taxable period ended February 28, 1969, petitioner reported distributions of cash and property to Bohart in amounts of $ 62,543 and $ 83,250, respectively, of which it designated a portion 1 as a liquidating distribution in Form 1099L (Distributions In Liquidation During Calendar Year). It further indicated on the third page of its Form 1120 return (in response to question O) that it was not required to file either Form 1096 or 1099, relating to the payment of dividends to shareholders. Petitioner did not mark the appropriate box on its return stating that it was a personal holding company, nor did it attach a Schedule PH to its return. Schedule PH is the schedule required to be filed along with Form 1120 (the regular corporate income tax form) where the corporation is a personal holding company.1975 U.S. Tax Ct. LEXIS 109">117 On his individual Federal income tax return for 1969, Bohart reported long-term capital gain of $ 83,166 received as a liquidating distribution in exchange for his stock in petitioner.In the spring of 1969 petitioner filed a Certificate of Winding Up and Dissolution with the secretary of state of California, in which it certified that (a) the business of petitioner had been completely wound up, (b) the known debts and liabilities of petitioner had actually been paid, and (c) the known assets of petitioner had been distributed to its shareholder.Sometime in 1970 a revenue agent commenced an audit of petitioner's final income tax return. In the course of the audit, he tentatively determined and made known to petitioner's representatives that petitioner was a personal holding company and that it was subject to personal holding company tax liability with respect to its final return. Petitioner thereupon filed an amended Federal income tax return on December 27, 1971, which differed from its earlier return in that it omitted Form 64 T.C. 602">605 966 (Return Of Information To Be Filed By Corporations Within 30 Days After Adoption Of Resolution Or Plan Of Dissolution, Or Complete Or Partial1975 U.S. Tax Ct. LEXIS 109">118 Liquidation) and other information pertaining to its liquidation in place of which it attached a Schedule PH. On Schedule PH petitioner claimed a deduction of $ 25,469 for dividends paid on account of which it reported no undistributed personal holding company income and therefore no personal holding company tax liability. At the time of filing its amended income tax return, petitioner also filed Forms 1099L (Distributions In Liquidation During Calendar Year 1969), 1099 (information return relating to dividends paid), and 1096 (annual information return summarizing all distributions), all of which were labeled "Amended." On Form 1099 petitioner reported the payment of $ 25,469 to Bohart as a dividend in 1969, and on Form 1099L it reported a liquidating distribution of property valued at $ 57,697 to Bohart in 1969. Petitioner supplied Bohart's name, address, and identifying number on both forms.Despite the fact that petitioner identified Bohart in its amended income tax return as the distributee of a $ 25,469 dividend, there is no evidence that petitioner furnished Bohart with a statement of dividend distributions made to him during the year. Bohart never filed an amended 19691975 U.S. Tax Ct. LEXIS 109">119 income tax return to reflect additional tax due in respect of that part of the liquidating distribution which petitioner had recharacterized as a dividend. On April 11, 1973, the Commissioner issued a notice of deficiency to Bohart in which he determined that $ 25,469 of the distribution made by petitioner to Bohart was a dividend taxable at ordinary income rates. The amount of the deficiency was $ 7,358, which Bohart thereafter paid in full.In his notice of deficiency to petitioner, which he issued some 2 months after the notice to Bohart, the Commissioner determined that petitioner was a personal holding company for the taxable period ended February 28, 1969. The Commissioner furthermore disallowed petitioner's deduction for dividends paid, on account of which he determined that petitioner was subject to the personal holding company tax on its undistributed personal holding company income of $ 25,469. This determination was inconsistent with the prior determination, made in respect of Bohart, that he had received a dividend of $ 25,469 from petitioner.64 T.C. 602">606 Section 541, I.R.C. 1954, imposes a 70-percent tax on the "undistributed personal holding company income" (as defined1975 U.S. Tax Ct. LEXIS 109">120 in section 545) of every "personal holding company" (as defined in section 542). Broadly stated, the personal holding company tax is the mechanism which Congress adopted to deter the use of certain closely held corporations which, by retaining their earnings, shield the controlling stockholders in the upper brackets from tax on dividends at the top applicable rates. The highly burdensome 70-percent tax was designed, at least in part, to remove any such tax advantage otherwise available through the accumulation of earnings. See H. Rept. No. 704, 73d Cong., 2d Sess. 11-12 (1934); S. Rept. No. 558, 73d Cong., 2d Sess. 13-16 (1934); O'Sullivan Rubber Co. v. Commissioner, 120 F.2d 845, 847-848 (2d Cir.); Bittker & Eustice, Federal Income Taxation of Corporations and Shareholders, par. 8.20 (3d ed. 1971). But a personal holding company may mitigate the severity of the tax or, indeed, escape it altogether through relief provided by section 545(a). Because the purpose of the tax is achieved to the extent that a personal holding company distributes its earnings to its stockholders as taxable dividends, section 545(a) permits the corporation to subtract 1975 U.S. Tax Ct. LEXIS 109">121 the so-called "dividends paid deduction" in computing its undistributed personal holding company income, the amount upon which the tax is computed. As its name suggests, the dividends paid deduction, defined in section 561(a), 2 includes "dividends paid during the taxable year." Section 561(b)(1) states that in determining the amount of the deduction for dividends paid, the rules provided in sections 562 and 563 are applicable. And section 562(a) thereupon sets forth the general rule that, for purposes of the dividends paid deduction and except as otherwise provided in section 562, the term "dividend" includes "only dividends described in section 316."1975 U.S. Tax Ct. LEXIS 109">122 Section 316(b)(2), relating to distributions by personal holding companies, provides as follows:64 T.C. 602">607 SEC. 316. DIVIDEND DEFINED.(b) Special Rules. -- * * (2) Distributions by personal holding companies. -- (A) In the case of a corporation which --(i) under the law applicable to the taxable year in which the distribution is made, is a personal holding company (as defined in section 542), or(ii) for the taxable year in respect of which the distribution is made under section 563(b) (relating to dividends paid after the close of the taxable year), or section 547 (relating to deficiency dividends), or the corresponding provisions of prior law, is a personal holding company under the law applicable to such taxable year,the term "dividend" also means any distribution of property (whether or not a dividend as defined in subsection (a)) made by the corporation to its shareholders, to the extent of its undistributed personal holding company income (determined under section 545 without regard to distributions under this paragraph) for such year.(B) For purposes of subparagraph (A), the term "distribution of property" includes a distribution in complete liquidation occurring1975 U.S. Tax Ct. LEXIS 109">123 within 24 months after the adoption of a plan of liquidation, but --(i) only to the extent of the amounts distributed to distributees other than corporate shareholders, and(ii) only to the extent that the corporation designates such amounts as a dividend distribution and duly notifies such distributees of such designation, under regulations prescribed by the Secretary or his delegate, but(iii) not in excess of the sum of such distributees' allocable share of the undistributed personal holding company income for such year, computed without regard to this subparagraph or section 562(b).Thus, a personal holding company is entitled to include in its dividends paid deduction the amount of those distributions which qualify as dividends under section 316(b)(2) and, accordingly under section 545(a), to reduce its undistributed personal holding company income by the same amount. More particularly, in the case of a liquidating personal holding company, section 316(b)(2)(B) enlarges the usual meaning of dividend to include distributions in complete liquidation, but with certain qualifications, the pertinent ones of which for purposes of this case are contained in subparagraph (B)(ii). 1975 U.S. Tax Ct. LEXIS 109">124 By reason thereof, dividend treatment is available in respect of a liquidating distribution only to the extent that the corporation designates those amounts as dividends and notifies the distributees of such, under regulations prescribed by the Secretary. The relevant Treasury regulation, section 1.316-1(b), provides as follows:64 T.C. 602">608 (5) A corporation may designate as a dividend to a shareholder all or part of a distribution in complete liquidation described in section 316(b)(2)(B) and this paragraph by:(i) Claiming a dividends paid deduction for such amount in its return for the year in which, or in respect of which, the distribution is made,(ii) Including such amount as a dividend in Form 1099 filed in respect of such shareholder pursuant to section 6042(a) and the regulations thereunder and in a written statement of dividend payments furnished to such shareholder pursuant to section 6042(c) and sec. 1.6042-4, and(iii) Indicating on the written statement of dividend payments furnished to such shareholder the amount included in such statement which is designated as a dividend under section 316(b)(2)(B) and this paragraph.Section 1.316-1(b)(5)(ii) of the regulations incorporates1975 U.S. Tax Ct. LEXIS 109">125 certain portions of section 6042 and the regulations thereunder. Section 6042 details the reporting requirements in respect of the payment of dividends, which, by virtue of subsection (b), include distributions qualifying as dividends under section 316. As set forth in section 6042(a) and the accompanying section 1.6042-2, Income Tax Regs., every corporation must report on Forms 1099 and 1096 the aggregate amount of its yearly dividend payments of $ 10 or more along with the name, address, and identifying number of each distributee. These returns are to be filed on or before February 28 of the year following payment, which time may be extended, pursuant to section 1.6081-1(a), Income Tax Regs., a maximum of 6 months. It is further provided in section 6042(c) and section 1.6042-4, Income Tax Regs., that every corporation required to file an informational return under section 6042(a) also furnish each distributee named therein with a statement of the aggregate amount of payments to him. This statement must be furnished on or before January 31 of the year following such payments, but for good cause shown the District Director may grant an extension of time not exceeding 30 days. 1975 U.S. Tax Ct. LEXIS 109">126 Whether timely compliance with the reporting requirements of section 6042 is a necessary condition of dividend treatment for purposes of the dividends paid deduction in respect of a liquidating distribution of a personal holding company is the nub of the controversy before us.Petitioner admits that it failed to file the forms prescribed by section 6042(a) and to furnish the statement prescribed by subsection (c) within the respective times fixed in the regulations, even allowing for the maximum extensions of time. Nonetheless, it contends that the portion of its distribution to 64 T.C. 602">609 Bohart which it later designated was a "dividend" within the meaning of section 316(b)(2)(B), and, that, just as with the distribution of dividends in the normal course of business, its character should not be altered by petitioner's failure to designate it timely as such, an altogether separate matter for which the Commissioner has prescribed independent safeguards. Secs. 301.6652-1(a)(i) and 301.6678-1(a)(1), Proced. & Admin. Regs. Alternatively, petitioner argues that the Commissioner's regulations in this regard are contrary to the congressional intent and therefore invalid as applied1975 U.S. Tax Ct. LEXIS 109">127 to the situation at hand. The Commissioner, on the other hand, responds that the time limits fixed by the regulations are necessary in order to achieve the legislative purpose of section 316(b)(2)(B)(ii), that of ensuring that liquidating distributions designated as dividends by the corporation are in fact taxed at ordinary income rates in the hands of the recipient stockholders. We agree with the Commissioner.Petitioner attempts to draw an analogy between dividends distributed in the ordinary course of business and dividends in respect of a liquidating personal holding company, the suggested conclusion being that since timely reporting is not a necessary condition of the former it is likewise not essential to the existence of the latter. Notwithstanding the superficial plausibility of such consistency in the application of section 316, it is perfectly clear from the legislative history of section 316(b)(2)(B) that Congress regarded the treatment of liquidation distributions made by a personal holding company as a problem quite distinct from that posed by the usual dividend situation.Prior to 1964, virtually every liquidating distribution made by a personal holding company1975 U.S. Tax Ct. LEXIS 109">128 was, by reason of section 562(b), automatically deemed to be a dividend for purposes of the dividends paid deduction without regard to whether it also qualified as a dividend under section 316. At that time section 562(b) provided:SEC. 562. RULES APPLICABLE IN DETERMINING DIVIDENDS ELIGIBLE FOR DIVIDENDS PAID DEDUCTION.(b) Distributions in Liquidation. -- In the case of amounts distributed in liquidation, the part of such distribution which is properly chargeable to earnings and profits accumulated after February 28, 1913, shall be treated as a dividend for purposes of computing the dividends paid deduction. In the case of 64 T.C. 602">610 a complete liquidation occurring within 24 months after the adoption of a plan of liquidation, any distribution within such period pursuant to such plan shall, to the extent of the earnings and profits (computed without regard to capital losses) of the corporation for the taxable year in which such distribution is made, be treated as a dividend for purposes of computing the dividends paid deduction.Section 316, though, did not then contain a correlative provision governing liquidating distributions. Rather, section 316(b)(2) extended dividend 1975 U.S. Tax Ct. LEXIS 109">129 treatment in the case of a personal holding company to:any distribution of property (whether or not a dividend as defined in subsection (a)) made by the corporation to its shareholders, to the extent of its undistributed personal holding company income * * for such year.And it was well understood both at the time of its enactment and when subsequently interpreted by the courts that "any distribution of property" to shareholders did not refer to distributions in complete or partial liquidation. H. Rept. No. 2333, 77th Cong., 2d Sess. 136-137 (1942); S. Rept. No. 1631, 77th Cong., 2d Sess. 176-177 (1942); St. Louis Co. v. United States, 237 F.2d 151, 154-155 (3d Cir.). Accord, Michael C. Callan, 54 T.C. 1514">54 T.C. 1514, 54 T.C. 1514">1525-1526, affirmed per curiam 476 F.2d 509 (9th Cir.). Thus, stockholders receiving a liquidating distribution were taxed at favorable capital gain rates regardless of the character which it assumed at the corporate level. As a result of this gap in the statutory coverage, it was possible for a personal holding company, in the year of liquidation, to claim the relief afforded1975 U.S. Tax Ct. LEXIS 109">130 by the dividends paid deduction in respect of a liquidating distribution without thereby subjecting the distribution to ordinary graduated income tax rates in the hands of the distributees. This pattern of taxation, quite obviously, ran counter to the very purpose of the personal holding company provisions for which reason Congress, in 1964, passed remedial legislation. H. Rept. No. 749, 88th Cong., 1st Sess. 82, A104 (1963); S. Rept. No. 830, 88th Cong., 2d Sess. 112 (1964).Under the 1964 legislation, the formerly unrestricted applicability of section 562(b) was limited by the insertion of the introductory clause of current section 562(b)(1), which in relevant part states "Except in the case of a personal holding company described in section 542." 3 Revenue Act of 1964, sec. 64 T.C. 602">611 225(f)(3), 78 Stat. 88. At the same time section 316(b)(2) was amended by the addition of present subparagraph (B) in order to permit certain liquidating distributions made by personal holding companies to noncorporate stockholders to qualify for the dividends paid deduction, but only under conditions designed to ensure that the recipient stockholders would be taxed on such distributions at ordinary1975 U.S. Tax Ct. LEXIS 109">131 income rates. Revenue Act of 1964, sec. 225(f)(1), 78 Stat. 87-88. Thus, section 316(b)(2)(B) sets forth a single and consistent standard by which to classify liquidating distributions made by personal holding companies to noncorporate distributees for purposes of both the dividends paid deduction and the character of the distribution in the hands of the recipient stockholders.By reason of this single definition of "dividend" applicable to both the corporation and the distributees, Congress closed the definitional gap which had in prior years allowed the corporation and its distributees to characterize the liquidating distribution differently. Having thereby achieved at least conceptual consistency, though, Congress went further and added the active requirements of section1975 U.S. Tax Ct. LEXIS 109">132 316(b)(2)(B)(ii). Under that provision, the character of the distribution in the recipient stockholder's hands still follows the corporate level choice of treatment, but the corporation can choose the benefit of dividends treatment only by notifying the Internal Revenue Service (and the recipient stockholders) of its election to treat the distribution as a dividend. As explained in the House report (H. Rept. No. 749, 88th Cong., 1st Sess. 82 (1963)):the term "dividend" is to include any amounts distributed in this liquidation to other than corporate shareholders to the extent of its undistributed income (before any deduction for this amount) only if the corporation involved designates amounts as dividends (and so notifies the distributee). If the corporation does so designate the distributions as dividends the individuals receiving a liquidating distribution from the personal holding company must report the amount so distributed as a dividend in the year of receipt. * * See also S. Rept. No. 830, 88th Cong., 2d Sess. 112 (1964). Thus, in addition to creating a definitional equality between dividends at both the corporate and shareholder levels, section 316(b)(2)(B)(ii)1975 U.S. Tax Ct. LEXIS 109">133 further establishes an active reporting procedure designed to alert the Commissioner in the case of 64 T.C. 602">612 liquidating distributions that, on account of the corporation's decision to avail itself of the benefit of the dividends paid deduction, its stockholders are not entitled to report the distribution at favorable capital gain rates.In furtherance of this end, the Commissioner has prescribed, through regulations expressly authorized by section 316(b)(2)(B)(ii), that the designation include the name, address, and identifying number of each distributee. And it is plain to us that a limitation on the period during which such designation may be made is equally essential to the statutory purpose. Unless prompt and timely notice is required, section 316(b)(2)(B)(ii) could become an incentive for an otherwise undetected personal holding company to liquidate without disclosing its personal holding company tax liability, thereby permitting its stockholders to escape ordinary income tax rates in respect of the liquidating distribution. The feasibility of this course, though, would depend upon the ability of the corporation, if its personal holding company status were discovered1975 U.S. Tax Ct. LEXIS 109">134 by the Commissioner, to then make use of the dividends paid deduction by recharacterizing its liquidating distribution as a dividend and thereby avoid any personal holding company tax liability. Although the Commissioner might then be able to redetermine the recipient stockholders' income in respect of the newly deemed dividends, 4 the corporation and its stockholders, once detected, would pay no more tax than had they treated the distribution as a dividend at the outset. And, of course, some corporations would remain undetected altogether. So interpreted, section 316(b)(2)(B)(ii), which was enacted to assist the Commissioner in ensuring the integration of corporate and stockholder level taxation in respect of a liquidating distribution made by a personal holding company, would instead become the taxpayer's assurance that, if later determined to be liable for the personal holding company tax, it could, by then making the required designation, compel the Commissioner to respect its recharacterized "dividend." We think it unlikely that Congress ever intended section 316(b)(2)(B)(ii) to be put to such use, whereby 64 T.C. 602">613 the intended object of regulation would become1975 U.S. Tax Ct. LEXIS 109">135 its beneficiary, often at the expense of the fisc. By fixing the time in which a corporation may designate dividends under section 316(b)(2)(B)(ii), the regulations have, we think, reasonably used the authority granted therein to prevent a liquidating personal holding company from abusing the statute in this fashion.In light of the foregoing, it is fatuous to suggest that a timely designation in respect of a liquidating distribution is unnecessary here because it is not necessary to the existence of an ordinary dividend. To be1975 U.S. Tax Ct. LEXIS 109">136 sure, although every corporation which distributes dividends (of $ 10 or more to a single stockholder) is required to notify the Commissioner thereof within a prescribed time (section 6042(a); section 1.6042-2, Income Tax Regs.), the failure to do so timely does not prevent the Commissioner from determining the existence of a dividend. See, e.g., Sparks Nugget, Inc. v. Commissioner, 458 F.2d 631">458 F.2d 631, 458 F.2d 631">636-638 (9th Cir.), affirming a Memorandum Opinion of this Court, certiorari denied 410 U.S. 928">410 U.S. 928; Sammons v. United States, 433 F.2d 728 (5th Cir.), certiorari denied 402 U.S. 945">402 U.S. 945; Henry Schwartz Corp. 60 T.C. 728">60 T.C. 728, 60 T.C. 728">743-744; C. F. Mueller Co., 55 T.C. 275">55 T.C. 275, 55 T.C. 275">304 n. 27, affirmed 479 F.2d 678 (3d Cir.); George R. Tollefsen, 52 T.C. 671">52 T.C. 671, 52 T.C. 671">681, affirmed 431 F.2d 511 (2d Cir.), certiorari denied 401 U.S. 908">401 U.S. 908. Petitioners would have us conclude from this that the failure to file timely is also not dispositive 1975 U.S. Tax Ct. LEXIS 109">137 in determining whether the liquidating distribution of a personal holding company is a dividend, since the same filing requirement is applicable thereto. But it hardly follows that by so filing after the prescribed time, a personal holding company can compel the Commissioner to recognize the existence of a dividend, as petitioner argues here. Indeed, petitioner might as well challenge the language of section 316(b)(2)(B)(ii) itself inasmuch as the Commissioner may determine the existence of an ordinary dividend absent any designation, timely or otherwise. Clearly, in enacting section 316(b)(2)(B)Congress was concerned with a problem quite distinct from the ordinary dividend situation, one in which the taxpayer's interest in obtaining dividend treatment varied according to the extent of the Commissioner's knowledge of the taxpayer's full tax liability. The only way in which the Commissioner can be sure that the corporation has not silently enjoyed what is tantamount to a dividends paid deduction without also exposing its shareholders to dividend treatment is to 64 T.C. 602">614 require the corporation to bring promptly to the Commissioner's attention the manner in which it, and1975 U.S. Tax Ct. LEXIS 109">138 its stockholders, have chosen to treat the liquidating distribution.In this regard, it is of some significance that, prior to the Commissioner's own discovery that petitioner was a personal holding company, petitioner failed entirely to alert the Commissioner to this fact. It neither checked the box on its income tax return for the taxable period identifying itself as a personal holding company nor attached the required Schedule PH. Moreover, petitioner specifically denied that it was required to file Form 1099, relating to the distribution of dividends. Instead, it filed Form 1099L, designating the entire amount in question as a liquidating distribution, not a dividend. 5 Indeed, during the entire process of liquidation it appears that petitioner itself regarded the distribution solely as one in liquidation. The legislative history of section 316(b)(2)(B) gives every indication that Congress had no intention to permit a corporation, by designating dividends only after the Commissioner discovered its personal holding company tax liability, to thereby compel the Commissioner to accept such a self-serving recharacterization. Hence, we conclude that timely compliance1975 U.S. Tax Ct. LEXIS 109">139 with the reporting requirements of section 1.316-1(b)(5), Income Tax Regs., as fixed by sections 1.6042-2(c) and 1.6042-4(c), Income Tax Regs., is necessary to the existence of a "dividend" within the meaning of section 316(b)(2)(B). Petitioner has failed in this respect, for which reason it is not entitled to claim a deduction of $ 25,469 for dividends paid in respect of its liquidating distribution, which amount is therefore includable in its undistributed personal holding company income.Petitioner nonetheless argues that sections 1.6042-2(c) and 1.6042-4(c), Income Tax Regs., are invalid as applied to it, reasoning1975 U.S. Tax Ct. LEXIS 109">140 that they result in a "subversion and distortion of the Congressional intent." It is well settled that "Treasury regulations must be sustained unless unreasonable and plainly inconsistent with the revenue statutes and * * * should not be overruled except for weighty reasons." Commissioner v. South Texas Co., 333 U.S. 496">333 U.S. 496, 333 U.S. 496">501; see also Bingler v. Johnson, 394 U.S. 741">394 U.S. 741, 394 U.S. 741">749-750; 64 T.C. 602">615 Colgate Co. v. United States, 320 U.S. 422">320 U.S. 422, 320 U.S. 422">426; Textile Mills Corp. v. Commissioner, 314 U.S. 326">314 U.S. 326, 314 U.S. 326">336-339; Fawcus Machine Co. v. United States, 282 U.S. 375">282 U.S. 375, 282 U.S. 375">378; Brewster v. Gage, 280 U.S. 327">280 U.S. 327, 280 U.S. 327">336; Boske v. Comingore, 177 U.S. 459">177 U.S. 459, 177 U.S. 459">470; Estate of William J. Ellsasser, 61 T.C. 241">61 T.C. 241, 61 T.C. 241">248; Regal, Inc., 53 T.C. 261">53 T.C. 261, 53 T.C. 261">263-264, affirmed per curiam 435 F.2d 922 (2d Cir.); William F. Sanford, 50 T.C. 823">50 T.C. 823, 50 T.C. 823">832, affirmed 412 F.2d 201 (2d Cir.), certiorari1975 U.S. Tax Ct. LEXIS 109">141 denied 396 U.S. 841">396 U.S. 841. Contrary to petitioner's contention, we have already decided that the times fixed by the regulations for designating dividends and notifying recipient stockholders under section 316(b)(2)(B)(ii) conform well to the purpose underlying that provision. Since the regulations accurately reflect the legislative purpose, we can perceive no reason to interfere with their application here.We are aware that section 316(b)(2)(B)(ii) may thus bring about a seemingly harsh result in the case of a liquidated personal holding company. Because the deficiency dividend procedure of section 547 is unavailable to a liquidated corporation, Michael C. Callan, 54 T.C. 1514">54 T.C. 1514, unless the corporation recognizes its personal holding company tax liability in time to make the necessary designation and notification under section 316(b)(2)(B)(ii), it is foreclosed from alleviating the heavy tax burden imposed by section 541. However, as we concluded in Callan, "we think that the statute leaves us with no other choice." 54 T.C. 1514">54 T.C. 1529.Finally, petitioner argues that in any event the Commissioner is 1975 U.S. Tax Ct. LEXIS 109">142 estopped from determining the deficiency herein by reason of his prior inconsistent determination of a deficiency against Bohart, which Bohart paid in full. It is, however, clear beyond the necessity for discussion that the Commissioner is not estopped from determining a deficiency by reason of any prior inconsistent determination. See Estate of Goodall v. Commissioner, 391 F.2d 775, 781-784 (8th Cir.), certiorari denied 393 U.S. 829">393 U.S. 829; Freeport Transport, Inc., 63 T.C. 107">63 T.C. 107, 63 T.C. 107">111, 63 T.C. 107">116-117; Brantly L. Watkins, 53 T.C. 349">53 T.C. 349, 53 T.C. 349">359; Leon R. Meyer, 46 T.C. 65">46 T.C. 65, 46 T.C. 65">82-83, affirmed 383 F.2d 883 (8th Cir.); Nat Harrison Associates, Inc., 42 T.C. 601">42 T.C. 601, 42 T.C. 601">617. Where it is undisputed that one of two taxpayers is liable for tax in respect of a single transaction, the Commissioner is not bound to proceed against only one party at the peril of an unfavorable decision and the possible inability to thereafter pursue the other party. 64 T.C. 602">616 Provided that the Commissioner is not acting arbitrarily, 1975 U.S. Tax Ct. LEXIS 109">*143 he may, in order to protect the revenues, determine inconsistent deficiencies against both parties and thereafter assume the posture of a stakeholder in the final resolution of the matter. There is no doubt here that the Commissioner's determination of a deficiency against petitioner was neither arbitrary nor with any intention to collect taxes beyond those lawfully due. That Bohart chose to pay the deficiency determined against him can hardly be said to foreclose the Commissioner from seeking a decision in respect of this taxpayer's liability. In any event, it was open to Bohart to protect his interests by filing a claim for refund after payment of the deficiency, and we have nothing before us to suggest that he has failed to do so.Decision will be entered for the respondent. Footnotes1. The record does not disclose the exact amount designated as a liquidating distribution.↩2. SEC. 561. DEFINITION OF DEDUCTION FOR DIVIDENDS PAID.(a) General Rule. -- The deduction for dividends paid shall be the sum of -- (1) the dividends paid during the taxable year,(2) the consent dividends for the taxable year (determined under section 565), and(3) in the case of a personal holding company, the dividend carryover described in section 564↩.3. Sec. 562(b) was further amended by the addition of par. (2), by which the earlier dividend treatment of sec. 562(b) was retained in respect of liquidating distributions made by personal holding companies, but only to corporate↩ distributees.4. Because the Commissioner may assess the personal holding company tax any time within 6 years after the corporation files an income tax return on which it fails to identify itself properly as a personal holding company (sec. 6501(f)), it is entirely possible that the 3-year limitation on assessment generally applicable to individuals (sec. 6501(a)) may expire in respect of the recipient stockholder before the Commissioner determines the corporation's personal holding company tax liability.↩5. With respect to the statement of dividends to be furnished to the recipient stockholder, there is no evidence that petitioner ever supplied such to Bohart. In view of that fact that the burden of proving its compliance with the statute lies with petitioner, we can only conclude that petitioner did not duly notify the distributee, timely or otherwise, as expressly required by sec. 316(b)(2)(B)(ii)↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625344/	J. W. Gaddy and Ruth Gaddy, Petitioners, v. Commissioner of Internal Revenue, RespondentGaddy v. CommissionerDocket No. 90213United States Tax Court38 T.C. 943; 1962 U.S. Tax Ct. LEXIS 68; September 26, 1962, Filed 1962 U.S. Tax Ct. LEXIS 68">68 Decision will be entered under Rule 50. 1. Held, funds constituting overpayments made in 1957 under a rental agreement made in 1956 are not includible in gross income within the meaning of section 61(a) of the Internal Revenue Code of 1954, where in the year of overpayment the recipient discovers the overpayments, renounces his claim of right to the overpayments, and provides for their repayment under a new contract.2. Held, further, where, under the second rental agreement executed October 1, 1957, the recipient does not discover that an overpayment was made until after the close of the taxable year, the recipient has not had the opportunity to renounce his claim of right and recognize his obligation to repay in the same taxable year and the funds are includible in gross income in the year of receipt under the claim-of-right doctrine announced by the Supreme Court in North American Oil Consolidated v. Burnet, 286 U.S. 417">286 U.S. 417.3. Held, further, even though petitioners' counsel conceded in their brief that petitioners are taxable in 1957 upon the amounts received in 1956 under the 1956 contract, such concession cannot be accepted because1962 U.S. Tax Ct. LEXIS 68">69 it is one of law and not of fact and is contrary to law. Ohio Clover Leaf Dairy Co., 8 B.T.A. 1249">8 B.T.A. 1249 (1927). Brooks L. Harman, Esq., for the petitioners.Harold D. Rogers, Esq., for the respondent. Black, Judge. BLACK38 T.C. 943">943 The respondent determined a deficiency in the income tax of petitioners for the year 1957 in the amount of $ 29,928.57. The adjustments to taxable income are as follows:Taxable income shown on return$ 41,515.06Additional income and unallowable deductions:(a) Transport income$ 39,401.90(b) Abandonment loss850.57(c) Depreciation7,039.63Total addition to income47,292.10Taxable income as adjusted88, 807.1638 T.C. 943">944 Only adjustment (a) is in issue. It is explained in the deficiency notice1962 U.S. Tax Ct. LEXIS 68">70 as follows:(a) It is determined that you received transport income of $ 39,401.90 from the El Paso Natural Gas Products Company in the taxable year 1957 which was not reported on your return for that year. Therefore, your taxable income is increased $ 39,401.90.Petitioners assign error as to adjustment (a) as follows:(a) Respondent erroneously determined that petitioners received transport income of Thirty-nine thousand four hundred one and 90/100 ($ 39,401.90) Dollars from the El Paso Natural Gas Products Company in the taxable year 1957, which was not reported on petitioners' return for that year, and, thereby increased petitioners' taxable income by Thirty-nine thousand four hundred one and 90/100 ($ 39,401.90) Dollars.FINDINGS OF FACT.Most of the facts have been stipulated and a stipulation of facts, together with exhibits attached thereto, was filed by the parties and is incorporated herein by this reference. Only such facts as seem necessary to an understanding of the issue will be recited herein.Petitioners J. W. Gaddy (sometimes hereinafter referred to as Gaddy) and Ruth Gaddy, husband and wife, reside in Odessa, Ector County, Texas. They filed a timely joint income1962 U.S. Tax Ct. LEXIS 68">71 tax return for the calendar year 1957 on the cash receipts and expenditures method of accounting with the district director of internal revenue, Dallas, Texas. The income of the petitioners for the year in question was community income.Gaddy was engaged in truck transport hauling during the years 1956, 1957, and 1958 for El Paso Natural Gas Products Company (hereinafter referred to as El Paso). He was also engaged in the production of oil and gas as an independent operator, and in the pipe-coating business. In 1956 El Paso needed trucks to haul petroleum and petroleum products. It desired to have full control over the trucks, including the assignment of drivers and dispatchers, but it was not interested in purchasing such equipment. Sometime during the month of June 1956 El Paso and Gaddy entered into an oral agreement whereby El Paso leased certain tank truck equipment from Gaddy at a rental rate which, when added to the operating and maintenance costs, would not exceed the amount El Paso would have to pay if the hauling was done by a contract hauler.Pursuant to that oral agreement, the parties entered into a written contract dated July 1, 1956. The contract provided for 1962 U.S. Tax Ct. LEXIS 68">72 a rental rate of 23 cents per mile for certain equipment for hauling such petroleum and petroleum products. Both Gaddy and El Paso understood that 38 T.C. 943">945 this rental rate would be checked at regular intervals and adjusted either by an amendment to such contract or by writing a new contract in the event such rental rate, plus the costs of operating such equipment, proved to be too high or too low in comparison with the rate El Paso would have to pay if the hauling had been done by a contract hauler. The parties agreed that the rate of 23 cents per mile should constitute the proper rate for the rental of such equipment to meet the orally agreed level of total costs.The rate of 23 cents per mile specified in the contract of July 1, 1956, proved to be too high. However, due to changes in El Paso's accounting personnel who were not familiar with the agreement to review and adjust the contract rate, the contract price was not adjusted until October 1, 1957. Sometime during the month of September 1957 El Paso discovered and informed Gaddy that from July 1, 1956, through July 31, 1957, Gaddy had been paid $ 15,434.41 more than the contract hauling rate would have been for the same 1962 U.S. Tax Ct. LEXIS 68">73 work by contract hauler and consequently $ 15,434.41 more than the parties had agreed upon. Of this amount, $ 14,990.01 had been paid to Gaddy during the calendar year 1956. Sometime prior to October 1, 1957, the parties agreed that the overpayment figure was correct and a new contract was negotiated and executed on October 1, 1957, at a rental rate of 18 cents per mile for such equipment. It was agreed at the time that Gaddy would return such overpayment to El Paso. The new contract was designed to recover the excess funds by reducing the rental to 18 cents per mile and it was intended that the overpayment would be returned by Gaddy in that manner.A review of the facts in February 1958 revealed that the rental rate specified in the contract of October 1, 1957, was still too high. This was mainly due to changes in the transportation needs of El Paso, and the parties agreed that Gaddy had been overpaid in the amount of $ 24,411.89 during the entire calendar year of 1957, which, added to the overpayment of $ 14,990.01 during 1956, resulted in a total overpayment as of December 31, 1957, in the amount of $ 39,401.90.A third contract was negotiated and executed on March 1, 1958. 