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https://www.courtlistener.com/api/rest/v3/opinions/4625400/	Margarita Touche, Petitioner v. Commissioner of Internal Revenue, RespondentTouche v. CommissionerDocket No. 4462-70United States Tax Court58 T.C. 565; 1972 U.S. Tax Ct. LEXIS 95; June 29, 1972, Filed 95 Decision will be entered for the petitioner. In 1966 petitioner purportedly transferred by deed of gift a 5.25-percent interest in certain property to each of four donees and in 1967 she purportedly transferred a 2.1-percent interest in such property in the same fashion. In preparing the deeds of gift, petitioner's attorney made a mistake in calculating the percentage interest to be transferred. At the time of such deeds of gift, petitioner intended to transfer only one-half of the aforementioned percentage interests. Held, under Texas law, by virtue of petitioner's unilateral mistake, she transferred only bare legal title to one-half of the interests described in the deeds of gift and retained, during the taxable years in question, an unqualified right to revest such title in herself. Held, further, that such power to revest made such portion of the purported transfers incomplete and to that extent not subject to gift tax. Towner Leeper, for the petitioner.James N. Mullen, for the respondent. Tannenwald, Judge. TANNENWALD566 Respondent determined deficiencies in the Federal gift tax of petitioner as follows:YearDeficiency1966$ 958.8219671,143.71The only issue before the Court is whether petitioner made gifts during the years in question in excess of the annual exclusion provided by section 2503(b)1 and the lifetime exemption provided by section 2521.FINDINGS OF FACTSome of the facts have been stipulated and, along with the exhibits in support97 thereof, are incorporated herein by this reference.Petitioner is a United States citizen who resided in Chihuahua, Mexico, at the time her petition herein was filed. Gift tax returns were filed for 1966 and 1967 with the district director of internal revenue, Austin, Tex.In 1966, petitioner and her sister, Loretto, each owned an undivided one-half interest in certain income-producing property located on Stanton Street in El Paso, Tex. (hereinafter referred to as the Stanton Street property). Petitioner and her sister wished to make gifts of some of their interest in the property so as to enable their other four sisters to share in the ownership of the property on an approximately equal basis. Towards this end, they consulted a Texas attorney, who advised them that they could avoid Federal gift tax liability by staggering the ultimately intended gift over a period of years. The fair market value of this property during 1966 and 1967 was $ 276,920.On December 30, 1966, petitioner and her sister, Loretto, each created four trusts to benefit their four sisters, one trust for each of the four sisters.Also on December 20, 1966, petitioner executed a deed of gift, prepared by the98 aforesaid attorney, which purported to transfer to each trust "an undivided 5.25 percent interest" in the Stanton Street property. The gift tax return filed by petitioner for 1966 specified a transfer of four 5.25-percent interests, which were valued on the return at $ 7,269.15 each, or a total amount of $ 29,076.60. Such amounts corresponded 567 to the values of four 2.625-percent interests, or an aggregate 10.5-percent interest in the entire property. The discrepancy between the percentage of interest in the property purportedly transferred and the dollar value attributable thereto was due to an error in the attorney's mathematical calculation of which petitioner was not aware.In 1967, petitioner, still unaware of her attorney's error, executed another deed, also prepared by him, which purported to transfer an "undivided 2.1 percent interest" in the Stanton Street property to each of the four trusts. The gift tax return filed by petitioner for 1967 specified a transfer of four 2.1-percent interests, which were valued on the return at $ 2,907.66 each, or a total amount of $ 11,630.64. Such amounts corresponded to four 1.05-percent interests, or an aggregate 4.2-percent99 interest in the entire property.According to the calculations on said returns, no gift taxes were due.Petitioner's attorney first learned of his error in November 1968, when he received a letter from the Internal Revenue Service informing him of a possible deficiency in petitioner's gift tax for the years in issue. Since that time, no further interests in the property have been transferred by petitioner to her sisters, but she has made an annual gift of $ 3,000 to each trust for the years 1968 through at least 1971.On petitioner's income tax returns for the years 1966 through 1970, the income and deductions attributable to the Stanton Street property were reported in accordance with the percentage interests purportedly transferred by petitioner to the trusts. The returns were prepared by petitioner's accountant, who relied upon the aforesaid attorney for information in respect of ownership interest in the Stanton Street property.On January 10, 1972, a correction deed was recorded for both the 1966 and 1967 deeds and the percentage interest purported to be transferred by the original deeds was divided in half.ULTIMATE FINDINGS OF FACTPetitioner intended to transfer and actually100 transferred to each trust in 1966 only a 5.25-percent interest in her undivided one-half interest in the Stanton Street property, or a 2.625 undivided interest in the entire property.Petitioner intended to transfer and actually transferred to each trust in 1967 only a 2.1-percent interest in her undivided one-half interest in the Stanton Street property, or a 1.05-percent undivided interest in the entire property.568 OPINIONThe question before us is to what extent did petitioner make taxable gifts to trusts for the benefit of four of her sisters in 1966 and 1967? Respondent contends that we should look only to the percentage interests in the Stanton Street property as set forth in the deeds of gift and that consequently petitioner made gifts in twice the dollar amounts reported on her returns for those years. Petitioner counters with the assertion that the facts clearly establish that she intended to transfer only the interests in the property represented by the dollar values shown on her returns and that the percentage interests set forth in the deeds relate to her one-half undivided interest and not to the property as a whole. We agree with petitioner.Both parties have101 preoccupied themselves with the impact of the parol evidence rule and the effect, if any, of the correction deed filed on January 10, 1972. In so doing, they have analyzed various aspects of the law of reformation in relation to arm's-length transactions or to varying the dispositive provisions and limitations of instruments of voluntary transfer, and the applicability of the principle of relation back in tax cases. Neither has focused upon what we consider to be the most significant element involved herein -- namely, the right of a grantor to obtain reformation of a voluntary conveyance where innocent parties have not relied on such conveyance to their detriment. In short, they have failed, proverbially speaking, to see the forest for the trees, and the authorities which they cite are, therefore, wholly beside the point.A situation almost identical to that involved herein arose in Dodge v. United States, 413 F. 2d 1239 (C.A. 5, 1969), affirming 292 F. Supp. 573">292 F. Supp. 573 (S.D. Fla. 1968), and in Henry W. Dodge, Jr., T.C. Memo 1968-238">T.C. Memo. 1968-238, two cases which both parties herein have apparently overlooked. 102 Both cases involved the same transaction by a husband and wife who filed separate income tax returns. They were the owners of certain property and decided to make a gift thereof to a charitable organization. In order to stay within the 30-percent limit placed upon charitable contributions, they planned to make the transfer over a period of years at the rate of a one-fifth interest each year. The initial transfer was made in 1960; as the result of an error by their attorney, the deed of gift purported to transfer the entire property. In 1961, they conveyed a one-fifth interest to the charity; each claimed a deduction in that year for a pro rata share of that interest. The Commissioner disallowed the claimed deduction on the ground that the entire property had been transferred in the prior year. Both we and the Fifth Circuit 569 held for the taxpayers, the latter specifically adopting the rationale of this Court in Henry W. Dodge, Jr., supra.2103 The rationale of both Dodge decisions was that, under the applicable local law, the grantor of a voluntary conveyance is entitled to restructure the transfer because of a unilateral mistake. Consequently, both we and the Fifth Circuit concluded that the charitable donee was given complete ownership of only one-fifth of the property in 1960 and bare legal title to the other four-fifths; the purported transfer of the other four-fifths in 1960 was illusory and therefore did not have the necessary degree of completeness to be recognized for Federal tax purposes. See authorities cited in the Dodge opinions. See also sec. 25.2511-2(c), Gift Tax Regs.Based upon the foregoing, we view this case as requiring the simple determination whether under the law of Texas, where the property was situated, petitioner had, during the taxable years before us, a right of reformation against the gratuitous donees of the 1966 and 1967 deeds of gift because of the unilateral mistake on her part stemming from the actions of her attorney in preparing those deeds of gift. Clearly, under the various authorities set forth in the Dodge opinions, she would have had that right in many jurisdictions. 104 While we have found no Texas decision covering the particular legal point involved herein, we are satisfied that petitioner would have such a right under Texas law under such circumstances. See, generally, Holloway v. Wheeler, 261 S.W. 467">261 S.W. 467 (Tex. Civ. App. 1924); Brown v. Bradley, 259 S.W. 676 (Tex. Civ. App. 1924); Grundy v. Greene, 207 S.W. 964">207 S.W. 964 (Tex. Civ. App. 1918); 19 Tex. Jur. 2d, Deeds, sec. 37.It follows that, inasmuch as petitioner had, during the taxable years before us, the power to revest title in herself as to one-half of the interest purportedly conveyed in the 1966 and 1967 deeds, no completed gift was made as to that portion of the interest during those years. 3105 In light of our decision, we need not consider whether the correction deed filed by petitioner on the date of trial has any retroactive effect for Federal tax purposes. See Van Den Wymelenberg v. United States, 397 F.2d 443">397 F.2d 443 (C.A. 7, 1968), and Samuel S. Davis, 55 T.C. 416 (1970). See also Harris v. Commissioner, 461 F.2d 554">461 F. 2d 554, 556, fn. 2 (C.A. 5, 1972), affirming a Memorandum Opinion of this Court.Decision will be entered for the petitioner. Footnotes1. All references are to the Internal Revenue Code of 1954, as amended.↩2. The Government dismissed its appeal from this decision after the decision by the Fifth Circuit.↩3. We expressly make no finding, nor do we venture any opinion, as to when petitioner did, in fact, make completed gifts of this portion of her interest in the property, e.g., when the petitioner's right of reformation expired. See, e.g., Burnet v. Guggenheim, 288 U.S. 280↩ (1933).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625401/	Michael W. Patin and Sandra H. Patin, et al., 1 Petitioners v. Commissioner of Internal Revenue, RespondentPatin v. CommissionerDocket Nos. 31925-83, 7434-84, 9257-84, 15992-84, 16937-84United States Tax Court88 T.C. 1086; 1987 U.S. Tax Ct. LEXIS 62; 88 T.C. No. 62; April 29, 1987April 29, 1987, Filed 62 Decisions will be entered for respondent in docket Nos. 31925-83, 7434-84 and 15992-84.Appropriate orders will be issued in docket Nos. 9257-84 and 16937-84 restoring them to the general docket for trial of the remaining issues in each case. Ps, individual investors, each purchased from O specified tonnages of ore in the form of one or more undesignated ore blocks for a price of $ 50 plus a 50-percent overriding royalty. Under the purchase agreements, ore blocks were to be randomly assigned to Ps by O at an unspecified later date and from an unspecified mining property or properties. Ps then contracted with A, an affiliate of O, to perform mining development services with respect to such ore for a fee of $ 50 per ton. The development fee was paid one-sixth with cash and five-sixths with funds allegedly borrowed from K, evidenced by a 10-year promissory note which on its face was recourse as to principal and nonrecourse as to interest. In fact, a circular flow of investors' cash from A to E, then to K, then back to A was used to create the appearance that K had funded investors' promissory notes. Ps deducted the full contract amount of the development fee as mining development63 expenses pursuant to sec. 616(a) on their 1980 Federal income tax returns. No payments were ever made on the promissory notes, and such notes were canceled and returned to Ps during 1982 or 1983. Specific ore blocks were never assigned to investors, nor was any mining ever performed on their behalf. Held:1. The transactions herein lack economic substance, and are to be disregarded for Federal income tax purposes;2. Such transactions are "tax motivated transactions" within the meaning of sec. 6621(d);3. Ps in docket Nos. 15992-84 and 16937-84 are liable for the addition to tax under sec. 6653(a) for negligence or intentional disregard of rules or regulations. David A. Aughtry, for the petitioners.Ana G. Cummings and Bernard B. Nelson, for the respondent. Featherston, Judge. Peterson, Special Trial Judge. FEATHERSTON; PETERSON1087 These consolidated cases were assigned to Special Trial Judge Marvin F. Peterson pursuant to section 7456(d) 2 (redesignated as section 7443A(b) by the Tax Reform Act of 1986, Pub. L. 99-514, sec. 1556, 100 Stat. 2755), and Rules 180, 181, and 183. 3 The Court agrees with and adopts his opinion which is set forth below. 64 OPINION OF THE SPECIAL TRIAL JUDGEPeterson, Special Trial Judge: These consolidated cases were selected by counsel and approved by the Court to 1088 serve as test cases for resolving issues common to a much larger group of petitioners who invested during 1980 in the "Gold Ore Purchase and Mining Program" marketed by Omni Resource Development Corp. Respondent determined deficiencies and additions to tax in petitioners' 1980 Federal income taxes as follows:Addition to taxI.R.C. 1954,Docket No.PetitionerDeficiencysec. 6653(a)31925-83Michael W. Patinand Sandra Patin$ 49,807.920 7434-84Gordon W. Hatheway, Jr.,and Barbara S. Hatheway11,729.410 9257-84Arthur Espy19,121.250 15992-84Edward N. Gombergand Helen E. Gomberg71,719.66$ 3,635.9016937-84William S. Skeenand Alison Skeen20,000.001,000.0065 The issues for decision are (1) whether and to what extent petitioners are entitled to deductions for mining development expenditures under section 616 or, in the alternative, for mining exploration expenditures under section 617, (2) whether petitioners Gomberg (docket No. 15992-84) and Skeen (docket No. 16937-84) are liable for additions to tax under section 6653(a) as set forth above, and (3) whether petitioners are liable under section 6621(d)4 for additional interest with respect to tax-motivated transactions. This last issue was raised by respondent by amended answers in these cases.FINDINGS OF FACTSome of the facts have been stipulated and are so found. The stipulations of fact and exhibits attached thereto are incorporated herein by this reference. At the time their respective petitions were filed, petitioners Michael W. Patin and Sandra H. Patin resided in66 Houston, Texas; petitioners Gordon W. Hatheway, Jr., and Barbara S. Hatheway resided in Fairfax, Virginia; petitioner Arthur Espy resided 1089 in Dallas, Texas; petitioners Edward N. Gomberg and Helen E. Gomberg resided in Hixon, Tennessee; and petitioners William S. Skeen and Alison Skeen resided in Irvine, California.General Overview of Gold ProgramOmni Resource Development Corp. (Omni) was formed March 17, 1980, under the laws of the State of Delaware. American International Mining Co., Inc. (AMINTCO) was formed under Delaware law on April 14, 1980. During 1980, Dr. Phillip A. Myers (Myers) and Elwood E. Parrish (Parrish) each owned 50 percent of the capital stock of each corporation.The deductions in dispute in these cases arise out of the participation of petitioner-husbands and petitioner Espy (hereinafter petitioners, unless otherwise indicated) in Omni's "Gold Ore Purchase and Mining Program" (sometimes hereinafter referred to as the gold program). The gold program was organized and promoted through the efforts of Myers and Parrish during 1980 ostensibly to mine gold and silver ore from the "Shamrock" and "Encino Vivo" lode claims located near Silver City67 in southwestern New Mexico. Neither Myers nor Parrish had any previous gold mining experience at the time they organized the Omni gold program.The gold program was promoted as providing a tax deduction equaling 6 times the cash invested in 1980 by prospective investors. The offering materials (hereinafter referred to as the prospectus) petitioners received contained the following description of the gold program:Structure of the Program -- For a PRINCIPAL 5 who wishes to both mine gold and silver and generate a large 1980 tax loss, the program would work as follows. If the PRINCIPAL wishes, as an example, to generate a $ 60,000 ordinary tax loss in 1980, he would first buy 1,200 tons of gold-bearing ore from OMNI -- at a total cost of $ 50 plus a 50% royalty of the gold and silver contents. Second, the PRINCIPAL would sign a $ 60,000 contract with American International Mining Co., Inc. ("AMINTCO") to develop the mine site for the 1,200 tons, and to then mine and process the ore all the way to bullion. The $ 60,000 contract 1090 would be paid by the PRINCIPAL with $ 10,000 in cash, and the proceeds of a $ 50,000 ten year recourse note. In a typical case, part of68 the bullion produced would be sold to repay the note, over a five year period.The prospectus detailed the tax benefits of the gold program in several places, including the following description in question-and-answer form:WHAT IS THE TAX WRITE-OFF (ALSO CALLED THE REDUCTION OF ADJUSTED GROSS TAXABLE INCOME) FOR THE 1980 TAX YEAR?The tax write-off or reduction of adjusted gross taxable income is 6 to 1.WHAT DOES 6 to 1 MEAN?This means that the write-off or reduction of adjusted gross taxable income is 6 times your cash outlay.HOW IS THIS DERIVED?We shall use a simple example of a Principal who has $ 10,000 in cash, needs to shelter $ 60,000 in other income during 1980, and wants to make a very handsome return on his cash. This Principal would buy 1,200 tons of gold and silver bearing ore from Omni Resource Development Corporation ("OMNI"), which owns the Shamrock and Encino Vivo gold lodes in New Mexico. The cost to the 69 Principal would be $ 50. [sic] plus 50% of the gold and silver contents processed from the ore. The Principal now owns the ore. If the Principal wishes to get the maximum tax advantage, he would next contract with American International Mining Co., Inc. ("AMINTCO") to develop his mine site, and process his ore. The Principal pays AMINTCO $ 50 per ton for mine development, or $ 60,000 in total (1,200 tons X $ 50. = $ 60,000). OMNI has made arrangements for Kensington Financial Corporation to loan Principals 5/6 of this development expense, or $ 50,000 in this case, at 10% simple interest, on a ten year note. The Principal will borrow this $ 50,000 by signing a note to Kensington, and directing Kensington to pay the money directly to AMINTCO. The $ 10,000 in cash plus the $ 50,000 borrowed equals $ 60,000, which gives the 6 to 1 writeoff. The tax code clearly states that mine development expenses (the $ 60,000) are deductable in full in the year in which incurred, thus the Principal can deduct the entire $ 60,000 in 1980.* * * Following are the tax savings you could expect in 1980, assuming you fully shelter your other income with this program. All figures are in dollars. 70 1091 NetCash 6taxable incomeFederalStateTotalsavingsMarried --$ 42,000$ 16,319$ 3,360$ 19,679$ 12,679separate60,00027,1645,40032,56423,564[sic]return84,00042,6368,40051,03637,036150,00088,36215,500103,68278,682Married --42,00011,0862,94014,0267,026joint60,00019,6784,20023,87813,878return84,00032,6387,56040,19826,198150,00073,52815,00088,52863,528Single42,00013,6673,36017,02710,02760,00023,9435,40029,34319,34384,00039,1738,40047,57333,573150,00084,88716,500100,38775,387The federal taxes, above, are taken from tax tables, and State taxes are estimated. If you have no State taxes, you are very fortunate.71 Additionally, the prospectus included materials generally describing the financial aspects of the gold program, the history of the Shamrock and Encino Vivo properties, and literature concerning then current projections of gold price trends. Also included with the prospectus were the following documents:1. -- Tax opinion letter by the Los Angeles law firm of Warner, Sannes & Greenberg.2. -- Securities opinion letter by John A. Karayan, Esq. of Burbank, California.3. -- "Purchase Agreement."4. -- "Mining Agreement."5. -- "Promissory Note and Security Agreement."6. -- "Purchaser Questionnaire."7. -- "Principal Information and Instruction Sheet."The tax opinion letter concluded that the proposed mining development fee would be deductible in its entirety during the 1980 tax year. The opinion letter stated that it was based upon the law applicable to the facts and representations 1092 as made to its author by Parrish, and that no effort was made to verify such facts and representations.The securities opinion letter concluded that the structure of the gold program was such that the purchase agreement "should not be classified as a security under current Federal or California72 law." The purchaser questionnaire included in the prospectus elicited information concerning investors' income, net worth, and investment experience.Under the purchase agreement, Omni purported to sell discrete ore blocks to the individual investor and permit him either to mine such blocks himself or to contract to have them mined by a "reputable" mining services contractor. If an investor chose to mine the ore himself he was required by the agreement to post a $ 10,000 bond in favor of Omni. The purchase agreement required that mining operations be commenced within 1 year and completed within 6 years from the date of such agreement. In addition, the purchase agreements executed by petitioners Patin, Skeen, and Espy provided that the ore sold would be "designated by blocks of ore six feet wide, one hundred feet deep from the surface, and generally not less than eight feet long * * * randomly selected from areas of the mine site believed by SELLER to contain commercial quantities of ore" and that such ore blocks would then be precisely mapped, physically marked on the mine site, and recorded in the purchaser's name.The purchase agreement also called for a total purchase price 73 of $ 50 (without regard to the number of tons of ore purchased). Additionally, Omni was granted an overriding royalty of 50 percent with respect to gold and silver bullion mined and processed from the property. The agreement further provided that in the event the initially purchased ore block(s) did not produce gold and silver worth at least $ 220 per ton, Omni would then sell an equivalent amount of ore to the buyer for an additional $ 50 (plus a 50-percent overriding royalty), and would mine and process such ore at no additional cost to the buyer. The purchase agreement further required that Omni bear the cost of all environmental and conservation expenditures. The purchase agreement did not, however, include a legal description of the mining 1093 claim or claims purportedly sold, nor did it specifically mention by name either the Shamrock or Encino Vivo claims.Concurrent with the execution of their respective purchase agreements, each of the petitioners executed a "mining agreement" and a "promissory note and security agreement." 7 Investors were to pay $ 50 per ton for development, and $ 5 per ton for extraction, processing, refining, and shipping of the ore. The minimum74 development fee was set at $ 30,000 ((600 tons of ore) X ($ 50 per ton)), payable upon execution of the agreement. The extraction fee was payable upon extraction of an investor's gold and silver bullion. AMINTCO promised under the mining agreement to develop, and then to extract, an investor's ore before performing such services with respect to any investor who subsequently executed a mining agreement with AMINTCO.Under the mining agreement, an investor could either pay the entire development fee in cash upon execution of the agreement, or pay one-sixth of it to AMINTCO and "simultaneously * * execute a note in favor of and borrow from Kensington Financial Corporation * * * the balance of the cost of said mining development." AMINTCO was authorized under the mining75 agreement to receive payment of the proceeds of such note directly from Kensington. Further, AMINTCO warranted that it and Kensington were independent organizations with no interest in the proceeds of the venture, except for Kensington's interest as a creditor. Finally, the mining agreement provided that all costs to meet requirements imposed by any governing body would be borne "solely by AMINTCO and/or Omni," and AMINTCO warranted that meeting such requirements would not delay its performance under the contract.The mining agreement executed by petitioner Patin included three additional provisions: (1) A declaration that AMINTCO was an independent contractor; (2) a provision requiring AMINTCO to carry casualty insurance covering personal injury and property damage, and requiring that 1094 AMINTCO provide petitioner with certificates of insurance prior to commencing any work under the contract; and (3) an agreement by AMINTCO to hold petitioner harmless with respect to any damages and costs arising out of violations of law, statute, or regulations of any governing body.During the year in issue, petitioners each invested cash and executed promissory notes in the following76 amounts:Petitioner/docket No.Cash investedPromissory noteTotal 8Michael W. Patin,docket No. 31925-83$ 15,000$ 75,000$ 90,000Gordon W. Hatheway, Jr.,docket No. 7434-845,0009 25,00030,000Arthur Espy,docket No. 9257-8412,00060,00072,000Edward N. Gomberg,docket No. 15992-8420,000100,000120,000William S. Skeen,docket No. 16937-845,00025,00030,000The "promissory note and security agreement" (the note) executed by each petitioner was a 10-year note calling for simple interest at a rate of 10 percent per annum (12 percent in the cases of petitioners Hatheway and Espy). 10 The terms77 of the note required prepayment during years in which mining took place, in the amount of 50 percent of gross proceeds. The note provided that it was recourse as to principal, nonrecourse with respect to interest. Kensington was granted a secured interest in the maker's ore and any gold or silver proceeds from such ore. The note provided that it was to be governed by California law and that any action to enforce the note must be brought in the State of California. Additionally, the notes executed by petitioners Patin, Espy, and Skeen contained the following language:Lender warrants that it has no interest other than as a creditor in any activities of MAKER, OMNI, or the mining contractor, if any, which MAKER has employed.1095 Funding the Promissory NotesKensington Financial Corp. was incorporated in Delaware by Harvey J. Levitan (Levitan) on May 19, 1980. 11 Pursuant to a verbal agreement between Myers and Levitan, 78 Levitan was to act through Kensington as a loan broker, taking loan applications of gold program investors and attempting to fund such loans through unrelated financial institutions. Levitan was to receive a 1-percent fee for loans funded through his efforts.After incorporating Kensington, Levitan placed in storage its certificate of incorporation and the accompanying corporate kit (including, among other things, a corporate minute book, corporate seal, and blank stock certificates), and awaited further instructions from Myers. However, sometime between July and September of 1980, Levitan decided to withdraw from the deal because of other business commitments which had arisen in the interim, and because of a lack of progress in the Kensington matter. Shortly thereafter, Levitan mailed79 the Kensington certificate of incorporation and corporate kit to Myers. At such time no shares of Kensington stock had been issued and Kensington had not engaged in any business activity.Allen Yeh (Yeh) was employed as Kensington's vice president and general manager from November 3, 1980, through March of 1983. At the time Yeh was hired by Kensington, he had approximately 4 years' experience as an accountant, but had no previous experience in banking or finance. Yeh was interviewed for the position by Myers, and he initially reported to work at Myers' residence. Subsequently, Yeh reported to work at AMINTCO's offices, and eventually to an office leased through Myers' efforts on behalf of Kensington.Shortly after Yeh was hired by Kensington, Levitan sent a letter, at Myers' request, to Kensington's registered agent naming Yeh as his successor.Myers explained to Yeh that Kensington was a subsidiary of Erylmore Co., Ltd. (Erylmore), a Hong Kong finance company which would fund the promissory notes of the gold 1096 program's investors. Myers also explained that he (Myers) would act as agent of Erylmore in the United States. Yeh was supervised by Myers during the entire 80 course of his employment at Kensington. With the exception of a secretary and some temporary clerical workers, Yeh neither met nor had knowledge of any other Kensington employees. He also has never had any contact with any director, officer, or other employee of Erylmore.At the commencement of his employment, Yeh was given signatory authority (shared by Myers) over Kensington's checking account at the Sumotomo Bank of California, which at that time had a balance of approximately $ 100,000. By early December 1980, Kensington ceased transacting business at the Sumotomo Bank, eventually closing its account there during 1981. Kensington opened two checking accounts toward the end of 1980 -- one at Interstate Bank (used as a petty cash account) and another at TransWorld Bank (used to fund investors' promissory notes). Yeh and Myers both had signatory authority with respect to the account at Interstate Bank. The record is inconclusive, however, as to signatory authority over the account at TransWorld Bank.Processing the LoansErylmore was formed April 23, 1980, under Hong Kong law. The ownership of Erylmore is not ascertainable on this record.Lynn Pooler (Pooler) was employed81 as AMINTCO's bookkeeper from November 1980 through May 1982. While employed at AMINTCO, Pooler carried out her duties under Myers' supervision. Her duties included establishing and maintaining books and records for both Omni and AMINTCO, and maintenance of checking accounts in Erylmore's name. Additionally, Pooler was responsible for the processing of investor "packets" as received by AMINTCO. Each packet included the documents 1282 executed by the investor, the investor's check in the amount of $ 50 payable to Omni pursuant to the purchase agreement, and the investor's check to AMINTCO covering one-sixth of its mining development 1097 fee. Since the mining agreement required a mining development fee of at least $ 30,000, the check payable to AMINTCO was always in an amount of $ 5,000 or more. These checks were deposited daily by Pooler into the appropriate checking accounts. Pooler would make and send copies of all documents in the packet to the investor, and a copy of the promissory note, the purchase agreement, and the mining agreement to Kensington. AMINTCO retained the originals of all such documents. 13Under Myers' direction, Pooler and Yeh coordinated their efforts to maintain a circular flow of AMINTCO's funds (received as the mining development fee) through Erylmore to Kensington, and then back to AMINTCO. The objective of this circular money flow was to give the appearance that Kensington had sufficient funds to fund investors' promissory notes. Erylmore would borrow these funds from AMINTCO, then loan them to Kensington. Kensington would then issue checks payable to AMINTCO, thereby giving the appearance that the investors' promissory notes were fully funded. 14 Each transfer of funds from AMINTCO to Kensington typically took 1 or 2 days. In connection with each transfer, Pooler would deposit into Erylmore's account a check drawn on AMINTCO's account, wait a day or two for the funds to clear, then prepare a check drawn on Erylmore's account for deposit into Kensington's account. (Checks drawn on AMINTCO's and Erylmore's accounts83 were signed by Myers). In order to avoid overdrafts in the Erylmore account, the Erylmore check was typically smaller in amount than the preceding AMINTCO check. Pooler usually delivered the Erylmore check to Yeh for deposit by him into Kensington's account. On other occasions, Pooler would make the deposit into Kensington's account, then notify Yeh of the deposit.Pooler would periodically prepare a schedule of deposits summarizing transfers of funds from Erylmore to Kensington. Using such schedules, Yeh would prepare and sign on behalf of Kensington promissory notes payable to 1098 Erylmore. To evidence each transfer of funds from AMINTCO to Erylmore, Pooler would prepare promissory notes (referred to as "commercial paper") payable to AMINTCO in the appropriate amounts. In connection84 with the gold program, Erylmore issued promissory notes payable to AMINTCO totaling in excess of $ 55 million. Such notes were signed on behalf of Erylmore by either Myers or Yeh.Kensington, Erylmore, and AMINTCO entered into an agreement pursuant to which Erylmore was relieved of making payments of principal or interest with respect to the promissory notes it had executed in favor of AMINTCO, except to the extent that Erylmore received payments of principal and interest owed it by Kensington. In turn, Kensington was not required to make payments of principal or interest it owed Erylmore, except to the extent Kensington received payments of principal and interest from gold program investors on their promissory notes. This agreement between AMINTCO, Erylmore, and Kensington was described in AMINTCO's audited financial statements for the year ended March 31, 1981, as follows:the ultimate realizability of notes receivable [from Erylmore] and of the accrued interest thereon is dependent on the repayment of notes to Kensington by program participants. Whether or when such repayment will occur cannot reasonably be estimated at present because of the uncertainty surrounding the amount85 of precious metal which will be recovered from the participants' mineral properties and the market value of such precious metal at the time it becomes available * * . Since [AMINTCO] has no prior experience in [mine development] operations, the likelihood that the contracted revenues will equal or exceed the cost to perform the contracted services cannot reasonably be estimated at present.Kensington made no attempt to investigate the credit of the investors before funding their respective promissory notes, although in each case Yeh would check Kensington's copy of the purchase agreement, the mining contract, and the promissory note for mathematical errors. Based upon the record, we find that virtually all moneys used by Kensington to fund the notes were provided by Erylmore which, in turn, received the funds it advanced to Kensington from AMINTCO. Except for small amounts of start-up capital, and rental and interest income, AMINTCO received all of its funds, which totaled $ 10,923,000, from 1099 investors in the gold program. No principal or interest payments were ever made by petitioners on their promissory notes to Kensington. Sometime prior to March 1983, the respective86 notes were returned to petitioners. 15The Mining ProgramThe gold program herein was structured so that each investor would receive his own87 ore block measuring approximately 6 feet wide (corresponding to the claimed average width of the ore vein found on the Shamrock and Encino Vivo properties), 8 feet long, and 100 feet deep. Each investor was entitled only to the gold or silver contained in his own ore block. Each investor was assured that his ore block would be mined selectively and that his ore would not be commingled with that of other investors. Based upon our analysis of expert testimony presented at trial concerning possible mining methods, we find that selective mining of individual ore blocks of the size purportedly sold by Omni without the commingling of such ore is not possible using conventional mining practices. 1688 The Shamrock and Encino Vivo lode claims 17 were described at length in the prospectus and were purportedly the claims from which investors were to receive ore block 1100 assignments. The Shamrock property consists of five unpatented lode mining claims known as Shamrock Nos. 1 through 4 and Jo Sheridan (collectively referred to as Shamrock). The Encino Vivo property consists of four unpatented lode claims, Encino Vivo Nos. 1 through 4, located several miles from the Shamrock property in the Burro Mountain mining district of Grant County, New Mexico.89 Omni leased Shamrock from Louis L. Osmer, Jr. (Osmer), and his wife, Mary L. Osmer, on May 1, 1980. In a similar lease agreement, Omni leased the Encino Vivo property on May 14, 1980, from the Osmers, who owned a 50-percent interest in the property, and Osmer's partner, David Garcia, who owned the remaining 50-percent interest. Both leases granted the lessors overriding royalty interests in gold and silver extracted from the properties. Each lease granted Omni an option to purchase. The stated purchase prices, to be paid out of royalties, were $ 2 million for Encino Vivo and $ 5 million for Shamrock. A minimum royalty of $ 500 per month was payable with respect to Encino Vivo, whereas the Shamrock lease called for no minimum royalty payments. Omni was given the right to terminate either lease without cause upon 15 days' notice. The lessors could terminate the leases upon 60 days' notice of default, provided Omni did not cure the default within such time period.The Shamrock property is described in the prospectus as having a 7,000-foot uninterrupted vein length, with vein thickness ranging from that of a "cigarette paper" to "four and five feet." The prospectus states that 90 Shamrock has been mined intermittently since the early 1800's, with rich ore having been produced from various portions of the vein, "but the ore shoots were small and mining operations were short-lived." The ore vein is also described as discontinuous and fractured. The property is further described as having 15 openings with a combined total of 605 feet of vertical workings, but with no work having been done below 100 feet from the surface. The prospectus reveals that Osmer owns the property.The prospectus also includes a statement authored by Osmer in which he claims that the most recent mining done 1101 at Shamrock, from 1933 through 1939, resulted in total production in the amount of $ 60,000.The Encino Vivo property was discovered in 1977 by Osmer and David Garcia. The prospectus reveals that Encino Vivo is held in David Garcia's name and that Osmer is his "silent partner." This property has no record of past production, but has been prospected in the past. The prospectus contains a brief description of the property, authored by Osmer, which states in part:THE ENCINO VIVO VEIN SYSTEM CONTAINS SEVERAL 6" AND 8" VEINS, AND ONE MAIN STRUCTURE AVERAGING TWO FEET91 IN WIDTH. DURING THE LATE TWENTIES, A COUPLE OF OLD PROSPECTORS (KNOWN IN LATER YEARS TO THE WRITER) SANK TWO SHALLOW HOLES ON THE MAIN STRUCTURE, BUT COULDN'T SUSTAIN THEIR ACTIVITIES LONG ENOUGH TO DO ANY GOOD. DURING LATER TIMES THE WRITER ADVISED THE PRESENT CLAIM HOLDER TO PROSPECT THE AREA, WHICH HE DID, FINDING VISIBLE GOLD. ONE SAMPLE, SELECTED BY A PRACTICING GEOLOGIST, CARRIED 5.5 OZ AU., AND 16 OZ. AG. THE GROUND WAS SUBSEQUENTLY STAKED AND PROVEN UP ON.In another part of the prospectus, Osmer writes of the Encino Vivo property:AT THE PRESENT, ORE RESERVES ARE NOT BLOCKED. [THEREFORE], RESERVES CAN ONLY BE ESTIMATED, NOT MEASURED. POSSIBLE RESERVES COULD BE ONE HALF MILLION TONS WITH AN AVERAGE TENOR OF 1/2 OZ. AU.Included in the prospectus was a report by Dr. Ralph E. Pray (Pray), a consulting engineer and metallurgist who, during 1980, operated a commercial assay laboratory located in Pasadena, California. Pray had visited neither the Shamrock nor the Encino Vivo property before preparing the report. The report consists of a 1 1/2 page geological summary of the Burro Mountain mining district accompanied by assay results of 11 rock samples allegedly taken from92 Shamrock and 4 rock samples allegedly taken from Encino Vivo. Osmer purportedly took such samples at 750-foot intervals along the veins of the Shamrock and Encino Vivo properties, then shipped the samples he had taken to Pray's laboratory in Pasadena. It is apparent from 1102 the prospectus that Osmer took the samples analyzed by Pray in his report. 18The report showed sample results ranging from a "trace" of gold to 2.10 ounces of gold per ton, with most of the samples revealing less than .5 of an ounce of gold per ton. The samples also showed silver content ranging from "nil" to 3.3 ounces per ton. 1993 Pray's geologic report concluded with the following paragraph:The underground potential of the Shamrock group may be investigated through a sampling of the quartz vein in which values occur. The possibility of surface, or open pit, mining is extremely remote. A partial clean-out of the numerous shafts, open stopes, trenches and pits would be necessary prior to entrance for examination.Potential investors also received the following explanation in the prospectus regarding the reasons no underground sampling, such as a core drilling program, was undertaken: 20Surface samples of gold/silver properties tend to give consistently lower results than below-the-surface samples. This occurs for two basic reasons. First, millions of years of weathering and water tend to dissolve gold and silver, and "leach" them from surface rocks to lower levels. Silver is particularly soluble, over long periods of time, and may migrate fifty or more feet downward in an ore body. Secondly, since both ore bodies have been known, prospected, and occasionally mined over the last one hundred years, attractive ore shoots and veins reaching the surface have already been mined. What remains94 on the surface, therefore, would not be expected to show high values, since it has been picked nearly clean. It has, however, shown very high production values in the past.One might ask why sub-surface samples were not taken. Sub-surface sampling of an extensive nature is very costly, and was felt to be unnecessary and a waste of money. * * *1103 Included with the prospectus was a title opinion authored by J. Wayne Woodbury, a Silver City, New Mexico, attorney, regarding the Shamrock and Encino Vivo properties. 21 The title opinion states, in part:In order to verify that these are good unpatented lode mining claims, it is necessary that a field inspection be made on the ground to determine that the claims are properly staked, that a valid discovery was made, that there are no overlapping or conflicting mining claims and that the annual labor required by the laws of the95 United States and the State of New Mexico have been performed. It is my understanding that this has been done, however, I did not make a field inspection of the property and cannot address myself to this.On or about July 10, 1980, Omni hired a geologist named Robert W. Mathis (Mathis) to make a geologic report on the Shamrock property. At that time, Mathis verbally expressed to Parrish his opinion that, based upon surface observations and the sparse sampling done up to that point in time (the Pray assays), it was impossible to conclude that the Shamrock property had any economic potential. Mathis subsequently submitted a written report to Omni dated October 27, 1980, in which he recommended that extensive sampling be undertaken in order to determine whether a core drilling program was warranted and, if so, the extent and direction of such a program.During September of 1980, AMINTCO hired Western Testing Laboratories (Western96 Testing), a commercial assayer and geologic consulting company, to prepare a geologic report and take assay samples from the Shamrock and Encino Vivo properties. Additionally, Western Testing was expected to map the Shamrock claims. Pursuant to this request, Western Testing submitted a geologic report, assay results, and a map to AMINTCO on or about October 3, 1980, for which it was paid $ 4,500. Assay results are summarized in the report as follows:Gold and silver contents of Samples R-1 through R-43 were determined by the conventional fire-assay fusion method. Twenty-five of the samples ran only a trace or nil on gold, whereas only eight samples ran nil on silver. The remaining samples ran from 0.001 to 0.091 ounces of gold per ton of ore, and from 0.02 to 0.71 ounces of silver per ton of ore. * *1104 In the report, Billy Mack Clem (Clem), owner of Western Testing, concluded that the surfaces of the properties showed no signs of enriched mineral content at depth (such as by downward leaching of minerals) and recommended that no further work be done at Shamrock and Encino Vivo.Despite receiving these unfavorable geological reports, AMINTCO hired Osmer during October97 1980 to take complete charge of selecting mining equipment for acquisition and hiring of employees as he deemed necessary. Prior to hiring Osmer, AMINTCO had no mining or milling equipment.In October of 1980, AMINTCO acquired an old brick yard south of Silver City which was to be used for storage and repair of mining equipment. From the latter part of 1980 through March of 1981, Osmer acquired approximately $ 2 million worth of mining and milling equipment, hired employees, and applied to various governmental agencies for permits needed to commence mining. In January 1981 AMINTCO named Osmer as its vice president for field operations.In either January or February of 1981, AMINTCO hired Dr. A.F. Frederickson (Frederickson), a geological consultant, to evaluate the commercial potential of the Shamrock and Encino Vivo properties. After analyzing assay results from samples he had taken on the Shamrock property, Frederickson reported to Omni sometime in March 1981 that the Shamrock claim showed little commercial potential. In addition to Shamrock, Frederickson evaluated the Encino Vivo property and a number of other mineral properties which Omni had leased between September 198098 and February 1981, concluding that none of these properties exhibited commercial potential.Omni decided on or about March 31, 1981, to abandon the Shamrock and Encino Vivo claims. Early in April 1981, AMINTCO dismissed Osmer and 39 of its 64 employees at the Silver City location. At this point in time, AMINTCO had not yet done any work on the Shamrock and Encino Vivo properties, with the exception of having staked possible core drilling sites.Omni then hired Frederickson to search for substitute mineral properties. Frederickson found a mineral property 1105 located in southern Colorado known as the Mary Murphy mine. Omni leased the property, commencing in July 1981. The lease required an initial payment of $ 100,000 plus monthly lease payments of $ 8,333.33. Omni paid Frederickson a $ 100,000 finder's fee in connection with this transaction.The Mary Murphy mine had been mined from the 1870's through 1949, but it was impossible to determine in 1981 from then existing records the extent or quality of any remaining ore shoots. Frederickson recommended that AMINTCO clean up the access roads and old tunnels in the Mary Murphy mine so that core drilling could be performed99 to determine whether the mine had remaining commercial potential.From July 1981 through January 1982, AMINTCO cleared roads, excavated cave-ins and re-timbered tunnels at the Mary Murphy mine. Work was slowed somewhat with the onset of winter and its accompanying cold temperatures and heavy snowfall. In November 1981, consulting geologists were hired to determine core drilling target areas. On January 18, 1982, AMINTCO began operating a core drill within one area of the mine. AMINTCO also started taking bulk samples (apparently weighing several hundred tons). Such samples showed disappointing results. AMINTCO ceased operations at the Mary Murphy mine early in February 1982. During March of that year, AMINTCO moved its equipment from the Mary Murphy mine to storage in Silver City, New Mexico. By May 1982, AMINTCO had sold or was in the process of selling all of its mining equipment and fixed assets, and had terminated all but four of its employees. AMINTCO thereafter engaged in no further mining activities at the Mary Murphy mine or at any other site, with the exception of reclamation work at the Mary Murphy mine as required under Colorado law. Subsequent to leasing the 100 Mary Murphy mine, Omni continued with the assistance of Frederickson in its efforts to locate other mineral properties. Omni staked placer claims in Nevada based upon Frederickson's work, but such claims became subject to dispute with conflicting claimholders.For the year ended March 31, 1981, Omni borrowed more than $ 850,000 from AMINTCO. Such funds were used in 1106 large part to pay Omni's operating expenses. Omni's only other sources of cash during such year were as follows:SourceAmountPaid-in capital$ 1,000Sales to gold program investors22 56,80057,800During 1981 and 1982, AMINTCO occasionally informed investors, through "Principals' Newsletter(s)," of the progress and setbacks experienced by the 1980 gold program. Petitioners 101 received a total of eight Principals' Newsletters, as follows:NumberDated1Jan. 30, 19812May 8, 19813June 30, 19814Oct. 6, 19815Dec. 14, 19816Apr. 9, 19827Nov. 20, 19828Feb. 2, 1983Investors were informed in Principals' Newsletter No. 2 that the Shamrock and Encino Vivo properties were to be abandoned and that Omni was searching for substitute properties. In this context the newsletter also stated, "Naturally, we are being extremely careful to not jeopardize the tax advantaged aspects of the program."Principals' Newsletter No. 3 informed investors of Omni's acquisition of the Mary Murphy mine. This newsletter also informed investors that ore block assignments would eventually be made to them from the Mary Murphy mine or from other Omni properties instead of Shamrock and Encino Vivo, "Unless we hear to the contrary from you." None of petitioners opted out of the gold program at this point in time.In Principals' Newsletter No. 5, investors were told that "mining" had commenced at Mary Murphy, but that it was limited to the taking of bulk samples for purposes of testing and analysis. The newsletter disclosed that some of the investors had been102 audited by the Internal Revenue Service 1107 and that their deductions based upon the gold program had been disallowed. In this context, the newsletter stated, "We have been told that performance is the best possible thing that we can do to sustain the deduction claimed for the program." Investors were also informed that Omni and AMINTCO had retained tax counsel for the purpose of litigating a test case in this Court.Principals' Newsletter No. 6 disclosed that the Mary Murphy mine had been shut down in January 1982 for the duration of the winter. The newsletter also informed investors that Omni had staked placer claims in Nevada and that the rights to such claims were the subject of litigation then recently filed by Omni.Principals' Newsletter No. 7 disclosed that AMINTCO's operations at Mary Murphy had not been resumed in the spring of 1982 and that the property had been abandoned by Omni. Investors were also informed that AMINTCO would return to them their Kensington promissory notes immediately if they executed a "Termination Agreement" 23 or, in any event, by January 1983.103 Michael W. PatinDuring the year in issue, petitioner was employed as a stock broker. Late in October 1980, petitioner learned of the gold program and was given a copy of its prospectus by Sam Jones (Jones), a coworker's client. Jones was employed at the time as a business analyst for the Martin Cohn family. Shortly thereafter, petitioner was introduced to Jones' business associate, Bart Munro (Munro), who was involved in marketing the gold program. Neither Jones nor Munro had any experience or expertise in gold or silver mining. During the ensuing weeks petitioner had numerous conversations concerning the gold program with both Jones and Munro. Jones and Munro had each visited the Shamrock and Encino Vivo lode claims and had spoken with Myers, Parrish and Osmer about the program. Both men had checked references given by Myers, and Munro had verified some of Parrish's references. Although Munro had taken seven or eight rocks from the Shamrock property and 1108 had two of them assayed, the sample used was too small to be of any value.Prior to investing in the gold program, petitioner performed rough calculations of his potential profit from the gold program, using104 assumptions contained in the prospectus with respect to the grade of ore at Shamrock and Encino Vivo, and approximate market prices for gold ($ 500 per ounce) and silver ($ 15 to $ 19 per ounce).Petitioner executed the necessary contracts with Omni and AMINTCO on November 21, 1980. The purchase agreement which petitioner signed called for the sale to petitioner of 1,800 tons of ore for $ 50, which petitioner paid by check, plus a 50-percent overriding royalty in favor of Omni. The agreement contained no description of the claim or claims from which such ore was to be designated and eventually extracted.Pursuant to the mining agreement which petitioner executed, petitioner paid AMINTCO $ 15,000 by check and executed a $ 75,000 promissory note in favor of Kensington. This $ 90,000 total contract amount was derived by multiplying a $ 50 per ton "development" fee times 1,800 tons. Such agreement contained three provisions not found in the typical mining agreement as executed by other investors in the program. (These provisions had been drafted by an attorney on behalf of Jones' employer and shared with petitioner by Jones). One of these provisions required AMINTCO to maintain 105 liability insurance coverage with respect to its mining operations at Shamrock and Encino Vivo. Petitioner did not seek proof of insurance coverage from AMINTCO prior to executing the mining agreement, nor did he ever receive such proof. However, sometime during December 1980, Jones informed petitioner that Munro had seen an insurance policy obtained by AMINTCO. On Schedule C of his 1980 joint Federal income tax return petitioner deducted $ 90,000 of "mining expense."After executing such contracts, petitioner remained in contact with Jones who, on behalf of his employer, called AMINTCO in Silver City intermittently in order to inquire about progress at the Shamrock and Encino Vivo properties. Petitioner also maintained files in his home wherein he included correspondence from AMINTCO, Omni, and 1109 Kensington. Included in his files, was a copy of Kensington's canceled check to AMINTCO with which it had allegedly funded his loan. Also included in petitioner's files were copies of the Principals' Newsletters. On November 17, 1981, petitioner attended a meeting conducted by Myers in Houston concerning, among other things, AMINTCO's activities at the Mary Murphy mine.The106 promissory note which petitioner had executed in favor of Kensington was canceled and returned to him sometime late in 1982 or early in 1983.Arthur EspyDuring the year in issue, Arthur Espy (Espy) was a self-employed sales consultant. One aspect of his work was the production of audiovisual sales training films. Prior to his involvement with marketing the 1980 Omni gold program, Espy had approximately 20 years of experience selling, among other things, securities, commodities, and military hardware.Espy was introduced to the gold program in late summer or early fall of 1980 and immediately became interested in selling the program to prospective investors. On or about October 22, 1980, he traveled to Silver City, New Mexico, where he met Parrish and Osmer. While there, Espy produced a promotional film featuring views of the Shamrock and Encino Vivo claims, and descriptive narration by Parrish and Osmer. Espy utilized this film in his efforts to market the gold program.Prior to commencing his gold program sales activities, Espy called Myers' personal references, called the New Mexico Bureau of Mines, and read some materials concerning the history of gold mining in Grant107 County, New Mexico, where Shamrock and Encino Vivo are located. Espy also did some general reading at the Southern Methodist University library on the subject of gold mining. Additionally, Espy telephoned a mining consulting firm to inquire about what steps were necessary to verify Omni's claims with respect to ore reserves at Shamrock and Encino Vivo. Espy learned that such verification would initially require several days' work by a geologist and two assistants taking numerous assay samples and conducting other investigations, 1110 and would cost between $ 10,000 and $ 25,000. Espy elected not to pursue verification of Omni's claims.Espy commenced selling the gold program sometime in November 1980. AMINTCO agreed to pay him a commission in an amount equal to 15 percent of the cash raised through his efforts. Additionally, AMINTCO was to pay a gold bullion bonus, payable in installments, starting in 1981. 24Espy employed a sales staff to assist him in marketing the gold program. Espy's sales efforts brought in more than $ 1.7 million of investors' cash and resulted in over $ 260,000 in commission income to him.108 On or about December 30, 1980, Espy executed the agreements with Omni, AMINTCO, and Kensington which form the basis of the dispute herein. The purchase agreement, the mining agreement, and the promissory note and security agreement, which Espy executed are the same in all material respects as those executed by the other petitioners. Pursuant to the purchase agreement, Espy was to be designated ore blocks weighing 1,440 tons. In return, Espy granted Omni a 50-percent overriding royalty and paid a total of $ 50 to Omni upon execution of the purchase agreement. The mining agreement called for AMINTCO to develop such ore at a cost of $ 50 per ton, resulting in a total "mining development" fee of $ 72,000, in satisfaction of which Espy paid AMINTCO $ 12,000 at closing and executed a promissory note in favor of Kensington for the remaining $ 60,000. On Schedule C of his 1980 Federal income tax return, petitioner Espy deducted $ 72,000 of "mine development" expenses. On the same Schedule C, petitioner Espy also reported commission income and expenses from his sales of gold program interests.Espy kept files concerning his investment in the Omni gold program, including a copy of Myers' 109 resume, the Principals' Newsletter(s) which AMINTCO sent him during 1981 and 1982, and a copy of the check with which Kensington allegedly funded his promissory note. He followed gold and silver prices regularly on network television 1111 news programs. During 1981 and 1982, Espy made phone contact with AMINTCO approximately once every other month.The promissory note and security agreement which Espy had executed in favor of Kensington was canceled and returned to him sometime late in 1982 or early in 1983.Gordon HathewayPetitioner Gordon Hatheway (Hatheway) has been engaged in the private practice of law since 1973.Hatheway was introduced to the Omni gold program in August or September of 1980 and was given a copy of its prospectus by his "financial analyst," Ron Goldberg. Mr. Goldberg, in turn, had received the prospectus from a Roger Lindsay at a financial analysts' convention.Prior to investing in the gold program, Hatheway made a number of phone calls, primarily to people whose names appeared in the prospectus, to check on the reputations of Myers, Parrish, Osmer, AMINTCO, and Omni. He spoke with J. Wayne Woodbury, the attorney who had written the title opinion110 included in the prospectus, and with an attorney from the firm which had rendered the tax opinion accompanying the prospectus. Hatheway also spoke at length with Mr. Lindsay, who he understood had visited the Shamrock and Encino Vivo lode claims, concerning Lindsay's impressions of the program and the reputations of the people and companies involved. Finally, Hatheway testified that since late 1979, he had been involved through his legal practice in litigation concerning a gold and silver mine and had thus acquired some familiarity with mining terminology and had become acquainted with certain individuals who he considered to be "mining experts." In casual conversations with these "mining experts" Hatheway described the gold program to them in general terms and asked for their general impressions concerning the program. Hatheway also asked such individuals whether they had heard anything negative concerning the promoters or the companies involved in the gold program. Hatheway also, apparently by mental approximations, concluded that an investment in the gold program would return a profit even if the amount of gold recovery per ton of ore were only 50 percent of the amounts claimed111 1112 in the prospectus, or if the price of gold were to decline to approximately 50 percent of the then current market price.Hatheway entered into the contracts with Omni, AMINTCO, and Kensington on or about December 19, 1980. The purchase agreement called for the sale of 600 tons of ore to Hatheway for $ 50 and a 50-percent overriding royalty interest in favor of Omni. AMINTCO was to develop such ore under the mining and security agreement for a total "mining development" fee of $ 30,000 (a charge of $ 50 per ton), in satisfaction of which Hatheway paid $ 5,000 at closing and executed a promissory note in favor of Kensington for the remaining $ 25,000. The agreements which Hatheway executed are in all material respects the same as those executed by the other petitioners. On Schedule C of his 1980 joint Federal income tax return, Hatheway deducted $ 30,000 of "mining development expenses."Hatheway kept files concerning the gold program, including a copy of the prospectus, a copy of the check with which Kensington allegedly funded his promissory note, the agreements which he executed, and the Principals' Newsletter(s). During the first six months of 1981 he spoke several112 times with Mr. Lindsay concerning the progress of the program. He also kept abreast of gold and silver prices.The promissory note which Hatheway had executed in favor of Kensington was returned to him no later than March of 1983.Edward GombergSince 1971 petitioner Edward Gomberg (Gomberg) has owned and managed Synair Corp., a very profitable manufacturer of urethane systems. During the year in issue, he had personally accumulated substantial sums of cash which he was seeking to invest.Gomberg was introduced sometime in 1980 to Wilfred E. Duvall, an investment advisor to one of Gomberg's close business associates. Mr. Duvall informed Gomberg of the gold program and supplied him with a copy of the prospectus. Gomberg gave a copy of these materials to his attorney and a copy to an accountant who he believed had experience in accounting for mining companies. There is no 1113 reliable evidence in the record indicating the scope of inquiry by Gomberg's attorney and the accountant into the gold program, or the exact nature of the advice they gave to Gomberg. Prior to investing in the gold program, Gomberg read the prospectus and discussed it with Mr. Duvall. Gomberg113 also performed a "best case/worst case" analysis of the venture's profit potential. Assuming the accuracy of Omni's projection that the ore sold contained a half ounce of gold per ton, he calculated his "break-even point" at a market price for gold of $ 233 per ounce, even without any silver content in such ore. In the "best case" computation, he calculated his profit potential at $ 1.3 million in the event gold were to sell for $ 2,000 per ounce and assuming the accuracy of Omni's projections as to the gold content of the ore.On or about September 12, 1980, Gomberg executed the contracts with Omni, AMINTCO, and Kensington. Under the Purchase agreement, Omni was to sell to Gomberg 2,400 tons of ore for $ 50 and a 50-percent overriding royalty. Gomberg executed a mining and security agreement with AMINTCO requiring him to pay a $ 120,000 (at a rate of $ 50 per ton) "mining development" fee. He paid $ 20,000 of such amount at closing and executed a $ 100,000 promissory note in favor of Kensington in satisfaction of the remaining amount. Such agreements are in all material respects the same as those executed by other petitioners. In addition to the aforementioned agreements, 114 Gomberg executed documents entitled "Special Gold Bonus Offer" and "Special Gold Bonus-Mining Agreement." 25115 Under the agreement styled "Special Gold Bonus Offer," Omni provided Gomberg with a 10-percent (240 ton) ore bonus subject to Omni's 50-percent overriding royalty. 26 Under the "Special Gold Bonus-Mining Agreement" Gomberg was required to 1114 pay AMINTCO $ 50 per ton for development and $ 5 per ton for extraction of the bonus tonnage, but payment of the fees for development, and then for extraction, was required only as AMINTCO completed such services with respect to the bonus ore.On Schedule C of his 1980 joint Federal income tax return, Gomberg deducted $ 120,000 of mining development expenses. Pursuant to a preprinted schedule attached to his return, Gomberg allocated the $ 50 per ton development fee to 5 major categories of expense and, within such major categories, to 29 subcategories of expense. The schedule contained blanks filled in with Gomberg's name, address, total mining income for 1980 (in this case equaling zero), number of tons (2,400) of ore to which the $ 50 development fee applies, and total deduction for mining development expenses (in Gomberg's case the product of 50 X 2,400, equaling $ 120,000).Gomberg maintained files concerning his investment in the gold program, including the prospectus, copies of the agreements he had executed, a copy of the check with which Kensington had allegedly funded his promissory note, and the Principals Newsletter(s) sent to116 him by AMINTCO. He attended an investors' meeting, held late in 1981, conducted by Myers. The promissory note which he had executed in favor of Kensington was returned to him no later than January 1983.William SkeenDuring the year in issue, William Skeen (Skeen) was employed as Vice President of Human Resources and Administration by Smith International, a large manufacturer of petroleum and mining drilling equipment. Skeen was introduced to the gold program by his investment advisor, Leland Wurtz (Wurtz, phonetically spelled), sometime in mid-November 1980. At Mr. Wurtz' invitation, Skeen attended a meeting sometime in late November at which Myers and Parrish promoted the program. Skeen received a copy of the prospectus at such meeting. Among others present at the meeting were two of Skeen's coworkers, also officers at Smith International. During the meeting, Skeen scribbled a rough calculation of the profit 1115 potential of the gold program. Such calculation, however, is not in evidence.Sometime shortly after attending this meeting, Skeen had one or more discussions with Mr. Wurtz, who he understood had personally met with Myers and Parrish. He also spoke117 with his two co-workers (both of whom Skeen believed had mining backgrounds) concerning their impressions of the gold program.On or about December 5, 1980, Skeen executed the agreements with Omni, AMINTCO, and Kensington. The purchase agreement, mining agreement, and promissory note and security agreement which Skeen executed are in all material respects the same as those executed by other petitioners. The purchase agreement called for the sale by Omni to Skeen of 600 tons of ore for $ 50 and a 50-percent overriding-royalty interest. Under the mining agreement AMINTCO was to develop such ore at a cost of $ 50 per ton, resulting in a total "mining development" fee of $ 30,000. Skeen paid AMINTCO $ 5,000 at closing, and executed a promissory note in favor of Kensington for the remaining $ 25,000.On Schedule C of their 1980 joint Federal income tax return, petitioners Skeen reported a $ 30,000 net loss for mining and development activity using the following breakdown: 27a. Mine site preparation$ 9,900b. Processing plant preparation12,000c. Transportation system development3,000d. Control systems1,500e. General and administrative/miscellaneousexpenses3,600Total deduction30,000118 Skeen maintained records concerning his investment in the program, including the prospectus, a copy of each document which he had executed, a copy of the checks he had written to Omni and AMINTCO, a copy of Kensington's $ 25,000 check to AMINTCO, with which Kensington had allegedly funded his promissory note, and Principals' Newsletter(s) 1116 which he had received from AMINTCO. He followed gold and silver prices through reading newspapers. During 1981 and 1982, Skeen occasionally discussed his investments, including his investment in the gold program, with Mr. Wurtz. At some point during 1981, Skeen telephoned Myers and discussed with him the reasons for Omni's abandonment of the Shamrock and Encino119 Vivo properties and for its change to the Mary Murphy mine.The promissory note which Skeen had executed in favor of Kensington was canceled and returned to him no later than January 1983.OPINIONThe principal issue in these cases is the deductibility of petitioners' payments to AMINTCO as mining development expenses under section 616 or, in the alternative, as mining exploration expenses under section 617. Respondent's primary position is that the disputed expenditures were part of a tax-avoidance scheme lacking in economic substance and that the entire transaction should, therefore, be disregarded for Federal income tax purposes. Petitioners assert that the transactions represent a bona fide attempt to make a profit, had economic substance, and should therefore be respected for tax purposes.It is well established that a transaction entered into solely for favorable tax consequences, having no commercial, legal, or profit objective will not be given effect for Federal income tax purposes. Frank Lyon Co. v. United States, 435 U.S. 561">435 U.S. 561, 573 (1978); Knetsch v. United States, 364 U.S. 361">364 U.S. 361, 366 (1960); Rice's Toyota World, Inc. v. Commissioner, 752 F.2d 89 (4th Cir. 1985),120 affg. in part and revg. in part 81 T.C. 184">81 T.C. 184 (1983); Beck v. Commissioner, 85 T.C. 557">85 T.C. 557, 569 (1985); Thomas v. Commissioner, 84 T.C. 1244">84 T.C. 1244, 1269 (1985), affd. 792 F.2d 1256">792 F.2d 1256 (4th Cir. 1986). In essence, it is the substance of the transaction, not its form, that determines its tax consequences. James v. Commissioner, 87 T.C. 905">87 T.C. 905, 918 (1986), and cases cited therein.In transactions where tax motivation is apparent, it is necessary to determine whether sufficient business purpose existed for the taxpayer to obtain the claimed benefits. Rose v. Commissioner, 88 T.C. 386">88 T.C. 386, 412-413 (1987). We 1117 found at page 412 of the Rose case, a Court-reviewed opinion, that tax motivation is apparent in activities having objective characteristics such as:(1) Tax benefits were the focus of promotional materials; (2) the investors accepted the terms of purchase without price negotiation; (3) the assets in question consist of packages of purported rights, difficult to value in the abstract and substantially overvalued121 in relation to tangible property included as part of the package; (4) the tangible assets were acquired or created at a relatively small cost shortly prior to the transactions in question; and (5) the bulk of the consideration was deferred by promissory notes, nonrecourse in form or in substance. * Accordingly, whether or not petitioners are entitled to the deductions claimed for mining development or exploration expenses is dependent upon the Court's finding that their mining activities constituted a trade or business or were undertaken and carried on for the production of income. Rose v. Commissioner, supra at 406; Beck v. Commissioner, supra at 569.In the instant cases, tax motivation is apparent since tax benefits were highlighted in the gold program's promotional materials and newsletters; petitioners did not negotiate the purchase price or the mining development fees; the mining properties were overvalued and investors failed to receive any clear evidence of title or ownership; the mining properties were acquired by Omni shortly before the transactions in question for negligible amounts; and the bulk of the 122 consideration was deferred by valueless promissory notes.Based on the entire record it is abundantly clear that sufficient business activity did not exist which would support an objective finding that the transactions herein had a business purpose. Rose v. Commissioner, supra at 412.Petitioners' Pre-Acquisition ActivitiesIn searching for business purpose, we must examine the objective facts surrounding petitioners' activity in light of their claim to have been engaged in a profit-seeking endeavor. In the Rice's Toyota World case we examined a purchase-leaseback of computer equipment where residual value was critical to an economic profit. We found, however, that Mr. Rice failed to evaluate the transaction on that basis and, despite his lack of knowledge about computers, 1118 chose to rely "upon the representations of the deal's promoter, of a friend, and the 'gut' feeling that it was a good deal." 81 T.C. at 202. Mr. Rice made no attempt to determine whether Rice's Toyota was purchasing an obsolete computer or one with potentially high residual value. We concluded that there was little reason, apart from123 the significant tax benefits, which could explain the entry of Rice's Toyota into the purchase-leaseback and, therefore, held that there was no valid business purpose underlying the transaction.In the instant cases, petitioners claim to have been motivated by the tremendous profit potential which the gold program appeared to offer. Petitioners each contend that their pre-investment investigation into the profit potential of the gold program equaled or exceeded the level of investigation which they would normally have conducted prior to placing time or money into an activity in which they had no previous experience. Respondent argues that petitioners' actions merely reflect concern with establishing a plausible pretext for tax benefits, rather than evidencing bona fide attempts by them at a profit-seeking activity. Based on the record before us, we agree with respondent.The record demonstrates petitioners' complete indifference to the gold program's chances for economic success. We note that none of petitioners had any experience in gold or silver mining, nor were they actively involved in carrying out the program in which they invested. We, therefore, find significant the fact124 that petitioners chose to rely exclusively on the promoters' representations concerning the quantity and quality of ore reserves at Shamrock and Encino Vivo. Such reliance is remarkable in light of the fact (easily gleaned from the prospectus) that Omni's representations were based upon sparse surface sampling performed by Osmer, the owner of the mining properties. Yet petitioners did not attempt to verify such reserve estimates through qualified independent sources. 