1962 U.S. Tax Ct. LEXIS 68">74 The March 1, 1958, contract contained a rental provision calling for a rate of 12.5 cents per mile until such equipment had been driven a total of 1,128,800 miles, and a rate of 16 cents per mile thereafter. It was estimated that the rate of 16 cents per mile, plus the operating and maintenance costs of such equipment, would be equivalent to the contract carrier rate. The differential of 3.5 cents per mile (the difference between the 12.5 and the 16 cent rates per mile) for the first 1,128,800 miles would recover the overpayment of $ 39,401.90 and it 38 T.C. 943">946 was agreed, through the execution of the contract, that such overpayment would be recovered in this manner. Gaddy was notified that the overpayments to him for the years 1957 and 1956 totaled $ 39,509.17. This figure was subsequently corrected to $ 39,401.90. The amount of the overpayment was determined by subtracting from the amounts paid to Gaddy the equivalent contract carrier rate.Additional overpayments occurred in 1958. The total overpayment was $ 57,664.14 and Gaddy repaid $ 10,000 in 1958, at the rate of $ 2,000 per month, which was withheld from the monthly remittances made to Gaddy during the months from March1962 U.S. Tax Ct. LEXIS 68">75 through July 1958. Petitioners have not paid any other amounts to El Paso other than the $ 10,000 paid during 1958 except through possible adjustments and credits made in arriving at the net overpayment of $ 47,664.14 as of July 31, 1958.The final contract dated March 1, 1958, was terminated as of July 31, 1958. At the time of termination of that contract the overpayments totaled $ 47,664.14. At the time the March 1, 1958, contract was terminated, Gaddy acknowledged his liability to El Paso for all overpayments in accordance with the oral agreement. He orally agreed to repay all that he owed to El Paso. The hauling contract was terminated because El Paso changed to a pipeline operation and the equipment was no longer needed. At the time of termination, El Paso discussed with Gaddy other possible hauling contracts and it was contemplated that El Paso would recover the overpayments in this manner; however, a further lease agreement was never made.All records pertaining to the computations of amounts due Gaddy were made and kept by El Paso. Gaddy has never executed any written agreements or notes acknowledging any liability to El Paso although Gaddy has had verbal discussions1962 U.S. Tax Ct. LEXIS 68">76 with El Paso concerning his indebtedness. No time has been set for repayment and Gaddy has never agreed to pay, nor has he paid, interest on the overpayments.The rental payments received by Gaddy in 1957 from El Paso were deposited in Gaddy's bank account and subsequently used by him in his other business enterprises. El Paso has never instituted or initiated any legal proceedings to collect any amount of said overpayments. Gaddy borrowed substantial amounts of money from various banks in 1958, 1959, and 1960 and made substantial repayments on all of said loans.OPINION.Facts have been stipulated as to certain other overpayments under Gaddy's contracts which were made to him by El Paso subsequent to 1957. The taxable year 1957 is the only year which 38 T.C. 943">947 we have before us in this proceeding; therefore, we shall confine ourselves to a discussion of the deficiency determined for that year. We shall not discuss any overpayment which may have been made in 1958.Section 61(a) of the 1954 Code provides that gross income means all income from whatever source derived, including income from rents (subpar. (5)). Respondent has determined in his deficiency notice that Gaddy, who1962 U.S. Tax Ct. LEXIS 68">77 was on the cash basis "received transport income of $ 39,401.90 from the El Paso Natural Gas Products Company in the taxable year 1957 which was not reported on your return for that year. Therefore, your taxable income is increased $ 39,401.90." As a matter of fact, the stipulation shows that Gaddy did not receive from such source $ 39,401.90 in 1957; $ 14,990.01 of this amount was received by him in 1956 and only the amount of $ 24,411.89 was received in 1957. Therefore, it seems clear that respondent was wrong in his determination that Gaddy received in 1957 transport income in the amount of $ 39,401.90. As we have already pointed out, he received $ 14,990.01 of this amount in 1956. The tax consequences which follow the receipt of this amount of $ 14,990.01 in 1956 will be later discussed herein. It is stipulated that Gaddy received in transport rental fees $ 24,411.89 from El Paso in 1957. Respondent contends that this amount of $ 24,411.89 was subject to Gaddy's unfettered command and was therefore taxable to him under the holding of the Supreme Court of the United States in North American Oil Consolidated v. Burnet, 286 U.S. 417">286 U.S. 417 (1932),1962 U.S. Tax Ct. LEXIS 68">78 wherein the Court stated:If a taxpayer receives earnings under a claim of right and without restriction as to its disposition, he has received income which he is required to return, even though it may still be claimed that he is not entitled to retain the money, and even though he may still be adjudged liable to restore its equivalent. * * The case of 286 U.S. 417">North American Oil Consolidated v. Burnet, supra, is, of course, the fountainhead of the claim-of-right doctrine and, simply stated, the issue in the instant case is whether the overpayments in rentals of $ 24,411.89 received by Gaddy in 1957 are includible in gross income in 1957 under the claim-of-right doctrine. Petitioners do not contest the facts that the amount of $ 24,411.89 was actually received in 1957 and that Gaddy commingled the funds with his own funds. Petitioners' position is that where an obligation to repay has been recognized in the year of overpayment by both parties, the amounts of the overpayments are without the scope of the claim-of-right doctrine. Petitioners primarily rely on the decision of the Ninth Circuit in United States v. Merrill, 211 F.2d 297 (1954),1962 U.S. Tax Ct. LEXIS 68">79 for this proposition. In that case the taxpayer, the surviving husband, as executor 38 T.C. 943">948 of his deceased wife's estate, paid to himself by mistake an executor's fee from his wife's share of community property. The entire community was properly chargeable with the fee. Taxpayer was not held to be subject to an income tax on that portion where the mistake was discovered and an adjustment made in the books of the taxpayer and the estate, all in the same year. The court found that:In the instant case appellee received an overpayment of $ 2500 from his deceased wife's estate in 1939. The mistake was not discovered until 1940 and the sum was not repaid until 1943. * * As executor he paid the funds to himself, as an individual, under an honest mistake. As an individual he received the funds under a good faith claim of right. He must therefore be held taxable upon the $ 2500 he erroneously received from his wife's share of the community funds in 1939.A different problem is presented, however, with respect to the $ 7500 in executor's fees which were mistakenly paid out of the wife's share of the community property in 1940. For as to that part of the fee, the mistake was discovered1962 U.S. Tax Ct. LEXIS 68">80 in the same year as the sum was received (1940) and appropriate adjustments were made in his own books and those of his wife's estate in that year in recognition of the mistake. We think the $ 7500 receipt in 1940 was thereby placed outside the operation of the "claim of right" rule. That rule is founded upon the proposition that, when funds are received by a taxpayer under claim of right, he must be held taxable thereon, for the Treasury cannot be compelled to determine whether the claim is without legal warrant, and repayment of the funds in a later year cannot, consistently with the annual accounting concept, justify a refund of the taxes paid. United States v. Lesoine, supra, 203 F. 2d at page 126, and cases there cited. The usual case for application of the rule involves a taxpayer who has received funds during a taxable year, who maintains his claim of right thereto during that year, and who subsequently, in a later year, is compelled to restore the sum when his claim proves invalid. n5 We are not aware that the rule has ever been applied where, as here, in the same year that the funds are mistakenly received, the taxpayer discovers and1962 U.S. Tax Ct. LEXIS 68">81 admits the mistake, renounces his claim to the funds, and recognizes his obligation to repay them. Cf. Carey Van Fleet, 2 B.T.A. 825">2 B.T.A. 825; Curran Realty Co. v. Commissioner, 15 T.C. 341">15 T.C. 341. We think there is no warrant for extending the harsh claim of right doctrine to such a situation. In such case the Internal Revenue Bureau is not faced with the problem of deciding the merits of the claim to the funds received, for the question has been resolved by the interested parties. No question is here raised as to the bona fides of appellee's 1940 bookkeeping entries relative to the mistaken payments. Good faith is indicated by the fact that the taxpayer's $ 7500 obligation to the estate was not only recognized by him in 1940 but was paid in cash in 1943. [Footnote omitted.]See also Bates Motor Trans. Lines v. Commissioner, 200 F.2d 20 (C.A. 7, 1952), affirming 17 T.C. 151">17 T.C. 151.The case of United States v. Merrill, supra, admittedly creates an exception to the claim-of-right doctrine. The Tax Court in Charles Kay Bishop, 25 T.C. 969">25 T.C. 969 (1956),1962 U.S. Tax Ct. LEXIS 68">82 has accepted the doctrine of United States v. Merrill, supra. We have not found any decision which has 38 T.C. 943">949 eliminated the exception to the claim-of-right doctrine announced in United Statesv. Merrill, and Bates Motor Trans. Lines v. Commissioner, both supra. Consequently, if the facts in the instant case fall within the protection of the exception announced in those cases, we feel free to apply it. We are of the opinion, however, that most of the amount of $ 24,411.89 here in issue is within the scope of the claim-of-right doctrine and is therefore reportable as gross income. Stated briefly, the Merrill case holds that where a fixed and definite obligation to repay is recognized in the year of overpayment and provision is made for its repayment, the amounts received are not within the scope of the claim-of-right doctrine. The claim-of-right doctrine and the exception to that doctrine announced in the Merrill case are both in essence predicated upon the practical principle of requiring taxpayers to account on the basis of an annual accounting period; cf. Burnet v. Sanford & Brooks Co., 282 U.S. 359">282 U.S. 359 (1931).1962 U.S. Tax Ct. LEXIS 68">83 Therefore, if the taxpayer does not discover the mistaken overpayment, renounce his claim of right thereto, and recognize his obligation for repayment in the same taxable accounting period, the general rule of the claim of right applies and the exception to the doctrine is inapplicable. See Healy v. Commissioner, 345 U.S. 278">345 U.S. 278.Overpayment of $ 444.40 Received in 1957 Under the Contract of 1956.Our understanding of the facts in the instant case as stipulated is to the effect that in the year in issue, 1957, El Paso and Gaddy realized that an overpayment was made to Gaddy under the first contract dated July 1, 1956. A total overpayment of $ 15,434.41 was made under this contract. Of this amount, $ 14,990.01 had been paid to Gaddy in 1956 and we shall discuss this $ 14,990.01 later in this opinion. Consequently, a total overpayment of $ 444.40 was made to Gaddy in 1957 under the 1956 contract in the same year the overpayment was discovered. We find this amount should be excluded from gross income in 1957. There is no question raised as to Gaddy's good faith and there is ample evidence to support the conclusion that both parties recognized1962 U.S. Tax Ct. LEXIS 68">84 the existence of Gaddy's liability to El Paso under this contract for the overpayments made thereunder. We hold that Gaddy was not liable for tax on the $ 444.40 overpaid in 1957 under the contract of 1956. He renounced his claim to that amount in that year and provided for its repayment to El Paso under the new contract whereby the price for transportation was reduced from 23 cents a mile to 18 cents a mile. As to this amount, we hold for petitioners.38 T.C. 943">950 Overpayments Received in 1957 Under the Second Contract.We reach a different conclusion as to the remainder of the overpayments received in 1957 amounting to $ 23,967.49. The overpayments made to Gaddy in 1957 by El Paso under the second contract executed on October 1, 1957, were not discovered until February 1958. The second contract was designed to recover the excess funds paid to Gaddy under the first contract in 1956 and 1957 by reducing the rental to 18 cents per mile but it failed to fulfill that goal. In fact, Gaddy received further overpayments in 1957 in the amount of $ 23,967.49 under the second contract, due mainly to changes in the transportation needs of El Paso. But Gaddy could not have renounced 1962 U.S. Tax Ct. LEXIS 68">85 his claim of right to these overpayments in the year of their receipt because the facts were not discovered until February of the following year. There was no way for him to know the overpayments existed under the second contract in 1957. As to these funds, Gaddy received them without restriction as to their disposition; they were commingled with his other funds and used without restraint of any kind. Gaddy did not discover and admit the mistake, renounce his claim to the funds, and recognize his obligation to repay them in the year of overpayment as was done in United States v. Merrill, supra.As to the $ 14,990.01 Received in 1956 Under the First Contract.In their reply brief, petitioners concede that the payments received in 1956 under the first contract were taxable income in 1957. It was stated therein that:Certainly, the Petitioners concede the correctness of the Respondent's determination as to said $ 14,990.01 inasmuch as this amount was overpaid during the year 1956, but was not discovered during said year, and therefore, since El Paso and Petitioners did not agree that the amount had been overpaid during the year of overpayment1962 U.S. Tax Ct. LEXIS 68">86 (1956) it was properly placed within the scope of the claim of right doctrine. * It was also stipulated that: "Only $ 24,411.89 of the $ 39,401.90 is in controversy in this proceeding." Notwithstanding this concession of petitioners' counsel in their reply brief, we cannot agree that the $ 14,990.01 was taxable income to petitioners in 1957. It certainly was not received in that year. It is stipulated that it was received in 1956 and deposited in the bank in the same way as petitioners' other funds were deposited. Inasmuch as it is stipulated that petitioners were on the cash basis, if the $ 14,990.01 was taxable to petitioners under the claim-of-right doctrine of 286 U.S. 417">North American Oil Consolidated v. Burnet, supra, it was clearly taxable to petitioners in 1956 and not in 1957.38 T.C. 943">951 The Tax Court is not bound as to the law of the case by any concession or stipulation made by the parties. Cf. Ohio Clover Leaf Dairy Co., 8 B.T.A. 1249">8 B.T.A. 1249 (1927), affirmed per curiam 34 F.2d 1022 (C.A. 6, 1929). In that case, among other things, we said:That portion of the agreement between counsel1962 U.S. Tax Ct. LEXIS 68">87 which we have quoted must be disregarded as of no effect for two reasons. In the first place, insofar as it attempts to stipulate that an item is deductible under the statute as a loss, it is a conclusion of law. As such it is either an agreement which entirely removes the question from the proceeding, or else it is an attempt to limit the function of the Board to decide the issue of liability. In either aspect it is ineffective. * See also Lucius N. Littauer Et Al., Executors, 25 B.T.A. 21">25 B.T.A. 21 (1931). Cf. Ernst Kern Co., 1 T.C. 249">1 T.C. 249, 1 T.C. 249">264 (1942); Bloomfield Steamship Co,. 33 T.C. 75">33 T.C. 75, 33 T.C. 75">86 (1959).In the instant case the facts relating to the amounts received by Gaddy in 1956 and 1957 have been stipulated. We, of course, must accept these stipulated facts as true and we do accept them as true. However, the petitioners' tax liability in 1957 is not a question of fact; it is a question of law which the Tax Court must decide for itself on the facts which have been stipulated. We cannot accept the concession of petitioners' counsel that petitioners are liable for tax on the $ 14,990.01 in1962 U.S. Tax Ct. LEXIS 68">88 question in 1957. Doubtless petitioners were taxable in 1956 on the $ 14,990.01 which they received in that year under the 1956 contract. No reason occurs to us why they would not be taxable in that year under the claim-of-right doctrine. They received it in that year, commingled it with their other funds, and had unfettered command over it in 1956. Doubtless petitioners returned it as income in 1956 but we do not know as to that because nothing is stipulated about petitioners' taxable income in 1956. Since that year is not before us we decide nothing about the tax liability for 1956. What we do decide in the instant case is that this amount of $ 14,990.01 was not taxable to petitioners in 1957. We have already given our reasons as to why the $ 444.40 received in 1957 under the 1956 contract is properly excluded from gross income in 1957.Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625345/	SIDNEY AND SHEILA RIMMER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentRimmer v. CommissionerDocket No. 8416-93United States Tax CourtT.C. Memo 1995-215; 1995 Tax Ct. Memo LEXIS 217; 69 T.C.M. 2620; May 18, 1995, Filed 1995 Tax Ct. Memo LEXIS 217">217 Decision will be entered for respondent. P contributed a large collection of sheet music to a qualified sec. 170(c), I.R.C., organization. Ps deducted an amount on account of such contribution, which amount exceeded the permissible amount for the year of contribution. Ps carried the excess over to subsequent years. R disallowed a portion of P's deduction on the ground that Ps had overstated the value of the contribution. Held: R's disallowance is sustained. The value of the contribution was insufficient to provide a carryover to the years in question. For petitioners: Orrin Eliot Tilevitz. For respondent: Peter J. Gavagan. HALPERNHALPERNMEMORANDUM FINDINGS OF FACT AND OPINION HALPERN, Judge: Respondent has determined deficiencies in petitioners' Federal income tax of $ 14,949, $ 14,255, and $ 11,037 for petitioners' taxable (calendar) years 1989, 1990, and 1991, respectively. The sole remaining issue to be decided is the fair market value of a quantity of sheet music contributed by petitioner Sidney Rimmer to a charitable organization. 11995 Tax Ct. Memo LEXIS 217">218 All section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. FINDINGS OF FACT IntroductionSome of the facts have been stipulated and are so found. The stipulation of facts and accompanying exhibits are incorporated herein by this reference. Petitioners Sidney and Sheila Rimmer are husband and wife. They made joint returns of income for the years in issue, and they resided in Brooklyn, New York, at the time the petition was filed. Hereafter, the term "petitioner" will be used to refer to Sidney Rimmer. Petitioner's CollectionIn May 1974, petitioner purchased approximately 85,000 pieces of Yiddish and Hebrew sheet music from Metro Music Co. (Metro) for $ 10,000. Metro had gone out of business in 1970, and petitioner's purchase was of Metro's remaining, unsold stock of such music. Mostly, the music had been published by Metro from the late 1920's through 1950. With Metro's closing, the sheet music likely would have been abandoned if not for petitioner's purchase. Petitioner was not a dealer in sheet music. He was employed by the City of New York, in 1995 Tax Ct. Memo LEXIS 217">219 the Office of Contract Administration. He purchased the sheet music to save it from destruction and possibly ensure its distribution. He stored the sheet music in his own garage. The sheet music was packaged and stored in filing cabinets purchased specifically for that purpose. Petitioner sold some of the sheet music to individual buyers. Buyers were directed to petitioner by individuals associated with Metro. Buyers contacted petitioner in order to purchase specific pieces of sheet music. The sheet music was stored without any order. That posed difficulties for those interested in obtaining specific pieces from petitioner. Contribution to the National Yiddish Book CenterIn 1986, petitioner contributed the remaining sheet music to the National Yiddish Book Center (Center). The Center is located in Amherst, Massachusetts, and is a qualified section 170(c) organization. While the Center had a collection of about one-half million books, its Yiddish sheet music collection numbered about 200 pieces prior to the Rimmer contribution. Although the contribution was of approximately 85,000 separate pieces of sheet music, there were only approximately 650 separate titles among1995 Tax Ct. Memo LEXIS 217">220 that total. There were between 2 and 1,000 copies of each title in the donated inventory. Most of the titles consisted of individual song folios. However, 28 of the titles were song books containing numerous pieces of music. The collection consisted mostly of Yiddish music, but contained some Hebrew, Zionistic, and instrumental pieces as well. The collection, despite its age, was in new condition. Center's Marketing of the Rimmer CollectionIn early 1987, the Center prepared an inventory of the collection. The inventory set out the titles, number of copies of each title, the price the Center intended to set for each title, and the cumulative price of each title, based on the price of one copy multiplied by the number of copies of the title in the inventory. The Center set its prices for the music in part by assessing the current prices of both individual folios and sheet music booklets in local music stores. The Center then prepared two different catalogs containing the prices for the music. The prices for the music differed according to which catalog was being used for ordering music and whether the buyer was a member of the Center. Membership in the Center is open1995 Tax Ct. Memo LEXIS 217">221 to individuals at a cost of $ 25 per year ($ 15 for students and senior citizens). The first catalog, a comprehensive catalog, set individual prices for each separate title of the entire inventory. The nondiscounted prices ranged between $ 3 and $ 5 apiece for a large majority of the pieces. A handful of book compilations and opera scores were priced between $ 10 and $ 25. The comprehensive catalog also set forth a number of discounts. A 25-percent discount existed for Center members. A 30-percent discount existed for Israeli institutions. A 35-percent discount existed for classroom orders of 10 or more copies of the same title. The second catalog, an illustrated catalog, set package prices for buying multiple titles and encompassed approximately 360 of the 650 titles. The prices set for each item were less than the nonmember price set forth in the comprehensive catalog. Sets of 10 to 20 pieces were available for prices ranging from $ 12 to $ 36. A 25-percent discount existed for members. Through March 1994, sales proceeds for the sheet music were approximately $ 95,000. The sales were made to individual buyers, and 33 universities, libraries, and similar institutions. 1995 Tax Ct. Memo LEXIS 217">222 Leif Laudamus AppraisalTo support his claimed charitable contribution deductions (described below), petitioner sought an appraisal of the contributed collection. Based on the Center's advice, in March 1987, petitioner requested an appraisal from Leif Laudamus, the proprietor of Leif Laudamus Rare Books in Amherst, Massachusetts. Mr. Laudamus appraised the collection at $ 220,120. He reached that figure by adding the prices of each of the 85,000 pieces, as listed in the Center's inventory (which prices are the same as the comprehensive catalog's prices for nonmembers), and dividing the total by two. Petitioners' DeductionsBased on the Laudamus appraisal, petitioners began claiming charitable deductions for the contribution of the sheet music starting with petitioners' 1986 return. For the years 1986, 1987, and 1988 petitioners claimed a total of $ 96,616 of the $ 220,120 music collection appraisal amount as charitable deductions under section 170. The period of limitations for assessment and collection of any deficiency for those years has expired. For the years 1989, 1990, and 1991 petitioners claimed charitable contribution deductions based on the sheet music1995 Tax Ct. Memo LEXIS 217">223 contribution in the amounts of $ 53,036.75, $ 49,376.39, and $ 22,970.70, respectively. OPINION I. IntroductionPetitioner has contributed a large quantity of sheet music (the collection) to a charitable institution. Petitioners have claimed charitable contribution deductions under section 170. Section 1.170A-1 (c)(1), Income Tax Regs., provides that the amount in money of a contribution of property other than money is the fair market value of the property at the time of the contribution. Fair market value of property is defined for purposes of the charitable contribution deduction as the price, as of the date of contribution, at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having a reasonable knowledge of relevant facts. Sec. 1.170A-1(c)(2), Income Tax Regs.Although the regulations under section 170 do not specify whether a wholesale or a retail market is to be used, the answer clearly provided elsewhere is that the retail market must be used under the circumstances existing herein. See Skripak v. Commissioner, 84 T.C. 285">84 T.C. 285, 84 T.C. 285">321 (1985); 1995 Tax Ct. Memo LEXIS 217">224 Anselmo v. Commissioner, 80 T.C. 872">80 T.C. 872, 80 T.C. 872">881-882 (1983), affd. 757 F.2d 1208">757 F.2d 1208 (11th Cir. 1985); sec. 20.2031-1(b), Estate Tax Regs.; sec. 25.2512-1, Gift Tax Regs. Fair market value is a question of fact to be determined from the entire record. Zmuda v. Commissioner, 79 T.C. 714">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 proof. Rule 142 (a). The facts here are uncomplicated. Petitioner purchased the collection for $ 10,000. The collection consisted of approximately 85,000 pieces, which comprised roughly 650 separate titles. There were between 2 and 1,000 copies of each title in the inventory. Petitioner contributed the collection to the Center. The Center prepared two catalogs, setting prices in part by assessing the current prices of sheet music in local bookstores. The catalogs included discounts for members and institutional purchasers. The majority of the pieces were listed in the catalogs for a nondiscounted price of $ 3 to $ 5. Through March 1994, sales proceeds were approximately $ 95,000. II. Expert Opinions1995 Tax Ct. Memo LEXIS 217">225 A. IntroductionIn order to prove the fair market value of the collection, both respondent and petitioners have relied on expert witnesses. Rule 143 requires an expert witness to prepare an expert witness report to aid the Court in its final determination. Petitioners argue that the Laudamus appraisal, which valued the collection at $ 220,120, and upon which petitioners based their deductions, is incorrect, because it was based on "wholesale" value, and is therefore "irrelevant". Petitioners rely instead on the appraisal and expert testimony of Dr. Maurice Tuchman, the Library Director of Hebrew College. Dr. Tuchman appraised the collection at $ 340,000. Respondent counters petitioners' experts with her own expert, Gloria R. Mosesson. Ms. Mosesson valued the collection at $ 42,500, or alternatively, at $ 71,045. B. Petitioners' Expert1. Dr. Tuchman's AppraisalDr. Tuchman arrived at his $ 340,000 valuation by multiplying $ 4, his determined per-piece price, by 85,000, the number of individual pieces in the collection. A number of factors led to a $ 4 per-piece valuation: (1) Present prices for sheet music sold in various local general book and music stores1995 Tax Ct. Memo LEXIS 217">226 were in the $ 3 to $ 3.50 range; (2) prices and sales of Yiddish sheet music through auction houses and auction house catalogs were mostly in the $ 6 to $ 10 range; (3) the conclusion that a number of the pieces are "collectibles" due to either their age or cover design; and (4) the conclusion that Yiddish music popularity is on the rise and a definite market exists for a collection of this size. Dr. Tuchman concludes that his appraisal of $ 340,000 is a "very conservative estimate of the collection['s value]." Dr. Tuchman did not specifically take into account the size of the collection in arriving at his valuation. 2. Analysis of Dr. Tuchman's AppraisalWe do not find Dr. Tuchman's opinion to be persuasive. We are unpersuaded, in major part, because Dr. Tuchman did not specifically take into account the size of the collection and the number of duplicate items. Petitioners argue that a piece-by-piece valuation, without a "bulk discount", should be used to determine fair market value. We disagree because petitioner did not simply contribute one piece, or a few different pieces, of sheet music to the Center. Petitioner contributed approximately 85,000 pieces, mostly duplicates. 1995 Tax Ct. Memo LEXIS 217">227 Without evidence, we will not assume that the retail market could absorb that quantity for immediate sale without some discount. Although there is clear evidence that some, if not all, of the 650 separate titles in the collection were salable, we will not assume that, at any one time, one or more willing buyers could be found for all 85,000 items in the collection. In an analogous situation, concerning a contribution of books, we have said: The major flaw in petitioners' valuation approach * * is petitioners' failure to consider the sheer numbers of books that are to be valued for each petitioner. As against this, the information relied upon by petitioners is simply insufficient to represent the large universe of reprint titles the Court is called upon to value. Skripak v. Commissioner, 84 T.C. 285">84 T.C. 285, 84 T.C. 285">324 (1985). A determination of the fair market value of a group of items includes a consideration of how many of the items would be available for sale at any one time and the length of time necessary to liquidate the entire inventory. E.g., Calder v. Commissioner, 85 T.C. 713">85 T.C. 713, 85 T.C. 713">722-723 (1985) (blockage discount1995 Tax Ct. Memo LEXIS 217">228 applied separately to each of six simultaneous gifts of a large number of works of art by one artist). When property is being valued, the number of items of which such property consists, and not simply the value determined for each item, is a relevant consideration. E.g., Rushton v. Commissioner, 498 F.2d 88">498 F.2d 88, 498 F.2d 88">90 (5th Cir. 1974) ("when securities are being valued, the size of the holding, and not simply the quoted price per share is a relevant consideration"), affg. 60 T.C. 272">60 T.C. 272 (1973); 84 T.C. 285">Skripak v. Commissioner, supra at 324-325. In Estate of Smith v. Commissioner, 57 T.C. 650">57 T.C. 650, 57 T.C. 650">658 (1972), affd. 510 F.2d 479">510 F.2d 479 (2d Cir. 1975), we were required to value a sculptor's collection of 425 of his own works of art. We said: We think that, at the very least, each willing buyer in the retail art market would take into account, in determining the price he would be willing to pay for any given item, the fact that 424 other items were being offered for sale at the same time. The impact of such simultaneous availability of an extremely large number1995 Tax Ct. Memo LEXIS 217">229 of items of the same general category is a significant circumstance which should be taken into account. In this connection, the so-called blockage rule utilized in connection with the sale of a large number of securities furnishes a useful analogy. * * * [Fn. ref. omitted.] Furthermore, where all the items in an inventory cannot be sold simultaneously, carrying costs constitute a relevant factor. Estate of O'Keeffe v. Commissioner, T.C. Memo. 1992-210. Petitioners' expert merely arrived at a per-piece value that he multiplied by 85,000, the number of individual items. He did not take into account the sheer size of the collection and the effect on the market price that the addition to the market of such a huge collection would have. There is nothing in the record that would indicate that a comparable quantity of music existed for sale during the years in question. Indeed, the evidence supports a contrary conclusion. The existing market was small. Petitioners' expert based his appraisal on sales of no more than 100 pieces. Respondent's expert makes reference to collections in New York and in the Library of Congress, which number in the thousands. 1995 Tax Ct. Memo LEXIS 217">230 However, those collections were evidently not for sale on the public market. We conclude that the addition of 85,000 pieces of sheet music on the public market either would depress the market for each title or, perhaps more likely, would result in many copies being unsalable for a considerable period of time. To reflect those possibilities, we believe that a discount, in the nature of a discount to reflect blockage, is appropriate. See Skripak v. Commissioner, 85 T.C. 324-325. Petitioners argue that their expert effectively included a blockage discount into his appraisal due to the fact that the stores and catalogs upon which his appraisal was based implicitly included a blockage discount in their pricing. There is nothing in the record to support that hypothesis. In any event, it is irrelevant. What is relevant is the consequence of an additional 85,000 pieces coming into the market. Besides the issue of a discount to reflect the size of the collection, we have other difficulties with Dr. Tuchman's opinion of the value of each individual piece of sheet music. Dr. Tuchman arrived at his average value per item in part by referring to sales1995 Tax Ct. Memo LEXIS 217">231 prices set forth in catalogs and at music stores. Dr. Tuchman, however, admitted that the catalog and music store prices that he used included the prices for general interest sheet music that would have a much larger marketing audience than the Yiddish and Hebrew sheet music at issue herein, which is an extremely specialized type of music appealing to a limited audience. In addition, the catalogs he used were from 1990 and thereafter, 4 years after the date of the contribution. Further, he looked at music store prices in 1994, some 8 years after the contribution date. Without more, we can place little reliance on those prices as indicative of prices in 1986. Dr. Tuchman also asserts that he examined comparable sales of Yiddish sheet music in determining his per-item value. The purported comparable sales, however, occurred in 1990 through 1993 and, with one exception in 1993 of an auction of 99 items, generally encompassed the sale of between 15 and 32 items a year. Accordingly, the sales should not be considered comparable in that the quantity considered was insignificant when compared to the quantity (85,000 items) involved in the present case, and the earliest sales occurred1995 Tax Ct. Memo LEXIS 217">232 some 4 years after the valuation date at issue herein. Dr. Tuchman did not refer to any of the sales catalogs prepared by the donee in arriving at his average per-item price. Most importantly, he did not refer to the illustrated catalog wherein the majority of the donated inventory was being offered for sale at an average price of approximately $ 1.50 per-item. These catalogs from which actual sales were being made should have been important to Dr. Tuchman if he wanted to discover comparable sales. In fact, the illustrated catalog would have given Dr. Tuchman a strong indication that the bulk of the inventory was being offered for sale at an average price per item for nonmembers that represented a discount of approximately 60 percent from the average price per item ($ 4) he used in determining his value of the inventory. 2 Dr. Tuchman has disregarded in the illustrated catalog what could be considered a substantial component of the potential retail market for the sale of the subject sheet music. 1995 Tax Ct. Memo LEXIS 217">233 Petitioners' expert failed to base his valuation on the appropriate factors and standards that we have discussed. We cannot, therefore, accord his appraisal much weight as an aid in determining the collection's fair market value. C. Respondent's ExpertOn the other hand, respondent's expert, Gloria Mosesson, made her valuations based on the factors and incorporating the standards we have deemed requisite in determining fair market value. Ms. Mosesson arrived at two alternative values, each of which, in part, results from an analysis we can use as an aid in determining the fair market value of the collection. 1. The $ 42,500 ValuationMs. Mosesson reached a fair market value of $ 42,500. She calculated this figure by multiplying 85,000, the number of pieces, by 50 cents, her per-piece value. She reached that value by considering a number of factors overlooked by petitioners' expert, Dr. Tuchman. First, she recognized the limited market for a Yiddish music collection of such a vast quantity. The music was not rare or unique. A majority of items were published in the 1940's, when Yiddish theater and music were in declining popularity, and were, therefore, not among1995 Tax Ct. Memo LEXIS 217">234 the top offerings in that field. Second, she added in the fact that the length of time required to sell the entire collection would be substantial. Even Dr. Tuchman admitted that it would take at least 20 years to sell all 85,000 pieces. Finally, she relied on the fact that Metro, the publisher of the music, was not preeminent in the field. Its music was of lower value. Adding all those factors led her to a 50 cents per-item value. 2. The $ 71,045 ValuationMs. Mosesson determined, alternatively, that the collection had a fair market value of about $ 71,045. To reach that figure, Ms. Mosesson used the Center's prices as a basis for what the retail market for the music would be. She applied a 25-percent discount to account for the various discounts offered in the catalogs. She further applied discounts to account for relevant factors such as (1) costs of preparing an inventory and a catalog, (2) marketing expenses, (3) inventory retention and shrinkage, (4) the collection's vast quantity, and (5) the length of time it would take to sell the music. All of those are factors to be taken into account when determining fair market value. D. Bulk DiscountRespondent, 1995 Tax Ct. Memo LEXIS 217">235 in addition to Ms. Mosesson's valuations, posits that the music be valued using a blockage discount based on an analysis of the item's present value as of the contribution date. Respondent argues: Under this approach, as used by this Court in Calder v. Commissioner, 85 T.C. 713">85 T.C. 713, 85 T.C. 713">724-726 (1985), realization of the value of the sheet music can be compared to the right to receive an annuity of a stated amount over a given period, and the present value of such annuity can be determined from the appropriate valuation tables. Gift Tax Reg. § 25.2512-5A(d)(6). This can be accomplished by treating the sheet music as assets the worth of which could be realized only through the liquidation over a period of time at a uniform rate, 6 yielding an assumed amount of dollars each year over such period. 1995 Tax Ct. Memo LEXIS 217">237 85 T.C. 713">Calder v. Commissioner, supra at 724. Using this methodology and assuming that the entire inventory will be sold over 20 years and that the average retail price per item is $ 1.70, 7 the present value, and, hence, fair market value of the contribution as of July, 1986, would be $ 61,511.00. This result was calculated as follows: 1995 Tax Ct. Memo LEXIS 217">236 8Present 9 value factor Average numberat 10 percentof items sold Average price= Determinedfor annuitiesXper yearXper item Value 8.51364,250 10$ 1.70$ 61,511.00This calculation recognizes that an ascertainable comparable market for this type and bulk of sheet music is the market created by the donee through its catalogues. In addition, it takes into account material factors affecting fair market value such as the quantity involved in the donation, the time interval required for liquidation through sale of the entire inventory and discounts offered by the seller. Including other relevant factors, such as carrying costs and marketing and inventory expenses, respondent arrives at a fair market value "in line with the $ 42,500 fair market value determined by Ms. Mosesson." E. DiscussionWe are materially aided in determining the 1995 Tax Ct. Memo LEXIS 217">*238 fair market value of the collection both by respondent's expert, Ms. Mosesson, and by respondent's Calder analysis. We believe that, when contributed, the value of the collection was not in excess of $ 71,045, Ms. Mosesson's alternative valuation. Since, however, petitioners deducted their contribution in what, in effect, amounts to installments, and the period of limitations expired on $ 96,616 of such installments, it is sufficient that we find that the fair market value of the collection was not in excess of $ 96,616, and we so find. III. ConclusionHaving found that the collection had a fair market value not in excess of $ 96,616 when it was contributed to the Center in 1986, we sustain respondent's disallowances of deductions for 1989 through 1991 on account thereof. We hold that petitioners were entitled to no charitable deductions on account of the contribution of the collection to the Center during 1989, 1990, or 1991. Decision will be entered for respondent. Footnotes1. A portion of the deficiency for 1991 results from incorrect computations of passive losses and itemized deductions and is not in dispute. ↩2. In fact, the illustrated catalog also offered discounts in a similar manner to the comprehensive catalog. The average $ 1.50 price in the catalog should be reduced to reflect such advertised discounts, since the potential consumers who would be receiving the catalog would already be members of the National Yiddish Book Center.↩6. Based on the record in this case the majority of the sales of the sheet music by the donee occurred in the first years after the issuance of the catalogues and sales dropped off dramatically thereafter. Although it does not appear that annual sales of the times would be uniform, for purposes of determining the present value of the sheet music as of the contribution date under the sophisticated approach used by this Court in Calder↩, respondent assumes that the entire inventory will be sold uniformly over a period of 20 years, the time frame asserted by Dr. Tuchman.7. This average per item price of $ 1.70 was determined based on the fact that at least 75 percent of the inventory was offered for sale in the illustrated catalogue for average approximate price of $ 1.50 per item while using Dr. Tuchman's $ 4.00 per item price for the remaining 25 percent of the inventory. Further, an average discount factor of 20 percent was applied to the total to account for the discounts offered in both catalogues.↩8. See 85 T.C. 713">Calder v. Commissioner, supra↩ at 726.9. The present value factor is taken from Table B of Estate Tax Reg. § 20.2031-7A(d)(6) in accordance with Gift Tax Reg. § 25.2512-5A(d)(6)(ii) to determine actuarial factors showing the present worth at 10 percent of an annuity for a term certain of 20 years.↩10. 85,000 items divided by 20 years.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625347/	MICHAEL B. SMALL AND ANN SMALL, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentSmall v. CommissionerDocket No. 16461-91United States Tax CourtT.C. Memo 1992-613; 1992 Tax Ct. Memo LEXIS 639; 64 T.C.M. 1086; October 14, 1992, Filed 1992 Tax Ct. Memo LEXIS 639">639 For Michael B. Small and Ann Small, pro se. For Respondent: John T. Loetie. FAYFAYMEMORANDUM FINDINGS OF FACT AND OPINION FAY, Judge: This case was assigned to Special Trial Judge Carleton D. Powell pursuant to the provisions of section 7443A(b). 1 The Court agrees with and adopts the opinion of the Special Trial Judge that is set forth below. OPINION OF THE SPECIAL TRIAL JUDGE POWELL, Special Trial Judge: This case is before the Court on respondent's Motion to Dismiss for Lack of Jurisdiction, filed August 26, 1991. That motion alleges that a notice of deficiency was mailed to petitioners at their last known address on April 8, 1991, and that the petition was not filed timely. FINDINGS OF FACT On April 8, 1991, respondent mailed a notice of deficiency to petitioners. The notice determined deficiencies in income tax for the taxable years 1983 through 1987 in the respective amounts of $ 45,583, $ 49,819, $ 42,146, $ 40,657 and $ 27,207. The1992 Tax Ct. Memo LEXIS 639">640 notice also determined additions to tax for failure to timely file returns (section 6651(a)(1)), negligence (section 6653(a)) and substantial understatement of tax liability (section 6661) for each year. The address on the notice was 156 East Inlet Drive, Palm Beach, Florida 33480. The 156 East Inlet Drive address was petitioners' address at the time the notice was mailed. A letter, addressed to petitioners at the same address, was enclosed with the petition. That letter stated: Due to disclosure considerations, we did not send a copy of this Notice of Deficiency to the representative you named on Form 2848, Power of Attorney and Declaration of Representative. The notice includes a taxable year(s) not covered under the power of attorney. We have provided an extra copy of the report that you may wish to give to your representative. The U.S. Postal Form 3877 (Certified Mail List) shows that the notice was mailed, by certified mail, to petitioners on April 8, 1991. The address on the Form 3877 is 165 East Inlet Drive, Palm Beach, Florida 33480. (Emphasis added.) There is no such address. The notice of deficiency was not returned to respondent. Respondent, however, 1992 Tax Ct. Memo LEXIS 639">641 did receive a Postal Service Form 3811, Domestic Return Receipt, showing that the "Article Addressed to" petitioners at "156 East Inlet Drive, Palm Beach, Florida 33480" was delivered on April 10, 1991. (Emphasis added). The signature on that form acknowledging receipt of certified mail reads "Small". Petitioners, through their counsel, 2 mailed a petition to the Court on July 23, 1991. Relevant here, the petition alleges that the notice of deficiency was mailed to petitioners "at some date after April 8, 1991". There is no allegation in the petition that the notice was not sent to petitioners' last known address. Petitioners resided in Palm Beach, Florida, when the petition was filed. Respondent filed a motion to dismiss for lack of juridiction, alleging that the petition was not timely filed. Petitioners filed a response in which they allege that they had executed a power of attorney in favor of their accountants and that power provided: "Send1992 Tax Ct. Memo LEXIS 639">642 originals of all notices and all other written communications" involving the tax years in question to the accountants "and a duplicate copy of all notices and all other written communications to the taxpayer named above". Attached to the response are two copies of Forms 2848, Power of Attorney and Declaration of Representative. The first power (Exhibit I) contains so-called "CAF Nos." of both accountants and was executed by petitioner Michael Small, but not by petitioner Ann Small. A CAF Number is a centralized authorization file number that is assigned by the Internal Revenue Service to the donee of a power of attorney. The number is put on the power of attorney by the donee, if he has a number. If not, it is put on the power by the Internal Revenue Service. The second power, attached to petitioners' response (Exhibit 1) contains no CAF Nos. and was executed by both petitioners. The Exhibit 1 power is from petitioners' files. We find that Ann Small did not execute the power of attorney that was sent to the Internal Revenue Service. The Exhibit I power of attorney is the original power sent to the Internal Revenue Service. Petitioners' response to respondent's motion also1992 Tax Ct. Memo LEXIS 639">643 states that: On July 22, 1991, Petitioner, MICHAEL B. SMALL, telephoned WOLFE [petitioners' counsel] and informed him that unbeknownst to his prior knowledge he had located an individual Tax Court Petition for himself and spouse, ANN SMALL that had been set aside in a stack of papers. With regard to when petitioners received the notice, petitioner (Mr. Small) testified: THE COURT: So you don't recognize that signature [on the PS Form 3811, Domestic Return Receipt]? THE WITNESS: Absolutely not. That is not our signature. That is not anyone in our household's. Once again, the only thing that I can surmise, under oath, Your Honor, is that apparently the delivery was made to 165 East Inlet, which is not our address. Perhaps the people there, because we have lots of renters in our neighborhood, people that are only living there seasonally -- * * THE COURT: You found it [the notice] in your house? THE WITNESS: Yes, sir, that's correct, on July 20, 1991, without an envelope, sitting in the front hall closet up on a shelf. Someone apparently had put it there. OPINION Section 6213(a) provides in relevant part that, if a notice of deficiency is addressed to a person not outside1992 Tax Ct. Memo LEXIS 639">644 of the United States, "the taxpayer may file a petition for a redetermination of the deficiency" within 90 days. This 90-day period is jurisdictional, and, if a petition is not filed within that period, the case must be dismissed for lack of jurisdiction. (11 Cir. 1985). 31992 Tax Ct. Memo LEXIS 639">645 There is no question here that the petition was filed more than 90 days after the mailing of the notice. The notice was mailed on April 8, 1991, and the petition was received by the Court on July 24, 1991, 107 days after the notice was mailed.4 Petitioners contend, however, that the notice of deficiency was invalid, and, therefore, the Court should dismiss the case on that ground. See . Section 6212(a) authorizes respondent to send a notice of deficiency to the taxpayer by certified or registered mail. The mailing is sufficient if the notice is addressed "to the taxpayer at his last known address". Sec. 6212(b)(1). If the address to which the notice is mailed is not the taxpayer's last known address, the notice is generally invalid. , affd . Petitioners argue that the power of attorney that was executed served to notify respondent that they wished that any notice of deficiency be sent to their accountants, and, therefore, their accountants' address constituted their "last known address". See , affd. without published opinion . While, as discussed infra, under the circumstances this argument is not controlling, we note that there are several1992 Tax Ct. Memo LEXIS 639">646 factual problems with petitioners' position. First, the power of attorney filed with respondent (Exhibit I) contains only the signature of Mr. Small. 5 The most that can be suggested then is that Mr. Small may have intended to change his address, but not that of his wife. But, under the circumstances that scenario seems somewhat whimsical. Second, putting aside the issue whether sending the notice to the accountants may have been improper because of section 6103, the accountants' address on the power is not complete. 