28 Nor did any of petitioners, 1119 with the exception of petitioner Espy, even seek information concerning the nature and extent of geologic testing necessary to establish the presence of ore reserves or even to verify the promoters' claims with respect to reserves at Shamrock and Encino Vivo. Petitioner Espy, upon learning that extensive sampling and other work was necessary in order to verify Omni's claims, chose not to pursue the matter further.125 The record shows that in establishing the existence of gold or silver ore reserves, standard mining industry practice involves, among other tests and observations, surface sampling at intervals of 15 to 50 feet and, if such samples show promise, subsurface sampling. By contrast, Omni's claims as clearly set forth in the prospectus were based upon surface samples allegedly taken at 750 foot intervals at Shamrock and Encino Vivo by the owner of such properties. Petitioners' claimed reliance on this "evidence" of rich ore reserves simply does not ring true. Moreover, we note that Omni's claims as set forth in the prospectus are nothing short of fantastic in light of testimony by both respondent's and petitioners' experts that such claims, if true, would have meant that Shamrock and Encino Vivo were among the richest unmined deposits of gold then known to exist.Petitioners are all sophisticated businessmen. We simply do not believe that they would enter into profit-motivated transactions with an unknown party and rely solely on the representations of such party with respect to the most crucial aspect affecting the viability of the proposed venture. Only the promised six-to-one tax126 deduction can adequately explain petitioners' entry into the gold program under such circumstances. See Rice's Toyota World, Inc. v. Commissioner, 81 T.C. at 202.Petitioners' Acquisition ActivitiesEach petitioner asserts that at the time he entered into the gold program he was looking to the ore reserves of the 1120 Shamrock and Encino Vivo properties and, more specifically, to his own ore blocks for a return on his investment. The record clearly contradicts such an assertion. The purchase agreements entered into by petitioners do not designate the ore blocks allegedly purchased by them, but merely provide that (at some unspecified point in time) Omni would randomly assign ore blocks to each investor. Equally as important is the fact that the purchase agreements do not name or describe the Shamrock or Encino Vivo properties as the mining claims from which ore blocks would eventually be designated. 29 Under the circumstances, petitioners' claimed belief in the extraordinary values of these two specific mineral properties clearly lacks credibility.127 Petitioners' lack of concern about exactly what they purchased, if anything, is not unlike that of the taxpayer in Moore v. Commissioner, 85 T.C. 72 (1985). In Moore, the taxpayer, a lawyer, purportedly purchased an exclusive territorial franchise for $ 384,000 under an agreement which failed to pinpoint the location of the territory allegedly purchased. We stated at page 104 of the opinion:It staggers the imagination to believe that any careful lawyer like petitioner would even consider obligating himself to purchase an exclusive territorial franchise for $ 384,000 * * * when the location of the territory was not specified in the contract. * * * The location of the territory does not appear to have been of critical importance to petitioner, and the real explanation for this seemingly extraordinary situation is that this was no true, bona fide agreement to purchase an exclusive territorial franchise.Like the taxpayer in Moore, petitioners are all sophisticated businessmen. We think our analysis in Moore applies with equal force to the alleged purchases by petitioners in the instant cases of unspecified ore blocks on unspecified mining128 properties.1121 We observe that the title opinion included with the prospectus did not address the effectiveness of the alleged transfers of ore blocks from Omni to gold program investors, but dealt only with the validity of the transfers to Omni from the Osmers and Garcia of their interests in Shamrock and Encino Vivo. Moreover, the title opinion clearly stated that it was based upon certain assumptions which could only be verified by "field inspection" and that its author, Woodbury, had not performed such an inspection prior to rendering his opinion. We also note that petitioner Patin's prospectus did not include Woodbury's title opinion and that, like the other petitioners, he did not obtain a title opinion with respect to Omni's alleged transfer to him. Finally, with respect to petitioner Gomberg, the evidence indicates that the purchase agreement was not executed by Omni or, at the very least, that he did not have a copy in his files of such agreement fully executed.We also find unpersuasive petitioners' contention that they were influenced to enter into the disputed transactions by Omni's promise to mine, at no cost to petitioners, a second block of ore in the event129 the first block assigned to them failed to produce at least $ 220 worth of gold and silver per ton. In fact, petitioners' original ore blocks were never assigned and, consequently, were never mined. Hence, Omni's "guarantee" never came into play. Nor did petitioners seek to have Omni and AMINTCO meet their obligations under the agreements. Petitioners took no steps to ascertain whether Omni, a newly formed corporation, was financially capable of performing its "guarantee." The record shows that Omni's primary source of funds during the year in issue was loans from AMINTCO, and that petitioners had no idea when they entered into the disputed transactions whether or not Omni's "guarantee" had any value.In sum, petitioners appeared completely indifferent to the success or failure of the venture, and such indifference cannot be explained away as reliance by them on Omni's "guarantee." Under the circumstances, we can find no reason why petitioners engaged in the disputed transactions other than to obtain promised significant tax benefits.1122 Petitioners' Post-Acquisition ActivitiesFurther evidence supporting the conclusion that petitioners had no business purpose for130 entering into the disputed transactions are the significant facts that petitioners made no attempt to determine whether AMINTCO was fulfilling the mining contract and took no action to save their respective investments in the program once the failure at the Shamrock and Encino Vivo properties became apparent. Petitioners' occasional inquiry into the activities of Omni and AMINTCO rose merely to the level of curiosity, and certainly did not reflect the level of concern which would normally attend a business activity and subsequent potential loss of a substantial investment. Also, petitioners were indifferent to the fact that they did not even receive an assignment of their promised "ore block" from Omni. "Where, as here, the promised tax benefits are suspiciously excessive and the transaction as a whole is entered into and carried out with a complete indifference to profit, it is clear what the parties intended to accomplish." Flowers v. Commissioner, 80 T.C. 914">80 T.C. 914, 941 (1983).The Promissory NotesPetitioners contend that the contribution of their own funds to the gold program and the use of borrowed funds for which they were personally liable, 131 is proof that they possessed business purpose, i.e., a profit objective, for investing in the program. To the contrary, respondent argues that the promissory notes lack economic substance 30 and that petitioners' own funds merely represent payments by them for anticipated tax benefits.We have found as a fact that the promissory notes were "financed" by use of a circular flow of money controlled by Myers. This was clearly an attempt to create the appearance of legitimate financing when, in fact, AMINTCO received no funds from the promissory notes, 31 and under its "compensating balance" arrangement with Kensington and Erylmore could receive such funds only to the extent investors made payments on the notes to Kensington. In 1123 essence, the checks issued by Kensington to AMINTCO were a return to AMINTCO of its own funds, minus Kensington's operating expenses. In substance, no funds changed 132 hands since the circulated funds were at all times under Myers' control.Petitioners contend that they executed the promissory notes in good faith, and without knowledge of the circular flow of money or the "compensating balance" 32 arrangement between AMINTCO, Erylmore, and Kensington. Petitioners further contend that such promissory notes were valid negotiable instruments on their face which Kensington could have negotiated at any time, thus exposing petitioners to great financial risk. Petitioners argue, therefore, that the notes had economic substance as to them and should be recognized for tax purposes without regard to any financial machinations in which the promoters of the gold program may have engaged. Based upon this record, however, it is beyond belief that petitioners had no inkling of what was going on. The promissory notes in question included terms that petitioners could not have obtained at arm's length with a bona 133 fide financial institution -- a 10-year deferral on the repayment of principal, interest well below the then current market rate, nonrecourse with respect to interest, and the principal sum secured solely to the proceeds of what can only be described as a very risky venture. Even petitioners' expert admitted under cross-examination that at the times petitioners executed the promissory notes in question, such notes could not have been negotiated to a third party for more than 5 percent of their face amounts and, even if a buyer could be found, would probably have sold for much less. In any event, even a good-faith belief by petitioners that they had incurred genuine indebtedness 1124 would not affect our determination that the promissory notes in question lacked economic substance. See Karme v. Commissioner, 73 T.C. 1163">73 T.C. 1163, 1194 (1980), affd. 673 F.2d 1062">673 F.2d 1062 (9th Cir. 1982).134 The record shows that AMINTCO retained possession of petitioners' promissory notes, and that Kensington received copies of such notes. Without possession of the original notes, Kensington clearly had no intention, nor did it have the ability, as petitioners contend it did, to either enforce the notes or to negotiate them to third parties.Kensington was formed during 1980 by an associate of Myers, and all of its activities were carried out pursuant to Myers' directions. For most of November 1980 through March 1983, Kensington operated with only two permanent employees and some temporary clerical workers. We find very significant the fact that Kensington purportedly loaned in excess of $ 55 million without investigating the borrowers. Compare Capek v. Commissioner, 86 T.C. 14">86 T.C. 14, 49 (1986). No payments were ever made on the notes by petitioners. AMINTCO held the notes for approximately 2 years, then returned them to petitioners. It is clear from these facts that the alleged loans lacked any economic substance whatsoever and were engaged in solely to inflate investors' tax deductions. The alleged loan transactions are, therefore, to be disregarded135 for Federal income tax purposes. Falsetti v. Commissioner, 85 T.C. 332 (1985). Also see Gregory v. Helvering, 293 U.S. 465">293 U.S. 465, 469 (1935); Rice's Toyota World, Inc. v. Commissioner, 752 F.2d 89">752 F.2d 89 (4th Cir. 1985); Moore v. Commissioner, 85 T.C. at 107. Thus, petitioners are not entitled to any deductions based upon such allegedly borrowed sums.The Mining PropertyThe mining property itself is strong evidence to show that the transaction did not have a realistic opportunity for economic profit.The evidence is clear that the Shamrock and Encino Vivo properties could not have supported a mining program the size of that which Omni proposed. Even the most promising geologic report in evidence, that of petitioners' expert King W. Troensegaard, supports a finding of estimated reserves of only 1,500 tons at Shamrock and none at Encino Vivo. In 1125 comparison, Omni purportedly sold in excess of 1.3 million tons of ore to 1980 gold program investors. Under the circumstances, we find that petitioners had no reasonable possibility of profiting economically136 from the disputed transactions other than through the promised tax benefits. Rice's Toyota World, Inc. v. Commissioner, supra; Grodt & McKay Realty, Inc. v. Commissioner, 77 T.C. 1221">77 T.C. 1221 (1981).Having found that petitioners lacked business purpose, and that they had no realistic hope of profiting economically from the gold program except for tax benefits, we hold that the disputed transactions lack economic substance and are to be disregarded for Federal income tax purposes. We further hold that petitioners are not entitled to any deduction with respect to their cash payments to AMINTCO during the year in issue. Such amounts merely represent the fee which petitioners paid to purchase tax benefits and, consequently, are not deductible. Rice's Toyota World, Inc. v. Commissioner, 752 F.2d at 95, affg. on this issue 81 T.C. at 207 and 210.In so holding, we have given thorough consideration to petitioners' contention that the gold program failed as the result of unforeseen circumstances and judgmental errors, and not by design as respondent asserts. Petitioners assert that Omni made a Herculean137 effort to provide a successful outcome for its gold program investors, pointing to the "back-up" mineral properties which Omni held at the time of the initial transactions, Omni's search for mineral properties to replace the abandoned Shamrock and Encino Vivo properties, and AMINTCO's activities at the Mary Murphy mine. The agreements executed by the parties, however, did not call for such actions by Omni or AMINTCO, and the evidence clearly shows that before executing such agreements petitioners did not consider the use of substitute mineral properties by Omni as part of the transaction. We note that petitioners took no action following Omni's abandonment first of the Shamrock and Encino Vivo properties, and then of Mary Murphy, remaining all but totally passive until their promissory notes were canceled and returned to them. When the dust finally settled ore block assignments had not been made and no mining had taken place. We find revealing Omni's explanation to 1126 investors in Principals' Newsletter No. 5 dated December 14, 1981, that "performance is the best possible thing we can do to sustain the deduction claimed for the program." From these facts, it is clear that138 Omni's activities subsequent to the year in issue were merely "window dressing" intended to impart the appearance of substance to an already lifeless transaction. We, therefore, place no weight on such activities as proof of petitioners' business purpose or as evidence that the transactions in question had economic substance at the time they were entered into.As further evidence of the economic substance of the gold program, petitioners point to the facts that AMINTCO purchased approximately $ 2 million worth of mining and milling equipment, hired in excess of 60 employees, and applied to appropriate governmental agencies for the permits necessary to commence mine development at Shamrock and Encino Vivo. Based on the entire record, however, we find these isolated facts of little assistance to petitioners' cause. Whatever intentions the promoters may have had with respect to AMINTCO's equipment and employees, there is no evidence of any intent on their part to ever develop or mine Shamrock and Encino Vivo. The facts show that Parrish clearly knew core drilling would be necessary to establish the existence of reserves on such properties and that he was informed by Mathis in July139 of 1980 that the surface sampling done by Osmer was suspect. In October 1980, Clem's geologic report confirmed that Shamrock and Encino Vivo were such poor prospects that core drilling was not warranted. Yet, Osmer was hired by AMINTCO in October 1980 and placed in charge of purchasing mine equipment and hiring employees. By April 1981, Osmer had been fired and the official decision to abandon Shamrock and Encino Vivo was made. Under the circumstances, and taking into account the labyrinth of paper transactions which formed the foundation of the gold program, we regard AMINTCO's activities merely as additional attempts by the promoters to put meat on the bones of a moribund transaction in the hope of sustaining tax deductions they had been paid to create. Such activities certainly added nothing to the substance of the transactions at issue.1127 Having found that such transactions lack economic substance for tax purposes, we need not consider other arguments by the parties.Finally, we note that our decision has been reached without regard to the burden of proof in these cases, although such burden rests with petitioners as to matters raised in the notices of deficiency. 140 33 Rule 142(a).141 Additional Interest Under Section 6621(d)Section 6621(d) provides for an increased interest rate with respect to any "substantial underpayment" (greater than $ 1,000) in any taxable year "attributable to one or more tax motivated transactions." Sec. 6621(d)(1) and (2). The increased rate applies to interest accrued after December 31, 1984. 34By amended answers, respondent asserts the applicability of section 6621(d) to any portion of the underpayments in these cases attributable to a "valuation overstatement," as described in section 6659(c), or to "any loss disallowed by142 reason of section 465(a)." Sec. 6621(d)(3)(A)(i) and (ii). In his amended answers, respondent also makes a general prayer for the application of section 6621(d).We have not reached the applicability of section 465(a) in these cases, and respondent has failed to show how the underpayments in these cases involved valuation overstatements 1128 within the meaning of section 6659(c). 35 Hence, we find that clauses (i) and (ii) of section 6621(d)(3)(A) are inapplicable in the instant cases.However, for reasons which we explain below, we find section 6621(d) applicable in the instant cases to the extent the substantial underpayments result from sham transactions since they were without economic substance. Although respondent in his amended answers does not specifically143 address the applicability of section 6621(d) in the context of sham transactions, respondent does make a general claim under section 6621(d). Respondent raised both the sham and section 6621(d) issues prior to trial. Thus, petitioners have had a full opportunity to present any available evidence and all relevant arguments concerning both the sham issue and the applicability of section 6621(d). Accordingly, we find it appropriate in these cases to consider whether section 6621(d) applies to a sham transaction. Compare Zirker v. Commissioner, 87 T.C. 970 (1986), wherein we declined to consider the application of section 6621(d) to a sham transaction since the Commissioner in that case made no general claim under section 6621(d), but limited his allegations concerning such provision to the extent that a valuation overstatement was found; cf. Johnson v. Commissioner, 85 T.C. 469">85 T.C. 469, 483 (1985), wherein we found that the taxpayers were not prejudiced by our application sua sponte of section 6621(d) based upon our finding of a valuation overstatement since the taxpayers in such case had a full opportunity to litigate the valuation144 issue.In the instant cases, it is clear that petitioners are liable for the increase in the rate of interest pursuant to the provisions of section 6621(d) as evidenced by the Tax Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2085, 2750 (the act). See Price v. Commissioner, 88 T.C. 583">88 T.C. 583 (1987); DeMartino v. Commissioner, 88 T.C. 583">88 T.C. 583 (1987). Section 1535 of the act specifically amends section 6621(d), 36 adding to the list of tax-motivated transactions "(v) any sham or fraudulent transaction." (This amendment is effective with respect to interest accruing after December 31, 1984, the original effective date of sec. 6621(d).) The Conference 1129 Committee report accompanying section 1535 of the act states in part:The conference agreement * * * makes a technical correction to the present-law provision that increases the rate of interest for tax-motivated transactions. * * ** * * Accordingly, the conference agreement, consistent with the legislative intent in originally enacting section 6621(d) in 1984, explicitly adds sham or fraudulent transactions to the list of transactions subject to this higher interest rate. 145 * This clarification of present law applies to interest accruing after December 31, 1984, which is the date this higher interest rate took effect. This clarification does not apply, however, to any underpayment with respect to which there was a final court decision (either through exhausting all appeals rights or the lapsing of the time period within which an appeal must be pursued) before the date of enactment of this act. [H. Rept. 99-841 (Conf.) (1986), to accompany H.R. 3838 (Pub. L. 99-514), Vol. II at 796.]We have held in the instant cases that the transactions in issue were without economic substance and, therefore, were economic shams. Such transactions are clearly "tax motivated transactions" within the purview of section 6621(d). Moreover, we note that even without taking into account the changes made by the recent act, respondent's temporary regulations treat as a tax-motivated transaction "any deduction disallowed for any period under section 165(c)(2) relating to any transaction146 not entered into for profit." Sec. 301.6621-2T, Q-4 and A-4, Proced. & Admin. Regs. (Temporary), T.D. 7998, 1 C.B. 368">1985-1 C.B. 368, 49 Fed. Reg. 59394 (Dec. 28, 1984). 37 As part of our holding that the transactions lack economic substance, we have explicitly found that the disputed transactions were not entered into for profit. The losses from such transactions are thus not allowable under section 165(c)(2). Accordingly, we also find that pursuant to respondent's temporary regulations, the interest rate under section 6621(d) is applicable to the underpayments attributable to such disallowed losses. Section 301.6621-2T, A-5 of the temporary regulations provides for the method of computing the additional interest under section 6621(d).147 Section 6653(a) Additions to TaxRespondent determined additions to tax under section 1130 6653(a) for negligence or intentional disregard of rules and regulations in the cases of petitioners Gomberg (docket No. 15992-84) and Skeen (docket No. 16937-84) in the amounts of $ 3,635.90 and $ 1,000, respectively. Petitioners bear the burden of proof on this issue. Bixby v. Commissioner, 58 T.C. 757">58 T.C. 757, 791 (1972).Petitioner Gomberg contests the addition on the ground that he relied upon his attorney and his accountant in choosing to invest in the gold program, citing for support Hill v. Commissioner, 63 T.C. 225">63 T.C. 225, 251-252 (1974), affd. without opinion sub nom. Tenner v. Commissioner, 551 F.2d 313">551 F.2d 313 (9th Cir. 1977) (reliance on accountants and attorneys), and Moorman v. Commissioner, 26 T.C. 666">26 T.C. 666, 680 (1956) (reliance on attorney.) We find both cases distinguishable from the instant case. In Hill we found that the taxpayers had relied totally on experienced attorneys and accountants in structuring the transactions and in completing their tax returns. 148 The Moorman case involved a taxpayer whose tax return had been prepared incorrectly by his attorney. In both cases, the taxpayers' income tax returns were prepared by a tax expert who was fully apprised of all facts relevant to the transactions in question. In the instant case, it appears that the attorney and the accountant consulted by Gomberg had no tax expertise, did not prepare Gomberg's income tax return, and had access only to the prospectus in formulating their advice to Gomberg. We note that Gomberg's failure to go beyond the information supplied by the promoters in the prospectus before entering the transactions in question was a crucial factor in our finding that he lacked business purpose with respect to such transactions. We think that "reliance" by Gomberg on advice rendered by his attorney and accountant based only upon the same scant information is not the type of reliance upon professional advice which was found in Hill and in Mooreman to overcome the addition to tax for negligence or intentional disregard of rules and regulations. Accordingly, respondent is sustained on this issue with respect to petitioner Gomberg.Petitioner Skeen asserts that he149 was not negligent because he was introduced to the gold program and advised concerning it by Wurtz, a Certified Public Accountant, and because two of Skeen's co-workers, both with educational 1131 backgrounds in mine engineering, spoke favorably of the gold program and decided to invest in it.Skeen claims to have relied upon Wurtz for financial and tax advice. It was Wurtz who prepared Skeen's tax return for the year in issue. Skeen testified that he believed Wurtz had fully investigated the gold program "from the standpoint of 'was it real?'" including personal conversations by Wurtz with Myers and Parrish. On his Federal income tax return, Skeen deducted $ 30,000 in mine development expenses, broken into five categories pursuant to Wurtz' advice. Skeen testified that Wurtz had advised him that such categories were "separable and fairly safe categories to use."Based upon this record, we hold that petitioner Skeen has failed to carry his burden of showing that in taking the disputed deductions, he did not do so negligently or without intentional disregard of respondent's rules and regulations. Although Skeen may have relied upon the advice of his tax accountant, we find150 that such reliance was unreasonable under the circumstances of this case.We have found that Skeen entered into the transactions without a business purpose, but with the hope of a return on his investment solely from tax benefits. It appears from Skeen's testimony that he relied upon Wurtz' advice only as to whether the gold program and the deductions associated with it were plausible, and not as to their legality. In an obvious attempt to make such deductions more believable, petitioner reported them in five "safe" categories without knowledge as to whether such categories or the amounts reported in each category were correct. No reasonable and ordinarily prudent person would have done so under the circumstances. At the very least, such conduct constitutes negligence or intentional disregard of respondent's rules and regulations. Finally, with respect to petitioner Skeen's alleged reliance upon his co-workers' endorsement of the gold program, there is no reliable evidence in the record suggesting the exact nature of the advice, if any, that Skeen received from such individuals. Neither of Skeen's co-workers testified (see Wichita Terminal Elevator Co. v. Commissioner, 6 T.C. 1158">6 T.C. 1158, 1165 (1946),151 affd. 162 F.2d 513">162 F.2d 513 (10th Cir. 1947)), and petitioner Skeen's testimony on the 1132 subject is too general to support a finding in this respect. Accordingly, respondent is sustained on this issue.Decisions will be entered for respondent in docket Nos. 31925-83, 7434-84 and 15992-84.Appropriate orders will be issued in docket Nos. 9257-84 and 16937-84 restoring them to the general docket for trial of the remaining issues in each case. Footnotes1. Cases of the following petitioners are consolidated herewith: Gordon W. Hatheway, Jr., and Barbara S. Hatheway, docket No. 7434-84; Arthur Espy, docket No. 9257-84; Edward N. Gomberg and Helen E. Gomberg, docket No. 15992-84, and William S. Skeen and Alison Skeen, docket No. 16937-84.↩2. All section references are to the Internal Revenue Code of 1954 as amended, unless otherwise indicated.↩3. All Rule references are to the Tax Court Rules of Practice and Procedure.↩4. Sec. 6621(d) has been redesignated as sec. 6621(c)↩, effective Jan. 1, 1987, pursuant to sec. 1511(c)(1), Tax Reform Act of 1986, 100 Stat. 2744.5. Investors in the gold program were referred to as "principals" in the prospectus.↩6. The figures in the "cash savings" column are apparently derived by subtracting an investor's required cash payment to AMINTCO from the tax savings to be received. For example, an investor wishing to fully shelter $ 150,000 of taxable income would make a one-sixth cash payment of $ 25,000 to AMINTCO and sign a note for the remaining $ 125,000. Assuming the investor is married and files a joint income tax return, the chart shows tax savings of $ 88,528. "Cash savings" is thus derived as follows: $ 88,528 - $ 25,000 = $ 63,528.↩7. The documents executed by petitioners Gomberg and Hatheway were actually entitled "Mining and Security Agreement" and "Promissory Note," respectively, but contained essentially the same language as those executed by petitioners Patin, Skeen, and Espy.↩8. Petitioners each deducted their total contract amount as "mining development expenses" on Schedule C of their respective returns.↩9. The promissory note executed by petitioner Hatheway was not dated and did not state the amount borrowed and owed. However, the check from Kensington to AMINTCO with respect to petitioner Hatheway was in the amount of $ 25,000.↩10. Notes executed after Nov. 30, 1980, provided for the higher interest rate.↩11. The parties have stipulated, in what is probably a typographical error, that Kensington was formed May 16, 1980. The parties have also stipulated, as a joint exhibit, a copy of the certificate of incorporation, dated May 19, 1980.↩12. Investor packets included the executed mining agreement, the promissory note and security agreement, the purchase agreement, and the purchaser questionnaire.↩13. We base our finding that Kensington received only copies of such documents, including the notes, on the testimony of Pooler and Yeh who handled such documents.↩14. The terms "borrow," "fund," and "loan" are used merely for the sake of our convenience in describing the alleged transactions, and are not to be construed as a finding by us as to the substance of the transactions described.↩15. An agreement between AMINTCO and Erylmore dated Apr. 26, 1982, provides, in pertinent part:Whereas, it was the intent of ERYLMORE, KENSINGTON, and AMINTCO, that principal and interest balances on the commercial paper would be paid off by ERYLMORE only to the extent that Principals' notes were paid off to KENSINGTON, and not before they were paid off.Therefore, for full and valuable consideration, receipt of which is hereby acknowledged, ERYLMORE AND AMINTCO Hereby Agree As Follows:* * * *d. Should KENSINGTON return a note to any Principal(s) voluntarily as part of any settlement agreement, recision, or for any other reason, or should Principals' obligations to KENSINGTON otherwise for any purpose whatever (except for Principals' payment) be reduced, then the principal balance owed by ERYLMORE to AMINTCO shall thereupon be promptly reduced by an equal amount.↩16. Petitioners' expert Robert Mathis testified that the mining of individual ore blocks without commingling was possible, but it is clear from his testimony that he was basing his conclusion on the assumption that such blocks were 60 feet or more in length. We note that the purchase agreement provided for ore blocks approximately 8 feet in length.↩17. Mining location laws authorize two main types of claims -- lode and placer -- depending upon the character of the deposit. Lode claims are staked on veins or lodes of quartz or other rock in place bearing gold, silver, or other valuable deposits. A lode is frequently considered as a zone or belt of mineralized rock clearly separated from neighboring nonmineralized rock. Placer claims are staked on all forms of deposit, except veins of quartz, or other rock in place.↩18. The prospectus received by petitioner Patin did not disclose the fact that Osmer had taken the ore samples upon which Pray based his report.↩19. Petitioner Patin received assay reports showing only composite results regarding the two properties as follows:↩Gold (oz/ton)Silver (oz/ton)Shamrock0.360.2Encino Vivo0.283.220. The prospectus received by petitioner Patin did not include a copy of the documents in which the quoted excerpt appears.↩21. The prospectus received by petitioner Patin did not include a copy of this title opinion.↩22. Omni received $ 50 from each of the 1,135 gold program investors pursuant to their respective purchase agreements. Although 1,135 X $ 50 = $ 56,750, the record reflects total sales income of $ 56,800, resulting in an unexplained discrepancy of $ 50.↩23. This "Termination Agreement" is not in evidence.↩24. It appears that Espy was owed more than 3,000 ounces of gold bullion bonuses under his agreement with AMINTCO. Although in 1982 he made written demand that the bonuses be paid to him, he decided shortly thereafter not to pursue the matter further, and apparently has not received any such amounts. Espy testified that he decided not to pursue his claimed bonuses in order to remain on good terms with Myers.↩25. The parties have stipulated to copies of various documents pertaining to petitioner Gomberg, including copies of the documents entitled "Purchase Agreement," "Mining and Security Agreement," "Special Gold Bonus Offer," and "Special Gold Bonus-Mining Agreement." Although these four documents bear the signature of petitioner Gomberg, none shows any evidence of having been executed by the other party, to wit, Omni or AMINTCO. With respect to the "Mining and Security Agreement," the line designated as being for acceptance by Kensington is also blank.↩26. Ten percent "bonuses" were apparently offered to those investors who invested in the program prior to Sept. 30, 1980; 25-percent "bonuses" were offered to those who invested before Aug. 1, 1980.↩27. Petitioner Skeen, upon cross-examination by respondent's counsel, had no recollection as to how the numbers with respect to these five categories of expenses were determined. He recalled, however, that he was advised by Mr. Wurtz that the five categories were "safe" categories to use on his income tax return.↩28. Petitioner Patin claims to have relied in part upon the assay results of two rocks picked up by Munro at Shamrock. We note that Munro is trained as an accountant, having no expertise in geology or mining. Patin testified that he was impressed that the samples taken by Munro contained any gold and silver whatsoever and that he thus regarded such samples as confirmation of Omni's claims with respect to ore values at Shamrock. We find petitioner's testimony in this respect implausible. We simply do not believe that petitioner, a trained stockbroker, would evaluate an obviously risky venture based upon such scant information supplied by a person whom he had known for approximately 1 month and with whom he had no previous business dealings. Finally, we note that Munro was paid a commission with respect to petitioner's investment in the program. Although petitioner testified that he knew nothing of such commission, we have some trouble believing that petitioner actually thought that Munro's efforts were supplied gratis.↩29. The parties have submitted arguments with respect to whether petitioners actually obtained title to anything pursuant to the purchase agreement under New Mexico law. We need not decide this issue. See e.g., Sanchez v. Garcia, 72 N.M. 406">72 N.M. 406, 384 P.2d 681">384 P.2d 681 (1963) (competence of extrinsic evidence to identify the land intended to be described in the deed); see generally 23 Am. Jur. 2d Deeds, secs. 296↩-320 (1983). It is sufficient for our purposes to note that the absence of a description in a document purporting to transfer title would usually cause concern in the mind of a would-be purchaser, a factor that petitioners all appeared to ignore in these cases.30. With respect to whether this issue is properly before the Court in docket No. 31925-83, see note 33 infra↩.31. Cf. Ford v. Commissioner, T.C. Memo. 1986-104↩.32. Petitioners analogize the agreement between Kensington, Erylmore, and AMINTCO to that of a "compensating balance" arrangement between a lender (Kensington) and a homebuilder (AMINTCO) under which the lender releases to the homebuilder funds borrowed by the homeowner (petitioners) only as work on the home (the mine) is completed. However, unlike a true compensating balance agreement, the agreement in question here required the release of funds to AMINTCO only to the extent Kensington received payments with respect to investors' promissory notes, and not necessarily as AMINTCO completed mine development work. This is so because payments under the notes during the 6 years AMINTCO had under the mining agreements to complete development (and for 4 years thereafter) were linked to production of gold and silver. We, therefore, reject petitioners' attempt to somehow legitimize such an arrangement as a "compensating balance" agreement when closer scrutiny reveals it to be just another part of the paper facade creating the appearance that petitioners' notes had been funded.↩33. Petitioners Patin assert that profit objective was not raised as an issue in the notice of deficiency and is therefore a new matter as to them for which respondent bears the burden of proof. Petitioners Patin further claim that the economic substance of the promissory note was not raised as an issue in the notice of deficiency and is therefore not in issue in their case. We find, however, that the language contained in the notice of deficiency issued to petitioners Patin is sufficiently broad to encompass both issues, since it states, in part, "Further, you have not established that you acquired an interest in any mineral property, that any mining expenses were paid or incurred, or that the claimed mining transactions occurred or occurred as claimed." Both issues are therefore raised in the notice of deficiency and petitioners bear the burden of proof. Sorin v. Commissioner, 29 T.C. 959">29 T.C. 959, 969 (1958), affd. per curiam 271 F.2d 741">271 F.2d 741 (2d Cir. 1959). We also find no elements of surprise or detriment since petitioners were clearly informed of respondent's intention to pursue such issues at least 3 months before trial in respondent's status report filed with this Court and served upon petitioners. See Sorin v. Commissioner, supra; see also Foster v. Commissioner, 80 T.C. 34">80 T.C. 34, 220-222 (1983), affd. in part and vacated in part on another issue 756 F.2d 1430">756 F.2d 1430↩ (9th Cir. 1985).34. Petitioners challenge on constitutional grounds the applicability of the increased interest rate under sec. 6621(d) to transactions entered into, and returns filed, prior to the date of enactment of such provision. We have considered and rejected similar arguments in Solowiejczyk v. Commissioner, 85 T.C. 552">85 T.C. 552 (1985), affd. without published opinion 795 F.2d 1005">795 F.2d 1005↩ (2d Cir. 1986).35. Respondent presented arguments concerning the applicability of sec. 6621(d)↩ for the first time in his reply brief. We, therefore, will consider respondent's arguments on this issue only to the extent a basis therefor exists in his amended answers.36. See note 4 supra↩.37. These temporary regulations were promulgated pursuant to sec. 6621(d)(3)(B), which grants the Secretary authority to specify types of transactions which will be treated as tax motivated in addition to those types specifically enumerated in sec. 6621(d)(3)(A)↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625403/	Bert B. Rand and Myra F. Rand, Petitioners, v. Commissioner of Internal Revenue, RespondentRand v. CommissionerDocket No. 76230United States Tax Court35 T.C. 956; 1961 U.S. Tax Ct. LEXIS 202; March 20, 1961, Filed 202 Decision will be entered for the respondent. During the taxable year 1953 petitioner paid to an officer of a corporation in which petitioner was a stockholder and creditor an amount of $ 8,890.50, which payment was intended as additional compensation to the officer for his services as president of the corporation. Held, petitioner is not entitled to any deduction from gross income by reason of such payment, either as a trade or business expense under section 23(a)(1) or as a nontrade or nonbusiness expense under section 23(a)(2), I.R.C. 1939, as amended. Charles M. Trammell, Esq., for the petitioners. 203 Peter P. Weidenbruch, Jr., Esq., for the respondent. Arundell, Judge. ARUNDELL956 OPINION.Respondent determined a deficiency in income tax for the taxable year ended December 31, 1953, in the amount of $ 3,002.74.The only error assigned is "The Commissioner erred in disallowing a deduction of $ 8,890.50 as 'fees' paid by petitioner Bert B. Rand to S.A. Carraway."The facts were all stipulated and are incorporated herein by this reference.Petitioners are husband and wife and during the year 1953 were residents of the District of Columbia. They filed a joint Federal income tax return for 1953 with the district director of internal revenue 957 at Baltimore, Maryland. Petitioner Myra F. Rand is involved herein solely by reason of having joined in the filing of the aforementioned return. Petitioner Bert B. Rand will hereinafter be referred to as the petitioner.During the years 1952 and 1953 and thereafter, petitioner was engaged in the private practice of law in the city of Washington, D.C. During those years he was also engaged in the performance of services as a corporate official, as noted hereinafter.Seaboard Machinery Corporation was incorporated in 1951204 under the laws of the State of Delaware. Its principal place of business was at Panama City, Florida. On November 12, 1953, Seaboard Machinery Corporation was merged into Seaboard Maritime Corporation, a newly organized Florida corporation. Seaboard Machinery Corporation and its successor by merger, Seaboard Maritime Corporation, will hereinafter be referred to as the corporation.Throughout the year 1953, petitioner owned not less than one-third of the outstanding capital stock of the corporation. The corporation was also indebted to him in an amount in excess of $ 60,000 on account of advances made to it by petitioner.Prior to December 22, 1952, the corporation was engaged in the business of fabricating steel. On December 22, 1952, the corporation's plant was destroyed by fire.Subsequent to December 22, 1952, the corporation's primary business activities were the liquidation of certain of its assets, the licensing of patents held by it, and the conduct of litigation which arose from the destruction of its plant and its inability to fulfill certain of its contractual commitments. At the present time, the corporation is engaged in the business of licensing patents and performing205 engineering services related thereto.Throughout the year 1952 and until February 19, 1953, petitioner was president of the corporation and S. A. Carraway was vice president. On February 19, 1953, Carraway became president and petitioner became general counsel.Prior to September 29, 1952, the salary authorized by the corporation's board of directors to be paid to its president was $ 36,000 per annum. Subsequent to September 29, 1952, and throughout the year 1953 the salary authorized to be paid by the corporation to its president was $ 30,000 per annum.During the year 1952, throughout which petitioner was president of the corporation and Carraway, vice president, petitioner received $ 24,769.19 and Carraway received $ 13,374.18 from the corporation as compensation for their services.During the year 1953, petitioner, who was president until February 19, 1953, and general counsel thereafter, received $ 8,307.65 from the corporation as compensation for his services.958 During the year 1953, Carraway, who was vice president until February 19, 1953, and president thereafter, received $ 6,843.86 from the corporation as compensation for his services.As president of the corporation, 206 Carraway assumed responsibilities which were considerably more burdensome than those which had been his as vice president. He worked longer and harder than he had as vice president and was required to travel considerably more.During the calendar year 1953, Carraway was paid $ 8,890.50 by petitioner. This payment was intended as additional compensation to Carraway for his services as president of the corporation.The last four paragraphs of the stipulation of facts are as follows:14. By letter dated May 14, 1956, petitioner submitted to the District Director of Internal Revenue affidavits executed by himself and Carraway relative to the aforementioned payment. True copies of these documents are attached hereto as joint exhibits, as noted:Joint ExhibitPetitioner's letter dated May 14, 19562-BPetitioner's affidavit dated May 14, 19563-CCarraway's affidavit dated May 14, 19564-D15. The amount of $ 8,890.50 was included as an expense item in a separate schedule entitled "Schedule of Income and Expenses Other Than From Partnership," which was attached to Schedule C of the joint federal income tax return filed by petitioner and his wife for the year 1953.16. During207 the years 1952, and 1953, Hans A. Nathan, petitioner's law partner and predecessor as general counsel of the corporation, received the amounts of $ 11,407.70 and $ 1,615.39, respectively, as salary for services performed as an officer of the corporation.17. During the years 1954 through 1958, inclusive, petitioner's law firm received legal fees in the following amounts from DeLong Corporation on behalf of L. B. DeLong, indemnitor for the corporation:Amount1954$ 19,000.00195512,000.00195610,250.00195712,000.00195812,000.00Petitioner has requested that we find as ultimate facts that the payment by petitioner to Carraway in 1953 of $ 8,890.50 represented "fees for services to Taxpayer" ("Taxpayer" being the petitioner herein); that such "fees" were reasonable in amount, bore a reasonable and proximate relation to petitioner's business as a necessary, appropriate, and helpful expense; and that such "fees" did not constitute an investment in a new enterprise and did not result in the acquisition of any capital assets.It is true that in the agreement between petitioner and Carraway, dated December 23, 1953, referred to in the affidavits (Jt. Exs. 3-C, 4-D), 208 it was stated that whereas during the years 1949 through 1953 petitioner and Carraway "have been involved in various business 959 matters of divers nature"; that as a result thereof petitioner had "advanced" to Carraway substantial sums of money, some of which advances the parties regarded as business loans and others of which were the subject of a dispute, petitioner maintaining them to be business loans, and Carraway maintaining "that these advances, originally regarded as business loans by mutual agreement, are to become fee payments for the extensive services performed by Carraway for Rand during 1953, including but not limited to negotiations with E. A. Killoren and L. B. DeLong"; and that whereas both parties were desirous of settling any disputes in a spirit of fairness, it was agreed that the net sum of $ 8,890.50 should be "fee payments for services rendered in 1953." Regarding these so-called fee payments, petitioner in his affidavit (Jt. Ex. 3-C) states:As Mr. Carraway's affidavit points out, the fees paid to him by myself for the year 1953 were paid in order to enable him to devote his time as an officer of the Seaboard Machinery Corporation * . The corporation209 itself could not afford to make a substantial payment to him which his services required. I was at the time an officer of that corporation and one of its largest stock holders. It was my belief that Mr. Carraway's services to the corporation were essential to protect an investment by me of what amounted to a considerable part of my savings.Carraway, in his affidavit (Jt. Ex. 4-D), states in part thus:Mr. Rand asked me early in 1953 if I would be willing to continue with Seaboard and to also handle some personal negotiations for him in connection with his Seaboard investment; if he would apply compensation for my services against my personal obligations to him, to the extent that the corporation could not compensate me. * * I was anxious to continue to do my best for the corporation. When Mr. Rand assured me that he would personally pay me a sufficient amount to make it possible for me to do this work, I agreed to the arrangements which were formalized in an agreement between Mr. Rand and myself dated December 23, 1953.We do not think the agreement of December 23, 1953, together with the affidavits of petitioner and Carraway, warrants a finding of the ultimate facts requested210 by petitioner. We regard such ultimate facts asked for by petitioner as being in conflict with paragraph 13 of the stipulation of facts, which is as follows:13. During the calendar year 1953, Carraway was paid $ 8,890.50 by petitioner. This payment was intended as additional compensation to Carraway for his services as president of the corporation.The question of whether the $ 8,890.50 paid by petitioner to Carraway was for services rendered by Carraway to the petitioner or to the corporation, in our opinion, has been resolved by paragraph 13 of the stipulation. We hold the latter to be controlling. Iowa Bridge Co. v. Commissioner, 39 F. 2d 777, 780 (C.A. 8, 1930), reversing and remanding 14 B.T.A. 1048">14 B.T.A. 1048; William C. Chick, 7 T.C. 1414">7 T.C. 1414, 1425, affirmed on other grounds 166 F. 2d 337 (C.A. 1, 1948).960 Petitioner contends that the amount he paid Carraway in 1953 is deductible from petitioner's gross income, either as a trade or business expense under section 23(a)(1) or as a nontrade or nonbusiness expense under section 23(a)(2) of the Internal Revenue211 Code of 1939, as amended. 1 The respondent contends that no part of the $ 8,890.50 is deductible from petitioner's gross income within the purview of any of the provisions of section 23, supra.Section 39.23(a)-1 of Regulations 118 specifically provides that, in order to be deductible as a business212 expense, it is essential that it be established not only that the expense was an ordinary and necessary one but that it was "directly connected with or pertaining to the taxpayer's trade or business." Although the same regulations under section 23(a)(2) do not expressly include a parallel requirement, the case law under the latter subsection is clear in setting forth the requirement that an expense may be deducted by a taxpayer only if it is truly his own expense and not that of another taxpayer. See Deputy v. duPont, 308 U.S. 488">308 U.S. 488; Jacob M. Kaplan, 21 T.C. 134">21 T.C. 134, 145 (Issue V), appeal to C.A. 2 dismissed pursuant to stipulation, Nov. 26, 1954; Harry Kahn, 26 T.C. 273">26 T.C. 273.In the instant case, the expenditure of the $ 8,890.50 by petitioner was not an expense incurred by him in carrying on his own trade or business or incurred in the production or collection of his own income or for the management, conservation, or maintenance of property held by him for the production of income, but was compensation paid to a corporate officer for services which the latter rendered213 to the corporation.The facts in the instant case are practically on all fours with the facts in Harry Kahn, supra. In that case the taxpayer was a corporate shareholder, officer, and creditor who had expended $ 2,108.12 of his own funds in entertaining customers of the corporation, which was operating at a loss at the time. Like petitioner here, he claimed the expenditure as a deduction under either section 23(a)(1)(A) or section 23(a)(2) of the 1939 Code. In denying the deduction under section 23(a)(1)(A), we deemed it sufficient to refer to the rule in Deputy v. duPont, supra, holding that the business of a corporation cannot be regarded as the business of its shareholders. The nonbusiness 961 deduction was denied on basically the same grounds, this Court stating in its opinion that "the expense must be 'ordinary and necessary' and it must be such an expense as is personal to the taxpayer and immediately related to his own income or property."In Friedman v. Delaney, 75 F. Supp. 568">75 F. Supp. 568 (D. Mass. 1948), affirmed on this point 171 F. 2d 269214 (C.A. 1, 1948), the taxpayer was a practicing attorney. He paid a $ 5,000 debt owed by one of his clients and claimed it as a deduction under section 23(a)(1)(A) as a business expense of his law practice. In holding against the taxpayer, Judge Wyzanski, in his opinion, said:If a lawyer pays the debt of his client the payment is not deductible, regardless of whether the payment was requisite to keep in business a client who had brought, was bringing and was expected to bring much legal work to the lawyer. There are several reasons for holding that the deduction does not come within § 23(a)(1). The payment proximately results not from carrying on the taxpayer's business but from carrying on the client's business. Deputy v. DuPont, 308 U.S. 488">308 U.S. 488, 494 * * . There is no evidence that it is a transaction of common or frequent occurrence in the business of practicing law. Id., 308 U.S. p. 495, 60 S. Ct. 367">60 S. Ct. 367. * We think the language just quoted from the opinion in Friedman v. Delaney, is equally applicable to the facts in the instant case.Petitioner relies heavily upon our decisions215 in the cases of Charles J. Dinardo, 22 T.C. 430">22 T.C. 430, and Cubbedge Snow, 31 T.C. 585">31 T.C. 585, as supporting their contentions. We think those cases are distinguishable. In the Dinardo case, the members of a partnership formed for the practice of medicine paid the operating deficits of a hospital incorporated as a nonprofit corporation, and were allowed such payments as a deduction under section 23(a)(1)(A), supra. Likewise, in the Snow case the lawyer-petitioners had been instrumental in establishing a Federal savings and loan association, which had no capital stock and in the profits of which they had no proprietary interest. In conjunction with certain other individuals, they had undertaken to make good any operating deficits incurred by the association until such time as it was on a profitable basis. As it developed, deficits were incurred which the petitioners were called upon to cover. Here, too, the amounts so paid were allowed as deductions under section 162(a) of the 1954 Code, which is for our purposes here the same as section 23(a)(1)(A) of the 1939 Code. The basis for our decisions in those cases was stated216 in the Snow case as follows (p. 596):We think that the essential underlying facts in Dinardo and in the instant case are indistinguishable. In Dinardo, the doctors were already practicing and merely wanted to protect and augment their practices. Similarly, petitioners' law firm had an abstract plant and sought to protect and supplement their income from legal fees by obtaining additional abstract clients. The Association (as well as the hospital) was in operation when the payments were made. In both instances, the taxpayers were, at least in some measure, economically affected by the existence of the institutional facilities which they agreed to 962 underwrite. Thus, the doctors would not earn the medical fees from patients hospitalized at Collinwood if they didn't maintain the facilities, and the law firm would not get the abstract business of the Association if it were not in operation.In both the Dinardo and Snow cases we regarded the expenditures there in question as being directly connected with or pertaining to the taxpayer's trade or business rather than to the hospital or the association. Here, the expenditures in question are directly connected217 with the trade or business of the corporation and not with petitioner's trade or business.Petitioner herein has not shown that the expenditure in issue was in any way related to his law practice. Accordingly, it seems clear, even without regard to the fact that the payments made by the petitioner were for the admitted purpose of protecting his capital investment in the corporation, that his claim for a business expense deduction under section 23(a)(1)(A), supra, is without foundation.The same conclusion must follow with regard to petitioner's claim for a nonbusiness deduction under section 23(a)(2), supra. The expenditure of $ 8,890.50 was made to further the business of the corporation; it was not in fact and in law an expense of the petitioner. Consequently, the deduction must be denied.We hold that no error was committed by the respondent in disallowing the claimed deduction.Decision will be entered for the respondent. Footnotes1. SEC. 23. DEDUCTIONS FROM GROSS INCOME.In computing net income there shall be allowed as deductions:(a) Expenses. -- (1) Trade or business expenses. -- (A) In General. -- All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered; * . * * *(2) Non-trade or non-business expenses. -- In the case of an individual, all the ordinary and necessary expenses paid or incurred during the taxable year for the production or collection of income, or for the management, conservation, or maintenance of property held for the production of income.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625404/	Carolina, Clinchfield & Ohio Railway Company, Petitioner v. Commissioner of Internal Revenue, RespondentCarolina, C. & O. R. Co. v. CommissionerDocket No. 10761-78United States Tax Court82 T.C. 888; 1984 U.S. Tax Ct. LEXIS 62; 82 T.C. No. 68; June 4, 1984, Filed 62 Decision will be entered under Rule 155. 1. P, a common carrier by rail, leased all of its railroad properties on a net basis for 999 years. The lessee purchased and retired outstanding bonds of P, and the amounts expended by the lessee were reflected in open accounts that P would, subject to other adjustments, be required to satisfy at the end of the 999-year lease. Held, the indebtedness to the lessees differs so fundamentally from the original bond obligation that P may not treat one as a substitute for the other.2. P claimed an investment credit for replacement property and additions and betterments (A-B property) constructed on the leased premises by the lessees. Held: P has no cost basis in the replacement property since the lessee is solely responsible for those costs, and P may not claim an investment credit thereon. P may not claim an investment credit on the A-B property to the extent its cost is reflected only in the open account that is to be settled (subject to various adjustments) at the end of the 999-year lease. P may claim an investment credit on certain A-B property for which it has demonstrated a cost basis.3. P elected on an amended return to63 exclude cancellation of indebtedness items from income under sec. 108, I.R.C. 1954, and make a corresponding basis adjustment. Held, under the unusual circumstances herein, the election on P's amended return is proper. Held, further, no recapture of the investment credit on the property subject to the basis adjustment is required.4. Held, P properly elected to amortize certain pre-1969 railroad grading and tunnel bores on an amended return. George K. Dunham, for the petitioner.Stuart B. Kalb, for the respondent. Wilbur, Judge. WILBUR889 Respondent determined the following deficiencies in the Federal income tax of the Carolina, Clinchfield & Ohio Railway Co.:1972$ 300,276.231973353,140.191974331,341.911975476,515.98Total1,461,274.31The issues for our decision are (1) whether petitioner realized additional income from cancellation of indebtedness in the years at issue; (2) whether petitioner is entitled66 to claim an investment credit on additions, betterments, and replacements of its track structure made by its lessees; (3) whether petitioner's election to exclude certain items from income under section 1081 is effective despite being first filed with the amended return, and, if so, whether some portion of the investment credit must be recaptured under section 47; and (4) whether petitioner may claim a deduction in 1975 for amortization of its railroad grading and tunnel bores.FINDINGS OF FACTGeneralSome of the facts have been stipulated, and those facts are so found. The stipulations and attached exhibits are incorporated by this reference.Petitioner Carolina, Clinchfield & Ohio Railway Co. (CC & O) is a corporation that was organized in 1905 under the laws of the Commonwealth of Virginia. It is a common carrier by rail governed by the Interstate Commerce Commission67 (ICC). The stock of petitioner is publicly held, and is traded on the New York Stock Exchange. Petitioner's assets consist of its 890 railroad properties and track, all of the stock of the Carolina, Clinchfield & Ohio Railway of South Carolina, and all of the stock of the Holston Land Co.The petitioner is an accrual basis taxpayer whose headquarters are in New York, N.Y. Corporate income tax returns for tax years ending December 31, 1972 through 1975, were timely filed at the Internal Revenue Service Center in Holtsville, N.Y. An amended return, to which Form 982 "Consent to Adjustment of Basis" was attached, was filed for tax year 1975 in January 1977.In October 1924, petitioner and its two rail subsidiaries (hereinafter lessor) entered into a lease with the Atlantic Coast Line Railroad Co. and the Louisville & Nashville Railroad Co. (hereinafter lessees). 268 These latter two companies were the co-owners of an unincorporated operating organization referred to as the "Clinchfield Railroad Company." 3The lease provided that all of the railroad properties of the petitioner and its subsidiaries were to be leased to the lessees, subject to all outstanding liens and encumbrances, for a period of 999 years. The ICC approved the contract on the condition that the petitioner and its subsidiaries remain an operating unit separate from the lessees.Long-term leases like the one at issue here were common during the 1920's in the railroad industry, and were often mandated by the ICC. Many railroad companies began as small lines serving one or two towns or cities. Gradually the smaller lines merged, forming larger and larger systems. The ICC realized that these merged lines were far more efficient, but feared that too much amalgamation would be anticompetitive. In order to achieve the dual goals of promoting efficiency through economies of scale, and avoiding monopoly and antitrust problems, the ICC decided69 to allow companies to enter long-term leases such as the one at issue here. The two 891 parties could combine their assets, thereby decreasing operational costs, yet because they were required to remain distinct entities, they could be separated relatively easily if joint operation became monopolistic.The lease at issue here is a "net lease." All of the lessor's railroad assets were leased to the Clinchfield, which was responsible for operating the lines that ran through Kentucky, Tennessee, North Carolina, and part of Virginia. The lessees paid an annual rental of $ 1,250,000 4 to the CC & O, and were required to pay a sum, not to exceed $ 12,000 per year, sufficient to cover the annual corporate expenses of the petitioner. The cash rental payments were primarily used to pay dividends to CC & O shareholders. In addition to these rental payments made directly to the lessor, the lessees were required under article first to pay all interest due on petitioner's outstanding bonds and obligations. Article second required them to pay all taxes and assessments on the leased premises and on the lessor or its franchises. Petitioner had no other sources of income, since virtually70 all of its properties passed to the lessees under the granting clause of the lease.Issue 1. Cancellation of IndebtednessFINDINGS OF FACTThe lessor had several outstanding obligations when the lease was entered, and the lessees took the property subject to all the liens and encumbrances securing those debts. The lease does not contain any provision requiring the lessees to pay the principal of any of those outstanding obligations, yet the language of article eighth indicates that this was probably intended. First, that article provides that the lessor will deliver new bonds or obligations to the lessees "sufficient to reimburse the lessees * * * for all payments, costs and expenditures of the lessees, paid or made on behalf of [the] lessors, in taking71 up, paying and discharging the maturing bonds." 5 The parties also agreed that if for any reason the 892 lessees paid the principal on the bonds, "such bonds or other obligations shall not be deemed to have been paid or extinguished but shall * * * be deemed to be valid outstanding obligations and secured in all respects by the mortgage, * * * or other agreement, under which the same were issued, and by which they are secured."In 1965, petitioner's outstanding long-term debt included first mortgage series A bonds totaling $ 16,884,000. On April 1, 1965, prior to the September 1, 1965, maturity date of the series A bonds, petitioner issued first-mortgage72 series B, 4 1/2-percent bonds in the principal amount of $ 16,800,000. The bonds were sold on the market at 98.53 percent of face value; the proceeds were used to retire the outstanding series A bonds. The ICC approved the new issue on the condition that petitioner pay $ 336,000 annually into a sinking fund. These payments could be made in cash or in series B bonds, valued at the lesser of face value or cost. The trustee was to use any sinking-fund payments made in cash to redeem outstanding series B bonds; any bonds delivered in satisfaction of the requirement were to be canceled and cremated. Under a separate guaranty agreement, also dated April 1, 1965, the lessees agreed to pay principal, premium, and interest on the bonds, and to make the required sinking-fund payments, if petitioner failed to do so.The lessees made the required sinking-fund payments beginning in 1966. They purchased series B bonds in the market, generally at a discount, and in March of each year, delivered bonds with an aggregate cost of $ 336,000 to the trustee for cancellation. The lessees sometimes purchased more bonds than were needed to satisfy the sinking-fund payment; the extras were kept in an73 account and used for future payments.Both petitioner and lessees viewed the lessees' sinking-fund payments as being made for the petitioner's account. Various entries were made in the books of both parties when the bonds were acquired by the lessees, when they were transferred to the trustee, and when they were canceled. The net effect of these entries vis-a-vis the petitioner/lessor was to decrease the "long-term obligations" account in the full face value of the bonds, to increase the liability account called "Clinchfield 893 Railroad Company, Lessees-Open Account" by the cost of the bonds, and to increase the "miscellaneous income" account by the difference between face value and cost. This latter amount was reported on the petitioner's return as income from cancellation of indebtedness. 674 The lessees accounted for the sinking-fund payments by decreasing "cash" in an amount equal to the cost of the bonds and by increasing the asset account "Carolina, Clinchfield & Ohio Railway, Carolina, Clinchfield & Ohio Railway of South Carolina, Lessors-Open Account" in like amount.The lease contains no specific provisions governing repayment of informal debts between the lessor and lessees. Article 20th governs the settlement of accounts at termination of the lease, and provides that the lessees are to return all of the leased property, along with any money or securities that they received from the lessors at the outset. The lessor, in return, is to pay the lessees (1) the fair value of all additions and betterments for which stock, bonds, or other obligations were not issued; (2) the amount expended by the lessees in discharging any bonds, equipment notes, etc.; and (3) the amount of any money paid by the lessees into any sinking fund of the character discussed in the 1922 mortgage. The amounts due from the lessor are limited, however, by this clause:provided further, however, that the lessors, in making the payment or payments aforesaid, shall not be required to pay an75 aggregate sum in excess of the then existing fair value of the leased property so returned.Thus, while the open account will become due at termination of the lease, it is possible that it will never be paid in full.In the notice of deficiency, respondent determined that the petitioner realized additional taxable income in each of the 4 years in question. He claims that the full face value of the 894 canceled bonds should be returned as income, not merely the difference between face value and cost. 776 Issue 1OPINIONIn this case, we are presented with the Federal tax consequences of various transactions between the lessor and lessees under a 999-year lease. The first issue involves the correct treatment of the purchase of the petitioner/lessor's bonds by the lessees, and the subsequent cancellation by the trustee.The petitioner/lessor had several outstanding obligations at the outset of the lease, one of which was a series of bonds secured by a mortgage. The 1923 bond issue was replaced in 1965 by first-mortgage series B, 4 1/2-percent bonds. The new indenture required the petitioner to make an annual sinking-fund payment of $ 336,000 to the trustee, who would use the funds to purchase, and then cancel, some of the outstanding bonds. The lessees were secondarily liable on these bonds pursuant to a guaranty agreement executed contemporaneously with the bond indenture.Beginning in 1966, the lessees acquired bonds on the market and transferred a set amount of them to the trustee for cancellation, thereby satisfying the sinking-fund requirement. The lessees carried the cost of these bonds on their books as an 895 account receivable from the lessor; the petitioner/lessor, 77 in turn, showed a matching account payable. The difference between the face value of the bonds acquired each year and the net amount due the lessees was reported as income from cancellation of indebtedness.The parties agree that the taxpayer recognizes income to the extent that its overall liabilities were reduced by the lessees' payments. The parties disagree, however, on the size of that reduction. Petitioner contends that because the bond liability was replaced by a liability to the lessees, income is limited to the difference between the two amounts. Respondent contends that the amounts due under the open account with the lessees are not bona fide debts, and thus says that the full value of the canceled bonds must be included in income.The different positions of the two parties stem from two different characterizations of what occurred here. Petitioner views the transaction as analogous to that of United States v. Kirby Lumber Co., 284 U.S. 1">284 U.S. 1 (1931), where the taxpayer purchased its own bonds at a discount and was required to recognize income to the extent of that discount. Petitioner says the lessees purchased the bonds on its behalf, that78 they were acting as its agent, and that the new obligation to the lessees is a partial substitute for the old. In essence, we are asked to impute the cost incurred by the lessees to the petitioner/lessor, and to limit realizable income to the difference between the face value of the canceled bonds and the lessees' cost.Respondent maintains that the cost cannot be attributed to petitioner because the obligation to repay is illusory. He thus views the transaction as within the ambit of Old Colony Trust Co. v. Commissioner, 279 U.S. 716">279 U.S. 716 (1929), where the Supreme Court held that discharge of a debt by a third party creates income to the obligor. Respondent also argues that the noninterest-bearing open account cannot be viewed as a substitution for the canceled series B bond indebtedness. While we do not view the open account as illusory, we agree with respondent that on the record before us, petitioner's "substitution-of-indebtedness" theory must be rejected.First, we do not believe that the lessees' costs should be imputed to the petitioner/lessor. Petitioner offered no evidence of an agreement that the lessees were to act on its behalf, that the79 lessees had any fiduciary obligations to the 896 lessor, or that the lessees had power to affect the legal relations of the lessor. There are some of the traditional indicia of an agency relationship. Restatement, Agency 2d, secs. 13-15 (1958). What we see here is a standard lessor-lessee relationship that cannot, without more, serve as a basis for imputing costs to the petitioner.Second, we find that the new indebtedness to the lessees differs so fundamentally from the original bond obligation that the petitioner may not treat one as a substitute for the other. Income recognized under the principles of either Kirby Lumber Co. or Old Colony Trust Co. is in one sense a creature of the balance sheet. The taxpayer is deemed to realize income, not because he has received money or property in hand, but because his liabilities have been decreased without an offsetting decrease in his assets. Looking at petitioner's balance sheet here, we find that the steps taken by the lessees allowed the petitioner to recharacterize a portion of its debt load each year: a fixed bond obligation scheduled to mature in 1989 was replaced by an account payable, due only at termination 80 of the lease -- nearly 10 centuries later (in the year 2923) or earlier should the parties so agree. The open account obligation, due nearly a millennium from now, carried no fixed interest, was not represented by a note or other formal evidence of indebtedness, and did not require fixed payments.We believe that the fundamental differences between the two obligations require us to view the sinking-fund payments as consisting of two separate, distinct events. First, the lessees spent $ 336,000 to purchase the lessor's bonds on the market. They made this purchase on behalf of the lessor and accordingly created an account receivable on their books. This advance from the lessees is a loan, and thus need not be reported as income. James v. United States, 366 U.S. 213">366 U.S. 213, 219 (1961). Petitioner did not realize any cancellation-of-indebtedness income at this time. The mere purchase of one's obligations by a third party does not give rise to income since the issuer is still legally liable to meet the terms of the bonds. Cf. Peter Pan Seafoods, Inc. v. United States, 417 F.2d 670">417 F.2d 670 (9th Cir. 1969).The second transaction was the81 cancellation of the bonds by the trustee. Under the bond indenture, the trustee was obligated to retire bonds with a market value of $ 336,000 each year. Because the sinking-fund payments were made by 897 delivery of discounted bonds, the trustee needed merely to cancel them; had the payment been made in cash, the trustee would have gone into the market, itself, spent the money to purchase bonds, then canceled them. The net effect was the same: without any direct payment, the lessor was relieved of all liability on the series B bonds. It therefore must recognize income in the full face value of the retired bonds. Sec. 61(a)(12); Old Colony Trust Co. v. Commissioner, supra.Petitioner would have us view the two events as interrelated, and thus find that the open account was a substitute for the now-extinct bond liability. This "substitution-of-indebtedness" theory has been used in other cases involving the issuance of new obligations upon retirement of older, maturing bonds. 8 In that line of cases, which began with Great Western Power Co. v. Commissioner, 297 U.S. 543">297 U.S. 543 (1936), the substituted debt was similar82 in nature to the old issue. 9 The open account involved here is an entirely different beast. The retired bonds were obligations carrying a fixed rate of interest and a fixed maturity date; they were freely transferable, and the lessor was obligated to any party holding the bond. A formal bond indenture set forth the terms of issuance, interest, and redemption. The open account, by contrast, represents an advance made by the lessees to the petitioner. The bookkeeping entries of the two parties provide the only evidence of the debt. The account carries no interest, nor does it have any fixed maturity date. Absent specific details, repayment is governed by the general provisions of the lease. Under article 20th, the lessor is required to pay --898 The amount expended by the lessees * * under the terms of this indenture, to pay off and discharge the principal of all or any of the bonds * * * for which stock, bonds, or other obligations of the lessors shall not have been issued. * * But the amount due is limited:Provided further, however, that the lessors, in making the payment or payments aforesaid, shall not be required to pay an aggregate sum in excess of 83 the then existing fair value of the leased property so returned.Thus while the lease contemplates a settlement of accounts at termination, which we note could be as late as the year 2923, it is possible that the debt will never be fully repaid.84 On these peculiar facts, we cannot conclude that the petitioner has merely substituted one liability for another. Cf. Zappo v. Commissioner, 81 T.C. 77">81 T.C. 77 (1983). Instead, it has incurred a new and far more contingent liability to the lessees, and it has been relieved completely of the outstanding liability on its series B bonds. Because a party must recognize income when a third party discharges its obligations ( Old Colony Trust Co. v. Commissioner, supra), the petitioner must include the full amount of the discharged bonds in its income.In so finding, we do not agree with the respondent's contention that the open account was illusory and not a valid debt. The advances made by the lessees to the petitioner are covered by the lease, and we have no reason to doubt its validity or enforceability. The parties, themselves, clearly feel bound by the provisions of the lease, and in fact have sought judicial clarification of certain provisions. Also, in Atlantic Coast Line Railroad Co. v. Commissioner, 31 B.T.A. 730">31 B.T.A. 730 (1934), affd. 81 F.2d 309">81 F.2d 309 (4th Cir. 1936), 10 this85 Court held that the lessees could not take a deduction properly allocable to the lessor merely because there was a chance that the debts underlying the expense would not be repaid. Likewise, we do not refute petitioner's "substitution-of-indebtedness" theory on the ground that the open account might never be repaid. Instead, we find a valid debt, but find that it cannot be deemed a substitute for the liability because of the fundamental differences between the two obligations.899 Issue 2. Investment Tax CreditFINDINGS OF FACTThe lessees were to manage and operate the leased properties, and to perform all existing contracts and undertakings of the lessor at their own cost and expense. They also agreed to "keep up, maintain, repair and renew the leased property, and all replacements thereof" so that the railroad would remain in good operating order. The lessees were to bear the cost of any repairs or replacements of the leased premises, but title to86 such replacements was to vest in the lessor.During the years at issue, the lessees repaired and replaced portions of the existing track structure. They reported the amounts so spent as operating expenses in their annual reports to the ICC 11 and on their Federal income tax returns. 1287 These expenses are not reflected on the lessor's books at all. 13The lease also empowered the lessees to "make all such additions, betterments, improvements and extensions upon and to the leased property, as the lessees shall deem to be necessary or proper for the best interests of the leased property." The lessees were to provide and pay for any additions or betterments, but were to be "promptly reimbursed 900 by Carolina, Clinchfield and Ohio Railway with either bonds or capital stock, 88 or both, of Carolina, Clinchfield and Ohio Railway, as the lessees shall at the time specify." Any expenditures for which stock or bonds were not issued were to be repaid by the lessor at termination of the lease. 14 Title to any improvements paid for with funds transferred to the lessees at commencement of the term, 15 or with stock, bonds, or other obligations of the lessor, was to vest in the lessor, and those new properties would become part of the leased premises.The lessees made additions, betterments, and extensions on the lines 89 leased to them and charged the petitioner for them as required by article seventh. The petitioner showed these outlays as capital expenditures on its annual financial statements to the ICC. 16 On its books, petitioner increased the appropriate asset accounts by the cost of the additions, and at year's end also increased the "Clinchfield Railroad Company, Lessees -- Open Account" in a like amount. 17 The lessees, in turn, decreased "cash" by the cost of the addition and increased the asset account "Carolina, Clinchfield and Ohio Railway and Carolina, Clinchfield and Ohio Railway of South Carolina, Lessor's -- Open Account" in a like amount.90 These increases in the petitioner's liability to the lessees were offset by other transactions. First, article 18th empowers the lessees to sell or otherwise dispose of properties as they see fit. The net proceeds from the sale of unencumbered assets go into a fund to be applied to payment for additions, betterments, 901 and improvements. 18 Second, the lessees are liable to the petitioner for the value of retired assets. Thus, when assets are retired, the petitioner decreases the liability account "Clinchfield Railroad Company, Lessees -- Open Account" by the cost of those assets. 1991 The lessees deduct the difference between the cost of these retired assets and their salvage value as an operating expense in their reports to the ICC. 20During the years at issue, the petitioner's indebtedness under the open account was, therefore, increased by the cost of bonds turned over to the trustee and by the cost of additions and betterments constructed on the leased properties. These increases were offset by the cost of assets retired by the lessees and by the net proceeds received from the sale of any of the leased properties. The balance due92 to the lessees increased during the years at issue; in 1975 it stood at $ 23,206,527.52. 21902 The petitioner claimed an investment tax credit on its returns for the years 1972, 1973, 1974, and 1975. The property referred to on the "computation of investment credit" forms was tangible personal property or other tangible property used as an integral part of furnishing transportation services; it included both replacement properties and additions and betterments. Petitioner included railroad grading with other93 assets for which the credit was claimed. 22 Respondent disallowed the credit, contending that because the expenses were borne by the lessees rather than the petitioner, the petitioner was not entitled to any credit. The CC & O has conceded that $ 67,500 of the $ 173,073 credit claimed in 1975 was erroneous, but otherwise challenges respondent's determination.Issue 2OPINIONThe second issue for our decision is whether petitioner is entitled to an investment tax credit for replacement property and for additions and betterments (A-B property) constructed on the leased premises by the lessees. The lease provided that the lessees were to repair, replace, and renew parts as necessary to keep the track in good working order; they were not to be reimbursed for these expenses. On both the ICC annual report and its income tax return, the Clinchfield (lessees) showed the costs of replacements94 as operating expenses, and deducted them currently. The lease also authorized the lessees to make improvements to the leased premises, but the lessor was responsible for these costs. These A-B properties were capitalized on the petitioner's books; their cost was reflected by an increase in the open account liability to the lessees.903 Respondent contends that the petitioner has neither title to, nor any bona fide investment in, either the replacement or the A-B properties, and concludes that it is not entitled to an investment tax credit. 23 The petitioner, relying on the terms of the lease, argues that it has title to, and investment in, the properties, that the other requirements of section 38 have been met, and that it is therefore entitled to claim the credit. We agree with respondent that the CC & O may not claim a credit for any of the replacement properties; it may, however, claim some credit for the additions and betterments.95 The 7-percent investment tax credit was originally enacted in 1962. 24 The subsidy was designed to encourage capital-intensive industries to expand and modernize their productive assets. H. Rept. 1447, 87th Cong., 2d Sess. (1962), 3 C.B. 405">1962-3 C.B. 405, 411. Only certain assets are eligible for the credit. Called "section 38 property," the category generally includes tangible personal property "with respect to which depreciation (or amortization in lieu of depreciation) is allowable." Sec. 48(a)(1). The credit is calculated on the basis of a taxpayer's "qualified investment" in the asset (sec. 48), defined by section 46(c)(1) as "the applicable percentage of the basis of each new section 38 property" or the "applicable percentage of the cost of each used section 38 property." The controversy here centers not on whether the assets qualify for the credit, but on whether the petitioner/lessor is entitled to claim it.96 In Hanna Barbera Productions, Inc. v. United States, an unreported case, 39 AFTR 2d 77-1169, 1172, 77-1 USTC par. 9365, at 86,847 (C.D. Cal. 1977), the court wrote that:In light of the goal of the investment tax credit to encourage private investment in capital assets, the Court finds that the most important factor 904 in determining ownership of property eligible for a tax credit is the source of the investment capital. * * 25The capital for the A-B properties was initially provided by the lessees, and the parties do not contend otherwise. Our inquiry does not end here, however, for we must determine the effect of petitioner's liability, reflected by the open account, to reimburse the lessees for the cost of the additions and betterments. The calculation base for the credit is the taxpayer's "qualified investment" which is, in turn, computed from his basis in the asset. Basis is, in general, equal to cost (sec. 1012), increased by any liabilities encumbering the property acquired. Commissioner v. Tufts, 461 U.S. 300">461 U.S. 300 (1983); Crane v. Commissioner, 331 U.S. 1">331 U.S. 1 (1947).97 Cost means "'cost to the taxpayer,' even though the property 'may have a cost history quite different from its cost to the taxpayer.'" United States v. Chicago, Burlington & Quincy R. Co., 412 U.S. 401">412 U.S. 401, 409 (1973), citing Detroit Edison Co. v. Commissioner, 319 U.S. 98">319 U.S. 98, 101 (1943). Liabilities encumbering the property are not included in basis for depreciation or investment credit if they are highly contingent and unlikely to be repaid. Denver & Rio Grande Western R.R. Co. v. United States, 205 Ct. Cl. 597">205 Ct. Cl. 597, 505 F.2d 1266">505 F.2d 1266 (1974); cf. CRC Corp. v. Commissioner, 693 F.2d 281">693 F.2d 281 (3d Cir. 1982), revg. and remanding on other grounds Brountas v. Commissioner, 73 T.C. 491">73 T.C. 491 (1979); Brountas v. Commissioner, 692 F.2d 152">692 F.2d 152 (1st Cir. 1982), vacating and remanding on other grounds 73 T.C. 491">73 T.C. 491 (1979).98 Petitioner has no cost basis whatsoever in the replacement properties. The lessees are solely responsible for replacement costs, as these fall within the obligation to maintain the properties in good working order. The petitioner/lessor carries the cost of the original asset on its books, but this reflects the peculiarities of RRB accounting rather than evidence of 905 capital investment; the mere fact of replacement demonstrates that the initial capital provided by the petitioner has been used up. The expenses, in fact, are not even recorded in petitioner's books.The CC & O's cost basis in the additions and betterments consists of (1) proceeds from the sale of operating assets and (2) the value of assets retired by the lessees pursuant to the lease. During the years at issue, this totaled $ 395,221. See notes 19-20 supra.We are not convinced that petitioner's liability under the open account should be included in basis for purposes of the investment credit. Liabilities contingent upon the occurrence of some event, or which, for some other reason, are unlikely to be repaid, may be excluded from basis. Anderson v. Commissioner, 446 F.2d 672">446 F.2d 672 (5th Cir. 1971);99 Denver & Rio Grande Western R.R. Co. v. United States, supra; Lemery v. Commissioner, 52 T.C. 367 (1969), affd. on other issues 451 F.2d 173">451 F.2d 173 (9th Cir. 1971); Columbus & Greenville Railway Co. v. Commissioner, 42 T.C. 834">42 T.C. 834, 847 (1964), affd. per curiam 358 F.2d 294">358 F.2d 294 (5th Cir. 1966). To include such liabilities is to pervert the definition of "cost" in section 1012, and to allow deductions and credits based on liabilities that may never be paid.In the instant case, the likelihood that the lessor will repay the lessees is minimal. There is no obligation to make current payment of interest, and eventual payment of principal on the open account may not occur (if it occurs at all) for nearly a millennium. Nothing at all is due until the lease is terminated, which could be as late as 2923. The lessees have no incentive to demand earlier payment since the lessor has no source of income. Thus, it is entirely possible that petitioner will not pay one cent on its alleged capital investment in these assets for nearly 10 centuries, if 100 at all. The ceiling set by article 20th may even limit the amount paid at that time. The lessees provided the source of the investment capital, and bear not only the economic risk of the business, but also all of the other benefits and burdens associated with the properties for which the credit is claimed. We believe these factors are inconsistent with ownership, a key factor in determining which of two parties is entitled to the credit. Hanna Barbera Productions, Inc. v. United States, supra; cf. Carnegie Productions, Inc. v. Commissioner, 59 T.C. 642">59 T.C. 642 (1973).906 Our result is also supported by the policy considerations alluded to in Hanna Barbera Productions, Inc. v. United States, supra. The goal of section 38 is to encourage investment by reducing the cost of new assets. If the incentive is to work properly, the party making the decision to invest and the actual investment should receive the credit. Here the lessees made the purchasing decisions under article seventh of the lease, and also made the cash outlay. We do not believe that Congress intended that a party such as petitioner, who played no role in decisionmaking, provided101 no capital up front, and bore no economic risk on the loan, should be able to include the liability in its basis when calculating the credit.The petitioner insists that the open account is a bona fide debt stemming from a contract negotiated at arm's length, and that the obligation should be so recognized for tax purposes. With some reservations, we agree in general, but this does not help petitioner. The parties, themselves, have already disregarded the language of article seventh by neglecting to issue stocks or bonds to represent the obligation to the lessees vis-a-vis the A-B properties. 26 The lessees' decision to accept the informal open account, and to let it increase over the years without any demand for repayment, indicates a degree of cooperation unusual to arm's-length contracting parties. While we do not agree with respondent that the debt is illusory, close analysis of the parties' relationship convinces us that we must look beyond the formal structure in making our determination. If we were to accept petitioner's position, the incentives of section 38 would certainly not have the desired effect on investment decisions.102 Respondent also contends that petitioner is not entitled to any credit for expenses related to construction of railroad grading and tunnel bores, relying on section 185(f). 27 That section states that "Property eligible to be amortized under 907 this section shall not be treated as section 38 property within the meaning of section 48(a)." We do not agree. Gradings and bores are not "eligible to be amortized" until the taxpayer has made the election under section 185(c). 28 Petitioner made no such election in 1972, 1973, or 1974, and, therefore, may include costs of grading and bores in calculating the credit to which it is entitled. The CC & O did make an election in 1975 and thus the 1975 expenditures for grading must be excluded. See pp. 914-915 infra.103 We conclude that petitioner/lessor is not entitled to any investment credit for replacements constructed by the lessees. Petitioner's qualified investment in the additions and betterments is limited to (1) proceeds from assets sold by the lessees, and (2) the value of assets retired by the lessees.Issue 3. The Section 108/1017 ElectionFINDINGS OF FACTThe lessees were responsible for preparation of the petitioner's Federal income tax return. Prior to 1972, the work was done in Erwin, Tenn., by Mr. Beales of the Clinchfield Railroad. 29104 In 1966 or 1967, John Wylie, director of income taxes for the Family Lines Rail System, 30 told Mr. Beales that the CC & O could elect to defer some of its income from cancellation of indebtedness by using section 108. Mr. Beales seemed interested, and indicated that he would make the election on the following year's return. Mr. Wylie did not check to see if the election had been made as promised. In 1969, he realized that the election had not been made, discussed the matter with Mr. Beales, and again relied upon 908 Mr. Beales' statement that he would file the election with the current return.In 1972, the Family Lines System became the sole owner of the Clinchfield, and soon thereafter all of the tax and accounting personnel moved to Jacksonville, Fla. A Mr. Haines prepared the CC & O return. Technically, Mr. Wylie was his superior, but due to confusion resulting from the move, certain personality conflicts, and the fact that the return had to be signed at CC & O's official headquarters in New York, Mr. Haines did not see the return until after it was filed. Thus, he did not realize that the CC & O had not elected to use section 108 until after the first 1975 return was filed. An amended return containing the Form 982 election was filed on January 7, 1977.Issue 3OPINIONThe third issue for our decision is whether the Commissioner105 abused his discretion in refusing to accept the section 1017 election filed with petitioner's amended 1975 return. Petitioner maintains that it has shown reasonable cause for the delayed election, and that the Commissioner is therefore required to accept it under section 1.108(a)-2, Income Tax Regs. The respondent, however, asserts that there was no reasonable cause for the delayed filing, and that petitioner does not qualify for section 108 treatment in 1975. We agree with petitioner.Section 108 allows a corporate taxpayer to exclude discharge of indebtedness income from gross income if the taxpayer "makes and files a consent to the regulations prescribed under section 1017." 31106 Sec. 108(a)(2). Section 1017 requires that 909 amounts so excluded be applied to reduce the basis of property held by the taxpayer during the year in which the discharge occurred. The procedure for making an election is set out in section 1.108(a)-2, Income Tax Regs.32 Generally, the consent to reduction of basis must be filed with the initial return. However the regulations permit a late election if the taxpayer shows reasonable cause for the delay.Section 108 is the successor to section 22(b)(9) 107 of the Internal Revenue Code of 1939. The regulations promulgated under that provision required a taxpayer to file the election with the original return. In Denman Tire & Rubber Co. v. Commissioner, 192 F.2d 261">192 F.2d 261 (6th Cir. 1951), affg. 14 T.C. 706">14 T.C. 706 (1950), the Sixth Circuit refused to recognize the effect of a consent first filed with an amended return. Soon thereafter the Code was amended, with the following explanation:Section 304 of your committee's bill makes a technical amendment to section 22(b)(9) to allow for greater flexibility as to the time for filing the required consent to a reduction of basis. Under the present law, the taxpayer must file its consent with its return for the taxable year. * * * Under this amendment, the Department could continue to require that the consent be filed with the return in the ordinary case, but might make provision for filing of the consent at a later date in appropriate hardship cases. [S. Rept. 781, 82d Cong., 1st Sess. (1951), 2 C.B. 458">1951-2 C.B. 458, 500.]In Columbia Gas System, Inc. v. United States, 473 F.2d 1244">473 F.2d 1244 (2d Cir. 1973),108 one issue was whether the Commissioner had abused his discretion in rejecting an election filed after a 910 deficiency was asserted. Admitting that this was a close case, 33109 the Second Circuit upheld the Commissioner. 34 The reasons behind that result were clarified in Magill v. Commissioner, 70 T.C. 465">70 T.C. 465 (1978), affd. 651 F.2d 1233">651 F.2d 1233 (6th Cir. 1981), where this Court wrote that:In view of the legislative delegation of authority to promulgate regulations on making and filing a consent under section 108, the issue is narrowed to whether the Commissioner has abused the broad discretion granted him by rejecting petitioner's delinquent consent. * * [Magill v. Commissioner, 70 T.C. at 474.]Thus our task is not to decide anew whether the petitioner has shown reasonable cause for its delayed filing, but rather to determine whether the Commissioner's decision not to accept it constituted an abuse of discretion. We believe that it was.Neither the statute, nor the regulations, nor the cases offer much guidance in defining reasonable cause. Petitioner argues that the circumstances surrounding preparation of the 1975 return were unusual, and says that they constitute reasonable cause for the delayed filing. We agree that the shift in ownership, changes in responsibility, relocation of accounting personnel, and personality conflicts combined to make preparation of the CC & O return110 confused and difficult. Even the respondent concedes in his reply brief that the facts in this case are unusual. We believe that in this particular situation, the Commissioner abused his discretion by ignoring Congress' mandate -- implemented in the regulations -- that the filing requirements be treated flexibly in hardship cases. Petitioner's 1975 election to defer recognition of the income from discharge of indebtedness by reducing basis under section 1017 is therefore valid.The respondent contends that our conclusion that petitioner's election is valid calls section 47 into play, requiring petitioner to recapture a portion of the investment credit 911 claimed in 1975. Petitioner argues that the recapture provisions are not applicable to a basis reduction under section 1017. We agree with petitioner.Section 47, designed to prevent abuse of the investment credit, requires taxpayers to recapture a portion of the credit taken in a prior year if the property is not used for the full period used in computing the credit. Panhandle Eastern Pipe Line Co. v. United States, 228 Ct. Cl. 113">228 Ct. Cl. 113, 654 F.2d 35">654 F.2d 35 (1981); B. Bittker, Federal111 Taxation of Income, Estates and Gifts, par. 27.4 (1981). The amount included in income is the excess of the credit first allowed over the credit that would have been allowed had it been calculated on the basis of the period of time the asset was actually used in the specified manner. Sec. 1.47-1(a), Income Tax Regs.; B. Bittker, supra. The recapture rules are triggered when an asset is "disposed of, or otherwise ceases to be section 38 property." Sec. 47(a). There was no disposition in the instant case, thus the issue is whether a reduction in basis pursuant to section 1017 is a cessation within the intendment of section 47.Respondent relies on section 1.47-2(c), Income Tax Regs., in support of his affirmative answer. That section provides that if --the basis (or cost) of section 38 property is reduced, for example, as a result of a refund of part of the cost of the property, then such section 38 property shall be treated as having ceased to be section 38 property * * to the extent of the amount of such reduction in basis. 35We believe that this regulation, when read in the context of the statute, other regulations, and the general policy behind recapture, does112 not include basis adjustments made under section 1017.The term "cessation" is never defined, but the regulations offer the following guidelines for determining when one has occurred:Sec. 1.47-2. "Disposition" and "cessation". --(a) General rule -- * (2) "Cessation". (i) A determination of whether section 38 property ceases to be section 38 property with respect to the taxpayer must be made for each taxable year subsequent to the credit year. Thus, in each such taxable year 912 the taxpayer must determine, as if such property were placed in service in such taxable year, whether such property would qualify as section 38 property (within the meaning of section 1.48-1) in the hands of the taxpayer for such taxable year.This first part of the regulation clearly contemplates some113 change in the property or its use which would render it ineligible for the credit. 36 An adjustment to the cost basis (sec. 1012) because of a reduction in the purchase price, for example, is analogous: the taxpayer no longer has a "qualified investment" (sec. 48) to the extent of that decrease, and this renders the property ineligible for the credit. Section 1.47-2(c), Income Tax Regs., clearly applies to that situation.The regulations also provide that:(ii) Section 38 property does not cease to be section 38 property with respect to the taxpayer in any taxable year subsequent to the credit year merely because under the taxpayer's depreciation practice no deduction for depreciation with respect to such property is allowable to the taxpayer for the taxable year, provided that the property continues to be114 used in the taxpayer's trade or business (or in the production of income) and otherwise qualifies as section 38 property with respect to the taxpayer. [Sec. 1.47-2(a)(2)(ii), Income Tax Regs.]Thus, even if the adjusted basis for determining gain or loss (sec. 1011) is zero, the asset remains "section 38 property" so long as it has the same useful life and the same role in the taxpayer's trade or business. Comparing the two rules, it is plain that the crucial inquiries are whether the asset continues to qualify as section 38 property and whether the cost remains a "qualified investment." Only when some change occurs is there a cessation which triggers recapture. Adjustments under section 1011 are not within the scope of section 1.47-2(c), Income Tax Regs., therefore, because they affect neither the asset in question nor the qualified investment, but only the amount of gain to be recognized at disposition.A distinction is made in the Code between the section 1012 cost basis of an asset and the section 1011 adjusted basis for determining gain or loss on a sale or other dispositions. Some transactions or expenditures will affect only the section 1012 913 basis, some only115 the section 1011 basis. Section 1.47-2(c), Income Tax Regs., refers, we believe, only to adjustments in a taxpayer's cost basis.Adjustments made pursuant to an election under section 108 relate to the adjusted basis for determining gain or loss under section 1011, not to section 1012 cost basis. The rule of section 108 allowing deferral of discharge of indebtedness income was designed to ease the impact of debt restructuring. Rather than recognizing income in the year of discharge, a taxpayer reduces the basis of some asset, putting off recognition until the asset is sold. B. Bittker, supra at par. 6.4.7. Neither the cost of the asset, its use in the taxpayer's trade or business, or its actual useful life vis-a-vis the taxpayer is affected by this adjustment; it relates solely to the basis for determining gain or loss when the asset is sold. Furthermore, section 1.1011-1, Income Tax Regs., provides that "the adjusted basis for determining the gain or loss * * * is the cost or other basis prescribed in section 1012 * * * adjusted to the extent provided in sections 1016, 1017, and 1018." Thus it is clear that only the adjusted basis for determining gain, and not the cost 116 basis, is affected by section 1017.Our conclusions that section 1.47-2(c), Income Tax Regs., relates only to adjustments to cost basis, and that the section 1017 adjustment is to the basis for determining gain or loss, lead us to decide that section 1.47-2(c), Income Tax Regs., is not applicable to section 1017 basis reductions. This result is supported by the policies underlying the recapture rules of section 47 and the deferral rules of section 1017. The petitioner/lessor's basis in certain assets was reduced because of transactions and provisions wholly unrelated to the investment credit. The assets qualifying for the credit were no different in 1975 when the section 1017 election was made than they were in prior years. There was no change in cost, in useful life, or in their role in the business. We cannot conclude that Congress intended the recapture provisions to apply to this situation. Also, if we interpret the regulation as respondent suggests, the goal of sections 108 and 1017 will be thwarted: petitioner will be forced to recognize income and pay tax in the current year as a result of its discharge of indebtedness. Section 108 was designed to alleviate this problem, 117 and we refuse to stand in the way of that goal.914 We conclude, therefore, as has the Court of Claims in Panhandle Eastern Pipe Line Co. v. United States, 228 Ct. Cl. 113">228 Ct. Cl. 113, 654 F.2d 35">654 F.2d 35 (1981), that petitioner's reduction of basis under section 1017 does not trigger recapture.Issue 4. Section 185 AmortizationFINDINGS OF FACTPetitioner filed an amended return for the taxable year 1975 on January 7, 1977. This return included a deduction for amortization of railroad grading and tunnel bores 37 as permitted by section 185. Attached to that return was a schedule which contained the following information:Description ofAmortization1975propertyCostperiodamortizationAccount 3 --railroad grading$ 17,043,757.0950 yrs.$ 340,875.14Account 5 --tunnel bores5,756,104.9350 yrs.115,122.1022,799,862.02455,997.24118 This was the only information submitted by petitioner concerning the grading and bores. We have no exact description of the properties, nor do we know whether original use commenced before or after December 31, 1968.Gradings and bores with a cost basis of $ 11,657,514 were transferred, with the other railroad assets, to the lessees at the beginning of the lease. Between 1925 and 1975 an additional $ 5,757,405 was expended for grading. 38 These costs were 915 recorded on the books of either the Carolina, Clinchfield & Ohio Railway or the Carolina, Clinchfield & Ohio Railway of South Carolina. We do not know which party paid for these assets.119 Issue 4OPINIONThe final issue for our decision is whether petitioner is entitled to a deduction in 1975 for amortization of all of its railroad grading and tunnel bores under section 185. Respondent contends that the election, first filed with the amended return, was both untimely and defective. Alternatively, he argues that petitioner has no basis in the subject properties. Petitioner says that in light of the 1976 amendments to section 185, only one election needs to be made, and contends that that election is covered by Temporary Regs., 26 C.F.R. sec. 7.0(b)(2) (1977), rather than by section 1.185-3(b), Income Tax Regs. Petitioner argues that, at the very least, the deduction should be allowed for the pre-1969 grading.Section 185 was added to the Code in 1969. Prior to that time, railroads were generally not allowed to depreciate or amortize the cost of their gradings or tunnel bores because the useful life could not be determined with any certainty. 39 In 1969, the Senate recommended that railroads be allowed to amortize these costs using a 50-year average life. S. Rept 91-552 (1969), 3 C.B. 423">1969-3 C.B. 423, 584. The Conference Committee retained120 the basic provision, but decided to limit amortization to "such property the original use of which commences after December 31, 1968." Conf. Rept. 91-782 (1969), 3 C.B. 644">1969-3 C.B. 644, 674; sec. 185(f)(2).Regulations governing amortization were promulgated in 1971. They provide that an election to amortize should be 916 made with the first return; it may be made by amended return "only if such amended return is filed no later than the time prescribed by law * * * for filing the return." Sec. 1.185-3(a), 121 Income Tax Regs.40 The election is to include, inter alia, a description of the property and a statement of when original use commenced. Sec. 1.185-3(a), Income Tax Regs.122 In 1976, Congress decided to extend the amortization provision to grading and tunnel bores placed in service prior to 1969. 41123 The new rule provides that "A taxpayer may * * elect * * * to treat the term 'qualified railroad grading and tunnel bores' as including pre-1969 railroad grading and tunnel bores." Sec. 185(d). The temporary regulation governing an election under section 185(d) maintains the general rule of section 1.185-3, Income Tax Regs., requiring that elections be made with the original return. 42 A limited exception is 917 made for taxpayers who filed returns for years ending before December 31, 1976, by January 1, 1977: they may make the election in an amended filing. 26 C.F.R. sec. 7.0(b)(2) (1977), Temporary Regs. This exception was necessary because section 185(d), enacted in 1976, was made retroactive to tax years beginning after December 31, 1974.124 Resolution of the present controversy depends upon our interpretation of section 185(d). Petitioner contends that because the clear intent of the 1976 Act "was to place both sets of grading on the same basis," an election under section 185(d) covers assets placed in service before and after 1969. From that premise, petitioner concludes that Temporary Regs. section 7.0 governs all amortization elections. Respondent argues that section 185(d) and Temporary Regs. section 7.0 only apply to amortization of pre-1969 assets.We agree with petitioner's basic premise that the purpose of the 1976 amendment was to make amortization available for all railroad grading and tunnel bores, and to abolish the distinction between pre- and post-1969 grading. 43 But we cannot agree with its conclusion. Both the permanent and temporary regulations require that the election be made within the time prescribed for filing an original return. A 918 single exception is made for taxable years ending before December 31, 1976 (such as the year 1975 before us), for which original returns were filed before January 31, 1977. Without this exception, Congress' desire to make the provision retroactive would125 have been frustrated. We believe that the exception should not be extended beyond where it is needed, however, and thus hold that an election in an amended return will only be effective for pre-1969 grading and bores. This construction of the statute and regulation enables petitioner to benefit from the 1976 change without allowing it to avoid the general rule prohibiting elections from being made in an amended return. Petitioner's election was, therefore, not timely as to properties placed in service after 1969, but is timely for pre-1969 assets.126 The next question is whether the election was defective because petitioner failed to provide the information required by section 1.185-3, Income Tax Regs. Respondent contends that this regulation applies to pre-1969 assets even though it was promulgated before amortization was extended in 1976. We do not agree. First, the information required by section 1.185-3(a)(i) and (ii), Income Tax Regs., seems designed to assist the Commissioner in ensuring that deductions are taken only for post-1969 property. That information is unnecessary now that amortization has been extended to all grading and bores. Second, section 185(e), also added by the Revenue Act of 1976, sets out the means for determining the adjusted basis of pre-1969 property in some detail; the information necessary to that calculation is quite different from that required by section 1.185-3(a), Income Tax Regs. It seems likely, therefore, that if the Commissioner needs specific facts, he will promulgate regulations requiring them. Third, in the temporary regulation covering section 185(d), no reference is made to the requirements of section 1.185-3, Income Tax Regs. Subsection (f) of that regulation states that if127 permanent regulations requiring more information are promulgated in the future, an electing taxpayer will be required to submit that data. This clearly indicates that the temporary regulation was not intended to incorporate the rules of section 1.185-3, Income Tax Regs.Petitioner's election is, therefore, neither untimely nor defective vis-a-vis pre-1969 properties. Thus, if the other requirements of the section have been met, petitioner may 919 take the deduction it has claimed. Petitioner bears the burden of proof on this issue. Rule 142(a), Tax Court Rules of Practice and Procedure; Welch v. Helvering, 290 U.S. 111">290 U.S. 111 (1933).As with depreciation, a taxpayer must have both a capital investment in, and suffer economic loss on, properties for which he claims a deduction for amortization. Atlantic Coast Line Railroad Co. v. Commissioner, 31 B.T.A. 730">31 B.T.A. 730 (1934), affd. 81 F.2d 309">81 F.2d 309 (4th Cir. 1936), cert. denied 298 U.S. 691">298 U.S. 691 (1936).44 In the instant case, the parties have stipulated that petitioner transferred grading with a cost basis of $ 11,657,514 to the lessee128 at commencement of the lease; petitioner thus has the required capital investment in those assets. It also bears the burden of loss due to exhaustion, wear and tear, and obsolescence. North Carolina Midland Railway Co. v. United States, 143 Ct. Cl. 30">143 Ct. Cl. 30, 163 F. Supp. 610">163 F. Supp. 610 (1958). Thus, petitioner may claim amortization with respect to those properties.As to railroad grading and tunnel bores constructed after 1925, the doubts we expressed at issue 2, supra, concerning petitioner's capital investment in properties added to the line after commencement of the lease also plague us here. Petitioner has offered virtually no evidence showing that129 it paid for these gradings and bores, and we therefore cannot find that it has the requisite investment in these assets.Decision will be entered under Rule 155. Footnotes1. All section references are to the Internal Revenue Code of 1954 as amended and in effect during the years at issue, unless otherwise noted.↩2. The two other parties to the lease are the Carolina, Clinchfield & Ohio Railway of South Carolina and the Clinchfield Northern Railway of Kentucky. The parties stipulated that the Carolina, Clinchfield & Ohio Railway of South Carolina was wholly owned by petitioner. The Clinchfield Northern Railway is referred to as a rail subsidiary, but the only indications of its relationship to the petitioner are statements in the granting clause of the lease that (a) all its properties were leased to the petitioner, and (b) that the petitioner owns all of its outstanding capital stock and mortgage bonds.↩3. The similarity between the name of this operating organization and that of the petitioner/lessor does not reflect any joint ownership or other relationship outside of that created by the lease.↩4. Rental payments were to begin on Jan. 1, 1925. For the period from that date until Dec. 31, 1927, the annual rental was $ 750,000; from Jan. 1, 1928, until Dec. 31, 1937, the lessees were to pay $ 1 million per annum; thereafter rent was fixed at $ 1,250,000.↩5. The lessees were to specify the denomination, interest rate, terms, and security for any bonds issued by the lessor. The lessees were also to specify the kind and class of stock to be issued, but the lease provided that any such stock could not participate in dividends declared from money rental paid by the lessees to the Carolina, Clinchfield & Ohio Railway.↩6. The face amount of the bonds acquired each year, the cost of the bonds, and the amount of gross income reported by the petitioner were as follows during the years at issue:1972197319741975Face amount$ 434,000$ 557,000$ 530,000$ 227,000Cost291,055378,032333,600133,999Income142,945178,968196,40093,001The indenture required that bonds with an aggregate cost↩ of $ 336,000 be delivered to the trustee each March. We assume that the discrepancy between that figure and the cost used by the petitioner in calculating its cancellation-of-indebtedness income stems from the timing of the bond purchases.7. In the notice of deficiency, respondent determined that petitioner's income should be increased as follows:1972197319741975Face value of$ 534,000 $ 511,000 $ 495,000 $ 523,000 bonds canceledBond discount(142,945)(178,968)(196,400)(93,001)income reportedNet increase391,055 332,032 298,600 429,999 in incomeRespondent used the face amount of bonds canceled each year to determine petitioner's income, while petitioner used the face amount of bonds acquired in its calculations. See note 6 supra. Petitioner's treatment is consistent with its own accounting procedure (income was shown on the books when bonds were acquired by the trustees, not when canceled) but technically is incorrect. Until the bond is actually canceled, petitioner is liable on it, and thus has realized no increase in wealth.Respondent's treatment is consistent with article eighth of the lease which provides that even if the lessees pay principal on any obligations, those debts will continue to be treated as outstanding. (See p. 891 supra↩.) The purchase by the lessees followed by transfer to the trustee is analogous to a payment of principal, and thus, standing alone, does not give rise to cancellation-of-indebtedness income.8. The issue facing the court in the line of cases beginning with Great Western Power Co. v. Commissioner, 297 U.S. 543">297 U.S. 543 (1936), was whether to treat the difference between the face value of the new issue and that of the old as current income under United States v. Kirby Lumber Co., 284 U.S. 1">284 U.S. 1 (1931). The other option was to treat it as a premium received on issuance, or as an adjustment in the interest rate, which would be amortized over the life of the bonds. Eustice, "Cancellation of Indebtedness and the Federal Income Tax: A Problem of Creeping Confusion," 14 Tax L. Rev. 225">14 Tax L. Rev. 225↩ (1959). By including the difference between the cost of the canceled bonds -- i.e., the new liability -- and their face value in income, petitioner has conceded this question.9. In Great Western Power Co. v. Commissioner, supra, the taxpayer substituted general-lien 8-percent bonds for series B bonds, both of which were secured by a mortgage. See also Virginia Electric & Power Co. v. Early, 52 F. Supp. 835">52 F. Supp. 835 (E.D. Va. 1943) (taxpayer's exchange of new bonds for old ones, identical except for form and date of maturity, deemed a substitution of indebtedness); Commissioner v. Stanley Co., 185 F.2d 979">185 F.2d 979 (2d Cir. 1951) (taxpayer who exchanges its bonds pro rata for those of its predecessor company only recognizes income to the extent of the difference between two issues); cf. Zappo v. Commissioner, 81 T.C. 77">81 T.C. 77 (1983). See generally Eustice, supra↩ note 8.10. This case also involved the lease at issue here.↩11. David Freedman, manager of income tax for the Family Lines Rail System, testified that "The ICC requires that all of the expenses relating to the leased property be reported on the lessee's ICC accounting forms." These ICC reports were the starting point for preparation of the Federal tax return.↩12. The petitioner and the lessees use the Retirement-Replacement-Betterment (RRB) method of accounting. The key to this system is the assumption that the entire track structure constitutes one asset which has an indeterminate useful life. Gradual exhaustion of the asset is measured, therefore, not by ratable depreciation of the separate items of the track, but rather by assuming that annual expenses for replacements and retirements are a "rough equivalent of what would be a proper depreciation allowance for all the working assets of the company for that year." Boston & M.R.R. v. Commissioner, 206 F.2d 617">206 F.2d 617, 619 (1st Cir. 1953).The mechanics of the RRB method are simple. All assets are carried on the taxpayer's books at their initial cost; no annual adjustments are made. When an item is replaced, the cost, or the cost less salvage value, of the used asset is charged to operating expense and deducted currently. When an asset is retired without replacement, its basis less any salvage value is charged to operating expense. In essence, replacement expenses are a measure of ordinary wear and tear, while retirement expenses measure the obsolescence of the railroad structure.↩13. In a desposition duly admitted into evidence at trial Mr. John K. Wylie, director of income taxes for the Family Lines Rail System, testified that this information was omitted from the lessor's return for purposes of convenience only. He explained that, technically, the replacement expense should be reported as rental income to the lessor, and taken as a rental expense by the lessees. But because the lessor would have an operating expense exactly equal to its income, the net effect on taxable income was zero. Mr. Wylie noted that the petitioner should perhaps switch to the longer, more accurate method so as to clarify its entitlement to the investment tax credit.↩14. As noted in our findings on issue 1, article 20th placed a ceiling on the amount which the lessor would be required to pay upon termination of the lease.↩15. The granting clause of the lease included "All * * moneys in possession of or on deposit in bank to the credit of the lessors * * * and also all of the net income of the leased property * * * between the 11th day of May, 1923, and the date of delivery of possession of said railroads to the lessees under this lease."↩16. As noted in note 12 supra↩, the lessor used the RRB method of depreciation. It required capitalization of all new assets which were not replacements of existing parts of the track structure.17. The amounts credited to the account entitled "Clinchfield Railroad Company, Lessees -- Open Account" representing the cost of additions and betterments were as follows:↩YearAmount1972$ 645,2031973849,01319741,048,9191975904,330Total3,447,46518. During the years at issue proceeds received from the sale of property under the lease totaled $ 46,810. The annual figures were:↩YearAmount1972$ 10019731,540197434,520197510,650Total46,81019. The retirements debited to "Clinchfield Railroad Company, Lessees -- Open Account" by the petitioner were as follows:↩RetirementRetirementYearwithout replacementwith replacement1972$ 88,621$ 24,631197343,90224,522197431,8791975127,6057,251Sub total292,00756,404Total$ 348,41120. This is standard practice under the RRB method of depreciation, the cost of the retired asset representing a measure of obsolescence. David Freedman, manager of income tax for the Family Lines Rail System -- which now owns the lessees -- testified at trial that this accounting method and characterization was mandated by the ICC. He noted that technically the net outlay (original cost less salvage value) represents a rental expense of the lessees, rental income to the lessor, and an offsetting operating expense of the lessor. These extra accounting steps were not followed because the ICC required all expenses relating to the leased property to be reported on the lessees' ICC accounting forms.↩21. The petitioner's books reflected the following amounts due to, and from, the lessees:Clinchfield openaccount - balanceBalance dueYeardue to lesseesfrom lessees1972$ 19,631,401.92$ 1,371,669.35197320,747,991.431,372,538.25197422,101,030.691,403,044.49197523,206,527.521,413,460.08There is a $ 50 discrepancy between the 1975 balance due the lessees as shown by petitioner and the balance receivable as shown by the lessees. It has not been accounted for.↩22. The following amounts were expended for grading:↩YearAmount1972$ 114,3321973177,726197458,9771975481,25223. Respondent also argues that the assets in question are not depreciable in the hands of the petitioner/lessor. This argument can be refuted on two grounds. First, the retirement-replacement-betterment has long been accepted as a method of depreciation. Chesapeake & Ohio Railway Co. v. Commissioner, 64 T.C. 352">64 T.C. 352 (1975); cf. sec. 1.48-1(b)(1), Income Tax Regs. ("a deduction for depreciation is allowable if the property is of a character subject to the allowance for depreciation under sec. 167 and the basis * * * is recovered through a method of depreciation, including * * * the retirement method"). Second, to the extent of petitioner's investment in the A-B assets (p. 905 infra), it is entitled to depreciation since it bears the burden of loss due to obsolescence. Sec. 1.167(a)-9, Income Tax Regs.; see, e.g., North Carolina Midland Railway Co. v. United States, 143 Ct. Cl. 30">143 Ct. Cl. 30, 163 F. Supp. 610">163 F. Supp. 610 (1958); Southern Pacific Transportation Co. v. Commissioner, 75 T.C. 497">75 T.C. 497, 788 (1980); cf. Royal St. Louis, Inc. v. United States, 578 F.2d 1017">578 F.2d 1017↩ (5th Cir. 1978).24. The credit was increased to 10 percent of qualified investment by the Tax Reduction Act of 1975, Pub. L. 94-12, (1975), 89 Stat. 26.↩25. See also Panhandle Eastern Pipe Line Co. v. United States, 228 Ct. Cl. 113">228 Ct. Cl. 113, 654 F.2d 35">654 F.2d 35 (1981). The issue facing the court in that case was whether a basis reduction under sec. 1017 triggered the recapture rules of sec. 1.47-2(c), Income Tax Regs. The court held that it did not, and in the process expressed this view of the investment tax credit:"The legislative history of the Revenue Act of 1962 * * * shows that the purpose of enacting the investment credit was to stimulate domestic investment by reducing the net cost of acquiring depreciable assets and increasing the flow of cash available for investment. * * * It was intended that the investment credit only be available to taxpayers who actually used the section 38 property in their trade or business, and that the amount of the credit be limited by * * * the actual period during which the taxpayer has funds invested in qualified property. [654 F.2d at 39↩; citations omitted.]'26. We note that article seventh requires the lessor to issue "bonds or capital stock, or both" to reimburse the lessees for the costs of additions and betterments. Under article eighth, the lessor is to deliver "new bonds or other obligations or stock, or both" to reimburse the lessees for their expenses in taking up and retiring maturing bonds, equipment notes, etc. The reason for this difference is not obvious, yet it indicates that when the lease was drafted the parties viewed the two types of advances as standing on different footings. The parties clearly failed to make any distinction in practice, however, since both the cost of additions and betterments and of the sinking-fund payments were charged to the open account.↩27. Sec. 185(f) was redesignated as sec. 185(h)↩ effective Oct. 4, 1976. See Pub. L. 94-455, 90 Stat. 1760, 1976-3 C.B. (Vol. 1) 236.28. See also sec. 48(a)(8) which specifically excludes certain classes of amortized property from assets eligible for the investment credit. It is significant that sec. 185↩ is not mentioned.29. From the commencement of the lease until 1972, the lessee Clinchfield Railroad Co., an unincorporated association, was owned by the Atlantic Coast Line Railroad and the Louisville & Nashville Railroad Co. Each corporation only owned 50 percent of the Clinchfield, thus neither could exert control if disagreements arose. The result of this stalemate was that Clinchfield employees often had the final say in controversial matters. The income tax returns, for instance, were not seen by the Atlantic's tax personnel until after they were sent to corporate headquarters in New York for signing and filing.↩30. In November 1972, the Seaboard Coast Line Railroad (the successor corporation to the Atlantic Coast Line Railroad) became the sole owner of the Louisville & Nashville, and, therefore, of the Clinchfield. The Seaboard Coast Line Railroad is, in turn, a wholly owned subsidiary of Seaboard Coast Line Industries, a member of the Family Lines Rail System.↩31. Sec. 108(a), as in effect in 1975, read as follows:SEC. 108. INCOME FROM DISCHARGE OF INDEBTEDNESS.(a) Special Rule of Exclusion. -- No amount shall be included in gross income by reason of the discharge, in whole or in part, within the taxable year, of any indebtedness for which the taxpayer is liable, or subject to which the taxpayer holds property, if -- (1) the indebtedness was incurred or assumed -- (A) by a corporation, or(B) by an individual in connection with property used in his trade or business, and(2) such taxpayer makes and files a consent to the regulations prescribed under section 1017↩ (relating to adjustment of basis) then in effect at such time and in such manner as the Secretary or his delegate by regulations prescribes.The statute was amended in 1980 to include rules governing the tax treatment of debt discharge in bankruptcy and to modify the rules regarding which assets of a solvent debtor would be eligible for a reduction in basis. S. Rept. 96-1035 (126 Cong. Rec.) (1980).32. Sec. 1.108(a)-2, Income Tax Regs., reads as follows:Sec. 1.108(a)-2. Making and filing of consent.In order to take advantage of the exclusion from gross income provided by section 108(a), a taxpayer must file with his return for the taxable year a consent to have the basis of his property adjusted in accordance with the regulations prescribed under section 1017↩ which are in effect at the time of filing such return. See sections 1.1017-1 and 1.1017-2. In special cases, however, where the taxpayer establishes to the satisfaction of the Commissioner reasonable cause for failure to file the necessary consent with his original return, he may file the consent with an amended return or claim for credit or refund; and in such cases, the consent shall be to the regulations which, at the time of filing the consent, are applicable to the taxable year for which such consent is filed. In all cases the consent shall be made by or on behalf of the taxpayer on Form 982 in accordance with these regulations and the instructions on the form or issued therewith.33. In Columbia Gas System, Inc. v. United States, 473 F.2d 1244">473 F.2d 1244 (2d Cir. 1973), the taxpayer did not report cancellation-of-indebtedness income upon conversion of certain debentures, relying on a provision of the indenture. On audit, the Commissioner determined that income was realized and asserted a deficiency. Columbia paid the assessment, then filed claims for a refund together with a sec. 1017↩ consent. The District Director denied the refund claim and rejected the election.34. Judge Mansfield, one of three judges on the panel, dissented. He believed that the taxpayer's predicament constituted a special case where there was reasonable cause for the delayed filing. He felt that the Commissioner's refusal was arbitrary and unreasonable, thus an abuse of discretion. Columbia Gas System, Inc. v. United States, supra↩ at 1252 (Mansfield, J., dissenting).35. Respondent's position is also expressed in two revenue rulings: Rev. Rul. 72-248, 1 C.B. 16">1972-1 C.B. 16, and Rev. Rul. 74-184, 1 C.B. 8">1974-1 C.B. 8↩.36. The first example given in this section of the regulations refers to an individual who converts an asset from business to personal use, thereby removing it from the sec. 38 category. Sec. 1.47-2(a)(2)(iii)↩.37. Railroad grading provides the foundation for the track structure. The cost is the cost of moving one cubic yard of earth -- either a "cut" which involves removal of excess soil, or a "fill," which builds up the track structure. A tunnel bore is the "horizontal passageway that is made through a hill or mountain in order to accommodate the placement of a roadbed through the same." Burlington Northern Inc. v. United States, 230 Ct. Cl. 102">230 Ct. Cl. 102, 676 F.2d 566">676 F.2d 566, 568 (1982). Sec. 185(f)(1)↩ describes grading and tunnel bores collectively as improvements resulting from "excavations (including tunneling), construction of embankments, clearings, diversions of roads and streams, sodding of slopes, and * * * similar work necessary to provide, construct, reconstruct, alter, protect, improve, replace, or restore a roadbed or right-of-way for railroad track."38. The grading expenses are broken down as follows:Expenditures as of 1/1/25$ 11,657,514 Additions thereto from 1925-75per books of CC & O5,109,839 Additions thereto from 1925-75per records of CC & O of South Carolina647,566 Subtotal17,414,919 Less: Retirements 1925-75($ 371,162)Account 3 -- railroad grading17,043,757 The petitioner concedes that if the investment tax credit is allowed for grading costs for 1975, then $ 481,252 was erroneously included in the amortization base.↩39. Although this was the general rule, taxpayers able to establish a useful life as required by sec. 167 were entitled to depreciate their grading and tunnel bores. This was difficult to do because with proper maintenance, grading and bores are usually not subject to physical exhaustion. Burlington Northern Inc. v. United States, supra at 568; Kansas City Southern Railway v. Commissioner, 76 T.C. 1067">76 T.C. 1067, 1152↩ (1981), on appeal (8th Cir., Oct. 25, 1982).40. Sec. 1.185-3, Income Tax Regs., reads as follows:Sec. 1.185-3. Time and manner of making and terminating elections.(a) Election of amortization -- (1) Initial election. Under section 185(c), an election by the taxpayer to take the amortization deduction provided in section 185(a)↩ shall be made on a statement attached to its income tax return filed for any taxable year beginning after December 31, 1969 during which year the taxpayer has qualified railroad grading or tunnel bores which are eligible for such deduction (see paragraph (a)(2)(i) of section 1.185-1). If the taxpayer does not file a timely return (taking into account extension of the time for filing) for the taxable year for which the election is first to be made, the election shall be filed at the time the taxpayer files his first return for that year. The election may be made with an amended return only if such amended return is filed no later than the time prescribed by law (including extensions thereof) for filing the return for the taxable year of election. If an election is not made within the time and in the manner prescribed in this paragraph, no election may be made (by the filing of an amended return or in any other manner) with respect to such taxable year. * * 41. The legislative history offers this rationale for its amendment:"In the intervening period [1969-76], Congress has studied the desirability of extending amortization to past investments in railroad property. The basic issue of allowing amortization of this otherwise nondepreciable property was resolved in the 1969 Act, and fair valuation of property placed in service in the past has been reached for the vast majority of grading and tunnel bores by the Interstate Commerce Commission and counterpart State regulatory bodies. As a result, Congress believes it is now appropriate to extend the 50-year amortization to railroad grading and tunnel bores placed in service before 1969."Staff of Joint Comm. on Taxation, Summary of the Tax Reform Act of 1976, at 463-464 (Comm. Print 1976), 1976-3 C.B. (Vol. 2) 475-476.↩42. The pertinent provisions of Temporary Regs. sec. 7.0 are as follows:Sec. 7.0 Various elections under the Tax Reform Act of 1976.(a) Elections covered by temporary rules. * * DescriptionAvailabilitySectionof electionof election * * (2) Second Category185(d) of CodeAmortization of railroadAll taxable yearsgrading andbeginning aftertunnel bores.December 31, 1974 * * (b) Time for making election or serving notice -- * *(2) Category (2)↩. A taxpayer may make an election under any section referred to in paragraph (a)(2) for the first taxable year for which the election is allowed or for the taxable year selected by the taxpayer when the choice of the taxable year is optional. The election must be made (i) for any taxable year ending before December 31, 1976, for which a return has been filed before January 31, 1977, by filing an amended return, provided that the period of limitation for filing claim for credit or refund of overpayment of tax, determined from the time the return was filed, has not expired or (ii) for all other years by filing the income tax return for the year for which the election is made not later than the time, including extensions thereof, prescribed by law for filing income tax returns for such year.43. At first blush, this conclusion seems contradicted by the structure of sec. 185. Subsec. (a) gives the general rule allowing amortization of "qualified railroad grading and tunnel bores." That term is defined in sec. 185(f)(2)↩ as property "the original use of which commences after December 31, 1968," yet subsec. (d) states that taxpayers may elect to treat that term as including pre-1969 assets. Thus the distinction between pre- and post-1969 grading is maintained. We see two possible explanations. First, Congress set out special rules for determining the adjusted basis of pre-1969 assets, and thereby ensured that some line would be drawn. Second, the bifurcated structure adopted by Congress simplified the mechanics of the retroactivity provision. These technical considerations do not change our interpretation of the basic thrust of the amendments.44. The cited case refers to the requirements for depreciation rather than for amortization. Generally, the two terms refer to the same process of writing off the cost of an asset over time. Certain conventions determine which term will be used and when. B. Bittker, Federal Taxation of Income, Estates and Gifts, par. 23.1.1 (1981).↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625405/	JAMES T. SHIOSAKI, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentShiosaki v. CommissionerDocket Nos. 346-71, 8440-71, 4476-73.United States Tax CourtT.C. Memo 1975-28; 1975 Tax Ct. Memo LEXIS 344; 34 T.C.M. (CCH) 127; T.C.M. (RIA) 750028; February 18, 1975, Filed James T. Shiosaki, pro se. Clifford C. Larson, for the respondent. FEATHERSTONMEMORANDUM FINDINGS OF FACT AND OPINION FEATHERSTON, Judge: These consolidated cases involve income tax deficiencies determined by respondent as follows: YearAmount1968$304.481969319.681971515.35345 The issue is whether expenses incurred by petitioner in traveling between his home in Azusa, California, and Las Vegas, Nevada, where he gambled, are deductible under section 212(1) of the Internal Revenue Code of 1954 as ordinary and necessary expenses incurred for the production of income. FINDINGS OF FACT Petitioner James T. Shiosaki was a legal resident of Azusa, California, at the time the petitions in these cases were filed. He filed timely income tax returns for each of the years 1968, 1969, and 1971. Since his graduation from college in 1957, petitioner's principal occupation has been that of an electrical engineer. In this profession his earnings have approximated $15,000 per year. In addition, in the years immediately following his college graduation, he invested in stocks in order to supplement his salary income. During the Labor Day weekend of 1957, petitioner went to Las Vegas with friends and was introduced to the game of craps. He was fascinated with the game, and he began reading books on the subject and attempting to devise a method which would enable him to win at the Las Vegas craps tables. Notwithstanding these studies, as well as346 extensive experimentation, petitioner has not been able to develop a winning formula. In 1959 he won a net amount of approximately $6,000 in his gambling activities. Each year since 1959, however, he has consistently lost net amounts of $5,000 to $10,000 gambling in Las Vegas. During each of the years 1968, 1969, and 1971, petitioner made several trips to Las Vegas to engage in gambling. On his 1968 and 1971 income tax returns, he reported gambling income of $1,400 and $4,800, respectively, and gambling losses in equal amounts. While on his trips to Las Vegas during 1968, 1969, and 1971, petitioner cashed checks at the Sands Hotel in amounts totaling $8,000, $7,800, and $14,000, respectively. He also took some money with him on each trip to Las Vegas. Ordinarily, upon losing the money taken with him and the money received from cashing checks, he would return to his home in Azusa, California. During the years in issue, petitioner made the following expenditures in connection with his travels to Las Vegas: Amounts196819691971Transportation toand from airport$ 42.00$ 24.00$ 80.00Air insurance13.508.00Transportation toand from Las Vegas247.80292.30602.00Hotel235.20248.90585.66Meals98.0098.00175.00Cabs81.0056.00132.00Auto storage33.4518.0037.75Totals$750.95$745.20$1,612.41347 He claimed deductions for these expenditures on his returns for the respective years, and respondent disallowed the deductions. OPINION To support his claim to the disputed deductions, petitioner relies upon section 212(1) 1 of the Internal Revenue Code of 1954, which allows as a deduction all the ordinary and necessary expenses paid or incurred by an individual during the taxable year "for the production or collection of income." Respondent denies that the disputed expenses were incurred for the production of income and maintains that they fall within the nondeductible category of personal expenses covered by section 262 2 of the Code. On a trial record presenting almost precisely the same facts as the present one, 348 this Court held that petitioner was not entitled to deduct expenses incurred in 1967, similar to the ones here involved, James T. Shiosaki,T.C. Memo 1971-24">T.C. Memo. 1971-24, and the Court of Appeals for the Ninth Circuit affirmed our holding, 475 F.2d 770">475 F.2d 770 (1973), certiorari denied 414 U.S. 830">414 U.S. 830 (1973). Our conclusion in that case was stated in these words: It is our opinion that petitioner has failed to show that in incurring expenses for trips to Las Vegas in 1967 to engage in gambling he was motivated by a bona fide profit seeking purpose. We have drawn this conclusion not from any determination that some hypothetical "reasonable man" faced with petitioner's consistent and continued losses could not expect a profit, but from a conviction that petitioner himself, were he not so inextricably caught up in the gambling game, could not expect, by reason of these sustained losses, to turn a profit. There is nothing in the trial record of the instant case on which we could base a contrary finding. Indeed, the evidence here adds three more years to petitioner's long history of enormous, unceasing gambling losses and thus provides additional support for349 our conclusion that petitioner's gambling activities were not motivated by a profit-seeking purpose. Margit Sigray Bessenyey,45 T.C. 261">45 T.C. 261, 273 (1965), affd. 379 F.2d 252">379 F.2d 252 (C.A. 2, 1967), certiorari denied 389 U.S. 931">389 U.S. 931 (1967). Petitioner acknowledges that the odds are against the customers' winning at the craps tables. He knew this to be true throughout the years in controversy. We do not think his evanescent hope that luck will eventually attend his efforts is sufficient to show that the disputed expenses were made for profit-seeking purposes, i.e., in the words of section 212(1), "for the production or collection of income." See Citizens & So. Nat. Bank et al. v. United States,83 Ct. Cl. 618">83 Ct.Cl. 618, 622-623, 14 F. Supp. 915">14 F.Supp. 915, 918 (1936); Edward T. Dicker,T.C. Memo 1963-82">T.C. Memo. 1963-82. 3To reflect the foregoing conclusion and adjustments conceded350 by petitioner, Decisions will be entered for the respondent.Footnotes1. SEC. 212. EXPENSES FOR PRODUCTION OF INCOME. In the case of an individual, there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year-- (1) for the production or collection of income; ↩2. SEC. 262. PERSONAL, LIVING, AND FAMILY EXPENSES. Except as otherwise expressly provided in this chapter, no deduction shall be allowed for personal, living, or family expenses.↩3. Respondent contends in the alternative that if sec. 212(1) applied, sec. 165(d), I.R.C. 1954, would limit the deduction of the expenses to the amount of the net gambling gains. Since we have held sec. 212 (1)↩ inapplicable, we need not reach that question.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625407/	JONES LUMBER CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Jones Lumber Co. v. CommissionerDocket No. 3275.United States Board of Tax Appeals5 B.T.A. 1159; 1927 BTA LEXIS 3659; January 25, 1927, Promulgated 3659 The debts herein were ascertained to be worthless and were charged off within the taxable year. Held properly deductible from gross income. Paul Kayser, Esq., for the petitioner. Robert A. Littleton, Esq., for the respondent. MARQUETTE 1159 This is a proceeding for the redetermination of a deficiency in income and profits taxes for the year 1921 in the amount of $2,985.48. Only so much of the deficiency is in controversy as arises from the disallowance by the respondent of deductions claimed by the petitioner on account of debts alleged to have been ascertained to be worthless and charged off in the taxable year. FINDINGS OF FACT. The petitioner is a corporation organized under the laws of Texas with its principal office at Houston. It is, and was during the year 1921, engaged in the business of selling lumber. In the year 1921, J. M. Sullivan and J. C. Sparks, two carpenters, took a contract to build a house. The petitioner furnished them, on credit, the lumber that was used in constructing the house. The 1160 contract price was not sufficient to pay for the material and labor used in the construction of the house3660 and Sullivan and Sparks were not able to pay the full amount due the petitioner, and at the conclusion of the transaction they owed the petitioner approximately $3,000. The petitioner reduced the indebtedness to judgment, but has been able to collect only about $280 from Sullivan and Sparks. Sullivan and Sparks have, and had at December 31, 1921, no property, and they support themselves and their families by day labor. On December 31, 1921, the petitioner charged off the amount of the debt as it then existed - $2,721.55, as worthless and deducted that amount in computing its net income for the year 1921. The petitioner also sold lumber to the amount of $195.98 to an individual who represented that he was going to establish a business in Houston under the name of the Houston-Tampico Steamship Co. A short time later the person who purchased the lumber left Houston and the petitioner has never been able to locate him or to collect anything on his account for the lumber sold. The account was charged off as worthless on December 31, 1921, and was deducted from the petitioner's gross income for that year. The Commissioner, upon audit of the petitioner's income and profits-tax return*3661 for the year 1921, disallowed both of the deductions set forth herein. OPINION. MARQUETTE: Upon consideration of the evidence herein, we are of the opinion that the debts in question were worthless on December 31, 1921, and that they were ascertained to be worthless and charged off within the year 1921. The petitioner is, therefore, entitled to deduct the amount of the debts in computing its net income for the year 1921. Judgment will be entered on 15 days' notice, under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625408/	FRISHKORN REAL ESTATE CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Frishkorn Real Estate Co. v. CommissionerDocket No. 14270.United States Board of Tax Appeals15 B.T.A. 463; 1929 BTA LEXIS 2856; February 15, 1929, Promulgated 2856 1. Accounts or commissions receivable acquired by petitioner at its incorporation in January, 1917, in exchange for capital stock are capital assets. 2. The cost of surveying and staking land held capital expenditure 3. Traveling and entertaining expenses authorized by a corporation but not shown actually to have been expended and to be ordinary and necessary business expenses, disallowed. R. H. Ritterbush, Esq., for respondent. VAN FOSSAN 463 This proceeding is brought to redetermine the income and profits taxes of the petitioner for the years 1920 and 1921. The respondent has asserted deficiencies in the amounts of $25,237.42 and $30,737.55, respectively. The case was submitted on depositions. The petitioner alleges the following errors: (1) The inclusion in the net income of 1920 of the sum of $9,440.41, representing commissions receivable acquired by the petitioner as capital assets in January, 1917. (2) The disallowance as a deduction from gross income of the sum of $900 expended for surveying and staking a parcel of land during 1920. (3) The reduction of the Improvement Reserve from $75,000 to $15,000 for the years2857 1920 and 1921. (4) The disallowance of certain expenditures made in the current maintenance of the petitioner's properties during 1921. (5) The reduction of the alleged net operating loss for 1919 from $30,000 to $6,221.06 through the disallowance of expenses for traveling and entertaining and the rejection of losses claimed to have been sustained by reason of the concellation of land contracts. (6) The treatment of the sale of a certain tract of land as a transaction fully completed within the year 1921 rather than a sale on the installment basis. (7) The disallowance as deductions of commissions credited during the year 1921 to the accounts of individuals indebted to the petitioner. (8) The inclusion of the sum of $2,251.54 in income for the year 1921, representing a brokerage commission on transactions not consummated during that year. FINDINGS OF FACT. The petitioner is a corporation organized in January, 1917, under the laws of the State of Michigan, with principal offices at Detroit. 464 It is engaged in the real estate business, both as a principal and as a broker. At the time of its organization in January, 1917, the petitioner acquired certain2858 assets in exchange for its capital stock. Among them were accounts receivable representing commissions due in the sum of $78,829.17. During the years 1917, 1918, and 1919 the sum of $69,388.76 was collected on such accounts, leaving a remainder un-collected of $9,440.41. On December 31, 1921, there remained un-collected $202.53. The amount of such collections for 1920 was $9,237.88. In 1920 the petitioner expended the sum of $900 for surveying a certain subdivision, known as Frishkorn Highlands Subdivision, and placing wooden lot boundary stakes thereon. The petitioner charged this amount to expense. The respondent disallowed the item as an expense but did not increase the cost of the property by including it as a capital item. Prior to 1920 the petitioner acquired certain acreage, subdivided and promoted it as "Frishkorn Highlands Subdivision." It platted the land, graded and cindered streets, installed sidewalks, planted shade trees and otherwise rendered the subdivision attractive to prospective purchasers of lots. The petitioner set up on its books an account entitled "Reserve for Improvements" and credited thereto the sum of $75,000. No date is given for such action. 2859 The respondent reduced this reserve to $15,000. During the period from 1920 to 1923, inclusive, the petitioner expended the sum of $21,658.64 in such anticipated improvements, while on October 3, 1927, it paid to the City of Detroit $47.15 to cover a charge for the installation of water service. On January 1, 1928, the balance to the credit of that reserve was $53,294.21, and only three lots remained unsold at that time. On January 25, 1918, and January 25, 1919, the board of directors of the petitioner entered orders fixing certain salaries for its officers and adopting allowances to them for traveling expenses and entertaining, aggregating $10,000 per year. The respondent allowed as expense deductions $5,000 per year. No evidence was introduced to prove the amount actually expended. At the time of its incorporation the petitioner received certain land contracts, totaling $43,878.93, in exchange for its capital stock. Land contracts of the value of $794.13 and $3,847.55 at date of cancellation were canceled during 1918 and 1919, respectively. The lots represented by these contracts were again sold, either in the same or subsequent years. During the summer of 1921 the2860 petitioner sold, under contract, 71 lots in a certain subdivision known as "Park View, St. Clair" for $48,255, of which the purchasers paid initial installments of $8,210.94. 465 During November, 1921, the petitioner sold to R. H. Dunning the remaining 210 unsold lots in that subdivision, together with its land contracts for the 71 lots previously sold, for a total consideration of $40,000. Dunning paid $4,789.06 in cash, making a total of $13,000 cash received by the petitioner in 1921. During the year 1921 the brokerage department of the petitioner accrued on its books brokerage fees aggregating $2,251.54, representing commissions expected from the sales of real estate during that year, but which sales were never consummated. On January 31, 1922, the petitioner made a reverse entry by debiting the "Surplus Adjustments Account, Prior Years" with the amount of $2,251.54 termed "adjusting previous year's commission." Assignments of error numbers 4 and 7 were abandoned by the petitioner. OPINION. VAN FOSSAN: At the time of its organization the petitioner received in exchange for its capital stock certain assets, including commissions receivable amounting to $78,829.17. 