1992 Tax Ct. Memo LEXIS 639">647 In all events, even if the address to which the notice is mailed is not a taxpayer's last known address, if a taxpayer actually receives the notice within ample time to file a petition, the notice is valid. , revg. and remanding an Order of this Court; . Petitioners maintain, however, that the first time that they discovered the notice was July 20, 1991. Petitioners speculate the notice and the attached letter must have been sent to them at 165 East Inlet Drive, were accepted by persons unknown, and then surreptitiously found their way into petitioners' house without an envelope. This explanation is cut from whole cloth. First, the most likely explanation for the 165 East Inlet Drive address appearing on the Form 3877 is that it was a typographical error on that form. The return receipt (PS Form 3811), the notice of deficiency and the attached letter were all addressed to the 156 East Inlet Drive address. Second, there is no 165 East Inlet Drive from which the notice could have been forwarded. Third, it1992 Tax Ct. Memo LEXIS 639">648 is inconceivable that the notice and letter were opened, the envelope destroyed, and the notice and letter put in petitioners' hall closet by someone unknown. In short, we conclude that the envelope in which the notice was mailed was correctly addressed to 156 East Inlet Drive and was received by petitioners at that address on April 10, 1991. Even if we assume then that the address was not the last known address for Mr. Small, the notice was received by petitioners, and they had ample time to file a timely petition. Accordingly, the notice was valid, and the petition was not timely filed. The case must be dismissed for lack of jurisdiction. 61992 Tax Ct. Memo LEXIS 639">649 An appropriate order will be entered. Footnotes1. All section references are to the Internal Revenue Code.↩2. Petitioners' counsel subsequently withdrew from the case.↩3. Venue for an appeal in this case would be in the Eleventh Circuit. Sec. 7482(b)(1)(A). Under the so-called Golsen doctrine, the Court would follow the case precedent of that Circuit. See , affd. on other grounds .↩4. The petition was mailed on July 23, 1991.↩5. Petitioners contend that the operative power of attorney contained the signatures of both petitioners. This dispute focuses on the differences between Exhibit 1 (from petitioners' files) and Exhibit I (from respondent's files). We have found that the operative power is Exhibit I. That power bears the CAF Nos. of the donees of the power. While the accountants did not testify, it seems more likely that Mr. Small copied the form, executed the power, and sent it to the accountants who then added the CAF Nos. and forwarded it to respondent. Mrs. Small apparently executed the retained copy at a later date. Mrs. Small did not testify. See , affd. .↩6. Petitioners urge that we should use our powers to save jurisdiction in this case. The long and short of the matter, however, is this Court is a court of limited jurisdiction, and we have no such powers. See ; , affd. on other issues .↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625348/	ESTATE OF ROBERT WOOD, DECEASED, CONSTANCE WOOD, SURVIVING SPOUSE, AND CONSTANCE WOOD, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentEstate of Wood v. CommissionerDocket No. 16170-83.United States Tax CourtT.C. Memo 1985-517; 1985 Tax Ct. Memo LEXIS 118; 50 T.C.M. 1232; T.C.M. (RIA) 85517; September 30, 1985. Gino P. Cecchi, for the petitioners. James S. Daubney, for the respondent. KORNERMEMORANDUM OPINION KORNER, Judge: Respondent determined1985 Tax Ct. Memo LEXIS 118">119 a deficiency of income tax against Robert Wood and Constance Wood for the year 1979 in the amount of $7,022.31. After concessions, the sole issue which we must determine is whether Robert Wood suffered a deductible casualty loss in 1979 on account of the alleged worthlessness, in that year, of an asset used in Robert Wood's trade or business. Robert and Constance Wood, husband and wife, filed a joint income tax return for the calendar year 1979 with respondent at Fresno, California. Robert Wood (hereinafter "decedent") died on January 26, 1983, and his estate and Constance Wood are the petitioners herein, with residence in San Francisco, California. In 1959, decedent applied to the San Francisco Police Commissioner, under then-existing ordinances and regulations of the City and County of San Francisco, for a transfer to him of a "certificate of public convenience and necessity," which he had purchased from a third party, and which would entitle him to operate a taxi for hire in that jurisdiction. Permission was granted, and an appropriate taxicab permit was issued to decedent, authorizing him to operate one vehicle as a taxicab for hire within the jurisdiction of the San Francisco1985 Tax Ct. Memo LEXIS 118">120 Police Department. Unless revoked for cause, this permit was automatically renewable from year to year. Under ordinances and police regulations in effect at that time, the issuance and transfer of taxicab permits in the City and County of San Francisco was regulated by the Police Commission. Subject to approval by the Commission, the transfer of a taxicab permit from one person or firm to another was permitted, and holders of a taxicab permit were also permitted to lease out the use of their permit to another. Decedent had a cost basis in the taxicab permit so procured of $16,265. Decedent owned this permit from the time he acquired it in 1959 until his death in 1983. Beginning in 1978, however, he leased the operation of the taxicab under his permit to others, and reported income therefrom in his income tax returns for the years and in the amounts as follows: 1YearIncome From Permit Lease1978$4,70019794,70019806,12519819,100198210,250198326,0501985 Tax Ct. Memo LEXIS 118">121 On June 6, 1978, the voters of San Francisco voted upon and adopted Proposition K. So far as relevant herein, the adoption of Proposition K changed the system with respect to taxicab permits, in that such permits, once issued, were thereafter not to be sold, assigned or transferred. Holders of existing permits were given a period of 60 days after the effective date of the new ordinance within which to exchange their existing permits for new permits, and the old permits then outstanding would become void. Taxicab permits were declared to be the property of the people of the City and County of San Francisco. Thereafter, the permit of a holder who died, who failed to use his permit within a given period of time, or who had his permit otherwise revoked for cause had to be surrendered to the Police Commission. No change, however, was made to existing law, whereunder a permit could continue to be used indefinitely by the holder thereof, or leased to other persons. Although the record does not disclose the effective date of Proposition K, certain taxicab operators in San Francisco, after the election, sought to block the new ordinance going to effect by seeking an injunction in the1985 Tax Ct. Memo LEXIS 118">122 California Superior Court against enforcement of Proposition K. An appeal from the denial of such an injunction by the Superior Court wad denied by the California Court of Appeals on March 6, 1979. At least by that date, therefore, Proposition K was in full force and effect. In their joint income tax return for 1979, decedent and petitioner Constance Wood claimed the amount of $16,500 as a loss from "casualty or theft" with respect to an asset used in the trade or business, viz the taxicab permit. Respondent denied the claimed deduction, determining that no deductible loss had occurred. The parties apparently recognize that the issue before us is controlled by the provisions of section 165. 2 The parties, however, appear somewhat ambivalent as to the proper classification of the alleged loss, each side at various times arguing that the events here should be measured by the standards of section 165(c)(1) and, at other times, addressing the matter as covered by section 165(c)(3). In our view, there should be no ambiguity here: the result of the action of the voters, in curtailing decedent's rights in his taxicab permit by the enactment of Proposition K, is to be measured under1985 Tax Ct. Memo LEXIS 118">123 the standards of section 165(c)(1). The action of the voters clearly did not cause a casualty to or a theft from decedent with respect to any property, as those terms are defined in section 165(c)(3). See Durden v. Commissioner,3 T.C. 1">3 T.C. 1, 3 T.C. 1">3 (1944); Matheson v. Commissioner,54 F.2d 537">54 F.2d 537, 54 F.2d 537">539 (2d Cir. 1931), affg. 18 B.T.A. 674">18 B.T.A. 674 (1930). Petitioners claim that the enactment of Proposition K, restricting decedent's right to assign, sell or transfer his taxicab permit, rendered that valuable asset used in his trade or business worthless, and that he was therefore entitled to a casualty loss deduction for 1979 in the amount of his cost basis. We think the law is clear that a loss, in order to be deductible, must be evidenced by a closed and completed transaction. United States v. White Dental Co.,274 U.S. 398">274 U.S. 398 (1927); section 1.165-1(b), Income Tax Regs. For purposes of the closed and completed transaction1985 Tax Ct. Memo LEXIS 118">124 rule, the various rights which decedent had in his taxicab license cannot be separated into separate pieces of property so that the elimination of one of those rights can constitute a closed and completed transaction within the meaning of the statute. The facts in this case show that after the adoption of Proposition K, decedent continued to have the right to operate his taxicab, as before, and continued to have the right to lease his permit to others, as in fact he did. The only right which was removed from his taxicab permit was the right to transfer it to someone else.In these circumstances, we think there was no identifiable loss for purposes of section 165. In Beatty v. Commissioner,46 T.C. 835">46 T.C. 835 (1966), the taxpayer held an Arizona liquor license. Such licenses were issued in limited number, were freely transferable, and did not have to be used in order to remain effective. The legislature of Arizona thereafter amended the law so as to prohibit the free transfer of liquor licenses, unless such transfer was done in connection with selling the entire business to which the license related.The right of leasing the licenses was also eliminated, and it was further1985 Tax Ct. Memo LEXIS 118">125 provided that the licenses would lapse if they were not used for a period of six months. In addition, the legislature authorized an increase in the number of licenses issued. As a result, the taxpayer contended that the value of his Arizona liquor license had been substantially reduced, and claimed a loss under section 165 for such alleged reduction in value. In rejecting taxpayer's claim, and holding that there was no closed and completed transaction for purposes of section 165, we said (46 T.C. 835">46 T.C. 841-842): Prior to the 1961 amendments, petitioners' license had three elements -- the right of free transfer, the right to lease, and the right to use in the liquor business. After the 1961 amendments, the right of transfer could still be exercised, albeit only in connection with a bulk sale of the entire business and stock in trade. The right to lease was eliminated.The right to use the license in the liquor business continued, perhaps in a somewhat weakened state, because of the increase in the number of licenses potentially allowable. The 1961 amendments debased the value of, but did not destroy, any of these rights, with the exception of the right of lease1985 Tax Ct. Memo LEXIS 118">126 (which petitioners have not put in issue). Whatever may be the quality of severability of rights of ownership in other situations (cf. Rev. Rul. 54-409, 1954-2 C.B. 174), we are not prepared to sever these rights from each other nor to herniate the right of sale and hold the hernia irreparable, as petitioners would have us do. We take as our text what we said in Louisiana Land & Exploration Co.,7 T.C. 507">7 T.C. 507, 7 T.C. 507">518 (1946), affd. 161 F.2d 842">161 F.2d 842 (C.A. 5, 1947): We can * * * foresee innumerable administrative difficulties as a consequence of allowing a taxpayer, upon showing that an asset owned by him is valueless for one of several purposes for which it was acquired, to deduct the part of the purchase price which might be apportioned to that purpose. Moreover, to permit such a deduction would be to allow the taxpayer to make one asset into as many as there were contemplated uses for it, and would have the effect in many cases of nullifying the established rule that mere shrinkage in the value of an asset prior to closing of the transaction with respect thereto does not give rise to a deductible loss. See Edith K. Findley,46 B.T.A. 1219">46 B.T.A. 1219.1985 Tax Ct. Memo LEXIS 118">127 The approval of petitioner's contention would thus, in our view, constitute the adoption of a principle which is in conflict with the correct and long established interpretation of the loss provisions of the code and would lead to confusion in their administration. We hold that there was no closed transaction in 1961 so as to support the claimed deduction. Petitioner's loss, if any, must abide further events. [Footnote omitted.] [Emphasis in original.] See also Consolidated Freight Lines, Inc. v. Commissioner,37 B.T.A. 576">37 B.T.A. 576 (1938), affd. 101 F.2d 813">101 F.2d 813 (9th Cir. 1939), cert. denied 308 U.S. 562">308 U.S. 562. And see further Reporter Publishing Co., Inc. v. Commissioner,201 F.2d 743">201 F.2d 743, 201 F.2d 743">744 (10th Cir. 1953), cert. denied 345 U.S. 993">345 U.S. 993, affg. 18 T.C. 86">18 T.C. 86 (1952), where the Court of Appeals said: A taxpayer is not chargeable with a capital gain resulting from an enhanced value of a capital asset while it is still being used in the business; neither may he take a deduction from gross income because of the diminution in value of such an asset while it is still a part of the business and is being used in the business. 1985 Tax Ct. Memo LEXIS 118">128 Since there is no conflict in the decisions with respect to these principles of law, citing numerous decisions in support thereof would be superfluous and add nothing of value to the opinion. We think the above cases are dispositive of the issue presented here. The passage of Proposition K by the voters changed decedent's taxicab permit in only one respect: he could not thereafter sell or assign it. So far as the record shows, all his other rights remained the same, and in fact, beginning in 1978 and apparently extending to the time of his death in 1983, decedent derived substantial income from the leasing of his taxicab permit. That such permit continued to have value in decedent's trade or business is not to be doubted. We accordingly hold that there was no closed and completed transaction giving rise to a deductible loss within the meaning of section 165. 31985 Tax Ct. Memo LEXIS 118">*129 To give effect to the concessions which the parties have made on other issues, Decision will be entered under Rule 155.Footnotes1. The record does not disclose whether petitioner operated a taxicab under his permit personally from 1959 to 1978, or whether he leased it out for all or part of such period. For purposes of this case, however, it does not matter.↩2. All statutory references are to the Internal Revenue Code of 1954, as in effect in the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure, except as otherwise noted.↩3. As we noted in Beatty v. Commissioner,46 T.C. 835">46 T.C. 835, 46 T.C. 835">842 n. 8, even if we could conclude that the various rights in the taxicab permit were severable, for purposes of section 165(a), there is nothing in this record to show what the fair market value of the permit was in 1979, nor how much of such value, or the stipulated cost basis, should be allocated to the right to transfer which was eliminated. Compare Consolidated Freight Lines, Inc. v. Commissioner,37 B.T.A. 576">37 B.T.A. 576, 37 B.T.A. 576">582 (1938), affd. 101 F.2d 813">101 F.2d 813 (9th Cir. 1939), cert. denied 308 U.S. 562">308 U.S. 562↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625349/	JOSEPH T. TRIPI and MIRIAM V. TRIPI, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentTripi v. CommissionerDocket No. 8137-80United States Tax CourtT.C. Memo 1983-483; 1983 Tax Ct. Memo LEXIS 312; 46 T.C.M. 1094; T.C.M. (RIA) 83483; August 15, 1983. Edgar C. NeMoyer, for the petitioners. George W. Connelly, Jr., for the respondent. WILBURMEMORANDUM FINDINGS OF FACT AND OPINION WILBUR, Judge: Respondent determined deficiencicies in petitioners' Federal income taxes as follows: YearDeficiency1975$23,094197614,893197723,094The sole issue presented for our decision is whether petitioners' 1983 Tax Ct. Memo LEXIS 312">314 thoroughbred horse racing, raising, and breeding endeavors constitute an "activity * * not engaged in for profit" within the meaning of section 183(a) of the Internal Revenue Code of 1954. 1FINDINGS OF FACT Some of the facts have been stipulated. The stipulation of facts and attached exhibits are incorporated herein by reference. Petitioners, Joseph T. Tripi and Miriam V. Tripi, husband and wife, resided in Kenmore, New York at the time their petition was filed. They filed joint Federal income tax returns for the years 1975 through 1977 with the Internal Revenue Service Center, Andover, Massachusetts. Petitioners first became involved with thoroughbred horses during 1958 when petitioner Joseph T. Tripi (hereinafter referred to as Joseph) purchased a horse at an auction for $200. Petitioners have been involved in horse racing, raising, and breeding continuously from 1958 to the time of trial in March, 1982. During this period, the greatest number of petitioners' horses involved in racing in any one year1983 Tax Ct. Memo LEXIS 312">315 was approximately six. The greatest number of horses involved in breeding was approximately 15. 2 During the years in issue, 1975 through 1977, petitioners owned between 15 and 20 horses. From 1958 through 1972, petitioners maintained their thoroughbred horse operations primarily in Canada. Although they continued to race their horses in Canada after 1972, they moved their horses to western New York State and began concentrating their activities in that area during 1973. Petitioners have centered their operations in western New York State since that time. During the years in issue, petitioners raced their horses in Canada, New York, Florida, Maryland, and Pennsylvania. 3 During these years approximately 90 percent of their racing took place in New York State of which the lion's share was conducted at Finger Lakes Racetrack and Commodore Downs Racetrack. Many of the races in which petitioners1983 Tax Ct. Memo LEXIS 312">316 have entered their horses provide purses of between $8,000 and $10,000. At all times relevant to this case, such purses were distributed in roughly the following manner: Place of FinishPercentage of Purse First60%Second20-22%Third10-12%Fourth5- 6%Petitioners regularly traveled to racetracks in New York State and Canada where the bulk of their horse racing was conducted. They spent time in the club houses of those tracks, ate meals there, and would retire to the paddock area after their horses had run to discuss the races with their trainers. They did not, however, travel to such distant locations as Maryland and Florida to see their horses race. Petitioners also did not ride their horses either professionally or for pleasure. One of the reasons petitioners moved the base of their operations from Canada to New York in 1973 was to take advantage of certain1983 Tax Ct. Memo LEXIS 312">317 financial incentives established by New York State to promote the breeding and development of thoroughbred horses in that state. In 1973, the New York Legislature enacted N.Y. Unconsol. Laws secs. 8048 - 8048e (McKinney Supp. 1979) which established the New York Thoroughbred Breeding and Development Fund. This fund is financed by a levy on pari-mutual betting pools and, for years after 1977, an equal levy on offtrack betting pools. Pursuant to N.Y. Unconsol. Laws sec. 8048-c.2.1. (McKinney Supp. 1979), the fund annually disburses "breeders awards" to the breeders of New York-bred thoroughbreds that finish first, second, third, or fourth in open races in New York State. Pursuant to N.Y. Unconsol. Laws sec. 8048-c.2.2. (McKinney Supp. 1979), the fund annually disburses "stallion awards" to the owners of New York stallions who have sired New York-bred thoroughbreds that finish first, second, third, and fourth in open races in New York State. At the time of trial, petitioners had received breeder awards of $1,690.50 for 1980, and $4,000 for 1981. Petitioners have never received a stallion award, however. This is due, in large measure, to the fact that they have never stood one1983 Tax Ct. Memo LEXIS 312">318 of their stallions for stud in New York State. In addition to breeder awards, petitioners also derived income from their horse breeding activities through stud fees. In a good year a good stallion could potentially be bred 40 times at $2,000 a breeding. At the time of trial, however, the greatest number of times any of petitioner's stallions have stood for stud in any one year was six. This occurred prior to 1975 and the highest stud fee received in that year was $500. Petitioners first began reporting the results of their thoroughbred horse operations on their income tax return for the taxable year 1958. For each of the years 1958 through 1972, they filed a single Schedule C as part of their return on which they reported the combined income and expenses from their activities. On their 1973 return and on each subsequent return up to the time of trial, 4 they filed a Schedule C for their horse racing endeavors and a separate Schedule C for their horse raising, and breeding endeavors. For each of the taxable years 1958 through 1960, petitioners1983 Tax Ct. Memo LEXIS 312">319 reported a net loss from their combined horse racing, raising and breeding operations. The parties, however, did not submit evidence into the record as to the amount of the loss for each of these years. For taxable years 1961 through 1972, petitioners reported the following gross receipts, expenses, and net losses from their combined operations on the Schedule C filed with their return: TaxableGrossTotalNet ProfitYearReceiptsExpenses(Loss)1961$ (5,104.00)1962$5,011.20$16,817.75(11,806.00)196312,370.0020,052.64(7,682.64)19644,180.4014,442.45(10,262.05)19653,022.0016,325.97(13,303.97)19668,775.0021,053.00(12,278.00)196715,456.0024,238.82(8,783.02)196823,720.8038,156.16(14,435.36)196920,315.0034,060.00(13,545.13)1970(15,677.00)197117,074.0029,278.76(12,204.76)197213,656.0035,595.91(18,919.89)For taxable years 1973 through 1980, petitioners reported the following gross receipts, expenses, and net profits or losses from their horse racing operations on the Schedule C filed with their return: TaxableGrossTotalNet ProfitYearReceiptsExpenses(Loss)1973$404.00$15,598.45$ (15,194.45)197413,216.0017,614.98(4,398.98)197523,410.1521,821.081,589.07 197620,567.5019,318.421,249.08 19776,937.0017,104.91(10,251.91)197813,375.0028,462.06(15,087.06)197917,030.0026,779.18(9,749.18)198017,501.5011,559.042,942.46 1983 Tax Ct. Memo LEXIS 312">320 For taxable years 1973 through 1980, petitioners reported the following gross receipts, expenses, and net losses from their horse raising and breeding operations on the Schedule C filed with their return: TaxableGrossTotalNet ProfitYearReceiptsExpenses(Loss)1973$10,150.61$ (10,150.61)1974$1,460.0010,823.78(9,363.78)19752,400.0022,781.50(20,381.50)19762,000.0025,851.95(23,851.95)1977500.0020,717.90(20,217.90)19781,450.0011,566.60(10,116.60)197916,196.63(16,196.63)19807,240.5016,335.48(9,094.98)Petitioner's cumulative reported losses since 1961 for their combined thoroughbred horse operations are as follows: Cumulative Losses RacingRaising and BreedingCombined1961-72$144,002.371973$15,194.45$10,150.61169,347.43197419,593.4319,514.39183,110.19197518,004.3639,895,89201,902.62197616,755.2863,747.84224,505.49197727,007.1983,965.74254,975.30197842,094.2594,082.34280,179.06197951,843.43110,278.97306,124.87198048,900.97119,373.95312,277.391983 Tax Ct. Memo LEXIS 312">321 At trial, Joseph estimated that he and his wife had spent approximately $100,000 to acquire all of the horses purchased between 1958 and the time of trial. He also estimated that all of the horses they owned at the time of trial were worth approximately $150,000. Petitioners have never received an offer for all of their horses, however, but on one occasion they did receive an offer of $15,000 for one of their horses. Petitioners oversaw and controlled all facets of their horse racing, raising, and breeding during the years at issue. They paid the bills, maintained the records of income and expenses; selected, hired, and discharged trainers; selected and inspected the locations at which the animals were kept; purchased and sold horses; and participated in decisions to breed and race their animals. In fact, it was not unusual for Joseph to devote over 20 hours in a particular week to his thoroughbred horse activities. During the years in issue, the books and records which petitioners maintained for expenses of their thoroughbred horse operations consisted of cancelled checks, check stubs, invoices, bills, a ledger book, and handwritten notes. Entries of expenses in the ledger1983 Tax Ct. Memo LEXIS 312">322 book did not include all of their expenses, but did include many references to dates, payees, and amounts. Payment of expenses by check came from a single checking account. This account was also used by petitioners to pay their personal expenses as well as the expenses of several other business endeavors. In taxable year 1977, petitioners began separating expenses in their ledger book between those for horse racing and those for breeding and raising horses. Prior to that time, they maintained aggregate expense records for their thoroughbred horse activities despite the fact petitioners had been filing separate Schedules C with their tax returns since taxable year 1973 for their horse racing endeavors, and for their horse raising and breeding endeavors. For the taxable years 1973 through 1976, petitioners have, in effect, made an after-the-fact allocation of expenses in order to prepare separate Schedules C. Despite petitioners' use of two separate Schedules C beginning with taxable year 1973 and despite petitioners' efforts to categorize expenses in their ledger book beginning with taxable year 1977, petitioners' horse racing, raising, and breeding endeavors have been closely1983 Tax Ct. Memo LEXIS 312">323 interrelated since 1958. Petitioners have kept and raced the offspring of their thoroughbreds. They have retired horses from racing and used them for breeding. They have also avoided gelding their stallions although aware that gelding stallions could improve or extend their racing potential.With the exception of a few seminars, the only formal training petitioners have received with respect to their thoroughbred horse endeavors was a genetics course that Joseph took during 1935 when he was a sophomore in college. They have read and purchased numerous books about various facets of thoroughbred horses, however. Petitioners feel they are competent in dealing with their thoroughbred horse activities, but do not consider themselves "experts" in the field. In addition to their thoroughbred horse operations, petitioners have been involved in the ownership and operation of several motels, a construction company, and rental properties. During the years 1958 through 1974, the income from these endeavors and the cash flow generated by the depreciation of their rental properties furnished the funds with which petitioners financed their thoroughbred horse operations. During the years1983 Tax Ct. Memo LEXIS 312">324 in issue, petitioners continued to receive substantial levels of income which permitted them to carry the losses sustained in their thoroughbred horse operations. They received the following income from wages, interest, and dividends as well as gross proceeds from the sale of stock and other capital assets. Proceeds from Sales ofYearWagesDividendsInterestStock and Capital Assets 1975$5,200$8,125.59$28,525.79$190,764.6619765,50010,995.9033,906.62102,716.2619772,20013,446.3455,503.3215,301.25OPINION During the years in issue, 1975 through 1977, petitioners were involved in the racing, raising, and breeding of thoroughbred horses. Petitioners sustained substantial losses annually from these endeavors. The sole issue before us is whether petitioners' involvement with thoroughbred horses is an "activity * * not engaged in for profit" within the meaning of section 183. If so, petitioners are restricted as to the losses which may be taken with respect to such activity. Respondent contends that petitioners' thoroughbred horse1983 Tax Ct. Memo LEXIS 312">325 activities were not primarily motivated by hopes of profit. Respondent relies in large measure on the unbusinesslike manner in which the activity has been conducted and the long history of losses incurred by petitioners beginning in 1958. Petitioners maintain they entered into their activities with the expectation of making a profit and that they still expect to make a profit. We are convinced after a careful review of the entire record that petitioners did not conduct their thoroughbred horse activities in the years before us with the objective of making a profit. Section 183(a)5 provides that no deduction shall be allowed to an individual for expenses attributable to an activity not engaged in for profit except as provided in section 183(b). Section 183(b) essentially states that losses in excess of income are disallowed with respect to such an activity. Section 183(c) defines the phrase "activity not engaged in for profit" to mean any activity other than one with respect to which deductions are allowable for the taxable year under section 1626 or under paragraphs (1) or (2) of section 212. 7 Thus, only if deductions would be allowable under sections 162 or 212(1) or1983 Tax Ct. Memo LEXIS 312">326 (2) with respect to the activity, is that activity engaged in for profit. 1983 Tax Ct. Memo LEXIS 312">327 A common prerequisite of deductibility under section 162 and paragraphs (1) and (2) of section 212 is a predominant purpose and intention of making a profit from the activity with respect to which the expenses are incurred. Allen v. Commissioner,72 T.C. 28">72 T.C. 28, 72 T.C. 28">33 (1979); Dunn v. Commissioner,70 T.C. 715">70 T.C. 715, 70 T.C. 715">720 (1978), affd. an another issue, 615 F.2d 578">615 F.2d 578 (2d Cir. 1980). The taxpayer's expectation of profit need not be a reasonable one, but the facts and circumstances must indicate that he had an actual and honest objective of making a profit. Section 1.183-2(a), Income Tax Regs.; Dreicer v. Commissioner,78 T.C. 642">78 T.C. 642, 78 T.C. 642">645-46 (1982), affd. in an unpublished opinion (D.C. Cir. Feb. 22, 1983). Therefore, in essence, section 183 distinguishes between nondeductible hobby losses and deductible business losses. S. Rept. No. 91-552 (1969), 1969-3 C.B. 423, 489. Accordingly, in this case we must determine whether petitioners had an actual and honest profit objective in conducting their thoroughbred horse activities. Petitioners bear the burden of proof. Welch v. Helvering,290 U.S. 111">290 U.S. 111 (1933);1983 Tax Ct. Memo LEXIS 312">328 Rule 142(a), Tax Court Rules of Practice and Procedure. While ultimately we are deciding subjective intent, that intent can be ascertained from objective factors which are entitled to greater weight than a taxpayer's statement. Section 1.183-2(a), Income Tax Regs.; Engdahl v. Commissioner,72 T.C. 659">72 T.C. 659, 72 T.C. 659">666 (1979); Golanty v. Commissioner,72 T.C. 411">72 T.C. 411, 72 T.C. 411">426 (1979), affd. per order (9th Cir., Mar. 25, 1981).Before determining whether petitioners held the requisite profit objective as required by section 183, it is necessary to determine whether their horse racing, raising, and breeding endeavors during the years at issue constituted one, or alternatively, more than one "activity" for purposes of applying section 183. We understand petitioners to be arguing that they were engaged in two separate activities: horse racing as one activity, and horse raising and breeding as a second activity. 8 Respondent, on the other hand, contends petitioners' thoroughbred horse racing, raising, and breeding endeavors were components of a single activity for purposes of section 183. 1983 Tax Ct. Memo LEXIS 312">329 Section 1.183-1(d)(1), Income Tax Regs., provides in pertinent part: In order to determine whether, and to what extent, section 183 and the regulations thereunder apply, the activity or activities of the taxpayer must be ascertained. For instance, where the taxpayer is engaged in several undertakings, each of these may be a separate activity, or several undertakings may constitute one activity. In ascertaining the activity or activities of the taxpayer, all the facts and circumstances of the case must be taken into account. Generally, the most significant facts and circumstances in making this determination are the degree of organizational and economic interrelationship of various undertakings, the business purpose which is (or might be) served by carrying on the various undertakings separately or together in a trade or business or in an investment setting, and the similarity of various undertakings. Generally, the Commissioner will accept the characterization by the taxpayer of several undertakings as a single activity or as separate activities. The taxpayer's1983 Tax Ct. Memo LEXIS 312">330 characterization will not be accepted, however, when it appears that his characterization is artificial and cannot be reasonably supported under the facts and circumstances of the case. In applying this regulation to the facts of the case before us, we agree with respondent that petitioners' thoroughbred horse racing endeavors during the years in issue comprise one activity for purposes of section 183. Petitioners began their operations in 1958 with one horse and there is no indication that petitioners' various thoroughbred horse endeavors had separate beginnings.From 1958 through 1972, petitioners reported the results of their activities on a single Schedule C each year. Although petitioners began filing separate Schedules C in taxable year 1973 for their horse racing, and for their horse raising and breeding, they have offered no explanation for this change. In fact, only in taxable year 1977 did petitioners begin separating expenses of racing from those of breeding and raising horses in the ledger book in which they recorded expenses. Prior to that time, petitioners had, in effect, made an after-the-fact allocation of expenses in order to prepare separate Schedules C. 1983 Tax Ct. Memo LEXIS 312">331 Furthermore, all facets of petitioners' endeavors involved, to a large degree, the same horses. Petitioners have kept and raced the offspring of their breeding horses. They have retired horses from racing and used them for breeding. These facts indicate petitioners' thoroughbred horse endeavors were not conducted separately, but were economically and practically related. They constituted a unitary activity and must be so regarded for purposes of section 183. Having determined that petitioners were involved in only one "activity" for purposes of section 183, we must now determine whether petitioners conducted that activity with the requisite profit objective. Section 1.183-2(b), Income Tax Regs., sets forth some of the relevant factors, derived principally from prior case law, which are to be considered in determining whether an activity is engaged in for profit. They are: (1) the manner in which the taxpayer carries on the activity, (2) the expertise of the taxpayer or his advisors, (3) the time and effort expended by the taxpayer in carrying on the activity, 1983 Tax Ct. Memo LEXIS 312">332 (4) the expectation that assets used in the activity may appreciate in value, (5) the success of the taxpayer in carrying on other similar or dissimilar activities, (6) the taxpayer's history of income or losses with respect to the activity, (7) the amount of occasional profits, if any, which are earned, (8) the financial status of the taxpayer, and (9) elements of personal pleasure or recreation. These factors are not exclusive and are to be applied according to the unique facts of each case. Accordingly, no one factor, or a majority of nine factors, need be considered determinative. Golanty v. Commissioner,72 T.C. 411">72 T.C. 411, 72 T.C. 411">426-27 (1979), affd. per order (9th Cir., Mar. 25, 1981); Benz v. Commissioner,63 T.C. 375">63 T.C. 375, 63 T.C. 375">382-83 (1974). An analysis of the relevant factors as applied to petitioners' thoroughbred horse operations follows. Factor (1): The manner in which the taxpayer carries on the activity.--The manner in which petitioners conducted their thoroughbred horse operations in many ways belies a concern for profits. They kept expense records, hired and changed trainers, bought and sold animals, read numerous books and articles, and attended1983 Tax Ct. Memo LEXIS 312">333 seminars about horses. Petitioners' conduct, however, is equally consistent with an activity pursued for pleasure, and is insufficient to demonstrate an objective to make a profit. 72 T.C. 411">Golanty v. Commissioner,supra at 430. Petitioners' decision to move their operation from Canada to New York State in 1973 in order to take advantage of certain "breeder" and "stallion" awards offered by New York State9 would suggest, in particular, a concern for profitability. This action by petitioners must be viewed in light of the entire mosaic of petitioners' actions, however. The significance of petitioners' decision to move the base of their operations is considerably diminished when the probable return from such breeder and stallion awards is weighed against the large losses incurred by petitioners during the years at issue. In fact, petitioners never received an award from New York State prior to taxable year 1980 and then only in the somewhat modest sums of $1,690.50 and $4,000 for 1980 and 1981, respectively. Petitioners also paid the expenses of their thoroughbred horse operations out of1983 Tax Ct. Memo LEXIS 312">334 their personal checking account. Although the failure to maintain a separate checking account may tend to suggest the lack of a profit objective, the fact petitioners utilized their personal account to pay the expenses of several other business endeavors neutralizes any adverse inference that might otherwise be drawn. Factor (2): The expertise of the taxpayer or his advisors.--Petitioners have read numerous books about various aspects of their thoroughbred horse operations. They have also hired competent trainers to prepare their horses for racing. On the other hand, petitioners have had virtually no formal training and presented no evidence that would indicate they sought and relied upon experts in conducting their horse breeding operations. This factor, therefore, is not particularly helpful in bolstering either petitioners' or respondent's position. Factor (3): The time and effort expended by the taxpayer in carrying on the activity.--Petitioners devoted considerable time to their thoroughbred horse activities. In fact, Joseph estimated at trial that he spent approximately 20 hours per week overseeing their horse operations. Although this factor would normally1983 Tax Ct. Memo LEXIS 312">335 suggest an objective of making a profit, we think it is of little significance in the present case for two reasons. First, petitioners' efforts in carrying on their activity consisted of substantial personal and recreational aspects such as attending nearby racetracks to watch their horses race. Second, petitioners did not withdraw from another occupation to devote their energies to their thoroughbred horse activities. Section 1.183-2(b)(3), Income Tax Regs.Factor (4): The expectation that assets used in the activity may appreciate in value.--At trial, petitioners estimated that they had spent approximately $100,000 to acquire all of their horses since beginning their horse operations in 1958. Petitioners also testified their horses were worth approximately $150,000 at the time of trial. Even granting petitioners' estimates, the appreciation in petitioners' horses since 1958 is modest at best. Given this rather modest appreciation and the losses which petitioners have incurred annually since beginning their horse operations, we do not think petitioners seriously expected their horses to appreciate in value to the point where they could realize1983 Tax Ct. Memo LEXIS 312">336 an overall profit from their operations. Factor (5): The success of the taxpayer in carrying on other similar or dissimilar activities.-- Section 1.183-2(b)(5), Income tax Regs. provides that the fact the taxpayer has engaged in similar activities in the past and converted them from unprofitable to profitable enterprises may indicate that he is engaged in the present activity for profit, even though the activity is presently unprofitable. Petitioners have never been involved in an activity similar to their present thoroughbred horse activities. A consideration of this factor in the present case therefore would not be helpful. Factor (6): The taxpayer's history of income or losses with respect to the activity.--Petitioners have realized a loss from their thoroughbred horse activities each year since beginning their operations in 1958.The cumulative losses through taxable year 1980 exceed $300,000. Although no one factor is determinative of the taxpayer's objective to make a profit, a record of substantial losses over many years and the unlikelihood of achieving a profitable operation are important factors bearing on taxpayer's true intention. 1983 Tax Ct. Memo LEXIS 312">337 Section 1.183-2 (b)(6), Income Tax Regs.; Jasionowski v. Commissioner,66 T.C. 312">66 T.C. 312, 66 T.C. 312">322 (1976).Given the information in the record concerning the operation of petitioners' thoroughbred horse operations, we are convinced that petitioners had no actual and honest objective of realizing "a profit on the entire operation, which presupposes not only future net earnings but also sufficient net earnings to recoup the losses which have meanwhile been sustained." Bessenyey v. Commissioner,45 T.C. 261">45 T.C. 261, 45 T.C. 261">274 (1965), affd. 379 F.2d 252">379 F.2d 252 (2d Cir. 1967). Factor (7): The amounts of occasional profits, if any, which are earned.--Petitioners have not shown a profit for any year since beginning their thoroughbred horse activities in 1958. Factor (8): The financial status of the taxpayer.--During the years at issue, petitioners received dividends and interest ranging from $36,651.38 in 1975 to $68,949.66 in 1977. Petitioners also received considerable proceeds from the sale of stock and other capital assets ranging from $15,301.25 in 1977 to $190,764.66 in 1975. Factor (9): The elements of personal pleasure1983 Tax Ct. Memo LEXIS 312">338 or recreation in conducting the activity.--Petitioners testified at trial that they regularly traveled to racetracks in New York State where most of their racing was conducted. They derived considerable pleasure from these excursions and from managing their horse operations generally.Although the gratification received from an activity by itself is insufficient to cause the activity to be considered not engaged in for profit, it is clear that petitioners would not have been willing to sustain losses year after year from their horse operations were it not for their desire to continue a pastime that was enjoyable to them. In conclusion, after a review of all the facts and circumstances of this case, we hold that petitioners' thoroughbred horse operations were an "activity * * * not engaged in for profit" within the meaning of section 183(a), since they did not have an actual and honest profit objective in conducting their activity. Decision will be entered under Rule 155.Footnotes1. All statutory references are to the Internal Revenue Code of 1954 as in effect during the years in issue unless otherwise indicated.↩2. Petitioners have not been able to utilize their horses for racing during the period they are involved in breeding. It has been their experience that stallions do not run well if they are being used for studding, and mares are obviously unavailable for racing during gestation.↩3. Since 1977, petitioners have also raced their horses in Massachusetts and New Jersey. Losses are cumulative in each of these columns.↩ No horses finishing after fourth shared in the purse except at Finger Lakes Racetrack where the fifth and sixth place finishers received 3 percent and 2 percent of the purse, respectively.4. As of the time of trial, March 10, 1982, petitioners had not prepared their income tax return for the taxable year 1981.↩. Petitioners also realized partnership income of $6,400 in taxable year 1977.↩5. Sec. 183(a) through (c) provides as follows: SEC. 183. ACTIVITIES NOT ENGAGED IN FOR PROFIT. (a) General Rule.--In the case of an activity engaged in by an individual or an electing small business corporation (as defined in section 1371(b)), if such activity is not engaged in for profit, no deduction attributable to such activity shall be allowed under this chapter except as provided in this section. (b) Deductions Allowable.--In the case of an activity not engaged in for profit to which subsection (a) applies, there shall be allowed-- (1) the deductions which would be allowable under this chapter 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 under paragraph (1) or (2) of section 212↩. 6. Sec. 162(a) provides in pertinent 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. ↩7. Sec. 212(1) and (2) provides: In the case of an individual, there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year-- (1) for the production or collection of income; (2) for the management, conservation, or maintenance of property held for the production of income.↩8. Petitioners argue that they have shown a small profit from their horse racing endeavors for two of the three years in issue and presumably seek to rely on the presumption of profitability offered by section 183(d). Section 183(d)↩ provides that, in the case of an activity which consists in major part of the breeding, training, showing, or racing of horses, if the gross income derived from such activity exceeds the deductions for any two of seven consecutive taxable years, then the activity shall be presumed to be engaged in for profit unless the Commissioner establishes to the contrary.9. See N.Y. Unconsol. Laws secs. 8048 - 8048(e) (McKinney Supp. 1979).↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625383/	Pittsburgh Terminal Corporation, Petitioner v. Commissioner of Internal Revenue, RespondentPittsburgh Terminal Corp. v. CommissionerDocket No. 562-71United States Tax Court60 T.C. 80; 1973 U.S. Tax Ct. LEXIS 142; 60 T.C. No. 10; April 23, 1973, Filed 142 Decision will be entered for the respondent. Held, petitioner sustained no loss on the sale of coal lands in 1966. Monroe Guttmann (an officer), for the petitioner.Louis 143 A. Boxleitner, for the respondent. Irwin, Judge. IRWIN80 Respondent determined a deficiency of $ 58,655.37 in the income tax of petitioner for 1966. The ultimate question to be decided is whether petitioner had any allowable capital loss from sale of coal lands in 1966; however, the decision on this question depends upon the resolution of the following issues:(1) Whether the cost basis of coal lands acquired by Terminal Railroad & Coal Co. (Terminal Coal No. I) exceeded the deductions for depletion, allowed and allowable, taken by Terminal Coal No. I and its successors from 1902 until 1966;(2) Whether the bankruptcy reorganization in which petitioner acquired the coal lands from the successor of Terminal Coal No. I constituted a reorganization under section 112(b)(10), I.R.C. 1939, which would entitle petitioner to use a carryover basis for such lands;(3) Whether the transaction in which petitioner disposed of the coal lands in 1966 was a sham which should be disregarded for tax purposes. Petitioner must prevail on each of these issues in order to prevail on the ultimate question of whether a capital loss is allowable in 1966.81 FINDINGS OF FACTGeneral Facts144 Some of the facts have been stipulated. We incorporate the stipulations and the exhibits attached thereto by this reference.Petitioner is the Pittsburgh Terminal Corp. which has had its principal place of business at all relevant times in Castle Shannon, Pa. Prior to December 1955 petitioner's name was Pittsburgh Terminal Realization Corp.Petitioner was incorporated in Pennsylvania in December 1944 as part of a plan of reorganization in a chapter X proceeding in the U.S. District Court, docket No. 20716 in bankruptcy, to receive and liquidate the remaining assets of Pittsburgh Terminal Coal Corp. (Terminal Coal No. II), the debtor in that proceeding.Terminal Coal No. II was formed on December 1, 1924, as the corporation resulting from the merger of Meadow Lands Coal Co. and Pittsburgh Terminal Coal Co. (Terminal Coal No. I).Terminal Coal No. I was incorporated on April 28, 1902, in Pennsylvania with initial capital of $ 1,000 consisting of 10 shares of $ 100 par value common stock. From its inception until 1922, Terminal Coal No. I used the name Pittsburgh Terminal Railroad & Coal Co. The record does not disclose who the original shareholders of Terminal Coal No. I were, but145 as of June 25, 1902, J. G. Patterson and W. K. McMullin were its president and secretary, respectively.On June 24, 1902, the authorized capital stock of Terminal Coal No. I was increased to 140,000 shares of $ 100 par value common stock, and its authorized indebtedness was increased to $ 7 million to be represented by 7,000 first mortgage, 5-percent, 40-year sinking fund bonds in the face amount of $ 1,000 each.The newly authorized stock and part of the bonds were used by Terminal Coal No. I to purchase on July 1, 1902, approximately 10,600 acres of coal lands located in Allegheny County, Pa. At the time of the purchase there were no mines operating upon these coal lands; however, between 1902 and 1920 eight coal mines were opened upon these lands.Between 1902 and 1966 Terminal Coal No. I, Terminal Coal No. II, and petitioner disposed of various interests in the 10,600 acres of Allegheny County coal lands. On December 20, 1966, petitioner executed a deed transferring its remaining interest in the Allegheny County coal lands to South Hills Terminal Co. (South Hills). As consideration for this transfer South Hills agreed to pay petitioner $ 5,000 with terms of $ 1,000 down and146 four yearly payments of $ 1,000 beginning on December 20, 1970.82 The stock of South Hills was owned by Janet S. Gilfillan, petitioner's secretary and bookkeeper, and her husband. The primary purpose for petitioner's transfer of the coal lands to South Hills was to obtain a capital loss to offset a substantial capital gain realized by petitioner in 1966 on the sale of other property.On September 30, 1968, petitioner's president and principal shareholder, Monroe Guttmann (Monroe), purchased the stock of South Hills from Janet S. Gilfillan and her husband for $ 34,000, $ 10,000 down and $ 24,000 payable in installments over a 20-year term. Shortly after purchasing the South Hills stock Monroe liquidated the corporation and sold the coal lands to an unrelated party for $ 40,000 in cash. This sale had been arranged by Monroe prior to his purchase of the South Hills stock.In its original return for 1966 petitioner claimed that it realized a long-term capital loss of $ 573,526.85 on the sale of the Allegheny County coal lands to South Hills. In an amended return petitioner claimed that the amount of the loss realized was $ 1,202,709.39, and in its petition to this Court petitioner147 stated that the loss was $ 1,887,853.58. In any event petitioner claims that its basis for the coal lands transferred to South Hills is traceable to the July 1, 1902, purchase of coal lands by Terminal Coal No. I.Facts re Issue 1. Cost of Coal Lands in 1902On June 25, 1902, Terminal Coal No. I entered into an agreement with Charles Donnelly (Donnelly), Frank F. Nicola (Nicola), and Frank M. Osborne (Osborne). The agreement provided that:(a) Donnelly, Nicola, and Osborne would transfer certain coal and surface lands to Terminal Coal No. I as well as all the stock of West Side Belt Railroad Co. (West Side Railroad) and of Belt Line Railway Co. (Belt Line Railway). Only 10 percent of the subscription price of Belt Line Railway had been paid at that time.(b) Donnelly, Nicola, and Osborne would pay $ 350,000 in cash to Terminal Coal No. I.(c) In consideration of the coal lands, railroad stock and cash to be transferred to it, Terminal Coal No. I would deliver to Donnelly, Nicola, and Osborne:(i) 139,990 shares of its $ 100 par value capital stock; and(ii) approximately 5,500 of its first mortgage bonds, the precise number to be adjusted as hereinafter stated.According to148 the June 25, 1902, agreement, the bonds to be delivered to Donnelly, Nicola, and Osborne by Terminal Coal No. I were to be determined as follows:(a) From the $ 5,500,000 face amount of such bonds, $ 1 million in 83 bonds (1,000 bonds) was to be deducted and delivered to Colonial Trust Co. for the purpose of its redeeming and retiring the $ 1 million first mortgage bond issue of West Side Railroad then outstanding; such $ 1 million in bonds was in fact deducted and delivered to Colonial Trust Co.(b) From the $ 5,500,000 face amount of such bonds, a further portion thereof would be retained by Terminal Coal No. I to reimburse it for the value of any coal lands which Donnelly, Nicola, and Osborne failed to convey or to deliver satisfactory title to Terminal Coal No. I.The first mortgage of Terminal Coal No. I, guaranteed by West Side Railroad, was executed by Donnelly as president of Terminal Coal No. I.On July 1, 1902, West Side Railroad also executed a mortgage to Colonial Trust Co. securing its guarantee of the first mortgage bonds of Terminal Coal No. I. Donnelly also executed this mortgage in his capacity as vice president of West Side Railroad.The total amount of bonds149 issued by Terminal Coal No. I did not exceed $ 4,310,000.On July 1, 1902, Donnelly and Nicola executed a deed to Terminal Coal No. I conveying 187 tracts of coal lands in Allegheny County. These tracts totaled about 10,600 acres of undeveloped and unmined coal in place.Donnelly was the president and a director of Terminal Coal No. I at the time he and Nicola conveyed these 187 tracts of coal lands to it. Nicola was also a director of that corporation at that time.The West Side Railroad was about 3 miles long in 1902. The Belt Line Railway was only a paper corporation which never conducted any business.The term "coal in place," as used in this proceeding, does not include surface lands or coal which has been mined.By their deed of July 1, 1902, Donnelly and Nicola also conveyed to Terminal Coal No. I their title and interest in 38 acres of surface land in Allegheny County.The coal lands purchased by Terminal Coal No. I were completely undeveloped. There had been virtually no geological exploration of the coal lands prior to the purchase to determine the nature and extent of the coal in place; however, it was generally known that the Pittsburgh seam of coal ran uniformly throughout150 Allegheny County in a 5-foot vein. A 5-foot seam of coal could be mined in an economical fashion; however, such a seam was considered thin and not as desirable as a seam of 6 feet or more. The 10,600 acres of coal lands had relatively few outcrop areas -- places where the seam of coal was exposed on the surface. In the absence of outcrop areas coal had to be mined through 84 deep-mining methods which required the digging of a vertical shaft to reach the coal. Outcrop coal can be mined through drift-mining methods in which a shaft is dug in a hillside. Generally, deep mining is more costly than drift mining because it is more difficult to provide drainage for a deep mine and to remove the coal from a deep mine than it is for a drift mine.The 187 tracts of coal lands in place in Allegheny County conveyed by Donnelly and Nicola to Terminal Coal No. I had been purchased by them from five individuals at a total cost of $ 3,444,519.32 in cash on or shortly prior to the date of their conveyance of the said 187 tracts to Terminal Coal No. I. The persons from whom Donnelly and Nicola purchased each of said tracts, the cash consideration paid by them to each of these transferors, 151 and the coal acreage acquired from each of them were as follows:Person from whom DonnellyCash considerationTractsand Nicolapaid by Donnellymade purchaseand Nicola forcoal purchased1 to 16 (16 tracts)James C. Boyer$ 211,478.1717 to 63 (47 tracts)James B. Corey1 664,291.0064 to 104 and 187 (42 tracts)John V. LeMoyne475,398.40105 to 184 (80 tracts)John S. Scully1,979,247.25185 (1 tract)do36,083.50186 (1 tract)James Linehart, et al78,021.00Total3,444,519.32Number ofAverageTractsacres in eachprice paidpurchaseper acre1 to 16 (16 tracts)978$ 216.2317 to 63 (47 tracts)1,898350.0064 to 104 and 187 (42 tracts)2,377183.18105 to 184 (80 tracts)5,030393.49185 (1 tract)90400.93186 (1 tract)260300.00Total10,633The deed from Corey to Donnelly and Nicola also conveyed 7 acres of surface land in Allegheny County. The average price per acre for the 1,898 acres of coal lands plus 7 acres of surface from Corey was $ 340.87.Boyer, Corey, Scully, LeMoyne, and Linehart were each paid in cash by Donnelly and Nicola for the 152 coal in place which they respectively transferred and each of these transferors specifically acknowledged in his deed his receipt of the cash consideration recited in his deed.Boyer had acquired the coal lands conveyed by him to Donnelly and Nicola in 1902 at various dates in 1900, 1901, and 1902 in 16 separate transactions at a total cost to him of $ 130,821.16. Boyer had a profit of $ 80,657 on his sale to Donnelly and Nicola.Corey had acquired the coal lands conveyed by him to Connelly and Nicola in 1902 at various dates in 1900, 1901, and 1902 in 47 separate transactions at a total cost to him of $ 306,169.34. Corey had a profit of $ 358,122 on his sale to Donnelly and Nicola.LeMoyne had acquired the coal lands (tracts 64-104 and 187) conveyed by him to Donnelly and Nicola in 1902 at various dates in 1894 through 1900 in 42 separate transactions at a total cost to him of $ 92,470.03. 85 LeMoyne had a profit of $ 382,928 on his sale to Donnelly and Nicola.Scully had acquired the coal lands (tracts 105-184) conveyed by him to Donnelly and Nicola in 1902 at various dates in 1889 through 1901 in 80 separate transactions at a total cost to him of approximately $ 770,000. 153 Tract 185 had been acquired by Scully in 1902 at a cost of $ 36,083.50. Scully had a profit of $ 1,209,247 on his sale to Donnelly and Nicola.On July 1, 1902, Terminal Coal No. I purchased 3,059 acres of Pittsburgh seam coal in Washington County from James V. Morris for $ 229,429.42 in cash and the assumption of mortgages totaling $ 116,829.02, or a total cost of $ 346,258.44. The average price per acre paid in this transaction was $ 113. Morris had acquired this coal land in 1901 and 1902 at a total cost of $ 232,642.51, $ 115,813.49 in cash plus the assumption of mortgages totaling $ 116,829.02.In July 1902 Terminal Coal No. I acquired four tracts of Pittsburgh seam coal lands in Washington County from one Charles W. Taylor for the following consideration:MortgagesAcres acquiredCash paidassumed155.00$ 10,075.00$ 6,200.00145.1579,435.205,806.28113.4067,371.134,536.08128 acres and 65 perches (128.406acres)8,021.404,936.24541.965TotalCost to TaylorAcres acquiredconsiderationof coaltransferred155.00$ 16,275.00$ 9,300.00145.15755,241.488,709.42113.40611,907.216,804.12128 acres and 65 perches (128.406acres)12,957.647,404.36541.96556,381.3332,217.90154 The average price per acre paid to Taylor was $ 104.In August 1902 Terminal Coal No. I acquired 5 acres of Pittsburgh seam coal lands in Washington County, which adjoined Allegheny County, for $ 300 or $ 60 per acre.In April 1903 Terminal Coal No. I acquired 277.38 acres of Pittsburgh seam coal lands in Washington County for $ 31,013.23 at an average cost of $ 112 per acre.The 10,600 acres of coal lands which Donnelly and Nicola acquired from Boyer, Corey, LeMoyne, Scully, and Linehart and sold to Terminal Coal No. I were all contiguous or nearly contiguous. In some of the tracts Terminal Coal No. I only acquired the right to mine the Pittsburgh seam of coal; however, in 1902 the Pittsburgh seam was the only seam which could be mined. In some instances the tracts which had been acquired individually either by Boyer, Corey, LeMoyne, Scully, or Linehart formed large contiguous areas; however, in other cases such tracts either were isolated or formed small contiguous 86 areas. A fairly large contiguous area is necessary for the most efficient coal mine although an area of a few hundred acres can make a viable coal mine.During the period from 1901 to 1903 coal lands were 155 purchased by Terminal Coal No. I and other coal companies in the general vicinity of the subject 10,600 acres of Allegheny County coal lands for prices which did not exceed $ 200 per acre. Some of these tracts adjoined the subject acreage, and none were more than 15 miles from it. Although none of the purchases involved tracts as large as 10,600 acres, transactions involving 1,000 to 2,000 acres were common.In 1902 a coal mine had to be located near either water or rail transportation to be economically viable. The 10,600 acres purchased by Terminal Coal No. I were not near to any water transportation or to any existing railway except the West Side Railroad which was owned by Terminal Coal No. I and which was still under construction. In 1902 there was a general shortage of railroad cars suitable for transporting coal.In 1902 there was a strong demand for coal in the Pittsburgh area because of a strike in the anthracite coal fields in eastern Pennsylvania.From 1902 to 1917 Terminal Coal No. I mined the following tonnages of coal from mines 1 through 7 located on its Allegheny County coal lands:YearTons mined19021903578,03219041,332,50019051,063,64419061,539,34719071,451,8751908877,6151909716,94019101,695,10419111,576,34619122,360,6553/1/13361,797Total to 3/1/1313,553,85519132,447,45219142,394,57619152,125,94519162,799,159Total 1913-169,767,13219173,038,760156 Mine 8 of Terminal Coal No. I, which was opened in 1920, was sold by the trustee in reorganization in 1941. Accordingly, petitioner only transferred to South Hills in 1966 the coal lands on which mines 1 through 7 of Terminal Coal No. I had been located.Between March 1, 1913, and November 30, 1966, Terminal Coal No. I, Terminal Coal No. II, and petitioner claimed and were allowed in the aggregate $ 5,442,188 of depletion deductions for the coal lands upon which mines 1 through 7 of Terminal Coal No. I were located.87 OPINIONIn 1902 Terminal Coal No. I purchased 10,600 acres of Allegheny County coal lands, the stock of two railroad companies, and received cash from Donnelly, Osborne, and Nicola for 139,990 shares of its $ 100 par value common stock plus debentures in the face amount of $ 4,310,000. After the sale Donnelly, Osborne, and Nicola owned all but an insignificant amount of the outstanding stock of Terminal Coal No. I. Over the years Terminal Coal No. I merged with another company to form Terminal Coal No. II, which in turn underwent a bankruptcy reorganization in 1941. Petitioner was formed as a result of the bankruptcy reorganization and it acquired therein 157 the major part of the 10,600 acres of Allegheny County coal lands.In 1966 petitioner transferred its interest in these coal lands for $ 5,000 to South Hills. We now are to decide what petitioner's basis was for these coal lands.Assuming that petitioner is entitled to succeed to the basis of Terminal Coal No. I and that the transaction with South Hills was not a sham (the second and third issues herein) petitioner's basis for determining loss is the 1902 cost of the lands reduced by depletion deductions which were allowed or allowable since that time. Secs. 1011, 1012, and 1016. 1158 As a preliminary matter we note that the parties disagree as to the proper measure of cost basis under section 1012. Petitioner bids us to measure the basis of the coal lands by the value of the stock and notes given in the exchange while respondent asks us to look at the value of property received. As a general rule the cost basis of property purchased with other property is the fair market value of the property received. Philadelphia Park Amusement Co. v. United States, 126 F. Supp. 184 (Ct. Cl. 1954); Halsey L. Williams, 37 T.C. 1099 (1962). On the other hand, cases involving the purchase of property by a corporation with its own stock have uniformly held that the cost basis of the assets purchased is the value of stock given up in the exchange. Ida I. McKinney, 32 B.T.A. 450 (1935), affd. 87 F. 2d 811 (C.A. 10, 1937); Lanova Corporation, 1178">17 T.C. 1178 (1952); Moore-McCormack Lines, Inc., 44 T.C. 745">44 T.C. 745 (1965).The departure from the general rule is undoubtedly due to the fact that a corporation159 does not recognize any gain or loss when it purchases 88 property with its own stock. As a practical matter the distinctions of measuring cost basis through one rule rather than the other are more theoretical than real. We have not found a case where the use of one rule rather than the other would have been crucial, nor do we think that the facts before us present such a case.While it may be true that the stock of a going concern can be valued independently of the assets which are acquired with such stock, we think that it is nonsensical to try to look at the value of the stock separately from that of the property where, as here, all of the stock of a corporation which has never conducted any business is exchanged for property which will become all of the assets of such corporation. Any evaluation of the stock of the corporation will necessarily be based upon the income which can be expected from the property.Regardless of the precise rule of valuation that we were attempting to apply, we have always followed the evidence of value on either side of a transaction which we considered to be the most reliable. MacCallum Gauge Co., 32 B.T.A. 544">32 B.T.A. 544 (1935);160 Amerex Holding Corporation, 37 B.T.A. 1169 (1938), affd. 117 F. 2d 1009 (C.A. 2, 1941); Moore-McCormack Lines, Inc., supra. We shall follow that approach here.The fair market value of property is the price at which the property would be sold by a knowledgeable seller to a knowledgeable buyer with each party under no compulsion to act. Commissioner v. Marshman, 279 F. 2d 27, 32 (C.A. 6, 1960). We realize the difficulty of applying this standard to a transaction which occurred over seven decades ago, but we note that the parties were able to place a ponderous amount of evidence in the record concerning the 1902 value of the coal lands.Petitioner's expert witness testified that the stock of Terminal Coal No. I had a value of $ 90 per share and that the debentures were worth their face value of $ 1,000 each as of July 1, 1902. Accordingly, Terminal Coal No. I would have paid nearly $ 17 million to acquire the coal lands, railroad stocks, and cash from Donnelly, Osborne, and Nicola of which about $ 15 million has been allocated to the coal lands by petitioner. 161 2 Petitioner's witness relied upon the following assumptions in determining the value of the stock and debentures: (1) That Terminal Coal No. I would have responsible management; (2) that 89 the corporation could begin to extract coal immediately at a maximum rate of production; (3) that such maximum rate of production would be 3 million tons per year; (4) that Terminal Coal No. I could ship and sell all the coal that it could produce; and (5) that a profit of about $ 0.30 would be realized on every ton of coal mined by Terminal Coal No. I. We agree with petitioner that the validity of his expert's opinion of the value of the stock and debentures must be judged by facts known to exist in 1902 and not by subsequent events which proved almost every assumption used by him to be inaccurate; however, it is clear that in making his evaluation petitioner's expert resolved every contingency known to exist to exist in 1902 in the favor of petitioner.162 At the time that Terminal Coal No. I purchased the coal lands it had little capital for opening mines, the coal lands were totally undeveloped and untested, the West Side Railroad was not completed, there was a general shortage of railroad cars, and the demand for coal was unusually strong because of a strike in the coal fields of eastern Pennsylvania. Accordingly, there were a number of clouds in the sunny skies seen by petitioner's expert. In fact, the securities of Terminal Coal No. I were a very speculative investment in 1902. Any knowledgeable investor would have discounted the potential value of these securities by a considerable amount to account for the riskiness of the investment.Although his testimony was clearly biased in respondent's favor, respondent's expert witness demonstrated the folly of trying to estimate the value of undeveloped property by looking to its anticipated earnings. By using the same information but resolving every contingency in respondent's favor and by requiring a higher rate of return on the investment in the coal lands respondent's expert opined that the coal lands were worth only $ 225 per acre. This figure contrasts with a value in the neighborhood163 of $ 1,400 per acre when the value of the securities used to buy the coal lands as determined by petitioner's expert is divided by 10,600. Although the approaches of both experts were somewhat different, both claimed to rely upon the 1902 value of the future earnings of the coal lands in making their estimates. The testimony of the two experts may demonstrate nothing but that capitalizing future earnings is an unsatisfactory method of resolving the question before us.Respondent claims that $ 3,444,519.32 is the maximum value that can be placed on the 10,600 acres of coal lands as of July 1, 1902. This represents the amount that Donnelly and Nicola paid in cash to five individuals to acquire the coal lands shortly before selling them to Terminal Coal No. I. Respondent contends that the price of about $ 325 90 per acre paid to the five individuals represents a significant premium over the price for which comparable parcels of coal land were being sold in 1902 and that Donnelly and Nicola did nothing to increase the value of the lands. On the other hand, petitioner claims that the value of a large aggregation of coal lands is significantly greater than the sum of the values164 of its individual parts. Although we do not quarrel with petitioner's assertion that aggregation increases the value of coal lands, we believe that petitioner has greatly overestimated the increase in value attributable to the aggregating activities of Donnelly and Nicola.A major theme of petitioner's argument is that respondent's evidence of prices for comparable tracts of coal lands is inapposite because such prices merely reflect the value of small tracts of land suitable only for farming unless aggregated with contiguous tracts. While it may be true that many of the transactions relied upon by respondent to set a market price for coal lands did involve the purchase of a small tract from a farmer, it is also true that Donnelly and Nicola did not buy such tracts themselves. The five individuals from whom Donnelly and Nicola bought the 10,600 acres were not farmers but coal lands aggregators. They had already assembled large holdings by the time that they sold out to Donnelly and Nicola, and they realized large profits for their efforts. We believe that the profits realized by the five individuals represent the most significant portion of the increase in value attributable *165 to aggregation and that by putting together already large pieces of coal lands Donnelly and Nicola did not add greatly to their value.Even if we allow a substantial markup for the efforts of Donnelly and Nicola on the $ 3,444,519.32 they paid for the lands, we do not believe that the fair market value of the 10,600 acres of Allegheny County coal lands exceeded $ 5 million on July 1, 1902. Accordingly, we hold that the cost basis of these lands of Terminal Coal No. I did not exceed $ 5 million.Between March 1, 1913, and November 30, 1966, Terminal Coal No. I, Terminal Coal No. II, and petitioner claimed and were allowed in the aggregate $ 5,442,188 of depletion deduction for the part of the 10,600 acres of coal lands upon which mines 1 through 7 of Terminal Coal No. I were located. Therefore, even if petitioner were to prevail on the second and third issues herein, it had no unrecovered basis and suffered no loss when it sold such coal lands to South Hills in 1966.In view of the foregoing we shall not consider the second and third issues.Decision will be entered for the respondent. Footnotes1. Includes 7 acres of surface land.↩1. All statutory references are to the Internal Revenue Code of 1954, as amended, unless otherwise stated.In the case of property acquired before Mar. 1, 1913, sec. 1053 provides that the basis for determining gain shall be the greater of historical cost or Mar. 1, 1913, fair market value. Under sec. 612 and its predecessors the basis for determining cost depletion is the basis for determining gain. Accordingly, deductions for depletion may exceed historical cost in the case of property acquired before Mar. 1, 1913, if the fair market value of the property on such date was greater than its cost.↩2. In petitioner's brief it claims an additional amount of cost basis for mortgages assumed. Although there is a 1903 financial statement of Terminal Coal No. I in the record which indicates that $ 1,131,591 of mortgages were assumed on July 1, 1902, nowhere in the record is there evidence that the 10,600 acres of coal lands in question here were encumbered in any way. It is our belief based upon the stipulation filed by the parties that these lands were acquired by Donnelly and Nicola for cash only and that they were resold to Terminal Coal No. I only for its securities. In any event petitioner has never claimed until brief that there was any consideration given by Terminal Coal No. I except its securities, and we shall not consider such claim now.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4477093/	OPINION. Fisher, Judge: Respondent determined that gains realized by petitioner from real estate transactions during the years 1947 through 1949 are taxable as ordinary income from the sale of property held by him primarily for sale to customers in the ordinary course of his trade or business. In his return for each of the years in question, petitioner reported such income as capital gains, and he herein assigns as error respondent’s determination to the contrary. The issue presented therefore is whether at the time of sale petitioner held each item of property “primarily for sale to customers in the ordinary course of his trade or business” within the meaning of that phrase as used in sections 117 (a) (1) and 117 (j), Internal Revenue Code of 1939. As has been frequently stated, this ultimate issue is essentially a factual one dependent upon the precise facts of the particular case under consideration. See Curtis Co., 23 T. C. 740, and cases cited therein at page 750. In the instant case, during the years in question, petitioner was engaged in many facets of the real estate business. He bought and sold both developed and undeveloped land. He was a general contractor and constructed for himself and others houses, apartments, and other buildings on land owned both by himself and by others. He also held real estate (in his own name and in the names of corporations controlled by him) for rental and other investment purposes. In our findings it is demonstrated that during the years 1944 through 1951 petitioner’s largest source of annual income fluctuated considerably from year to year between rentals, construction contracts, and sales of real estate. Under these circumstances, it is clear that petitioner was both a dealer and an investor in real estate, a dual role which we-have previously recognized. See Walter R. Crabtree, 20 T. C. 841, and Nelson A. Farry, 13 T. C. 8. Accordingly, in deciding the ultimate issues in the instant case, we must determine as to each transaction whether the disposition was of property held primarily for sale in the ordinary course of business or of property held as an investment. During the taxable years, petitioner disposed of some of his income-producing properties as well as some vacant and unimproved pieces of real estate. We turn first to a discussion of the latter. During the taxable years, petitioner sold vacant lots and lots upon which he had constructed houses in the Chantilly Subdivision. 354 lots in the subdivision (which was then well established) had been acquired in 1937 by a joint venture of which petitioner was a member for the purpose of further improving the land and holding it for sale. Homes were constructed on some of the lots by petitioner pursuant to contracts with their respective purchasers. After 1940, petitioner acquired the interests of the other joint venturers and continued to sell lots in the quantities set out in our findings and to build houses under contracts with individual purchasers. In 1946, a corporation controlled by petitioner procured transferable commitments for F. H. A. mortgage insurance on 90 houses to be built in Chantilly. Thereafter petitioner constructed and sold over 90 houses in addition to selling many vacant lots during the years in question. Petitioner reported in his returns for the taxable years the sales of all lots as sales of capital assets held for more than 6 months and the profit on building the houses as income from his trade or business. During the taxable years petitioner also disposed of a number of pieces of vacant real estate under the following circumstances: (a) Scotland Hills, a tract in Charlotte acquired in 1947 and developed into a subdivision of 182 vacant lots by petitioner, was sold at a profit in 1948 to a corporation controlled by petitioner for which he thereon erected 182 houses to be held for sale by that company; (b) the Belk tract in Charlotte was acquired in 1948 and portions of it were thereafter sold at a profit by petitioner; (c) a vacant portion of B tract in Jacksonville acquired in 1948 was sold by petitioner in 1948 to a Buick dealer for commercial purposes; and (d) a number of vacant lots in Overbrook Subdivision were sold by petitioner during each of the taxable years. It is our view that the Chantilly properties and the above items of vacant realty were acquired and held by petitioner at all times pertinent hereto primarily for sale to customers in the ordinary course of his business as a real estate dealer. We stated the applicable principle in Curtis Co., supra (p. 755), as follows: However, the essential fact seems to be that these properties were acquired for the purpose of resale whenever a satisfactory profit could be made. Petitioner may not have aggressively promoted the sale of these properties; but, nevertheless, the frequency and volume of its sales of undeveloped real estate and its substantial holdings of such properties convince us that these properties were held, not only for sale at some time in the future, but primarily for sale to its customers in the ordinary course of its business during each of the years here in issue. Petitioner was a dealer in undeveloped land, and gains derived from the sale of such property are taxable as ordinary income. Petitioners contend that the sales of Chantilly properties were ancillary to the construction business, but, since petitioner was for many years in the business of selling properties in Chantilly, we deem it immaterial that some were sold during the taxable years in connection with construction contracts. In this respect the instant case is clearly distinguishable from Dunlap v. Oldham Lumber Co., (C. A. 5, 1950) 178 F. 2d 781, and W. T. Thrift, Sr., 15 T. C. 366, cited by petitioner. Petitioners also contend that the other properties mentioned above were held by petitioner primarily for investment purposes. Our view to the contrary with respect to Scotland Hills and the Belk tract, both of which were vacant at the time of the transactions here involved, requires no further discussion. B tract and Overbrook, however, were in part then used for income-producing purposes, and some further discussion of the sales of vacant land therein is warranted. The B tract in Jacksonville consisted of various parcels acquired by petitioner during the years 1942 through 1948. Petitioner improved and held some of this tract for investment purposes, i. e., apartments, motor court, and supper club building. Some of the land, however, remained vacant, and in 1948 petitioner sold a vacant lot to a Buick dealer. Similarly, in the Overbrook subdivision petitioner constructed houses for rental purposes on some of the land, but he also sold 22 vacant lots in the subdivision during the years in question. As a dealer in real estate, such vacant land was part of petitioner’s stock in trade. Moreover, there is no convincing evidence that he was holding vacant pieces adjacent to his investment properties for any purpose other than resale whenever a profitable proposition might be presented to him. Under these circumstances we are convinced that the vacant realty in tract B and Overbrook were, like the Chantilly properties and the other vacant realty mentioned above, held by petitioner primarily for sale to customers. Cf. Curtis Co., supra. As previously stated, during the years in question petitioner was an investor in income-producing property as well as a dealer in real estate. The remaining transactions to be discussed herein concern sales of some of his income-producing properties. We hold that these properties were held by petitioner for investment purposes at the time of their respective sales, and were not held primarily for sale in the ordinary course of business. The reasons for our views with respect to these transactions are set out below. In 1949, petitioner sold a farm in Carteret County, North Carolina, to a paper manufacturing corporation which had approached him about buying it, apparently for its timber value. Petitioner had acquired this 1,400-acre farm in 1944 as a farm and timber investment. He thereafter attempted to rent the farm. Petitioner also had hopes that oil in commercial quantities might be discovered there, but oil explorations did not prove successful. Under these circumstances, we are convinced that this farm was held by petitioner for investment purposes and not primarily for sale in the ordinary course of business at the time of its disposition in 1949. We now consider the sale of houses in Overbrook Subdivision in Jacksonville. Petitioner originally became interested in this project in 1942 at the suggestion of F. H. A. officials who were attempting to procure the erection of single-family houses for rental purposes near Camp LeJeune. Thereafter, petitioner acquired vacant land and, through a corporation controlled by him, acquired F. H. A. commitments for 100 houses to be erected thereon for rental purposes. The houses were completed in 1943. Although petitioner was thereafter authorized under F. H. A. regulations to sell one-third and later all of the rental housing units, for a time he refused to sell any of them despite repeated offers by some tenants. In October 1944 and April 1945, however, he did sell houses to two tenants who had repeatedly sought to make purchases. No sales were made thereafter until the last half of 1946 when three houses were sold to persons who approached the subdivision manager, petitioner’s brother, for that purpose. We are convinced by the above circumstances that the Overbrook houses were originally erected and held by petitioner as an investor in income-producing real estate. Moreover, in view of the few houses sold, despite authority to sell some or all of them, accompanied by a heavy demand for housing during that period, it seems clear that petitioner was holding the houses primarily for investment purposes, at least until August 3,1946, when the first of many subsequent sales took place. It was during the last part of 1946 that petitioner advised his brother that Overbrook houses could be sold if interested buyers appeared, but that he, petitioner, was then in no hurry to sell. By that time, the houses, which were of frame construction, were beginning to require extensive repairs due in part to the brackish water in the vicinity. About that time also petitioner acquired a millwork plant in Charlotte and he was purchasing machinery and equipment necessary for its operation. Moreover, there was then a great demand by tenants, former servicemen, and marines stationed nearby to purchase houses in Overbrook. Accordingly, petitioner decided to allow tenants and others to buy houses in Overbrook. A decision to sell investment property, however, does not alone establish that it is thereafter held primarily for sale in the ordinary course of a business. In this respect, we stated in Curtis Co., supra (p. 752): It has frequently been stated that, in determining whether the gain derived from the sale of real property is entitled to capital gains treatment under section 117 (j), the test which deserves greatest weight is the purpose for which the property was held during the period in question. Walter R. Cr ah tree, supra. This holding period does not terminate upon the decision to sell but extends until the project is actually sold. Naturally, once a decision has been made to sell investment property, such property is thereafter held for sale. However, this does not preclude the application of section 117 (j) since the critical issue is whether it is held for sale by the seller “in the ordinary course of his trade or business.” To obtain capital gains treatment under section 117 (j), a taxpayer may choose the most advantageous method of liquidating his investment in properties originally acquired and held for investment purposes, so long as such method of disposal does not constitute his entrance into the trade or business of selling such properties. It may be more expeditious to enter such business in order to dispose of investment properties; but once this is done, the benefits of section 117 (j) are lost. Accordingly, in the instant case, in reaching our ultimate conclusion, we must give consideration to the manner in which the houses were sold. See Home Co. v. Commissioner, (C. A. 10, 1954) 212 F. 2d 637, 641, affirming a Memorandum Opinion of this Court. During the years 1947 through 1949, petitioner sold, respectively, 54,22, and 14 Overbrook houses. Petitioner’s brother represented him at each of the closings. Many of these houses were sold to the same persons who had occupied them as tenants, and only vacant-houses were sold to persons other than tenants. In connection with the sales, no advertising was employed, no “For Sale” signs were displayed, no real estate agents represented petitioner, and no sales promotion was undertaken. It is our view that the sale of rental property under such circumstances did not convert investment property into property primarily held for sale in the ordinary course of business. In Frieda E. J. Farley, 7 T. C. 198, the petitioner was a nursery owner who sold 2514 lots from his property for residential purposes during one taxable year under circumstances analogous to those in the instant case. In holding that the sales were not made in the ordinary course of a business, we stated in part as follows (p. 202) : the method of selling the property in lots, we think, was determined by the purchasers rather than by petitioner. Although taking no active steps to sell the property, petitioner was approached by individual purchasers seeking small residential lots. These unsolicited approaches were what lent the element of frequency and continuity to the sales. Petitioner might have eliminated the frequency and continuity of the sales by selling the entire tract in one piece. It is not improbable, however, that to interest an individual or group of individuals in a purchase of such magnitude would have required more elements of business activity than did petitioner’s acceptance of individual offers as they occurred from time to time. Under these circumstances, it appears to us that the frequent and continuous character of the sales resulted notwithstanding petitioner’s passivity rather than from any business activity on his part. * * * We believe that in the case at hand, as in the Farley case, supra, petitioner maintained a passive role, and that the frequent and continuous character of the sales likewise resulted notwithstanding that passivity rather than from any business activity on his part. Although there is evidence that in at least one instance in 1948 petitioner’s brother advised a tenant that the house he occupied was for sale and that he had first chance to purchase it, such action is consistent with petitioner’s decision to sell the houses under the circumstances above described, and does not establish that he thereupon held them primarily for sale in the ordinary course of business. This view is equally applicable to the one occasion in 1947 when the brother sold a house rather than rent it to a prospective occupant. The passive nature of petitioner’s activities in the sale of Overbrook houses is emphasized by comparing them with his activities in liquidating other investment properties about the same time. In 1946, in one transaction, petitioner sold at a profit all 30 duplex houses (60 rental units) in a defense housing project owned by him in Burlington, North Carolina. This transaction was arranged by a real estate agent representing the purchasers without any solicitation on petitioner’s part. He reported the gain on his 1946 return as long-term capital gain. On the other hand, a corporation controlled by petitioner which owned the Scotland Hills development of 182 houses sold them individually in 1950 and 1951 in the course of aggressive sales activities which included using agents to promote sales. The parties agree that the corporation correctly reported the profits from such sales as ordinary income in its return for each of those years. Petitioner’s activities in conducting a sales business are aptly demonstrated by the aggressive actions connected with the sale of Scotland Hills houses. It is our view, however, that petitioner was no more active in selling each of the Overbrook houses individually than he was in selling the entire Burlington development in one transaction. We have also noted that after the taxable years petitioner still owned five of the Overbrook houses. Three of them were sold in 1950 and the remaining two in 1951. Thus, it took about 5 years for petitioner to sell out Overbrook completely after he had indicated his willingness to sell. This period of time is consistent with a comparatively gradual and passive liquidation of investment property as distinguished from the operation of a business of selling houses, particularly in view of the housing shortage which respondent himself contends made selling activities superfluous at that time. We noted such circumstances in the Farley case, supra, as follows (p. 203) : We are further impressed by the fact that the sales in question appear to have been essentially in the nature of a gradual and passive liquidation of an asset. We appreciate that the so-called liquidation test has been rejected in certain cases wherein the manner of conducting the alleged liquidation was such as to constitute a trade or business. * * * It is undoubtedly true that where the liquidation of an asset is accompanied by extensive development and sales activity, the mere fact of liquidation will not be considered as precluding the existence of a trade or business. Where, however, the active elements of development and sales activities are absent, the fact of liquidation is not, in our opinion, to be disregarded. The liquidation factor has been given consideration and weight in such cases as United States v. Robinson, 129 Fed. (2d) 297; Fuld v. Commissioner, 139 Fed. (2d) 465; Harriss v. Commissioner, 143 Fed. (2d) 279. In Walter R. Crabtree, supra, we were concerned with a real estate dealer and broker who was also an investor. During 1943 and 1944, he constructed a defense housing project of 148 units of which 54 were sold upon completion. 45 others were sold in 1944. The gain from such sales was reported as ordinary income. Beginning late in 1945, petitioner sold the remaining 49 houses of which 16 were sold in 1945 and 33 in 1946. Other than the 54 houses which were sold upon completion, the houses were all held by petitioner prior to their sale for rental purposes. We held, in effect, that the 1945 and 1946 sales constituted the liquidation of investment property and that the profit therefrom was to be taxed at capital gains rates. In this respect, we stated as follows (p. 848) : In the instant case, to reach the conclusion for which respondent contends would be tantamount to saying that a dealer in real estate could never sell a defense-housing project and accord capital-gains treatment to such profit as may arise therefrom. To so hold would be a clear usurpation of the legislative prerogative. For nowhere does respondent point to nor can we find any evidence of Congressional intent to treat dealers in real estate, who sell investment property, differently from dealers of another sort. In Carl Marks & Co., supra, we allowed a security dealer in 1941 to take from his dealer’s account certain securities and place them in an investment account. The following year, more securities were added to the investment holdings. The holdings in each account were carefully separated as were accounting entries pertaining thereto. In 1942, when some of the investment holdings were sold, we allowed capital-gains treatment of the profits therefrom. We see no such clear dissimilarity in that case and this, except in the kind of property dealt in, to warrant our according capital-gains treatment in the one and not the other. In the instant case, as in the Crabtree case, supra, petitioner is an investor in real estate who sold some of his investment property at a profit but who thereafter retained substantial real estate holdings (and subsequently increased them) for investment purposes. In both cases, the taxpayers played passive roles in connection with the solicitation of sales. In view of these and other similarities, we believe that Walter R. Crabtree, supra, is controlling in the instant case. See also Delsing v. United States, (C. A. 5, 1951) 186 F. 2d 59, and Nelson A. Farry, supra. Our holding above that the vacant lots in Overbrook were held by petitioner primarily for sale is not inconsistent with our contrary view with respect to the houses. As stated above, vacant lots in general were a large part of petitioner’s stock in trade as a real estate dealer. In the absence of evidence to the contrary, the sales of vacant lots in Overbrook at a profit during the years 1946 through 1951 are persuasive evidence that they were held primarily for that purpose at all times. The Overbrook houses, on the other hand, had been held by petitioner for rental purposes for a number of years prior to their sale, and a proper analysis of the circumstances surrounding their sale leads to a result differing materially from that relating to sales of vacant land which was not held for investment purposes. Petitioner has pleaded that the deficiency determined for the taxable year 1947 is barred by limitations since the statutory notice for that year was mailed to petitioner more than 3 years after the date of filing the 1947 return. Respondent, however, contends that, because petitioner improperly reported his income from real estate transactions as capital gains, he therefore omitted 50 per cent of that income from the gross income stated in the return; that this amount (plus certain depreciation adjustments) exceeded 25 per cent of the gross income stated in the return; and that the statutory notice was thus timely because it was mailed within 5 years of the date of filing the 1947 return. See sec. 275 (c) of the 1939 Code. Specifically, respondent contends that petitioner reported a gross income of $181,790.86 in his 1947 return, and that he failed to report as gross income $96,770.51 which exceeded $45,447.72, or 25 per cent of the reported gross income. Assuming arguendo that reporting ordinary income as capital gain constitutes an omission from gross income within the meaning of section 275 (c), we nevertheless hold, in the light of our determination that the sales of Overbrook houses were properly reported by petitioner in his 1947 return, that respondent has not established that an amount in excess of 25 per cent of the gross income stated in the return was omitted therefrom. Sales other than Overbrook houses resulted in total profit to petitioner in 1947 of $82,446.58. See schedule A of our findings. Assuming that petitioner reported all such profits improperly as long-term capital gains instead of ordinary income as contended by respondent, petitioner’s omission of 50 per cent thereof from his return for that year amounted to only $41,223.29, which did not exceed the required amount ($45,447.72, according to respondent’s view) for extending the period of limitation to 5 years. We hold, therefore, that respondent’s determination with respect to 1947 is barred by limitations and there is no deficiency for that year. In view of the above holding, it is unnecessary to consider whether transactions other than the sales of Overbrook houses in 1947 resulted in capital gains or ordinary income to petitioner. Other issues in the instant case are dependent upon those decided above and will be disposed of under Rule 50. Decisions will ~be entered under Rule 50.	01-04-2023	01-16-2020