2861 During the years 1917, 1918, and 1919 the petitioner collected a considerable portion of the commissions so acquired. During 1920 petitioner collected, and the respondent included in the petitioner's income, the sum of $9,237.88, representing all but $202.53 of the entire remaining balance of commissions receivable acquired by the petitioner on organization, January 1, 1917. It is clear that the commissions receivable turned in to petitioner for stock constituted capital assets. The subsequent collection of the same, if not in excess of the value at the date of acquisition, was merely a conversion of capital assets to a different form and did not give rise to income. The item of $900 covering the cost of surveying and "staking" Frishkorn Highlands Subdivision is a capital expenditure. ; . The petitioner's custom of treating such a charge as an expense does not establish its character as such. The cost of the properties should be increased by the amount of this item. The petitioner arbitrarily set up an account of $75,000 as a "reserve for improvements" applicable2862 to the Frishkorn Highlands Subdivision. This amount was presumed to cover the cost of platting the land, grading and cindering streets, installing sidewalks and making other desirable and necessary improvements preparatory to and coincident with the sale of lots to the general public. On January 1, 1928, the total amount expended for such purpose was approximately $21,600 and at this time only three lots were left unsold. The respondent reduced the amount from $75,000 to $15,000 as of the years 1920 and 1921, which action gave rise to the sole question 466 raised as to this item. While it appears that petitioner's estimate of $75,000 was entirely too liberal, it further appears that during the period involved petitioner actually spent the sum of $21,658.56 in such anticipated improvements. This sum should be allowed. The petitioner seeks to have its 1919 net operating loss increased by $12,441.68 by the addition of an allowance for traveling and entertaining expenses of its officers, amounting to $5,000 in each of the years 1918 and 1919 and by the amounts of $354.13 and $2,087.55, representing losses sustained during 1918 and 1919, respectively, by reason of the cancellation2863 of certain land contracts acquired by the petitioner at its organization. The petitioner authorized its officers to expend an aggregate of $10,000 during each of the years 1918 and 1919 as traveling expenses and cost of entertaining prospective purchasers. The petitioner has presented no evidence that its officers expended more than the $5,000 per year allowed by the respondent; neither has it shown that such expenses were ordinary or necessary in its business. Therefore, we find no error in the determination of the respondent. ; . The land contracts were acquired by the petitioner at their face value in exchange for stock and constituted capital assets on January 1, 1917. Upon the subsequent cancellation of the contracts presumably the lots were repossessed. If equal in value to the unpaid balance of the contracts no loss was suffered. We do not know their value. We do know they were resold in many cases at a profit. The evidence is insufficient to enable us to determine that there was a loss. During the summer of 1921 petitioner promoted the Park View, St. Clair Subdivision and*2864 sold 71 lots therein to various purchasers for $48,255, of which $8,210.94 was paid in cash. In November, 1921, the petitioner sold to R. H. Dunning for $40,000, with $4,789.06 in cash, its entire holdings in the subdivision, including the contracts of purchase relating to the 71 lots. So far as petitioner was concerned the $40,000 represents the total sale price of its interest in the entire property. The rights arising from the prior contracts were supplanted by the Dunning contract. When December 31 arrived petitioner had in its hands $13,000. It was no longer interested in either the property or the contracts. The entire transaction was closed. The respondent correctly refused to allow petitioner to report this income on the installment basis. As to the last item, the commissions accrued in the brokerage department, the evidence is so inadequate and confused as to make it impossible to determine the precise situation obtaining. In this event, we have no alternative but to hold that petitioner has not demonstrated that respondent erred. Judgment will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625409/	WALLACE HUNTINGTON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. ANNIE HUNTINGTON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Huntington v. CommissionerDocket Nos. 25806, 25807.United States Board of Tax Appeals15 B.T.A. 851; 1929 BTA LEXIS 2776; March 14, 1929, Promulgated 2776 Where one who has sold a tract of land on the deferred-payment plan and has so returned for tax the gain arising from the sale, and where after the sale had been completed, entered into a contract with certain of his children to whom he had attempted to make oral gifts of parts of the land sold whereby he irrevocably assigned to each child that part of each purchase-money note which represented the part of the sale price of the tract attempted to be given, and by the terms of the contract agreed to and did place the notes in the possession of a bank, the bank to pay each child his part, held that the vendor is not taxable on so much of the gain as was represented by the portions of the notes so assigned. Robert T. Jacob, Esq., for the petitioners. Albert S. Lisenby, Esq., for the respondent. MILLIKEN 852 These proceedings were, by order duly entered, consolidated for hearing and decision. The appeal of Wallace Huntington involves deficiencies in income taxes for the calendar years 1922 and 1923 in the respective amounts of $654.47 and $1,418.26, and the appeal of Annie Huntington involves the redetermination of a deficiency in income2777 tax for the calendar year 1922 in the amount of $454.84. Both petitioners complain that respondent erred in including in their gross income for the years involved, income arising from the sale of certain real estate which belonged to their children, Roma, Frances and Jean, which petitioners had prior to sale given to said children. Petitioner, Wallace Huntington, further complains that respondent erred in refusing to permit his wife, Annie Huntington, to make and file a separate income-tax return for the year 1923. This last allegation of error was withdrawn by said petitioner at the hearing. Respondent in his answer admits that petitioners gave to their daughter, Roma, the tract of 100 acres which petitioners allege they gave this child and at the hearing of these proceedings further admitted that there is no dispute as to this gift. FINDINGS OF FACT. Petitioners, Wallace Huntington and Annie Huntington, are husband and wife and resided during the years in controversy in the State of Washington. They were married in the State of Washington in the year 1891. As a result of said marriage, three children were born to said petitioners, to wit, Roma, Frances, and Jean. After2778 their marriage, and while residents of the State of Washington, petitioners acquired by their joint efforts 218/240 of certain tracts of land situated in the County of Cowlitz, State of Washington, aggregating in all about 1,300 acres. Subsequently and in the year 1918, petitioners made oral gifts out of said tract of 1,300 acres of 100 acres to each of their children, Roma, Frances, and Jean. The site and boundaries of each tract of 100 acres were selected and agreed upon by petitioners and the child to whom such 100-acre tract was given. No written conveyances were made. Roma Huntington took possession of her tract, erected thereon certain buildings, fenced it in, cultivated it and lived upon it for about two years. The other two children who are younger than Roma had laid their plans for the improvements for their respective tracts, and Jean had done a little grubbing in his. But neither had done anything more in the way of taking possession. Jean lived with his parents at their homestead on the original 1,300-acre tract and Frances was away from home a large part of the time, being in the East, either going to college or teaching. Subsequent to the occurrence of the above2779 facts, petitioners began negotiations with the Long-Bell Lumber Co. for the 853 sale of the 1,300-acre tract and, before the culmination of the negotiations into a binding contract, petitioners consulted their attorney, T. B. Fisk, as to the best way to conserve the interests of their three children. They explained to said attorney that they had given to each child 100 acres out of the 1,300-acre tract but had not executed any conveyances. At the time of this consultation and at the time of the execution of the agreement hereinafter referred to, petitioners took no thought with reference to the question of income taxes and were seeking solely the protection of their children with respect to their oral gifts. Said attorney advised that petitioners should not convey to the children the 100-acre tracts orally given to each of them, but that the transaction should take the form and manner shown by the agreement hereafter set forth. Thereafter the negotiations with the Long-Bell Lumber Co. were completed and by deed dated and acknowledged January 29, 1921, and recorded February 14, 1921, in the office of the County Auditor of Cowlitz County, petitioners conveyed the whole of2780 said 1,300-acre tract to the Long-Bell Lumber Co. The deed recited a consideration of $10 but the real consideration appears in the agreement which petitioners and their children entered into pursuant to their attorney's advice, the material parts of which read: THIS INDENTURE made this 1st day of March, 1921, by and between Wallace Huntington and Annie Huntington, husband and wife, parties of the first part and Roma H. stoner, Jean E. Huntington and Frances R. Huntington, parties of the second part, being the children of the parties of the first part, WITNESSETH: That Whereas the parties of the first part did during the year 1920 contract to sell to the Long-Bell Lumber Company, a corporation all of their real estate in Diking District Number Four of Cowlitz County, Washington for the sum of Two Hundred Thousand ($200,000) Dollars, and Whereas the said parties of the first part had agreed to convey to each of said parties of the second part an interest in said real estate amounting to the sum of Fifteen Thousand ($15,000) Dollars for each of said parties of the second part and Whereas said sale has been completed and the said parties of the first part have received from the said2781 Long-Bell Lumber Company payment for said land in the sum of Two Hundred Thousand ($200,000) the sum of $28,000 in cash and the sum of $172,000 in five notes each for the sum of $34,400 one of said notes being due one year after date or February 1st, 1922 and one note being due each year thereafter, and said notes being secured by a mortgage on the following described property, to-wit: (Here follows description of property.) And Whereas to carry out said agreement made with said parties of the second part, said parties of the first part do desire to assign, and do hereby assign to said parties of the second part and to each of them an interest in said notes and mortgage as follows To each of said parties the sum of $12,500 interest in all of said notes and the mortgage given to secure the same, said mortgage and notes being dated February 1st, 1921, and executed by the Long-Bell Lumber Company, a corporation. 854 It is further agreed by said parties of the first part that said notes and mortgage shall be deposited for collection in the Cowlitz Valley Bank at Kelso, Washington, and it is further agreed that whenever any part of said principal sum secured by said mortgage2782 shall be paid or the interest thereon that said Cowlitz Valley Bank shall distribute said payment in accordance with the rights of the parties of the first part and the parties of the second part herein; that is, that it will pay to each of said parties of the second part from the proceeds of each of said notes the sum of $2,500 together with interest on said sum of $2,500 as paid, And said parties of the first part do hereby sell and assign said interest in said notes and mortgage securing the same irrevocably, and do hereby authorize and direct said Cowlitz Valley Bank to distribute the payments on said notes and mortgage in accordance with the terms of this agreement. It is further agreed that a copy of this agreement, duly executed by the parties of the first part shall be deposited in said Cowlitz Valley Bank, together with said notes and mortgage as authority for said bank to distribute said sums in accordance with the terms of this agreement. In Witness Whereof, the parties of the first part have executed this instrument this 1st day of March, 1921. WALLACE HUNTINGTON. ANNIE HUNTINGTON. At the instance of the Cowlitz Valley Bank, the above agreement was filed2783 for record in the office of the County Auditor of Cowlitz County on December 6, 1921. The children at first objected to the sale, but finally, and before the completion of the contract of sale, agreed thereto and to the agreement above set forth between them and petitioners. In 1921, petitioners paid to each of said children the sum of $2,500 out of the cash payment received from the Long-Bell Lumber Co. The purchase-money notes were then placed in the custody of the Cowlitz Valley Bank to be held and collected by it under the above contract. The bank accepted said trust and has performed and has strictly carried out the conditions thereof. As the notes were collected the Cowlitz Valley Bank paid to each to said the part of the principal and interest thereon which was due to said child under said contract. No part of said amounts was paid to or passed through the hands of either petitioner. The sale to the Long-Bell lumber Co. was made on the deferred-payment plan and petitioners have returned for income taxation each year only that part of each installment which remained to them, and have not returned that part of principal and interest which belonged to said three children2784 under the above agreement and which had been paid directly to them by the Cowlitz Valley Bank. OPINION. MILLIKEN: The parties have agreed that the sale by petitioners in the year 1921 to the Long-Bell Lumber Co. was an installment sale as that term is defined in section 212(d) and section 1208 of the 855 Revenue Act of 1926 and that petitioners properly reported on their tax returns the income arising in that year in such manner. Counsel for respondent also conceded that the gift to Roma was completed and, since the gift was made prior to the negotiations with the Long-Bell Lumber Co., that any gain made on the sale of the tract belonging to Roma should not be taxed to petitioner. This brings us to the question whether petitioners are taxable on so much of the gain as arose from the sale of the two 100-acre tracts which they attempted to give to Jean and Frances. Counsel for respondent contends there was not a completed gift of the 100-acre tracts to Jean and Frances, because there was no conveyance of title to them and they had done nothing to reduce their tracts to possession. There is no disagreement between counsel on this phase of the case, because counsel2785 for petitioners states in brief filed "we have not claimed that the gift of the real property was consummated." The good faith of petitioners is perfectly apparent and respondent makes no contention to the contrary. In fact, the question of income tax played no part either in the attempted making of the gifts or in the contract of assignment. All that petitioners desired was that their children should receive that part of the purchase price which represented the land they had attempted to give to them and which they had accomplished in so far as Roma was concerned. This leaves for our consideration the sole question whether petitioners are taxable on so much of the gain arising from the sale as is represented in that part of the purchase price which they assigned to Jean and Frances. At the outset we are met with the contention of respondent that section 3423 of Remington's Compiled Statutes of Washington (1922 Ed.) applies. That section reads: The endorsement must be an endorsement of the entire instrument. An instrument, which purports to transfer to the endorsee a part only of the amount payable, or which purports to transfer the instrument to two or more endorsees severally, 2786 does not operate as a negotiation of the instrument. It may be pointed out that it does not appear that the purchase money notes were negotiable. There is nothing in the record which describes these notes, except the agreement between petitioners and their children. They are there referred to as "notes." Whether they were payable to order or to bearer does not appear. Assuming for the purpose of argument that the notes were negotiable, it does not appear that petitioners attempted to negotiate them or any interest therein. What they did was to assign an interest in each note to the children. This is not forbidden by the above section of the Negotiable Instruments Act of Washington. In Edgar v. Haines,109 Ohio St. 159">109 Ohio St. 159; 141 N.E. 837">141 N.E. 837, the facts were that a negotiable promissory note was executed payable to Edgar and another, 856 each being entitled to a half interest therein. The note was secured by mortgage. Edgar assigned his half interest to Mayer and, as it afterwards appeared, was defrauded by his assignee. Mayer afterwards assigned his interest to another person, who in turn assigned it to a third. The two subsequent assignees2787 paid value and were without notice of the fraud on Edgar. All these persons were parties to an action on the note and for the foreclosure of the mortgage. The court, after quoting section 8137 of the General Code of Ohio, which is the same as section 3423 of the Statutes of Washington, said: If, therefore, it is attempted to transfer a negotiable instrument in such manner as to violate the provisions of section 8137, General Code, it does not operate as a negotiation of a negotiable instrument. It does not follow, however, that the transfer of only a part of the amount payable is a void act, or that the transferee acquires nothing by the transaction. It cannot be doubted that any legislative attempt to deny the right of a holder of a part interest in a negotiable instrument to sell and transfer such interest would be unconstitutional. As a general rule, any person may sell and transfer property, or any interest therein, under the inherent power to make contracts, all of which is recognized by the letter and the spirit of section 1 of the Ohio Bill of Rights. It is, of course, an exception to such general rule that the Legislature may limit such right on the ground of public2788 policy, the best examples of which are champertous and usurious contracts, contracts in restraint of trade, and other agreements which need not be enumerated. It is likewise within the limits of legislative power to give to promissory notes and bills of exchange the attribute of negotiability, to place limitations thereon, and to take the same away under certain prescribed conditions. The Legislature would not, however, have the power to take away from a promissory note the force and effect of a contract, if it possesses all of the formal requisites and essential attributes of a contract. In the instant case, after the transfer of the part interest in the note, it still had all of the character and quality of a contract, and as such it could lawfully be transferred. We have no difficulty, therefore, in reaching the conclusion that Mayer and the subsequent transferees were holders of a nonnegotiable chose in action. It is well settled that whatever may be the rights at law of an assignee of a part of a negotiable note or of any other chose in action, his rights are enforceable in equity. 8 C.J. 343; 5 C.J. 894; 2789 Edgar v. Haines, supra.Here petitioners did not by a writing endorsed on the notes assign a part of them to the children and thus attempt to require the purchaser to pay a part of each note to each assignee. The purchaser did not have to split up his payments. As each note fell due, he paid the whole note to its holder, the bank. What petitioners did do was to transfer the notes intact to the bank together with the contract by which they assigned to each child a part of each note, and then authorized and directed the bank to collect the notes as they fell due and pay the proceeds and all interest paid thereon to them and to their children, in certain proportions. The functions of the bank under the contract were to a large extent those of a trustee. It held 857 a fund represented by the notes for the benefit of petitioners and their children, it agreed to carry into effect the contract, and it complied with its agreement. We are of the opinion that the contract was complete and vested in each child a present interest in each note. That the contract operated as of the date of its execution to convey a then present interest, is shown by its words2790 and especially by the fact that each child was entitled to all the interest which pertained to his or her share. This brings us to the question whether petitioners are taxable in the years involved on so much of the gain in each note as was attributable to each child's share. It is to be observed that the peculiar provisions of the various revenue acts relative to the taxation of the income of partnerships are not applicable to the instant proceedings. Cf. Mitchel v. Bowers, 15 Fed.(2d) 287. No partnership is involved. Neither is this a case where one who continued to be the owner of the property assigned future income arising therefrom as it might accrue. Cf. Samuel V. Woods,5 B.T.A. 413">5 B.T.A. 413. Petitioners had disposed of the land and of their interest in the notes to the extent of the assignment. Further, these proceedings do not fall within that class of cases where a corporation has leased its property and required that the rental be paid directly to the stockholders and where it has been held that the corporation was in receipt of income on the grounds that it continued to be the owner of the property from which the income was derived and2791 that the corporate entity was to a certain extent disregarded. Cf. Rensselaer & Saratoga R.R. Co. v. Irwin,249 Fed. 726, and Blalock v. Georgia Ry. & Electric Co.,246 Fed. 387. Lastly, the doctrine of constructive receipt of income can not be applied, for the obvious reason that the income when collected was payable and during the taxable years was actually paid to the persons legally entitled thereto and to which neither petitioner had any right whatever. One can not be held to be in constructive receipt of that to which he is not entitled and which in fact belongs to another. We now approach the vital question whether the petitioners by voluntarily but irrevocably assigning an interest in the notes, each of which contained a part of the gain realized upon the sale and by voluntarily returning their gain upon the deferred-payment basis, can escape taxation on so much of the gain as is contained in the parts of the notes assigned to the children. We repeat that in these proceedings there is not the slightest suspicion of tax evasion. It is also proper to point out that if petitioners had been advised of their rights with reference2792 to income tax they could have conveyed, prior to the making of a binding contract of sale, to Frances and Jean their several tracts and thus have placed themselves, with respect to these portions, in the same position they now occupy as to the 858 tract of Roma. The sale of the 1,300-acre tract was made on the deferred-payment basis. Section 212(d) of the Revenue Act of 1926, which was made retroactive by section 1208, provides: (d) Under regulations prescribed by the Commissioner with the approval of the Secretary, a person who regularly sells or otherwise disposes of personal property on the installment plan may return as income therefrom in any taxable year that proportion of the installment payments actually received in that year which the total profit realized or to be realized when the payment is completed, bears to the total contract price. In the case (1) of a casual sale or other casual disposition of personal property for a price exceeding $1,000, or (2) of a sale or other disposition of real property, if in either case the initial payments do not exceed one-fourth of the purchase price, the income may, under regulations prescribed by the Commissioner with the2793 approval of the Secretary, be returned on the basis and in the manner above prescribed in this subdivision. As used in this subdivision the term "initial payments" means the payments received in cash or property other than evidences of indebtedness of the purchaser during the taxable period in which the sale or other disposition is made. It seems to be the theory of respondent that when a deferred payment sale has been consummated the vendors are at once in receipt of income and that the only benefit conferred by section 212(d) is that it permits the vendors to return such income over the years during which the notes mature. This contention not only does violence to the words of the statute, but overlooks the purpose which Congress had in view when they enacted it. Prior to the date of its enactment, the Commissioner had been holding that where purchase money notes had no real market value they were not returnable as income, but while so holding as a matter of law, he very often determined that such notes had a value equal to cash, in cases where the initial payment was quite small. It was the purpose of Congress to deny to the Commissioner the right to place any value on such2794 notes where the initial payment did not exceed one-fourth of the purchase price. See Report of Committee on Finance, 69th Cong., No. 52, p. 19. If unpaid purchase money notes had no real market at the date of delivery or during the taxable year in which the sale was consummated, they can in no sense be deemed income or to include income, since the receipt of that which has not such value can not be construed as the receipt of income. Congress has in effect now declared that when the initial payment does not exceed one-fourth of the purchase price, the unpaid notes do not possess market value. It follows that petitioners were not in receipt of income when they received the notes in question and when they gave them to their children. Nor do we perceive why petitioners should be liable for the tax on the parts of the notes transferred, any more than that their estates after their deaths should be liable for the tax on the gain arising from the sale. If petitioners are liable for the tax from 859 the date of the consummation of the sale, it would seem to follow that such liability could not be escaped by death. Beyond all this we are confronted by the very words of the2795 section. The words of this provision are plain to the point of bluntness. It requires a taxpayer to return in any taxable year as income that proportion of he installment payments "actually received in that year," which the total profit realized or to be realized when payment is complete, bears to the total contract price. It is clear that if no installment payment is received in a taxable year, no gain is returnable or taxable in that year. This was the purpose of the provisions. We are to be controlled by the plain meaning of the words used and can not supply some recondite meaning which is not suggested by the words themselves or by the context. Thus it is said in United States v. Merriam,263 U.S. 179">263 U.S. 179: On behalf of the government it is urged that taxation is a practical matter and concerns itself with the substance of the thing upon which the tax is imposed rather than with legal forms or expressions. But in statutes levying taxes the literal meaning of the words employed is most important for such statutes are not to be extended by implication beyond the clear import of the language used. If the words are doubtful, the doubt must be resolved against2796 the government and in favor of the taxpayer. Gould v. Gould,245 U.S. 151">245 U.S. 151, 153. The rule is stated by Lord Cairns in Partington v. Attorney General, L.R. 4 H.L. 100, 122; "I am not at all sure that in a case of this kind - a fiscal case - form is not amply sufficient; because, as I understand the principle of all fiscal legislation, it is this: If the person sought to be taxed comes within the letter of the law, he must be taxed, however great the hardship may appear to the judicial mind to be. On the other hand, if the crown, seeking to recover the tax, cannot bring the subject within the letter of the law, the subject is free, however apparently within the spirit of the law the case might otherwise appear to be. In other words, if there be admissible in any statute what is called an equitable construction, certainly such a construction is not admissible in a taxing statute, where you can simply adhere to the words of the statute." And see Eidman v. Martinez,184 U.S. 578">184 U.S. 578, 583. See also 2797 Shwab v. Doyle,258 U.S. 529">258 U.S. 529, and United States v. Field,255 U.S. 257">255 U.S. 257. Petitioners did not receive during the taxable years the proceeds of any part of the notes assigned to Jean and Frances. None of it passed through their hands. What is more, they were not entitled to any portion of the part assigned. Since they did not "actually receive" the portions of Jean and Frances and since these portions include the part of the gains sought to be taxed, it follows under the plain words of the statute they can not be taxed thereon. The fact that this results from the voluntary return of this gain on the deferred-payment basis does not alter the case. We can not read into the statute words which are not there. In John S. Gullborg,5 B.T.A. 628">5 B.T.A. 628, the same contention was urged that is presented in these proceedings, 860 and there we held that all the gain arising from a sale on the deferred-payment plan was taxable to the assignor on the ground that the taxpayer had not relinquished his interest to the entire proceeds of the sale. We concluded our opinion as follows: We are of opinion from the entire record that the2798 petitioner did not by the assignment part absolutely with his right, title, and interest in the unpaid installments provided in the sales agreement, and that the Commissioner correctly held that whatever gain resulted from the payments made to petitioner during the taxable years was income to him. Cf. O'Malley-Keyes v. Eaton, 24 Fed.(2d) 436; Young v. Gnichtel, 28 Fed.(2d) 789; James F. Foster,13 B.T.A. 496">13 B.T.A. 496; Edith H. Blaney,13 B.T.A. 1315">13 B.T.A. 1315; and J. V. Ledig,15 B.T.A. 124">15 B.T.A. 124. These conclusions are confirmed by the action of Congress in inserting section 44(d) into the Revenue Act of 1928. That provision reads: SEC. 44. INSTALLMENT BASIS. * * * (d) Gain or loss upon disposition of installment obligations. - If an installment obligation is satisfied at other than its face value or distributed, transmitted, sold, or otherwise disposed of, gain or loss shall result to the extent of the difference between the basis of the obligation and (1) in the case of satisfaction at other than face value or a sale or exchange - the amount realized, or (2) in case of a distribution, transmission, 2799 or disposition otherwise than by sale or exchange - the fair market value of the obligation at the time of such distribution, transmission, or disposition. The basis of the obligation shall be the excess of the face value of the obligation over an amount equal to the income which would be returnable were the obligation satisfied in full. In reporting the above provision, the Committee on Finance of the Senate, and the Committee on Ways and Means of the House of Representatives, in Reports 960 and 2, 70th Cong., said at pp. 24 and 16: Gain or loss upon disposition of installment obligations. - Subsection (d) contains new provisions of law to prevent evasion of taxes in connection with the transmission of installment obligations upon death, their distribution by way of liquidating or other dividends, or their disposition by way of gift, or in connection with similar transactions. The situations above specified ordinarily do not give rise to gain and yet at the same time it is urged that they permit the recipient to obtain a greatly increased basis in his hands for the property received, except in the case of gifts. It therefore seems desirable to clarify the matter. The2800 installment basis accords the taxpayer the privilege of deferring the reporting at the time of sale of the gain realized, until such time as the deferred cash payments are made. To prevent the evasion the subsection terminates the privilege of longer deferring the profit if the seller at any time transmits, distributes, or disposes of the installment obligations and compels the seller at that time to report the deferred profits. The subsection also modifies the general rule provided in subsection (a) for the ascertainment of the percentage of profit in the deferred payments, in those cases in which the 861 obligations are satisfied at other than their face value or are sold or exchanged. The modification permits a compensating reduction in the percentage of profit in case the obligations are satisfied at less than their face value, or are sold or exchanged at less than face value. It is to be noted that this report states that, under the law as it existed at the time the report was made, the recipient of such notes, except in the case of a gift, has a new basis upon which to compute his income. The reason donees of gifts are excepted is to be found in section 202(a) 2801 of the Revenue Act of 1921, and section 204(a) of the Revenue Acts of 1924 and 1926. We have not the donees before us and therefore are not concerned with the question of their liability. It is sufficient to point out that Congress recognized the fact that under the then existing revenue acts the donor escaped liability by making a gift of such notes and sought to stop the practice permitted by section 212(d) of the Revenue Act of 1926. By this decision we do not cast doubt on many of our decisions that where the taxpayer retains his interest, ownership or control of the property from which the income is derived that an assignment of the income would not relieve him from the tax. But in the case at bar we have an irrevocable assignment of the corpus to take immediate effect. Petitioners disposed of their property to the extent of said assignment and it seems to us of no determining effect that possibly wrapped up in such property there may have resulted income to petitioners if they had been the owner of the part of the notes when they matured in future years. Cf. *2802 People ex rel. Brewster v. Wendell,188 N.Y.S. 510">188 N.Y.S. 510. A transaction such as in the instant case must be carefully scrutinized, but when the clear bona fides is established, as here, we think the respondent erred in treating as the income of petitioners the sums that pursuant to the instrument of assignment became and were the property of some one else when so received. Reviewed by the Board. Judgment will be entered under Rule 50.STERNHAGEN, TRAMMELL, and MURDOCK dissent. PHILLIPS: There is one consideration to which I give some weight which is not mentioned in the prevailing opinion. While our decision seems on first consideration to permit income to escape taxation, I do not conceive that this is so. The income represented by the note would appear to be taxable to the donee. Section 202(a)(2), Revenue Act of 1921; Taft v. Bowers,278 U.S. 470">278 U.S. 470. To hold the petitioner liable for tax upon income which is taxable to the donee would result in double taxation of the same income. The presumption is that no such result was intended by the law. With these observations, I concur in the result reached.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625410/	Sidney Alper and Sydelle Alper v. Commissioner.Alper v. CommissionerDocket No. 55715.United States Tax CourtT.C. Memo 1956-271; 1956 Tax Ct. Memo LEXIS 29; 15 T.C.M. (CCH) 1415; T.C.M. (RIA) 56271; November 30, 195629 Aaron M. Diamond, Esq., 132 West 43rd Street, New York, N. Y., for the petitioners. Joseph F. Rogers, Esq., for the respondent. OPPERMemorandum Findings of Fact and Opinion OPPER, Judge: Respondent determined deficiencies in income tax of $1,960.34 for 1948 and $276.40 for 1949. The parties stipulated settlement of all issues except one. The remaining issue is whether respondent erred in allocating to a covenant not to compete a portion of the proceeds from a transaction in which Sidney Alper sold his stock in a corporation. Findings of Fact Certain facts are stipulated and are hereby found. Sidney Alper, hereafter referred to as petitioner, and his wife, Sydelle Alper, filed joint individual income tax returns for 1948 and 1949 with the collector of internal revenue for the third district of New York. Sydelle Alper is involved here only because of the joint return. In May 1947, petitioner purchased stock in Barclay Lunch, Inc., hereafter referred to as the corporation, which engaged in the luncheonette business. Until he sold the stock in February 1948, he and Samuel Greenfield operated the luncheonette. The luncheonette was located in downtown New York30 City about a half block from New York University. The luncheonette did a thriving business serving thousands of students each day. Many customers who walked in at lunch time could not be accommodated for lack of seats. Petitioner knew no customers by name and was acquainted with only about twenty or thirty. He built up little personal following. Other stockholders of the corporation were Leon Ackerman and Gertrude Greenfield. Each stockholder owned one-third of the shares. Following a prolonged conference on February 18, 1948 at their attorney's office, they sold all their stock in the corporation to Joseph Cohen, Allen Tillis and Michael Conner. Those present at the conference included the three sellers, the three buyers, an attorney for each group and the buyers' accountant. Because the corporation occupied its premises under a nonassignable lease, the buyers agreed to buy the stock of the corporation. The buyers paid $27,765 in cash for the stock. They assumed an existing mortgage carried on the corporate books at $15,000 and a total additional amount of $42,235 was to be paid in monthly installments. The parties agreed that the series of 59 monthly payments totaling $42,23531 would be represented by notes of the corporation. As security for the payments the corporation executed a 5-year chattel mortgage on its fixtures in favor of the sellers. The sellers executed a covenant not to compete recited to be "in consideration of" the $42,235 to be paid by 59 notes and secured by a chattel mortgage on the corporate fixtures. The covenant prohibited their engaging for 5 years in a business competitive with the corporation in an area extending 2 blocks north, east and west of the luncheonette and 6 blocks south. The consideration of the covenant not to compete was not arrived at by bargaining but was set according to the sellers' instruction. Although a covenant not to compete is a normal part of this type of sale, its allocable value rarely is negotiated. The buyers would not have completed the transaction without a protective covenant. The buyers assumed they had contracted to pay over $80,000 for the stock which represented the business as a whole including fixtures, lease, goodwill, restrictive covenant, and other things. The parties did not negotiate a selling price for any separate items. When the buyers' accountant requested a ruling from the Commissioner32 of Internal Revenue, he stated that the "Agreed price of stock" was $85,000. After the sale, the restrictive covenant was entered on the corporation books as an expense item, represented by 59 notes payable. The corporation took deductions for amortization of the cost of the covenant over a 5-year life. Petitioner treated his proportionate share of the total cash and notes received as in payment for the stock, and reported the gain as long-term capital gain, allocating nothing separately to the covenant not to compete. The sellers did not execute the covenant not to compete as a transaction separate from the sale of the stock, it was not separately bargained for, and no part of the total consideration was agreed to be paid as a severable consideration for it. Opinion Petitioners reported as capital gain the proceeds of a transaction by which they sold their stock in a corporation operating a luncheonette. Respondent claims that approximately half of the total consideration was paid for a covenant not to compete, which he says is ordinary income to petitioners and not capital gain. As in , affd. (C.A. 10) ,33 "The nub of the question is whether the agreement not to compete was actually dealt with as a separate item in the transaction * ." In , we found that "The covenant not to compete was never actually dealt with as a separate item in the business transaction, never bargained for, never evaluated." "On the evidence in this case we reach the same conclusion * * as to the nature of the contract, that it was not divisible, but that the total consideration * * * was the price * * * paid for the going business and intangible assets, including the good will and the covenant not to compete." , affd. (C.A. 6) , certiorari denied . In describing the transaction in a practically contemporaneous letter to respondent on which he now heavily relies, the buyers' representative begins his description of the transaction by using the significant phrase "Agreed price of stock $85,000." [Italics added.] This was the total amount paid. 134 We are satisfied that the purchasers of the stock required that the sellers agree not to compete and that very probably without such an agreement there might have been no sale. But what they were buying was an entire business including goodwill. "We are convinced that the total consideration paid was the agreed-upon price of the stock * * and that the covenant not to compete was but an incidental factor meant to assure the effective transfer of the * * * goodwill." . Certainly the price appearing to be the consideration for the covenant is wholly unrealistic unless it also incorporates the earning power of the corporation's business. We accept the testimony of petitioner's then attorney, as to which indeed there is no conflict, that the transaction was cast in that form purely as a matter of convenience. None of the buyers could testify that they bargained separately with respect to the consideration to be paid for the covenant. Cf. And indeed no such conclusion is possible from all the evidence. On authority of , this issue is determined in petitioners' favor. *35 In order to give effect to the stipulation of the parties settling two other issues, Decision will be entered under Rule 50. Footnotes1. In addition, one of the buyers testified: "I paid for the fixtures, for the lease, for the good will, for the restrictive covenant and maybe I overlooked a couple of things at the moment, sitting here, but I paid for it all."↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625411/	OLIVER W. BIRCKHEAD, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Birckhead v. CommissionerDocket No. 72389.United States Board of Tax Appeals33 B.T.A. 466; 1935 BTA LEXIS 749; November 14, 1935, Promulgated 749 In 1929 the petitioner contributed $16,000 to a pool which was to buy and sell shares of stock of the American Seating Co. The pool was unsuccessful. It was dissolved in 1930, leaving the petitioner indebted to the pool for a large amount. Held, that the petitioner's loss of $16,000 was a legal deduction from gross income of 1930. Allen G. Gartner, Esq., for the petitioner. O. W. Swecker, Esq., for the respondent. SMITH 466 OPINION. SMITH: This is a proceeding for the redetermination of a deficiency in income tax for 1930 of $2,422.25. The petition alleges that the respondent erred in his determination of the deficiency in the disallowance of a deduction from gross income of a loss of $15,861.40 467 on an investment in a pool organized in 1929 for the purpose of dealing in the common shares of the American Seating Co. During 1926 the petitioner became the president of the Murray Hill Trust Co. of New York, in which capacity he met Frederic L. Yeagel, who was also a director of the trust company and a partner of Sutro & Co., stockbrokers. Under date of September 30, 1929, Yeagel wrote to the petitioner inviting him750 to participate in a syndicate stock pool being organized and managed by him for the purpose of trading in the stock of the American Seating Co. Attached to the letter was a syndicate agreement which reads as follows: I have been requested to form, and am forming, an account of which I am to be the Manager, and in which I may participate as a member, to trade in the Common stock of American Seating Co. The Syndicate will trade in the shares of said stock and no other security. The commitment of the Syndicate shall not at any one time exceed 50,000 shares, either short or long, of said stock; and all transactions for the account of the Syndicate shall be in accordance with and subject to the rules and regulations of the New York Stock Exchange. Subject only to the limitations aforesaid, the Manager in a trading account, on books duly kept entitled "American Seating Co. Stock Account", shall have full power and authority hereby granted in his uncontrolled judgment and discretion, during the life and for the account of the Syndicate, to buy and sell and generally trade in the shares of the Common Stock above mentioned, either long or short, and at either public or private sale, 751 and to deal in puts and calls thereon. I am reserving for you a participation of 2,000 shares in the Syndicate, subject to delivery to me of your acceptance in the form indicated below, not later than noon on October 5, 1929. The profits and losses of the Syndicate shall be divided among and borne by the participants in the proportion which their respective participations bear to 50,000. The participants shall be deemed to participate in each transaction in proportion to their several interests in the Syndicate. Any loss resulting from the failure of any participant to carry out his obligations hereunder shall not be charged as a loss to the Syndicate, but in respect of any such loss incurred or threatened, resulting from such failure, the Manager shall have full power and authority hereby granted to take such action, by sale or otherwise and with or without notice, as in his uncontrolled discretion is necessary, to protect the Manager against loss. The Syndicate will expire at the close of business on December 1, 1929 unless sooner terminated by the Manager, and may be extended at the discretion of the Manager for two additional periods of three months each, or any part752 thereof. The Manager may from time to time and upon two days' notice, call, and the participants shall thereupon pay in cash, such amounts on account of the Syndicate liability whether for purchase price, margin or otherwise, as the Manager may deem proper, provided the Manager shall not require the participants to maintain a margin in excess of 35% of the entire Syndicate liability. Interest and commissions shall be paid to the Manager and charged to the Syndicate, as in any trading account, under the rules of the New York Stock Exchange, and the Manager may be interested in the Syndicate as a participant 468 subject to the same liability as any other participant and the same rights of profit or otherwise; and in addition thereto, as additional compensation for services as Manager of the account, shall be entitled to receive 10% of the Syndicate profits, if any, at the termination of the Syndicate. All expenses incidental to the operation of the Syndicate, including legal expenses, advertising, printing, postage, and all clearance charges, floor charges, and commissions, payable by the Manager to other brokers, or for transactions conducted by the house of the Manager, 753 shall be a charge upon and paid by the Syndicate. The Manager shall have full discretionary power and authority hereby granted to borrow money for the Syndicate, for any of the purposes covered by this agreement, and to pledge as security therefor any of the Syndicate assets in their general loans maintained by the house of the Manager without regard to the Syndicate indebtedness of the participants to the Manager; and also to pledge as security therefor this Agreement and the several obligations of the participants hereunder. The Manager may in his sole discretion release any participant for any cause, and substitute another satisfactory to the Manager, providing the said substitute assumes the obligations of the released participant. In case of any default on the part of any participant, his interest in the Syndicate, or any shares which he may be required to take up, may be sold at public or private sale, with or without notice, and the Manager or any participant or participants may be the purchaser or purchasers, notwithstanding which every such defaulting participant shall be responsible to the extent of his full liability hereunder. The Manager may in his sole discretion754 make any such adjustment with any participant as the Manager deems proper. No participant shall in any manner be relieved of his obligations hereunder, by default of any other participant, nor shall his obligations be in any manner increased thereby. Any participant, with the consent of the Manager, may take up and carry his ratable share of the Syndicate stock, and upon payment therefor shall be relieved of any further liability on the Syndicate account; provided such participant shall agree with the Manager that the stock so taken up shall not be sold during the life of the Syndicate, without consent of the Manager in writing first obtained and that the same shall be held during the life of the Syndicate, subject to the call of the Manager; and upon such withdrawal, the limit of commitment in the trading account shall be correspondingly reduced and the proportionate interest of the remaining participants shall be ratably increased. Upon the termination of the Syndicate, the Manager shall account to the participants upon the assets remaining in the Syndicate account, distributing to the participants against payment, their respective proportions of any shares of stock then in755 the hands of the Manager for account of the Syndicate, together in their respective proportions of any cash on hand; and in the event of a loss, a statement of their respective proportions thereof, which the participants shall forthwith pay to the Manager. Apportionment and distribution by the Manager of profits and losses and expenses shall be conclusive upon the Syndicate and upon the participants, as shall also be the written statements of the Manager of the result of the Syndicate operations. The Manager shall not be liable under any of the provisions of this agreement or for any other matter connected herewith, or for the exercise of his judgment and discretion in the management of the Syndicate except for want of good faith. Nothing herein contained shall constitute the participants partners with the Manager or with one another, or render them liable for more than their proportionate shares, respectively, of the entire Syndicate liability. Nothing contained in this agreement shall be construed as creating any trust or obligation in favor of any person or corporation other than the parties 469 hereto, nor any obligations in their favor otherwise than as herein756 expressly provided. The agreement shall extend to and bind the successors and personal representatives of the respective parties. This agreement is entered into and is to be performed in the State of New York, and shall be construed in accordance with the laws of said State. Any notice from the Manager to any participant shall be deemed to have been duly given if mailed or telegraphed to such participant at the address furnished to the Manager by such participant. Please confirm your acceptance of your participation under the terms stated above, by signing upon the enclosed duplicate hereof the form of acceptance set forth below, returning the same to the Manager. The petitioner accepted the invitation and put up $10,000 upon an allotment of $2,000 shares. A month or so later, when the stock declined in value, the petitioner was asked to pay and did pay $6,000 more to the syndicate, making his total cash commitment in the syndicate $16,000. During the latter part of 1929 and 1930 the market value of the stock continued to decline and the petitioner being, mindful and concerned over his inevitable loss in the investment, requested Yeagel, the syndicate manager, "to757 take me out of the position that I could not in any way live up to." The syndicate agreement expired by limitation on June 1, 1930, whereupon Yeagel, without petitioner's knowledge or consent, charged the petitioner, in an account on the books of Sutro & Co. entitled "American Seating Co. stock account No. 2", with 2,000 shares of syndicate stock, comprising the petitioner's investment in the syndicate. A transcript of such account shows the petitioner charged with $48,000 on account of his participation in the pool, and credited weth 2,000 shares American Seating Co. stock. Until about 1934, the petitioner received monthly statements from Sutro & Co. showing that he was still charged with this debt of $48,000, but no demand has ever been made upon him for the payment of the debt. At the time the syndicate was dissolved, the market price of American Seating Co. common stock was $10 per share. Subsequently the stock sold down to 50 cents per share, and at the time of this hearing in 1934 the market price was approximately $3 per share. On his income tax return for 1930 petitioner claimed the deduction of a loss of $16,000 representing his contribution to the syndicate. Upon758 the audit of the return by the respondent the petitioner was allowed the deduction of $138.60 of this amount. The balance of $15,861.40 was disallowed. In his deficiency notice upon which this proceeding is predicated the respondent advised the petitioner: * * * The stock was purchased by the syndicate at about $32.00 per share, making a total of $64,000.00 for which you were obligated. Having put up $16,000.00 as collateral, there remained a balance due by you of $48,000.00. 470 The pool was not successful and early in 1930 the pool manager called upon the participants to take up their stock and pay the balance due thereon. The 2,000 shares contracted for by you were transferred to your trading account on the books of the broker and are still held on your account as "long" 2,000 shares of American Seating Company stock. As the account with the broker was still open in 1930 and you were still the owner of the stock there was no completed transaction in 1930. * * Section 23 of the Revenue Act of 1928 provides that in computing net income there shall be allowed as deductions: (e) Losses by individuals. - In the case of an individual losses sustained during759 the taxable year and not compensated for by insurance or otherwise - (1) if incurred in any transaction entered into for profit though not connected with the trade or business; * * As we understand the respondent's position, it is that the loss claimed by the petitioner is not evidenced by a closed and completed transaction. No contention is made by the respondent that the investment of $16,000 was not incurred in a transaction entered into for profit within the meaning of the statute, and in the light of the evidence we think that no such contention could be made. The respondent cites in support of his contention article 171 of Regulations 74, which provides that "Losses must usually be evidenced by closed and completed transaction." We note that the syndicate agreement evidenced a clear intent on the part of the participants to vest in the syndicate manager independent powers or control of the assets of the syndicate and in the management of the syndicate's affairs. During the continuance of the syndicate, profits or losses sustained upon purchases and sales of stock by the syndicate were the profits and losses of the syndicate and not of the participants. Cf. 760 ; . The syndicate was dissolved on or about June 1, 1930. Upon dissolution the petitioner was charged with owning 2,000 shares of American Seating Co. stock which had a then market value of $20,000 and with debts of $48,000. If the petitioner had received upon dissolution of the syndicate cash and property of a value in excess of his contribution to the pool he would have been taxable upon the profit. ; ; certiorari denied, ; . If the amount that he received from the dissolution of the pool had a value less than his contribution to the pool he would be entitled to deduct a loss. If the petitioner had been able to respond to the request of the syndicate manager and had paid the additional amount of $48,000 he would have received upon the dissolution of the pool on June 1, 1930, for his investment of $64,000 in the pool, shares of stock having a 471 value of only*761 $20,000. We think it can not be questioned that his loss in such case would have been the difference between $64,000 and $20,000, or $44,000. But the evidence indicates that the petitioner was not able to respond to the request of the syndicate manager for an additional contribution of $48,000. His actual contribution to the pool was $16,000. The year of deductibility of a loss is determinable by a practical test. ; . Applying such test to the facts which obtain in the instant proceeding, we have no question but that the petitioner sustained a deductible loss in the year 1930 of $16,000. 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/4625413/	Billy V. and Betty L. Wann v. Commissioner.Wann v. CommissionerDocket No 2301-66.United States Tax CourtT.C. Memo 1968-246; 1968 Tax Ct. Memo LEXIS 52; 27 T.C.M. (CCH) 1301; T.C.M. (RIA) 68246; October 28, 1968. Filed 52 In 1959 petitioners rented a 25-acre farm with a residence and barn located on it and moved there to live. They continued regular, full-time employment at places away from their residence. In 1962, 1963, and 1964, petitioners sold livestock for gross sales proceeds of $214.95, $274 and $258.60, respectively, against which they claimed operating business expense deductions of $2,869.51, $6,837.45 and $6,667.21, respectively, with resulting farm losses. A substantial portion of the alleged farm business expense was the estimated cost of commuting from the farm residence to petitioners' respective places of employment and alleged salaries to petitioners' children. The petitioners' gross income from wages for the years 1962, 1963, and 1964, was $12,499.88, $13,897.27, and $13,505.26, respectively. Held: Petitioners' livestock raising endeavors did not constitute a trade or business or a venture for the production of income; the respondent's disallowance of the losses claimed for the years in question is sustained. Held, further: Assets purchased were not used in a trade or business or for the production of income, and therefore petitioners are not entitled to investment credits for the 53 taxable years 1963 and 1964. Held, further: Petitioners failed to prove the total amount of support or the amount they contributed toward a claimed dependent's support; petitioners are not entitled to a dependency deduction for this alleged dependent for the taxable year 1962. Betty L. Wann and Billy V. Wann, pro se, Box 17, Hopland, Calif. Sheldon M. Sisson, for the respondent. HOYTMemorandum Findings of Fact and Opinion HOYT, Judge: Respondent determined the following income tax deficiencies against petitioners: Taxable YearDeficiency1962$ 712.6019631,667.4819641,349.87The primary issue for decision is whether or not the petitioners' farming activities constituted a trade or business or, alternatively, a venture entered into for the production of income. If it is held that the petitioners were so engaged, we must then determine whether certain alleged expenses, some of which have been conceded by respondent, were ordinary and necessary as to the conduct of a farming business or for the production of income. The resolution of the primary issue governs the disposition of an ancillary issue of whether the petitioners are entitled to claim investment credits for certain expenditures 54 during two of the years in question. A secondary issue for decision is whether the petitioners are entitled to claim Loda Dawson, Billy Wann's mother, as a dependent for the taxable year 1962. Respondent has conceded a minor issue as to the basis of certain assets sold in 1964. Findings of Fact Some of the facts and exhibits have been stipulated and are adopted as our findings and incorporated herein by this reference. Petitioners are husband and wife, and, at the time of filing their petition herein resided at Hopland, California. They filed joint Federal income tax returns for the calendar years 1962, 1963, and 1964 with the district director of internal revenue, San Francisco, California. In December 1959, petitioner rented a 25-acre parcel of rural land with a delapidated house located on it. The property, which was rented from an unrelated person, is located on U.S. Highway 101 just south of the bridge over the Russian River, and a few miles south of Hopland, California. 1302 The annual rent for the property, $600, was paid for each of the years in question. The property consists of two long strips of land along both sides of U.S. Highway 101; it is approximately a half mile 55 long and 200 yards wide on each side of the highway. Going north toward Hopland, the land on the left side of the highway had alfalfa growing on it; the right side, which is very hilly, was used as pasture land. The Russian River flows along the left side of the property which is below the level of the roadbed. All of the structures are at the northern end of the parcel on a leveled area on the right side of the highway. The residence is constructed of wood and contains three bedrooms, a kitchen, living room, and a bathroom. In order to make it more livable, the petitioners made substantial repairs to the roof and other parts of the house in 1959 before moving in. Also located on the property were a garage, a small barn, approximately 30 by 40 feet, a chicken house, and a storage shed. In 1962, 1963, and 1964, Betty Wann was employed by the State of California at Mendocino State Hospital at Talmage, California, as a psychiatric technician. The distance from the petitioners' house to the hospital is approximately 18 miles. Betty started working at the hospital in 1956. Prior to that she had worked as a waitress for a short period of time. Her working hours in 1962, 1963, and 1964, began 56 at 6:30 a.m. and concluded at 3 p.m. She did not arrive home before 3:30 and if there were any errands, she might return as late as 5 p.m. She regularly worked five days each week. In 1962, 1963, and 1964, Billy Wann was employed by Lindroth Timber Products at Cloverdale, California, as a panel patcher and as a sheet turner with the spreader crew. The distance from the house to Lindroth Timber Products is approximately 14 miles each way. Billy normally worked at Lindroth Timber Products six days a week. He normally began work at 5 a.m. and worked many hours each day. He usually returned home between 5 p.m. and 8 p.m., but on some days he reached home earlier. Billy had been employed by various lumber companies, such as Lindroth Timber Products, from 1951 through 1966. In 1966 he was employed as a general laborer by the Italian Swiss Colony Wine Company. In 1962, 1963, and 1964, Billy and Betty had an automobile and a pick-up truck. Betty usually drove the automobile to the hospital at Talmage and Billy usually drove the pick-up truck to Lindroth Timber Products. At some undisclosed time between December of 1959 and the year 1962, Billy acquired some cattle. Thereafter he raised some 57 beef cattle at his farm near Hopland and he also went into a cattle-raising venture with his brother at Willits, California, where they had a rent-free lease of property. He also bought and sold cattle. In 1962, the petitioners made the following livestock sales of cattle raised: 1 Whiteface cross heifer$104.001 Whiteface heifer69.391 Bull with whiteface86.901 Heifer, black50.401 Angus heifer44.201 White horse 75.00Total$429.89 Billy and Betty Wann reported one-half of the sales proceeds, $214.95, as did Billy's brother, as each had a one-half interest in the animals. Some of these animals had been raised at Willits, California, on the rent-free property leased by petitioners and Billy's brother. In 1963, the petitioners made the following livestock sales: 1 Whiteface calf$ 69.001 Holstein calf56.001 Guernsey cow150.001 Angus heifer calf58.001 Black Whiteface bull calf58.001 Holstein steer130.001 Black Whiteface bull calf65.00Total$586.10Of this total for 1963, $158 was from sale of cattle raised and $428.10 from sale of cattle purchased at a cost of $312. Gross profit from all sales of cattle was $274. In 1964, the petitioners made the following livestock sales: 1 Red Whiteface heifer calf$ 66.001 Whiteface Jersey calf-heifer70.001 Angus steer 122.60Total$258.60In 58 the same year the petitioners received $80 from an unrelated party for mowing and baling eight tons of hay. They reported this as farm income from machine work. In their 1962 return, petitioners deducted $1,246 as a mileage expense attributable to the trade or business of farming. The petitioners estimated that they had driven 23,076 miles in 1962 and, of this amount, 12,460 miles, at ten cents per mile, was estimated 1303 and treated by the petitioners as businessrelated mileage. In 1963 and 1964, petitioners paid $1,072.56 and $962.24 for gasoline, respectively. Each of these amounts were deducted on their 1963 and 1964 returns as a business expense. A substantial part of the mileage and gasoline expense deducted in 1962, 1963, and 1964, related to the travel between the petitioners' residence and their places of employment. The remainder of the mileage pertained to the various trips to town which Betty Wann made to pick up groceries and supplies and the transportation by Betty of Loda Dawson, Billy's mother, between her home in Hopland and petitioners' residence. The record does not reflect if any additional gasoline expense was incurred in 1963 and 1964 for personal use of petitioners' 59 vehicles. In 1962, the petitioners did not report the payment of any salaries. In 1963, payments for "labor hired" were reported and an expense deduction claimed therefor in petitioners' farm expense schedule in the total amount of $2,516. These amounts were allegedly paid as follows: $ 598Billy Wann, age 11598Jack Wann, age 101,300Loda Dawson$2,49620Paid to unrelated person for hauling cows$2,516In 1964, "labor hired" payments of $2,600.90 were reported and claimed as part of the farm expense. They were allegedly paid as follows: $ 598.00Billy Wann (age 12)598.00Jack Wann (age 11)1,300.00Loda Dawson$2,496.00104.90Paid to unrelated person for digging fences104.90Paid to unrelated person for digging fences$2,600.90Loda Dawson aided the petitioners for a number of years, including the years in question, by staying with her grandchildren while their parents were at work. During the years in issue, Loda would arrive at the petitioners' home at 6 a.m. each morning. Betty drove to Hopland to pick her up, then drove her back to the farm to stay for the day before Betty left for work. Loda awoke the children and got them ready for school. In addition, she cleaned house, mopped floors, washed, 60 ironed, and performed other miscellaneous household tasks. On some occasions when the Wanns did not arrive home in the evening, Loda supervised the children in the feeding of the livestock and other chores. In 1963, petitioners began to pay Loda $108 a month for her services; the amounts deducted as salary to her are set forth above and represent the total paid in 1963 and 1964. In the years 1962 through 1964, the two older boys Billy and Jack and the two other Wann children attended school five days a week. Their hours were from 9 a.m. to 3:30 p.m. and they went back and forth to school by bus leaving home before 8 a.m. and getting home at approximately 4 p.m. The two older boys helped around the house with the household duties, and also with the outdoor chores. In 1963, petitioners claimed the deductions mentioned for salaries allegedly paid to their two sons. The boys, however, were not paid on a regular basis and petitioners did not maintain any payroll records. The salary claimed for each boy, $598, was estimated and chosen by petitioners as an arbitrary sum so as to eliminate the necessity of having the boys file an income tax return. Both boys performed such chores as the feeding 61 of the livestock, helping with the building of fences, cutting grass, picking up their clothes, and making their beds. They were not given any other funds or allowances except the alleged salary payments and used whatever was paid to them for spending money, clothing and other personal needs. The amount actually given them is not established by any evidence of record. The petitioners made no purchases of animals in 1962. The following livestock purchases were made in 1963: 1 Whiteface Jersey calf heifer$ 501 Guernsey heifer calf501 Holstein steer501 Black Whiteface bull calf451 Black Whiteface sow2251 Angus bull calf01 Guernsey cow1551 Angus heifer calf01 Whiteface cow1551 Holstein bull calf201 Whiteface heifer calf171 Holstein bull calf201 Black Whiteface bull calf251 Red Whiteface calf heifer 0$812In 1964, the following purchases were made: 1 Charlet01 Black Whiteface$ 151 Guernsey cow1801 Red Whiteface heifer calf 0$195 1304 The Wanns did not own a bull during the years at issue. As of September 25, 1967, the date of trial, the Wanns no longer owned any livestock. Their highest inventory of livestock had been approximately 16 head at an undisclosed time. The petitioners reported 62 farm losses of $2,654.56, $6,563.45, $6,328.61, in the years 1962, 1963, and 1964, respectively. Following is a schedule of their farm income and expenses as reported for each year: 196219631964Income:Cattle raised$ 214.95$ 158.00$ 258.60Cattle purchased (less basis)0116.000Machine work 0080.00Total Income$ 214.95$ 274.00$ 338.60Expenses:Labor hired0$2,516.00$2,600.90Repairs, maintenance$ 115.79181.29761.12Interest133.37112.7832.08Feed & Seed131.33278.33171.56Machine hire0012.50Supplies0520.0052.00Breeding fees0015.00Veterinary061.113.95Gasoline01,072.56962.24Taxes84.00122.72215.51Insurance125.12190.08311.27Utilities135.00198.73237.06Rent600.00600.00600.00Damages37.5000Commission on sale9.7000Brand fee3.003.000Accounting20.0025.000Mileage1,246.0000Depreciation 128.70955.85692.02Total Expenses1 $2,869.51$6,837.45$6,667.21Loss ($2,654.56)($6,563.45)($6,328.61)The petitioners' gross income from wages for the years 1962, 1963, and 1964, was $12,499.88, $13,897.27 and $13,505.26, respectively. On their 1963 return petitioners claimed an investment credit of $250.28 for the purchase of a $2,600.40 pick-up 63 truck purchased that year for $2,600 and a tractor costing $975. On their 1964 return petitioners claimed an investment credit of $22.02 for the purchase of a $175 tractor attachment (disc) and a self-priming water irrigating pump costing $139.50. They paid $175 for the disc and $139.50 for the pump in 1964. In 1964, the tractor and its attachment were sold by the petitioners as was a bailer and rake. Petitioners' cost basis in the bailer and rake was $185 and in the tractor and disc $1,150 as reported in Schedule D on their 1964 return. Loda Dawson lives in Hopland, California. The house she lives in there is owned by her and was built in 1957 or 1958 by Billy Wann and his brother. It has four rooms and a bath. Its fair rental value in 1962 was $50 per month. She began receiving social security benefits in about 1962 or 1963. Loda filed a return in 1963 showing that she was over 65 years of age. In their 1962 return, petitioners claimed Loda Dawson as a dependent. Some of the items claimed as farm expenses on petitioners' returns were estimates made by petitioners and others were not substantiated or established at trial. No books, records, receipts or other documentary evidence was 64 produced. The parties have stipulated as follows with respect to various items of alleged farm expense claimed: Petitioners paid $84 in 1962; $122.72 in 1963; and $215.51 in 1964 for personal property taxes and automobile licenses. Petitioners paid a total of $125.12 in 1962; $190.08 in 1963; and $311.27 in 1964 for automobile and personal liability insurance. Petitioners paid $135 in 1962; $198.73 in 1963; and $237.06 in 1964 for a portion of their electric and telephone bills. 1305 In 1963, petitioners paid $61.11 for breeding fees and medicine for the animals. In 1964, the amounts paid were $15 (breeding fees) and $3.95 (medicine for the animals). In 1962, petitioners paid $37.50 for the death of three sheep which a neighbor claimed had been killed by the Wanns' dog. This was claimed as "Damages" on the return for 1962. In 1962, petitioners paid $9.70 as a commission to the auction yard where they sold some animals. In 1962 and 1963, petitioners paid $3 (in each year) to the State of California as a brand registration fee. Petitioners paid $20 in 1962 and $25 in 1963 for accounting services. Petitioners estimated $10 a week times 52 weeks in 1963 for supplies, including tires, 65 bailing wire, (total $520). In 1964, the estimate for supplies was $1 per week times 52 weeks. Petitioners paid $115.79 in 1962; $181.29 in 1963; and $761.12 in 1964 for repairs and maintenance. In 1964, the amount includes materials for a fence along the river bottom. During the Christmas week flood of 1964 the fence was damaged. Petitioners paid $133.37 in 1962; $112.78 in 1963; and $32.08 in 1964 in interest to the California State Employees' Credit Union. The money was used in 1960 or 1961 to buy Angora goats which had been kept at Willits, California. Petitioners paid $131.33 in 1962; $278.33 in 1963; and $171.56 in 1964 for feed and seed for the animals. In 1962, some of the feed may have been used at Willits. Billy and Betty Wann paid $12.50 in 1964 to rent an auger to dig holes for a fence (machine hire). Petitioners claimed an investment credit of $250.28 for 1963 and $22.02 for 1964 on undescribed new and used property acquired during the respective years, at respective costs of $3,575.40 and $314.50. In his statutory notice of deficiency the respondent determined that the investment credits claimed for 1963 and 1964 were not allowable because of petitioners' failure to substantiate 66 their entitlement to such credits. He also disallowed the farm losses claimed for 1962, 1963 and 1964 for failure of petitioners to substantiate the farm expenses claimed and because petitioners failed to establish that the losses resulted from transactions entered into for profit or were incurred in a trade or business. Since adjusted gross income as determined exceeded $10,000 in each year, the standard deduction was allowed in lieu of the lesser itemized deductions claimed. For 1962 respondent also disallowed the dependency exemption claimed for Billy's mother, Loda Dawson, for failure of petitioners to establish that they provided more than one-half the total cost of her support for that year. In their 1962 return Loda was claimed by petitioners as a dependent whose support was furnished 51 percent by petitioners with $720 reported as the amount of support furnished by others. The petition filed herein does not assign error to respondent's denial of the claimed investment credits or to his determination that for 1962 petitioners are not entitled to a dependency exemption for Loda Dawson. However, at trial and on brief the parties have tried and argued the case as if those issues 67 were involved and present for decision. Opinion The primary question presented for our decision is whether or not the petitioners' farming activities constituted a trade or business or, alternatively, a venture entered into for the production of income. If this question is answered in the affirmative, we must then decide whether certain expenses and losses therefrom are deductible under sections 162(a), 212, and 165(a) and (c)(1) and (2) of the 1954 Internal Revenue Code. 168 69 The petitioners' claim to investment credits for the taxable years 1963 and 1964 is also dependent upon the determination of the 1306 initial question. In the absence of a trade or business or production of income status, a depreciation deduction would not be allowable with respect to the petitioners' purchased property, sec. 167(a), 2 and they would, therefore, not be entitled to an investment credit. Secs. 38 and 48(a)(1). 