https://www.courtlistener.com/api/rest/v3/opinions/4477094/	OPINION. PIarron, Judge: The question is whether the sum of $14,000, which petitioner received in 1948, representing increased alimony for prior years, which petitioner received from her former husband as a result of the settlement of her suit in the New Jersey Chancery Court constituted “periodic payments” within the meaning of section 22 (k) of the 1939 Code. Upon due consideration of the undisputed facts and of the arguments advanced by petitioner, it is concluded and held that the $14,000 represented merely the aggregate of various amounts of “periodic” alimony payments, or arrearages in periodic alimony payments, which were due petitioner under the 1943 agreement and the Nevada divorce decree for prior years, and, in part, for 1948. The sum of $14,000 was due and owing to petitioner by her former husband under the terms of the 1943 agreement or under the obligation imposed by the Nevada decree of divorce. The question presented is controlled by Elsie B. Gale, 13 T. C. 661, affd. 191 F. 2d 79. See also Lily R. Reighley, 17 T. C. 344; Estate of Sarah L. Narischkine, 14 T. C. 1128, affd. 189 F. 2d 257; Jane C. Grant, 18 T. C. 1013, affd. 209 F. 2d 430; and Antoinette L. Holahan, 21 T. C. 451. As we did in Elsie B. Gale, supra, we here reject as unsound upon all of the facts, petitioner’s contention that the total sum of $14,000 applicable to prior years was a “principal sum” payable in installments of less than 10 years. What was stated (at p. 666) in the Gale case applies here: The term “principal sum” as used in section 22 (k) contemplates a fixed and specified sum of money or property payable to the wife in complete or partial discharge of the husband’s obligation to provide for his wife’s support and maintenance, as distinct from “periodic” payments made in connection with an obligation indefinite as to time and amount. Not every sum specified in dollars in a divorce decree is to be regarded as a “principal sum” within the meaning of the statute. To so regard it would mean that every additional sum awarded to increase a wife’s alimony for a definite year would make that amount a principal sum, however insignificant it might be. The fact that Congress provided that a principal sum would not he taxed to the wife unless the discharge of this obligation extended over ten years makes clear that minor adjustments such as are present here were not to be regarded as principal sums, payable in installments. In the instant case, the award of $19,000 represented no new or different obligation of the husband, nor was it imposed in respect to any right of the wife arising from the divorce other than the right she acquired under the original decree and separation agreement to adequate “periodic” payments of alimony. In short, the $19,000 represented merely the aggregate of various amounts of “periodic” alimony determined by the court to be owing by the husband for prior years under the terms of the separation agreement or the obligation imposed by the original decree of divorce. The petitioner herein, as in Elsie B. Gale, supra, acquired her rights under the separation agreement and decree of divorce. It was these rights which she sought to enforce in her suit in Chancery Court of New Jersey. It is therefore apparent that the sum of $14,000 represents satisfaction of those rights. The petitioner relies upon the case of Frank J. Loverin, 10 T. C. 406, as support for the proposition that the sum of $14,000 constitutes a lump-sum payment such as to exclude it from the taxable income of the petitioner within the meaning of section 22 (k). In the Loverin case, the taxpayer was divorced from his wife in the State of New York in 1940. The divorce decree provided that the taxpayer pay his wife $60 per week for support and maintenance. His wife had filed suit against the taxpayer alleging conversion of household goods which belonged to her. She sought a judgment of $3,000. This suit was pending on January 2, 1942. On January 2, 1942, the taxpayer and his former wife entered into an agreement, conditioned upon her remarriage, wherein the taxpayer was to pay her $8,500, together with $1,500 for attorney’s fees, and wherein she agreed, among other things, to accept the settlement in lieu of any and all further payments of alimony or her maintenance and support, to dismiss the lawsuit alleging conversion of her goods, to sign the necessary papers to obtain an order vacating that part of the divorce decree obligating him to pay her $60 weekly for her support and maintenance, to release her right of dower or share in his estate, and to waive the right of election to take against his last will and testament. The taxpayer paid his former wife $10,000 and paid his own attorney $1,000. On January 13, 1942, the divorce decree was modified by annulling the provision for payments of $60 per week for support and maintenance. The taxpayer claimed a deduction for the $11,000 under section 23 (u) of the 1939 Code. This Court, after eliminating the $1,000 and $1,500 payments to attorneys as having no basis for a deduction under 23 (u), confined its attention to the $8,500 balance. It was pointed out that section 22 (k), in general, provided that periodic payments of alimony made pursuant to and subsequent to a divorce decree or a written instrument incident to a divorce, shall be taxable income to the divorced wife. It was further pointed out that lump-sum payments or installment payments of a specified principal sum were not “periodic payments” within section 22 (k), unless under the terms of the decree or instrument, the installments were to be paid over a period of more than 10 years. This Court, assuming under the facts in this matter that the 1942 agreement was incident to the divorce, stated that as the divorce decree had been modified to eliminate any support payments thereunder as of the beginning of 1942, the sum paid by the taxpayer and received by the wife was pursuant to the agreement entered into in 1942. This agreement contemplated neither periodic payments nor installment payments during a period exceeding 10 years. It dealt only with a single, lump-sum payment and, as such, was not taxable income within section 22 (k) nor a deduction within section 23 (u). Frank J. Loverin, supra, stands for the proposition that where a divorce decree is amended so that it no longer provides for alimony, and a separate agreement is entered into providing for a lump-sum payment of any and all future alimony, and also providing for the settlement of other claims or contingencies, the settlement agreement must stand on its own and not be confused with the divorce decree. As the agreement did not provide for periodic payments nor installment payments of a specified’sum over a period of more than 10 years, the payment does not fall within the purview of section 22 (k). In the instant proceeding there is a Nevada divorce decree, and the incorporation therein of a separation agreement which provided for certain payments of alimony. A suit was commenced by the petitioner requesting, inter alia, compliance with the separation agreement and relief under the Nevada divorce decree. The decree entered in said suit required the payment of $14,000 in satisfaction of arrearages under the agreement. The distinction between Frank J. Loverin, supra, and the instant proceeding is obvious. In Frank J. Loverin, supra, the payment was a lump sum in full payment of all future alimony and other claims of the former wife against the former husband. The agreement providing for such payment, as of the taxable year-1942, was the only instrument under which the taxpayer could possibly claim he was paying alimony, as the divorce decree had been modified on or about January 13,1942, to eliminate alimony payments. The Loverm case is clearly distinguishable upon its facts from this proceeding. The payment in the instant proceeding was not a payment in full settlement of future alimony but was in settlement of accrued alimony, which, as previously discussed, retains its “periodic” characteristics for the purposes of section 22 (k). The payment of $14,000 was in settlement of alimony arrearages for the years 1944 to 1947, inclusive, in the amount of $12,863.84, and for increased alimony due for the period January 1,1948, to September 15,1948, in the estimated amount of $1,136.16, which full amount constitutes taxable alimony income under the provisions of section 22 (k) of the Internal Revenue Code. A question of the severability of the agreement.of 1948, referred to in our Findings of 'Fact, similar to that considered by the Court of Appeals in Grant v. Commissioner, 209 F. 2d 430, was not presented by the parties in this case and there are not sufficient facts in the record herein upon which such an issue could properly be decided. The respondent’s determination is sustained. Decision will be entered for the respondent.	01-04-2023	01-16-2020
https://www.courtlistener.com/api/rest/v3/opinions/4477095/	OPINION. Johnson, Judge: The first issue we must consider is whether the exchange of partnership assets for corporate stock and drawing accounts occurred in 1946 or 1947. The petitioners contend that the exchange occurred in 1946 and under section 275 (c) 1 of the 1939 Code the statute of limitations would have run against respondent’s determination. It is respondent’s contention that the exchange occurred in 1947. Under Missouri law the existence of a corporation dates from the time of the filing of the articles of incorporation with the secretary of state. The certificate given by the secretary of state is evidence in the State courts of the existence of the corporation. However, a corporation may not commence business until certain requirements are met, and a certificate authorizing it to commence business has been issued by the secretary of state. See secs. 351.070 and 351.075, E. S. Mo. 1949. Also, under State law the filing of the articles of incorporation by the secretary of state constitutes acceptance by the corporation of all existing subscriptions to its shares, and thereupon subscribers for shares or their assignees shall be deemed to be stockholders of the corporation. Sec. 351.175, R. S. Mo. 1949. Since the corporation filed its articles of incorporation in 1946, and since a certificate was issued by the secretary of state in 1946, the corporation did exist in 1946. In addition, the articles of incorporation stated that petitioners and Greve subscribed to all the authorized capital stock; therefore, the corporation had bona fide shareholders in 1946. However, according to the jurisprudence of Missouri, the articles of incorporation are not proof conclusively that the stock was fully paid. Raleigh Investment Co. v. Bunker, 285 Mo. 440, 227 S. W. 121; Yardley v. Caruthersville Motor Co., 225 Mo. App. 321, 35 S. W. 2d 971. Therefore, the articles of incorporation are not proof conclusively that the partnership assets were transferred to the corporation in 1946. Let us briefly review the facts. There was a partnership that closed its books as of December 31, 1946. Also in 1946 there was a corporation with bona fide stockholders, but the corporate books show no record of any corporate property ownership until January 2, 1947. No corporate tax return was filed for 1946. The articles of incorporation, dated December 23, 1946, stated that the petitioners gave $455,000 of assets subject to $305,000 of liabilities for $150,000 of corporate stock, but the corporate books as of January 2, 1947, show that $548,426.59 of assets subject to liabilities of $92,543.48 ($44,019.92 plus $48,523.56) to petitioners, and $305,883.11 to others, was exchanged for $150,000 of corporate stock. The discrepancy between the stated values in the articles of incorporation and the actual book values was a result of a rough approximation on the part of petitioners’ attorney when he drafted the articles of incorporation. It is significant that if the assets had in fact been transferred at the time the articles of incorporation had been drafted or immediately thereafter, there would have been no need for an approximation. The books would have reflected the actual value of the assets involved in the transfer. The statement in the articles of incorporation that certain assets were transferred to the corporation is not conclusive proof of the transfer, particularly since there has been no showing that the assets were closed out of the partnership books prior to December 31, 1946. Further, there is no showing that the assets were transferred to the corporate books prior to January 2, 1947. Finally, the intention of the petitioners was that the corporation would commence business as of the first day of January 1947. On these facts we can only conclude that the assets were transferred in 1947 and not 1946. That statute of limitations is not a bar to the respondent’s determination. Next, we shall consider the remaining two issues together, that is, was there an exchange under section 112 (b) (5), and if not, was there a gain within section 112 (c) (1). First, we must consider whether the exchange of the partnership assets was within the provisions of section 112 (b) (5), that is, was there an exchange of property to a corporation by petitioners solely in exchange for stock and securities of the corporation, and immediately after the exchange were petiti-tioners in control of the corporation, and, finally, was the amount of stock and securities received by petitioners substantially in proportion to their interest in the property prior to the exchange. If the exchange was within section 112 (b) (5), no gain or loss would be recognized. Respondent contends that petitioners received something other than stock and securities in the exchange because drawing accounts are not securities within the contemplation of section 112 (b) (5). Respondent determined that the drawing accounts were “other property” and under section 112 (c) (l)2 petitioners incurred a recognized gain in the exchange. On the other hand, petitioners contend that they have complied with section 112 (b) (5). The net worth of the partnership at the close of business on December 31,1946, was $242,400.62. There is no dispute that the $150,000 of capital stock was distributed to petitioners in the proportion of their interest in the partnership property. The question arises as to the $92,400.62 which is the difference between the partnership net worth and the stated value of the capital stock. This $92,400.62 was credited on the corporate books as “John W. Harrison, Drawing $44,019.92” and “Clifford F. Harrison, Drawing $48,523.56.” No explanation was given for the variance between $92,400.62 and the aggregate of the drawing account entries which amounted to $92,543.48. According to the stipulated facts the journal entry on the corporate books correctly reflected all of the partnership assets and liabilities as of December 31, 1946. But upon careful examination of the record it appears that the corporate journal entries, denominated drawing accounts, did not have similar liability accounts in the partnership. Rather the drawing accounts’ counterpart in the partnership was an undenominated net worth of at least $92,400.62. It now appears, even though a goodwill account was not set up on the.corporation’s books, that this net worth was in the nature of partnership goodwill. jby setting up part of the partnership net worth as drawing accounts, petitioners acquired a right to withdraw substantial sums from the corporation: The record contains no evidence as to restrictions on the use of the drawing accounts. Now, if this exchange is to be within section 112 (b) (5), the drawing accounts must come within the definition of “securities.” In the past securities have been held to be such obligations as bonds, debenture notes, and subscription rights, but short-term notes for 3, 4, and 5 years are not deemed securities. Neville Coke & Chemical Co., 3 T. C. 113, affd. 148 F. 2d 599; Pacific Public Service Co., 4 T. C. 742, affd. 154 F. 2d 713. Thus it would appear under prior decisions that “securities” are in the nature of long-term obligations. When long-term obligations and stock are exchanged for property, the original interest in the business is continued and perpetuated, which is in accord with the underlying theory of a tax-free exchange. The original interest is not retained where cash or short-term notes are given in exchange for property; similarly, the original interest is impaired when drawing accounts are given in exchange for property. It is our conclusion, considering the nature of the drawing accounts in this case, that they are not “securities” within the meaning of section 112 (b) (5). Therefore, the exchange in these proceedings is one where property was exchanged for stock and other property. Since stock and other property were involved in the exchange, section 112 (c) must be considered to determine whether petitioners had a taxable gain. Under section 112 (c) (1) if an exchange would be within the provisions of section 112 (b) (5), if it wrere not for the fact that the property received in exchange consists of not only stock and securities but also other property or money, then the gain, if any, to the recipient shall be recognized but in an amount not in excess of the sum of such money and the fair market value of such other property. Now the question arises, what is the fair market value of the drawing accounts? No attempt has been made to show that the book value of the drawing accounts was not fair market value. No evidence was offered to show that the corporation could not pay the stated value of the drawing accounts, and no evidence was offered to show what might be a discounted value if the drawing accounts were assigned to others by petitioners. Notwithstanding the fact that the petitioners have not shown what might be a fair market value for the drawing accounts, they have attacked respondent’s determination in another way. Petitioners maintain that all assets in excess of $455,000 (the value of the assets transferred according to the articles of incorporation) had an offsetting account on the corporate books as the petitioners’ drawing accounts. They contend that the excess over $455,000 was goodwill even though no specific goodwill account has been set up on the corporate books. The parties have stipulated that the value of goodwill was $255,317.20. Now, on brief, without proof that the stipulation was erroneous, petitioners argue that goodwill should be approximately $42,000, and the inference is that the fair market value of the drawing accounts could not exceed $42,000, the alleged value of goodwill. We think on the present facts that the actual value of goodwill is not important to this decision. What is important is the fact that both parties agree that the corporation acquired something in value more than the net worth represented by $150,000 of corporate stock. Petitioners have not shown what might be a fair market value of the drawing accounts. Nor have petitioners shown respondent’s determination to be erroneous. Therefore, on this record, respondent’s determination must be sustained. Reviewed by the Court. Decisions will be entered for the respondent. SEC. 275. PERIOD OF LIMITATION ÜPON ASSESSMENT AND COLLECTION. (c) Omission from Gross Income. — If the taxpayer omits from gross Income an amount properly includible therein which Is In excess of 25 per centum of the amount of gross Income stated In the return, the tax may be assessed, or a proceeding In court for the collection of such tax may be begun without assessment, at any time within 5 years after the return was filed. SEC. 112. RECOGNITION OF GAIN OR LOSS. (c) Gaik from Exchanges Not Solely in Kind.— (1) If an exchange would be within the provisions of subsection (b) (1), (2), (3), or (5), or within the provisions of subsection (1), of this section if it were not for the fact that the property received in exchange consists not only of property permitted by such paragraph or by subsection (1) to be received without the recognition of gain, but also of other property or money, then the gain, if any, to the recipient shall be recognized, but in an amount not in excess of the sum of such money and the fair market value of such other property.	01-04-2023	01-16-2020
https://www.courtlistener.com/api/rest/v3/opinions/4477096/	OPINION. Fisher, Judge: The issues presented for our consideration are whether a renegotiation proceeding in respect to petitioner for its fiscal year ended December 31, 1944, was timely commenced or, if so timely commenced, whether it was timely completed in accordance with the provisions of section 403 (c) (3) of the Eenegotiation Act of 1943. Questions raised in connection with these issues are indicated below in the statement of petitioner’s and respondent’s several contentions, and are considered, to the extent required, in our discussion. The [Renegotiation Act of 1943 (as amended by the Eevenue Act of 1943, which became effective on February 25,1944) applicable to fiscal years ended after June 30,1943, limits the period in which a proceeding to determine excessive profits may be commenced and also the period in which it must be completed if so timely commenced. Failure either to timely commence or timely complete a renegotiation proceeding for any fiscal year relieves the contractor (or subcontractor) of all liability for such year. Section 403 (c) (3) of the Act provides, in part, as follows: No proceeding to determine the amount of excessive profits shall be commenced more than one year after the close of the fiscal year in which such excessive profits were received or accrued, or more than one year after the statement required under paragraph (6) is filed with the Board, whichever is the later, and if such proceeding is not so commenced, then * * * all liabilities of the contractor or subcontractor for excessive profits received or accrued during such fiscal year shall * * * be discharged. * » * With respect to completion of a proceeding timely commenced, section 403 (c) (3) further provides: If an agreement or order determining the amount of excessive profits is not made within one year following the commencement of the renegotiation proceeding, then upon the expiration of such one year all liabilities of the contractor or subcontractor for excessive profits with respect to which such proceeding was commenced shall thereupon be discharged, except * * * such one-year period may be extended by mutual agreement. Paragraph (5), referred to in section 403 (c) (3) in respect to the contractor’s statement required for determining the period for timely commencement, provides, in pertinent part, as follows: Every contractor and subcontractor * * * shall, in such form and detail as the Board may by regulations prescribe, file with the Board on or before the first day of the fourth month following the close of the fiscal year * * * a financial statement setting forth such information as the Board may by regulations prescribe as necessary to carry out this section. * * * It is further provided, that, In addition to the statement required * * * every such contractor or subcontractor shall, at such time or times and in such form and detail as the Board may by regulations prescribe, furnish the Board any information, records, or data which is determined by the Board to be necessary to carry out this section. * * * In accordance with the provisions of the Act in section 403 (c) (5), the Board has promulgated Eenegotiation Eegulation 222, in pertinent part, as follows: (1) The “Standard Form of Contractor’s Report” * * * is hereby prescribed as the form of mandatory financial statement generally required to be filed by contractors and subcontractors. * * * * * * * 222.1 Sufficiency of Contents. * * * The Reports are required to comprise all the information and exhibits specified by the forms and the instructions. However, if all the information called for by the appropriate “Standard Form of Contractor’s Report” has been furnished by the contractor to an Agency authorized to conduct renegotiation proceedings under the 1943 Act, the contractor may complete the “Standard Form of Contractor’s Report” by incorporating by reference the information so furnished and making a specific statement of the time and place of such filing. In such case, the fact that the information has been received will be certified to by the renegotiating Agency on the copy of the “Standard Form of Contractor’s Report” which it will forward to the War Contracts Board within sixty days after the date of receipt of the Report by such Agency. A “Standard Form of Contractor’s Report” so prepared and filed will be deemed to constitute a sufficient compliance with the mandatory filing requirements * * * in the absence of a notice of insufficiency sent to the contractor within 90 days after the Report has been filed. The manner of timely commencement is specifically provided for in the Act in section 403 (c) (1), as follows: Whenever^ in the opinion of the Board the amounts received or accrued under contracts with the Departments and subcontracts may reflect excessive profits, the Board shall give to the contractor or subcontractor, as the case may be, reasonable notice of the time and place of a conference to be held with respect thereto. The mailing of such notice by registered mail to the contractor or subcontractor shall constitute the commencement of the renegotiation proceeding. Renegotiation Regulation 241 merely reiterates that renegotiation proceedings are commenced by the mailing, by registered mail, of reasonable notice of the time and place of a conference to be held with respect to the renegotiation, and provides a form (in paragraph 721 of the regulations set out below1) which may be used for such purpose. We think that our analysis of the problem will be more readily followed if we first state in some detail the series of closely interrelated alternative contentions of petitioner and respondent. Petitioner first contends that the letter from Chicago P. A. D., dated May 8, 1945, setting a “preliminary conference” between Northwest and the representatives of Chicago P. A. D., timely commenced renegotiation proceedings in respect to petitioner for its fiscal year ended December 31, 1944, despite transmittal by other than registered mail. This contention is made conditionally, and only in connection with its related argument, that if the letter had the effect of timely commencement the determination of excessive profits issued by the Bureau of Federal Supply on April 30, 1947, was not made within the 1-year period following commencement of the proceeding as required under section 403 (c) (3) of the Act. Petitioner’s second contention is that the filing of the contractor’s report for 1944 on May 4, 1945, in accordance with section 403 (c) (5) of the Act, marked the beginning of the 1-year period in which renegotiation proceedings might be commenced under section 403 (c) (3), and that no proceeding was so timely commenced within 1 year from that date, (a) because the letter from Chicago P. A. D., dated May 1, 1946, purporting to commence the proceeding was a nullity since there was not set therein any time or place for an initial conference as required by section 403 (c) (1) of the Act, and (b) because the letter from Treasury P. A. D., dated April 21, 1947, sent by registered mail and setting a “final renegotiation conference,” if sufficient to comply with the requirements of section 403 (c) (1) in respect to notice of commencement, was sent after the 1-year period in which the proceeding might be commenced. Petitioner further contends, in response to a position taken by respondent and set forth below, that if its contractor’s report for 1944 was not sufficiently complete and accurate to comply with the requirements of the Act (and regulations promulgated thereunder) as of the date it was first filed, May 4, 1945, such additional information and data as was required to so complete the report was finally filed with Chicago P. A. D. at least by February 11,1946. Accordingly, if the notice of May 1,1946, was a nullity, the notice of April 21, 1947, regardless of whether or not it was in compliance with the provisions of the Act respecting notice of commencement, could not timely commence a renegotiation proceeding having been sent more than 1 year after even the February 11,1946, date of filing of the required contractor’s report. Despondent contends, on the other hand, that the registered letter of May 1, 1946, which omitted the paragraph of the form letter (see note 1, supra) setting a time and place for an initial conference, was sufficient to timely commence the renegotiation proceeding, since several conferences had already been held between the parties and another had been set by agreement shortly before May 1 for several days hence. Accordingly, completion of the proceeding on April 30, 1947, would also be timely. Despondent further argues that the letter of May 8, 1945, did not commence a renegotiation proceeding, since it was merely a preliminary notice of conference and was not sent to petitioner by registered mail as required by section 403 (c) (1), but respondent contends by affirmative pleadings, if that letter did constitute a commencement then petitioner is estopped from asserting that the proceeding was not timely completed on April 30, 1947, because of an alleged agreement between the parties to extend the period for completion. Eespondent’s last contention is that the period for commencement of a renegotiation proceeding had not begun to run until July 3,1946, at which time the petitioner’s contractor’s report required by section 403 (c) ,(5) was first completely and accurately filed, and that the notice of April 21, 1947, setting a “final renegotiation conference,” in all particulars met the requirements of a commencement notice, and therefore, did timely commence the proceeding within 1 year from the date of the filing of petitioner’s financial statement. It is argued, therefore, that the proceeding was timely completed by the order of April 30,1947. We first consider whether the letter of May 8, 1945, from Chicago P. A. D. requesting a preliminary conference with representatives of Northwest commenced renegotiation proceedings in respect to petitioner for its fiscal year ended December 31, 1944, in accordance with the provisions of the Eenegotiation Act of 1943. For the reasons set out below we do not think that this letter was either intended to commence a proceeding or that it complied with the requirements of a notice of commencement under section 403 (c) (1) of the Act. The letter in question has been fully set out in our Findings of Fact and we need only summarize briefly the mode of transmission and its contents. The letter was sent by regular mail. It indicated that Northwest had been reassigned to Chicago P. A. D. for renegotiation for its fiscal year 1944, and that past experience pointed to the importance of a preliminary conference with the representatives of the contractor in expediting the work of the Board. Accordingly, a meeting was requested for May 18,1945. Petitioner contends (conditionally, as set forth supra) that this communication fulfills all of the essential statutory requirements of section 403 (c) (1) for a notice of commencement, since it reports reassignment of Northwest to Chicago P. A. D. for renegotiation, and since it gives leasonable notice of a time and place of a conference to be held with respect to renegotiation. Petitioner argues that designation of the conference as “preliminary” is unimportant and that the meeting was intended to be an “initial” conference on the matter, which was then ready for renegotiation, the contractor’s report for 1944 having been filed on May 4. Petitioner further argues that failure to mail the letter of May 8, 1945, by registered mail does not render it ineffective to commence a proceeding, since the petitioner did in fact receive the notice and subsequently acted upon it by attending the May 18,1945, meeting held in Chicago. We cannot agree with petitioner’s contentions. In Harold F. Buck v. War Contracts Price Adjust. Board, 10 T. C. 623 (1948),. we had occasion to consider what constitutes commencement of a renegotiation proceeding under the statutory provisions here applicable. By enacting the Revenue Act of 1943, Congress, in effect, completely rewrote the limitations provisions of the Renegotiation Act for years ending after June 30,1943, providing for both a period in which a renegotiation must be commenced and in which it must be concluded. For the first time a specific manner for commencement was provided for in section 403 (c) (1) requiring that whenever, in the opinion of the Board, the amounts received or accrued under war contracts may reflect excessive profits, the Board shall give the contractor reasonable notice of the time and place of a conference to be held with respect thereto and that the mailing of such notice, by registered mail, shall constitute the commencement of the renegotiation proceeding. In Buck the letter purporting to commence renegotiation merely contained a request for the submission of certain data and information. We held that Congress, when, for the first time, it prescribed a specific manner of commencement, was fully aware of the numerous different and conflicting interpretations previously existing as to what constituted a commencement, and did not intend that the making of a request for submission of data and information on which the renegotiation might be based would also constitute commencement. We stated: To the contrary, we think that * * * for the purpose of starting the newly established period of limitation * * * Congress did not intend that a request for data and information was to be regarded as the commencement of renegotiation. The reasoning there expressed is applicable here in respect to the letter of May 8,1945, which in the circumstances of this case, we think was intended as a preliminary step with a view toward renegotiation. The purpose of the proposed conference appears to have been primarily exploratory. However, even if the officials of Chicago P. A. D. were at any time of the opinion that the letter of May 8,1945, or any other act or communication prior to that of May 1,1946, commenced renegotiation, as might be indicated by their statement in the letter of May 1,1946, that “There is a difference of opinion as to when renegotiation commences in a particular case * * we nevertheless hold, as we did in the Buck case, that Congress did not intend that a notice such as the one here in question should have the effect of a commencement of renegotiation. If Congress had so intended it would no doubt have plainly provided for alternative forms of notice of commencement. Moreover, it is vital to commencement of a proceeding, -within the meaning of the Act, that the notice of commencement be sent by registered mail. The statute is explicit in this respect and it is immaterial that Northwest did in fact receive the communication. It is evident that in view of the difficulties faced under earlier renegotiation acts in construing the acts and circumstances which constituted commencement of a proceeding, Congress had this very problem in mind when it virtually rewrote the renegotiation law by passage of the Renegotiation Act of 1943. Mailing of the notice of commencement by registered mail is an act of sufficient definiteness to dispel most doubts in respect to when a proceeding is formally commenced' for the purpose of applying the limitations on commencement and completion of a renegotiation proceeding. Congress obviously intended thereby to eliminate, to the extent possible, uncertainty as to timely commencement and as to the beginning of the critical period for timely completion of a proceeding. We have previously considered a like issue involving the necessity of mailing a notice of deficiency by registered mail in order to determine whether a petition therefrom to this Court is timely filed within the permissible 90 days. In Henry M. Day, 12 B. T. A. 161 (1928), where a deficiency notice was admittedly delivered manually, we said, that Congress intended, in providing for notice in a certain manner, i. e., by registered mail, to exclude all other forms as the condition precedent to our jurisdiction. This view has much weight because of the many difficulties of proof which would attend a determination of whether we had jurisdiction or not once it should be held that the method prescribed by statute is not the exclusive method. * * * See also, Henry Wilson, 16 B. T. A. 1280 (1929); William M. Greve, 37 B. T. A. 450 (1938); John A. Gebelein, Inc., 37 B. T. A. 605 (1938); Oscar Block, 2 T. C. 761 (1943); Midtown Catering Co., 13 T. C. 92 (1949). In the Block case we added to this view the belief that to hold otherwise would deprive the statute of some of the important benefits which Congress intended should be derived from it. The principle underlying our decisions in these tax cases is equally applicable to a case involving commencement of a renegotiation proceeding. It is that ail parties be properly apprised of commencement in order to eliminate doubt as to the moment of commencement. Provision for sending such notice of commencement by registered mail provides an adequate means of meeting this need and must be deemed a necessary requirement in every case if those benefits intended by Congress are to be assured. We come then to consider whether the letter of May 1,1946, timely commenced renegotiation. This letter also has been fully set out in our Findings of Fact. In form it is largely as prescribed in the regulations, stating that renegotiation proceedings with respect to petitioner for its fiscal year ended December 31, 1944, were to be conducted initially by Chicago- P. A. D., and that the notice sent by registered mail constituted commencement of the renegotiation proceeding, except that no time or place was set for a conference in respect to renegotiation. Petitioner contends that the notice of May 1, 1946, was materially defective since the most important element of a notice of commencement, namely, the time and place of conference, was not contained therein. Respondent; on the other hand, argues that, in the circumstances of this case, it is immaterial that no conference was set. In this connection, respondent urges that a conference had been held the day before (on April 30, 1946) and that another had been arranged for the following week. There is little in the record to indicate what generally transpired at the “conferences,” or what their significance may have been. With respect to the meeting of April 30,1946, the record indicates only that the representatives of Chicago P. A. D. and Griswold were in contact with each other, but the surrounding circumstances and the purposes of that meeting are not made clear, except that the meeting appears to have related to Micro-matic and not Northwest. The other meeting (the following week) occurred when Mr. Cahill, one of the representatives of Chicago P. A. D., was in Minneapolis on other business. At that time he was to pick up the extension agreements sent by Chicago P. A. D. to Gris-wold on May 1 (see Findings of Fact, supra), if they had been executed by Griswold. He was also to contact Peat, Marwick & Mitchell with respect to a proposed audit of Micromatic. It appears that after some unfriendly telephone conversations between Cahill and Griswold, the substance of which is not fully apparent from the record, Cahill met with Griswold at the Northwest plant. However, we find nothing in the record to support the view that either of these so-called conferences had any formal significance or was intended to be in substitution for the conference with respect to which reasonable notice of time and place is required by the provisions of section 403 (c) (1). It is manifest that the only manner in which a renegotiation proceeding may be commenced is that provided in said section, the requirements of which have already been set forth. This includes the requirement that the registered letter give to the contractor “reasonable notice of the time and place of a conference.” See Oregon Brass Works v. W. C. P. A. B., 16 T. C. 1145 (1951). That the letter of May 1, 1946, did not give such notice is not disputed. We find neither reason nor authority for disregarding such specific statutory standards or requirements. The instant case is clearly distinguishable from United States v. Wissahickon Tool Works, (S. D., N. Y., 1951) 99 F. Supp. 331, affd. (C. A. 2, 1952) 200 F. 2d 936, where the usual letter informing the contractors of commencement of renegotiation proceedings referred to the fiscal year ended December 31, 1943, when the contractors’ fiscal year in fact ended July 31, 1943. The court held that defendants’ contention was “little more than a quibble,” and that while the giving of a proper notice is a statutory prerequisite to the institution of renegotiation proceedings, under the circumstances there considered, the letter was sufficient notice. It was clear that the contractors had not been misled and the error did not involve any element which is set forth in the statute as one required to be included in the statutory notice of commencement. As applied to the facts of the instant case, however, the statute is clear and must be administered without judicial modification. If Congress had intended only that the contractor be given reasonable notice of commencement by registered mail, it could have so provided, but it saw fit to require specifically that the notice of commencement be reasonable notice, by registered mail, of a time and 'place for conference in respect to the renegotiation. We next consider whether any valid notice of commencement was given within the statutory period for commencement, i. e., within 1 year after the contractor’s report was filed with the Board. Petitioner first submitted its contractor’s report for 1944 on May 4, 1945, but respondent contends that it was not then accurately completed, and accordingly cannot be considered as having been “filed” for the purpose of computing the statute of limitations on commencement at any time before July 3,1946, on which date respondent concedes that the report was “filed” within the meaning of the statute. Petitioner argues that if the report was not “filed” on May 4, 1945, it was complete and accurate, and thus “filed” within the meaning of the statute and regulations promulgated thereunder, no later than February 11, 1946. Consequently, petitioner argues that the notice of April 21, 1947, was too late to commence renegotiation, whereas respondent considers it fully within the 1-year period from the time of completed filing on July 3, 1946. We will assume arguendo that the notice of April 21, 1947, in all respects meets the statutory requirements of section 403 (c) (1) in respect to a notice of commencement, and determine first whether or not it was transmitted within the statutory period for commencement. The statute requires that the contractor file a financial statement in accordance with regulations promulgated thereunder specifying the form and detail of the information to be submitted. By appropriate regulations, petitioner was required to complete the applicable Standard Form of Contractor’s Report by supplying all of the information and exhibits specified therein. Filing of the form contractor’s report so completed is deemed to have satisfied the statutory requirement in the absence of a notice of insufficiency sent to the contractor within 90 days. Northwest prepared and submitted such a report on May 4, 1945, completed fully, except for certain data under section B required of contractors who have not received clearance notices for prior years. Petitioner believed that it had received such clearance for its fiscal year 1943, though, in fact, it had merely received a notice of cancellation which did not have the effect of discharging any of its liabilities. The record clearly shows, however, that any information which was called for in section B of the contractor’s report for 1944 was submitted in part on November 14, 1945, and fully by February 11, 1946, as set forth in our Findings of Fact. Renegotiation Regulation 222.1 (3) (a) provides in part as follows: A “Standard Form of Contractor’s Report” so prepared and filed will be deemed to constitute a sufficient compliance with the mandatory filing requirements of this section in the absence of a notice of insufficiency sent to the contractor 90 days after the report has been filed. Respondent does not argue that a “notice of insufficiency” was sent to the contractor within the meaning of the regulation or that corre-pondence calling upon petitioner for additional information is to be construed as such a notice. We need only add, in this context, as already set forth, that the information which petitioner was called upon to furnish was actually furnished in the letters and accompanying enclosures submitted to Chicago P. A. D. on November 14, 1945, and February 11,1946. Upon consideration of all of the circumstances above set forth, we hold that petitioner’s financial report was filed under section 403 (c) (5) of the Act no later than February 11,1946. Respondent’s contention that petitioner’s report was not completely and accurately filed until July 3, 1946, is based largely on the assertion that serious doubt then existed as to the accuracy of the information contained in the report in the light of the charges made by Bliss who had asserted that the accounts of Micromatic were incorrect and would reflect on the accounts of Northwest. Respondent also alleges that Griswold, petitioner’s president, admitted that the reports were incorrect, and thereby revoked the filing of the financial statement, pending a complete audit, which was not submitted until at least July 3,1946. We do not think that the record supports respondent’s view. With respect to Griswold’s alleged admission, the evidence submitted in support thereof is vague and inconclusive and does not justify a finding that Griswold intended to revoke the filing of Northwest’s contractor’s report for 1944. At the time when Bliss made the charges upon which respondent’s other contention is based, Bliss was engaged in a bitter lawsuit with Griswold over Micromatic and was no longer an employee of Northwest. It is clear from the record that if the representatives of Chicago P. A. D. did not know this at the time the charges were made, they were so informed at the meeting of' January 3, 1946. There is, therefore, no basis for respondent’s contention that the representatives of Chicago P. A. D. reasonably relied on the Bliss charges on the theory that they were made by an agent of Northwest. Assuming that Chicago P. A. D. had believed the Bliss charges, however, it is our view that such belief would not, of itself, justify our holding that the contractor’s report for 1944 was not filed within the meaning of the statute. We are of the opinion that in the absence of any intentional or fraudulent misstatement of information in or omission from the contractor’s report, respondent may not disregard the filing of the report and the data by which it was supplemented. The filing of the required report is only a preliminary step in the process of renegotiation. The appropriate authorities may determine from the information submitted that there may be excessive profits and then act to commence a renegotiation proceeding to determine what amount, if any, of excessive profits was realized. This does not, however, lead to the conclusion that the sufficiency of the report is to be measured by a requirement that it supply every detail of data and information which might ultimately be necessary to successfully complete a renegotiation proceeding before the period for commencement of such proceeding begins to run. It is evident that the purpose of the filing of the report is otherwise. The statute recognizes this by allowing one year from the date of filing in which to commence proceedings, and another year in which to complete them. It also provides that the renegotiation authorities may at any time, whether prior to commencement or during the course of a proceeding, request such additional information and data as is necessary to complete renegotiation. It is apparent that such provisions would be unnecessary and bare of practical significance if, as is contended here, a report complete and perfect in every detail were required of the contractor before the periods of limitations would begin to run. Moreover, the Board may, in the case of a recalcitrant contractor, or one who refuses to submit information as requested, issue a unilateral order on the basis of such information as is available. We think it clear under the circumstances that the function of the contractor’s report was fully served no later than February 11,1946, by the filing of the contractor’s report for 1944 on May 4, 1945, and the subsequent furnishing of the information missing from the original report. Since the later date is more than one year before April 21, 1947, the letter of April 21, 1947, is not to be deemed to have resulted in the timely commencement of the proceeding. It is, therefore, unnecessary to consider whether or not it complied with the statutory requirements for a notice of commencement. Respondent argues that petitioner is estopped from asserting that the renegotiation proceeding was not timely completed. In view of our holding that the renegotiation proceeding was not timely commenced, as a result of which all of petitioner’s liabilities for excessive profits are discharged under the statutory provisions of section 403 (c) (3), we need not consider an argument pertaining to timely completion of such a proceeding. In view of our determination, we need not give consideration to petitioner’s motion to strike with respect to evidence conditionally received over its objection. Reviewed by the Court. Decision will he entered for the petitioner. (Assignee Department or Service) Date Gentlemen : The War Contracts Price Adjustment Board has determined that renegotiation proceedings under the Renegotiation Act (Title VII of the Revenue Act of 1943) for your fiscal year ended_shall be conducted initially by this office. A conference with you with respect to this matter is hereby set for_ at_if that time is not convenient, kindly advise us promptly in order that a continuance may- be arranged. This notice, sent by registered mail, constitutes commencement of the renegotiation proceedings in conformity with the provisions of subsection (c) (1) of the Renegotiation Act. Very truly yours,	01-04-2023	01-16-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625384/	RICHARD E. WARNER AND VIRGINIA A. WARNER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentWarner v. CommissionerDocket No. 8012-72.United States Tax CourtT.C. Memo 1974-243; 1974 Tax Ct. Memo LEXIS 73; 33 T.C.M. (CCH) 1080; T.C.M. (RIA) 74243; September 19, 1974, Filed. 73 Held, respondent's determination of a deficiency within 3 years of the filing of a return is not barred by the granting of a refund claimed on the return more than 2 years prior to the determination. Sec. 6532(b), I.R.C. 1954, not applicable. Richard E. Warner, pro se. George W. McDonald, for the respondent. DRENNENMEMORANDUM OPINION DRENNEN, Judge: Respondent determined a deficiency in petitioners' income tax for the year 1969 in the amount of $683. The issues are (1) whether petitioners understated their taxable income by the amount of $3,999.84 in their return for the year 1969 and (2) whether assessment and collection75 of any deficiency in income tax for the year 1969 is barred by the statute of limitations. This case was submitted on a fully stipulated set of facts. The stipulation of facts is incorporated herein by this reference. Petitioners were husband and wife who resided in Temecula, Calif. Petitioners resided in California during the entire taxable year 1969 and at the time of the filing of the petition herein were residents of Temecula, Calif.Petitioners filed a joint individual income tax return for the year 1969 prior to April 15, 1970. Attached to the petitioners' income tax return was a Treasury Department Form W-2 which indicated "Federal Income Tax Withheld" of $2,069.62, "Wages Paid Subject to Withholding in 1969" of $12,631.43, and "Other Compensation Paid in 1969" of $3,999.84. The return listed petitioners' adjusted gross income as $12,631. No tax liability was listed, and a refund was requested of the full amount of the Federal income tax withheld. By check dated May 15, 1970, petitioners received a refund for 1969 in the amount of $20.70. Petitioners telephoned the Ogden, Utah, Internal Revenue Service office to report the error in the refund they had received. 76 A follow-up telephone call was made a few days later, and petitioners were advised by respondent's representative that their W-2 form had been lost and they were requested to forward a copy of it. The petitioners complied with this request, and as a result, a check dated June 26, 1970, in the amount of $2,070.15 was issued to petitioners. With petitioners' 1970 income tax return a registered letter dated February 22, 1970, was sent by petitioners to the Internal Revenue Service Center, Western Division, Ogden, Utah, calling attention to a possible error or omission by petitioners on their 1969 return. The letter requested the Internal Revenue Service to check into the matter and if an error or omission had been made, authorized the Internal Revenue Service to deduct any deficiency from petitioners' 1970 refund. Respondent did not acknowledge the letter, and issued a refund check for 1970 to petitioners in the full amount claimed on the return for that year. Within a few months petitioners were notified by the respondent that they were to be audited for the year 1969. Petitioners submitted to a partial audit by authorizing the Internal Revenue Service auditor to select any77 category of receipts from petitioners' records. The auditors examined petitioners' telephone expense deductions and petitioners' offered to permit an audit of any other category of business expenses. Petitioners declined further audit except by disinterested third parties. Petitioners were sent a Report of Audit Changes indicating a proposed deficiency of $2,106 and appealed to the district conferee. The district conferee accepted the substantiation offered by petitioners of all of their employee business expense deductions. Respondent subsequently issued a notice of deficiency dated July 26, 1972, asserting a deficiency of $683 against petitioners based upon petitioners' failure to include the $3,999.84, listed as "Other Compensation Paid in 1969" on their W-2 form for 1969 in their taxable income for that year. Petitioners timely filed a petition in this Court. When this case was called for trial, petitioner Richard W. Warner, who was representing petitioners, stated orally on the record that petitioners were not contesting the fact that they had failed to include in their taxable income for the year 1969 the $3,999.84 of other compensation received in 1969, that they78 were not contesting the underlying deficiency, and that the case would be submitted on a fully stipulated set of facts. We, therefore, find that petitioners omitted from their taxable income for the year 1969 the aforesaid amount of $3,999.84 upon which the deficiency is based. Petitioners' argument, as we understand it, is that the omission of $3,999.84 from their taxable income was apparent from the W-2 form filed with the return, that additionally they informed the Internal Revenue Service when they filed their 1970 return of the possible omission on their 1969 return, and that the failure of the Internal Revenue Service to act on this information until more than 2 years after the payment to petitioners of a refund for 1969 bars the later assessment and collection of the deficiency under the provisions of sections 6501(e), 6532(b), and 7405 of the Internal Revenue Code of 1954 (hereinafter referred to as the Code). Respondent contends that none of the aforementioned sections of the Code are applicable, that all appropriate procedures for the assertion of the deficiency were followed, and that the notice of deficiency was sent to petitioners well before the expiration of the79 3-year statute of limitations provided for in section 6501(a) of the Code. Section 6532(b) of the Code provides that the recovery of an erroneous refund of tax by suit under section 7405 shall be allowed only if such suit is begun within 2 years after the making of such refund. Petitioners maintain that since the Government did not bring suit within 2 years after the making of the refund, they cannot now bring an action for the recovery of the erroneous refund. The obvious fallacy in petitioners' argument is that the procedure followed by respondent in this case is not a suit for the recovery of an erroneous refund under section 7405 of the Code. Instead of following that procedure respondent issued a notice of deficiency under section 6212 of the Code, which he was entitled to do, as hereinafter discussed. Hence, the limitation period provided in section 6532(b) is not applicable. In Clark v. Commissioner, 158 F.2d 851">158 F.2d 851 (C.A. 6, 1946), it was held that - Refunds of alleged excess withheld from wages under "pay-as-you-go" income tax plan are a matter of grace to taxpayer made in consequence of amount due as shown on return, are subject to final audit and adjustment, 80 and hence are not final determinations so as to preclude subsequent disallowance of deductions. * * [Headnote.] The rule established in the Clark case has been relied on in numerous cases decided by this Court to hold that the respondent is not precluded by making tentative refunds of amounts claimed on taxpayers' returns from proceeding in the oridinary manner to audit the taxpayers' returns for those years, increase income or disallow deductions, and issue notices of deficiency under section 6212 for any additional tax determined to be due. Henry C. Warren, 13 T.C. 205">13 T.C. 205 (1949); Carl H. Thorsell, 13 T.C. 909">13 T.C. 909 (1949); Mary R. Milleg, 19 T.C. 395">19 T.C. 395 (1952); Rendell Owens, 50 T.C. 577">50 T.C. 577 (1968); John S. Neri, 54 T.C. 767">54 T.C. 767 (1970). The Neri case involved a tentative refund resulting from a claimed operating loss carryback and we rejected the taxpayer's argument that the erroneous refund procedure was exclusive. We conclude that respondent was authorized to follow the deficiency procedure in this case, rather than proceed under section 7504 to collect an erroneous refund, and that the applicable statute of limitations is81 that prescribed in section 6501(a) of the Code. Section 6501 provides that an assessment may be made at any time within 3 years of the date the return was due to be filed. Section 6212 authorizes respondent to issue a notice of deficiency to a taxpayer if he determines that there is any additional tax due from the taxpayer. Section 6213(a) provides generally, with exceptions not here relevant, that no assessment or collection of the deficiency in tax may be made until a notice of deficiency has been mailed to the taxpayer. In this case petitioners' return for 1969 was due and was filed on or before April 15, 1970. The 3-year statute of limitations provided in section 6501(a) did not expire until April 15, 1973. The notice of deficiency was mailed to petitioners on July 26, 1972, prior to the expiration of the period of limitations prescribed by section 6501(a).Hence, respondent is not barred from assessing and collecting the deficiency in tax for the year 1969. The deficiency resulting from the omission of $3,999.84 of taxable income is $683 as determined in the notice of deficiency. Petitioners note that section 6501(e) (1) (A) (ii) provides that in determining an amount82 omitted from gross income, there shall not be taken into account any amount that is disclosed in the return or in a statement attached thereto. Petitioners contend that since the amount of the reimbursement for travel expenses, the $3,999.84 here involved, was shown on the W-2 form attached to the return, the Government was apprised of the nature and amount of such item, and since it did not include such amount in petitioners' income prior to making the refund, respondent cannot now assert a deficiency with respect to the unreported reimbursed income. Section 6501(e) relates to the special 6-year statute of limitations which applies where there is a 25-percent omission of gross income from the return. It has nothing to do with erroneous refund actions, and is an exception to the general 3-year statute applicable under section 6501(a) to assertions of deficiencies. It has no application to the present case, and petitioners' reliance thereon is misplaced. We find no support for petitioners' arguments in the several cases they cite without discussion in their briefs. Neither do we find merit in any of the various motions filed by petitioners both before and after this case was*83 submitted, and they are denied. Our conclusion herein based on the merits makes respondent's motion to dismiss for lack of prosecution moot. Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625386/	GEORGE T. HORVAT and CAROL R. HORVAT, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentHorvat v. CommissionerDocket Nos. 11910-78, 11911-78.United States Tax CourtT.C. Memo 1980-266; 1980 Tax Ct. Memo LEXIS 326; 40 T.C.M. (CCH) 724; T.C.M. (RIA) 80266; July 21, 1980, Filed George T. Horvat, pro se. Joseph R. Peters, for the respondent. FEATHERSTONMEMORANDUM FINDINGS OF FACT AND OPINION FEATHERSTON, Judge: In these consolidated cases respondent determined the following deficiencies and additions to tax under section 6653(a): 1/ Addition to TaxYearDeficiency(sec. 6653(a))1973$2,663.52$133.1819742,041.57102.0819752,209.00110.00The issues presented for decision are as follows: 1. Whether petitioners are taxable on the earnings of petitioner George T. Horvat which he assigned to a trust to which he conveyed his lifetime services; and 2. Whether petitioners are liable for328 the determined addtions to tax under section 6653(a). FINDINGS OF FACT Petitioners George T. Horvat (George) and Carol R. Horvat (Carol) were legal residents of Wisconsin when they filed their petitions. They timely filed joint Federal income tax returns for 1973 through 1975 with the Internal Revenue Service Center, Kansas City, Missouri. On June 21, 1971, George as grantor created a trust designated as the George T. Horvat Family Estate (A Trust). Under the terms of the trust agreement he purported to make an irrevocable conveyance of the following: * * the exclusive use of my lifetime services and all resultant earned remuneration and to be earned remuneration for all and any outside source; and all my right, title and interest in said earnings from my services rendered or to be rendered, said services and resultant remuneration therefrom, from this date forth, to be controlled, directed and owned SOLELY by THIS TRUST. The beneficiaries of the trust were petitioners and their two children. George, designated as "Trust Manager," and Carol, as "Trust Secretary," were authorized to draw checks on a bank account established in the name of the trust. The checks could329 be drawn-- whether said checks are payable to cash, bearer or the order of the Trust or to any third party or to the order of any signing Trustee or Manager or Secretary of THIS TRUST in either individual or official capacity. During 1973 through 1975, George was employed by the Heil Company. When his wages were received he endored them over to the trust and deposited them in the trust bank account. Petitioners then used the account to defray their living and other expenses. For the years 1973, 1974, and 1975, George received wages in the amounts of $14,033.66, $13,436.36, and $12,541.73, respectively, which were not reported as income in petitioners' joint returns for those years. Petitioners also received interest income which was not reported as income. Respondent determined that all such income was taxable to petitioners and that petitioners are liable for additions to tax under section 6653(a). OPINION Respondent's determination must be sustained. One of the most elementary principles of the income tax law is that income is taxable to the one who earns it and taxation of that income cannot be escaped by anticipatory arrangements assigning it to someone else. 330 . This principle has been applied in a long list of so-called family trust cases similar to the present one, including a case filed by petitioners. See, e.g., , affd. per order (7th Cir., June 7, 1978), cert. denied ; 2/ (Mar. 31, 1980), on appeal (10th Cir., June 2, 1980); (Mar. 31, 1980); . The facts relating to the small amount of income other than George's wages are not developed by the record. We think it clear that, if the trust had any economic substance whatever, the grantor trust provisions of sections 671 through 677 require this other income also to be taxed to petitioners. The more realistic view, however, is that the trust was devoid of economic reality and is to be treated as a nullity331 for tax purposes. See We think it equally clear that petitioners have not shown that the underpayment of tax was not due to negligence or intentional disregard of the rules and regulations within the meaning of section 6653(a). 3/ The creation of the trust was plainly a tax avoidance scheme. George testified that tax avoidance was one of his purposes. Petitioners failed to introduce any evidence to show that they proceeded with reasonable care or due regard to the tax laws in taking a step so drastic as assigning their future earnings and other income to another entity. We are compelled to hold that the addition to tax is applicable. 332 To reflect the foregoing, Decisions will be entered under Rule 155. Footnotes1. /↩ All Section references are to the Internal Revenue Code of 1954, as in effect during the tax years in issue, unless otherwise noted.2. /↩ Respondent does not allege or argue that petitioners are collaterally estopped by this prior opinion to deny that they are taxable upon the assigned income.3. / 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 (relating 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.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625387/	Estate of Vernon J. Reeve, Russell K. Reeve, Executor v. Commissioner.Estate of Reeve v. CommissionerDocket No. 92510.United States Tax CourtT.C. Memo 1962-115; 1962 Tax Ct. Memo LEXIS 195; 21 T.C.M. (CCH) 611; T.C.M. (RIA) 62115; May 14, 1962195 Thomas J. Smail, Jr., Esq., for the petitioner. Robert N. Elliott, Esq., for the respondent. MURDOCKMemorandum Findings of Fact and Opinion MURDOCK, Judge: The Commissioner determined a deficiency of $19,055.06 in estate tax. The issues for decision include: 1. Whether the decedent owned all or only one-half of real property in a farming partnership between him and his son, Robert. 2. The deductibility of certain debts. 3. The value of a one-third interest in an estate. 4. The value of improvements on the real estate, and the ownership of cattle and equipment used in the partnership. Findings of Fact The decedent, Vernon J. Reeves, died, unmarried, on October 22, 1956. He had been in poor health for several years. The estate tax return was filed with the district director of Internal Revenue at San Francisco. The decedent owned and operated a dairy farm in San Joaquin County, California, prior to 1946. He, his two sons and a daughter lived on the farm. The daughter and her husband moved off the farm after Robert was married. His son, Robert, born in 1922, did a great deal of the work on the farm without pay and, at his father's request, he continued196 to do so instead of serving in the Armed Forces during World War II. The father realized the worth of Robert's efforts and agreed orally at the end of 1945 that they would henceforth be equal partners in the ownership and operation of the farm, the improvements, the stock and the equipment. Thereafter partnership returns were filed annually in accordance with this agreement. No written partnership agreement was ever executed. Title to the real property used in the partnership business remained in the father's name and title to some additional land purchased for the partnership was taken in the name of the father. Robert and his father each owned equal interests in all real and personal property used in the farm partnership business at all times while the partnership existed. The farm partnership entered into a contract to buy some hay from Pompo & Sons. The first delivery under the contract was made on the day the decedent died and deliveries of the remaining hay were made during the following three months. Robert paid $2,951.36, the amount due for the hay. No part of that amount represented a debt of the partnership or of the decedent at the time of his death. Robert consulted197 a firm of lawyers shortly before his father's death in regard to his rights to property of the partnership or partnerships with his father. No part of the $294.86 paid by Robert for those legal services represented a debt of the decedent or of the partnership at the time of the death of the decedent. The decedent and his three children entered into a property settlement agreement on October 17, 1956, pursuant to which each was to have certain described properties (including some property claimed by petitioner to be partnership property), and Robert was to pay various expenses of the father and a $15,000 note given to his sister. The decedent executed a bill of sale dated October 17, 1956, transferring to Robert the undivided one-half interest in the farm machinery, equipment and livestock which Robert did not already own, thus giving "him the full and complete ownership of the same." The decedent and Robert entered into an agreement dated October 19, 1956, reciting, inter alia, as follows: 2. That all real and personal properties, including the buildings and land that Robert received from Vernon in the division of Vernon's property was in settlement for his share of our partnership198 that existed since 1945, on all lands, buildings and real and personal property. 3. That in the acceptance of the division of the property from Vernon, Robert hereby waives and gives up any and all claims he would have had on properties given to Keith and Dorothea. 4. That it is hereby mutually agreed that the partnership existing between Vernon and Robert is hereby dissolved as of the 17th day of October, 1956. All stipulated facts not set forth above are incorporated herein by this reference. Opinion The Commissioner agrees that a valid partnership existed between the decedent and his son, Robert, during the period from the close of 1945 until it was dissolved on October 19, 1956. He determined and contends, however, that all of the real property used in the operation of that partnership belonged throughout and on October 22, 1956, to the decedent. Values of items involved have been stipulated. The petitioner contends that only a one-half undivided interest in the farm property belonged to the decedent because the other undivided one-half belonged to Robert. 1 The decision of this issue turns upon the factual question of whether the decedent and Robert intended that they199 should have equal ownership of all properties used during the ten years in the business and operations of their partnership. The Commissioner relies heavily upon the record title to the real estate to show full ownership in the decedent and upon the absence of book records to show capital accounts. There is considerable evidence to show that the decedent and Robert intended, when they entered into their oral agreement late in 1945, that the farm land then owned and the improvements thereon, all essential to the farm operation, should henceforth belong equally to both as partnership property. There is even less doubt that subsequent improvements and land acquisitions thereafter used in the partnership business were to be partnership assets, the rights in which belonged equally to the partners. They were farmers, father and son, and the fact that title to the land was always in the name of the father is not determinative. En Taik Ha v. Kang, 187 Calif. Ap. Rep. 2d 84; 9 Cal. Reptr. 425. All of the evidence bearing upon this question has been carefully considered and200 it fairly preponderates in favor of the petitioner, which is entitled to a favorable decision on this issue. The petitioner claims no more than one-half of the farm partnership debts in computing a deduction under such circumstances. Two items are not deductible as debts of the decedent. One is one-half of the amount paid by Robert for some hay, all of which was delivered to Robert and used by him after the partnership had been dissolved. There is no reason to conclude that this hay ever was an asset of the partnership or that the partnership ever owed a debt for such hay. The one would wash out the other for estate tax purposes if those conclusions were wrong. The other item is a legal fee. The evidence not only fails to show that it was an expense or a debt of the partnership but shows, on the contrary, that it was not and was incurred solely for the personal benefit of Robert. The petitioner's briefs contain no argument with respect to the treatment of assets or debts of a milking machine partnership, mentioned in the stipulation and testimony, and the Court has no occasion to discuss how any such items should be treated. The Commissioner, quite belatedly, filed an amended*201 answer claiming an increase in the deficiency on the grounds, (1) that the value of farm land improvements to be included in the gross estate should be $75,000 instead of $30,000, as determined and also conclusively stipulated by him, and (2) that all, instead of one-half of the value of partnership cattle and farm equipment should be included in the gross estate. There is no merit to either contention, assuming that they were timely made. It would not be proper to consider evidence contrary to the express stipulation, introduced jointly by the parties, that the value of the farm improvements at the valuation date was $30,000 and furthermore, there is no such contrary evidence. It is quite clear that livestock and farming equipment of the partnership belonged equally to the partners. The petitioner challenges the Commissioner's valuation of the decedent's one-third interest in the estate of Cora E. Mitchell but offers no proof of what a correct value might be. The evidence does not show any error in the value of this item used by the Commissioner in determining the deficiency. Decision will be entered under Rule 50. Footnotes1. Petitioner concedes that items 7, 8, and 9 in Schedule G of the return belonged to the decedent.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625388/	EARL AND BETTY CAPEHART, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentCapehart v. CommissionerDocket No. 7970-76.United States Tax CourtT.C. Memo 1978-409; 1978 Tax Ct. Memo LEXIS 103; 37 T.C.M. (CCH) 1704; T.C.M. (RIA) 78409; October 12, 1978, Filed Lloyd Taylor, for the petitioners. Alan Summers, for the respondent. QUEALYMEMORANDUM FINDINGS OF FACT AND OPINION QUEALY, Judge: Respondent determined a deficiency of $ 558.48 in petitioners' Federal income taxes for the 1974 calendar taxable year. The two issues for determination are (1) whether petitioners are entitled to a dependency exemption for the son by a former marriage of petitioner Earl Capehart and (2) whether petitioner Betty Capehart in computing her sick-pay exclusion is subject to one or to two 30-day waiting periods. FINDINGS OF FACT Petitioners resided in Redwood City, California, at the time this petition was filed. Petitioners' Federal income tax return for the 1974 calendar year was filed with the appropriate office of the Internal Revenue Service. From January 1 of 1974, through the first two weeks of August of that year, excluding the last two weeks in July, petitioner Earl Capehart's son, Keith, lived with petitioners. For the remainder of the year and the last two weeks in July, Keith105 lived with his mother, Mr. Capehart's former wife. While the son lived with his mother, Mr. Capehart paid the mother as child support $ 50 for the last half of July, and $ 100 a month from September 1, for the remainder of the year. Petitioner Betty Capehart, a pharmacist employed at the Sequoia Hospital District in Redwood City, was absent from her job from January 19, 1974, through April 21 of that year because of a back injury incurred in the latter part of 1973. On April 22, 1974, she returned to work part time until June 20 of 1974, when she left work for the remainder of 1974 because of the same back injury. From April 22, 1974, until June 20, 1974, when Mrs. Capehart worked part time for the hospital, she performed work similar to the work she performed when she was working full time. While working part time, her daily hours at work varied from two to eight. Of the 36 days Mrs. Capehart worked part time, she worked five hours or more on 28 of such days. During her entire period of absence from January 19 through April 21, 1974, Mrs. Capehart received payments from the hospital attributable to accrued sick pay and payments from the California State Disability Fund. 106 During the first 30 calendar days of her absence beginning June 20, 1974, she received vacation pay from the hospital in addition to the payments as sick pay from the hospital and payments from the California State Disability Fund. Had Mrs. Capehart worked full time during her two periods of absence, her weekly rate of pay would have been $ 245. OPINION Petitioners had custody of Mr. Capehart's son Keith for more than half of the 1974 calendar year. For the remainder of the year when Keith was in the custody of his mother, Mr. Capehart paid Keith's mother child support. During 1974, petitioner Betty Capehart from January 19 through April 21, 1974, and again from June 20, 1974, for the balance of the year was absent from work because of a back injury. In the interim between April 21 and June 19, 1974, she worked part time at her job, performing tasks similar to those she performed while working full time. The first issue is whether petitioner Earl Capehart is entitled to a dependency deduction for his son Keith. This question is answered by sec. 152. 1 Sec. 152(a)(1) defines "dependent" as including a son of the taxpayer "over half of whose support, for the calendar year107 in which the taxable year of the taxpayer begins, was received from the taxpayer." Mr. Capehart qualifies under the general rule of sec. 152(e)(1) 2 for the personal exemption deduction for his son Keith. Mr. Capehart and his former wife were divorced prior to the taxable year in issue. Keith received over half of his support from his divorced parents. Mr. Capehart had custody of Keith for the greater portion of the calendar year. 3108 The second issue is whether petitioner Betty Capehart in computing her sick pay exclusion under sec. 105(d) is subject to one or to two 30-day waiting periods. Sec. 105(d) provides that if the employee's sick pay is more than 75 percent of his "regular weekly pay," no exclusion from gross income is allowed for the first 30 days of absence. Petitioners accede that the 75 percent plateau has been exceeded. The question is whether Mrs. Capehart's period of absence from work ended during the interim between April 22 and June 19, 1974, when she returned to work part time. If not, she was not subject to a second 30-day waiting period when she left work on June 20, 1974, for the remainder of the year. The statute specifically grants to the Treasury authority to prescribe regulations governing the applicability of the exclusion under sec. 105(d). While not included within the specific grant of authority therein, the promulgation of regulations defining what shall constitute "absence from work" is equally appropriate. Sec. 1.105-4(a)(4), Income Tax Regs., states "absence from work shall commence the moment the employee first becomes absent from work and shall end the moment the*109 employee first returns to work." The meaning of "returns to work" is illustrated in sec. 1.105-4(a)(5), Income Tax Regs.: An employee is not absent from work when he performs any services for his employer at his usual place or places of employment, whether or not the services are the usual services performed by the employee… If an employee returns to his usual place or places of employment and performs any services for his employer, he has returned to work… (Emphasis added) Mrs. Capehart "returned to work" during the interim between April 22 and June 19, 1974. During that period she worked part time at the hospital, performing work similar to the work she performed when she was working full time. Moreover, on 28 of the 36 days she worked part time, she worked five hours or more. Mrs. Capehart is subject to a second 30-day waiting period for her absence from work beginning June 20, 1974. Sec. 105 (d). 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. Sec. 152(e)(1) provides: (e) Support Test in Case of Child of Divorced Parents, Et Cetera.-- (1) General Rule.--If-- (A) a child (as defined in section 151(e)(3)) receives over half of his support during the calendar year from his parents who are divorced or legally separated under a decree of divorce or separate maintenance, or who are separated under a written separation agreement, and (B) such child is in the custody of one or both of his parents for more than one-half of the calendar year, such child shall be treated, for purposes of subsection (a), as receiving over half of his support during the calendar year from the parent having custody for a greater portion of the calendar year unless he is treated, under the provisions of paragraph (2), as having received over half of his support for such year from the other parent (referred to in this subsection as the parent not having custody). ↩3. Respondent contends Mr. Capehart did not have custody of Keith for more than half of 1974, thus bringing into play sec. 152(e)(2). We disagree with the factual contention of respondent.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625389/	Raymond Spector and Selma Spector, Petitioners, v. Commissioner of Internal Revenue, RespondentSpector v. CommissionerDocket No. 94867United States Tax Court42 T.C. 110; 1964 U.S. Tax Ct. LEXIS 121; April 13, 1964, Filed 121 Petitioners' representative negotiated a settlement stipulation with Government counsel, which was filed with this Court. Petitioners thereafter retained new counsel who sought to set aside the stipulation. Held, no valid grounds for setting aside the stipulation have been established. Morris W. Primoff, for the petitioners.Edward Hance and W. T. Holloran, for the respondent. Raum, Judge. RAUM110 OPINIONThis is a proceeding on an order to show cause, as more fully hereinafter set forth.111 The Commissioner determined certain deficiencies in income tax against petitioners, husband and wife, for the years 1955-58, and they filed a petition in this Court contesting those deficiencies122 on October 30, 1961. On November 1, 1961, Jack A. Rothenstein, a member of the bar of this Court, entered his appearance for the petitioners. Thereafter, on December 10, 1962, the clerk of this Court served notice setting the case for trial in New York on March 18, 1963.As a result of four separate settlement conferences between Rothenstein and representatives of the Government, a settlement agreement was entered into and signed by Rothenstein for the petitioners and by (or on behalf of) the Chief Counsel of the Internal Revenue Service for the Government. In that agreement it was stipulated that "the Court may enter" a decision the terms of which were set forth in full in the document containing the stipulation. That stipulation was received by the Court on March 8, 1963, the decision, agreed upon by counsel, was signed by Judge Tietjens of this Court, and that decision was entered March 11, 1963. That decision read as follows:Pursuant to agreement of the parties in the above-entitled case, it isOrdered and Decided: That there are deficiencies in income taxes due from the petitioners for the taxable years 1955, 1956 and 1957 in the amounts of $ 58,995.79, $ 850.31 and $ 232.00, 123 respectively, and that the following statement shows the petitioners' income tax liability for the taxable year 1958:Tax liability$ 12,662.17Tax assessed and prepaid1,554.01Deficiency (to be assessed)11,108.16(Signed) Norman O. Tietjens,Judge.On May 13, 1963, a "Motion to Vacate Decision" was filed on petitioners' behalf, signed by Morris W. Primoff, a member of the bar of this Court, who, on June 5, 1963, entered his appearance. That motion alleged, inter alia, that "the respondent was not aware of all the pertinent facts," particularly those relating to a claimed 1958 net operating loss carryback which would have eliminated the deficiency for 1955. It alleged also that there was a net operating loss for 1959 which was not taken into account as a carryback in determining liability for the years 1956-58. The motion further alleged that the Government representatives were not aware of the 1959 net operating loss carryback and that petitioners' representative had not imparted to them any information concerning that issue.On June 5, 1963, Rothenstein moved to withdraw as counsel, indicating an understanding that petitioners "have other counsel representing124 them." That motion was granted June 6, 1963.112 On June 10, 1963, Judge Tietjens entered the following order:For cause appearing of record, it isOrdered that the decision entered in this case on March 11, 1963, is hereby vacated and it is furtherOrdered that the parties shall show cause at 10:00 A.M., July 10, 1963, at Washington, D.C., why the Court should not enter a decision in accordance with the stipulation of the parties and the proposed decision received by the Court on March 8, 1963.