370 A secondary issue for decision is whether the petitioners are entitled to claim Loda Dawson, Billy Wann's mother, as a dependent for the taxable year 1962. The question of whether the petitioners' farming or cattle raising activities constituted either a trade or business or a venture for the production of income turns, to a significant extent, upon the factual determination of the petitioners' intent, or lack thereof, to realize a profit from their livestock raising endeavors. Margit Sigray Bessenyey v. Commissioner, 45 T.C. 261">45 T.C. 261, 273 (1965), affd. 379 F. 2d 252 (C.A. 2, 1967). The realization of this profit need 71 not be immediate, although the prospects of eventual profit have a strong bearing on the taxpayer's maintenance of the requisite good faith intent to make a profit. Hirsch v. Commissioner, 315 F. 2d 731, 736 (C.A. 9, 1963), affirming a Memorandum Opinion of this Court. Our determination of the intent question, which is one of fact, must be made upon the entire record before us in light of the fact that the petitioners have testified positively and contended ardently that they rented the farm and entered the cattle business to make a profit and that the expenses claimed for the years in question were ordinary and necessary to their farming "business." Most of the expenses claimed by the petitioners, such as mileage and salaries, even if deductible as business expenses, are of the recurring type and, therefore, if a profit was ever to be realized by petitioners the income from their livestock sales would have to be substantially increased to exceed these expenses. This, of course, would necessitate a substantial increase in operations by the petitioners, and upon the record presented it is obvious that the petitioners were in no position and did not intend to increase their farming 72 operations substantially. This is evidence that they therefore lacked the requisite intent to realize a profit even eventually. Petitioners contend that their livestock "enterprise" during the taxable years in question had not as yet been developed to the extent that a profit could be realized. Petitioners call the Court's attention to our country's bountiful history of little businesses growing into giants. On the record before us, however, we cannot see the slightest promise that the petitioners' farming activities might grow to the level of a small profitable business, let alone a giant. An examination of all the relevant facts and circumstances revealed by the record can 1307 only lead to the conclusion that the petitioners did not intend to realize a profit from their cattle operation but used it to the greatest extent possible only for the purpose of creating what they hoped and expected would be a tax benefit. We are dealing with 25 acres of land with a small barn and a moderately sized residence upon it. The $600 annual rent for the entire premises which petitioners deducted in toto as a farm expense, hardly attests to the value of this property as farmland from which a profitable 73 cattle operation could be run. Approximately half of the property, 12 1/2 acres at most, is used as pasture land. This was steep and hilly and on this portion of the "ranch" all of the buildings were located. The other half had alfalfa growing on it, and while it appeared to be good bottom land along the Russian River, the evidence before us does not demonstrate that it would support much of a cattle ranch operation. We are convinced that upon the entire record presented petitioners, too, did not have a bona fide profit purpose in the operation of their "farm." A profitable cattle raising venture would entail a substantially increased number of cattle and it is not likely that less than 12 1/2 acres of very hilly pasture land and an approximately equal size alfalfa field would afford the necessary "spread" for such an operation. Neither of the petitioners has had any training for or experience in farming or cattle raising activities. With the petitioners' working long hours at full-time jobs and their young children in regular school attendance during the years, the farming enterprise in 1962, 1963 and 1964 received a minimal amount of attention. Except for some occasional peripheral 74 farming duties and supervision of petitioners' young sons, Loda Dawson spent most of her time as the housekeeper and "baby sitter" for petitioners. We must observe that petitioners, while hardworking and industrious, were somewhat lackadaisical in their efforts to make their farm operation profitable. They obviously had little time or strength to be otherwise. Petitioners put in a long day at work away from their home; Billy left home at or before dawn and generally returned in mid or late afternoon or after dark, and Betty started going before 6 a.m. and often did not get back home until late afternoon. Their oldest sons were only 10 and 9 in 1962, and while apparently helpful at home and around the farm, the children could not be counted on to run a successful cattle operation in the years before us. Neither the sales ($214.95 in 1962, $586.10 in 1963, $258.60 in 1964) nor purchases (none in 1962, $812 in 1963, $195 in 1964) over the years in question show that petitioners were seeking to increase the volume of their cattle operations. If anything, there was a downtrend in the petitioners' farming activities. This downtrend did level off, however, for by 1967, the petitioners had 75 no cattle at all on their farm. In fact the only thing that seemed to increase over the years were the claimed farm losses. Billy indicated in his testimony at trial that he stopped his cattle operation when the Internal Revenue Service began to question his losses. We are persuaded that the motive for the operation was anticipated tax savings and benefits rather than expected profits. This conclusion is fortified by the piling on of alleged farm expense items claimed to increase those losses over the years. The young boys were put on the payroll of the farm at $598 per year each at ages 10 and 11 and that amount was deducted as farm expense even though it was arbitrarily selected as a figure out of thin air to keep each boy's income less than $600. There is no evidence that it was in fact ever paid or that any amount even approaching that sum was given to the boys. While the evidence might justify the conclusion that Billy's mother, Loda Dawson, was paid $1,300 a year as claimed for 1963 and 1964, it is obvious she was paid for her personal services in petitioners' household, if at all, and not for any farm labor or duties attached to cattle raising. Yet petitioners deducted her entire 76 yearly pay as farm salary. They likewise deducted all of their automobile and truck expenses as farm expense even though almost the entire use for the vehicles was clearly for commuting between petitioners' home and their employment and thus personal in nature rather than for farm purposes. We conclude that petitioners moved to the farm for personal reasons and that any and all of their alleged cattle ranching activities in the years before us were personally motivated and inspired; their cattle operation was not operated for profit or with any bona fide expectation or hope of deriving a profit therefrom. We conclude that petitioners' activities did not constitute a trade or business or a venture entered into for the production of income and that the losses and expenses in 1308 question are not deductible in the years before us. In that the pick-up truck, tractor, and water pump were not used in a trade or business, or for the production of income, and are therefore not depreciable under section 167(a), the petitioners are not entitled to claim investment credits for the purchase of these assets. Secs. 38 and 48(a). The respondent's determination denying the claimed farm expenses to 77 the extent that they exceeded farm income for each year and the claimed investment credits for 1963 and 1964, must be sustained. Petitioners and respondent are not in agreement as to whether Loda Dawson can be claimed as a dependent for the taxable year 1962. Section 152(a) includes in its definition of "dependent" the father or mother of taxpayer, or an ancestor of either, over half of whose support was received from the taxpayer. The burden is on the petitioners to prove not only their own expenditures in support of Loda Dawson, but also that the amount they contributed exceeded one-half of the total support provided. Aaron F. Vance, 36 T.C. 547">36 T.C. 547 (1961); Bernard C. Rivers, 33 T.C. 935">33 T.C. 935 (1960). Although petitioners need not conclusively prove the exact or precise total cost of Loda Dawson's support, they must provide us with convincing evidence that the amount they provided exceeded one-half of that support. James E. Stafford, 46 T.C. 515">46 T.C. 515 (1966). Petitioners have not made the slightest effort to provide us with any evidence to establish the total amount of support or the amount they contributed toward Loda Dawson's support in 1962. Having completely failed to carry their burden, it 78 is, accordingly, our holding that respondent's determination that petitioners have failed to establish that they provided more than one-half of Loda Dawson's support for the taxable year 1962, must also be sustained. Decision will be entered under Rule 50. Footnotes1. An apparent mathematical error of $100 in total expenses is not explained in the record.↩1. 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; (2) traveling expenses (including amounts expended for meals and lodging other than amounts which are lavish or extravagant under the circumstances) while away from home in the pursuit of a trade or business; and (3) rentals or other payments required to be made as a condition to the continued use or possession, for purposes of the trade or business, of property to which the taxpayer has not taken or is not taking title or in which he has no equity. * * SEC. 212. EXPENSES FOR PRODUCTION OF INCOME. In the case of an individual, there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year - (1) for the production or collection of income; (2) for the management, conservation, or maintenance of property held for the production of income; or (3) in connection with the determination, collection, or refund of any tax. SEC. 165. LOSSES. (a) General Rule. - There shall be allowed as a deduction any loss (sustained during the taxable year) and not compensated for by insurance or otherwise. * * * (c) Limitation on Losses of Individuals. - In the case of an individual, the deduction under subsection (a) shall be limited to - (1) losses incurred in a trade or business; (2) losses incurred in any transaction entered into for profit, though not connected with a trade or business, and * * * [All Code references herein are to the Internal Revenue Code of 1954.] ↩2. SEC. 167. DEPRECIATION. (a) General Rule. - There shall be allowed as a depreciation deduction a reasonable allowance for the exhaustion, wear and tear (including a reasonable allowance for obsolescence) - (1) of property used in the trade or business, or (2) of property held for the production of income. ↩3. SEC. 38. INVESTMENT IN CERTAIN DEPRECIABLE PROPERTY. (a) General Rule. - There shall be allowed, as a credit against the tax imposed by this chapter, the amount determined under subpart B of this part. (b) Regulations. - The Secretary or his delegate shall prescribe such regulations as may be necessary to carry out the purposes of this section and subpart B. SEC. 48. DEFINITIONS: SPECIAL RULES. (a) Section 38 Property. - (1) In General. - Except as provided in this subsection, the term "section 38 property" means - (A) tangible personal propery, or (B) other tangible property (not including a building and its structural components) but only if such property - (i) is used as an integral part of manufacturing, production, or extraction or of furnishing transportation, communications, electrical energy, gas, water, or sewage disposal services, or (ii) constitutes a research or storage facility used in connection with any of the activities referred to in clause (i), or * * * Such term includes only property with respect to which depreciation (or amortization in lieu of depreciation) is allowable and having a useful life (determined as of the time such property is placed in service) of 4 years or more.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625414/	RICHARD T. HERRICK and REGINA W. HERRICK, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentHerrick v. CommissionerDocket No. 12356-80.United States Tax CourtT.C. Memo 1984-195; 1984 Tax Ct. Memo LEXIS 479; 47 T.C.M. (CCH) 1550; T.C.M. (RIA) 84195; April 18, 1984. William A. Cruikshank, Jr.,Stanford I. Millar, and MichaelAntin, for the petitioners. Michael C. Cohen, for the respondent. WILESMEMORANDUM FINDINGS OF FACT AND OPINION WILES, Judge: Respondent determined the following deficiencies in petitioners' Federal income taxes: Taxable YearDeficiency1974$19,023197530,057197614,644The sole issue for decision is whether480 payments made to petitioner, Richard Herrick, by Farmers Insurance Group in exchange for cancellation of petitioner's contract rights to overwrite commissions on a specialized insurance policy, developed by petitioner, constitute ordinary income or amounts received from the sale or exchange of a capital asset. FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. Richard T. Herrick (hereinafter petitioner) and Regina W. Herrick, husband and wife, resided in Los Angeles, California, at the time they filed their petition herein. They filed joint Federal income returns (Forms 1040) for the taxable years 1974, 1975, and 1976 with the Internal Revenue Service Center at Fresno, California. Prior to 1960, petitioner had accumulated extensive experience in the automobile dealer industry, particularly with General Motors dealerships. In or about September 1960, petitioner entered the insurance business. He was appointed as an insurance sales agent of Farmers Underwriters Association and its affiliates (hereinafter referred to as Farmers) by F. E. Woodbridge, who was a district manager for Farmers. At the time petitioner was appointed as a sales agent, 481 Leslie August (hereinafter August) was also an agent appointed by Woodbridge. At all relevent times, Farmers employed the following types of agents and district managers: local agents; district manager; originating agent; and originating district manager. A local agent is an insurance agent appointed by a district manager who earns commissions based solely on his own sales. A district manager is appointed by Farmers under a written agreement to train and supervise local agents. A district manager receives commissions based on sales made by local agents operating under his supervision. In general, in the event of the retirement, death, or permanent disability of a district manager, he or his personal representatives may nominate a successor. If none is nominated and accepted by Farmers within 30 days of notice by Farmers to do so, then the goodwill of the agency shall be purchased by Farmers in accordance with the formula based solely upon a multiple of the immediately preceding six-month service commissions (contract value). An originating agent is a local agent who develops a particular sales program such as a group policy, obtains a central group endorsement of the policy, 482 and receives compensation called an "overwrite commission." The overwrite commission is earned by the originating agent on sales of the particular policy by any other Farmers' agent. An originating district manager is a district manager for the originating agent who receives an overwrite commission from Farmers from all sales of policies developed by his originating agent. No contract value attaches to the originating district manager's overwrite commissions. Sometime during 1960 to June 23, 1961, petitioner and August conceived of what was then called "General Motors Dealer Policy Plan and Solicitation," (hereinafter known as the unitized program). The unitized program was a single insurance policy that covered all the insurance needs of an automobile dealer including such converage as liability, fire, theft, casualty, and workers compensation. This program was unique because of the rating system used to calculate the premiums. Using underwriting standards formulated by petitioner and August, premiums were calculated monthly based upon the dealer's gross receipts. Historically, premiums had been determined by using separate underwriting standards for each coverage. The program's483 simplified method of premium calculation and consolidation of coverage under one policy substantially reduced a typical dealer's total insurance cost. In a letter dated June 23, 1961, Farmers agreed to develop a package for automobile dealers using the unitized program. The letter provided, in pertinent part: So far as underwriting is concerned, it was fully understood that the right to accept or decline a risk would rest with [Farmers] and the Regional underwriters, based on the conditions surrounding each individual risk and its past experience. * * * That if the arrangements work out satisfactorily with General Motors so far as their acceptability of our plan and the accessibility of their dealers as insureds, there will be a 2% overwrite paid on business produced by any representative of the Farmers Insurance Group, limited at the present time to the State of California. * * * Commissions will be paid to August and [petitioner] only so long as they are agents of record in good standing of the member companies in the Farmers Insurance Group. The regular Appointment Agreements will control this business as it does [sic] any other business. Specifically, renewals484 and expirations are and will remain the property of the member companies of the Farmers Insurance Group. Further, in considering the value of the right of nomination under the contract of each of you the overwrite 2% commission above referred to will not be considered. The arrangement with General Motors that Farmers expected to work out prior to payment of the overwrite commissions was that petitioner would secure a General Motors endorsement of the unitized program.Although the endorsement never materialized, Farmers continued to pay petitioner and August the overwrite commissions.Petitioner and August were the only agents who received an overwrite commission without obtaining a central endorsement. In September 1963, petitioner and August formed an equal partnership and purchased Woodbridge's agency for $28,082. On September 1, 1963, Farmers entered into a district manager's appointment agreement with petitioner and August (hereinafter sometimes referred to as the 1963 agreement). This agreement generally set forth the relationship, rights, and duties between Farmers and the district manager. On that same day, Farmers, petitioner, and August executed an addendum to485 the district manager's appointment agreement (hereinafter referred to as the addendum). The addendum set forth the contractual agreement of the parties concerning the unitized program. Under the addendum, petitioner and August received the exclusive right to sell the unitized program in Los Angeles County either directly or through their agents. In areas outside of Los Angeles county, petitioner and August were required to assist Farmers in promoting the sale of the unitized program, but they were prohibited from selling policies, either directly or through agents. Petitioner and August were also obligated to maintain contact with General Motors Corporation; process, field underwrite and rate all new business; maintain business records for the unitized program; and use their best efforts to educate company agents in the handling of the unitized program. In exchange, petitioner and August received the agreed two percent overwrite commissions for all policies written by Farmers in the unitized program. The parties referred to the two percent overwrite commissions as the originating district manager's overwrite commissions. On March 25, 1966, petitioner entered into a contractual486 acknowledgement with Farmers which provided that effective April 1, 1966, petitioner would assume all contractual obligations previously entered into between petitioner, August, and Farmers. That same day, petitioner and Farmers entered into a new district manager's appointment agreement, effective April 1, 1966. This appointment agreement was similar in all relevant respects to the 1963 agreement. While the new agreement made no mention therein of the unitized program or the addendum, Farmers and petitioner continued to perform under the terms of the addendum. On March 31, 1966, petitioner purchased August's interest in the partnership for $52,938.50. On April 1, 1966, petitioner and Farmers executed a loan and sales option agreement, known as the California Marketing Plan. Under this plan Farmers would advance petitioner an amount not to exceed $20,000 for the purpose of expanding and promoting the sale of the unitized program throughout the State of California. Petitioner was obligated to repay Farmers one-half of the amount actually advanced. Pursuant to this plan, petitioner endeavored to expand the unitized program throughout the State of California. In this regard, 487 petitioner conducted market analysis, effectiveness studies, and undertook field underwriting through 1969. Farmers advanced petitioner the amount of $14,674.51 and, under a payback arrangement entered into on January 14, 1970, petitioner agreed to repay Farmers one-half of the amount advanced at the rate of $300 per month. From that date through January 18, 1974, petitioner continued his efforts to expand the unitized program throughout the State of California. The unitized program became successful and Farmers wanted to expand it into other states. However, the relationship between Farmers and petitioner was unique. Petitioner was the only district manager who could write insurance policies, and the only district manager who received an overwrite commission on a group policy without obtaining a central endorsement for the policy. Specifically, petitioner received a two percent commission on all policies written by Farmers in the unitized program without obtaining a central endorsement from General Motors. Farmers would not expand the marketing of the program into additional states unless it could acquire petitioner's right to receive the overwrite commissions. On January 18, 1974, petitioner488 and Farmers executed an agreement whereby Farmers purchased from petitioner "certain contract rights under a District Manager's Appointment Agreement with [Farmers] and others which have been identified and referred to by [petitioner and Farmers] in past business transactions as originating district managers' overwrite commissions." In other words, Farmers acquired petitioner's right to receive the two percent overwrite commission on all policies written in the unitized program. In accordance with the provisions of this agreement, petitioner received and reported on the installment method the following cash payments for the calendar year described: YearAmount1974$76,8711975121,638197686,900The contract price paid to petitioner was arrived at through an arm's-length negotiation and did not represent the present value of commissions as provided for in the district manager's appointment agreement. 1489 During the years prior to 1974, petitioner reported all amounts he received by way of overwrite commissions on the unitized program as ordinary income on his Federal income tax returns. At all times mentioned, petitioner and Farmers did not file partnership returns with either Federal or state governments; petitioner was not liable for any losses suffered by Farmers; and Farmers retained the exclusive power to accept or decline any risk on the unitized program. On petitioner's Federal income tax returns for 1974, 1975, and 1976, petitioner reported the amounts received for the sale of his "contract rights" in the unitized program as long-term capital gain. In the notice of deficiency, respondent determined the amounts petitioner received from Farmers constituted ordinary icome. OPINION The primary issue for decision is whether the payments received by petitioner from Farmers for the sale of petitioner's "contract rights" in the unitized program constitute long-term capital gain or ordinary income. In their petition, petitioners alleged that the "rights * * * in the Unitized Program * * * constitute a capital asset which he acquired * * * by purchase from others * * . 490 " On brief, however, petitioners' primary argument is directed toward the proposition that petitioner and Farmers were joint venturers, petitioner sold his interest in the joint venture to Farmers, and the amounts he received in 1974, 1975, and 1976, were taxable as amounts received from the sale or exchange of an interest in a partnership under section 741. 2Petitioners' argument is indistinguishable from the argument presented by the taxpayer in Luna v. Commissioner,42 T.C. 1067">42 T.C. 1067 (1964). In Luna, the taxpayer was entitled to receive commissions from Pioneer Life and Casualty as a result of formulating a new type of insurance policy which was later491 sold by Pioneer. Several years after the taxpayer terminated his relationship with Pioneer, he received a lump-sum payment in exchange for cancellation of his contract right to continue receiving commissions on the policy which he developed. In Luna, as in the instant case, the taxpayer argued that he and Pioneer were joint venturers and that the amount he received was for sale or exchange of an interest in a partnership. In rejecting taxpayer's argument, this Court set forth the following factors, none being conclusive, which bear on the question of whether a joint venture exists between the two parties: The agreement of the parties and their conduct in executing its terms; the contributions, if any, which each party has made to the venture; the parties' control over income and capital and the right of each to make withdrawals; whether each party was a principal and coproprietor, sharing a mutual proprietary interest in the net profits and having an obligation to share losses, or whether one party was the agent or employee of the other, receiving for his services contingent compensation492 in the form of a percentage of income; whether business was conducted in the joint names of the parties; whether the parties filed Federal partnership returns or otherwise represented to respondent or to persons with whom they dealt that they were joint venturers; whether separate books of account were maintained for the venture; and whether the parties exercised mutual control over and assumed mutual responsibilities for the enterprise. [42 T.C. at 1077-78.] Applying the above factors to the record herein, we similarly conclude that petitioner and Farmers were not joint venturers. The relationship between petitioner and Farmers is outlined in the letter of June 23, 1961, and the addendum to the district manager's appointment agreement of September 1, 1963. According to these documents, petitioner, as an agent of Farmers, had the exclusive right to sell the unitized program within Los Angeles County and the right to receive a two percent overwrite commission on all policies written by Farmers in the unitized program. Undoubtedly, Farmers agreed to these conditions because petitioner formulated the program. Nonetheless, petitioner's only "contract rights" in493 the unitized program were his exclusive right to sell the program within Los Angeles county and his right to the two percent overwrite commission; these rights are not indicative of a proprietary interest in the unitized program, or of a joint venture between petitioner and Farmers. Moreover, at all relevant times petitioner was under a district manager's appointment agreement with Farmers. In the addendum to the 1963 agreement, petitioner agreed to promote and sell the unitized program and to assist in training other agents to do the same. In exchange for his services, petitioner received an overwrite commission on all policies written by Farmers in the unitized program. These commissions were based upon gross premiums and in no way reflected a share of the profits Farmers was or was not making in the unitized program. Indeed, Farmers retained the exclusive right to accept or decline any risk because Farmers alone bore the risk of loss associated with issuance of the policies. In support of his position that a joint venture existed between himself and Farmers, petitioner points to the fact he was obligated to repay Farmers one-half of the monies advanced under the California494 Marketing Plan. However, this factor alone does not establish a joint venture between Farmers and petitioner. Since petitioner's commissions rose commensurately with the number of policies written, it was in his own best interest to expand the marketing of the unitizing program. Indeed, both petitioner and Farmers were anxious to begin promoting the program in other states, but Farmers refused to expand the program beyond California until it acquired petitioner's rights to receive the overwrite commission. Finally, there is no evidence that petitioner or Farmers ever held themselves out as joint venturers, nor did they file Federal or state partnership returns. Having found that petitioner and Farmers were not joint venturers, we will discuss briefly petitioner's alternative contention that his "contract rights" in the unitizing program was a capital asset in his hands. In order to entitle himself to preferential capital gain treatment, petitioner must demonstrate that the gain was produced by the (1) "sale or exchange" of (2) a "capital asset." Sections 1221, 1222. Upon review of495 the extensive case law interpreting the capital gain provisions, we find that petitioner did not satisfy either requirement and, accordingly, we must find for the respondent on this issue. Section 1221 defines capital asset as property held by the taxpayer which is not stock in trade, or property held primarily for sale to customers in the ordinary course of his trade or business, or depreciable property used in his trade or business, or certain other specific types of property. It is well-settled law that merely showing that a contract is property and is outside of the statutory exclusion does not qualify the contract as a capital asset. Commissioner v. Gilette Motor Transport, Inc.,364 U.S. 130">364 U.S. 130, 134 (1960); Bisbee-Baldwin Corp. v. Tomlinson,320 F. 2d 929, 932 (5th Cir. 1963); Foote v. Commissioner,81 T.C. 930">81 T.C. 930, 934 (1983), on appeal (5th Cir., Mar. 2, 1984). The right to receive future ordinary income does not change into capital gain by the mere receipt of a lump sum in lieu of future payments. Holt v. Commissioner,303 F.2d 687">303 F. 2d 687, 691 (9th Cir. 1962), affg. 35 T.C. 588">35 T.C. 588 (1961). As we stated496 in Foote v. Commissioner,supra, "The central theme of the many cases denying capital gains treatment on the termination of such contract rights is that the payment received is essentially a substitute for ordinary income which would have been earned in the future." ( Foote v. Commissioner,supra at 935.) In the instant case, the "contract rights" in the unitized program purchased by Farmers consisted solely of petitioner's right to receive the two percent overwrite commission on all policies written in the unitized program. There is no evidence that petitioner transferred anything else to Farmers. After the transaction, petitioner remained an agent of Farmers and continued to receive the usual commissions under the district manager's appointment agreement for any policies which were written within his district; thus, petitioner retained any goodwill he may have developed with the automobile industry.3 While the value of the right to receive the overwrite commission increased from the inception of the program through January 14, 1974, the nature of the right remained the same. Prior to 1974, the overwrite commissions petitioner received497 clearly constituted ordinary income. The fact that petitioner received a lump-sum payment in lieu of future commissions does not change the nature of the right into a capital asset. Holt v. Commissioner,supra at 691; Foote v. Commissioner,supra at 935. Thus, we conclude that petitioner's contract rights in the unitized program do not qualify as a capital asset. Moreover, we are not convinced that there was a sale or exchange. In an arm's-length negotiation, petitioner merely settled for a lump-sum payment his claim for commissions to be paid in the future on all policies issued by Farmers in the unitized profram. In effect, this was an extinguishment of Farmers' obligation to pay the overwrite commissions.We think it is clear that in this case there was no sale or exchange. See Fairbanks v. United States,306 U.S. 436">306 U.S. 436 (1939).498 Petitioner's contract rights were not transferred to Farmers, they "merely came to an end and vanished." Foote v. Commissioner,supra at 936, citing Commissioner v. Starr Brothers, Inc.,204 F. 2d 673, 674 (2d Cir. 1953), revg. 18 T.C. 149">18 T.C. 149 (1952). To reflect the foregoing, Decision will be entered for the respondent.Footnotes1. The district manager's appointment agreement provided that in the event of termination of the relationship between the district manager and Farmers, Farmers could purchase the agency (including goodwill) for an amount not exceeding five times the district manager's service commissions paid to him during the preceding six month period.↩2. Section 741 provides in pertinent part: In the case of a sale or exchange of an interest in a partnership, gain or loss shall be recognized to the transferor partner. Such gain or loss shall be considered as gain or loss from the sale or exchange of a capital asset, except as otherwise provided in section 751↩ (relating to unrealized receivables and inventory items which have appreciated substantially in value).3. On brief, petitioner asserts that he transferred his goodwill that existed outside of Los Angeles County to Farmers. However, in the purchase agreement there is no mention of, or allocation to, goodwill. Moreover, at trial, petitioner failed to produce any evidence on the value of the goodwill allegedly transferred to Farmers.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625415/	Estate of Clara Edgar, Deceased, Century National Bank & Trust Company, Executor, Petitioner v. Commissioner of Internal Revenue, RespondentEstate of Edgar v. CommissionerDocket No. 1377-77United States Tax Court74 T.C. 983; 1980 U.S. Tax Ct. LEXIS 87; August 5, 1980, Filed 87 Decision will be entered under Rule 155. By trust agreements, two sisters created reciprocal revocable inter vivos trusts. According to the terms of decedent's trust, the income was payable to herself for life, and after her death, the income was payable to her sister for life. Upon the death of both sisters, the trust was to terminate. After certain dispositions, the remaining principal of decedent's trust was to pour over to her sister's trust. This latter trust provided that upon the death of both sisters, the trust would terminate. After certain dispositions, the trust provided that from its net income the trust would pay, monthly, during each of their lives to four beneficiaries, $ 75, $ 100, $ 150, and $ 50, respectively. The remaining income was to be distributed to qualifying charitable organizations. Decedent's sister predeceased her. Decedent in her will bequeathed the remainder of her estate to her sister's trust. Held, the transfer was a split interest and subject to the provisions of sec. 2055(e), I.R.C. 1954. John M. Duff, for the petitioner.Carmen J. Santamaria, for the respondent. Irwin, Judge. IRWIN983 OPINIONRespondent determined a deficiency in petitioner's estate tax of $ 28,074.21. Due to concessions, the only issue remaining for our consideration is whether petitioner is entitled to a charitable deduction for the value of the remainder interest of a trust which was bequeathed to qualifying institutions (within the meaning of sec. 2055(a)(2)).All of the facts have been stipulated, and the stipulation of facts is incorporated90 herein by this reference. At the time the 984 petition was filed herein, Century National Bank & Trust Co., Executor of the Estate of Clara E. Edgar (hereafter estate), was a national banking corporation, organized under the laws of the United States and having its principal place of business at New Brighton, Pa.By trust agreements dated August 29, 1961, Clara E. Edgar (hereafter sometimes referred to as decedent) and her sister, Jean Edgar Vaughan, created reciprocal revocable inter vivos trusts.Pursuant to the terms of her trust agreement, decedent transferred stocks, bonds, notes, and other assets to the Union National Bank, as trustee.According to the terms of decedent's trust agreement, the income of the trust was to be paid to her during her life. After her death, the income was to be paid to Jean Edgar Vaughan. The agreement provided that the trustee had the power, in its discretion, to "distribute to or apply for the benefit of the Donor, Clara E. Edgar, and her sister, Jean Edgar Vaughan, such amounts out of the principal of the trust estate held for said beneficiaries, as shall in the judgment of the trustee be necessitated by reason of illness or other emergency91 or inadequacy of the income, for the adequate support and the necessities of such beneficiaries." Upon the death of the survivor of the two sisters, the trust was to terminate. Several specific dispositions from the trust's principal were required, but the residue of the principal, and any accrued income, were to be poured over into Jean Edgar Vaughan's trust fund and be distributed "in accordance with the terms and conditions as in said Trust Agreement."According to the terms of the Jean Edgar Vaughan Trust Agreement, the income of said trust was to be paid to Jean Edgar Vaughan. After her death, the income was to be paid to Clara E. Edgar. This trust agreement also contained the following provision:The Trustee named may, from time to time, in its discretion distribute to or apply for the benefit of any beneficiary, from time to time, entitled to the receipt or application for his or her benefit of income hereunder, such amounts out of the principal of the trust estate held for such beneficiary, as shall in the judgment of the Trustee be necessitated by reason of illness or other emergency, or inadequacy of income, for the adequate support and the necessities of such beneficiary.92 985 Upon the death of the survivor of the two sisters, the trust was to terminate. Several specific dispositions from the trust's principal were required, but the residue of the principal was placed in trust with the Union National Bank as trustee. The agreement further provided that from the net income of the latter trust, these would be paid during each of their lives: $ 75 per month to Harriet T. Norris; $ 100 per month to Anna M. Ott; $ 150 per month to Virginia I. Reinehr; and, by means of the supplement to the agreement of August 29, 1961, $ 50 per month to Martha Powers. The remaining income was to be distributed equally among several religious, educational, or charitable institutions, all of which qualified within the meaning of section 2055(a)(2). 1 The agreement provided that, as each of the four life beneficiaries died, her share of the income of the trust would pass to the institutions.93 Jean Edgar Vaughan died on December 9, 1965.Clara E. Edgar died testate on March 22, 1973. By decedent's last will and testament, dated April 21, 1966, she bequeathed the residue of her testamentary estate to the Jean Edgar Vaughan trust created by agreement of August 29, 1961, "for the uses and purposes set forth herein." 2 At the time of Clara Edgar's death, the Jean Vaughan trust fund's principal was valued at approximately $ 249,000. During 1973, the trust generated income of $ 13,149. The property previously transferred by decedent to the Clara E. Edgar trust had a value of $ 138,170.24 at the time of her death.On December 30, 1975, petitioner applied to the Orphans Court Division of the Court of Common Pleas of Beaver County, Pa., seeking to obtain a construction of the Clara E. Edgar Will and Trust94 Agreement and the Jean Edgar Vaughan Trust Agreement. The court decreed, in pertinent part, as follows:2. That paragraph of the Jean Edgar Vaughan trust created August 29, 1961, reading as follows, and thus incorporated by reference in the decedent's trust as set forth above:"The Trustee named may, from time to time, in its discretion distribute to or 986 apply for the benefit of any beneficiary, from time to time, entitled to the receipt or application for his or her benefit of income hereunder, such amounts out of the principal of the trust estate held for such beneficiary, as shall in the judgment of the Trustee be necessitated by reason of illness or other emergency, for inadequacy of the income, for the adequate support and the necessities of such beneficiary."is hereby construed to apply only to the life estates reserved and/or granted to or for the benefit of Jean Edgar Vaughan and Clara E. Edgar, such reservation and/or grant being contained in the two paragraphs immediately preceding the principal invasion clause quoted above in full.3. Following the deaths of Jean Edgar Vaughan on December 19, 3 1965 and Clara Edgar on March 22, 1973 no beneficiaries of the95 decedent's trust had any interest in the principal thereof except the five named charitable beneficiaries, viz: Passavant Homes (Rochester), First Presbyterian Church (New Brighton), The Lighthouse (New Brighton), Hillsdale College and The Salvation Army (Beaver Falls Barracks).4. Following the deaths of the above-named life tenants, the trustee neither had nor has any power to invade principal for the benefit of any beneficiary, specifically including the following annuitants or income beneficiaries: Hariett [sic] Townsend North, Anna M. Ott, Virginia Inman Reinehr and Martha Powers.In its estate tax return, petitioner claimed as a charitable deduction under section 2055(a)(2) the entire net balance of the decedent's estate, amounting to $ 179,982.89. Petitioner has conceded that the correct amount should be $ 142,000. 4Respondent96 contends that the transfer in question is a split interest and subject to the provisions of section 2055(e) because interests in the same property (the income of the trust) passed both to qualifying institutions (within the meaning of sec. 2055(a)(2)) and to nonqualifying individuals. In such cases, no deduction is permitted unless, in the case of a remainder interest, the interest passes to a charitable remainder annuity trust, a charitable remainder unitrust, or a pooled income fund, or, in the case of all other interest, the interest is in the form of a guaranteed annuity or is a fixed percentage, distributed yearly, of the fair market value of the property.Petitioner argues to the contrary that the nonqualifying beneficiaries have no interest in the income of the trust and, therefore, section 2055(e)(2) does not apply to disallow the 987 charitable deduction. This argument is based upon petitioner's contention that the trust fund created by Jean Edgar Vaughan will generate enough income to fully satisfy the income interests of the individual, noncharitable beneficiaries, and that decedent's residuary estate, considered as a separate trust, will, therefore, never be invaded97 for the benefit of the nonqualifying beneficiaries. 5 Petitioner points out that at the time of decedent's death, the Jean Vaughan trust was valued at $ 249,000 and generated income of $ 13,149 in 1973.The essence of petitioner's argument, thus, is that where the economic facts concerning a transfer which provides for nonqualifying beneficiaries to receive a part interest in property are such that those beneficiaries will never receive any portion of that part interest, section 2055(e) is inapplicable. We disagree. Section 2055(e)(2) was enacted in 1969, effective with respect to decedents dying after December 31, 1969 (with certain exceptions, not here relevant), Pub. L. 91-172, sec. 201(d)(1), 83 Stat. 487, 549, in order to correct perceived abuses in the charitable contributions area. One of these abuses was the manner in which trust assets might 98 be invested: for example, maximizing income interests by investing in high-income, high-risk assets, thus enhancing the value of the income interest but decreasing the value of the charity's remainder interest. To provide a closer correlation between the charitable contributions deduction and the ultimate benefit to charity, Congress provided rules which have to be met before a gift can qualify for a deduction. H. Rept. 91-413 (1969), 3 C.B. 200">1969-3 C.B. 200, 237-239. Although this specific situation may not have been regarded as abusive by Congress when it enacted this legislation, 6 as petitioner contends, permitting 988 economic factors to be considered would directly contradict Congress' intent to establish specific rules in this area. It is clear that the trust document created, in legal terms, a remainder interest in favor of the charitable institutions. We hold that such an interest must in all events conform to the statutory requirements.99 Petitioner apparently concedes that the trust fails to meet the statutory requirements set forth in sections 2055(e)(2)(A) (which are, in turn, set forth in secs. 664 and 642(c)(5)) and 2055(e)(2)(B).In the alternative, petitioner contends that because the value of the annuitants' interests in the trust can be definitely ascertained and valued using the standard tables for valuing annuities, the trust qualifies under section 2055, relying on sec. 20.2055-2(a), Estate Tax Regs.Prior to the enactment of section 2055(e)(2), a deduction was allowed for the charitable remainder in a trust created for private purposes if the remainder was readily ascertainable and hence severable from the noncharitable interest. Sec. 20.2055-2(a), Estate Tax Regs. Henslee v. Union Planters National Bank & Trust Co., 335 U.S. 595">335 U.S. 595 (1949), rehearing denied 336 U.S. 915">336 U.S. 915 (1949); Merchants National Bank of Boston v. Commissioner, 320 U.S. 256">320 U.S. 256 (1943). As stated above, however, the law in this area was changed for decedents dying after December 31, 1969, and the regulation upon which petitioner relies is, by its own terms, 100 inapplicable to decedents dying after December 31, 1969. 7Decision will be entered under*101 Rule 155. Footnotes1. All statutory references are to the Internal Revenue Code of 1954 as in effect during the years in issue.↩2. Anna M. Ott predeceased Clara E. Edgar. However, Harriet T. Norris, Virginia I. Reinehr, and Martha Powers, named as income beneficiaries in the Jean Edgar Vaughan Trust Agreement, survived Clara E. Edgar.↩3. The parties stipulated that the date is Dec. 9, 1965.↩4. Net amount passing from decedent's estate less the value of the nonqualifying individuals' life estates in the trust income.↩5. The discretionary authority of the trustee to invade principal was held, in a county court proceeding, inapplicable after the death of decedent and her sister.↩6. We note, however, that the annual distribution from such a charitable remainder trust must be an amount equal to at least 5 percent of the value of the trust's assets in order to qualify as either a charitable remainder annuity trust or a charitable remainder unitrust. Sec. 664(d)(1) and (d)(2). This provision was enacted to prevent a charitable remainder trust from being used to circumvent the current income distribution requirement imposed on private foundations. S. Rept. 91-552 (1969), 3 C.B. 481">1969-3 C.B. 481. In the absence of these rules, a charitable remainder trust could provide for a minimal payout to the noncharitable income beneficiary (substantially less than the amount of the trust income). Since the trust generally is exempt from income taxes, see sec. 664(c), this would allow it to accumulate trust income in excess of the payout requirement of the unitrust or annuity trust without tax for the future benefit of charity. It is not at all clear, therefore, that such a trust was not considered to be potentially abusive. This reason, alone, is sufficient to find that the trust fails to meet the remainder annuity trust requirements, sec. 664(d)(1), even if we were to consider the two trusts to be separate (although by its terms decedent's trust poured over to Jean Edgar Vaughan's trust). Sec. 664(d)(3)↩, which provides an exception to the "5 percent" rule if certain requirements are met, is not applicable here.7. Sec. 20.2055-2 Transfers not exclusively for charitable purposes.(a) Remainders and similar interests. If a trust is created or property is transferred for both a charitable and a private purpose, deduction may be taken of the value of the charitable beneficial interest only insofar as that interest is presently ascertainable, and hence severable from the noncharitable interest. Thus, in the case of decedents dying before January 1, 1970, if money or property is placed in trust to pay the income to an individual during his life, or for a term of years, and then to pay the principal to a charitable organization, the present value of the remainder is deductible. See paragraph (e) of this section for limitations applicable to decedents dying after December 31, 1969↩. See paragraph (f) of this section for rules relating to valuation of partial interests in property passing for charitable purposes. [Emphasis added.]	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625416/	Louisiana Western Lumber Company, Inc., Petitioner, v. Commissioner of Internal Revenue, RespondentLouisiana Western Lumber Co. v. CommissionerDocket Nos. 38643, 48798United States Tax Court22 T.C. 954; 1954 U.S. Tax Ct. LEXIS 136; July 19, 1954, Filed July 19, 1954, Filed 136 Decisions will be entered for the respondent. Held, on the facts, that the lots sold were held primarily for sale to customers in the ordinary course of a business and that the resulting gain is taxable as ordinary income. A. Leon Hebert, Jr., Esq., for the petitioner.Jackson L. Bailey, Esq., for the respondent. Johnson, Judge. JOHNSON 954 These proceedings were consolidated for hearing and involve the following deficiencies in income tax:Docket No.YearDeficiency386431947$ 2,367.254879819486,569.1519496,670.6619507,869.51The primary issue is whether profit realized from sales of real estate is taxable as ordinary income or as capital gain. Another question, dependent upon the conclusion reached under the principal issue, is whether petitioner is entitled to a capital loss deduction of $ 2,800.FINDINGS OF FACT.Petitioner, a Louisiana corporation with its principal office in Lake Charles, Calcasieu Parish, Louisiana, filed its income tax returns for the taxable years with the collector of internal revenue for the district of Louisiana. The principal business of petitioner at all times since its organization in 1919 has137 been the retail sale of lumber and other building material. It was the largest of about 12 building supply businesses within its trading area, which had a population of about 50,000.Petitioner owned no real estate prior to 1940 other than the property it used in connection with its primary business. Since 1940 a housing shortage has existed in and around Lake Charles. From about 1940 until 1945 or 1946 the Federal Government had restrictions on the sale of building materials, which required petitioner to obtain a priority for the purchase and sale of its products.To obtain an outlet for its products petitioner acquired in 1940, with cash reserves, a tract of land for the purpose of improving it with rental housing. In 1941 petitioner subdivided the land into lots and improved the property by constructing streets, sidewalks, sewers, and installing utilities. The subdivision was known as Victory Terrace.In 1941 petitioner transferred 120 lots in the Victory Terrace subdivision, at cost, to the Western Development Company, a subsidiary 955 of petitioner organized in 1941 for the construction of houses for rental to defense workers under a priority granted by the Federal138 Housing Administration. The houses were constructed by the Western Construction Company, another subsidiary of petitioner, with materials sold to it by petitioner at retail prices. The Western Development Company had an agreement with a corporation to pay rent on each house upon completion. During 1941 and 1942 the Western Development Company constructed 120 rental units in the subdivision. Permits granted by the Federal Housing Administration to construct the housing contained a provision prohibiting the sale of the property for 2 years. In 1942 or 1943 F. L. Peters, president of petitioner, purchased all of the stock of the Western Development Company. Thereafter Peters exchanged the stock for stock of petitioner in a deal with another officer of petitioner. Petitioner had no interest in the Western Development Company during the taxable years.In August 1946 petitioner acquired another tract of land, which it subdivided in 1947 into lots, and constructed streets, sidewalks, and sewer lines. The subdivision was known as East Side Addition No. 3. At undisclosed times between 1940 and 1950 petitioner purchased not less than 120 lots in about 4 other subdivisions, of which139 35, located in Sulphur, Calcasieu Parish, Louisiana, were acquired in 1950. None of the Sulphur lots were sold in 1950. It never purchased a lot with a house on it.On January 1, 1947, petitioner had 351 unsold lots. During the taxable years it made the following sales of the lots:1947194819491950Sold to --LotsSalesLotsSalesLotsSalesLotsSalesLawesco Corporation10 11 55 1/221 1F. L. Peters17 11 1Contractors3 28 616 1432 30Other35 1/42955 3/43034 2/52717 3/418Total65 1/433120 1/43950 2/54150 3/449The sales to Lawesco Corporation, a subsidiary of petitioner, and Peters were at book value. The Lawesco Corporation had houses constructed on the lots transferred to it. The sales to contractors were at 10 per cent less than market value as an inducement to purchase from petitioner their requirements of building materials to improve the lots.The general policy of petitioner at all times was to endeavor to tie the sale of a lot with an agreement to purchase building material140 from it to improve the land. All of the contractors, except one purchaser in 1950, built houses on the lots with material bought from petitioner. 956 Deeds to lots purchased by contractors were not delivered to the buyers until the completed houses were sold and the Federal Housing Administration loans were closed. Some of the contractor-purchasers were unable to sell the properties as promptly as they desired to after completion of the improvements, and sold their equities to the petitioner at agreed prices. Five of the sales made by petitioner in 1949 were of such properties, for which it had paid $ 28,417 for the improvements thereon.Sales to individuals other than contractors were not conditioned upon the purchase of building material from petitioner. Of such purchasers, 15 of the buyers in 1947, 8 in 1948, 10 in 1949, and 4 in 1950 purchased building material from petitioner to improve the lots.The gross sales of merchandise by petitioner, the net income reported in its returns, the total sales price of lots sold, and net gain thereon were as follows, omitting cents:1947194819491950Gross sales$ 1,035,954$ 1,553,385$ 1,518,030$ 1,460,644Net income107,523158,373143,709159,520Sales lots 130,89759,22089,29572,205Gain on lots18,20932,68440,95244,976141 Petitioner claimed $ 2,534.13 in its return for 1949 and $ 3,584.28 in 1950 as commission expenses incurred in connection with sales of the lots.It was not necessary to obtain a priority to purchase building materials during the taxable years. There was no shortage of lumber and other building materials during that period and petitioner had a good market for its products. It declined to accept some orders to insure a supply of material for regular customers. The demand for houses was so good that it was not necessary to do much advertising to sell them. Most of the houses built by contractors on lots acquired from petitioner were sold before completion.The subdivisions developed and lots acquired by petitioner were located in the old city limits of Lake Charles, whose school system was better than the one in the parish. This feature was attractive to prospective buyers and was regarded by petitioner as justification for conditioning sales to some purchasers by an agreement to buy building material142 from it to improve the lots.Petitioner did not have a license to sell real estate or advertise the sale of lots by means of signs, mail, or classified advertisements. Most of the sales made by it resulted from unsolicited offers. It did not maintain a real estate department known as such. All sales made by it were handled by its employees under the general supervision of the corporation's treasurer.957 Petitioner never borrowed money specifically to purchase lots. It listed the lots for sale with the White Agency, a subsidiary of petitioner, subject to an agreement that the buyer purchase his requirements of building material from it. In addition to real estate brokerage, the White Agency handled insurance and mortgage loans. Sales made after about 1947 without an agreement to purchase material from petitioner were handled by Peters.In 1946 petitioner sold 79 lots in 49 transactions. Petitioner continued to sell lots in 1951 by the methods described herein.The respondent held in connection with his determination of the deficiencies that the gain realized from the sales of lots was taxable as ordinary income.The lots sold by the petitioner during the taxable years143 were held by it primarily for sale to customers in the ordinary course of its business.OPINION.The sole difference between the parties under the principal issue is whether the gain realized each year from sales of lots is taxable as ordinary income or as capital gain. The issue is a factual question and turns upon whether the lots constituted "property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business." Sec. 117 (a) (1), I. R. C. We said in W. T. Thrift, Sr., 15 T. C. 366, 369, in connection with a like question:The governing considerations have been the purpose or reason for the taxpayer's acquisition of the property and in disposing of it, the continuity of sales or sales related activity over a period of time; the number, frequency, and substantiality of sales, and the extent to which the owner or his agents engaged in sales activities by developing or improving the property, soliciting customers, and advertising. Boomhower v. United States, 74 F. Supp. 997">74 F. Supp. 997. No one of these tests can be regarded as determinative but the question must be viewed in the light144 of all pertinent factors and particularly the facts of the individual case.See also, Martin Dressen, 1443">17 T. C. 1443; Dunlap v. Oldham Lumber Co., 178 F.2d 781">178 F. 2d 781; and Nathan D. Goldberg, 22 T.C. 533">22 T. C. 533.The acquisition of parcels of land and their improvement as subdivisions for sale of lots to purchasers are evidences of intention to engage in the real estate business. Petitioner had two of such land developments, and in addition purchased lots in other subdivisions for sale in the ordinary course of its activities, the last of which acquisitions, consisting of 35 lots, was made in 1950, 10 years after the first tract of land was purchased for subdivision purposes. The second tract of land for subdivision purposes was acquired in 1946, when at least 60 lots were unsold in the first subdivision, known as Victory Terrace, the last of the lots in which were not disposed of until 1948. The extent of petitioner's holdings and activities in the sale of real 958 estate is shown by the fact that it held 351 lots in about 6 subdivisions at the beginning of the taxable years and 99 full lots145 at the close of 1950.The sales were not only continuous during the taxable years and prior thereto since 1941, but were continued under the same plan of activities in 1951. The sales were substantial, ranging from 33 to 49 during the taxable years, of from 50 to 120 lots at a profit equal to from about 20 to 40 per cent of the net income from other sources without adjustment for transfers at cost. The high rate of profit made on the sales of lots is shown in our findings.The fact that petitioner designated no branch of its chief business as real estate department, and did not have a license to sell lots is not decisive. The sales were handled by its employees as effectively as though they had acted under a special employment. A business may be conducted through an agency. Florence H. Ehrman, 41 B. T. A. 652, 663, affd. 120 F. 2d 607. The fact that commissions were claimed in 1949 and 1950 as selling expenses is evidence of employment of brokers to sell lots. No contention is made that petitioner was required to have a license to sell its own property.Sales made to contractors were at a discount and subject to a requirement146 that the vendees purchase from petitioner their requirements of building material to improve the lots. Except for 1950, as to lots sold, the number of lots sold and sales each year to individuals without a tie-in agreement exceeded sales to contractors subject to such an agreement.While petitioner did not advertise the lots it listed them for sale with the White Agency, a subsidiary corporation, coupled with an agreement to purchase building material from it. Petitioner, which had the burden of overcoming the presumption in favor of the correctness of the respondent's determination, offered no evidence to establish that the White Agency did not advertise the lots or otherwise actively engage in the solicitation of customers.Petitioner asserts that the initial acquisition of property was made as an investment to construct badly needed housing units and that upon the termination of the war the activity was continued to advance its lumber and building material business.Property acquired and held as an investment may in a subsequent year be liquidated in a business venture within the meaning of section 117 (a) (1). Florence H. Ehrman, supra. The important147 question is the conditions under which it is held and disposed of in the taxable years.The fact that one of the motives for acquiring the property was to sell it under a plan that would advance the lumber and building material business cannot affect the result, for the answer is the same whether the activities were carried on as an integral part of a recognized 959 business, or one separate and distinct from it. If the property is held as prescribed by the statute it is not a capital asset and any gain resulting from sales is taxable as ordinary income. A taxpayer may engage in more than one business. Williamson v. Commissioner, 201 F. 2d 564, affirming 18 T.C. 653">18 T. C. 653.Lots were sold without tie-in agreements and it does not appear that petitioner ever declined an offer of purchase because the offeror refused to agree to buy building material from it. Nothing here is opposed to the idea that at all times during the taxable years the property was for sale to the general public. The restrictions on building material were lifted in 1945 or 1946 and thereafter, while no shortage existed in lumber or other building148 material and petitioner enjoyed a good market for its products, some business was declined to meet the demand of regular customers and, as already pointed out, petitioner acquired additional lots for sale under its plan.While petitioner admits that the issue is controlled by the peculiar facts and cites no case as controlling, it refers us to several cases in its favor.In W. T. Thrift, Sr., supra, the taxpayer made no effort to sell or subdivide the land prior to the taxable year. The subdivision was made to facilitate the sale of lots to selected builders, pursuant to an agreement with them. No effort was made to sell to the general public and offers of individual purchasers were refused. The property was never listed with a real estate agent. Those facts are not present here. In Dunlap v. Oldham Lumber Co., supra, the sales were made in isolated transactions. No showing was made that the sales promoted the principal business of the taxpayer and there was no continuity of sales, contrary to the facts here.The facts present here support, rather than overcome, the determination of the respondent that the lots149 in question were held primarily for sale to customers in the ordinary course of a business.Petitioner concedes that a conclusion in favor of respondent under the principal issue will leave it without capital gain from which to deduct a capital loss of $ 2,800 sustained by it. Accordingly,Decisions will be entered for the respondent. Footnotes1. 54 were the remaining lots in Victory Terrace.↩1. The amounts for 1947, 1948, and 1950 include sales totaling about $ 2,000, $ 9,100, and $ 5,600, respectively, at or about cost. There was no transfer in 1949 for less than cost.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625417/	HORN & HARDART BAKING CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Horn & Hardart Baking Co. v. CommissionerDocket No. 32383.United States Board of Tax Appeals19 B.T.A. 704; 1930 BTA LEXIS 2338; April 25, 1930, Promulgated 2338 1. ACCOUNTING - BONUS. - Where petitioner accrued on its books during a taxable year certain sums for the payment of a bonus to employees, but the liability for payment thereof was dependent on the continuance of the employee in petitioner's service until a date in the following year, held that the bonus is not deductible in the year in which accrued, but in year when liability became fixed and payment was made. 2. COMMISSIONS paid to agents for securing a loan on mortgage are not deductible in full in the year when paid, but should be spread proportionately over the life of the mortgage. Andrew S. Wilson, C.P.A., for the petitioner. W. Frank Gibbs, Esq., and O. W. Swecker, Esq., for the respondent. BLACK 704 Respondent determined deficiencies against the petitioner of $2,028.74 for the fiscal year ended September 30, 1924, and $8,623.06 for the fiscal year ended September 30, 1925. Petitioner alleges that respondent erred in not allowing as deductible expenses amounts accrued by it during both taxable years to provide for the payment of bonuses to employees during December following the end of each fiscal year, and also his2339 failure to allow as an expense for the fiscal year ended September 30, 1925, the sum of $53,750 commissions paid by it to brokers for selling its $3,750,000 mortgage bonds. Petitioner is a New Jersey corporation with its principal office at 208 South Warnock Street, Philadelphia, Pa.It is engaged in the baking and restaurant business and operates about fifty dining rooms and stores in Philadelphia and its vicinity. In order to encourage its employees and reward those faithful and continuous in service, it has for many years had a regular bonus system of extra compensation paid in December of every year. Originally it was fixed at one week's wages, but in 1922 this was changed to a basis of a percentage of the employees' wages for the entire year. This was explained to prospective employees and became part of the contract of employment. The petitioner kept its accounts on the accrual system and on a fiscal year basis ending September 30 of every year. It made its tax returns accordingly. Its method of accruing this bonus charge was to estimate the amount monthly based on the amount paid the previous year. Thus for the fiscal year ending September 30, 1924, 705 2340 the amount accrued was based and estimated on that paid the previous year, and the same system was followed in other years. For the year ending September 30, 1924, petitioner accrued $80,066.70, which included approximately $22,000 which should have been accrued for 1923 and for 1925 accrued $53,424. The books of the petitioner were closed as of September 30, but the correct amounts of the bonuses were not figured until in December following the close of the fiscal year and the liability for and amount of the bonus to each employee was contingent on the employee remaining in service until December 1. In the event any employee left or was discharged from service between September 30, the end of the fiscal year, and December 1, such employee was not entitled to any bonus. There were some cases of this kind. Respondent allowed the amounts actually paid as deductible expenses in the year when paid and not in the year accrued by petitioner, to wit, payment of $44,460.64 made December 15, 1923, for the fiscal year ending September 30, 1924, instead of $80,066.70 claimed as accrued by petitioner, and payment of $51,005.39 made December 15, 1924, for the fiscal year ended September 30, 1925, instead2341 of $53,424 claimed as accrued by petitioner. During the fiscal year ended September 30, 1925, petitioner raised additional funds for business purposes by placing a 20-year mortgage for $3,750,000 on its various properties and selling bonds secured thereby. The expenses connected therewith were, legal expenses, $7,517.83; title expense, $5,597.75; acknowledgment fee, 50 cents, making a total of $13,116.08. This expense was spread over the life of the mortgage by the respondent and a proportionate part thereof allowed as a deduction for the taxable year 1925, which action is accepted by the petitioner. In addition there was a commission of $53,750 paid a firm of investment brokers for selling the bonds to the Metropolitan Life Insurance Co.Respondent determined this commission to be a capital expense and not deductible in full in the year when paid, but to be spread proportionately over the life of the bonds. Petitioner contends this is an ordinary and necessary expense deductible in full in the year in which paid. OPINION. BLACK: The facts plainly show that the amounts accrued by petitioner for the payment of bonuses for the fiscal year ending September 30, 1924, were2342 not paid and did not become a liability during such fiscal year, but only after December 1, 1924, and were actually incurred and paid in the fiscal year following that in which they were accrued, to wit, the fiscal year ended September 30, 1925. 706 The accruals made for the fiscal year ended September 30, 1925, were not paid nor was any liability incurred therefor until after December 1, 1925, which was in the fiscal year ended September 30, 1926, which is not before us. Section 234(a)(1), Revenue Act of 1924, provides: (a) In computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions: (1) All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered, and including rentals or other payments required to be made as a condition to the continued use or possession of property to which the corporation has not taken or is not taking title, or in which it has no equity. It will be observed that the Act provides that in order to be deductible the ordinary2343 and necessary expenses must be paid or incurred. In the instant case petitioner does not claim to have paid the amounts accrued for bonuses during the year in which it accrued them, and it is equally clear that liability therefor was not incurred until December 1 of the following year. In order to be deductible or accruable for tax purposes, the liability must be fixed or incurred during the taxable year. Here the right to the bonus and the liability therefor did not arise until the year following that in which accrued and claimed by petitioner, for it was dependent on the employee remaining in petitioner's service until December 1 in the following fiscal year. The action of respondent in allowing the actual amounts paid in the year in which they were incurred and paid was correct and is approved. ; ; ; ; ; 2344 ; affd., . Relative to the claim for deduction for the fiscal year ended September 30, 1925, of the sum of $53,750 paid as commissions for sale of mortgage bonds secured by mortgage of petitioner's properties, it is sufficient to say that we have recently had this question before us in the case of , which is practically on all fours with the instant case. It was there held that such an expense is a capital expenditure and that it was not deductible in full in the year when paid or incurred, but should be spread over the life of the bonds. That case is controlling here. This is what the respondent did and his action is approved. Cf. ; . Judgment will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625418/	ESTATE OF GEORGE A. WHEELOCK, JULIA E. WHEELOCK, EXECUTRIX, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Wheelock v. CommissionerDocket Nos. 12099, 13072.United States Board of Tax Appeals13 B.T.A. 828; 1928 BTA LEXIS 3176; October 8, 1928, Promulgated 3176 Held, that respondent did not err in including in the gross estate of decedent the value of certain real property transferred by him to his wife within two years prior to his death. Raymond S. Norris, Esq., for the petitioner. Frank T. Horner, Esq., for the respondent. TRAMMELL 828 These proceedings, which were consolidated, are for the redetermination of a deficiency in estate tax of $1,859.51. The deficiency results in part from the respondent's including in the decedent's gross estate as a transfer in contemplation of death an amount of $29,244, 829 representing the value of certain real property transferred by the decedent to his wife, the executrix of the estate within 2 years prior to his death. FINDINGS OF FACT. George A. Wheelock, whose estate is involved in these proceedings, died on November 10, 1922, leaving a last will and testament dated January 12, 1922. Julia E. Wheelock, the decedent's wife, is the sole executrix and beneficiary under the will. At the time of his death, Wheelock was a resident of the County of New York, State of New York. On September 12, 1921, Wheelock transferred to his wife certain3177 real property situated in the Borough of Manhattan, City, County, and State of New York, and known as No. 3 West 86th St., subject to an unpaid mortgage of $25,000 which the wife assumed. The consideration recited in the deed was $1 and love and affection. As a result of proceedings in the Surrogate's Court for New York County, New York, in the summer of 1923, Wheelock was declared to possess testamentary capacity at the time he executed his will on January 12, 1922. In the return filed for Federal estate-tax purposes the transfer of the real estate referred to above was reported and this property was shown as having a fair market value of not to exceed $45,000. The amount of the mortgage on the property with the accrued interest thereon was shown as $24,756. No part of the $45,000 was included in the decedent's estate for tax purposes. In an audit of the return the respondent determined that the property in question was transferred by the decedent in contemplation of death and, having determined that the value of the interest transferred was $29,244, included that amount in the gross estate for tax purposes. The total value of the gross estate as determined by the respondent3178 was $415,170.57 and the value of the net estate was $260,412.51. About July 11, 1913, the decedent borrowed from his wife $15,000, giving his note for that amount, which bore interest at 6 per cent per annum. About December 1, 1913, he also borrowed $15,000 from his wife, giving his note for that amount, which bore interest at 6 per cent. These notes, with the accrued and unpaid interest thereon at November 10, 1922, the date of the decedent's death, amounted to $46,052.50, which was taken as a deduction representing the debts of the decedent in the return filed for estate-tax purposes. The amount was allowed by the respondent in determining the tax liability of the estate. On February 26, 1922, Wheelock was examined for a rectal trouble which he had had for years by Dr. Jerome Wagner, who informed 830 him that an operation was about the only thing that would relieve his condition. Wheelock, however, was opposed to an operation. During the latter part of the same month, or early in March, Wheelock was examined and treated for the same trouble by Dr. Thomas F. De Naouly. About March 15, 1922, Dr. De Naouly was again called in to see Wheelock and at that time found3179 him to be suffering from the delayed effects of alcoholism. On May 2, 1922, Wheelock was examined by a Dr. Abram Arden Brill at Dr. Brill's office and found to be suffering from general paresis. On May 5, 1922, Wheelock was again examined in Dr. Brill's office, but by Dr. Menas S. Gregory, who found him suffering from the mental and physical symptoms of a very clear case of general paresis in a very advanced condition. In the afternoon of May 5, 1922, Wheelock, after acting irrational for a while, had a convulsion. Dr. De Naouly was called in and he found Wheelock in a state of coma, from which he emerged into a semicomatose condition, about which time he had another convulsion localized to the muscles of the neck and face. Upon the advice of Dr. De Naouly, Wheelock was taken to Bellevue hospital for observation purposes and was placed in a psycopathic ward. Subsequently, Wheelock was taken home from the hospital and afterwards was examined there by Drs. Wagner and Gregory, who found him to be suffering from paresis. On May 12, 1922, Wheelock was examined at his home by Dr. Frederick Tilney, Dr. Wagner being present. Dr. Tilney reached the same conclusion as the other physicians3180 as to the disease with which Wheelock was afflicted. Wheelock's death on November 10, 1922, was caused by paresis. In July, 1922, Wheelock was declared incompetent by the Supreme Court of New York, and about August 3, 1922, his wife and the American Trust Co. were appointed committee of his person and property. OPINION. TRAMMELL: The only issue involved in these proceedings is whether the respondent erred in including in the gross estate of the decedent, as a transfer in contemplation of death, the value of the property transferred by him to his wife, Julia E. Wheelock, on September 12, 1921. There is no controversy between the parties as to the value of the property in question. Section 402 of the Revenue Act of 1921 provides in part as follows: That 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, or with respect to which he has at any time created a 831 trust, in contemplation of or intended to take effect in3181 possession or enjoyment at or after his death (whether such transfer or trust is made or created before or after the passage of this Act), except in case of a bona fide sale for a fair consideration in money or money's worth. Any transfer of a material part of his property in the nature of a final disposition or distribution thereof, made by the decedent within two years prior to his death without such a consideration, shall, unless shown to the contrary, be deemed to have been made in contemplation of death within the meaning of this title. Inasmuch as the transfer in question was made approximately 14 months prior to the death of the decedent, there is a presumption under the statute that such transfer was made in contemplation of death. The phrase "in contemplation of death" has been held to mean not that general contemplation of death which is present with all persons, knowing as they do that at some time they must die, but that state of mind or present apprehension resulting from some existing bodily or mental condition or other producing cause which leads to the conviction that death is to be anticipated within a reasonable time in the near future. 3182 ; ; ; . Much evidence has been submitted as to the mental and physical condition of the decedent during the year 1922 and especially in the month of May of that year, but the record is very meager as to his mental and physical condition on September 12, 1921, the date of the transfer, nor does it disclose very much as to the facts and circumstances surrounding the transfer. While the evidence indicates that up until the early part of May, 1922, Wheelock was acting rationally, the weight of the evidence is that he was suffering from the disease which caused his death at least as far back as September, 1921. One physician who examined him in May, 1922, testified that in his opinion he had had the disease for at least a year prior to that time. Another physician testified that when he examined him in May, 1922, the disease was in a very advanced condition. Another physician testified that paresis always terminates fatally, and, while it may cause death in as short3183 a period as three months, it is generally accepted that the duration of the disease is from two to four years. Although as a result of the proceeding in the Surrogate's Court in 1923 Wheelock was declared to possess testamentary capacity at the time he executed his will on January 12, 1922, we do not think that such a declaration would be inconsistent with the conclusion that Wheelock had paresis on September 12, 1921, that he knew that he had this disease and also knew of its fatal character. It is also to be observed that the will was made only four months after the transfer. 832 From a consideration of all the evidence in the case, we do not think that the petitioner has overcome the presumption created by statute that the transfer was made in contemplation of death. In the petitioner's brief the statement is made that the value of the property involved was not a material part of the decedent's property when considered in connection with the whole of his estate subsequently bequeathed to his wife. We think, however, that it was a material part of the decedent's estate. See 3184 . From a consideration of the facts in these proceedings, we are of the opinion that the respondent did not err in including in the gross estate of the decedent as a transfer in contemplation of death the value of the property transferred by the decedent to his wife on September 12, 1921. Judgment will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625419/	DAVID L. AND LAURIE BIERER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentBierer v. CommissionerDocket No. 19578-89United States Tax CourtT.C. Memo 1991-199; 1991 Tax Ct. Memo LEXIS 223; 61 T.C.M. (CCH) 2542; T.C.M. (RIA) 91199; May 9, 1991, Filed 223 Decision will be entered for the respondent. David L. Bierer, pro se. Stephen S. Ash, for the respondent. DINAN, Special Trial Judge. DINANMEMORANDUM OPINION This case was heard pursuant to the provisions of section 7443A(b) and Rules 180, 181, and 182. 1Respondent determined deficiencies in petitioners' Federal income taxes and additions to tax as follows: Addition to Tax 2YearDeficiency Sec. 6653(a)(1)Sec. 6653(a)(2)1985$ 4,094 $ 205 224 19862,071104* The issues presented for decision are: (1) Whether petitioners are entitled to deduct certain employee business expenses for the 1985 and 1986 taxable years; (2) whether petitioners are entitled to deduct contributions to the Truth Fellowship, Inc. for the 1985 and 1986 taxable years; (3) whether petitioners are entitled to deduct certain claimed miscellaneous itemized expenses for the taxable years 1985 and 1986; and (4) whether petitioners are liable for additions to tax under section 6653(a)(1) and 6653(a)(2) for the years in issue. Some of the facts have been stipulated. The stipulations of fact and accompanying exhibits are incorporated by this reference. Petitioners resided in Tucson, Arizona, at the time they filed their petition. When this case was called for trial at Phoenix, Arizona, David L. Bierer (petitioner) submitted a 215-page document entitled "The Spirit Of Liberty, The Constitution And The -I.R.S.- Concerning Jurisdiction" (the Liberty document). The Liberty document consisted of nine exhibits which are as follows: (1) The225 Deity - Jurisdiction; (2) Constructive Notice to the IRS; (3) Unconstitutional Practice of the Private Interest Group - the Federal Reserve; (4) Declaration of Sovereignty and the Jurisdiction of Truth; (5) United States Jurisdiction; (6) Positive Law - Tax Code Not Positive Law; (7) From John Swift Society Work on National vs. Federal Concepts of Law and the Federal Fraud; (8) A Document Explaining Legal vs. Illegal Taxation; and (9) The Forgotten Ninth Amendment by Bennett B. Patterson - the Decision is for the Individual if the Power is Not Clearly Defined by the Constitutional Governments. Aside from submitting the Liberty document, petitioner refused to discuss or present evidence concerning the issues to be decided by the Court. The Court invited petitioner six times to explain or submit evidence to support the claimed deductions for 1985 and 1986. Petitioner instead repeatedly objected to the Internal Revenue Service's authority or jurisdiction, citing as his authority the Liberty document. The determination of respondent, as contained in his statutory notice of deficiency, is presumed to be correct. Petitioner bears the burden of proving that respondent erred in his226 determination. New Colonial Ice Co. v. Helvering, 292 U.S. 435">292 U.S. 435, 440, 78 L. Ed. 1348">78 L. Ed. 1348, 54 S. Ct. 788">54 S. Ct. 788 (1934); Welch v. Helvering, 290 U.S. 111">290 U.S. 111, 115, 78 L. Ed. 212">78 L. Ed. 212, 54 S. Ct. 8">54 S. Ct. 8 (1933); Rule 142(a). Petitioner's arguments in Court at the trial of this case served no useful purpose. He did not introduce any evidence to dispute respondent's determination. Petitioner had no intention of addressing the substantive issues before the Court for trial. Moreover, petitioner resisted every effort made by the Court to encourage him to address these issues. In sum, petitioner has failed to carry his burden of proof that respondent's determinations as to the disputed items and additions to tax are incorrect. Accordingly, respondent's determinations are sustained. It is apparent that petitioner brought this action purely for purposes of delay. His arguments before this Court were patently frivolous. Section 6673 provides that the Tax Court may require the taxpayer to pay to the United States a penalty not in excess of $ 25,000 where it appears that the taxpayer's position in the proceedings is frivolous, groundless, or instituted primarily for delay. Section 6673(a), as amended by section 7731 of the Omnibus227 Reconciliation Act of 1989, Pub. L. 101-239, 103 Stat. 2106, 2400. The Court concludes that the provisions of section 6673 are applicable to this case. Accordingly, we hold that petitioner is required to pay to the United States a penalty in the amount of $ 3,000. Decision will be entered for the respondent. Footnotes1. All section references are to the Internal Revenue Code as amended and in effect for the taxable years in issue. All Rule references are to the Tax Court Rules of Practice and Procedure.↩2. Sections 6653(a)(1) and (2) have been redesignated for taxable year 1986 as section 6653(a)(1)(A) and (B), respectively. Tax Reform Act of 1986, Pub. L. 99-514, sec. 1503(a), 100 Stat. 2742.↩. 50% of the interest due on $ 4,094↩**. 50% of the interest due on $ 2,071 ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625420/	The Edna Louise Dunn Trust, Morgan Guaranty Trust Company, Trustee, Petitioner v. Commissioner of Internal Revenue, RespondentDunn Trust v. CommissionerDocket No. 32031-85United States Tax Court86 T.C. 745; 1986 U.S. Tax Ct. LEXIS 120; 86 T.C. No. 46; April 17, 1986, Filed 120 Decision will be entered for the petitioner. In 1982, AT&T acquired additional stock of Pacific, a subsidiary corporation, in a taxable transaction. Pursuant to a plan of reorganization and divestiture, AT&T transferred all of its Pacific stock, along with other assets, to PacTel Group, a holding company, in a nontaxable exchange for PacTel Group stock, by virtue of which AT&T acquired control of PacTel Group within the meaning of sec. 368(c), I.R.C., 1954. On Jan. 1, 1984, AT&T distributed its PacTel Group stock to its shareholders. Held, no portion of the PacTel Group stock distributed to AT&T's shareholders constitutes "other property" under sec. 355(a)(3)(B), I.R.C., 1954. M. Carr Ferguson, for the petitioner.Kendall C. Jones, for the respondent. Tannenwald, Judge. Goffe, Parker, Whitaker, Shields, Hamblen, Cohen, Swift, Jacobs, Wright, and Parr, JJ., agree with this opinion. Sterrett, Simpson, Wilbur, Chabot, Nims, Korner, Clapp, Gerber, and Williams, JJ., did not participate in the consideration of this case. TANNENWALD746 OPINIONRespondent determined a deficiency of $ 29.64 in petitioner's Federal income taxes for the taxable year ended May 31, 1984. The issue for decision is whether a portion of the stock distributed to petitioner pursuant to a reorganization and divestiture plan constituted "other property" under section 355(a)(3)(B). 1This case was submitted fully stipulated under Rule 122. This reference125 incorporates herein the stipulation of facts and attached exhibits. We will set forth only those highly detailed stipulated facts (or a summary thereof) as are necessary to an understanding and disposition of the issue involved herein.Morgan Guaranty Trust Co. of New York, trustee of petitioner, maintained its offices in New York, New York, at the time the petition herein was filed. Petitioner timely filed its Federal income tax return for the taxable year ended May 31, 1984, with the Internal Revenue Service Center, Holtsville, New York.Throughout its fiscal year ended May 31, 1984, petitioner owned 400 shares of common stock of American Telephone & Telegraph Co. (AT&T) a corporation organized and existing under the laws of the State of New York. Petitioner received, as of January 1, 1984, a distribution with respect to its AT&T stock of 40 shares of stock of each of American Information Technologies Corp., Bell Atlantic Corp., BellSouth Corp., NYNEX Corp., Pacific Telesis Group (PacTel Group), Southwestern Bell Corp., and U S West, Inc. (AT&T's seven regional holding companies (RHCs)). Petitioner did not include in its gross income on its Federal income tax return for the126 year in question any amount on account of the receipt of these shares of the RHCs.Until January 1, 1984, AT&T was the common parent corporation of a group of corporations known as the Bell System, whose principal business was the furnishing of communications services and equipment. The group included 22 Bell operating companies (BOCs) which were direct or indirect subsidiaries of AT&T, Western Electric Co., Inc., 747 Bell Telephone Laboratories, Inc., and other companies. The BOCs provided various communications services within their respective geographic operating areas and with other operating areas. In addition to its function as a holding company for the group, AT&T was itself directly and continuously engaged in an active trade or business since 1885. Such business was conducted through its "Long Lines" division which provided interstate and international telecommunications service.On August 24, 1982, a longstanding antitrust suit between AT&T and the U.S. Government was disposed of by a judicially approved agreement between the parties. United States v. American Telephone & Telegraph Co., 552 F. Supp. 131 (D. D.C. 1982), affd. sub 127 nom. Maryland v. United States, 460 U.S. 1001 (1983). Under the terms of that decision and its subsequent judicially approved implementation (see infra pp. 748-749), certain "local exchange" functions of the BOCs were to be placed in the aforementioned seven RHCs and AT&T was to divest itself of its holdings therein.In an action unrelated to the antitrust suit, the Federal Communications Commission (FCC), on April 2, 1980, ordered that, on or before March 1, 1982, certain acts be taken to separate the functions of the BOCs. See Amendment of Section 64.702 of the Commission's Rules and Regulations (Second Computer Inquiry), 77 F.C.C. 2d 384 (1980), as modified on reconsideration, 88 F.C.C. 2d 512 (1981), affd. sub nom. Computer & Communications Industry Association v. FCC, 693 F.2d 198">693 F.2d 198 (D.C. Cir. 1982), cert. denied sub nom. Louisiana Public Service Commission v. Federal Communications Commission, 461 U.S. 938 (1983).In 1980, AT&T owned all of the outstanding stock of the BOCs, with the exception of some minority shares held by128 unrelated third parties in the New England Telephone & Telegraph Co., the Mountain States Telephone & Telegraph Co., Pacific Northwest Bell Telephone Co., and the Pacific Telephone & Telegraph Co. (Pacific).Various steps were taken to implement the FCC mandate and at the same time serve the business interests of the Bell system, of which only those steps relating to Pacific need to be described herein.748 Under an agreement of merger, dated November 5, 1981, between AT&T, Pacific and Pacific Transition Corp. (Transition), a newly formed, wholly owned subsidiary of AT&T, Transition would merge into Pacific and Pacific voting stockholders (other than AT&T and dissenting shareholders) would receive .35 shares of AT&T common stock (and cash in lieu of fractional shares) in exchange for each share of Pacific common stock and $ 60 in cash for each share of Pacific 6-percent voting preferred stock. The outstanding Pacific common and 6-percent voting preferred stock would be canceled and the outstanding share of Pacific Transition Corp. (held by AT&T) would be converted into one share of Pacific common stock.The merger was consummated on May 12, 1982. At that time, Pacific had 129 224,504,982 shares of voting common stock, 205,345,275 (91.5 percent) of which were owned by AT&T, 820,000 shares of 6-percent voting preferred stock, 640,957 (78.2 percent) of which were owned by AT&T, and 21,120,000 shares of nonvoting preferred stock, none of which were owned by AT&T. The balance of the voting stock was publicly held, and the nonvoting preferred stock was held by institutional investors. Because the nonvoting preferred stock remained outstanding after the merger, AT&T did not acquire control of Pacific within the meaning of section 368(c), and the merger therefore resulted in recognition of gain or loss to Pacific's common and voting preferred shareholders.On February 19, 1982, AT&T announced that, to accomplish the divestiture, the 22 BOCs would be grouped into seven regions. A separate, independent holding company structure was established for each region. This structure was subsequently incorporated in the plan of reorganization filed by AT&T on December 16, 1982, and approved by the court in United States v. Western Electric Co., 569 F. Supp. 1057">569 F. Supp. 1057 (D. D.C.), affd. sub nom. California v. United States, 464 U.S. 1013">464 U.S. 1013 (1983).130 The plan of reorganization provided that the articles of incorporation of Pacific would be amended to convert the 1 outstanding share of Pacific voting common stock into 224,504,982 shares of voting common stock (the number of common shares outstanding prior to the merger), and to 749 modify the rights of the nonvoting preferred stock to entitle each share to one vote per share with cumulative voting for directors as authorized by California law. By this change, AT&T would acquire control of Pacific by means of a tax-free reorganization, and then PacTel Group would be in control of Pacific within the meaning of section 368(c) at divestiture.On January 21, 1983, AT&T applied to the Internal Revenue Service (IRS) for rulings (the application) that, inter alia, the amendment to Pacific's articles of incorporation would be a reorganization within the meaning of section 368(a)(1)(E), and no gain or loss would be recognized by AT&T or by the preferred shareholders on the constructive exchange of their preferred stock. Under date of October 6, 1983, the IRS ruled that the amendment qualified as a reorganization within the meaning of section 368(a)(1)(E), and that no gain or loss131 would be recognized by Pacific, AT&T, or the preferred shareholders.In accordance with the plan of reorganization, AT&T and its affiliates would transfer to each regional holding company, in exchange for the latter's voting stock, the stock of the appropriate BOCs and other assets. Among the assets to be transferred to the PacTel Group were 224,504,982 shares of Pacific voting common stock. Thereafter, AT&T would then distribute to its stockholders 1 share of stock in each of the seven regional holding companies for every 10 shares of AT&T stock owned by AT&T shareholders of record at the close of business on December 30, 1983. Fractional shares would not be issued but would be aggregated and sold and the cash proceeds distributed to the stockholders.The January 21, 1983, application also asked for rulings that, inter alia, no gain or loss would be recognized on the transfers of the stock of the BOCs and other assets to the regional holding companies in exchange for stock and that no income, gain, or loss would be recognized by AT&T shareholders upon the receipt by them of the stock in the holding companies.The IRS ruled that no gain or loss would be recognized on the transfer132 of stock of the BOCs and other property to the seven regional holding companies in exchange for their stock and that no income, gain, or loss would be recognized 750 by AT&T shareholders upon the receipt of the stock of the six regional holding companies other than PacTel Group. With respect to the latter, the IRS ruled that a portion of the PacTel Group stock was taxable to the AT&T shareholders. The IRS thereafter advised that this portion of the PacTel Group stock had a value at the time of distribution equal to $ 0.39 per share of AT&T stock and the parties have accepted that value for the purposes of this case.Section 355(a)(1) allows a corporation to make a tax-free distribution of the stock of a controlled corporation (control being defined in section 355(a)(1)(D)(ii) by reference to section 368(c)) to its shareholders in a tax-free distribution, provided the active business requirement of section 355(b) is met and the transaction is deemed not to be merely a "device" to distribute tax free, earnings and profits which otherwise would be taxable as a dividend. There is no dispute between the parties that these conditions have been satisfied. The issue upon which they133 have parted company is whether the limitations of section 355(a)(3)(B) apply. That section provides for the taxation of part of the distribution as follows --(B) Stock Acquired In Taxable Transactions Within 5 Years Treated As Boot. -- For purposes of this section (other than paragraph (1)(D) of this subsection) and so much of section 356 as relates to this section, stock of a controlled corporation acquired by the distributing corporation by reason of any transaction -- (i) which occurs within 5 years of the distribution of such stock, and(ii) in which gain or loss was recognized in whole or in part,shall not be treated as stock of such controlled corporation, but as other property.[Emphasis added.]Section 356(b), in turn, provides that "the fair market value of such other property shall be treated as a distribution of property to which section 301 applies."Petitioner concedes that, if AT&T had distributed the Pacific stock directly to its shareholders, the Pacific stock acquired in the merger would have been treated as "other property" under section 355(a)(3)(B), because the merger was a taxable transaction that took place within 5 years of the divestiture. 134 Petitioner argues, however, that it was PacTel Group stock, not Pacific stock, which AT&T distributed 751 to its shareholders. Since this stock was acquired in what respondent concedes was a tax-free exchange, petitioner argues that none of such stock can be categorized as "other property."Respondent contends that petitioner's position is overly simplistic and that the language of section 355(a)(3)(B) is sufficiently broad to permit an interpretation which will be more accommodating to what he views as the legislative purpose behind the section's enactment, namely to preclude not only direct distributions of purchased interests in an active business but also indirect distributions of such interests emanating from a holding company structure. By way of amplification of his position, respondent argues that (1) we should treat a portion of the PacTel Group common stock as having been acquired via the prior taxable acquisition of Pacific stock with the result that the "by reason of any transaction" provision of section 355(a)(3)(B) is satisfied, or (2) in view of the overall statutory framework of section 355, Pacific, as part of the PacTel Group, falls within the ambit of the135 statutory phrase "controlled corporation" as that term is used in section 355(a)(3)(B). As a consequence, respondent concludes that such portion of PacTel stock as represents the fair market value of the Pacific stock (stipulated to be $ 0.39 per share of AT&T stock) constitutes "other property" and is taxable as a dividend.A literal reading of section 355(a)(3)(B) appears to support petitioner's position. On its face, the statutory language is directed to the distribution "of stock of a controlled corporation, acquired by the distributing corporation by reason of any [taxable] transaction [occurring] within 5 years of the distribution of such stock." (Emphasis added.) As used in section 355(a)(1)(A), the term "controlled corporation" means a corporation which the distributing corporation "controls immediately before the distribution" within the meaning of section 368(c). Since AT&T did not own directly any stock of Pacific immediately before the distribution, and because the stock attribution rules of section 318 are not applicable to section 368(c), 2 it follows that, 752 from a literal standpoint, Pacific was not a "controlled corporation" of AT&T for purposes136 of section 355(a)(3)(B). 3 On this basis, petitioner would prevail.We think it appropriate, however, not simply to adhere to the literal meaning of section 355(a)(3)(B). It can be argued -- as indeed respondent does herein -- that the words of that section are sufficiently ambiguous to permit a resort to legislative history, an aspect of this case to which we137 now turn our attention.The stock boot rule of section 355(a)(3)(B) made its first appearance in the Senate version of the Internal Revenue Code of 1954, H.R. 8300, 83d Cong., 2d Sess. (1954). Section 355(a)(3) in the amendments to the bill as reported by the Senate Finance Committee on page 122 (June 18, 1954) provided that --stock of a controlled corporation acquired by the distributing corporation within 5 years of its distribution, in a transaction in which gain or loss was recognized in whole or in part, shall not be treated as stock of such controlled corporation, but as other property. [Emphasis added.]In commenting on the addition of this section, the Senate Finance Committee stated that --For purposes of determining the taxable nature of part of the exchange or distribution, stock in a controlled corporation acquired by purchase within 5 years of its distribution is treated as "other property." Thus, for example, if a corporation has held a minority stock interest in a corporation for 5 years or more prior to the distribution and within such 5-year period purchases control of such corporation only the stock so purchased will be considered "other property" 138 * * * [S. Rept. 1622, 83d Cong., 2d Sess. 267-68 (1954). Emphasis added.]The Conference Committee modified this proposal, however, and explained the modification as follows --in section 355(a)(3), the phrase "by reason of any transaction which occurs within 5 years of the distribution of such stock" has been inserted in lieu of the phrase "within 5 years of its distribution, in a transaction." The effect of this change is to make certain that, in addition to treating stock of a controlled corporation purchased directly by the distributing corporation as "other property," similar treatment will be given such stock if it is purchased within 5 years through the use of a controlled 753 corporation or of a corporation which, prior to a "downstairs merger," was in control of the distributing corporation. For example, if the parent corporation has held 80 percent of the stock of an active subsidiary corporation for more than 5 years but purchases the remaining 20 percent of such stock within the 5-year period, and distributes all of the stock, gain or loss will not be recognized nor will dividend treatment be accorded the stock distributed to the extent of 80 percent. 139 The 20 percent of the stock will be treated as "other property" for purposes of section 356. Similarly, under the amendment made, where such parent causes another subsidiary to acquire the 20 percent of the stock and then itself acquires such stock in a liquidation in which no gain or loss is recognized to such parent under section 332, or where the subsidiary having held 80 percent of the stock of its subsidiary for more than 5 years, acquires the 20 percent of the stock which has been purchased by the parent within the 5-year period through a nontaxable "downstairs" merger of the parent into the subsidiary, and all of the stock is distributed, such 20 percent of the stock will in either case be treated as "other property." [H. Rept. 2543, 83d Cong., 2d Sess. 38 (1954). Emphasis added.]Thus, the "by reason of any transaction" language was added to prevent a distributing corporation from avoiding taxation by acquiring additional controlled corporation stock via a purchase by a related entity coupled with some type of tax-free combination. The focus of section 355(c)(3)(B) both before and after the change remained the same; on the acquisition and distribution of stock140 of the controlled corporation, not on the acquisition of stock of the underlying, active subsidiary which was not actually distributed.This brings us to respondent's second argument, namely that the overall statutory framework of section 355 requires section 355(a)(3)(B) to be interpreted as focusing not merely on the stock of the controlled corporation being distributed, but on the actual operating subsidiary included in the spinoff. Respondent correctly points out that the statutory framework of section 355(b)(2)(A) "itself envisions situations where a holding company will be used as the distributing mechanism for an active subsidiary." It provides that a corporation will qualify as an "active business" if for the 5-year period ending on the date of distribution it has been --engaged in the active conduct of a trade or business, or substantially all of its assets consist of stock and securities of a corporation controlled by 754 it (immediately after the distribution) which is so engaged, * * * [Emphasis added.]Thus, section 355(b)(2)(A) allows the distributing corporation to "look through" the controlled corporation to its underlying active subsidiary in141 order to satisfy the active business requirement. Similarly, to qualify as an active trade or business under section 355(b)(2)(D) during the 5 years prior to the distribution of stock, it must be established that --control of a corporation which (at the time of acquisition of control) was conducting such trade or business -- (i) was not acquired directly (or through one or more corporations) by another corporation * Therefore, much like section 355(b)(2)(A), this section cuts through the form of the spinoff and focuses directly on the underlying active subsidiary when considering whether or not a corporation qualifies as an active trade or business.From this legislative framework, respondent concludes that, since it is the activity of the underlying subsidiary that qualifies the spinoff as a tax-free section 355 distribution to begin with, it is only logical and consistent that for section 355(a)(3)(B) purposes, we must also focus on the underlying active subsidiary. Unfortunately for respondent, as we have already observed neither the words of section 355(a)(3)(B), nor its legislative history, support his conclusion. Furthermore, although respondent discusses at142 great length the congressional purpose behind the passage of the "active business" provisions of section 355(b), his attempts to explain why we should interpret section 355(a)(3)(B) in a similar light, so that these two sections are read in "symmetry," with a focus on the active subsidiary, are far from convincing. Absent a clearer statement of legislative intent that we should look through the stock of the controlled corporation, we find it difficult to make the analytical jump respondent asks of us. Cf. Insilco Corp. v. Commissioner, 73 T.C. 589">73 T.C. 589, 597-598 (1979), affd. without published opinion 659 F.2d 1059">659 F.2d 1059 (2d Cir. 1981), and cases cited therein. In fact, in light of the clear and detailed statutory scheme of section 355(b), the conspicuous absence of similar language in section 355(a)(3)(B) suggests that Congress was not only aware of the claimed "inconsistency," 755 but intended just such a result. 4 Moreover, we have not overlooked the interpretative implications of the fact that, both in operative text and examples, respondent's regulations under section 355 have been for some 30 years, and are anticipated143 to continue to be, conspicuously silent in respect of transactions of the type involved herein. 5However, our inquiry is not over. While it appears that both the plain meaning of section 355(a)(3)(B), as well as its legislative history, support petitioner's position, we also recognize that --the courts have some leeway in interpreting a statute if the adoption of a literal or usual meaning of its words "would lead to absurd results * * * or would thwart the obvious purpose of the statute." See 380 U.S. at 571 (quoting Helvering v. Hammel, 311 U.S. 504">311 U.S. 504, 510-511 (1941)).144 [Knowlton v. Commissioner, 84 T.C. 160">84 T.C. 160, 163 (1985) (quoting Commissioner v. Brown, 380 U.S. 563 (1965)).]Or, to put it another way, we should not adopt a construction which would reflect a conclusion that Congress had "[legislated] eccentrically." See J.C. Penney Co. v. Commissioner, 312 F.2d 65">312 F.2d 65, 68 (2d Cir. 1962), affg. 37 T.C. 1013">37 T.C. 1013 (1962). We are satisfied that our reliance on the wording of the statute involved herein would not have any such deleterious consequences either in terms of section 355(a)(3)(B) specifically or section 355 generally.To begin with, pursuant to the merger, AT&T issued 6,705,897 shares of its common stock, with a fair market value of $ 370,500,834, in exchange for the 19,159,707 publicly held shares of Pacific common stock, and paid $ 10,742,580 for the 179,043 publicly held shares of Pacific 6-percent voting preferred stock. Thus, over 97 percent of the consideration furnished by AT&T to acquire the Pacific stock consisted of newly issued shares of its own stock. Since the underlying purpose of section 355(a)(3)(B) is to prevent the145 conversion of excess, liquid funds, such as cash and marketable securities, into additional controlled corporation stock that can then be distributed tax free in a spin off, we fail to see how respondent can argue that the spin 756 off of PacTel Group stock in any way frustrated the "obvious purpose of the statute."Furthermore, by spinning off PacTel Group stock, AT&T did not bail out earnings and profits and thus undermine the general statutory purpose of section 355, because the Pacific stock acquired from the minority shareholders pursuant to the merger has remained in corporate solution and has never passed into the hands of AT&T's shareholders. Although respondent argues that this is merely a form over substance argument because the benefit of the purchased interest in the Pacific stock was transferred to PacTel Group, and thus was indirectly distributed to AT&T's shareholders, we note that --A dividend does not confer an economic benefit on its recipient. The distribution leaves the shareholder no richer, since his directly owned assets increase only by the same amount that the beneficial ownership of those assets represented by his stock interest diminishes. 146 A dividend therefore is included in gross income not because it affects the shareholder's net worth (which is increased even by undistributed corporate profits), but because the distributed property no longer is in corporate solution. [Kingson, "The Deep Structure of Taxation: Dividend Distributions," 85 Yale L. J. 861, 863-864 (1976). Emphasis supplied.]Thus, even assuming, arguendo, that the net worth of each shareholder increased as a result of the AT&T stock purchase, 6 the simple fact remains that this did not give rise to a taxable event because AT&T did not distribute the Pacific stock. A bailout, like a dividend, by definition requires a distribution out of corporate solution. This has not occurred.147 That the Pacific stock which was acquired in a taxable transaction remained in corporate solution is most significant. It has caused us to focus on some of the problems which would arise if respondent's approach were adopted herein. For example, how would a future distribution of Pacific stock be treated? Another problem which would 757 arise, if respondent's approach were adopted, involves the necessity of determining the value of the "tainted" stock transferred in the later nontaxable exchange and allocating that value to the shares of stock acquired in that exchange which then become the subject of a section 355 distribution -- a problem which we are not required to face herein because of the parties' agreement as to the value attributable to the purchased Pacific stock and allocable to the distributed PacTel stock. The problem is even more difficult when more than one class of stock of the controlled corporation is received by the distributing corporation in the nontaxable exchange. Beyond this, is a still further complication if respondent should carry his approach to its logical conclusion and, in a later case, should ask us to extend the view which he asks us to 148 adopt herein to a purchase of stock of a subsidiary of a subsidiary of the controlled corporation within 5 years of a section 355 distribution. 7 Granted that the courts often deal with problems of allocation without specific legislative mandate, it does not necessarily follow that they should extend the interpretation of a statute to create such a problem.The long and the short of the matter is that we see no thwarting of legislative purpose by confining section 355(a)(3)(B) to the situations which Congress obviously had in mind at the time of its enactment. In so concluding, we are constrained to observe that, if respondent feels that a transaction of the type involved herein represents an obvious attempt to bail out earnings and profits in violation of the purpose behind section 355, he is not without his remedy. He can challenge such a transaction as a "device" under section 355(a)(1)(B). 8 He has chosen not to do so in 149 this case, because of the conceded business purposes involved in implementing the antitrust decree and FCC order, and we are satisfied that he should not be permitted to avoid this channel of attack by means of an overly broad construction of section 355(a)(3)(B). Thus, while we agree 758 with respondent that business purpose is irrelevant to the proper construction of section 355(a)(3)(B), we do not agree with his contentions, that "Congress, in enacting section 355, intended to put direct distributions of stock of existing corporations on a par with indirect distributions of such stock through the use of holding companies [and that] the 'by reason of any transaction' language was specifically added to section 355(a)(3)(B) to make it clear that the section was to be applied not only to direct purchase of stock by distributing corporations, but also to any conceivable indirect purchase of stock within five years of the distribution." (Respondent's brief, at 40. Emphasis added.)150 The absolutism of respondent's contentions is unacceptable. Essentially, respondent seeks to have us do what Congress might have done if the type of transaction involved herein had been brought to its attention. But it is not within the province of this Court thus to expand upon the handiwork of the legislature. Clark v. Commissioner, 86 T.C. 138">86 T.C. 138 (1986); see also Commissioner v. Stickney, 399 F.2d 828">399 F.2d 828, 834 (6th Cir. 1968), affg. 46 T.C. 864">46 T.C. 864 (1966).In view of the foregoing,Decision will be entered for the petitioner. Footnotes1. Unless otherwise indicated, all statutory references are to the Internal Revenue Code of 1954 as amended and in effect during the year in issue, and all Rule references are to the Rules of Practice and Procedure of this Court.↩2. See Stephens, Inc. v. United States, 464 F.2d 53">464 F.2d 53, 65 n. 12 (8th Cir. 1972); Breech v. United States, 439 F.2d 409">439 F.2d 409, 411 (9th Cir. 1971); Berghash v. Commissioner, 43 T.C. 743">43 T.C. 743, 757 (1965), affd. 361 F.2d 257">361 F.2d 257 (2d Cir. 1966); Rev. Rul. 56-613, 2 C.B. 213">1956-2 C.B. 213; cf. Insilco Corp. v. Commissioner, 73 T.C. 589">73 T.C. 589, 597-598 (1979), affd. without published opinion 659 F.2d 1059">659 F.2d 1059↩ (2d Cir. 1981).3. Compare sec. 355(b)(2)(A), discussed at p. 755 infra↩.4. Moreover, Congress has proven itself quite capable of enacting stock-taint rules when it has desired to do so. See, e.g., sec. 306(c)(1)(B)(ii) in which the same Congress that enacted sec. 355(a)(3)(B)↩ provided for an "inherited taint" rule with respect to preferred stock received in exchange for sec. 306 stock pursuant to a plan of reorganization.5. Sec. 1.355-2(f), Income Tax Regs., and sec. 1.355-2(f), Proposed Income Tax Regs.↩6. We note that AT&T's shareholders did not in fact benefit from the Pacific merger. While we recognize that the acquisition, on AT&T's books, resulted in an increase in total net assets and corporate net worth (because AT&T acquired the majority of the Pacific stock for newly issued shares instead of for cash or debt securities), this increase did not filter down to the existing AT&T shareholders. When a corporation issues new stock in exchange for adequate consideration, existing shareholders realize no increase in the value of their individual holdings, because although the overall net worth of the company rises, so does the number of shares outstanding.↩7. There are obviously an infinite number of variations on the theme of this approach.↩8. Sec. 355(a)(1)(B) provides, in pertinent part, that a shareholder of a distributing corporation who receives stock of a controlled corporation pursuant to a sec. 355 distribution shall recognize no gain or loss on such distribution if --the transaction was not used principally as a device for the distribution of the earnings and profits of the distributing corporation or the controlled corporation or both * * *↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625422/	RECORD WIDE DISTRIBUTORS, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentRecord Wide Distributors, Inc. v. CommissionerDocket No. 11595-78.United States Tax CourtT.C. Memo 1981-12; 1981 Tax Ct. Memo LEXIS 732; 41 T.C.M. (CCH) 704; T.C.M. (RIA) 81012; January 12, 1981; As Amended February 11, 1981 Claude Hanks and Leonard R. Yocum, for the petitioner. David T. Karzon, Jr., for the respondent. FORRESTERMEMORANDUM FINDINGS OF FACT AND OPINION FORRESTER, Judge: Respondent has determined deficiencies in petitioner's Federal income tax for its taxable years 1972, 1973, and 1974, in the amounts of $ 92,056.99, $ 34,444.54, and $ 21,232.29, respectively. The issues presented for our decision are (1) whether petitioner should have reported its income on734 an accrual rather than the cash method of accounting, (2) whether respondent properly calculated petitioner's increase in accounts receivable for the years in issue and (3) whether petitioner is entitled to a bad debt deduction for its taxable year 1974. FINDINGS OF FACT Some of the facts have been stipulated and are so found. Petitioner, Record Wide Distributors, Inc., is a Missouri Corporation with its principal place of business in Fenton, Missoui. It timely filed its U.S. Corporation Income Tax Returns, Form 1120, for the calendar years 1972, 1973, and 1974 with the Internal Revenue Service Center at Kansas City, Missouri. Petitioner was incorporated on March 7, 1972, prior to which the business was operated as a sole proprietorship known as Bootheel Records by Gayron Lytle. During the years in issue Gayron Lytle owned 100% of the stock of petitioner and was its president. His brother, Randall, was vice president and petitioner's managing officer during those years. Petitioner is a wholesaler in the business of selling phonograph records, 8-track tapes, and cassette tapes to wholesalers and retailers. The bulk of the merchandise sold by it are cut outs. Cut outs735 are budget products which the manufacturer has not been able to sell in its market. The petitioner assembles cut outs into lots of varying size and then ships them to retailers for sale at highly discounted prices. The nature of cut outs, being less marketable, makes it virtually impossible for a retailer to determine to what extent a given lot of records or tapes will be sold. For this reason petitioner guaranteed its customers that they could return any unsold items for full credit. There are no written contracts between petitioner and its customers, but petitioner has been profitable notwithstanding. Petitioner's policy has been not to require any payment for records and tapes until the retailer had sold all of the product that it could and returned the unsold merchandise. Although petitioner has a policy whereby it encourages returns and payments within 120 days of shipment, it often does not receive payments and returns for well over 120 days, sometimes even over a year. At the time petitioner shipped goods to a customer an invoice was sent along showing the amount, description, and price of the items sold. Petitioner has historically experienced returns of between 50736 and 60 percent. Of the goods shipped by petitioner in any taxable year 30-35 percent of the returns with respect thereto were received by petitioner in a later taxable year (usually within the first 4 months). One of petitioner's major customers was Sound On Tape Distributors, Inc., a wholesaler of 8-track tapes (hereinafter Sound On). Petitioner maintained the same return policy with Sound On that it did with its other customers. Until 1974 Sound On dealt heavily in what are known as bootleg, duplicate, or counterfeit tapes. In February 1974 Sound On was enjoined from selling such tapes. As a result, Sound On's inventory was nearly worthless and it returned the tapes to petitioner. After crediting Sound On for these returns Sound On owed petitioner $ 176,574.22. Although Sound On's financial position was unstable its management attempted to salvage the business. Petitioner no longer extended Sound On credit after 1974 but required payments (including return credit) at least equal to the amount of merchandise shipped prior to or at the time of shipment. Several of Sound On's checks bounced. Thus, starting in 1976, petitioner required cash only upon delivery. In 1978 petitioner737 and Sound On executed an agreement settling the latter's outstanding debt which had been reduced to the principal amount of $ 161,000 owed to petitioner, for $ 5,000. Sound On ceased doing business shortly after the execution of this agreement. On its books petitioner wrote off the uncollected Sound On debt in 1978, however, it has never been written off for Federal income tax purposes. During the years in issue, and before, petitioner operated on a hybrid method of accounting. It maintained an inventory on its books for determining its cost of sales 1 but determined its sales on the cash basis. That is, petitioner posted sales only as it received cash. Furthermore, petitioner did not include goods received from the manufacturer but not paid for on its Schedule A as "Merchandise bought for Manufacturer or Sale." Respondent has determined that petitioner's method of reporting income from sales, i.e., the cash receipts and disbursements method, does not clearly reflect income738 and that an accrual method of accounting does clearly reflect income. Consequently, respondent increased petitioner's income for taxable years 1972, 1973, and 1974 by $ 191,775.41, $ 71,759.47, and $ 44,233.93, respectively. 2OPINION Petitioner's primary contention is that its hybrid method of accounting and reporting income during the years in issue was consistent with its unique method of doing business since prior to the time of its incorporation. Furthermore, it argues that its methods clearly reflect income and are in conformity with generally accepted accounting principles. Respondent maintains that since petitioner must keep inventories for each taxable year in issue 3 it must report purchases and sales using an accrual method of accounting. 4739 Section 446(a)5 provides the general rule that 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. Section 446(b) provides two exceptions to this general rule. Where no method of accounting has been regularly used by the taxpayer, or where the method used by the taxpayer does not clearly reflect income, the computation of taxable income shall be made under such method as in the opinion of the Commissioner does clearly reflect income. Sec. 446(b). The respondent's determination pursuant to his authority under Section 446(b) is presumptively correct and must be upheld unless the petitioner has proved it clearly erroneous or arbitrary. Brooks-Massey Dodge, Inc. v. Commissioner,60 T.C. 884">60 T.C. 884, 891 (1973). The respondent's discretion in matters of accounting methods is very broad. See Commissioner v. Hansen,360 U.S. 446">360 U.S. 446 (1959). 740 Where one's method of accounting does not, in the opinion of the Commissioner, clearly reflect income the respondent may require the use of such method as does clearly reflect income. Sec. 446(b). This is true regardless whether the petitioner has consistently used some other method. See Iverson's Estate v. Commissioner,255 F. 2d 1, 5 (8th Cir. 1958). To allow otherwise would lead to the untenable conclusion that a taxpayer has unfettered discretion to select any method of accounting for tax purposes so long as it conforms to that used for bookkeeping purposes. Petitioner has entered no evidence that its hybrid method of accounting is in accord with generally accepted accounting methods. 6 Assuming, arguendo, that petitioner's method is proper for purposes of financial accounting this fact is not determinative for tax accounting purposes. See Thor Power Tool Company v. Commissioner,439 U.S. 522">439 U.S. 522 (1979). It is incumbent upon petitioner to prove respondent's determination arbitrary or clearly erroneous.741 See Thor Power Tool Company v. Commissioner, supra.This, petitioner has not proved. In his deficiency notice respondent determined that petitioner's computation of its income on the cash receipts and disbursements method does not clearly reflect income. Petitioner does not dispute that it must maintain inventories since the sale of merchandise is a principal income-producing factor of its business. See Secs. 1.446-1(a)(4)(i); 1.471-1, Income Tax Regs. Where inventories are required the regulations mandate the use of an accrual742 method of accounting for purchases and sales. Sec. 1.446-1(c)(2)(1), Income Tax Regs. This principle has been consistently upheld by the courts. See, e.g., Niles Bement Pond Company v. United States,281 U.S. 357">281 U.S. 357 (1930); Wilkinson-Beane, Inc. v. Commissioner,420 F. 2d 352 (1st Cir. 1970); Iverson's Estate v. Commissioner,255 F. 2d 1 (8th Cir. 1958); Caldwell v. Commissioner,202 F. 2d 112 (2d Cir. 1953); Ezo Products Company v. Commissioner,37 T.C. 385">37 T.C. 385 (1961). In light of these cases we can in no way find that respondent's determination is either arbitrary or clearly erroneous. Therefore, respondent's determination that petitioner must report its income on the accrual method must prevail. Alternatively, petitioner maintains that if it is required to report income on an accrual method of accounting it should nonetheless not report income until cash is received because, in light of its return policy, all events had not occurred which establish its right to receive any certain amount of income. We do not dispute that income is to be included only when all the events743 have occurred which fix the petitioner's right to receive such income and the amount thereof is determinable with reasonable accuracy. Spring City Foundry Company v. Commissioner,292 U.S. 182">292 U.S. 182 (1934); Sec. 1.446-1(c)(1)(ii), Income Tax Regs. However, it is clear that petitioner was dealing with its customers on a "sale or return" basis rather than on a consignment basis. 7 The fact that a buyer may return any part of the goods shipped but unsold does not render the transaction a consignment. See Mo. Ann. Stat. Sec. 400.2-327(a). Under a sale or return system the petitioner is required to report the income from the sale upon delivery of the goods to its customers. The right to receive payment, not the actual receipt, determines whether income has accrued and must be included in the gross income of an accrual basis taxpayer. Commissioner v. Hansen,360 U.S. 446">360 U.S. 446 (1959); Spring City Foundry Company v. Commissioner,292 U.S. 182">292 U.S. 182 (1934). Petitioner's right to receive payment is unaffected by predicted uncollectability, 744 no matter how certain. See Spring City Foundry Company v. Commissioner, supra.As stated in that case "if such accounts receivable become uncollectible, in whole or part, the question is one of deduction which may be taken according to the applicable statute." Id. at 185. 8745 The final issue for our decision is whether petitioner is entitled to a bad debt deduction for the debt of Sound On in 1974. Petitioner asserts that due to the prohibition against the sale by Sound On of duplicate tapes in 1974 it (Sound On) was ruined financially, rendering its debt owed to petitioner worthless at that time. Petitioner bases this conclusion on the fact that Sound On's only assets were worthless inventory and tape racks and that if Sound On had liquidated in 1974 the bulk of its accounts payable to petitioner could not have been paid. It is respondent's position that the debt owed to petitioner by Sound On did not become worthless until 1978 at which time Sound On ceased doing business and at which time petitioner settled its account with Sound On for $ 5,000. Section 1669 provides that a corporation may deduct bad debts for the taxable year when, and to the extent, they become wholly or partially worthless. The burden of proving the date of worthlessness is on the petitioner. Mueller v. Commissioner,60 T.C. 36">60 T.C. 36, 41 (1973); Perry v. Commissioner,22 T.C. 968">22 T.C. 968 (1954).746 In the instant case it is clear that Sound On's debt was not wholly worthless in 1974. Courts are reluctant to consider the debt of a business wholly worthless where it has been able to perpetuate itself as a going concern. Riss v. Commissioner,56 T.C. 388">56 T.C. 388 (1971), aff'd 478 F. 2d 1160 (8th Cir. 1973). Sound On continued in business for almost four years after the time at which petitioner asserts its debt became worthless. We do not suggest that Sound On was in healthy financial condition but we do not consider Sound On's attempts, to keep its business alive and growing unrealistic. The fact that Sound On could not have paid its debt during 1974 is not determinative. L.A. Shipbuilding and Drydock Corp. v. United States,289 F. 2d 222 (9th Cir. 1961). Petitioner continued to do business with Sound On after 1974. Although it would not extend Sound On credit it did accept its checks for approximately 2 years even though several bounced. On the facts presented we cannot find that Sound On's debt to petitioner became worthless in 1974. 747 Alternatively, petitioner on brief asserts that Sound On's debt became partially worthless in 1974. Respondent maintains that "the Commissioner cannot allow a partial bad debt deduction [under Sec. 166(a)(2)] in an amount which exceeds the part charged off by the taxpayer within the taxable year of the claimed worthlessness." 10 In the instant case petitioner charged off the entire debt owed by Sound On in 1978. 11 No part was charged off before that time. The petitioner alleges that had it been on an accrual method of accounting for 1974 it would have charged off the debt at that time. We need not consider whether under circumstances where the respondent changes the petitioner's method of accounting from cash basis to an accrual basis, the petitioner should be allowed to retroactively charge off some part of a debt which became worthless in a prior year and which would have been charged off had the petitioner consistently maintained an accrual method748 of accounting. 12 This Court has long taken the position that section 166(a)(2) confers broad discretion upon the respondent to determine deductibility of debts alleged to be partially worthless. See Sika Chemical Corp. v. Commissioner,64 T.C. 856">64 T.C. 856, 862-63 (1975) and cases cited therein. 13 Respondent's determination must be upheld unless found to be plainly arbitrary or unreasonable. Id. To overcome the respondent's presumption of correctness, it is the petitioner's burden to establish that in the year for which the partial worthlessness is claimed the amount of such worthlessness could be predicted with reasonable certainty. Id. This the petitioner has failed to do. Thus, we must uphold the respondent's determination that petitioner is not entitled to deduct any portion of the Sound On debt in 1974. 749 Because of certain concessions of the parties regarding accounts payable and the deductibility of bad debits, Decision will be entered under Rule 155.Footnotes1. Petitioner's inventory at the end of a taxable year included only those items situate in its warehouse. None of the records and tapes in the hands of its customers were included in its inventory.↩2. These adjustments are as reflected in respondent's deficiency notice. Since that time respondent has made certain concessions, the effect of which is to reduce these figures.↩3. See Section 1.471-1, Income Tax Regs.↩ Petitioner does not dispute the necessity of inventories for the correct reflection of income. 4. Respondent asserts, and there is substantial evidence, that petitioner has actually kept its books on an accrual method of accounting. However, for purposes of this opinion we will proceed on the basis that petitioner's books and records were maintained on a hybrid system.↩5. All statutory references are to the Internal Revenue Code, as amended and in effect for the taxable years in issue.↩6. Petitioner kept an accounts receivable ledger with a separate entry for each customer wherein appeared the hearings "Total Accounts Receivable Balance", "Current Amount Due", "30-60 Days", "60-90 Days", and "Over 90 Days". This was set up at the time of petitioner's incorporation by Price Waterhouse, a respected international accounting firm. The use by Price Waterhouse of accounts receivable records indicates that an accrual, not the cash method of accounting, may well be the generally accepted accounting method for petitioner's business.↩7. Had petitioner been operating on a consignment basis it would have reported income when the retailer sold the goods, not when petitioner was paid. Furthermore, petitioner has not shown that it retained title to the goods while in the retailer's hands. Randall Lytle noted only that risk of loss issues were only discussed with retailers after a loss by fire or otherwise occurred. The parties would work out the burden of loss at that time. Also, if petitioner had been on the consignment basis with its customers it would have had to include all consigned goods in its ending inventory. Sec. 1.471-1, Income Tax Regs. This petitioner did not do. Duesenberg, Inc. v. Commissioner,84 F. 2d 921 (7th Cir. 1936). See generally J.J. Little and Ives Co., Inc. v. Commissioner,T.C. Memo 1966-68">T.C. Memo. 1966-68. Finally, under Missouri law (the Uniform Commercial Code) petitioner unquestionably operated under a "sale or return", as opposed to a consignment, basis. Mo. Ann. Stat. Secs. 400.2-326↩; 400.2-327. 8. Under Sec. 458(a) (effective only for taxable years beginning after September 30, 1979) an accrual-basis distributor of records may elect to exclude from gross income the income attributable to merchandise returned within four and one half months after the close of the taxable year in which the sales were made. Although not effective for the taxable years in issue, the legislative history indicates that under pre-section 458 law petitioner is required to include the income from the sale of records in gross income when they are shipped to retailers, irrespective of the number of returns. H.R. Conf. Rep. No. 95-1800, 95th Cong., 2d Sess. 279, 1978-3 (Vol. 1) C.B. 521 (1978). Although we sympathize with the petitioner's plight -- that the effect of pre-section 458 law will result in a "bunching" of income in its taxable year 1972 -- we note that petitioner will enjoy an offsetting decrease in income for its taxable year 1980 due to section 458. For years after 1980 the effect of section 458 will be to more accurately reflect petitioner's income than at any time in the past.↩9. SEC. 166. BAD DEBTS. (a) General Rule.-- (1) Wholly worthless debts.--There shall be allowed as a deduction any debt which becomes worthless within the taxable year. (2) Partially worthless debts.--When satisfied that a debt is recoverable only in part, the Secretary or his delegate may allow such debt, in an amount not in excess of the part charged off within the taxable year, as a deduction.↩10. Benderr, Commissioner,T.C. Memo. 1967-26↩. 11. It should be, noted that although petitioner charged the debt off its books in 1978 it did not take an income tax deduction for it in 1978.↩12. Cf. section 481(a). We note that Bradstreet Co. v. Commissioner,65 F.2d 943">65 F.2d 943, 945 (1st Cir. 1933), lends some support to petitioner's assertion that the respondent as well as the petitioner bears a burden to select a method of accounting which clearly reflects income. See also Gordon v. Commissioner,63 T.C. 51">63 T.C. 51, 73 (1974); Harbin v. Commissioner,40 T.C. 373">40 T.C. 373, 376-77↩ (1963). 13. See also Production Steel Inc. v. Commissioner,T.C. Memo. 1979-361↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625423/	THE HARRY A. KOCH COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Harry A. Koch Co. v. CommissionerDocket No. 47798.United States Board of Tax Appeals23 B.T.A. 161; 1931 BTA LEXIS 1917; May 12, 1931, Promulgated 1917 1. EXPENSES - COMPENSATION. - For 1927 the petitioner paid to its officers only a portion of the commissions earned by them respectively, upon insurance and surety bond business actually written by them. Such officers received no other compensation and waived the 10 per cent dividend declared for that year. Held, that the total amount paid to such officers constituted commissions earned by their personal efforts and deductible, and that respondent erred in determining a portion thereof to be dividends. 2. Id. - CLUB DUES paid for the purpose of obtaining a place for petitioner's annual employees' picnic held to be deductible expense. 3. Id. - CONTRIBUTIONS held to be gifts and not deductible as a business expense. George E. H. Goodner, Esq., for the petitioner. L. W. Creason, Esq., for the respondent. TRUSSELL 161 The respondent has asserted a deficiency in the amount of $1,818.32 in this petitioner's income tax for the calendar year 1927, and the petitioner assigns as error the respondent's disallowance of a deduction of (1) the amount of $8,520 alleged to be a portion of salaries and commissions paid to officers1918 and (2) the amounts of $49.50 club dues and $140 donations alleged to be business expenses. FINDINGS OF FACT. The petitioner is a Nebraska corporation whose principal office is in Omaha. Since its incorporation in 1921 petitioner has been 162 engaged in the insurance and surety business in Nebraska and western Iowa as general agent and also as local agent in Omaha. It represents old line insurance companies and writes all types of insurance except life contracts; adjusts losses, pays claims and does all of its own engineering, surveying and pay-roll auditing. The petitioner's business is carried on through five underwriting departments, a claim department, an inspection department and an auditing department. During 1927 the five underwriting departments were managed by the officers, who were also stockholders and the directors of the petitioner, each one being responsible for all of the details connected with the underwriting of their respective types of insurance. The petitioner employed subagents, who received the regular standard commissions authorized by the insurance and surety companies represented by petitioner and the officers received the same commissions1919 on business actually written by them. The officers and directors received no commission on the business written by the subagents and their compensation depended upon their respective personal efforts in writing insurance and surety bonds. Each officer had a drawing account measured by commissions earned in the preceding year and at the close of the year the total commissions earned by each officer were computed and the amount thereof in excess of the drawing account was credited to them respectively. They were not paid regular salaries other than the said drawing accounts. The petitioner, as district and local agent, received a standard commission on all business written by its officers and subagents and out of such funds it paid its various expenses, including salaries of clerks and other persons employed in the office. For the year 1927 such income of petitioner was not sufficient to meet all of its operating expenses and the officers received only a portion of the commissions actually earned by them on their respective personal production of business during 1927. During 1927 petitioner had outstanding 888 shares of capital stock of the par value of $100 each and the five1920 officers and directors owned 852 shares. The balance of the stock was owned by various employees. The directors of petitioner passed a resolution declaring a 10 per cent dividend on all paid up stock, and further providing, "That the following stockholders waive payment of dividends, for the reason that they participate in the profit sharing of the company: Harry A. Koch, Joseph H. Friedel, Joseph L. Adams, E. W. Devereux, and Lyman G. Cross." Stock had been sold to the employees for the purpose of stimulating a greater interest in the business and the dividends paid on their paid-up stock and amounting to $227.82 were for the same purpose. The petitioner followed the practice of paying dividends only to the small stockholders for the 163 years prior to and including 1927 and in each year the directors and officers waived dividends because the petitioner's earnings were not sufficient to pay dividends on all of the outstanding stock. The expression used in the resolution that dividends were waived for the reason that they participate in the profit sharing merely meant that the officers received amounts in excess of their drawing accounts referred to as salary and not that1921 there was an actual distribution of petitioner's earnings as a bonus or dividend. For 1927 the compensation paid to petitioner's officers totaled $37,881.20 and that amount was deducted from its gross income on its tax return for 1927. The respondent disallowed $8,520 of that amount representing 10 per cent of the stockholdings of the five officers who waived dividends and he determined that that portion of the amount claimed as compensation of such officers constituted dividends in the form of bonuses. During the year 1927 the petitioner made the following contributions: St. Mary's College$10North Side Methodist Church15Police Relief Fund15Commissioner of Public Works, campaign fund100140Those contributions were made because the petitioner's president felt that it was not good business to refuse the requests for the reason that it received business from the St. Mary's College, and from the members of the North Side Methodist Church; it received aid from the police by their protection of property insured by petitioner, and as to the contribution to the campaign fund, petitioner's president felt that the city of Omaha and the businesses located1922 in that city would profit by the election of a certain candidate. During 1927 petitioner paid $49.50 to the Crater Lake Club as dues on a membership standing in the name of one of petitioner's officers. The membership had to be held in the name of an individual, but was obtained and used solely for the purpose of holding, at the club grounds, the annual picnic given by the petitioner for the purpose of stimulating the interest, morale and good fellowship of its employees. The petitioner deducted the said contributions totaling $140 and the said club dues of $49.50 as ordinary and necessary business expenses and the respondent disallowed such deductions. OPINION. TRUSSELL: The facts clearly establish that the amounts totaling $37,881.20, paid to the petitioner's officers during 1927 and deducted 164 upon its tax return as compensation of officers, constituted commissions earned by each of such officers by their personal efforts in writing insurance and surety bonds, and, further, that the amounts received by such officers were less than they had actually earned. The respondent erred in disallowing the amount of $8,520 as a deduction from petitioner's gross income*1923 for 1927. The amount of $49.50 club dues was spent for the sole benefit of petitioner's employees and was a part of the expense of the annual picnic, from which petitioner's business received a direct benefit. Such expense falls within the class of an ordinary and necessary business expense and as such was deductible from petitioner's gross income for 1927. The respondent erred in disallowing such deduction. The contributions totaling $140 constituted gifts and the benefits, if any, derived by petitioner's business were indirect and remote. The respondent properly disallowed the claimed deduction of the said $140 as a business expense. Judgment will be entered pursuant to Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625426/	DETROIT TRUST COMPANY, JEANIE M. LOW AND FRANK C. PAINE, EXECUTORS OF THE WILL OF ALFRED M. LOW, DECEASED, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Detroit Trust Co. v. CommissionerDocket No. 70415.United States Board of Tax Appeals34 B.T.A. 586; 1936 BTA LEXIS 678; May 19, 1936, Promulgated 678 Installment obligations held by a trustee of an active express trust in Michiganheld not transmitted by the death of a beneficiary, and section 44(d), Revenue Act of 1928, does not operate to charge decedent's estate with taxable gain for the period prior to death. Raymond H. Berry, Esq., and Arthur L. Evely, Esq., for the petitioners. Harold D. Thomas, Esq., for the respondent. STERNHAGEN 586 The Commissioner determined a deficiency of $8,356.32 in income tax of petitioners' decedent for the period January 1, 1930, to the date of his death, October 11, 1930. The only issue remaining for decision is whether, as the Commissioner held, installment obligations on land contracts were owned by decedent and transmitted by death, involving taxable gain under section 44(d), Revenue Act of 1928. 587 FINDINGS OF FACT. The petitioners are executors of the will of Alfred M. Low, deceased, who died October 11, 1930. On November 10, 1923, June 30, 1924, and December 19, 1924, decedent entered into agreements with several individuals which recited that he had purchased certain described lands in Detroit acting for and on behalf679 of the contracting parties; that each had contributed a specified part of the down payment made. It was provided that title to the lands was vested in him "in trust" for all the parties, each of whom was the owner of a stated undivided fractional interest in the lands and entitled to receive the same fraction of the net profits thereafter accruing from their sale. It was agreed that each would pay specified amounts to make up the remainder due on the purchase price and that the lands should be improved, subdivided and offered for sale in lots on installment contracts under the direction of a corporate agent which was to receive a commission for its services. In the event that sales proceeds were insufficient to cover cost of improvements and expenses, each party agreed to pay a proportion of the deficiency. Decedent was given charge of all collections on land contracts and was required to keep proper books of account. He was to receive a commission of 5 percent of the sale price of all lots sold, for his services in making collections, drawing deeds, delivering abstracts, keeping accounts and making all disbursements. On May 29 and June 12, 1925, Leroy L. Maxam entered into680 two agreements with decedent and others, which recited that Maxam had purchased for and on behalf of all the parties certain lands in Detroit, and had made an initial payment contributed in stated amounts by the parties; that title to the land was held by Maxam "in trust" for them. It was provided that Maxam hold the lands "in trust" for the parties in accordance with specified undivided fractional interests; that each party was entitled to profits from the sale of the lands in proportion to his interest, and was liable to the same extent for the mortgage indebtedness. It was agreed that Maxam, "the trustee herein", should have power and authority to improve and subdivide the tracts into lots, to enter into sale contracts and convey title "in his own name freed from the said trust the same as if he held title thereto absolutely, and not as trustee." A corporate real estate agent was given the supervision and direction of sales, and lots were to be sold: * * at such prices and upon such terms as may be mutually agreed upon by all the parties hereto in accordance with the sales contract entered into by and between [Maxam] and [the agent]. 588 "The trustee" was charged681 with the payment of "such obligations as may arise" from sales proceeds and with an accounting for receipts and disbursements. He also agreed: * * * whenever requested by the parties hereto to surrender the said trust and to account to the parties according to their respective interests. It was further provided that if the parties desired to terminate the trust or if Maxam became unable to continue to act as trustee, the lands should be conveyed to a specified corporation as successor trustee. During his lifetime decedent received cash distributions of profits from the sales of land pursuant to the first three instruments. Each year the sales profits made during the year were computed and each interest holder was informed of the amount of his share. After decedent's death, a successor trustee of each of the three trusts was appointed by separate orders of the Wayne County Circuit Court, dated April 17, 1931. In each instance the court ordered, adjudged, and decreed: * * * that Alfred M. Low, now deceased, held title to the property described in the Bill of Complaint, and was Trustee thereof for and on behalf of * * * in the proportions and under the terms and conditions, 682 as set forth in a certain Trust Agreement, copy of which is annexed to the Bill of Complaint, filed herein. * * The decrees recognize the trustee's authority to give conveyances of the trust property, to enter into contracts for the purchase and sale thereof, to make collections on land contracts, to sue therefor or for the forfeiture of purchasers' interest, to compromise and settle claims and disputes, to deliver abstracts, to make necessary disbursements for expenses incurred in the course of such duties, to pay taxes and assessments, and, after the deduction of expenses and retention of sufficient reserve, to distribute the net proceeds to the beneficiaries. The trusts are still in existence, have never been amended, and are administered in the same manner as they formerly were by decedent. The trustee has not distributed nor assigned the real estate or the land contracts to decedent's executors or to any other beneficiary, but has held them intact. In respect of the two Maxam trusts, cash distributions of profits from the sales of land were made to decedent during his lifetime by the second trust but not by the first. No distribution of any real estate, land contracts, 683 or installment obligations has been made to decedent's executors. In the income tax returns profits from sales of land and land contracts were reported on the installment basis by all five trusts. The first four filed partnership returns for 1930 and all years prior 589 to 1934. In 1934, by direction of the Commissioner, they filed corporate returns as associations. For purposes of the Michigan inheritance tax and inventory submitted to the probate court, decedent's property in respect of these trusts was treated as undivided interests in real estate syndicates. OPINION. STERNHAGEN: In determining the deficiency, the Commissioner included in the decedent's gross income for the period of 1930 ending with the date of death, $46,437.74, called "profit on the installment basis", citing section 44(d), Revenue Act of 1928. 1 For a consideration of this statutory provision, see ; ; . The petitioners assail this determination, contending that section 44(d) is not applicable since the decedent684 did not own installment obligations at the time of his death and no such obligations were therefore transmitted or otherwise disposed of by him. Petitioners say that the installment obligations which respondent attributes to decedent were in fact and in law owned by the five trusts, and that decedent's property was only his interest as a cestui que trust, which interest was legally distinct from the property owned by the trusts, whether it be land, land contracts or installment obligations. The respondent would identify the trust with the beneficiary, thus treat the ownership of the installment obligations as directly in the decedent beneficiary, and upon this conception apply the logical theory that the installment obligations were transmitted and disposed of by the decedent's death. This view is wholly theoretical, for the evidence shows without doubt that at decedent's death no installment obligations were transmitted to his executors directly or received by them from the trustee. 