(Signed) Norman O. Tietjens,Judge.After several continuances, requested by the parties, a hearing was had on March 3, 1964, in New York 1 on the matters covered by the order to show cause. Petitioners' present counsel, Morris W. Primoff, presented evidence in support of petitioners' position, and the Government presented evidence in opposition thereto. We heard oral testimony and received certain exhibits in evidence.125 We are fully satisfied that there is no basis for setting aside the agreed settlement heretofore filed with the Court on March 8, 1963, that the decision entered in accord therewith on March 11, 1963, was proper, that the order to show cause which vacated that decision on June 10, 1963, should be discharged, and that the proposed decision received by the Court on March 8, 1963, should be entered in accordance with the stipulation.The evidence presented to us persuades us that counsel for the parties were not laboring under any misapprehension or mutual mistake of fact when they executed the settlement agreement. One of the witnesses at the hearing was petitioner's former representative, Rothenstein. We are satisfied that he and Government counsel were fully aware of the matters that petitioners' new counsel seeks to press upon us as a basis for invalidating the settlement agreement. These matters, particularly the possible carryback from 1958, were taken into account by them in reaching the settlement agreement.As to that possible carryback from 1958, counsel were highly sensitive to the consequences of not pressing the claimed deduction for 1958 that would give rise to the net126 operating loss carryback. The Government's position was that the claimed deduction was in reality a nondeductible capital item; and the effect of the settlement was to increase the basis of stock owned by petitioners, thereby providing tax benefits for subsequent years that would offset at least in part the concession for 1958. The facts that would support petitioners' claim to the deduction for 1958 were known to both sides, and the settlement was arrived at in the light of known facts and the possibly conflicting interpretations that could be placed upon such facts. The agreement 113 was reached after making calculated judgments based upon a full evaluation of all pertinent matters. We do not intend to suggest that even if the matters alleged by petitioners' new counsel were true the stipulation could be set aside in the absence of fraud or like cause, cf. Fred M. Saigh, Jr., 26 T.C. 171">26 T.C. 171, 180; it is sufficient for present purposes to note that there were no such circumstances as alleged.As to the allegation relating to the carryback from 1959, only a word is necessary. The settlement agreement in no way affects any such possible carryback, 127 as yet undetermined. When and if any such carryback is determined, petitioners' rights in respect thereof are fully protected. Sec. 6511(d)(2), I.R.C. 1954.Petitioners' present counsel also argued at the hearing that Mrs. Spector was not consulted by Rothenstein prior to signing the settlement agreement, and testimony by her bears him out. However, the evidence shows that Rothenstein did consult with Mr. Spector, who acquiesced in the settlement, notwithstanding that he was plainly unhappy about it. Rothenstein had a power of attorney signed by both spouses on January 29, 1962. Its terms were broad and sweeping. It provided as follows:Know all men by these presents that I Raymond Spector and Selma Spector, residing at 136 East 46th Street, in the Borough of Manhattan, City and State of New York, individually, jointly, and severally, do hereby constitute and appoint Jack A. Rothenstein, of 850 Third Avenue, New York 22, New York, my agent and attorney to appear for me, and represent me, before the Treasury Department, in connection with any matter involving federal income taxes for the taxable years, 1955, 1956, 1957 and 1958, in which I am a party, giving my said attorney 128 full power to do everything whatsoever requisite and necessary to be done in the premises, and to receive checks, to execute waivers of the statute of limitations and to execute closing agreements as fully as the undersigned might do in my own capacity, with full power of substitution and revocation, at any time subsequent to the date hereof and prior to the revocation hereof.It is requested, that a copy of all communications addressed to the undersigned regarding any matter in which my said attorney is hereby authorized to act, be addressed to Jack A. Rothenstein, 850 Third Avenue, New York 22, New York.In witness whereof, I have hereunto executed this instrument this 29 day of January, 1962.(S) Raymond Spector.(S) Selma Spector.We think that Rothenstein had full authority thereunder to enter into the settlement in question. He did in fact consult with Mr. Spector, although he perhaps was not required to do so, and throughout the handling of the controversy he reasonably understood Mr. Spector to be the spokesman for both spouses. Mrs. Spector was a witness before us, and it was abundantly clear to us that she had very little comprehension of the matters involved, and129 that she relied upon her husband. Rothenstein was plainly not required to seek any oral approval 114 from Mrs. Spector in these circumstances, where his written authority was already complete and where he in any event had oral confirmation for the particular settlement from Mr. Spector who obviously spoke for both petitioners.It would cast doubt upon virtually thousands of settlement stipulations filed in this Court involving married petitioners living together who had filed joint returns, if decisions entered in accordance with such stipulations were open to attack by charges that counsel of record with full authority to represent both spouses had consulted only one of them prior to executing the stipulation. In any event, there is no basis in this case for setting the agreement aside. This appears to us to be a case merely where a party has second thoughts about a settlement and retains new counsel in an effort to upset it. There are no valid grounds here to attain that end.The order to show cause will be discharged, and decision will be entered in accord with the stipulation heretofore filed. Footnotes1. At the suggestion of the parties, and for their convenience, the hearing was held in New York rather than in Washington, as originally specified in the order to show cause.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625390/	DENNIS WAYNE LINKER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentLinker v. CommissionerDocket No. 2261-89United States Tax CourtT.C. Memo 1993-279; 1993 Tax Ct. Memo LEXIS 282; 65 T.C.M. (CCH) 3019; June 28, 1993, Filed 282 Decision will be entered under Rule 155. Held: Petitioner is found to be an unreliable witness. Therefore, respondent's determinations are upheld. For petitioner: Edward P. Guttenmacher. For respondent: Sheldon M. Kay and Alison W. Lehr. WHITAKERWHITAKERMEMORANDUM FINDINGS OF FACT AND OPINION WHITAKER, Judge: Respondent determined a deficiency in, and an addition to, petitioner's Federal income tax for the year and in the amounts set forth below: YearDeficiencySec. 6653(b) 11981$ 180,447$ 90,223.50Respondent determined, and petitioner does not dispute, that during the year 1981 petitioner was engaged in the business of selling marijuana. For the year 1981 petitioner was an accrual method, calendar year taxpayer. Respondent filed a motion for partial summary judgment which was answered by petitioner and in283 December 1990 a hearing was held on respondent's motion. Based on those pleadings and the hearing, we found that petitioner is estopped from denying liability for the fraud addition to tax with respect to whatever deficiency, if any, is determined for the year 1981. FINDINGS OF FACT Some of the facts have been stipulated and they are so found. Petitioner was a resident of the State of Florida at the time of the filing of the petition herein. While it is not material to the case, we note that the statutory notice of deficiency was issued to petitioner while he was incarcerated for selling drugs. Petitioner was engaged in the purchase and sale of marijuana from approximately 1978 through May 1982. For the 1981 taxable year petitioner's books and records reflected only the period January 1 through August 13, 1981. The statutory notice was based on petitioner's books and records and, therefore, reflects sales of marijuana only for that period. Apparently, petitioner maintained no written record of business done in 1981 subsequent to August 13. Most of the testimony at trial concerned the period August 14, 1981, through December 31, 1981. Petitioner sought to establish substantial284 losses and bad debts to offset 1981 income. Respondent contends that for this period petitioner's gross sales were $ 5,827,656 with a cost of goods sold of $ 4,889,080. Respondent also contends that petitioner's net profit for this period, taking into account transportation and distribution costs, was $ 350,306. Respondent has conceded, however, that petitioner is entitled to an adjustment of $ 2,400 for a return of marijuana. Hence, according to respondent, petitioner's net profit for this period is actually $ 347,906. Petitioner has admitted receiving gross income of $ 347,906 from the sale of marijuana for the period January 1, 1981, through August 13, 1981. During 1981 petitioner operated a small corporation by the name of Class Plus Enterprises, Inc. It is petitioner's contention that he put drug money into Class Plus Enterprises, Inc., and drew out a salary reflecting part of that drug money. Petitioner actually reported gross income on his 1981 return of $ 42,509, which he contends was money derived from the marijuana business. Petitioner contends that his gross income through August 13, 1981, was $ 347,906 and for the remainder of the year was $ 103,802 2 for a total285 gross profit of $ 451,708. Petitioner also contends that he had expenses of $ 29,900 in 1981 in connection with the marijuana business and that he incurred a bad debt or debts of $ 242,420 resulting from a sale of marijuana to two individuals as to which the purchase price was allegedly never paid, as well as another bad debt arising out of a similar situation in the amount of $ 32,575. Petitioner also claims that he lost $ 105,000 in cash in an unsuccessful attempt to purchase marijuana in Texas, thus incurring expenses and losses for the year of $ 409,895 with a resulting net income for the year of $ 41,813 which is less than the amount reported on his 1981 income tax return. Although petitioner worked with or was associated with other individuals during 1981, he was the principal witness at trial. Two of petitioner's alleged customers did testify, but their testimony does not help petitioner's case286 or our findings of fact in any material respect. No explanation was offered for the failure to produce other corroborative testimony. We observed petitioner carefully throughout the trial since it was apparent to us that his credibility would be significant, if not controlling. During his testimony we were particularly alert to petitioner's appearance, facial expressions, and body language. Unfortunately, we became and remain convinced that petitioner was not a credible witness. OPINION Respondent's determinations of income tax deficiencies are generally presumed to be correct, and petitioner bears the burden of proving that respondent erred in her determinations. Rule 142(a); . We ordinarily will not look behind the notice of deficiency to examine the sufficiency of evidence upon which respondent relied in making her determinations. , affd. without published opinion (7th Cir., Oct. 3, 1986); . Some courts have suggested, however, that287 for respondent to rely upon the presumption of correctness in a case involving alleged illegal unreported income, respondent must offer some predicate evidence connecting the taxpayer to the specific illegal income-producing activity alleged in the notice of deficiency. , affg. in part and revg. and remanding in part ; , revg. ; , affg. in part, revg. in part and remanding . As set forth in our Findings of Fact, respondent's determinations are supported by both petitioner's admissions and petitioner's books and records. Thus, a rebuttable presumption of correctness attaches to respondent's determinations, and the burden of going forward with evidence, as well as the burden of proof to establish petitioner's correct tax liability, remains with petitioner. See ,288 affg. . Petitioner's case rests largely upon the credibility of his own testimony. We are sure that his testimony includes a mixture of fact and fiction, but we have no way of separating fact from fiction except to the extent of the findings set forth herein. Petitioner's other two witnesses provide no material assistance. Our findings do not permit us to make any factual determination as to petitioner's actual net income or loss, as claimed by petitioner, from drug sales or otherwise during 1981. We cannot and do not accept petitioner's contentions as to this issue, having found him to be an unreliable witness. Therefore, we have no choice but to find for respondent in this case. Petitioner contends that if a deficiency is found in his 1981 income tax, then petitioner's tax liability must be computed using income averaging. Secs. 1301-1305. Petitioner did not claim income averaging on his 1981 return and, therefore, the burden of proof rests with petitioner. Respondent contends that petitioner is not entitled to income averaging for 1981 because petitioner did not establish his correct taxable income for the base period years. 289 Sec. 1302(c)(2); ; see ; ; . Petitioner's returns as filed for the base period years were admitted into evidence. We have reviewed petitioner's base period returns and the testimony relating thereto and are convinced that the returns do not accurately reflect the income realized by petitioner from his marijuana sales during 1978, 1979, and 1980. Therefore, petitioner has failed to meet his burden of proof with respect to the income averaging issue, and we decide this issue for respondent. In accordance with our earlier ruling, petitioner is estopped from denying liability for the fraud addition to tax with respect to the deficiency determined herein. A criminal conviction based on an indictment charging a willful attempt to evade or defeat taxes necessarily carries with it the ultimate factual determination that the resulting deficiency was due to fraud. ,*290 affg. ; ; ; ; , affd. . Furthermore, for purposes of applying the doctrine of collateral estoppel regarding the fraud issue, there is no difference between a conviction based on a guilty plea and a conviction after a trial on the merits. ; . Decision will be entered under Rule 155. Footnotes1. All section references are to the Internal Revenue Code of 1954 in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩2. Respondent contends that this figure should be $ 103,862. We make no effort to resolve this minor discrepancy.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625391/	DONALD D. AND VERA H. BURK, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentBurk v. CommissionerDocket No. 10020-84.United States Tax CourtT.C. Memo 1986-233; 1986 Tax Ct. Memo LEXIS 375; 51 T.C.M. (CCH) 1156; T.C.M. (RIA) 86233; June 9, 1986. Donald D. Burk, pro se. Robert F. Cunningham, for the respondent. PAJAKMEMORANDUM OPINION PAJAK, Special Trial Judge: This case was assigned pursuant to section 7456 of the Code and Rule 180. 1Respondent determined a376 deficiency in petitioners' 1980 Federal income tax in the amount of $1,976. The only issue for decision is whether petitioners are entitled to a residential energy credit under section 44C. To the extent stipulated, the relevant facts are so found. 2 Petitioners resided in Eau Claire, Wisconsin, at the time they filed their petition. In 1979, petitioners began the construction of a new residence. Petitioners wished to heat the residence with a heating system that would conserve energy and also would qualify for an energy tax credit. When petitioners made the decision sometime in 1979 to install the heating system, they were advised by Internal Revenue Service representatives that the expenditures for the system would qualify for such a credit. The heating system installed by petitioners extracts heat from ground water by means of a heat pump. The water used in the system is drawn from a well 190 feet deep. The system377 pumps ground water into the house and circulates the water through a bimetal coil. Freon coils around the bimetal coil are used to extract the natural warmth from the water. This apparatus is called a heat pump extractor. A forced air fan then circulates the heat through the home. Although the exact temperature of the ground water is not known, petitioners concede that it is less than 50 degrees Celsius (122 degrees Fahrenheit) at the wellhead. Based on petitioner Donald D. Burk's testimony, we find that it was about 14 degrees Celsius at the wellhead. On their joint 1980 Federal income tax return, petitioners claimed a geothermal energy credit in the amount of $1,976. Respondent disallowed this credit because the water used in petitioners' heating system did not qualify as a geothermal deposit. Section 44C [now section 23] provides that an individual taxpayer will be allowed a credit against tax for "qualified renewable energy source expenditures." These expenditures must be made with respect to renewable energy source property. Section 44C(c)(2)(A). Renewable energy source property includes property which, when installed in connection with a dwelling, transmits or uses378 energy derived from geothermal deposits. Section 44C(c)(5)(A)(i). Under section 44C(c)(6)(A)(i), the Secretary is authorized to issue regulations which establish specific criteria to be used in prescribing performance and quality standards for renewable energy source property. The Secretary has issued section 1.44C-2(h), Income Tax Regs., which provides in pertinent part that: The term "geothermal energy property" includes equipment * * necessary to transmit or use energy from a geothermal deposit to heat or cool a dwelling * * . A geothermal deposit is a geothermal reservoir consisting of natural heat which is from an underground source and is stored in rocks or in an aqueous liquid or vapor (whether or not under pressure), having a temperature exceeding 50 degrees Celsius as measured at the wellhead or, in the case of a natural hot spring (where no well is drilled), at the intake to the distribution system. [Emphasis added.] Petitioners' heating system does not qualify as geothermal property under the regulations because it does not use water which has a temperature exceeding 50 degrees Celsius at the wellhead. Petitioners first contend that the 50 degrees requirement, 379 as set forth in the regulation, is contrary to the intent of Congress in enacting section 44C. Since the regulation in question here was not in effect in 1979 when they made their decision to install the heating system, they also argue that it is arbitrary and unreasonable for respondent to apply his regulations retroactively. 3 Lastly, they claim they were advised by respondent's agents that they would be entitled to the credit. With respect to petitioners' first argument, this Court has upheld the validity of section 1.44C-2(h), Income Tax Reg. under facts similar to those present here. Peach v. Commissioner,84 T.C. 1312">84 T.C. 1312 (1985). See Hickey v. Commissioner,T.C. Memo 1986-186">T.C. Memo. 1986-186; Bayless v. Commissioner,T.C. Memo 1986-113">T.C. Memo. 1986-113; Rabenold v. Commissioner,T.C. Memo. 1985-309, on380 appeal (11th Cir., Sept. 23, 1985); Reddy v. Commissioner,T.C. Memo. 1984-395, affd. per order (4th Cir., August 29, 1985). In Peach v. Commissioner,supra, the Court explained that this regulation was promulgated pursuant to a specific legislative authority and since it is legislative in nature, it should be sustained unless clearly inconsistent with the statute. The Court held that: "a requirement of a temperature exceeding 50 degrees Celsius is a reasonable regulation for determining the heat requirement of a geothermal deposit." (Fn. ref. omitted.) Peach v. Commissioner,supra at 1317. Petitioners' second argument also has been considered and rejected by this Court. In Peach v. Commissioner,supra, the Court observed that under section 7805(b) respondent may apply regulations retroactively unless otherwise specified. The Court further noted that "except in unusual circumstances, making a regulation retroactive is not an abuse of discretion by the Commissioner." Peach v. Commissioner,supra at 1318. Lastly, whatever Internal Revenue Service representatives may have advised381 petitioners, it is well established that the Commissioner is not bound by an erroneous interpretation of law by his agents but must follow the statutes, regulations and case law. Dixon v. United States,381 U.S. 68">381 U.S. 68, 72-73 (1965); Neri v. Commissioner,54 T.C. 767">54 T.C. 767 (1970). Although petitioners' attempt to conserve energy and thus benefit the nation by reducing its dependency on imported fuel supplies is commendable, they are not entitled to a residential energy credit in 1980 under section 44C and section 1.44C-2(h), Income Tax Regs. Accordingly, respondent's determination is sustained. Decision will be entered for the respondent.Footnotes1. All section references are to the Internal Revenue Code of 1954 as in effect during the taxable year in issue, unless otherwise indicated. All rule references are to the Tax Court Rules of Practice and Procedure.↩2. Respondent has objected to paragraph 10 of the stipulation of facts on the grounds that the statements contained there are not relevant to the proceedings. We agree. Accordingly, we do not find as fact any of the statements contained in that paragraph.↩3. Proposed regulations setting forth a 60 degrees Celsius requirement were published by the Secretary in the Federal Register (44 Fed. Reg. 29923 (1979)) on May 23, 1979. Section 1.44C-2(h), Income Tax Regs., setting forth the 50 degrees requirement was published on Aug. 29, 1980 (45 Fed. Reg. 57712↩ (1980)).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625392/	RODNEY D. AND JUDITH E. MORRIS, ET AL., 1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Morris v. CommissionerDocket Nos. 2240-84, 15031-84, 15296-84, 34605-84, 40583-84, 4548-85.United States Tax CourtT.C. Memo 1987-7; 1987 Tax Ct. Memo LEXIS 7; 52 T.C.M. (CCH) 1304; T.C.M. (RIA) 87007; January 6, 1987. Jonathan8 A. Brod and Debra L. Bowen, for the petitioners. Joyce L. Sugawara, for the respondent. SHIELDSMEMORANDUM FINDINGS OF FACT AND OPINION SHIELDS, Judge: Respondent determined deficiencies in petitioners' Federal income taxes as follows: PetitionerDocket No.YearDeficiencyRodney D. and2240-841981$1,249Judith E. MorrisGordon B. and15031-8419804,559Martha J. Barrett40583-8419816,082Bennie Ward, Jr. and15296-8419811,448Sharon C. WardFlorence E. Harms34605-8419793,36534605-8419801954548-8519814,100The sole issue for decision is whether portions of amounts received as salary by petitioners are excludable from gross income under sections 104(a)(1), 104(a)(2), or 105(c). 2FINDINGS OF FACT All of petitioners resided in Claremont, California when they filed their petitions. During the years in issue Rodney D. Morris9 ("Morris"), Gordon B. Barrett ("Barrett"), Bennie Ward, Jr. ("Ward"), and Florence E. Harms ("Harms") were employed as officers by the Sheriff of Los Angeles County and each of them received or had previously received injuries in the course of their duties on the dates and in the manner set out below. MorrisMorris injured his back in January 1969, while on duty as a patrol officer. The injuries did not result in the permanent loss or loss of use of a member or function of his body. He was unable to work for a few days after the injury, but within a few weeks he returned to his regular duties. He has had no recurrence of the injury. In June 1969, Morris filed a claim with the California Worker's Compensation Appeals Board ("WCAB") for worker's compensation benefits as a result of the injury. The WCAB in March 1970 awarded him benefits of $1,470 based on a permanent disability rating of 7 percent. 3He was promoted from deputy to sergeant in 1974, and was assigned to the10 San Dimas Station in 1977 as station coordinator. On their income tax return for 1981, the Morrises reported the receipt by Morris of $47,449.94 in salary from the County of Los Angeles but excluded 7 percent of this amount ($3,322) from their gross income because of Morris' permanent disability rating. BarrettBarrett has sustained three injuries to his back while on duty. None of them resulted in the permanent loss or loss of use of a member of function of his body. The first occurred in October 1977 during a scuffle with a suspect. The second resulted from a fall from a stairway in March 1978 when its railing collapsed.The third injury, in March 1980, was also the result of a fall during inclement weather. At the time of each injury, Barrett was a sergeant, assigned to duty as a traffic and filed supervisor. After the 1980 injury, he was unable to work for a few days and on intermittent occasions thereafter. When he returned to full-time duty following the injury, he was placed on "light duty," which meant that he was not to engage in any arduous activity or take any action that would tend to increase the chance of re-injuring his back. During this period he11 frequently left work early because of pain, and occasionally went to therapy while on duty. His pay was not reduced for such periods. Barrett filed benefit claims with the WCAB for all three injuries. In January 1981, he was awarded worker's compensation benefits by WCAB of $21,280 for a permanent disability rating of 59 percent with respect to the 1980 injury. The claims for the 1977 and 1978 injuries were dismissed. On their income tax returns for 1980 and 1981, the Barretts reported $32,695.69 and $36,129, respectively, in salary from the County of Los Angeles. 4 On an amended return for 1980 and the original return for 1981 they excluded 59 percent of the salary ($19,290 and $21,316) from gross income because of Barrett's permanent disability rating. WardWard injured his Achilles tendon in October 1977 while serving as coordinator for the technical schools unit of the Sheriff's Department. He did not suffer a permanent loss or loss of use of a member or function of his body as a result12 of the injury. After the injury he remained in the same position until becoming a detective. In November 1981 WCAB awarded him worker's compensation benefits of $5,722.50 because of a permanent disability rating of 22.1 percent. On their income tax return for 1981, the Wards reported the receipt of $29,739 in salary from the County of Los Angeles but excluded 22.1 percent of this amount from gross income because of Ward's permanent disability rating. HarmsHarms injured her neck and both arms while on duty in June 1976, but did not suffer a permanent loss or loss of use of a member or function of her body as a result of the injuries. For several years thereafter, Harms was a watch sergeant at the Women's Jail but in 1981 she was removed from that position because of work restrictions caused by the 1976 injuries and was assigned to a "limited duty pool" where she performed duties usually assigned to deputies rather than sergeants. The residual effects of her 1976 injuries are such that she is unable to make full use of her hands and consequently is not permitted to carry a gun or to wear a uniform. In June 1976 WCAB awarded her worker's compensation benefits of $14,752.5013 because of a permanent disability rate of 45 percent. On her income tax returns for 1979, 1980, and 1981, Harms reported the receipt of $29,359, $31,627, and $34,790, respectively, in salary from the County of Los Angeles but on an amended tax return for 1979 and on the original return for 1981 she excluded 45 percent of the salaries received for these years ($13,210 and $15,656) from gross income because of the permanent disability rating.She did not exclude any of the salary on her 1980 return, but claimed an overpayment of taxes for that year in her petition. OPINION Petitioners contend that because of their disability ratings they are entitled to exclude a portion of their salaries from gross income under sections 104(a)(1), 104(a)(2), or 105. Section 104(a)(1)Section 104(a)(1) excludes from gross income "amounts received under workmen's compensation acts as compensation for personal injuries." Section 1.104-1(b), Income Tax Regs., provides that the exclusion set forth in section 104(a)(1) includes amounts received "under a statute in the nature of a workmen's compensation act which provides compensation to employees for personal injuries or sickness incurred14 in the course of employment." In these cases petitioners claim that a percentage of the salary they received after their injuries was paid pursuant to the workers' compensation statutes of California and the Los Angeles County Code (the "County Code"). In essence, they argue that, because they continued to receive the same salary after they became disabled and unable to perform some of their duties they were "overpaid" and the "overpayment" is excludable as worker's compensation. We, however, are unable to agree. To begin with, on this record petitioners are unable to demonstrate that any portion of their salaries was compensation for personal injuries. Admittedly each petitioner continued in the same position after his or her injuries and received the same salary. Furthermore Harms switched jobs in 1981 and was paid more in her new job than others performing the same duties. From the evidence before us, however, we are unable to find that the excess represented compensation for her injuries. In fact, Donald Sivard, a lieutenant with the Sheriff's Department who was responsible for the placement of injured employees, testified that all of the compensation paid to petitioners15 was considered regular salary and that petitioners would have received no payments unless services were rendered. In sum, it is clear from the record as s whole that the payments were for services and were totally dependent thereon. Furthermore, petitioners are unable to show that any portion of their salaries was made pursuant to a statute in the nature of a worker's compensation act. They have cited no statute providing benefits paid to officers in the form of salary when they continue to work after an injury. They cite section 4850 of the California Labor Code, but it only states that disabled officers on leave of absence are entitled to a full salary for up to one year. Petitioners, however, did not receive payments under this statute, and it is not relevant to the case before us. We conclude, therefore, that section 104(a)(1) is inapplicable to their situation. Section 104(a)(2)Section 104(a)(1) excludes from gross income "the amount of any damages received (whether by suit or agreement * * ) on account of personal injuries or sickness." This section, like section 104(a)(1), is also inapplicable because all of the payments received by petitioners were for16 services, not for injuries. In addition, there has been no showing that any portion of the payments constituted damages. As we stated in Glynn v. Commissioner,76 T.C. 116">76 T.C. 116 (1981), affd. without published opinion 672 F. 2d 682 (1st Cir. 1982): "The essential element of an exclusion under section 104(a)(2) is that the income involved must derive from some sort of tort claim against the payer." 76 T.C. at 119. Petitioners have asserted no tort claim against the County and could not have done so since their exclusive remedy is a claim for worker's compensation benefits. California Labor Code § 3601 (West 1971). Section 105(c)Section 105(c) excludes from gross income amounts received by an employee through accident or health insurance "to the extent such amounts - (1) constitute payment for the permanent loss or loss of use of a member or function of the body, or the permanent disfigurement, of the taxpayer, his spouse, or a dependent (as defined in section 152), and (2) are computed with reference to the nature of the injury without regard to the period the employee is absent from work." Here again, petitioners*17 have failed to place themselves within the statute because their payments were for services, not for anything else, including the loss of use of a member or function of the body. See Hines v. Commissioner,72 T.C. 715">72 T.C. 715, 719 (1979). We conclude, therefore, that section 105(c) is not applicable. Decisions will be entered for the respondent.Footnotes1. Cases of the following petitioners are consolidated herewith: Gordon B. and Martha J. Barrett, docket Nos. 40583-84 and 15031-84; Florence E. Harms, docket Nos. 34605-84 and 4548-85; and Bennie and Sharon C. Ward, docket No. 15296-84.↩2. All section references are to the Internal Revenue Code of 1954, 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 unless otherwise provided.↩3. A permanent disability rating of a certain percentage means that a worker is permanently excluded, because of his disability, from competing for that percentage of the jobs on the open market.↩4. The salary amounts reflected by petitioners on their returns did not include their worker's compensation awards, and only the treatment of the salary amounts is at issue.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625393/	LIVING FUNDED TRUST OF HARRY E. LYMAN, BY HARRY E. LYMAN, ONE OF ITS TRUSTEES, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Living Funded Trust v. CommissionerDocket No. 78200.United States Board of Tax Appeals36 B.T.A. 161; 1937 BTA LEXIS 762; June 17, 1937, Promulgated 762 Petitioner is a trust estate created by the grantor for the purpose of providing for the maintenance, welfare, and comfort of his wife, children, and grandchildren. Grantor conveyed to the trustees certain properties, with full power to hold, manage, and operate the same; to mortgage, sell, invest, and reinvest; and prohibited the beneficiaries from selling, encumbering, or otherwise anticipating or disposing of their respective interests in the corpus or income of the trust, prior to actual receipt. No stock certificates or certificates of beneficial interest were provided by the trust agreement or issued to the beneficiaries, and the usual corporate forms were not observed. Held, petitioner is not an association taxable as a corporation. Guitar Trust Estate,25 B.T.A. 1213">25 B.T.A. 1213; affirmed on this point, 72 Fed.(2d) 544. A. Harry Crane, Esq., and Delos C. Johns, Esq., for the petitioner. Carroll Walker, Esq., for the respondent. HILL 161 This is a proceeding for the redetermination of a deficiency in income tax for the period November 12 to December 31, 1932, in the amount of $753.74. The sole issue is763 whether petitioner is an association taxable as a corporation. The facts set out hereinbelow were stipulated by the parties. FINDINGS OF FACT. On or about October 12, 1932, Harry E. Lyman, a citizen and resident of Topeka, Kansas, executed and delivered a certain trust agreement, entitled "Living Funded Trust Agreement of Harry E. Lyman", between himself as party of the first part and himself, Wendell P. Lyman and Alice L. Dibble, as trustees, parties of the second part, and Ivan W. Dibble and the National Bank of Topeka, as substitute trustees, parties of the third part. The trust agreement provided in material part as follows: WHEREAS, said Grantor desires to create an irrevocable living funded trust by transferring to the Trustees certain stocks, bonds, securities and other real and personal property * * for the benefit of Grantor's wife, Anna M. Lyman, Grantor's children, Wendell P. Lyman and Alice L. Dibble, and for certain other beneficiaries hereinafter named, and for such other purposes as hereinafter provided. By the first paragraph, the grantor agreed to transfer irrevocably to the joint trustees all of his right, title, and interest in and to the properties764 described in the schedule attached to the agreement, and all other property which might, during his lifetime, be transferred 162 to the trustees, in trust for the benefit of his wife, son, and daughter, and such other beneficiaries and for such other purposes as thereinafter provided. The grantor authorized and empowered the remaining joint trustees or trustee, upon his death, to select an additional joint trustee, who should continue as joint trustee only during the time deemed advisable by the grantor's son and daughter, joint trustees. SECOND: The Trustee is hereby authorized and empowered to manage the said trust property with full power and authority in the discretion of the Trustee and in the same manner and to the same extent as the Grantor could or would do in the absence of this Trust Agreement; the Trustee is expressly authorized to sell, contract for sale, lease, mortgage, pledge, hypothecate or otherwise deal with any property or assets that may from time to time comprise this trust estate; to operate any business or interest in business comprised in this trust estate, or in which it is in any manner interested, or which might in the discretion of the Trustee765 be advantageously operated in connection with this trust estate; to invest and reinvest the property, real or personal, as in the discretion of the Trustee may be deemed most advisable for the benefit of the trust herein created, including the use of such portions of income and principal as the Trustee may deem advisable for the purpose of paying premiums in any life insurance policies upon the life of the Grantor, the proceeds of which policies of life insurance, upon the death of said Grantor, shall become a part of the assets of this trust estate, to be administered and distributed as hereinafter provided for the administration and distribution of the income and principal of this trust estate. During the lifetime of said Grantor the Joint-Trustees herein, who are referred to under the word "Trustee", are hereby expressly authorized and empowered to employ for a limited or unlimited time, a manager or one or more managers, for any or all of the property comprising this trust estate, and are authorized to delegate to such manager or managers such powers or authority herein vested in the Trustee as to said Trustee may be deemed most advisable. The Trustee hereof is also expressly766 authorized to purchase from the Executor or Administrator of Grantor's estate any property, real or personal, contained in said estate, and is also expressly authorized to make loans to such Executor or Administrator of Grantor's estate, either secured or unsecured, and at such rate of interest as the Trustee shall deem advisable, Provided, however, the Trustee hereof shall not be responsible for any loss resulting to this trust estate by reason of retaining as a part of this trust estate any property purchased from Grantor's general estate. THIRD: During the lifetime of the Grantor the Trustee shall distribute in convenient installments, preferably monthly, the net income of this trust estate to Grantor's wife, Anna M. Lyman, Grantor's son, Wendell P. Lyman, and Grantor's daughter, Alice L. Dibble, in such manner and in such proportion as the Trustee may deem most advisable, including the right in the event of the death of either of Grantor's children, to distribute such deceased child's share of said net income to the surviving issue of such deceased child. Upon the death of Grantor during the lifetime of Grantor's wife, Anna M. Lyman, then all the net income hereunder up to767 a sum equivalent to Five Hundred Dollars ($500.00) per month, shall be distributed to Grantor's said wife in convenient installments, preferably monthly, during her lifetime. Any portion of said net income in excess of Five hundred Dollars ($500.00) per month shall be distributed to Grantor's said children share and share alike, the issue of either deceased child to receive the parent's share by right of representation. 163 Upon the death of the grantor and his wife, it was directed that the net income of the trust be distributed, share and share alike, to the grantor's son and daughter, and upon the death of either son or daughter, leaving surviving issue, the residue of the trust was to be divided into two equal shares, the income therefrom to be paid to the issue of each deceased child for stated periods, and the corpus thereafter to be distributed to such issue. By the fourth paragraph, it was provided that if at any time during the continuance of the trust it became necessary or advisable to use some portion of the principal for the maintenance, welfare, comfort, or happiness of the grantor's wife, son, and daughter, or for the education of the surviving issue of768 grantor's children, the trustees were authorized and empowered to use so much of the principal as they might deem necessary, and the grantor suggested that the trustees be liberal in construing, for the benefit of his wife, children, and/or grandchildren any conditions or circumstances that might require the use or distribution of the principal to provide for their maintenance, welfare, comfort, or happiness. The fifth paragraph of the trust instrument vested in the trustees full and complete legal and equitable title to all of the property and estate embraced within the trust, both as to principal and income therefrom, subject only to the execution of the trusts, and provided that neither the principal nor income of the trust estate should be liable for the debts of any beneficiary, nor subject to seizure by any creditor of any deneficiary under any writ or proceeding at law or in equity, and that no beneficiary should have any power to sell, assign, transfer, encumber, or in any other manner anticipate pate or dispose of his or her interest in the trust estate, or the income produced thereby, prior to its actual receipt by such beneficiary. The sixth paragraph empowered the769 trustees, in case it became necessary to divide the principal of the trust, to make such division or distribution in kind, or partly in kind and partly in money, as they might deem advisable. The seventh paragraph required the trustees to keep books of account showing all transactions relating to the trust funds, and in each year to furnish to each beneficiary a statement showing how the funds were invested and all transactions relating thereto. On or about October 12, 1932, Harry E. Lyman conveyed by bill of sale to the trustees certain property known as the City Hand Laundry and Topeka Towel Supply Co. and Dry Cleaning Hatters & Dyers of Topeka, Kansas. Anna M. Lyman, his wife, joined with him in the conveyance. On or about October 13, 1932, Harry E. Lyman conveyed to the trustees by warranty deed certain residence property in Kansas City, Missouri, which was held for rental purposes. 