685 The respondent's determination is, we think, clearly unfounded. By the five instruments in evidence, express and active trusts were established in which was held the legal title to the lands and the obligations resulting from their sale, and to which were charged the duties of administration in accordance with fiduciary standards. In each instance, including those in which decedent was trustee before 590 his death, there were beneficiaries other than himself to whom as trustee he owed substantial obligations sufficient to preclude control of the properties by himself. He was but one of several persons whose relation to the properties was limited to that of trust beneficiary. Without the consent of the other beneficiaries, he, as an individual, could take none of the installment obligations or direct their sale or other use or disposition, except by agreeing with the others to terminate the trust. There was more than a mere agency. The instruments themselves expressly characterized the organizations as trusts, the Wayne County Circuit Court recognized them as such, in practice they were administered as such, and we can find no justification for treating them otherwise686 or ignoring them entirely with the result of taxing to the decedent amounts which were not in fact income or profits to him. These installment obligations were, as shown by this record, continuously owned by the trusts from the time that the land contracts were made, and their ownership was not affected by the death of this beneficiary. When the installments were received, they were income of the trusts and taxable when thus received in accordance with the proper provision of supplement E of the statute. To the extent that they were within the taxable income of the decedent and his successors, it was because they were distributable to them as trust beneficiaries and not as owners of the obligations or direct recipients of the installments. The trust was a "fiduciary to insulate the owners from direct taxation." : ; ; . Judgment will be entered under Rule 50.Footnotes1. SEC. 44. INSTALLMENT BASIS. * * * (d) Gain or loss upon disposition of installment obligations.↩ - If an installment obligation is satisfied at other than its face value or distributed, transmitted, sold, or otherwise disposed of, gain or loss shall result to the extent of the difference between the basis of the obligation and (1) in the case of satisfaction at other than face value or a sale or exchange - the amount realized, or (2) in case of a distribution, transmission, or disposition otherwise than by sale or exchange - the fair market value of the obligation at the time of such distribution, transmission, or disposition. The basis of the obligation shall be the excess of the face value of the obligation over an amount equal to the income which would be returnable were the obligaion satisfied in full.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625427/	LUIS JAMES PHELPS AND THOMAS B. SCOTT, JR., AS EXECUTORS OF THE LAST WILL AND TESTAMENT OF THOMAS B. SCOTT, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Phelps v. CommissionerDocket No. 50336.United States Board of Tax Appeals27 B.T.A. 1224; 1933 BTA LEXIS 1216; April 26, 1933, Promulgated 1216 In his lifetime the decedent created three trusts, reserving to himself no interest whatever in the first two, but reserving the right to dispose of by will the remainder after the life estate of the beneficiary of the third trust, and failing the exercise of the power of disposition, the said remainder went to his descendants. Held, the corpus of the first two trusts is not to be included in the decedent's gross estate; the present value (as of the date of the decedent's death) of the remainder interest in the third trust should be included in the decedent's gross estate. William G. Murphy, Esq., for the petitioners. Frank B. Horner, Esq., for the respondent. SMITH 1224 The respondent determined a deficiency of $16,812.57 in estate tax. The issues for our determination are (1) whether the corpus of certain trusts created by the decedent in his lifetime and property transferred as a gift should be included in the decedent's gross estate; and (2) the proper credit for inheritance taxes paid to New York and other states. The respondent duly asserts claim for an increased deficiency that may result from our redetermination. The facts1217 were stipulated. FINDINGS OF FACT. 1. The decedent, Thomas B. Scott, died testate on May 5, 1928, at the age of 64 years, a resident of Miller Place, Suffolk County, New York. 1225 2. The petitioners, Luis James Phelps and Thomas B. Scott, Jr., are the duly qualified and acting executors of the last will and testament of the decedent. 3. The decedent left him surviving his widow, Augusta May Scott, his son, Thomas B. Scott, Jr., and his daughter, Anne Scott Murphy. 4. Under date of October 14, 1925, the decedent created a trust naming his son, Thomas B. Scott, Jr., as primary beneficiary; the corpus of the trust possessed a value, as of the date of the decedent's death, of $120,008.20. In so far as material hereto the trust deed is as follows: Whereas the party of the first part [decedent] is now the owner and possessed of the personal property hereinafter described and is desirous of settling the same in the hands of trustees for the benefit of his son, Thomas Blythe Scott, Junior, and remaindermen, as in this instrument provided: Now this Indenture Witnesseth: That the said party of the first part in consideration of the premises and of the1218 sum of One Dollar to him in hand paid by the parties of the second part, the receipt whereof is hereby acknowledged, doth hereby sell, assign, transfer and set over unto the said parties of the second part and unto their successors and assigns the following described personal property, viz.: * * Second. Upon the death of said Thomas Blythe Scott, Junior, the Trustees shall pay over, assign and transfer the principal of the trust fund as it may then exist to such person or persons and in such share or shares either outright or in further trust as said Thomas Blythe Scott, Junior, may by his last will and testament admitted to probate in any State of the United States direct and appoint; or failing such appointment made as aforesaid the Trustees shall pay over, divide and distribute the principal of said trust estate as it may then exist to and among his descendants then living equally per stirpes and not per capita; or failing such descendants then to the other descendants of the party hereto of the first part then living equally per stirpes and not per capita; or failing such descendants then equally per stirpes and not per capita to such persons as would be under the laws1219 of the State of New York the next of kin of the party hereto of the first part had he died simultaneously with said Thomas Blythe Scott, Junior. 5. Under date of October 14, 1925, the decedent created a trust, naming his daughter, Anne Scott Murphy, as primary beneficiary; under date of October 6, 1927, the decedent transferred and added to the corpus of said trust, additional property which possessed a value as of the date of the decedent's death of $50,424.21; the corpus of the trust possessed a total value as of the date of the decedent's death of $170,447.63. Except for the name, the pertinent parts of this trust deed are identical with those quoted above. 6. Under date of May 3, 1927, the decedent created a trust naming his wife, Augusta May Scott, as primary beneficiary; the corpus of said trust possessed a value as of the date of the decedent's death of $128,470. Decedent and said Augusta May Scott were married in 1226 late April 1927; prior to their marriage the decedent agreed to create a trust fund for the benefit of said Augusta May Scott if she would marry him; the trust was created pursuant to the agreement. In so far as material hereto the trust deed1220 is as follows: Second. Upon the death of said Augusta May Scott, the Trustees shall pay over, assign and transfer the principal of the trust fund as it may then exist to such person or persons and in such share or shares either outright or in further trust as the Grantor may by his last will and testament admitted to probate in any state of the United States direct and appoint; or failing such appointment made as aforesaid the Trustees, having first deducted therefrom and retained or paid their lawful commissions, costs, expenses and charges incurred by them in the execution of the trusts hereby created, shall divide the residue of the principal of said trust estate into two equal parts or shares and shall assign, transfer, convey and dispose of the same as follows, viz.: One such equal part or share of the residue of the principal of this trust estate the said Trustees shall continue to hold during the lifetime and until the death of Ann Scott Murphy the daughter of the Grantor, if she be living at the time of the Grantor's death, in further trust to collect the income thereof (whether paid in cash or otherwise), and after deducting their legal commissions and all taxes which1221 may be levied and assessed thereon and all costs, expenses and charges which may be incurred by them in the execution of the trusts hereby created, shall apply the net income of said trust estate to the use of the said Ann Scott Murphy. Upon the death of said Ann Scott Murphy, the principal, if any, of the trust estate then held for her benefit hereunder shall be paid over, assigned and conveyed to her descendants then living equally per stirpes and not per capita, or failing such descendants then to Thomas Blythe Scott, Junior, son of the Grantor, or if he too be dead to his descendants then equally per stirpes and not per capita; or, failing such descendants then equally per stirpes and not per capita to such persons as would be under the laws of the State of New York the next of kin of the party hereto of the first part had he died intestate simultaneously with said Ann Scott Murphy. If said Ann Scott Murphy shall have died before said Augusta May Scott then and in that evdnt the one half part or share in the residue of the trust estate hereby created for the benefit of said Augusta May Scott shall be paid over, assigned and conveyed upon her death to the descendants then1222 living of said Ann Scott Murphy, equally per stirpes and not per capita, or failing such descendants then to Thomas Blythe Scott, Junior, son of the Grantor, or if he too be dead to his descendants then living equally per stirpes and not per capita; or, failing such descendants then equally per stirpes and not capita to such persons as would be under the laws of the State of New York the next kin of the party hereto of the first part had he died intestate simultaneously with said Augusta May Scott. The other one half part or share in the residue of the principal of the trust estate hereby created for the benefit of said Augusta May Scott shall, upon her death, be paid over, assigned and conveyed to said Thomas Blythe Scott, Junior, if living, or if he be dead to his descendants equally per stirpes and not per capita, or failing such descendants then to said Ann Scott Murphy, if living, or if she too be dead then to her descendants equally per stirpes and not per capita; or, failing such descendants then equally per stirpes and not per capita to such persons as would be under the laws of the State of New York the next of kin of the party hereto of the first part had he died intestate1223 simultaneously with said Augusta May Scott. 1227 7. Under date of October 6, 1927, the decedent made an absolute gift of personal property to his son, Thomas B. Scott, Jr., which possessed a value as of the date of the decedent's death of $50,424.21. 8. None of the transfers above enumerated were made in contemplation of death. 9. The ages of the respective primary beneficiaries of the above enumerated trusts, as of the date of the decedent's death, were as follows: Augusta May Scott45 yearsThomas B. Scott, Jr31 yearsAnne Scott Murphy33 years10. In determining the deficiency tax the respondent included in the gross estate the excess over $5,000 of the value of the property added to the trust of October 14, 1925, on October 6, 1927, Anne Scott Murphy, primary beneficiary, the excess over $5,000 of the value of the property given to Thomas B. Scott on October 6, 1927, and the excess over $5,000 of the value of the property constituting the corpus of the trust of May 3, 1926, Augusta May Scott, primary beneficiary; that no part of the original corpus of said trusts of October 14, 1925, naming the decedent's son and daughter as primary1224 beneficiaries, was included in the gross estate by the respondent in determining the deficiency. 11. In determining the deficiency the gross estate was valued at $2,099,514.85; deductions were allowed, including the specific exemption, in the sum of $593,104.47; the value of the net estate was determined to be $1,506,410.38, the tax upon the transfer of which was determined to be $89,076.93; the return filed on behalf of the estate disclosed a net estate of $1,297,054.49, and a total tax liability of $72,264.36. 12. The estate has paid to the State of New York transfer and inheritance taxes in the total amount of $61,886.90, and has paid to the States of Maine, Minnesota, Virginia and Wisconsin, on intangible personal property, total inheritance taxes in the sum of $5,288.37, and is entitled to a credit against the Federal estate tax on account thereof, pursuant to the provisions of section 301(b) of the Revenue Act of 1926, as amended by section 802 of the Revenue Act of 1932. OPINION. SMITH: The stipulated facts show that none of the several transfers was made in contemplation of death. On brief the respondent states that: 1225 In view of the decision of the Supreme Court in Donnan v. Heiner,52 Sup.Ct. 358, respondent concedes that the value of the property transferred by 1228 the decedent to his son on October 6, 1927, by absolute gift, as set forth in the stipulation of facts, paragraph numbered (7), is not subject to the estate tax and should, therefore, be excluded from the value of the gross estate. This leaves in issue the taxability of the corpus of the three trusts created by the decedent for the benefit of his son, daughter, and wife. No contention is made, and the trust deeds would not support such contention if made, that the trusts were revocable. Our question then is to determine whether there was a transfer "intended to take effect in possession or enjoyment at or after" decedent's death within the purview of section 302(c) of the Revenue Act of 1926. The respondent dwells much on the reversionary and remainder interests involved in the several trusts; and we have recently had occasion to consider exhaustively such possibilities under the New York law (applicable in this proceeding), and call attention to our decision in 1226 Elizabeth B. Wallace, Executrix,27 B.T.A. 902">27 B.T.A. 902. In creating the trusts for the benefit of his son and daughter, the decedent divested himself of all interest in the trust res, reserving to himself neither the reversion nor the right to dispose of the remainders after the termination of the precedent life estates. May v. Heiner,281 U.S. 238">281 U.S. 238, is authority for holding that the corpus of these trusts is not to be included in the decedent's gross estate. In creating the trust for the benefit of his wife, the decedent reserved to himself the right to dispose of the remainder upon the termination of the wife's life estate, and in the event of his failure to exercise that right of appointment, the remainder went to his descendants as provided in the trust deed. These provisions left the transfer incomplete and subject to tax. Saltonstall v. Saltonstall,276 U.S. 260">276 U.S. 260; Chase National Bank v. United States,278 U.S. 327">278 U.S. 327. The petitioners concede as much, but argue that: * * The retention of this power of appointment undoubtedly makes taxable the value of that remainder interest, that is to say, the1227 value of the full trust fund less the value at decedent's death of the widow's life interest. However, the widow's life interest is not taxable and for two reasons: A. The widow's life interest was not created by a transfer "intended to take effect in possession or enjoyment at or after (decedent's) death" (Act, Section 302c). It was created by the trust deed executed on 3 May, 1927, a year prior to death, and taking effect forthwith in possession and enjoyment. B. The creation of this life interest in the widow's favor was a "bona fide sale for an adequate and full consideration in money or money's worth" (Act, Section 302c). The consideration was the agreement made between Mr. Scott and his widow prior to their marriage that if she would marry him, he would create a trust for her benefit, an agreement faithfully carried out by both parties (Stipulation, Par. 6.) Under cases such as Ferguson vs. Dickson,300 Fed.Rep. 961, and McCaughn vs. Carver, 19 Fed.Rep.(2nd) 126, agreements such as this are held to satisfy the above quoted portion of the Act. 1229 The cited cases lend color to the petitioners' argument, which, however*1228 is amply substantiated by the facts. The decedent retained only the power to dispose of the remainder after the wife's life estate, and failing the exercise of that power, his descendants would receive the remainder upon the termination of the life estate. The wife's interest, that is her life estate, was irrevocably created in accordance with the antenuptial agreement, and vested in her at the time of the creation of the trust. The decedent's death did not in any way alter her interest. In these circumstances we hold that the stipulated value as of the date of the decedent's death of the corpus of the trust for the benefit of the wife, less the present value of her life estate on that date, should be included in the decedent's gross estate. Pursuant to the stipulation and in accordance with the provisions of section 301(b) of the Revenue Act of 1926, as amended by section 802 of the Revenue Act of 1932, there should be credited against the estate tax redetermined in accordance with this opinion, the amount of the inheritance taxes paid to the several states. Judgment will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625428/	JOSEPH S. WELLS ASSOCIATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Joseph S. Wells Asso. v. CommissionerDocket No. 54447.United States Board of Tax Appeals28 B.T.A. 271; 1933 BTA LEXIS 1145; June 6, 1933, Promulgated 1145 FAIR MARKET VALUE OF STOCK - FAILURE OF EVIDENCE TO OVERCOME PRESUMPTIVE CORRECTNESS OF COMMISSIONER'S DETERMINATION. - Where in 1928 the taxpayer exchanged stock which it owned in three certain corporations for stock in another corporation and returned for taxation a profit resulting from such transaction based on what was designated in the income tax return of the taxpayer as a trading price of $117 per share and the Commissioner accepted this figure as representing the fair market value of the stock in question in his determination of the deficiency, the correctness of the Commissioner's determination is not overcome by the testimony of expert witnesses that the stock had a fair market value of only between $25 to $30 per share, where an examination of the facts shows that such expert testimony is based upon a hypothetical question which furnishes inadequate information as to the factors which determine fair market value of stock. Percy W. Phillips, Esq., for the petitioner. F. B. Schlosser, Esq., and Bernard D. Hathcock, Esq., for the respondent. BLACK 271 OPINION. BLACK: Petitioner complains of a determination of a deficiency of1146 $177.54 in income tax for 1928 and in addition thereto claims an overpayment of tax in the amount of $2,475.27. 272 The petitioner is a corporation organized under the laws of the State of Utah. It was organized by the heirs of Joseph S. Wells for the purpose of holding together and administering certain securities owned by Joseph S. Wells after his death. The principal office and place of business of petitioner is Salt Lake City, Utah. During 1916 to 1924 petitioner acquired stock in three corporations at a total cost of $10,500. During 1928 it exchanged such stock and $53.10 in cash for 288 shares of stock in a fourth company, and $1,479.53 in cash. In its return for the year 1928 petitioner reported a profit on the exchange of $23,142.90, computed in Schedule B of the return as follows: Kind of PropertyDate Amount CostNet ProfitAcquiredReceivedOgden Gasoline Co. stock12/5/16$6,088.68$800.00$5,288.68Bennett Gasoline Co. stock12/5/169,600.002,000.007,600.00Ogden Paint Oil & Gl. Co. stock12/5/165,200.006/18/2417,954.222,500.0010,254.22Total23,142.90There also appears under1147 Schedule B of the return the following explanation: "(Received in exchange Bennett Glass and Paint Co. stock at trading price of 117.00 per share)." The respondent accepted petitioner's valuation of the 288 shares of Bennett Glass & Paint Co. stock as $117 per share, but determined that petitioner also should have included the cash received of $1,479.53 as a part of the sale price, which determination resulted in the deficiency herein of $177.54. No evidence was introduced by petitioner to the effect that it did not receive $1,479.53 in cash in the transaction. Hence we must regard respondent's determination as to that fact as being correct. Section 111(a) of the Revenue Act of 1928 provides that "the gain from the sale or other disposition of proporty shall be the excess of the amount realized therefrom over the basis provided in section 113 * ." Section 111(b) of the same act provides that the "amount realized from the sale or other disposition of property shall be the sum of any money received plus the fair market value of the property (other than money) received." Petitioner and respondent seem to agree that the proper basis to be used is the amount of $10,553.10; 1148 that respondent was correct in adding the amount of $1,479.53 to the sale price; that under section 112 of the Revenue Act of 1928 "the entire amount of the gain or loss, determined under section 111, shall be recognized"; and that none of the exceptions to such recognition mentioned in section 112 are applicable. 273 Petitioner, however, contends that both petitioner and respondent were in error in finding that the 288 shares in question had a "fair market value" of $33,696 (or $117 per share) when received by petitioner in 1928; that such stock did not have any fair market value, or, if it did, such value was not in excess of $30 per share and that there was no profit to petitioner in the transaction; and that petitioner is, therefore, entitled to a refund of all the taxes paid rather than liable for the deficiency determined by the respondent. The respondent's determination is prima facie correct and the burden of disproving it is upon petitioner. ; 1149 . In the effort to prove that respondent's determination was wrong, petitioner offered the testimony of Wallace F. Bennett, Edward L. Burton and a Mr. Adams. Bennett testified that he was secretary and treasurer of the Bennett Glass & Paint Co.; that he had been with the company since 1920; that he had no financial interest in petitioner; that his father organized the petitioner herein and has been the president of both petitioner and the Bennett Glass & Paint Co. since each was organized; that petitioner owned some stock in the Bennett Glass & Paint Co. and also some stock in three other companies, the Bennett Gasoline & Oil Co., Ogden Gasoline & Oil Co., and Ogden Glass & Paint Co.; that the two first named corporations had their offices in Salt Lake City and that the two last named corporations had their offices at Ogden, Utah; that the remaining stockholders of all four companies were principally the Bennett interests and W. R. Wallace; that the Bennett Gasoline & Oil Co. had been organized to take over the gasoline and oil business developed in its inception by the Bennett Glass & Paint Co.; that the operation of the last1150 two mentioned companies was had out of the same office with the Bennett Glass & Paint Co. doing the actual merchandise business of both companies; that the Bennett Glass & Paint Co. was, as its name signifies, engaged in the glass and paint business, principally at wholesale, and jobbing lubricating oils; that the latter company had a capital stock outstanding of 6,000 shares of the par value of $100 per share; that from 1923 to 1928, inclusive, its earnings averaged about $42,000 per year and during these years it paid a regular annual dividend of 6 percent or $36,000 a year; that from 1900 to 1928 there had been no sales of stock in any of the companies; that the stock in all the companies was closely held; that in 1928 it was agreed that petitioner and the Bennett family would take all the stock of the Bennett Glass & Paint Co. and the Wallace family would take all the stock of the other three companies; and that due to this agreement the Bennett Glass & Paint Co. lost gross 274 profit (the business it had had with the Bennett Gasoline & Oil Co.) of between $40,000 to $50,000 per year with only a compensating saving in salaries of between $14,000 to $15,000 per year. 1151 Burton testified that he had been in the investment banking and brokerage business in Salt Lake City for about 30 years; that he was fairly familiar with the market for unlisted stocks in 1928. The following hypothetical question was asked him by counsel for petitioner: The evidence in this case, Mr. Burton, shows that the Joseph S. Wells Association received 288 shares of the stock of the Bennett Glass & Paint Company in 1928; that the Bennett Glass and Paint Company had 6,000 shares of the par value of $100 each or a total capitalization of $600,000; that the earnings of that corporation for the period from 1923 to 1928, inclusive, had been approximately $7 per share or $42,000 a year; that the corporation had paid dividends of six per cent per year or $36,000 per year upon its capital stock from the year 1923 to 1928, inclusive; that at the time that the Joseph S. Wells Association received this stock of the Bennett Glass and Paint Company, the corporation was about to lose or surrender business which had produced a gross profit of between forty and fifty thousand dollars per year; that the savings anticipated by reason of the loss of this business were fourteen or fifteen thousand1152 dollars with perhaps some other minor savings which might be effected; that the testimony also showed that there had never been any sales of the stock of the Bennett Glass and Paint Company from the year 1900 to the year 1928, inclusive, and that the stock of the corporation had been held during all that time in a few hands - the hands of a very few people, mainly the Bennett and Wallace families, and that as a result of the transactions which took place in 1928, the Bennett family was acquiring the stock of the Bennett Glass and Paint Company. From these facts are you able to state whether or not 288 shares of the capital stock of the Bennett Glass and Paint Company could have been sold, and if so, for approximately what price such a sale could have been made? To this question, the witness answered he would not consider the stock worth over $25 or $30 per share marketwise; and that on account of the stock being closely held he did not believe the 288 shares could be sold at $30 per share to anyone other than Bennett or his family or some of the clerks within the organization. Adams did not appear at the hearing, but the parties stipulated that his testimony, if produced, would1153 be to the same effect as that given by Burton. The respondent introduced in evidence petitioner's income tax return for the taxable year involved, in which petitioner reported that it had "Received in exchange Bennett Glass and Paint Co. stock at trading price of $117 per share." Has petitioner overcome the prima facie determination of the respondent? We think not. Fair market value has been defined as "the cash price at which a seller willing but not compelled to sell and a buyer willing but not compelled to buy, both having reasonable 275 knowledge of all the material circumstances, will trade." , and cases therein cited. In the instant case, two separate and distinct interests, namely, petitioner and the Wallace interests, both dealing at arm's length, effected a transfer of stocks in which the Bennett Glass & Paint Co. stock was received by petitioner "at a trading price" of $117 per share. For the six years previous thereto this stock having a par value of $100 per share had been earning 7 percent and had paid a regular annual dividend of 6 percent. 1154 Notwithstanding these facts and the further fact that the corporation in question was a business of long standing and well established, petitioner asks us to find on the basis of Burton's and Adams' testimony that the stock did not have a fair market value of more than $30 per share. The Board is not bound to accept at face value the testimony of expert witnesses, if such testimony is contrary to the best judgment of its members. ; ; ; ; and . It is true that the testimony shows that by reason of the rearrangement of business interests between the Wallaces and the Bennetts, the Bennett Glass & Paint Co. lost from $40,000 to $50,000 gross business which it had previously had with the Bennett Gasoline & Oil Co., with an ability to effect a corresponding saving in salaries of between $14,000 to $15,000 annually. But this fact was1155 clearly known to all of the parties when they arrived at a "trading value" of $117 per share. It must therefore be assumed that in arriving at the fair market value of the stock in question due allowance had already been made for the loss of business, which seemed to be the principal factor considered by Burton in arriving at his opinion of value. Burton, in answering the hypothetical question put to him, knew nothing concerning the assets owned by the Bennett Glass & Paint Co., nor the gross annual business done. Ever since the enactment of the Revenue Act of 1924, Congress has provided that "In determining the fair market value of stock in a corporation as of March 1, 1913, due regard shall be given to the fair market value of the assets of the corporation as of that date." See sections 204(b) of the Revenue Acts of 1924 and 1926, section 113(b) of the Revenue Act of 1928, and section 113(a)(13) of the Revenue Act of 1932. Although Congress has not made the same requirement in valuing stock in a corporation as of a time other than March 1, 1913, yet it is a factor that might well have been considered in the instant case. As we have already pointed out, Wallace F. Bennett, 276 1156 secretary and treasurer of the Bennett Glass & Paint Co., testified at the hearing, but he gave no testimony concerning the assets of the company which were behind the stock, and which would under ordinary circumstances to some extent at least determine its fair market value. Cf. . We have also pointed out, that the company was capitalized at $600,000 and the witness gave no evidence that the capital was impaired at the time we are asked to find that stock having a par value of $100 per share, and paying an annual dividend of $6 per share, had only a fair market value of $30 per share. Nor did he give any testimony that this loss in gross profits due to the loss in gasoline and lubricating oil business was not made up in some other way, nor did he give any testimony that this loss in business caused the corporation thereafter to operate on a nonprofit basis and to cease its payment of dividends or even to reduce them. What the situation was in that respect, we do not know. What we do know is that for six years, including the year 1928, the taxable year which is before us, the corporation had paid a dividend of 6 percent*1157 on a par valuation of $100 per share. To say that a stock in a well established business, which for the six preceding years had paid an annual dividend of 6 percent on its par value, and which was actually exchanged at a "trading value" of $117 per share, according to the statement made in petitioner's own income tax return, and with no evidence that the capital of the corporation had become impaired, had a "fair market value" on the date of the exchange of only $30 per share, seems to us unreasonable and contrary to the actual conditions and circumstances of the case, and we feel compelled to hold that the evidence introduced by petitioner is insufficient to overcome the prima facie correctness of the determination made by the respondent. It follows that the determination made by the respondent must stand. Reviewed by the Board Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625430/	WALTER E. KRAMER, EXECUTOR, ESTATE OF JULIUS KRAMER, DECEASED, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. OLGA R. KRAMER, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. JACOB L. SCHNADIG, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Kramer v. CommissionerDocket Nos. 47247, 47329, 58943, 59191, 62842, 62843.United States Board of Tax Appeals27 B.T.A. 1043; 1933 BTA LEXIS 1256; April 3, 1933, Promulgated 1256 1. In 1926 one of the petitioners owned an undivided two-thirds interest, and another an undivided one-third interest, in certain real estate which was sold in said year for a total lump sum or undivided consideration of $450,000, consisting of $200,000 cash and a mortgage note for $250,000. Prior to the sale, the petitioners agreed that one should take $50,000 of the cash and the mortgage note for $250,000, and that the other should take $150,000 of the cash. Held, that the owner of the two-thirds interest received an initial payment in excess of one-fourth of the purchase price, and that the transaction was not an installment sale within the meaning of section 212(d) of the Revenue Act of 1926. 2. Certain deductions claimed as business expenses, and for exhaustion of alleged contractual rights to receive royalties, disallowed on the facts. Paysoff Tinkoff, Esq., for the petitioners. Chester A. Gwinn, Esq., for the respondent. TRAMMELL 1043 OPINION. TRAMMELL: These are consolidated proceedings for the redetermination of deficiencies in income tax as follows: PetitionerDocket No.YearDeficiencyJulius Kramer473291924$5,685.221925634.88192629,370.4659191192818,943.456284219291,010.29Olga R. Kramer628431929131.87Jacob L. Schnadig4724719242,473.005894319286,038.251257 The petitioner, Olga R. Kramer, agreed at the hearing that the deficiency determined against her by the respondent in Docket No. 62843 is correct, and that judgment may be entered accordingly. At the hearing, counsel for the petitioners suggested the death of the petitioner, Julius Kramer, and moved that Walter E. Kramer, executor of the estate of said decedent, be substituted as petitioner. which motion was granted. 1044 The issues submitted for decision are: (1) Whether or not the petitioners are entitled to deductions for exhaustion of alleged contractual rights to receive royalties from patents pooled under the terms of a certain contract dated November 3, 1916; (2) whether or not the petitioners are entitled to deduct from income for 1924 certain amounts refunded in that year to a corporation of which Julius Kramer and Schnadig were the sole directors and which amounts represented dividends unlawfully paid out of the corporation's capital; (3) whether or not amounts distributed to Julius Kramer and Schnadig in 1924 and 1925 from reserved royalties should be included in income for said years; (4) whether or not the petitioners are entitled to deduct from income1258 for 1924 amounts paid to repurchase stock from a former manager of a corporation of which said Kramer and Schnadig were directors; (5) whether or not the estate of Julius Kramer is entitled to deduct from income of said decedent for the years 1924, 1925 and 1926 amounts paid by said decedent to his son Walter E. Kramer for services rendered by the son during said years to a corporation whose stock was then owned by Julius Kramer and Schnadig; (6) whether or not the sale by Julius Kramer in 1926 of his two-thirds undivided interest in certain real estate was an installment sale within the meaning of section 212(d) of the Revenue Act of 1926; and (7) whether or not the petitioners are entitled to deduct from income for 1928 any amounts as representing losses on the sale in said year of the capital stock of the Davoplane Bed Company. The first issue for consideration here is whether or not the petitioners are entitled to deductions for exhaustion of alleged contractual rights to receive royalties under a certain pooling contract dated November 3, 1916. The petitioners claim that said rights were acquired on December 16, 1916, under the following circumstances: In November, 1906, 1259 Julius Kramer and Schnadig purchased stock in the Pullman Couch Company, a corporation organized in January, 1906, which was engaged in manufacturing couches and Turkish rockers. In 1907, the Pullman Couch Company acquired for $2,500 cash certain patents, known as the "Bostrom patents," covering davenport beds of folding steel construction inside of a wooden frame. These patents proved to be very valuable. In January 1910, a corporation known as the Davoplane Bed Company was organized for the purpose of holding the Bostrom patents, and its stock was issued one-third to one Kroehler and two-thirds to Julius Kramer and Schnadig. Just prior to that time Julius Kramer appears to have been the sole owner of the three Bostrom patents, and that he paid said patents in to the Davoplane Bed Company in exchange for 1,498 shares of its capital stock out 1045 of a total of 1,500 shares, one-third of which stock was then transferred to Kroehler for 10 shares of stock which he held in the Pulman Couch Company. It is not shown when or in what manner Julius Kramer acquired the Bostrom patents from the Pullman Couch Company prior to the organization of the Davoplane Bed Company in January, 1260 1910, except that he acquired said patents "as trustee" for the purpose of forming the Davoplane Bed Company. Infringement litigation was instituted by the Davoplane Bed Company for the purpose of establishing the validity of its Bostrom patents, which litigation was terminated in favor of said company by a decision of the United States Circuit Court of Appeals for the Seventh Circuit on April 18, 1916. . As a result of the establishment of the validity of the Bostrom patents, a pool was formed in November 1916, of numerous patents, including the Bostrom patents, relating to the construction of folding davenport beds and similar devices. On November 3, 1916, a written agreement was entered into between the owners of the various patents mentioned, which provided for the granting of an exclusive license to the Seng Company (which had formerly held a license from the Pullman Couch Company under the Bostrom patents) to manufacture and sell under all of said pooled patents, the specified royalties to be divided in stated proportions among the parties to said agreement. Of the total amount of said royalties, 33 per cent1261 was allotted to the Pullman Couch Company as the share of the Kramer-Schnadig group. The pooling contract also provided that each party or group should have a free shop right or license, and pursuant to this provision the free shop right to which the Kramer-Schnadig group was entitled was given to the Pullman Couch Company. On December 16, 1916, a meeting of the directors of the Pullman Couch Company was held, at which a resolution was adopted directing its officers to execute an assignment or order to the Seng Company, the licensee under the pooled patents, directing said licensee to pay to Julius Kramer and Schnadig all royalties due or to become due to the Pullman Couch Company under the pooling agreement. The license contract of November 3, 1916, was signed by the Davoplane Bed Company and also by the Pullman Couch Company, as well as by Julius Kramer and Schnadig, individually. The Pullman Couch Company "submitted" 13 patents to be controlled by the pool agreement, including two of the Bostrom patents, and the Davoplane Bed Company "submitted" 7 patents, including one of the Bostrom patents. Julius Kramer likewise "submitted" one patent. 1046 The foregoing facts, 1262 summarized from the evidence adduced by the petitioners, do not disclose the circumstance attending the numerous transfers of the Bostrom patents during the period from 1906 to 1916. Shortly after 1906 it is indicated that said patents had been acquired by Julius Kramer and Schnadig, and transferred to the Pullman Couch Company. In the early part of 1910, it is shown that Julius Kramer was the sole owner of said patents and paid them in to the Davoplane Bed Company in exchange for substantially all of its capital stock. In March 1913, petitioner's counsel states that the Bostrom patents "technically belonged to the Pullman Couch Co." but that Kramer and Schnadig owned all of the stock of that company. On November 3, 1916, we find two of the patents being submitted to the patent pool by the Pullman Couch Company and one of them submitted by the Davoplane Bed Company. The record fails to disclose why the entire 33 per cent of the total royalties accruing to the patent pool should have been assigned to the Pullman Couch Company instead of being divided between that company, the Davoplane Bed Company and Julius Kramer in proportion to the number or value of the patents contributed1263 to the pool by each. However, it is clearly established that in 1916 said patents were not owned directly either by Julius Kramer or by the petitioner Schnadig. Those individuals owned all the capital stock of the Pullman Couch Company and a majority of the Davoplane Bed Company, which corporations owned all the patents contributed to the pool by the Kramer-Schnadig group except one patent submitted by Julius Kramer. On December 16, 1916, Julius Kramer and Schnadig, who were the sole stockholders and directors of the Pullman Couch Company, caused that corporation to assign and transfer to them its right to receive the royalties from the patent pool. However, they were already entitled to receive those royalties from the corporation as dividends on their stock. Instead of permitting the corporation to receive the royalties and then pay the same over to them in the form of dividends, they caused the corporation to assign the royalties to them directly. This cutting of corners did not fundamentally change the situation and the amounts which constituted royalty payments to the corporation constituted dividends when assigned to and received by the stockholders. Under these circumstances, 1264 the so-called "contractual rights" of the petitioners to receive the corporation's royalties did not, in our opinion, give rise to a capital asset in respect of which amortization or exhaustion deductions are allowable. The petitioners contend that they are entitled to exhaustion deductions on the basis of the value of the alleged contractual rights 1047 at the time of acquisition in 1916, apparently on the theory that the assignment of the corporation's royalties to them constituted a gift. The petitioners offered evidence to establish the value at said date as distinguished from cost. It is to be observed, however, that the contract which gave rise to the royalty payments to the corporation was not assigned, but only the right to receive the payments under the contract still held by the corporation. There is no evidence that the corpus or res which gave rise to the right of the corporation to the royalties was assigned to the stockholders. The corporation merely directed that the royalties which it was entitled to receive be paid directly to its stockholders. We are unable to distinguish this situation in principle from the principle set forth1265 in the line of decisions of which a typical example is (certiorari denied, ). In that case, the plaintiff railroad company leased its properties to a second company which agreed to pay as rental, among other things, interest upon bonds of the lessor, and to pay directly to the lessor's stockholders amounts equal to dividends upon their stock at the rate of 8 per cent per annum. The court held that the amounts so paid directly to the lessor's stockholders as rental must be treated as corporate income of the lessor subject to taxation, and that as between the lessor and the stockholders these amounts constituted dividends. The court further pointed out that the provision for payment directly by the lessee was a mere labor-saving device. See also , and other decisions therein cited to the same effect. In the instant case, the resolution of the directors under which the corporation's royalties were paid directly to its stockholders instead of through the corporation would not have the effect of changing1266 the rights of the stockholders. Before the resolution was adopted, the stockholders had the right to receive as dividends the royalty payments to the corporation. After the resolution the stockholders in legal effect were in no different position, under the above cited decisions. What the stockholders received were still dividends. The right to receive dividends does not constitute a capital asset which may be made the subject of amortization deductions. Another contention of the petitioners is that the right to receive the royalties was given by the corporation to its stockholders for prior services and for certain patent rights yielded up to the corporation; that under these circumstances the right to receive the royalties became a valuable property right which is subject to amortization allowances. But even considering without deciding that the right to receive the royalties to which the corporation was 1048 entitled constituted "property," it was acquired after March 1, 1913, and in respect to property so acquired the basis for exhaustion allowances is cost. Section 204(c) of the Revenue Acts of 1924 and 1926. 1267 And there is in the present record no evidence of the cost of such "property." The cost of property is what is given for it. In this case what is claimed to have been given for the alleged contractual rights were services and patent rights, but the evidence does not establish the value of either. The contentions of the petitioners can not be sustained, and the action of the respondent on this issue is approved. ; . The second issue is whether or not the petitioners are entitled to deduct from income for 1924 certain amounts refunded in that year to a corporation, in the following circumstances: Julius Kramer and Schnadig were stockholders and directors of the Chicago Mail Order Company from 1916 to 1925. Prior to 1924 the board of directors of that company authorized the distribution to stockholders of dividends out of the corporation's capital. On being advised by counsel that such distributions were illegal and that the directors were personally liable on that account, both civilly and criminally, Kramer and Schnadig repaid to the corporation in 1924 the amounts of1268 such dividends received by them and the members of their families. The amount so refunded by Julius Kramer in 1924 was $41,036.24. The amount so refunded by Schnadig in 1924 was $45,353.53. The petitioners claim that these refunds are deductible from income for 1924 as losses sustained in that year. The respondent contends that the amounts constituted contributions to the capital of the corporation, and therefore are not deductible as losses in the year in which paid. We have consistently held in a long line of decisions that assessments levied upon stockholders on account of the impairment of a corporation's capital represent additional investments in the capital stock and are not deductible as losses. See the following cases and decisions therein cited: ; affd., ; . We can see no good reason why the rule announced in the cited cases should not be applicable here. It is not controlling, we think, that in the instant case the capital of the corporation was impaired through mistake or ignorance of its directors and that they may or may not have been criminally1269 liable for such acts. When the dividends were declared and paid out of capital, the capital of the corporation was impaired, and the value of the stock owned by the petitioners was lessened; when the funds were repaid to the corporation in 1924, the impairment and value of the capital stock were to that extent restored. The investment of the petitioners in the 1049 capital stock was increased by these amounts. The action of the respondent in disallowing the deductions claimed is approved. The third issue raised the question whether or not the amounts of $2,310 and $2,714.54 received by Julius Kramer in the years 1924 and 1925, respectively, and the amount of $2,310 received by Schnadig in 1924, from reserved royalties in the hands of the licensee see under the pooling contract of November 3, 1916, constituted taxable income. The correctness of the respondent's action in including these items in income was conceded by the petitioners in their reply brief filed herein on January 3, 1933. Respondent's action on this point is, therefore, approved. Issue (4) involves the question whether or not petitioners may deduct from income for 1924 amounts paid by Julius Kramer1270 and Schnadig in connection with the repurchase of stock of the Chicago Mail Order Company from a former manager of that company. The record shows that prior to 1924, one Benjamin Strauss was employed as manager of the Chicago Mail Order Company, and that his services proved to be unsatisfactory. At the time of his employment Strauss purchased from the corporation some stock then held in its treasury, and in order to terminate his connection with the corporation, his stock was repurchased by the corporation in 1924 and returned to its treasury. Julius Kramer and Schnadig each paid to the corporation in 1924 the amount of $5,147.97 to cover the alleged loss sustained by the corporation in that transaction. The petitioners assert that these expenditures were made by the stockholders to protect their business interests and are deductible from 1924 income as business expenses. The respondent urges that the expenditures were in the nature of capital investments in the stock of the company, and are not allowable as deductions. We have held that where a taxpayer makes an expenditure to promote or to protect his business, which is directly connected with or proximately results from1271 his business, and no capital asset is acquired thereby, such expenditure is deductible as a business expense. See ; also , and . The principle applied in those cases, however, is not, we think, applicable here on the facts. It does not appear in the instant case that the expenditures in question were made either to promote or to protect the business interests of the stockholders. It is not clear that the corporation sustained any loss in connection with the transaction in question. If it did sustain such loss, it was prior to 1924 when it sold the treasury stock to Strauss, and the amount probably was not the same as the alleged loss for which the corporation was 1050 reimbursed in 1924 by Kramer and Schnadig. The corporation suffered no loss by the act of repurchasing its stock from Strauss, even though the price at which the stock was so repurchased was in excess of the price at which it was sold. Whether or not the corporation ultimately would sustain a loss or derive a profit on the stock repurchased could not be1272 determined until the stock was finally sold again and a completed transaction effected. Apparently Kramer and Schnadig considered that the corporation had sustained a loss by reason of the fact that it repurchased its stock at a greater price than that at which it was originally sold to Strauss. On this point Schnadig testified as follows: A. Well, we hired a very good man by the name of Benjamin Strauss, and in order to obtain his services, we sold him some stock at a certain figure. The high-grade gentleman did not turn out so wonderful as he was supposed to be. In order to let him go, and clean up the indebtedness that he had against the corporation, and the stock had shrunk to a certain extent, and the directors having made the arrangement, we felt it was our duty under those circumstances - this stock had been taken out of the treasury stock, and it would go back into the treasury stock at a loss, and again we were told we did not do the proper thing, so we put the stock back, and put the difference in money back. Obviously it was not necessary for Julius Kramer and Schnadig to reimburse the corporation for its supposed loss in order to protect their business interests. 1273 Whatever menace, if any, Strauss may have been to the business, his connection with the corporation had been severed when his stock was repurchased by the corporation, and the subsequent payments made by Kramer and Schnadig to the corporation representing the difference between the original sale price and the repurchase price of the stock can not be regarded as having been made by them to protect their interests in the corporation against injury by Strauss. It is unnecessary for us to determine here whether the payments constituted gifts to the corporation, or represented additional investments in its capital stock. In the circumstances shown, we think they are not allowable as deductions from gross income of the petitioners for 1924 as business expenses. Under issue (5) the estate of Julius Kramer, deceased, seeks to deduct from income for the years 1924, 1925 and 1926 amounts paid in those years by the decedent to his son, Walter E. Kramer, for services rendered to the Pullman Couch Company. In 1924 Julius Kramer was receiving a salary of $30,000 per year from the Pullman Couch Company, and in December of that year his son. Walter E. Kramer, was employed by that company. 1274 The son rendered services to the company during the month of December 1924, and during the years 1925 and 1926. He was paid a salary of 1051 $125 per month, and gave his entire time to the company. His salary was paid by his father, Julius Kramer. The petitioners contend that the amounts so paid are deductible from the income of Julius Kramer as business expenses on the principle discussed under the preceding issue, that is to say, that Julius Kramer was moved to pay his son's salary in order to promote or to protect his own business interests. The respondent takes the position that the amounts in question represent gifts from the father to the son, and are not deductible. Again, we think, the contention of the petitioners must be denied on the facts. Not only does the record fail to disclose that the payments were made by Julius Kramer to promote or to protect his business interests, but quite the contrary is indicated by the following testimony of the witness Schnadig: A. * * * Mr. Kramer and myself had been drawing the same amount of pay all the time that we had been together. We practically drew the same amount in salary out of those firms. Walter Kramer1275 got out of school, and he had been there, he had been working a very short time and his services were not so valuable as he thought they were, and Mr. Walter Kramer promptly got married, and he needed more money. And we discussed it, and Mr. Kramer says, "Well, I don't think it is fair to give him money he is not entitled to." He says, "But he is going to work for the Pullman Coach Company as hard as he can," and he says, "Instead of giving it to him from the firm," he says, "I will take part of my salary off, and you pay it to him." That was about the substance of it. In the absence of evidence reasonably tending to show that the amounts claimed as deductions were in fact business expenses incurred and paid as such by Julius Kramer, the respondent's action on this issue is approved. Issue (6) presents the question whether or not the sale by Julius Kramer in 1926 of his two-thirds undivided interest in certain real estate was an installment sale within the meaning of section 212(d) of the Revenue Act of 1926, which provides that a taxpayer may return as income in any taxable year from a sale of real estate, where the initial payments do not exceed one-fourth of the purchase1276 price, that proportion of the installment payments actually received in that year which the total profit realized, or to be realized when the payment is completed, bears to the total contract price. In March 1916, Julius Kramer and Schnadig purchased a piece of real estate located at 63d Street and Ashland Avenue, in the city of Chicago, for $139,290.07. Julius Kramer took title to the property, and in November 1916, deeded an undivided one-third interest therein to Schnadig. In 1926 said Kramer and Schnadig sold the property by one contract of sale to a single purchaser for the total consideration of $450,000, of which $200,000 was paid in cash and the 1052 balance in deferred payments evidenced by mortgage notes in the amount of $250,000. The net profit realized by Kramer and Schnadig on the sale of this real estate amounted to $298,621.42, two-thirds of which is applicable to Julius Kramer and one-third to Schnadig. The contract for the sale of the real estate in question was executed under date of August 24, 1926. Prior thereto (on August 15, 1926), Julius Kramer and Schnadig executed a written agreement in which it was recited, among other things, that an offer1277 had been received from one Mecklenburg (who subsequently executed the contract of October 24, 1926) to purchase this property in its entirety for the total consideration of $450,000, of which $200,000 was proposed to be paid in cash and a mortgage given for $250,000, title to the whole property to be conveyed in one deed; and further that Schnadig "was anxious to accept this offer, as this would relieve his financial embarrassment." In this situation and because of other matters referred to thereon, Julius Kramer consented to accept the offer for his two-thirds undivided interest in the property on the express understanding that the sale should be regarded as a separate sale by each party of his respective undivided interest; that of the total consideration to be paid, Kramer should receive $300,000 as follows: $50,000 cash and "a $250,000.00 note, Secured by a Mortgage on said Property," and that Schnadig should receive for his undivided one-third interest $150,000 in cash. There is no controversy between the parties respecting the proportions in which the total profit derived should be allocated to Kramer and Schnadig. In fact, the respondent concedes, and so stipulated at the1278 hearing, that two-thirds of the total profit is applicable to Julius Kramer and one-third to Schnadig. The sole question is whether or not the sale by Kramer of his two-thirds undivided interest was an installment sale within the purview of the statute. At the time of the sale the real estate in question was held by Julius Kramer and Schnadig in joint possession by several and distinct titles. The only unity was that of possession. This constituted them tenants in common. ; ; ; ; ; . Each party sold his undivided interest in the real estate, which was what he owned and held title to. The two undivided interests constituting the whole fee were sold for a lump sum or total undivided consideration of $450,000, consisting of $200,000 cash and a mortgage of $250,000. Mecklenburg did not agree in the contract of purchase and sale to buy Julius Kramer's undivided two-thirds 1053 interest for a certain consideration1279 and Schnadig's undivided one-third interest for a different consideration. The contract provided for the purchase by Mecklenburg and the sale by Julius Kramer and Schnadig of the whole fee for a specified total consideration. When the sale was consummated and the total purchase price paid over in accordance with the terms of the contract, two-thirds of the proceeds of the sale belonged to Julius Kramer and one-third to Schnadig. The interest of each party in the total proceeds of sale was the same as their respective interests in the real estate sold. Two-thirds of the cash payment of $200,000 and a two-thirds interest in the mortgage note of $250,000 belonged to Julius Kramer, and a one-third interest belonged to Schnadig. It is immaterial that they had agreed beforehand to apportion the proceeds of sale between them in different proportions. Their agreement of August 15, 1926, concerning the amount of cash to be taken by each obviously did not attach until the proceeds of sale had been received from Mecklenburg, and at the instant of receipt their respective interests therein were the same as they had been in the real estate. The effect of the agreement was merely to provide1280 that Schnadig should have the right to exchange his interest in the mortgage note for a part of Kramer's cash, or that Kramer should purchase Schnadig's interest in the note for an equivalent amount of cash. If the parties had exchanged their real estate for other real property instead of cash and notes, their respective interests in the property acquired would have been the same as in the property exchanged, even if they had previously agreed that immediately upon the acquisition of the new property it would thereupon be divided among them or that one would take the whole property and compensate the other for his interest therein. If Mecklenburg had agreed in the contract of purchase and sale to give Julius Kramer $50,000 cash and a mortgage note for $250,000 for his undivided two-thirds interest in the real estate, a wholly different situation would be presented, but, as above pointed out, this was not done. Under the facts disclosed here, we must hold that the initial payment made by Mecklenburg to Julius Kramer for his undivided two-thirds interest exceeded one-fourth of the purchase price, and that the transaction was not an installment sale within the meaning of the1281 statute. The respondent's action on this issue is approved. The seventh and last issue is whether or not the petitioners are entitled to deduct from gross income for 1928 amounts representing losses on the sale in that year of stock in the Davoplane Bed Company. Julius Kramer and Schnadig each sold stock of the company 1054 in that year to Walter E. Kramer for $25. The number of shares of stock so sold by Julius Kramer was 200. The number of shares sold by Schnadig is not definitely shown, although each apparently sold the same number, since the loss of each is claimed to be the same. Petitioners contend that the stock had a fair value at March 1, 1913, of $36,000 or $180 per share, and that, when it was sold in 1928 for $25, each of the parties sustained a deductible loss in the amount of $35,975. The evidence on this point is incomplete, indefinite and in some particulars contradictory. It is shown that Julius Kramer acquired all the stock of the Davoplane Bed Company, except two qualifying shares, in 1910 in exchange for the Bostrom patents, of which he was then the sole owner according to evidence adduced by the petitioners at the hearing. It is further shown1282 that the stock was divided between Kroehler, Kramer and Schnadig, apparently one-third to each, and that in 1928 Julius Kramer and Schnadig each sold 200 shares to Walter E. Kramer for $25. The Davoplane Bed Company acquired the Bostrom patents in 1910 in exchange for its capital stock having a par value of $15,000, and Schnadig testified that said company had no other asset. No money was paid in to the company at the time of organization. Schnadig also testified that the Davoplane Bed Company still retains title to the Bostrom patents and improvement patents thereon; yet two of the three Bostrom patents were "submitted" to the patent pool in 1916 by the Pullman Couch Company, and all royalties due to the Kramer-Schnadig group (both corporations and individuals) on account of patents contributed to the pool, were assigned to the Pullman Couch Company. The pooling agreement of November 3, 1916, to which the Davoplane Bed Company was a party, discloses that said company "submitted" seven patents, including only one of the Bostrom patents, issued in various years from 1907 to 1915, there being two patents issued in each of the years 1914 and 1915. The patents issued in 1914 and1283 1915 had not expired in 1928, but whether the Davoplane Bed Company owned those patents, or any of them, in 1928 is not definitely shown. The last Bostrom patent expired in 1924, and apparently thereafter the Davoplane Bed Company had no asset of any kind. If it did have any asset after that year, neither the nature of such asset nor its value is established by the record. It is clearly shown, however, that the Davoplane Bed Company did not engage in active operations after November 3, 1916; that about that time it assigned its right to receive royalties under the patents owned by it, and never thereafter received any income. In the light of these facts, it would appear very doubtful whether the stock of the Davoplane Bed Company 1055 had any value in 1928. Certainly we can not affirmatively say from the evidence that this stock did have any value in that year. The respondent disallowed the deductions claimed under this issue on the ground that the stock of the Davoplane Bed Company became worthless in 1924, and hence that no value remained to be lost on the sale of the stock in 1928. In our opinion, the petitioners have not met the burden of proving by a preponderance1284 of the evidence that his determination was erroneous. Respondent's action, is, therefore, approved. In Docket No. 62843 judgment will be entered for the respondent. In Docket Nos. 47247, 47329, 58943, 59191 and 62842 judgments will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625431/	ESTATE OF REXFORD H. FOSTER, Deceased, MARGARET FOSTER, Executrix, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentEstate of Foster v. CommissionerDocket No. 16900-80United States Tax CourtT.C. Memo 1983-77; 1983 Tax Ct. Memo LEXIS 708; 45 T.C.M. (CCH) 679; T.C.M. (RIA) 83077; February 7, 1983. Joseph P. Reynolds, for the petitioner. Kenneth Bersani, for the respondent. WILBURMEMORANDUM OPINION WILBUR, Judge: Respondent determined a deficiency of $27,147.20709 in petitioner's Federal estate tax. The sole issue for our determination is whether a testamentary disposition benefiting decedent's spouse qualifies for the marital deduction under section 2056. 1This case was submitted fully stipulated pursuant to Rule 122. The stipulation of facts is incorporated by this reference. Margaret Foster, executrix of the Estate of Rexford H. Foster, resided in Georgetown, New York, when the petition in this case was filed. Rexford H. Foster (decedent) owned and operated a dairy farm in Madison County, New York. Decedent's will, dated April 2, 1963, 2 reads in pertinent part: Second. I give and bequeath to my wife, Margaret Foster, the use, income and profits, of and from, all my personal property, including the dairy livestock and the farm machinery and equipment, 710 for and during her lifetime, with the right to use so much of the principal thereof for her needs and the needs of my children as she in her discretion may deem necessary, and on her death I give all of such property then remaining to my children equally. Decedent died on November 21, 1977. On November 28, 1977, the Surrogate's Court of Madison County issued letters testamentary appointing decedent's wife as executrix of his estate. On its estate tax return, petitioner claimed a marital deduction in the amount of $137,143.05 in respect of the interest in property passing to decedent's wife (Mrs. Foster) pursuant to that portion of decedent's will quoted above. Respondent disallowed the deduction. We must determine whether Mrs. Foster's power to invade principal constitutes a general power of appointment within the meaning of section 2056(b)(5). If so, the parties agree that decedent's estate is entitled to a marital deduction pursuant to section 2056. 3711 To satisfy the requirements of section 2056(b)(5), a surviving spouse must have a power to appoint the interest to herself or her estate or both. See section 20.2056(b)-5(g)(1), Estate Tax Regs. A power of invasion qualifies under section 2056(b)(5) if it is unlimited, i.e., if "the surviving spouse [has] the unrestricted power exercisable at any time during her life to use all or any part of the property subject to the power, and to dispose of it in any manner, including the power to dispose of it by gift (whether or not she has the power to dispose of it by will)." Section 20.2056(b)-5(g)(3), Estate Tax Regs. See section 20.2056(b)-5(g)(1)(i), Estate Tax Regs. New York law determines whether Mrs. Foster's power of invasion is sufficiently unrestricted so as to qualify as a general power of appointment. Morgan v. Commissioner,309 U.S. 28">309 U.S. 28 (1940); Estate of Smith v. Commissioner,79 T.C. 974">79 T.C. 974 (1982). Decedent's will gave Mrs. Foster "the right to use so much of the principal [of decedent's personal property, dairy livestock, and farm machinery and equipment] for her needs and the needs of [decedent's] children as she in her discretion712 may deem necessary * * ." Petitioner argues that Mrs. Foster's power to consume principal was not limited by an ascertainable standard and, thus, constitutes a general power of appointment. Respondent, on the other hand, contends that Mrs. Foster's power to consume principal does not constitute a general power of appointment. We need not decide whether, as petitioner contends, the word "needs" should be given an expansive interpretation or whether, as respondent argues, Mrs. Foster's power to invade is limited to that required for support and maintenance after first taking into account the beneficiaries' other income. It is clear under New York law that a spouse's broad lifetime power of invasion to use the principal, but with remainder over, does not qualify as a general power of appointment for the purpose of section 2056(b)(5). United States v. Lincoln Rochester Trust Company,297 F.2d 891">297 F.2d 891 (2d Cir. 1962); May's Estate v. Commissioner,283 F.2d 853">283 F.2d 853, 855 (2d Cir. 1960), affg. 32 T.C. 386">32 T.C. 386 (1959); Estate of Opal v. Commissioner,54 T.C. 154">54 T.C. 154, 165-166 (1970), affd. 450 F.2d 1085">450 F.2d 1085 (2d Cir. 1971); Estate of Schildkraut v. Commissioner,T.C. Memo. 1965-239,713 affd. on this issue 368 F.2d 40">368 F.2d 40, 44 (2d Cir. 1966); Allen v. United States,242 F. Supp. 687">242 F. Supp. 687 (E.D.N.Y. 1965), affd. on other grounds, 359 F.2d 151">359 F.2d 151 (2d Cir. 1966); Betts v. United States,239 F. Supp. 444">239 F. Supp. 444 (N.D.N.Y. 1965). 4Even assuming arguendo that Mrs. Foster can use and consume the principal without limitation, she cannot appoint the property to herself and at her death the remaining property passes to decedent's children. As the Second Circuit said in United States v. Lincoln Rochester Trust Company,supra, a case in which the surviving spouse was given the right "to use any part of the principal" of the estate (297 F.2d at 892): While the widow might consume the principal, she might only do714 so in good faith, and had no power to dispose of any portion not consumed, by gift or appointment to herself or others, by instrument intervivos or will, disposition of any portion not so consumed being governed by testator's will. We adhere to the ruling in May's Estate that this is not a power exercisable in all events. [297 F.2d at 893. Emphasis in original.] Petitioner argues that the Surrogate's Court, Madison County, New York, has allowed the marital deduction. We cannot, however, automatically accept the Surrogate's Court's decision. Commissioner v. Estate of Bosch,387 U.S. 456">387 U.S. 456, 465 (1967). With all due respect to that court, we conclude that its decision cannot be supported under New York law. 5715 To reflect the foregoing Decision will be entered for the respondent.Footnotes1. All section references are to the Internal Revenue Code of 1954, as amended and in effect at the time of decedent's death. All Rule references are to the Tax Court Rules of Practice and Procedure.↩2. A codicil to the will was executed December 3, 1971. Pursuant to the codicil, decedent bequeathed his interest in a bank account to his daughter, Louise Foster.↩3. SEC. 2056. BEQUESTS, ETC., TO SURVIVING SPOUSE. (a) ALLOWANCE OF MARITAL DEDUCTION.--For purposes of the tax imposed by section 2001, the value of the taxable estate shall, except as limited by subsections (b) and (c), be determined by deducting from the value of the gross estate an amount equal to the value of any interest in property which passes or has passed from the decedent to his surviving spouse, but only to the extent that such interest is included in determining the value of the gross estate. (b) LIMITATION IN THE CASE OF LIFE ESTATE OR OTHER TERMINABLE INTEREST.-- (1) GENERAL RULE.--Where, on the lapse of time, on the occurrence of an event or contingency, or on the failure of an event or contingency to occur, an interest passing to the surviving spouse will terminate or fail, no deduction shall be allowed under this section with respect to such interest-- (A) if an interest in such property passes or has passed (for less than an adequate and full consideration in money or money's worth) from the decedent to any person other than such surviving spouse (or the estate of such spouse); and (B) if by reason of such passing such person (or his heirs or assigns) may possess or enjoy any part of such property after such termination or failure of the interest so passing to the surviving spouse; (5) LIFE ESTATE WITH POWER OF APPOINTMENT IN SURVIVING SPOUSE.--In the case of an interest in property passing from the decedent, if his surviving spouse is entitled for life to all the income from the entire interest, or all the income from a specific portion thereof, payable annually or at more frequent intervals, with power in the surviving spouse to appoint the entire interest, or such specific portion (exercisable in favor of such surviving spouse, or of the estate of such surviving spouse, or in favor of either, whether or not in each case the power is exercisable in favor of others), and with no power in any other person to appoint any part of the interest, or such specific portion, to any person other than the surviving spouse-- (A) the interest or such portion thereof so passing shall, for purposes of subsection (a), be considered as passing to the surviving spouse, and (B) no part of the interest so passing shall, for purposes of paragraph (1)(A), be considered as passing to any person other than the surviving spouse. This paragraph shall apply only if such power in the surviving spouse to appoint the entire interest, or such specific portion thereof, whether exercisable by will or during life, is exercisable by such spouse alone and in all events. Sec. 2056 has been amended to permit a deduction for a qualified life estate passing to a surviving spouse. Sec. 403(d)(1), Economic Recovery Tax Act of 1981, Pub. L. 97-34, 95 Stat. 302. This amendment is effective for estates of decedents dying after December 31, 1981, and is thus inapplicable to the present case. Sec. 403(e)(1), Economic Recovery Tax Act of 1981, Pub. L. 97-34, 95 Stat. 305.↩4. Although some of these cases were decided under the predecessor of section 2056, section 812(e) of the Internal Revenue Code of 1939, the 1954 Code is the same as the 1939 Code in all respects relevant to the instant case. See Estate of Opal v. Commissioner,450 F.2d 1085">450 F.2d 1085, 1087-1088 (2d Cir. 1971), affg. 54 T.C. 154">54 T.C. 154↩ (1970).5. Petitioner also calls our attention to Estate of otto v. United States,451 F. Supp. 378">451 F. Supp. 378↩ (D S D 1978). Those cases are distinguishable because they involve the issue of whether the decedent owned the entire farm at his death or whether the farm was the property of a parthership, only a half-interest in which was owned by the decedent. Unfortunately, they do not provide Support for petitioner's position in the instant case.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625432/	WASHINGTON-OREGON SHIPPERS COOPERATIVE, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentWashington-Oregon Shippers Cooperative, Inc. v. CommissionerDocket No. 21299-81.United States Tax CourtT.C. Memo 1987-32; 1987 Tax Ct. Memo LEXIS 32; 52 T.C.M. (CCH) 1406; T.C.M. (RIA) 87032; January 14, 1987. Mark J. Rosenblum, for the petitioner. Henry Thomas Schafer, for the respondent. PARKERMEMORANDUM FINDINGS OF FACT AND OPINION PARKER, Judge: Respondent determined deficiencies in petitioner's Federal income tax in the amounts of $801 and $1,697 for the taxable years 1977 and 1978, respectively. After concessions, the issues are whether certain interest income was "from business done with or for * * * patrons" within the meaning of section 1388(a)(3)1 and, if so, whether it was also income "derived * * * from members or transactions with members" within the meaning of section 277(a). 