164 On or about October 12, 1932, Alice L. Dibble, daughter of Harry E. Lyman, conveyed to the trustees by warranty deed certain properties described as lots 312, 121, and 123 in Topeka, Kansas. The property described as lot 312 was improved with a business building and held for770 rental purposes. The property described as lots 121 and 123 constituted the real estate upon which was located the City Hand Laundry and Topeka Towel Supply Co. and Dry Cleaning Hatters & Dyers of Topeka, Kansas, referred to above. On or about October 12, 1932, Alice L. Dibble conveyed to the trustees by general warranty deed a tract of land containing approximately 5.89 acres in Douglas County, Kansas. This was a small gardening tract, held for rental purposes. On or about December 17, 1932, Anna M. Lyman conveyed to the trustees lots 116 and 118 on Van Buren Street in Topeka, Kansas, held for rental purposes. On or about October 13, 1932, Anna M. Lyman conveyed to the trustees certain real estate in Clay County, Missouri, improved with a building suitable for manufacturing or warehouse purposes, and held for rental purposes. On or about December 21, 1932, Wendell P. Lyman, son of Harry E. Lyman, conveyed to the trustees certain property in Kansas City, Missouri, improved with a residence building and held for rental purposes. On or about December 14, 1932, S. W. Lyman, a brother of Harry E. Lyman, and Frances Lyman, wife of S. W. Lyman, conveyed to the trustees certain771 property in Kansas City, Missouri, held for rental purposes. The respective donors and the values of the properties when conveyed to the trust were as follows: DonorsValue of gifts as determined for gift tax purposesHarry E. Lyman$65,985Anna M. Lyman22,000Alice L. Dibble57,391Wendell P. Lyman16,000S. W. and Frances Lyman6,000No change in the method or proportion of the distributions of the net income of the trust was made upon the conveyance of additional property to the trust by Anna M. Lyman, Alice L. Dibble, Wendell P. Lyman, and S. W. Lyman. No stock certificates, certificates of beneficial interest, tranferable or nontransferable, were provided by the trust agreement, and none has been issued thereunder. Pursuant to the provisions of the trust agreement, the trustees thereunder appointed Harry E. Lyman general manager of the properties of the trust, for which supervisory services he received compensation of $2,500 for the taxable year ended December 31, 1932. 165 For the taxable year ended December 31, 1932, a fiduciary return, form 1041, was filed on behalf of the trust. This return disclosed that the trust772 derived total net income of $5,481.74, consisting of net profit from the City Hand Laundry in the amount of $5,190.39 and rents in the amount of $291.35. The return further disclosed that the entire net income of the trust for the taxable year was distributable in equal parts to Anna M. Lyman and Alice L. Dibble. The beneficiaries, Anna M. Lyman and Alice L. Dibble, to whom the net income of the trust for the taxable year was distributed, made individual returns and paid the respective individual income taxes based thereon. In the exercise of the discretion vested in them, the trustees made no distribution of income to Wendell P. Lyman for the taxable year. Upon audit of the fiduciary return above mentioned, an internal revenue agent prepared, or caused to be prepared, a return for the trust on form 1040, taxing to the trust the entire net income of the trust for the year ended December 31, 1932. At the same time the internal revenue agent concluded that there were overassessments with respect to the beneficiaries, Anna M. Lyman and Alice L. Dibble. This action of the revenue agent was based upon his finding that the net income shown by the fiduciary return to have been773 distributed to the beneficiaries was not actually distributed on or prior to December 31, 1932. Such distribution was made on or after January 1, 1933. All of the properties held by the trust during the taxable year were tracts of rental real estate from which income was derived in the form of rents, except the property known and described as the City Hand Laundry and Topeka Towel Supply Co. The Topeka Towel Supply Co. was merely a department of the City Hand Laundry. The City Hand Laundry was an ordinary commercial laundry, catering to domestic and industrial patronage. Harry E. Lyman, in his capacity as manager of the trust properties, exercised general supervision over the laundry, but the immediate management of the laundry was vested in a manager and an assistant manager, who devoted their entire time to the business of the laundry. OPINION. HILL: Respondent has determined that petitioner is an association taxable as a corporation, and has computed the deficiency on that basis. Petitioner assigns such action as error. The Revenue Act of 1932, in section 13, levies a tax upon the net income of corporations, and in section 1111(a)(2), provides that "the term 'corporation' 774 includes associations, joint-stock companies, and insurance companies." 166 Neither the facts nor the parties suggest that petitioner is a joint-stock company or an insurance company, and obviously it is not. The sole question is whether it is an "association" within the meaning of the quoted statute. The Supreme Court of the United States, in , defined the word "association" as used in the revenue acts in the following language: The word "association" appears to be used in the Act in its ordinary meaning. It has been defined as a term "used throughout the United States to signify a body of persons united without a charter, but upon the methods and forms used by incorporated bodies for the prosecution of some common enterprise." In the cited case, the Court held that the Hecht Real Estate Trust was an association taxable as a corporation, saying: The Hecht Real Estate Trust was established by the members of the Hecht family upon real estate in Boston used for offices and business purposes, which they owned as tenants in common. It is primarily a family affair. The certificates have no par value; the shares being775 for one-thousandths of the beneficial interest. They are transferable; but must be offered to the trustees before being transferred to any person outside of the family. The trustees have full and complete powers of management; but no power to create any liability against the certificate holders. There are no meetings of certificate holders; but they may, by written instrument, increase the number of trustees, appoint a new trustee if there be none remaining, modify the declaration of trust in any particular, terminate the trust, or give the trustees any instructions thereunder. That the trust involved in the case at bar is distinguishable from the Hecht trust in many vital respects is at once apparent. In the case under consideration the beneficiaries did not establish a trust for the management of properties owned by them as tenants in common. They did not associate themselves together for the prosecution of a common enterprise; they did not create an "association" upon the methods and forms used by corporations; they had no part in establishing the trust, and were without power to modify the trust agreement or to terminate the trust. The trust, irrevocable by its terms, 776 was established by Harry E. Lyman, who was himself in no event a beneficiary. The primary purpose of the grantor was to provide "for the maintenance, welfare, comfort and happiness" of his wife, son, and daughter, and grandchildren, if any. It was the method selected by him for the making of gifts for the benefit of those who were the natural objects of his bounty. The trust is not operated in essential respects according to corporate forms of management. The beneficiaries as such, have no control over the affairs of the trust. The trustees were all designated by the grantor, except only that after his death the son and daughter might select an additional trustee to serve at their pleasure. 167 No stock certificates or certificates of beneficial interest, transferable or nontransferable, are provided by the trust instrument. Title to all trust properties is vested in the trustees, subject to the execution of the trusts, and the net income is not distributable upon the basis of capital contributions of the respective beneficiaries. While the periodical distribution of the net income is mandatory under the terms of the trust agreement, the manner and proportion of777 distribution during the grantor's lifetime are matters within the discretion of the trustees. After the grantor's death, the manner and proportion of distribution are fixed by the trust instrument. Neither the principal nor income of the trust estate is liable for the debts of the beneficiaries, and no beneficiary has any power to sell, assign, encumber or otherwise anticipate or dispose of his or her interest in the corpus or income, prior to its actual receipt. A trust established by the owners of property who voluntarily associate themselves together for the purpose of holding and operating the property for business purposes and according to corporate form is materially different from a trust such as we are dealing with here. The fundamental distinction is clearly indicated in the following extract from the opinion of the court in : * * * A distinction is to be made between an agreement between individuals in the form of a trust and an express trust created by an ancestor, although they may have some features in common. The controlling distinction is that one is a voluntary association of individuals778 for convenience and profit, the other a method of equitably distributing a legacy or donation. Congress has recognized this distinction, classing the former as associations, to be taxed as corporations, and at the same time providing for a separate and distinct method of taxing the income of estates and trusts created by will or deed, classing them together for that purpose. In , it is pointed out that the term "association" implies associates, who enter into a joint enterprise for the transaction of business and the sharing of its gains. The principal additional characteristics of such an association are stated to be, (1) vesting in the trustees title to the property embarked in the undertaking; (2) designation of the trustees as a continuing body; (3) centralized management; (4) security of the enterprise from termination or interruption by the death of the owners of the beneficial interests; (5) transfer of beneficial interests without affecting continuity of the enterprise, and the introduction of large numbers of participants; and (6) limitation of the personal liability of the participants to the property embarked779 in the undertaking. To the same general effect, see also ; ; ; ; . When viewed in the light of the essential attributes above enumerated, we think it is plain that the trust in the present case does not fall into the classification of associations taxable as corporations. The facts of the instant case, in all material aspects, are similar to ; affirmed on this point at . On authority of the decisions cited, we hold that petitioner is not an association taxable as a corporation. Respondent's determination is reversed. Apparently all tax due at the rates applicable to a fiduciary has been paid either by the trustees or beneficiaries. In any event, respondent has not determined, nor is he here claiming, any deficiency in tax due from petitioner as a fiduciary. Judgment will be entered*780 for the petitioner.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625394/	Herbert L. Damner, Petitioner, v. Commissioner of Internal Revenue, RespondentDamner v. CommissionerDocket No. 2376United States Tax Court3 T.C. 638; 1944 U.S. Tax Ct. LEXIS 142; April 18, 1944, Promulgated 142 Decision will be entered under Rule 50. 1. The net worth of a business allocated between separate property of the petitioner and community property for the purpose of fixing the value of a gift to his wife by an agreement transmuting his separate property into community property.2. A presumption of California law favoring community property does not relieve the taxpayer of the burden of overcoming the presumption of correctness of the Commissioner's determination.3. A donor, who, under a mistaken conception of law, takes no part of the specific exemption in the gift tax return, is entitled to claim the exemption in a proceeding for redetermination. H. F. Baker, C. P. A., and A. D. Schaffer, Esq., for the petitioner.T. M. Mather, Esq., for the respondent. Arundell, Judge. ARUNDELL638 This proceeding is for the redetermination of a deficiency in gift tax for the calendar year 1939 in the amount of $ 3,130.77, and a penalty 639 in the amount of $ 469.62 for delinquency in filing a gift tax return. The primary questions involved are whether or not a gift was made by the petitioner to his wife when they entered into an agreement converting any separate143 property then held by either of them into community property, and, if so, the value of the gift. Also involved are the right of the petitioner to claim a specific exemption of $ 40,000, and the correctness of the delinquency penalty.FINDINGS OF FACT.The petitioner, Herbert L. Damner, is an individual residing in San Francisco, California, with his principal office at 146 Geary Street, San Francisco. The gift tax return for the period here involved was filed with the collector for the first district of California.From the year 1927 until January 31, 1936, the petitioner was a member of the partnership of Damner Brothers, engaged in the manufacture and wholesale fur business. While a member of that firm he received a salary and a share of the profits of the business. The partnership was dissolved on January 31, 1936, and the petitioner received, as his distributive share of the partnership assets, merchandise and accounts receivable of a value of $ 27,365.44.On September 23, 1929, the petitioner was married. His net worth as of that date is unknown. As of January 31, 1930, his net worth was $ 94,086.83. On January 31, 1935, his net worth had declined to $ 41,279.82, and on144 January 31, 1936, the date of dissolution of the partnership, it was $ 27,365.44.When the partnership was dissolved the petitioner embarked upon a retail fur business, as an individual, operating as concessionaire the fur department of H. Liebes & Co., a San Francisco store. Subsequently, he took over the operation of the fur department in the Emporium, another San Francisco store. The net worth of this business increased as shown below:Jan. 31, 1936$ 27,365.44Jan. 31, 193795,867.44Jan. 31, 1938101,126.17Jan. 31, 1939127,572.58In the operation of the business during the period 1936 to 1939 the petitioner purchased merchandise, supplies, etc., on his own unsecured credit, in the aggregate amount of $ 1,334,362.43. In the same period he borrowed from banks the amount of $ 414,213.94 on his unsecured credit.From the time of his marriage the petitioner maintained a single bank account, upon which he alone could draw checks and from which he paid both his business and personal expenses. No attempt was made to keep separate accounts of community income and separate income.640 The petitioner filed his income tax returns on the community property basis, allocating145 annual profit between return on capital and income attributable to personal services. A certain percentage of annual average invested capital was deemed to be return on capital, and the balance recompense for services. Over the three-year period the aggregate amount so allocated to return on capital was $ 15,594.63. In the same period the aggregate amount shown on the returns as attributable to services was $ 106,897.90. For each of these years the petitioner entered into an agreement as to final determination of tax liability with the Commissioner. The basis for the computation for tax for the fiscal years ended in 1937 and 1938 is unknown, but the recomputation underlying the closing agreement for the fiscal year ended in 1939 did not alter the item of return on capital.The petitioner's returns for those years consistently showed the capital investment in the business as his separate property. The return for the fiscal year ended January 31, 1939, showed as separate property the net worth of the business in the amount of $ 127,572.58. The closing agreement for that year, entered into May 1, 1941, fixed the tax due upon the basis of the petitioner's separate net worth of 146 $ 127,572.58 as of January 1, 1939.On January 17, 1939, the petitioner, in connection with the drawing of a new will, entered into an agreement with his wife, which agreement provided as follows:First: That, save and except such property as is now owned by the parties in joint tenancy or the interest of either of said parties in any life insurance contract or policy, all property now owned by them, or either of them, whether real or personal or of whatever kind or nature, is the community property of said parties, and each thereof so hereby declare it to be.Second: That, save and except such property as may be hereafter taken and acquired by the parties hereto as joint tenants or any hereafter acquired interest in any life insurance contract or policy, all property hereafter acquired by the parties, or either of them, whether earned by capital or by personal efforts or otherwise acquired, and irrespective of whether real or personal or whatever its nature, shall be deemed to be, and is hereby declared to be, the community property of the parties for all purposes.Third: That, subject to the exceptions noted above, it is the intent hereof, irrespective of whether the fulfillment 147 of such intent may presently involve gifts or conveyances between the parties hereto, that all property now held by them, or either of them, and all property to be hereafter acquired and accretions thereof or earnings of capital, or by the personal efforts of the parties, be deemed transmuted into community property of the parties, and so hereby declared to be the property of the community existing between them; -- it is not the intent hereof to alter the legal relation of the parties except as to such property.On May 17, 1940, the petitioner filed a delinquent gift tax return in which he reported a gift to his wife in January 1939 of one-half of whatever separate property he then possessed, which return showed 641 no tax due. The Commissioner determined that the separate net worth of the petitioner as of the date of the agreement was $ 127,572.58, and that the value of the gift was one-half of such amount, or $ 63,786.29, and determined a tax and penalty accordingly.The separate net worth of petitioner at the time he made the gift to his wife in 1939 was $ 42,960.07. One-half of this amount, or $ 21,480.03, was the value of the gift made to Mrs. Damner through the transmutation148 agreement.OPINION.The basic question is the value of the petitioner's separate property, if any, on the date of the so-called transmutation agreement. If the petitioner was possessed of any separate property on that date, it is unquestioned that a gift of one-half of the value of that separate property was made, since the wife, by virtue of section 161 (a) of the California Civil Code, takes a "present, existing, and equal" interest in property coming into the community estate after the effective date of that statute, July 29, 1927.The question is purely factual. The Commissioner has determined that the net worth of the petitioner's business at the time of the gift was approximately $ 127,000 and was the separate property of the petitioner. This determination was evidently based upon the income tax return for the fiscal year ended January 31, 1939, in which the income of the business was allocated between return on capital and compensation for services on the theory that the business was the separate property of the petitioner. He now contends that the return was erroneous in that respect and that $ 127,000 did not, in fact, represent his separate property.Indicative of the149 plausibility of this contention is the fact that the business growth was due exclusively to the retention of profits in the business from year to year. Those profits were preponderately community property and were treated as such by the Commissioner in the final determination of tax liability each year from 1937 to 1939. Manifestly, to the extent profits representing community property were plowed back into the enterprise, it was not the separate property of the petitioner, but community property.In the returns for each of the years in question the taxpayer apportioned the net profits of the business between income attributable to capital and income attributable to his services. The first, under the law of California, is his separate property and the latter represents community property. His method of allocation satisfied the Commissioner and is not here questioned. Over the three-year period a total amount of approximately $ 15,600 was thus allocated to separate income.642 Closing agreements for all three years were entered into by the petitioner and the respondent. Only the agreement for the fiscal year ended January 31, 1939, discloses the actual recomputation of 150 tax, and in this agreement the item representing income attributable to capital is left unaltered. From the comparatively small deficiencies agreed upon for the other two years, it is evident that there was, in those agreements, no substantial alteration of the separate income of the petitioner.Thus, the aggregate separate income of the petitioner during the three-year period was not more than approximately $ 15,600. More than this, he could not separately have contributed to the expansion. The balance of the increase must be due to community earnings, which in this period totaled approximately $ 107,000.Therefore, it seems inescapable that the petitioner's separate worth as of January 15, 1939, was not more than the sum of his separate net worth as of January 1936 and his separate income from that time to 1939, or approximately $ 42,960.07. One-half of this amount, or $ 21,480.03, was the value of the gift made to Mrs. Damner through the transmutation agreement.A word concerning the contentions of the petitioner, which we have not chosen to adopt, may not be inappropriate. He has argued that he was possessed of no separate property as of the date of the transmutation agreement; 151 first, because prior to that time there was an "understanding" between the spouses that all their property was held as community property; and, second, that in any event community property had been so commingled with the assets of the business as to make the whole community. In regard to the first contention, "the separate property of either or both spouses may be transmuted into community property and this may be done without the necessity of any written agreement providing the agreement or understanding to that effect is fully consummated." In re Sill's Estate, 9 Pac. (2d) 243. The only testimony on this point is to the effect that it was the intention of the husband that his wife should have an "equal partnership" in everything he possessed. Nothing shows that this intention was ever communicated to the wife; no discussion with reference to the property was ever had between them. We think that this evidence is inadequate to establish an understanding or agreement transmuting separate property into community property.As to the second contention, the rule in California is to the effect that where separate and community property are commingled the152 burden is upon him claiming the separate property to establish the segregation. In the absence of the segregation, the whole will be treated as community. This is an extension of the general presumption 643 favoring community property, and between litigants in the courts of California is undoubtedly controlling. However, in this proceeding the taxpayer is confronted with the presumption of correctness attaching to the Commissioner's determination. The conflict of presumptions resolves itself in favor of the respondent, and the petitioner retains the burden of proof. Shea v. Commissioner, 81 Fed. (2d) 937.One further question remains. The petitioner, thinking that no taxable gift had been made, claimed in his return no deduction under section 505 (a) (1) of the Revenue Act of 1932, as amended by section 301 (b) of the Revenue Act of 1935, 1 allowing a specific exemption of $ 40,000. He now claims the right to such deduction. It has been held that a donor who, under a mistaken conception of law, takes no part of the specific exemption in the computation of gift tax is entitled to claim the exemption in a proceeding for redetermination. 153 Amy Hutchison Crellin, 46 B. T. A. 1152; Richardson v. Commissioner, 126 Fed. (2d) 562, affirming on this point 39 B. T. A. 927. The petitioner is entitled to the specific deduction of $ 40,000 by reason of which there is no taxable net gift and accordingly no deficiency.Inasmuch as there is no deficiency in gift tax, the penalty must fall.Decision will be entered under Rule 50. Footnotes1. SEC. 505. DEDUCTIONS.In computing net gifts for any calendar year there shall be allowed as deductions:(a) Residents. -- In the case of a citizen or resident --(1) Specific exemption. -- An exemption of $ 40,000, less the aggregate of the amounts claimed and allowed as specific exemption for preceding calendar years.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625395/	WARY-DICKINSON CO., INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.WARY-DICKINSON CO. v. COMMISSIONERDocket No. 8914.United States Board of Tax Appeals6 B.T.A. 269; 1927 BTA LEXIS 3568; February 19, 1927, Promulgated 3568 1. The fair market value of purchase money second mortgage notes received on sale of Ford automobiles, determined. 2. Where additions to reserve, or $3,672.05, for losses, were not shown to be insufficient to cover anticipated losses on such notes, the respondent's inclusion of the notes in income at face value approved. Yandell Boatner, Esq., for the petitioner. J. Arthur Adams, Esq., for the respondent. MILLIKEN 270 This proceeding results from the determination by the Commissioner of deficiencies in income and profits tax for the calendar year 1921, in the amount of $4,445.38, of which $4,410.65 is in controversy. That part of the deficiency contested by petitioner results from the Commissioner's action in including, at their face value, in petitioner's income, promissory notes in the amount of $12,267.70. Petitioner avers that such notes had no fair market value and the addition to income is erroneous. The Commissioner denies that the notes had no fair market value, and also contends that the reserve for bad debts deducted was sufficient to cover losses resulting from inability to collect on the notes. FINDINGS OF FACT. 3569 Petitioner is a Louisiana corporation with its principal office at 306 Market Street, Shreveport. It was, during the year in question, engaged in the selling of Ford automobiles and accessories and rendering service to automobile owners. The commission derived from the sale of cars was 17 1/2 per cent of the list price fixed by the Ford Motor Co. During 1921 the gross profit from the sale of a touring car and a roadster was $78.75 and $63.00, respectively. During 1921, and prior thereto, petitioner had established the practice of selling Ford cars upon a deferred payment plan. A prospective purchaser made out a statement indicating his financial condition, upon which petitioner based its investigation as to his credit standing. In such sales, petitioner's practice was to require a down payment of $208 on touring cars and $196 on roadsters, the balance of the purchase price being represented by a series of 12 notes falling due over a period of 12 months, beginning with the first of the month following the date of sale. The notes were equal in amount; included charges for handling, service, brokerage and insurance; bore interest from the date of maturity; and were secured by3570 a first mortgage on the car sold, which was subject to foreclosure upon default in payment of any one of the notes. At that time petitioner was selling the notes, when they were sold, to the Meyer-Keyser Corporation, of Indianapolis, Ind., a finance corporation. Under the arrangement with the latter corporation, the notes were indorsed without recourse and placed with the First National Bank of Shreveport for collection. Petitioner would then draw a draft on the Meyer-Keyser Corporation for the balance due on the car, which gave it the cash just as if the sale had been made for cash. 271 During the latter part of 1921, the petitioner was required by the Ford Motor Co. to purchase more automobile than it behieved could be sold. To escape the cost of storage and the payment of interest on the oversupply, petitioner conceived and carried out a sales plan to attract purchasers. It advertised and sold the Ford cars, both touring and roadster, on a deferred plan requiring a down payment of $125; a series of 12 first mortgage notes for amounts equal to the amount represented by the notes, which it had been accustomed to receive and sell to the Meyer-Keyser Corporation under3571 its former plan; and a second series of 12 notes secured by a second mortgage on the car sold, for the balance of the purchase price, or approximately $90.41 and $77.00 on the touring cars and roadsters, respectively. The balance represented by the second mortgage notes was somewhat in excess of the petitioner's commission. These notes were similar to the first mortgage notes, except that interest was included in the face of the notes. The new sales plan was put in operation about November 23, 1921, and continued until the close of the year. The due dates of the notes received, both first and second mortgage series, dated from January 1, 1922, and one of each series fell due on the first of each month in 1922. The first mortgage notes were sold on the same terms as formerly to the Meyer-Keyser Corporation. The second mortgage series were held by the petitioner. The holders of either the first or the second mortgage notes could foreclose upon default in payment of any one note. The same statement, as to financial condition, was required of the purchaser under the new sales plan as had been required under the old, but very little investigation of credit standing was made by petitioner. 3572 The petitioner also handled used and repossessed cars and accessories and rendered service to car owners. Credit was extended in all of these departments, as well as on the sale of new cars. The credit extended was represented by both open accounts and notes receivable. The amount of open accounts standing on petitioner's books as of December 31, 1921, is not shown. The total of notes receivable of $58,030.03, as of that date, included notes received on the sale of used and repossessed cars as well as new cars. The face value of second mortgage notes received in the sale of new cars under the new credit plan carried out during November and December of 1921, was $12,267.70. Petitioner collected $10,149,00 of this latter amount during the year 1922 and additional sums in subsequent years. The fair market value of the second mortgage notes of the face amount of $12,267.70 was $8,750, which is $3,517.70 less than their face value. Petitioner kept its books on an accrual basis and made its returns on the calendar year basis. When a car was sold, under the new sales plan, the customer was charged with the selling price, including 272 accessories. He was then credited3573 with the cash payment, the amount of the draft drawn on the Meyer-Keyser Corporation an the amount of the second mortgage notes, less interest, to balance the account. The second mortgage notes received were entered into the notes receivable account but were credited to unearned profits a a closing entry for the year, thereby creating a reserve of $12,267.70 which was deducted from profits. Petitioner also carried a reserve for losses. Additions to such reserves on account of bad debts, in the amount of $7,820.86, were claimed and allowed as deductions for 1921. Of this $7,820.86, all but $3,672.05 was shown to be applicable to open accounts and notes receivable, other than the second mortgage notes; The item of $3,672.05 was to cover losses on notes outstanding in the amount of $18,279, the balance due on 147 cars sold. Whether these 147 cars sold and the notes received therefor include the cars sold under the emergency plan and the second mortgage notes of $12,267.70, was not established. The Commissioner added the amount of $12,267.70 to petitioner's income for 1921, for the reason that it appeared that the bad debt reserve was considered sufficient to take care of any3574 losses resulting from default in the payment of the second mortgage notes. OPINION. MILLIKEN: The petitioner contests that part of the deficiency due to the Commissioner's action in adding the $12,267.70 in second mortgage notes to its income for the year in question. It is not disputed that petitioner was on an accrual basis and that such notes were received in 1921 and were income to it to the extent of the fair market value thereof. Petitioner's contention is that the notes had no fair market value when received, and, accordingly, should be entirely eliminated in the computation of income for 1921. The testimony shows that it was generally considered unsafe to sell a Ford automobile on a deferred payment plan for loss than 33 1/3 per cent cash, where the only security for the balance was a mortgage on the car sold. It was also shown that the sales plan carried out by petitioner, to dispose of an oversupply of cars, by requiring a cash payment of from 20 to 25 per cent, had not been theretofore tried by retail automobile dealers. The second mortgage notes taken by petitioner were certainly not sufficiently secured to make the notes worth face value. On the other hand, 3575 it is admitted by petitioner that they had some value. Petitioner did not sell or offer to sell any of such notes. Three bankers of the locality in which the business of petitioner is located 273 and who had experience in passing on automobile paper, were of the opinion that the notes were not commercial paper unless indorsed by a responsible dealer, and, if such paper was offered in lots in the usual way, their banking firms would not even consider the lots worth inventigating. One of them stated that the actual worth of the notes would depend upon the maker, though responsible persons did not usually purchase cars on terms requiring a first and second mortgage. We do not think the fact that such notes would not have been accepted by a bank as commercial paper without investigating the individual maker establishes the absence of any fair market value in the notes. The fact that nearly 83 per cent of the face value of the notes, or $10,149.00, was collected in 1922, the year in which they were due, was brought out by questioning of the principal witness by the Board. Although that fact was not available in determining the fair market value of the notes when they were3576 received, we think it, when properly discounted in the light of the other evidence, tends to afford some criterion concerning the fair market value of the notes in question. After a careful consideration of all the evidence, we are of the opinion that the fair market value of the second mortgage notes, when they were received, was $8,750, and should have been reflected in computation of gross income in that amount. The difference between the face value and the fair market value of such notes is $3,517.70. However, the deficiency in controversy is not based solely upon the determination that the notes were worth their face value. It appears, from the evidence of record that the Commissioner considered that the reserve for bad debts maintained by petitioner was sufficient to cover losses upon the second mortgage notes in question and to grant any further allowance would be to allow a double deduction. The facts of record do not rebut the presumption. We have found as a fact that there is a bad debt item of $3,672.05, which is not shown by petitioner to have been deducted on account of obligations other than the notes in controversy. Since this item, not accounted for, is greater3577 than the difference between the face value and the fair market value of the notes in quesion, or $3,517.70, we are unable to determine that the Commissioner committed error in the determination of the deficiency. Petitioner was specifically put on notice as to the proof required, not only by the statement attached to the deficiency letter, but by the evidence adduced at the hearing of this proceeding by counsel for the Commissioner. Judgment will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625397/	Robert D. Marshall and Helen B. Marshall v. Commissioner.Marshall v. CommissionerDocket No. 78898.United States Tax CourtT.C. Memo 1960-288; 1960 Tax Ct. Memo LEXIS 11; 19 T.C.M. (CCH) 1577; T.C.M. (RIA) 60288; December 30, 196011 Petitioners are not entitled to deduction for a nonbusiness bad debt where evidence fails to show that debt became totally worthless in year in which deduction is claimed. Charles Blair, Esq., for the petitioner. Seymour I. Sherman, Esq., for the respondent. SCOTT Memorandum Findings of Fact and Opinion SCOTT, Judge: The respondent determined a deficiency in the income tax of petitioners in the amount of $13,900.53 for the taxable year 1954. The sole issue for decision is whether petitioners are entitled to a deduction of $50,200 as a nonbusiness bad debt. The Commissioner, in disallowing this deduction, stated in the notice of deficiency: It is held that worthlessness of advances of $50,200.00 to Tech-Mulsion Corporation did not occur during the taxable year 1954; therefore, deduction claimed12 in that amount for nonbusiness bad debt is not allowable under the provisions of Section 166 of the Internal Revenue Code of 1954. Findings of Fact Some of the facts are stipulated and are found accordingly. Petitioners are individuals, husband and wife, with a mailing address at P.O. Box 520, Rock Island, Illinois. They filed their joint Federal income tax return for the calendar year 1954 on the cash receipts and disbursements basis with the director of internal revenue at Chicago, Illinois. In January 1952 Tech-Mulsion Corporation, hereinafter referred to as T-M, was organized to engage in the photoprint business. At the time of its organization it expected to obtain a large volume of business from Aurora Aircraft Corporation for reproduction work on a large contract that Aurora Aircraft expected to receive from the United States Government. Aurora Aircraft failed to receive the contract it expected and the business that it gave to T-M was considerably less than T-M had anticipated. T-M obtained some other business from the aircraft industry and some canvas reproduction business. T-M's total original capital was $2,100 of which petitioners contributed13 $600 for their own account. T-M's operations required substantial additional funds and from 1952 through August 1954 petitioners advanced a total of $50,200 to T.M. in the amounts and on the dates as follows: DateAmount2- 4-52$ 5,000.002- 5-523,000.003-13-525,000.004- 7-526,000.004- 7-524,000.005-19-522,000.008-15-52900.0011- 7-525,000.002- 3-522,000.004- 6-532,000.005-13-532,000.006- 4-533,000.007- 4-532,500.009-11-532,000.001- 8-541,000.003-31-542,300.007-22-541,000.008-19-541,500.00Total$50,200.00 These advances were evidenced by 6 per cent demand notes, 18 in number. Petitioners made no further advances to T-M after August 19, 1954. T-M's operations resulted in gross income of $39,000, $57,000, and $73,000, respectively, for the years 1955, 1956, and 1957. T-M sustained net losses of $21,334.92, $17,139.61, and $5,130.84 for the years 1952, 1953, and 1954, respectively. Its net income for 1955 was $790.75. In 1956 its net loss was $898.93 and in 1957 its net income was $1.14. T-M's balance sheet as of December 31, for each of the years 1954 through 1957, was as follows: Assets1954195519561957Cash$ 1,712.44$ 3,219.81$ 3,194.80$ 4,355.61Plant Equipment2,963.722,963.722,963.722,963.72Office Equipment555.25555.25555.25555.25Building Improvements5,222.965,222.965,222.965,222.96Rent Deposit350.00350.00350.00350.00Utilities Deposit97.0097.0097.0097.00Deficit in Earned Surplus43,605.3742,814.6243,713.5543,712.41Total$54,506.74$55,223.36$56,097.28$57,256.95Liabilities and Net WorthR. D. Marshall Loans$50,200.00$50,200.00$50,200.00$50,200.00Taxes Payable157.30285.75Reserve for Depreciation2,049.442,923.363,797.284,671.20Capital Stock2,100.002,100.002,100.002,100.00Total$54,506.74$55,223.36$56,097.28$57,256.9514 No part of petitioners' advances to T-M has been repaid nor has any interest thereon ever been paid to petitioners. T-M filed a petition in bankruptcy in the United States District Court for the Southern District of California on August 24, 1960. Schedule A-3 attached to that petition lists 12 creditors with unsecured claims totaling $4,929.08. Neither of petitioners was among the creditors listed. The petition listed as assets $758.54, consisting entirely of deposits of money in banks and elsewhere. The statement of affairs attached to the petition of bankruptcy of T-M states that the corporation engaged in business from February 2, 1952, to March 31, 1960. This statement also contains the following: That during the year immediately preceding the filing of the original Petition herein, the Petitioner made repayments of loans, as follows: * * * Richard T. Pyles, president of corporation, loaned $2,000.00 cash to corporation January 6, 1959; was repaid final $500.00 on September 30, 1959. During the year immediately preceding the filing of the original Petition herein, the Petitioner transferred or disposed of, other than in the ordinary course of business, the following assets15 or properties: * In March, 1960, Petitioner sold equipment to W. M. Cissell Manufacturing Co. for $165.00 cash; Surfas, Inc., for $150.00 cash; J. W. Leser Co. for $150.00 cash and Signet Studios for $40.00 cash. All amounts received are included in present assets of bankrupt. In August of 1954, Robert D. Marshall (hereinafter referred to as petitioner) and his business adviser went to the plant of T-M in California and examined the plant and the books of the corporation. They also questioned the corporation's officers about the prospects of the corporation's business. After this visit to T-M's plant, petitioner agreed to lend T-M $1,500 but stated to the officers of T-M that no further loans would be made. The $1,500 advance to T-M was made on August 19, 1954, as hereinbefore shown. While in California petitioners' business adviser talked with a local attorney who handled the affairs of petitioners in connection with T-M about the condition of the corporation and the possibility of suing to collect petitioners' advances to T-M. Petitioners' business adviser later in the year 1954 talked to this attorney by telephone concerning these same matters. The attorney's advice16 was against suing to collect or forcing the corporation to liquidate or go into bankruptcy. The fixed assets of T-M were of such a nature that then value removed from the premises was substantially less than the amount of the value of these assets as shown on T-M's balance sheet. The advances by petitioners to T-M in the amount of $50,200 did not become totally worthless during the year 1954. Opinion In order to be entitled to a deduction for a nonbusiness bad debt, it must be shown that the debt became totally worthless during the taxable year. Rollins v. Commissioner, 276 F. 2d 368 (C.A. 4, 1960), affirming 32 T.C. 604">32 T.C. 604, and Miriam Coward Pierson, 27 T.C. 330">27 T.C. 330 (1956), affd. on another issue 253 F. 2d 928 (C.A. 3, 1957). The balance sheet of T-M at the end of 1954 shows cash of slightly over $1,700 and fixed assets of approximately $9,000 against which a depreciation reserve of approximately $2,000 is shown. The only liability shown other than petitioners' loans and capital stock is taxes payable of $157.30. This balance sheet indicates that at the end of 1954 T-M's indebtedness to petitioners had not become totally worthless. 17 While T-M's balance sheet at the end of 1954 is evidence of its insolvency, such evidence does not establish the total worthlessness of a debt. Trinco Industries, Inc., 22 T.C. 959">22 T.C. 959 (1954). Petitioners argue that it is obvious that T-M's balance sheet is on a cash basis and that there would exist accounts receivable and accounts payable which are not included in this balance sheet. However, no evidence of the amount of any such accounts receivable or accounts payable is shown in the record and we cannot assume without any proof that the value of accounts receivable would not equal or exceed that of accounts payable. Petitioners also point out that the actual value of T-M's fixed assets was less than the book value thereof if such assets were removed from the premises. This fact is pertinent in considering the amount that petitioners might collect if they attempted to enforce payment of their notes, but it does not establish the total worthlessness of T-M's indebtedness to them. The record shows that T-M continued in business for 6 years after the taxable year here involved and that it had gross income for the 3 years following the taxable year here involved in the amounts18 of $39,000, $57,000, and $73,000. It also shows that a $2,000 loan to the company by its president was repaid in 1959. Petitioners may have felt that their chance of collecting a higher proportion of T-M's total indebtedness to them was better if they did not attempt to enforce collection in 1954 but this does not establish that the debt became worthless in 1954. Worthlessness is determined by objective standards. Earl V. Perry, 22 T.C. 968">22 T.C. 968 (1954). Petitioners are not entitled to a deduction in 1954 for a nonbusiness bad debt in the amount of their advances to T-M. Respondent, in addition to arguing that petitioners' advances to T-M did not become worthless in the taxable year, contends in the alternative that when the advances were made no chance of recovery existed and argues that no deduction is allowable for this reason. Respondent also suggests, without argument, that the amounts of the advances were not loans but contributions to capital. It is unnecessary to decide these alternative contentions in view of our determination that T-M's indebtedness to petitioner did not become worthless in 1954. Decision will be entered for respondent.	01-04-2023	11-21-2020

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