34 FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulation of facts and supplemental stipulation of facts, as orally corrected at trial, and the exhibits attached thereto are incorporated herein by this reference. Petitioner, Washington-Oregon Shippers Cooperative, Inc., is a nonprofit cooperative corporation formed on October 29, 1953, in accordance with the laws of the State of Washington. Since its formation, and at the time the petition was filed in this case, petitioner's principal business office has been located in Seattle, Washington. Petitioner reports its income under the accrual method of accounting and on a calendar year basis. Petitioner timely filed its 1977 and 1978 U.S. Corporation Income Tax Returns (Forms 1120) with the Internal Revenue Service Center at Ogden, Utah. Petitioner is a nonexempt cooperative within the meaning of section 1381(a)(2). 2 Petitioner's membership is composed of approximately 320 separate business firms and organizations, most of which are located in the Pacific northwest region of the United States. These member business firms and organizations range in size from large, national firms such as J. 35 C. Penney Company to small, local firms. Some state agencies such as the Washington State Liquor Control Board and the Oregon State Department of Liquor Control are members of petitioner. Petitioner operates primarily to furnish services to its members, such services consisting primarily of consolidating and distributing freight for its members. Specifically, petitioner combines small, less-than-truckload size shipments of its members' goods for shipping and distribution purposes. By consolidating smaller shipments of its members' goods bound for common destinations into larger shipments, petitioner can normally reduce the cost its members would otherwise incur for individual shipment of such goods. Petitioner's function is to provide its members with the lowest possible freight rates commensurate with the shipping services the members require. Petitioner has no employees of its own, instead being a client of and operated by the Fred H. Tolan Freight Traffic Service (hereinafter the36 Tolan partnership). Edward H. Tolan (hereinafter Mr. Tolan) is the partner who is primarily responsible for handling all of petitioner's business matters. Petitioner's chairman of the board and treasurer set the policies and Mr. Tolan executes them, handling all fiscal matters based on those policies. For example, Mr. Tolan determines the freight rates to be charged to petitioner's members. Those freight rates are based on six factors or cost components. The first component is the cost to take goods from the member's point of origin to petitioner's consolidation terminals, there being 18 such consolidation terminals in the country. This cost component varies depending on the member's location and the location of the consolidation terminal in relation thereto. This cost component is an add-on cost item and is not included in the freight rate. 3 The other five cost factors or components that make up the freight rates are: the cost of receiving the goods at the consolidation terminal and loading them onto an outbound unit (steamship container, truck, rail car, etc.); the "line-haul" transportation; unloading the freight at the destination and distribution thereof; and the overhead37 and administrative cost of managing the entire system. These five cost factors or components making up the freight rates constitute a mixture of both fixed and variable costs. The two key variables in the operation are line-haul cost (converted back to a per-100-weight basis and dependent upon the volume shipped at any given time) and claims or other operating contingencies. The freight rates charged to members are necessarily based on estimates and averages, particularly as to the variable cost factors. Petitioner does not use any Government index or formula in making these estimates but relies instead on its 30 years of experience. Petitioner must estimate the amount of any contingent expenses or liabilities that might arise during a given year, and despite its long experience and rather close estimates on some factors, unanticipated events such as floods, weather delays and damage or other liability claims can and occasionally do result in increased expenses. In setting the freight rates it charges its members, petitioner38 does not factor in any amount as a profit margin. However, it does try to factor in some reasonable amount for contingencies. Due to the necessarily imprecise nature of certain of petitioner's cost factors, as discussed above, petitioner's cost estimates, and hence the freight rates it charged its members in 1977 and 1978, exceeded the actual costs of rendering services to its members. That excess of the freight rates charged to petitioner's members over actual costs will be referred to hereinafter as "excess operating funds." 4During each year Mr. Tolan regularly scrutinized petitioner's checking account on a daily basis, trying to anticipate receipts and disbursements. Petitioner's members were required by its bylaws to pay for the freight services within seven days after billing, and petitioner usually got about 90 percent of its money from its members within 30 days after billing. During the years before the Court, there were no penalties or charges to the members for late payments. While he regularly39 reviewed the checking account, Mr. Tolan did not adjust any surplus in the checking account on a daily basis or on any other regular basis. However, from time to time when he determined there were excess operating funds in the checking account, Mr. Tolan purchased financial instruments with such excess or transferred such excess to an interest-bearing savings account maintained by petitioner with the Peoples National Bank of Washington. The record shows a few deposits into and withdrawals from the savings account, in each instance in a substantial sum. Except for one instance where $300,000 was withdrawn from the savings account to purchase a 90-day certificate of deposit (CD), the record does not show for what purpose the other withdrawals were made. 540 Rather than deposit the excess operating funds into the savings account, Mr. Tolan occasionally purchased a Treasury bill (T-bill) or CD with those excess funds. His decision to purchase a T-bill or CD was based on the higher rate of interest such an instrument would yield compared to the interest rate on the savings account funds. The source of all of the funds deposited into the savings account and/or used to purchase financial instruments was excess operating funds. All of the interest generated by the savings account and those financial instruments was either used in petitioner's cooperative freight consolidation activities or ultimately refunded to the members as part of the annual distribution of patronage dividends. However, when setting the freight rates to be charged to members for the next year, Mr. Tolan considered the amount of interest income that would be earned on excess operating funds. The anticipated amount of such interest income had a direct, albeit small, impact on the freight rates charged to the members the next year. The specific details of petitioner's various interest-generating transactions will be set out below. In the last quarter of 1975, petitioner41 had excess operating funds on hand. On October 24, 1975, petitioner used such funds to purchase a 90-day T-bill in the face amount of $50,000 with a maturity date of January 22, 1976. On January 22, 1976, petitioner received income of $153.05 from that T-bill. About the time the T-bill matured, an amount of $50,000 was loaned to the Tolan partnership or to Mr. Tolan to be used exclusively to construct a terminal facility in Fairbanks, Alaska for the use of petitioner's members.That loan was evidenced by a promissory note (the Tolan note) payable to petitioner in the total sum of $50,000, with a variable interest rate of one percent under the prime rate. In 1976 and 1977, petitioner earned interest on the Tolan note in the amounts of $2,103.69 and $1,018.47, respectively. Also during 1976, petitioner had made a loan to B & W Trucks Transfer in the amount of $10,000. That loan evidenced by a promissory note (the B & W note) was made to induce B & W Trucks Transfer to distribute the freight of petitioner's members in the State of Alaska. The B & W note was issued on January 11, 1976, with payment due on April 10, 1977, at an interest rate of 8-3/4 percent per annum. During 197742 petitioner earned interest in the amount of $218.75 on the B & W note. On June 16, 1977, petitioner opened the savings account with the Peoples National Bank of Washington with a deposit of $100. Through November of that year, petitioner made three deposits of $75,000, $100,000 and $150,000. In November of 1977, petitioner withdrew $300,000 from the savings account and purchased a $300,000 CD from the Peoples National Bank. That 90-day CD bore interest at the rate of 6-1/2 percent and matured on February 16, 1978. Later in 1977, petitioner deposited another $100,000 of excess operating funds into the savings account. At the end of 1977, the balance in the savings account was $127,591.22. During 1977, petitioner earned interest of $1,491.04 on the savings account ad $2,297.26 on the CD. In 1978 when the $300,000 CD matured in February, petitioner purchased another 90-day CD from the Peoples National Bank in an amount of $200,000. At the same time, on or about February 15, 1978, petitioner also withdrew $127,491.22 from the savings account, leaving a balance in that savings account of only $100. The record does not show whether that $127,491.22 withdrawal was used as operating43 funds for petitioner's cooperative business, used to purchase an interest-bearing instrument, or used for some other purpose. The $200,000 CD matured on May 17, 1978, and the record does not show whether the proceeds were thereafter used as operating funds or working capital in petitioner's cooperative business, used to purchase another interest-bearing instrument, or used for some other purpose. For the rest of 1978, there were deposits into the savings account ($10,000, $100,000, and $50,000) and withdrawals therefrom, including withdrawal of some of the interest ($100,000 and $62,000). While the deposits were deposits of excess operating funds, the record does not establish the use to which the withdrawals were put. At the end of 1978, the balance in the savings account was $743.26. 6 In 1978 petitioner received interest income of $2,510.97 on the $300,000 CD and $3,328.77 on the $200,000 CD for a total of $5,839.74 from the CD's. Petitioner also received interest of $2,643.44 from the savings account that year. 44 Petitioner's total interest income from all of the above-described transactions was as follows: YearPromissory NotesT-billsCD'sSavings AccountTotal1976$2,103.69$153.05$2,256.7419771,237.22$2,297.26$1,491.045,025.5219785,839.742,643.448,483.18The year 1976 is before the Court only because of a net operating loss carryover of ($976) from that year. On its Form 1120 for each year, petitioner reported all of this interest in income and included this interest in its computation of its patronage dividend deduction. As obligated by its Articles of Incorporation, during its 1976, 1977, and 1978 taxable years, petitioner refunded to its members all net earnings of the cooperative that it considered to be attributable to services carried on with or for its members. Such refunds did not necessarily require withdrawal of the excess operating funds petitioner had deposited in its savings account or used to purchase T-bill's or CD's. The refunds were made in a single payment, usually in July, by which time excess operating funds attributable to the succeeding year could be used to make such refunds. Such refunds45 were always made within eight and one-half months of the close of the calendar year to which the net earnings were attributable, and petitioner claimed "patronage dividend" deductions therefor under section 1382(b)(1). In computing the amount of its allowable section 1382(b)(1) patronage dividend deduction for its 1976, 1977, and 1978 taxable years, petitioner included the full amount of the interest earned each year as part of the "net earnings * * * from business done with or for * * * patrons" within the meaning of section 1388(a)(3). The amount of the section 1382(b)(1) patronage dividend deduction claimed in each year was therefore accordingly increased by and reflected the amount of interest income earned in such year. In a statutory notice of deficiency dated May 18, 1981, respondent, citing section 277 as authority for his determinations, reduced the "membership" income by the amounts of the interest income reported on petitioner's 1977 and 1978 tax returns. Technically respondent did not disallow any of the patronage dividend deductions, leaving "membership deductions" unchanged, 7 but in effect has done so. 8 The specific details of respondent's various adjustments46 are set out in the parties' stipulation of facts and need not be repeated here. 47 OPINION Petitioner, a nonexempt freight consolidation cooperative, derived interest income from a loan made to encourage construction of a freight terminal (Tolan note), a loan made to encourage distribution of its members' goods in Alaska (B & W note), a T-bill, two CD's, and a savings account. Respondent having now conceded the interest income generated by the Tolan and B & W notes to be patronage-sourced, the main issue in this case is whether the interest income petitioner earned from its T-bill, CD's and savings account constitutes "earnings * * * from business done with or for its patrons" within the meaning of section 1388(a)(3), rendering distributions thereof deductible as patronage dividends under section 1382(b)(1). In the case of a corporation which, like petitioner, operates on a cooperative basis, subchapter T of the Code (sections 1381-1388) provides specific rules governing the tax treatment of patronage dividends with respect to both the cooperative distributing such amounts and the patrons who receive them. The term "patronage dividend" is defined in section 1388(a). 9 In order for a distribution to qualify as such, the amount of such distribution must be48 "determined by reference to the net earnings of the organization from business done with or for its patrons." Sec. 1388(a)(3). Further, the flush language of section 1388(a) specifically provides that "[s]uch term does not include any amount paid to a patron to the extent * * such amount is out of earnings other than from business done with or for patrons * * ." See also sec. 1.1388-1(a)(2)(i), Income Tax Regs. Thus, only earnings which are "patronage-sourced" may be distributed as deductible patronage dividends. 49 We have recently had occasion to reexamine carefully this whole area of patronage-sourced income under subchapter T, specifically involving interest income derived from a cooperative's excess operating funds or temporary surplus of working capital. Illinois Grain Corporation v. Commissioner,87 T.C. 435">87 T.C. 435 (1986). The test is whether the income is so closely intertwined with and inseparable from the main cooperative activity that it is directly related to, and inseparable from, the cooperative's business so as to actually facilitate the accomplishment of the cooperative's business purpose. This "directly related" test is, however, necessarily fact-intensive. In Illinois Grain, the nonexempt cooperative purchased, distributed, and sold its patrons' grains, principally corn and soybeans. 10 There was great price volatility in the grain business, creating sudden cash demands for increases in margin requirements and changes in inventory values. The cooperative needed a great deal of flexibility in the form of liquidity to fund changes in the current assets and liabilities. At times the cooperative was short of working capital and at times it had a temporary surplus50 in working capital. The cooperative was undercapitalized, had extensive long-term debt, and had rapidly fluctuating short-term debt in the form of notes payable, all of which generated both deficits and surpluses of working capital at different times. The cooperative was engaged in hedging transactions as an integral and necessary part of its grain business, resulting in increases and decreases in margin calls on a daily basis. In managing its deferred pricing program with its members, its members' notes, and its hedging transactions, the cooperative had to assess its cash needs each day before the close of the grain markets. Margin requirements had to be posted within 45 minutes of the closing of the market. If there was any surplus working capital on a given day, the cooperative first paid back short-term borrowings, either short-term bank loans or members' notes, and if there was still any excess would purchase short-term instruments -- commercial paper, certificates of deposit, Treasury bills, or repurchase agreements. These short-term instruments had lower interest rates than it could have earned elsewhere. Of these interest-bearing instruments, 72 percent of them were for51 overnight or overweekend periods, 21 percent for one week or less, and the remainder for periods more than a week. For those instruments for more than a week, many were in December when the cooperative knew it would not need the funds until January. There was a high level of overnight transactions because the cooperative never knew when it would again need the temporary surplus working capital in its business. Respondent treated all of this interest income as nonpatronage-sourced income. Recognizing that application of the "directly related" test depends upon all of the facts and circumstances of the particular case, the Court disagreed with respondent stating: As the cases make clear, such a determination is necessarily fact-intensive. Income derived by a cooperative from its various business activities may indeed be so closely intertwined and inseparable from the main cooperative effort that it may be properly characterized as directly related to, and inseparable from, the cooperative's principal business activity, and thus can be found to "actually facilitate" the accomplishment of the cooperative's business purpose. On the other hand, it is equally possible that a cooperative52 may undertake business activities which while profitable, have no integral and necessary linkage to the cooperative enterprise, so that it may fairly be said that the income from such activities does nothing more than add to the taxpayer's overall profitability. It all depends on the facts of each case. In the instant case, we consider the facts with respect to each type of income separately. 1. The Interest IncomeThe facts in this case show that petitioner's principal cooperative enterprise was the marketing of its patrons' grain. The financing of this enterprise was complex and called for petitioner's constant attention and management of its money so as to have available on short notice large amounts of cash to meet margin calls, to repay members' notes, to satisfy patrons' demands under the deferred pricing arrangements which petitioner had with its patrons, and to pay its current bills. On the other hand, petitioner received funds, not entirely on a predictable basis, from sales (reducing its inventories), and from lessening margin requirements (which fluctuated on a daily basis), as well as from its long-term and short-term borrowings. Although petitioner analyzed53 its cash needs on a daily basis, it could not always be precise. On some days, petitioner had to exercise its short-term line of credit to borrow from the First National Bank or the St. Louis Bank. On other days, petitioner would find itself in a surplus cash position. When the latter event occurred, petitioner, in the exercise of ordinary prudent business management, placed its temporary surplus funds in extremely short-term debt instruments -- for the most part, overnight or overweekend loans to the First National Bank, or its wholly-owned subsidiary. The primary purpose here was not to "invest," but to find a temporary parking place for its surplus funds, consistent with safety and prudent money management. We do not agree with respondent's contention that such placement of temporary surplus funds in short-term debt instruments constituted an "investment" of such funds, as that term would generally be understood. Petitioner's actions here were entirely comparable to placing the funds in a bank account. One does not make an "investment" in a bank account. The rate of interest which petitioner earned on these extremely short-term placements was less, as we have found, than54 the interest which petitioner could have earned elsewhere on longer-term debt instruments. In short, we are convinced that petitioner's money management activities in this case were inseparably intertwined with the overall conduct of its cooperative enterprise, and the interest income which it earned was therefore patronage sourced, to the same extent as in the Cotter [Cotter and Co. v. United States,765 F.2d 1102">765 F.2d 1102 (Fed. Cir. 1985)] and St. Louis Bank [St. Louis Bank for Cooperatives v. United States,624 F.2d 1041">624 F.2d 1041 (Ct. Cl. 1980)] cases. Illinois Grain Corporation v. Commissioner,supra,87 T.C. at 459-460. While in the instant case the cooperative's business activities are less volatile and considerably more static than those in Illinois Grain Corporation v. Commissioner,supra,55 the "directly related" test, here as in that case, must be applied to the business activity of the particular cooperative involved. Petitioner was not dealing in a grain market dramatically fluctuating on a daily basis. Its cooperative activities were more narrowly focused on freight consolidation services for its members. Petitioner was a small, essentially single-person (Mr. Tolan) operation, and its money management activities were considerably less systematized than those in Illinois Grain. Nonetheless, we must consider the relationship of the activity generating the income to the particular activities of the cooperative to determine if it is integrally related to the cooperative's business and actually facilitates the accomplishment of the cooperative's business purpose. On the record in this case, we cannot find the integral and necessary linkage between petitioner's money management activities and its overall conduct of its cooperative enterprise such as we found in Illinois Grain. We conclude that petitioner's money management activities did nothing more than add, if only in a small way, to its overall profitability. Petitioner seems to think that all it needs56 to establish is that the source of the funds that generated the interest is excess operating funds. Mr. Tolan testified categorically, and we believed him, that the source of the funds for the Tolan loan, the B & W loan, the T-bill, two CD's, and the savings account was in each instance excess operating funds. That alone does not transmute the interest income therefrom into patronage-sourced income. Mr. Tolan also testified, and we believed him, that the resulting interest income was used in petitioner's operations and that when he set the freight rates to be charged to the members the next year, he took into account the amount of interest that could be earned on the excess operating funds. In other words, petitioner argues that the interest income was used to reduce the freight rates charged to its members. Again that does not transmute the interest income into patronage-sourced income. The impact of this interest income on the freight rates charged to the members was rather minimal here. Nevertheless Mr. Tolan readily agreed that if more interest were earned, it would have a greater impact on those freight rates and that the cooperative would reduce the rates charged to its57 members "dependent upon the dollars generated from the interest income." That sounds more like a separate investment activity than necessary money management incident to the conduct of the cooperative's business. In the case of the Tolan loan made to induce construction of a freight terminal for the members' use and the B & W loan to induce the trucking company to distribute the members' goods in Alaska, there is a clear nexus between the interest income generating activity and the overall conduct of petitioner's freight consolidation cooperative business. Respondent has now conceded that the interest from those loans is patronage-sourced income. After respondent's concessions, the interest items remaining in dispute are the savings account and the 90-day financial instruments purchased by petitioner. As to the $50,000 T-bill purchased in October of 1975, the record hints, but does not clearly establish, that when this T-bill matured in early 1976 it may have been the source of the funds for the Tolan loan. If established, that fact might furnish a linkage, though admittedly a rather attenuated one, between the T-bill and the cooperative's activity of securing construction of58 the terminal. On balance, we can only conclude that even with such an indirect connection, the 90-day T-bill can only be viewed as an investment that merely added to overall profitability. As to the 90-day instruments generally, we are troubled by the rather long term involved, this being more akin to an investment than to temporary money management integrally related to the ongoing conduct of the cooperative's business activities. 11 Unanswered questions involving the two 90-day CD's tend to tilt them toward the category of investments. As will be discussed more fully below in connection with the savings account interest, the pattern, if any, in this case is a few scattered transactions involving rather substantial sums of money on those few occasions. Again this suggests investments, not regular money management activities integrally and necessarily linked to the cooperative's business activities. 59 In November of 1977, petitioner withdrew $300,000 from its savings account and purchased a 90-day CD. The decision to put the money into a CD was based on the fact that interest on a CD was higher than interest on the savings account. When that CD matured in early 1978, another 90-day CD in the amount of $200,000 was purchased. Thus, with the purchase of that second CD, petitioner had an amount of at least $200,000 tied up in CD's for a combined period of at least 180 days, which strongly suggests investment, not regular, routine money management in the active conduct of a cooperative business. The record does not show what happened to the other $100,000 of the first CD. Again, the $200,000 CD matured in May of 1978 and the record does not tell us what happened to that principal amount. Similarly, the record leaves unanswered questions in regard to the savings account deposits and withdrawals. Although Mr. Tolan testified the money in the savings account could be withdrawn when and if needed in petitioner's operations, the withdrawals were few and far between and always in a substantial amount. 12 The pattern of just a few deposits and withdrawals of substantial sums is troubling60 and seems more consistent with an investment activity than regular business operations. While Mr. Tolan scrutinized petitioner's checking account every day trying to anticipate receipts and disbursements, he did not adjust surplus in the checking account on a daily basis or on any other regular basis. The record does not show how, when, or on what basis Mr. Tolan determined there were excess operating funds. When asked to explain how he determined the amount to be placed into a T-bill or CD, for example, Mr. Tolan testified as follows: We basically looked at our checking account balance that we would get from the bank, and if we saw it consistently running at a certain level, then we felt it would probably be proper to pull $100,000 or $50,000 or whatever might be out of the checking account and place them in a CD or whatever the instrument might be. That sounds like an investment, not routine61 money management. Moreover, the one somewhat-documented transaction in the record -- the purchase of the $300,000 CD -- shows that the money was taken out of the savings account, not the checking account, and placed in a CD because the interest rate was higher than that for the savings account. In either event, this is indicative of a separate investment activity, not regular money management incident to its cooperative business activities. From time to time, Mr. Tolan transferred funds from the checking account to the savings account. He opened the savings account in June of 1977 with a deposit of $100. Through November of that year he made three deposits of $75,000, $100,000, and $150,000. Then in November he withdrew $300,000 from the savings account to purchase the 90-day CD. Then he deposited another $100,000 into the savings account and had a balance of $127,591.22 in that account at the end of the year. As noted earlier, when that CD matured in February of 1978, $200,000 was again used to purchase another 90-day CD. About the same time petitioner withdrew $127,491.22 from the savings account, the entire balance except for $100. The record does not show what happened62 to the $127,491.22. Similarly, for the rest of 1978, Mr. Tolan deposited $10,000, $100,000, and $50,000 and then withdrew $100,000 and $62,000. While we accept Mr. Tolan's testimony that the source of all deposits was excess operating funds, we are not satisfied as to what the withdrawals were used for. The record is simply devoid of any facts correlating either the deposits into or the withdrawals from that savings account with petitioner's ongoing cooperative business activities. For the reasons stated above, we conclude that the interest income from the T-bill, the two CD's, and the savings account did not constitute patronage-sourced income under subchapter T. In view of this holding, we need not reach respondent's alternative arguments under section 277. 1363 To reflect our holding, Decision will be entered for the respondent.Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954, as amended and in effect during the taxable years in question, and all "Rule" references are to the Tax Court Rules of Practice and Procedure.↩2. The parties have stipulated that petitioner is also a membership organization operated primarily to furnish services to its members and is subject to section 277. See n. 13, infra.↩3. Either the item was separately billed to the member or the member at the outset paid the cost of delivering the goods to the consolidation terminal.↩4. Respondent objects to the term "excess operating funds," preferring instead the description "idle surplus." We think this a semantic quibble without a difference.↩5. While Mr. Tolan testified that the funds in the savings account could be taken out when and if needed for petitioner's operations, the record does not establish that any of the withdrawals in 1977 and 1978, the years before the Court, were ever redeposited into the checking account or otherwise used in petitioner's cooperative activities. On the savings account statement in evidence, there is a handwritten note indicating that in 1979 a $49,000 withdrawal was deposited into the checking account and that in 1980 a $50,000 withdrawal was deposited into the checking account. Those two redeposits would tend to suggest that the funds were again available for use as operating funds or working capital, but do not establish that the funds were necessarily so used. Mr. Tolan testified that he made withdrawals from the checking account to purchase financial instruments such as a CD.↩6. The savings account record also reflects a similar pattern of deposits and withdrawals in 1979 and 1980, with ending balances of $387.71 and $723.73, respectively. The record does not show whether or not any of these excess operating funds were placed into 90-day T-bills or CD's in 1979 and 1980, or whether the withdrawals were to meet operating needs of petitioner's cooperative business or some other purpose.↩7. We note, however, that in his notice of deficiency respondent allowed petitioner an additional patronage dividend deduction in the amount of $1,018 for taxable year 1977, reducing petitioner's taxable income for such year accordingly. This amount was computed with reference to the interest income generated by the Tolan note, which respondent conceded to be patronage-sourced income. Respondent still contends that income was nonmember income. Respondent now concedes that the additional patronage dividend deduction provided for in the notice of deficiency should be further increased to $1,237 so as to take into account the $218.75 of interest received from the B & W note during 1977, which respondent now concedes to be patronage-sourced income. Again respondent still contends that the $218.75 was nonmember income. ↩8. While respondent's notice of deficiency ostensibly based the adjustments made to petitioner's income therein on the presence of "membership deductions" in excess of "membership income" pursuant to section 277, the parties' stipulations of fact, trial memoranda, and briefs deal extensively with whether the interest income involved herein constitutes "patronage-sourced" income deductible from petitioner's gross income pursuant to section 1382(b)(1). Accordingly, this issue was tried by the consent of the parties hereto. Rule 41(b)(1).↩9. Section 1388(a) provides as follows: (a) Patronage Dividend. -- For purposes of this subchapter, the term "patronage dividend" means an amount paid to a patron by an organization to which part I of this subchapter applies -- (1) on the basis of quantity or value of business done with or for such patron, (2) under an obligation of such organization to pay such amount, which obligation existed before the organization received the amount so paid, and (3) which is determined by reference to the net earnings of the organization from business done with or for its patrons.Such term does not include any amount paid to a patron to the extent that (A) such amount is out of earnings other than from business done with or for patrons,↩ or (B) such amount is out of earnings from business done with or for other patrons to whom no amounts are paid, or to whom smaller amounts are paid, with respect to substantially identical transactions. [Emphasis added.]10. While Illinois Grain had both member and nonmember patrons, business with nonmember patrons was done on a commercial basis, not on a cooperative basis, and the issue of patronage-sourced income and deductible patronage dividends concerned only the member patrons.↩11. We do not mean to suggest that a 90-day instrument could never come within our holding in Illinois Grain Corporation v. Commissioner,supra.↩ However, the facts and circumstances surrounding such a long-term instrument must be closely scrutinized in each case.12. We are not suggesting that there could not be a withdrawal of a substantial sum if there was a business need therefor, and it should not create any undue burden for a cooperative to show that it had a business need for a large sum at some particular time, if that were the fact.↩13. Our holding that the above interest income is not patronage sourced makes it unnecessary to consider section 277 in regard to the interest from the T-bill, CD's, and savings account. It can be argued that that is all that is in dispute in this case. However, respondent further argues on brief that income that is admittedly patronage-sourced income, such as the interest from the Tolan and B & W notes, nonetheless is not membership income and hence membership deductions are limited to the extent of membership income under section 277. Section 277(a) provides, in pertinent part, that: In the case of a social club or other membership organization which is operated primarily to furnish services or goods to members and which is not exempt from taxation, deductions for the taxable year attributable to furnishing services, insurance, goods, or other items of value to members shall be allowed only to the extent of income derived during such year from members or transactions with members * * . If for any taxable year such deductions exceed such income, the excess shall be treated as a deduction attributable to furnishing services, insurance, goods, or other items of value to members paid or incurred in the succeeding taxable year. This is a deduction deferral, not a deduction disallowance provision. Petitioner argues that respondent has agreed that this interest is membership income; however, the stipulation clearly describes the Tolan and B & W interest as "non-member, patronage-sourced income." Petitioner next argues that the test for membership income is essentially the same as for patronage-sourced income. We are not prepared in this case to say that "income derived * * from members or transactions with members" under section 277 necessarily has the same meaning as income "from business done with or for patrons" under section 1388(a). (Emphasis added.) We pretermit the issue in this case for several reasons. Although the parties in this case stipulated that petitioner is a membership organization subject to section 277, there is some doubt, as expressed by commentators, as to the applicability of section 277 to a nonexempt cooperative. See Clark & Erickson, "Taxation of Cooperatives," Tax Mgmt. 229-2 at A-19 (BNA 1984). We can of course disregard the parties' stipulation to the extent it constitutes a legal conclusion. Without conclusively resolving this matter, we note that in the only case in which we have directly addressed the issue, we found section 277 inapplicable to that nonexempt cooperative. Farm Service Cooperative v. Commissioner,70 T.C. 145">70 T.C. 145, 155-157 (1978), revd. on another issue 619 F.2d 718">619 F.2d 718 (8th Cir. 1980). In Farm Service Cooperative we found that the losses were not intentionally generated to shelter income from nonmembership sources. Consequently, we concluded there that the cooperative did not come within section 277 because "Congress enacted section 277 to attack sham losses, those losses that were constantly and intentionally generated in dealings with members so that the profits from commercial ventures -- such as investment activities- -could be passed on to such members free of tax." 70 T.C. at 156. See also S. Rept. 91-552, 3 C.B. 423">1969-3 C.B. 423, 471; Summary of H.R. 13270 Tax Reform Act of 1969, prepared by the staffs of the Joint Committee on Internal Revenue Taxation and the Committee on Finance, 91st Cong., 1st Sess. 30; and General Explanation of the Tax Reform Act of 1969, prepared by the Joint Committee on Internal Revenue Taxation, 91st Cong., 2d Sess. 72. While respondent argues here that petitioner in effect furnished freight services to its members below cost, that clearly is not the case. The excess operating funds were the result of the fact that petitioner charged its members more than cost. Thus, the fact pattern of the present case, like that in Farm Service Cooperative, does not come within the general intendment of section 277. Respondent's argument might have more force if a nonexempt cooperative were deliberately overstating its charges to its members in order to generate funds for investment purposes. There is no suggestion that petitioner was engaged in such a practice during the years before the Court. A further reason for declining to consider the section 277 issue is that respondent has not sought an increased deficiency even though the Tolan note interest was considered in the statutory notice of deficiency and taxable income reduced by the additional patronage deduction allowed therefor. That leaves only the $218.75 interest on the B & W note. Since respondent stipulated that the patronage dividend for 1977 should be increased by this amount, that could perhaps be handled in a Rule 155 computation. However, the record indicates that petitioner on its tax returns included all of the interest income in computing its patronage dividend deductions. Accordingly, when respondent again reduced the taxable income by the $1,018 patronage dividend in regard to the Tolan note interest, that was probably a duplication. Consequently, we leave the parties where we find them and make no adjustments to the deficiencies in the statutory notice.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4653931/	IN THE SUPREME COURT OF PENNSYLVANIA MIDDLE DISTRICT MICHAEL BAHNATKA, : No. 437 MAL 2020 : Petitioner : : Petition for Allowance of Appeal : from the Order of the Superior Court v. : : : VICTORY BREWING COMPANY, LLC, : : Respondent : ORDER PER CURIAM AND NOW, this 20th day of January, 2021, the Petition for Allowance of Appeal is DENIED.	01-04-2023	01-22-2021
https://www.courtlistener.com/api/rest/v3/opinions/4625453/	DR. EROL BASTUG, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentDr. Erol Bastug, Inc. v. CommissionerDocket No. 45933-85R.United States Tax CourtT.C. Memo 1989-262; 1989 Tax Ct. Memo LEXIS 262; 57 T.C.M. (CCH) 562; T.C.M. (RIA) 89262; 11 Employee Benefits Cas. (BNA) 1120; May 30, 1989. 262 In October 1981, P executed pension and profit sharing plans modeled after those of a previous employer which had received a favorable determination from the IRS in 1969. P's plans were not submitted to the IRS for initial qualification until March 1984, after the IRS notified P that its 1981 profit sharing plan return was under examination. After restructuring the plans in accordance with suggestions of the IRS, P received a favorable determination for its plans for post 1983 years. P received a final adverse determination letter for its plans for 1981-1983. Having exhausted its administrative remedies with the IRS, P petitioned the Tax Court for a redetermination of its plans' qualification for 1981-1983 in a declaratory judgment proceeding under sec. 7476(a), I.R.C. 1954, as amended. On its motion, P requests a trial, or in the alternative, the opportunity to take depositions to introduce evidence to prove that the Commissioner abused his discretion by not giving the amended plans retroactive effect. Held, P failed to demonstrate good cause why we should allow P to augment the administrative record, having had adequate opportunity to introduce this evidence into the record263 during the administrative determination proceeding prior to the issuance of the final adverse determination letter. Tamko Asphalt Products, Inc. v. Commissioner,658 F.2d 735">658 F.2d 735 (10th Cir. 1981), and Houston Lawyer Referral Serv. v. Commissioner,69 T.C. 570">69 T.C. 570 (1978), followed. Jolyon W. McCamic, for264 the petitioner. Paul S. Horn, for the respondent. CANTRELMEMORANDUM OPINION CANTREL, Special Trial Judge: This case was assigned pursuant to the provisions of section 7443A(b)(1) and Rule 180, et seq. 1 This case is before the Court on petitioner's Motion to Calendar for Trial. Dr. Erol Bastug, a radiologist, left the employ of Dr. Barger & Associates, a West Virginia corporation, in late 1980. In the early part of 1981, he contacted the Trust Department of Wheeling National Bank (the Bank) to enter into pension and profit sharing plans similar to those in effect for Dr. Barger & Associates. On July 16, 1981, the Bank's trust officer sent to petitioner's counsel copies of Dr. Barger's plans and a favorable determination letter with respect to those plans from the Internal Revenue Service (IRS), dated April 16, 1969. Counsel for petitioner drafted the pension and profit sharing plans which petitioner executed in October of 1981, 265 to be effective January 1, 1981, and submitted them to the Bank. Petitioner's certified public accountant filed Forms 5500-C "Return/Report of Employee Benefit Plan" reflecting contributions to the plans for 1981, 1982 and 1983. In response to question no. 25 on the 1981 Form 5500-C filed for petitioner's profit sharing plan, petitioner represented that the plan was intended to qualify under section 401(a) and that petitioner had received a favorable determination letter for the plan from the IRS. The District Director, IRS, Cincinnati, Ohio, notified petitioner by letter dated February 2, 1984, that the IRS was examining petitioner's 1981 profit sharing plan return and asked for additional information. The District Director wrote petitioner again on February 27, 1984, requesting the information. It was at this time that petitioner first discovered its plans had not been submitted to the IRS for determination letters. On March 23, 1984, petitioner applied for initial qualification of its plans by filing Forms 5300 "Application for Determination for Defined Benefit Plan" and 5301 "Application for Determination for Defined Contribution Plan." During the administrative determination266 procedure, respondent asked petitioner to restructure the plans. On or about May 26, 1984, petitioner submitted prototype pension and profit sharing plans from Massachusetts Mutual Life Insurance Company along with a Form 5307 "Short Form Application for Determination for Employee Benefit Plan," asking for a determination of the plans as amended May 24, 1984, to be effective January 1, 1981. Respondent made a favorable determination dated July 11, 1984, as to the plans submitted with the Form 5307, effective for plan years beginning after December 31, 1983. On November 26, 1984, the District Director notified petitioner that, based on his examination of petitioner's Form 5500-C submitted for 1981, he had made a proposed determination that petitioner's profit sharing plan did not qualify under section 401(a). On December 24, 1984, petitioner appealed the decision to the Regional Director of Appeals, Cincinnati, Ohio, by filing a protest which included a statement of facts and a presentation of the issue with cases and arguments in support of petitioner's position. In this protest, petitioner requested a conference at which it could present oral testimony and argument in support267 of its position. A hearing was scheduled for March 21, 1985, in Detroit, Michigan. The appeals officer advised petitioner that it could present facts, arguments and legal authority to support its position, but requested that petitioner give advance notice of any new evidence or information to be introduced. For reasons not stated in the record, no conference was conducted. Respondent issued a final adverse determination letter on October 31, 1985, determining that petitioner's plans were not qualified in 1981, 1982 and 1983 because the plans did not comply with the Employee Retirement Income Security Act of 1974 (ERISA), Pub. L. 93-406, 88 Stat. 829, and therefore, failed to satisfy certain requirements under section 401(a). Petitioner timely filed a petition in the Tax Court for declaratory judgment pursuant to section 7476(a), challenging respondent's determination that petitioner's pension and profit sharing plans do not qualify under section 401(a). By its motion to calendar, petitioner has requested a trial under Rule 217(a), or in the alternative, an opportunity to take depositions. Petitioner seeks to supplement the administrative record with the testimony of its counsel, 268 that of the trust officer of the Bank, an agent for Massachusetts Mutual Life, and petitioner's CPA, to establish petitioner's due diligence in seeking a favorable determination letter from the IRS for its plans for 1981-1983. Further, petitioner desires to prove that the objectionable provisions of the plans never became operable. Petitioner maintains that the Commissioner's abuse of discretion in denying retroactive qualification of the plans cannot be established from the administrative record alone. In opposition to petitioner's motion, respondent makes three points. Respondent argues that (1) any evidence petitioner seeks to elicit through the testimony is already in the administrative record contained in his appeals protest; (2) the evidence is irrelevant because it doesn't tend to prove petitioner's due diligence; and (3) respondent is willing to stipulate these facts. Section 401(a) lists the requirements that must be met by a trust forming part of a pension or profit sharing plan in order for that trust to be eligible for favorable tax treatment under the various sections of the Internal Revenue Code. Added to the Code by ERISA in 1974, section 7476(a) confers jurisdiction269 on this Court to issue declaratory judgments as to the initial or continuing qualification of retirement plans under section 401(a). In a declaratory judgment proceeding, this Court's function is to review the reasons provided by the IRS in its notice to the party requesting qualification, and thereupon make a redetermination of the IRS's determination, not a general examination of the provisions of the plan. H. Rept. 93-807 (1974), 1974-3 C.B. (Supp.) 236, 343. Rule 217(a) provides: Disposition of an action for declaratory judgment, which does not involve either a revocation or the status of a governmental obligation, will ordinarily be made on the basis of the administrative record, as defined in Rule 210(b)(11). Only with the permission of the Court, upon good cause shown, will any party be permitted to introduce before the Court any evidence other than that presented before the Internal Revenue Service and contained in the administrative record as so defined. * * * [Emphasis supplied.] Rule 210(b)(11) provides: "Administrative record" includes the request for determination, all documents submitted to the Internal Revenue Service by the applicant in270 respect of the request for determination, all protests and related papers submitted to the Internal Revenue Service, all written correspondence between the Internal Revenue Service and the applicant in respect of the request for determination or such protests, all pertinent returns filed with the Internal Revenue Service, and the notice of determination by the Commissioner. In addition -- (i) In the case of a determination relating to a retirement plan, the administrative record shall include the retirement plan and any related trust instruments, any written modifications thereof made by the applicant during the proceedings in respect of the request for determination before the Internal Revenue Service, and all written comments (and related correspondence) submitted to the Internal Revenue Service in those proceedings (see Section 3001(b) of the Employee Retirement Income Security Act of 1974). Facts and representations appearing in the administrative record are assumed to be true for purposes of the declaratory judgment proceeding. Rule 217(b)(1); Note to Rule 217(a), 68 T.C. 1048">68 T.C. 1048 (1977). "[T]here do not appear to be at this time any circumstances under which271 a trial will be held except as to disputed jurisdictional facts or to resolve disagreement between the parties as to the contents of the administrative record." Note to Rule 217(a), 68 T.C. 1048">68 T.C. 1048 (1977). In Houston Lawyer Referral Serv. v. Commissioner,69 T.C. 570">69 T.C. 570 (1978), a Court-reviewed opinion, this Court pointed out that to allow oral testimony or facts not otherwise in the administrative record to be introduced by testimony or stipulation in a declaratory judgment proceeding "would convert that proceeding from a judicial review of administrative action to a trial de novo." Houston Lawyer Referral Serv. v. Commissioner, supra at 577. See also Church in Boston v. Commissioner,71 T.C. 102">71 T.C. 102, 105 (1978); Thompson v. Commissioner,71 T.C. 32">71 T.C. 32, 38 (1978); Gen. Conf. of the Free Church v. Commissioner,71 T.C. 920">71 T.C. 920, 929 (1979); est of Hawaii v. Commissioner,71 T.C. 1067">71 T.C. 1067, 1077 (1979), affd. without published opinion 647 F.2d 170">647 F.2d 170 (9th Cir. 1981); Southwest Virginia Professional Standards Review Organ., Inc. v. United States, an unreported case ( D.D.C. 1978, 42 AFTR 2d 78-6167, 78-2 USTC par. 9747);272 Virginia Professional Standards v. Blumenthal,466 F. Supp. 1164">466 F.Supp. 1164 (D.D.C. 1979). Accordingly, we refused to grant taxpayer a trial in a declaratory judgment action brought pursuant to section 7476 in Tamko Asphalt Products, Inc. v. Commissioner,71 T.C. 824">71 T.C. 824 (1979), affd. 658 F.2d 735">658 F.2d 735 (10th Cir. 1981). In affirming this Court's decision, the Court of Appeals for the Tenth Circuit noted: That Congress intended only limited review by the Tax Court is supported, too, by the requirement in section 7476 that all administrative remedies be exhausted. To allow the party seeking plan approval to freely bring new evidence before the Tax Court would amount to a bypass of the Service's administrative remedies since the Tax Court would be considering factual contentions the IRS had no opportunity to consider. [Tamko Asphalt Products, Inc. v. Commissioner,658 F.2d at 739. Citations omitted.] This Court's role differs in an action in which a plan's qualification has been revoked pursuant to an audit. Where the IRS has conducted an independent investigation of the facts, it need not rely on factual assertions made by the taxpayer. 273 Trial may be necessary under these circumstances to resolve disputes of fact. Note to Rule 213(a), 68 T.C. 1042">68 T.C. 1042- 1043 (1977). By definition, a "revocation" is a determination that a previously qualified plan is no longer qualified. Rule 210(b)(9). The original applications submitted by petitioner for the plans request initial qualification, thus indicating that these plans had never been qualified. Therefore, this action does not involve a revocation. It has been suggested that because the IRS began an examination of petitioner's profit sharing plan, like a revocation case, the IRS may have conducted a separate investigation of the facts. Unlike a revocation case, the notice of examination here precipitated an administrative determination proceeding. Nothing in this record indicates that respondent made his adverse determination by considering anything other than those factual assertions made by petitioner in the documents submitted during the administrative process. Nor does the administrative record contain a copy of an official report, as required by section 601.201(o)(8)(i)(e) of the Statement of Procedural Rules, 26 C.F.R. Part 601 (1983), of a separate274 investigation of the facts made by the IRS. Factual inferences may be drawn from the administrative record by this Court in performing its review function. Nat. Assn. of American Churches v. Commissioner,82 T.C. 18">82 T.C. 18, 20 (1984). Here, we conclude the IRS made no separate investigation of the facts on which it based its adverse determination. Petitioner's sole argument in support of its motion is that it be allowed to demonstrate its due diligence in order to prove that the Commissioner abused his discretion in determining that the plans did not qualify in the pre-amendment plan years. Petitioner is correct that where no circumstances arose which caused the objectionable provisions of the plan to become operable, and where the employer exercised due diligence in attempting to obtain a favorable determination, a plan amendment made outside the statutory time frame may be given retroactive effect. Aero Rental v. Commissioner,64 T.C. 331">64 T.C. 331 (1975). See Jack R. Mendenhall Corp. v. Commissioner,68 T.C. 676">68 T.C. 676 (1977). We wish to note that both Aero Rental and Mendenhall Corp. relied upon by petitioner are deficiency actions in which275 trial is proper and was held. This Court granted retroactive relief in a declaratory judgment action in J. G. Kern Enterprises, Inc. v. Commissioner,T.C. Memo. 1987-580. The decision there was rendered on the basis of the pleadings and facts set forth in the administrative record. Indeed, in the final analysis, this Court's function under section 7476 is to resolve disputes as to the legal issues raised by the IRS in its final adverse determination letter on the basis of uninvestigated statements of facts submitted by the taxpayer in its application and related papers. Houston Lawyer Referral Serv. v. Commissioner, supra at 573. Petitioner's protest cites Aero Rental and Mendenhall Corp. in support of its argument that it exercised due diligence in seeking a favorable determination for its plans and that the plans' offending provisions never became operable. Petitioner requested a conference at which it intended to present further oral testimony and arguments to establish these matters. At any time up until issuance of the final adverse determination letter, petitioner could have submitted this evidence to the IRS in the form of affidavits, 276 and it would have become part of the administrative record in accordance with the definition thereof under Rule 210(b)(11)(i). See est of Hawaii v. Commissioner, supra at 1077, and Colorado State Chiropractic Society v. Commissioner,T.C. Memo. 1989-8. For reasons not appearing in this record, no such conference was ever conducted. The rule of law cited in Houston Lawyer Referral and Tamko Asphalt is predicated upon the legislative concern that the Court not bypass the administrative determination procedure without good cause. Petitioner has not given us any compelling reasons to deviate from this rule. Petitioner's failure to introduce this additional evidence into the record during the administrative process does not constitute "good cause" within the meaning of Rule 217(a) for permitting a trial or the taking of depositions. Houston Lawyer Referral Serv. v. Commissioner, supra at 578. From our review of the record, it appears that petitioner had adequate opportunity to present its complete case to the IRS during the determination proceedings. Petitioner has not asserted otherwise. If petitioner did not believe the administrative277 record to be complete, its counsel should not have stipulated that the materials submitted constitute the entire administrative record. est of Hawaii v. Commissioner, supra at 1077-1078. In view of our disposition of petitioner's motion, we need not address its due diligence argument. We wish to add, however, on these facts, we could not find that petitioner diligently pursued favorable determinations for its plans. See D.J. Powers Co. v. Commissioner,T.C. Memo 1981-622">T.C. Memo. 1981-622, which was also a deficiency action. On the basis of this record, petitioner's motion will be denied. An appropriate order will be issued.Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954, as amended and in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625455/	William Kirkman Gray, Petitioner, v. Commissioner of Internal Revenue, RespondentGray v. CommissionerDocket No. 5192United States Tax Court5 T.C. 290; 1945 U.S. Tax Ct. LEXIS 137; June 21, 1945, Promulgated 137 Decision will be entered under Rule 50. Petitioner and his wife were domiciled in Louisiana and filed separate returns for the taxable year 1941 on the community property basis. During the taxable year petitioner received income in the form of oil royalties, bonuses, and restored depletion as a result of oil leases of his separate property. There were no prenuptial or other agreements between petitioner and his wife with respect to such income and the marital community of acquets and gains existed between them. Held, under the law of Louisiana, the above mentioned income from the oil leases represented rent and as such was the community income of petitioner and his wife. Albert B. Koorie, Esq., for the petitioner.Homer J. Fisher, Esq., for the respondent. Black, Judge. Opper, J., dissenting. Arnold, J., agrees with this dissent. 138 BLACK 290 OPINION.This proceeding involves the determination by the respondent against petitioner of a deficiency of $ 8,289.44 in income tax for the calendar year 1941, a small part of which is not contested.The deficiency is the result of a minor adjustment of $ 1, not contested, and of an addition to income of $ 17,016.85 which the respondent, in a statement attached to the deficiency notice, explained as follows:(a) It is held that the portion of your distributive share of the net income of the Estate of John G. Gray, which resulted from bonuses and royalties received on oil leases, does not constitute a part of the acquets and gains of the marital community, but coming from your separately owned property is taxable to you individually.Petitioner, by appropriate assignments of error, contests this addition to income of $ 17,016.85 to the extent of $ 16,889.74.The facts were stipulated as follows:1. Prior to 1939 petitioner acquired by inheritance a one-third undivided interest in certain lands in Louisiana. Such lands were and are still operated 291 as a plantation, and sometime after acquisition and prior to 1939 oil was discovered thereon, and considerable139 oil income was realized thereafter.2. Said lands were operated in the taxable year 1941, and prior thereto, as a joint venture under the name, Estate of John G. Gray, Lake Charles, Louisiana, in which petitioner had a one-third share and his sister, Matilda Geddings Gray, had a two-thirds share. Petitioner's sister, Matilda Geddings Gray, had active management of its operation under a general power of attorney from the petitioner. She filed for the year 1941 a return of income for said joint venture upon Form 1065 which is used for partnerships, syndicates, pools, joint ventures, etc.3. During the taxable year 1941 the Estate of John G. Gray received income from the sale of cattle, horses and farm products; rentals from land; dividends; oil lease rentals, bonuses, royalties, and restored depletion.4. During the taxable year 1941 the one-third of the net income of the Estate of John G. Gray reported on Form 1065 as petitioner's share was $ 45,383.52. Petitioner, William Kirkman Gray, and his wife, Mrs. Opal Hughes Gray, reported said amount as community income and divided it equally between them in separate income tax returns filed with the Collector of Internal Revenue for the140 District of Louisiana for the year 1941.5. Said one-third of the net income of the Estate of John G. Gray was increased by the Commissioner to the amount of $ 45,637.74 by a depreciation adjustment which is not contested. Of said amount of $ 45,637.74 the Commissioner determined $ 11,858.26 to be community income of petitioner and his wife, and determined that the following items were the separate income of petitioner, William Kirkman Gray:Oil lease bonuses (1/3 of three bonuses received in 1941)$ 35,150.00Royalties received in 1941 (1/3 of total from various oilleases) 9,105.83Total 44,255.83Less: 27 1/2% depletion12,170.35Net 32,085.48Depletion restored to income upon cancellation of two oilleases in 1941 (1/3 of the 27 1/2% depletion taken upon receipt of two bonuses in 1939 and 1940, respectively) 1,694.00Total separate income as determined by the Commissioner 33,779.486. The Commissioner's determination resulted in the following allocation between the petitioner and his wife of the one-third distributive share of the income of the Estate of John G. Gray referred to hereinabove, with a resulting overassessment upon the income141 reported by petitioner's wife:HusbandWifeSeparate income$ 33,779.48Community income5,929.13$ 5,929.13 Total 39,708.615,929.13 Income as reported22,691.7622,691.76 Increase or decrease$ 17,016.85($ 16,762.63)292 7. Petitioner and his wife were married before the receipt of the income here in question.8. Petitioner and his wife were married and residing together in the State of Louisiana; were citizens of, and domiciled therein, during the year in controversy and up to the present date.9. Petitioner and his wife have no prenuptial or other agreement with respect to incomes of either or both received during the existence of the community.10. The marital community of acquets and gains existed during the year in controversy and still does exist between petitioner and his wife.11. The property from which the income here in question was received was the separate property of petitioner.12. In their income tax returns for the year 1941 petitioner and his wife allocated the personal exemption of $ 1,500 and one dependency credit of $ 400.00 between them so that each claimed one-half of the total. In the deficiency determination the entire142 personal exemption of $ 1,500 and the credit for dependent of $ 400 have been allowed to the petitioner. In the event of a decision under Rule 50, the personal exemption may be so adjusted as to yield to petitioner and his wife the maximum tax benefit in computation of their aggregate tax liabilities.The question for our determination is whether the income from bonuses, royalties, and restored depletion set out in paragraph 5 of the stipulation is the separate income of petitioner, or the community income of petitioner and his wife. The solution to such a question depends upon the state law. ; . In the instant proceeding we must therefore look to the law of the State of Louisiana. The pertinent statutes of Louisiana, which we think should be considered in deciding the issue we have here to decide, are printed in the margin. 1143 The parties have stipulated that there were no prenuptial or other agreements between petitioner and his wife with respect to the income of either or both; that the marital community of acquets and gains existed between the spouses; and that the property from which the income here in question was received was the separate property of petitioner.293 At the outset it may be noted that the income here in question is classified under three headings, namely, bonuses, royalties, and restored depletion on bonuses. As far as this proceeding is concerned, the governing principles are the same for all three classifications and it has been so regarded by the parties in their briefs. Cf. ; . In the latter case the court said, "in the light of the authorities which clearly establish that the bonus is, and will be treated as advance royalty, and, therefore, income, and that the restored depletion must likewise be treated as income."The facts which have been stipulated do not disclose whether the restored depletion in the year which we have before144 us had been taken as deductions in prior years by petitioner and his wife on the community property basis. We assume, however, that such was the fact and the Commissioner makes no contention to the contrary. We, therefore, make our decision on that basis.In presenting his contention that the three items of bonuses, restored depletion, and royalties are the separate property of petitioner, respondent submits:* * * The law is settled for similar income arising from oil lands situated in the adjacent community property state of Texas, that bonuses, royalties, and restored depletion of bonuses, are separate property if the lands are separate property. ; ; * * . It is believed that the rules established under Texas law are persuasive of what the rules should be under Louisiana law.We do not think the cases cited by respondent are applicable for the reason that, under the laws of Louisiana, the oil and gas not reduced to possession are not owned by the owner of the surface145 and hence are not, as in Texas, part of the corpus of the realty. The difference between the law of Texas and that of Louisiana in this respect was commented upon by the court in , one of the cases relied upon by respondent. In that case, presenting a question similar to the one here before this Court, the taxpayer was a resident of Texas and the land from which the royalties were derived was in Texas. The court, upon the basis of the Texas jurisprudence, sustained the decision of the Board of Tax Appeals holding the royalties to be separate income. Said the court:* * * royalties, * * * are not paid for time but for oil and gas taken out, and represent an actual removal and disposition of the contents of the soil. In some states, as for instance Louisiana, the law looks to the fugaciousness of oil and gas and considers that they belong to no one until captured and confined, so that an oil and gas lease is only a contract for the use of the land for the purpose of capture, and what is paid is rent. In Texas oil and gas in place in the soil are by the established rules of property a part of the realty and capable146 of separate ownership and conveyance. [Citing authorities.] When sold in the 294 ground, the proceeds are the proceeds of sale of land and not the rents or revenues from it. The royalties under an ordinary oil lease are such proceeds and not rents. . By Texas law the lessee under the ordinary lease retaining a one-eighth royalty acquires a title to seven-eighths of the oil in the ground. When the oil is produced, the lessor owns, because he has never ceased to own, an undivided one-eighth.It is true, of course, as respondent says in his brief, that what the court says in the Wilson case about the laws of Louisiana with respect to the nature of oil royalties was dictum, because the court was only deciding what the law of Texas was in this respect. However, we think that what the court said concerning the law of Louisiana with respect to oil royalties being rent is well supported by decisions of the Supreme Court of Louisiana. See ; ; ;147 ; ; .In the Shell Petroleum Corporation case, the court said: "It is well settled that the paying of a royalty under a mineral lease, is the paying of rent." (Citing cases among which are the two above cited.)In ; , the Supreme Court of Louisiana defined royalty as rental when it stated:Hence our conclusion is that a mine or quarry, or land adapted to mining or quarrying may be leased for a certain portion of the produce of such mine or quarry, and the fact that said portion is called "royalty", instead of rent, is not of the least consequence. For "rent (by whatever name called) is a certain profit in money, provisions, chattels, or labor, issuing out of lands and tenements in retribution for the use." , citing Bouv. Law Dict. verbo, "Rent."In the case of ;148 , the Supreme Court of Louisiana reaffirmed that principle:On several occasions this court has decided that the usual oil and gas lease, with a cash or royalty consideration, or both, such as presently before us, is a contract of letting and hiring within the meaning of the codal articles, and therefore does not create a servitude on the realty or a real right in the land. ; ; ; , L. R. A. 1916D, 1147, Ann. Cas. 1917D, 130; ; Hennen's Digest, vol. 1, 479, 480; ; and articles 2669, 2670, 2671, 2674, 2679 of the Revised Civil Code.Respondent149 cites no Louisiana case to the contrary. In his argument he relies mainly on statements made in a book by Harriet Spiller Daggett, professor of law at Louisiana State University, entitled "Mineral Rights in Louisiana." If the statements from Daggett's book quoted by respondent in his brief be deemed contrary to the holdings 295 of the Supreme Court of Louisiana, then we feel that we must follow the decisions of the Supreme Court of Louisiana. See , wherein it is said: "Except in matters governed by the Federal constitution or by acts of congress the law to be applied in any case is the law of the state." Naturally the best interpreter of the laws of Louisiana is the Supreme Court of that state. And it seems clear to us that the Supreme Court decisions of Louisiana hold, without exception, that oil royalties received under an oil lease are rents.It should be noted that the parties have stipulated in paragraph 3 of the stipulation that the estate of Gray received rentals from land and oil lease rentals (meaning delay rentals) in addition to the bonuses, royalties, and restored depletion. The150 respondent concedes that petitioner's share of the "rentals from land" and the "oil lease rentals" was community income. See ; , in which the court said:All collections of rents or revenues from property under the administration of a married man, during the existence of the community, belong to the community. R. C. C. art. 2402; .Therefore it follows that all rents collected by defendant from his separate property during the marriage were community funds, regardless of the fact that these revenues were kept by him in a separate account.The respondent, however, as has already been stated, contends that the "bonuses, royalties, and restored depletion" are in a different category from what the court had in mind in Peters v. Klein, in that they can not be classed as rents. That contention under the authorities above cited is not sustained. On this issue we hold for petitioner.Decision will be entered under Rule 50. OPPEROpper, J., dissenting: This case seems to me to present151 another aggravated example of the sterility of attempts 1 to mate peculiar local property law with a system of uniform national taxation, and particularly of the impossibility of reconciling the antique law of community property with such modern concepts as those exemplified by Helvering v. Clifford, 309 U.S. 331">309 U.S. 331. See 1 Paul, Federal Estate and Gift Taxation, sec. 1.09; Ray, "Proposed Changes in Federal Taxation of Community Property," 30 Calif. Law Review 397, 407; Mr. Justice Douglas, dissenting in Commissioner v. Harmon, 323 U.S. 44">323 U.S. 44, 49.It would be bad enough if the property earning this income were community property, considering that "It has been said, with respect 296 to Louisiana, that 'adherence152 to the theory of the wife's vested interest amounts to little more than lip-service, because neither the wife nor her creditors can exercise any control over the community property until dissolution of the community.'" Paul, op. cit., note 72.But here the income was produced by the husband's separate property, with respect to which even in community property states there is no claim of ownership by the wife. The domination and control by the husband, extending even to the power to sell the property unconditionally, is thus infinitely more complete than in Helvering v. Clifford, and a result which fails to tax him on the income seems to me fundamentally irreconcilable with the principle of that case. It certainly furnishes no satisfactory basis for arriving at a different result with respect to oil income in Louisiana from that obtaining in the neighboring State of Texas. Crabb v. Commissioner (C. C. A., 5th Cir.), 119 Fed. (2d) 772. Footnotes1. Art. 2334. Separate and common property of spouses. -- The property of married persons is divided into separate and common property.Separate property is that which either party brings into the marriage, or acquires during the marriage with separate funds, or by inheritance, or by donation made to him or her particularly.* * * Common property is that which is acquired by the husband and wife during marriage, in any manner different from that above declared. * ** * * Art. 2399. Community of acquets and gains -- Stipulation against required. -- Every marriage contracted in this State, superinduces of right partnership or community of acquets or gains, if there be no stipulation to the contrary. * * Art. 2402. Property forming community -- * . This partnership or community consists of the profits of all the effects of which the husband has the administration and enjoyment, either of right or in fact, of the produce of the reciprocal industry and labor of both husband and wife, and of the estate which they may acquire during the marriage, either by donations made jointly to them both, or by purchase, or in any other similar way, even although the purchase be only in the name of one of the two and not of both, because in that case the period of time when the purchase is made is alone attended to, and not the person who made the purchase. * *↩1. See e. g., ; ; .↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4477130/	OPINION. Raum, Judge: Section 122 (b) (2) (D) was added to the Internal Revenue Code of 1939 by section 330 (b) of the Revenue Act of 1951, and provides in part as follows: SEC. 122. NET OPERATING LOSS DEDUCTION. (b) Amount of Cabby-Back and CaRey-Ovee.— * * * * * * * (2) Net oeebating loss caeby-oveb.— ******* (D) Loss for Taxable Tear Beginning After December 31, 1946, and Before January 1, 1948, in tbe Case of a Corporation Which Commenced Business After December 31, 1045. — If for any taxable year beginning after December 31, 1946, and before January 1, 1948, a corporation which commenced business after December 31, 1945, has a net operating loss, such net operating loss shall be a net operating loss carry-over for each of the three succeeding taxable years, * * * It is not disputed that if the quoted provisions are inapplicable the net operating loss of petitioner sustained in its first taxable period was available, pursuant to section 122 (b) (2) (A), as a net operating loss carry-over for only the 2 succeeding taxable years, and the deduction taken by petitioner in the third succeeding taxable year (ending August 31, 1950) on account of such loss was properly disallowed. Petitioner’s net operating loss was suffered in a taxable period beginning September 6, 1946. Respondent rests his case upon the express language of section 122 (b) (2) (D), which is limited to taxable years beginning after December 31, 1946. Petitioner concedes that it is not within the express terms of that section, but contends that the purpose of section 122 (b) (2) (D) was to afford relief in respect of the type of loss suffered by it, namely, losses incurred after December 31,1946. We are called upon to disregard the express limitations contained in the section on the theory that to deny petitioner the relief sought would be unfair and inequitable, and contrary to what Congress would have provided had it considered the situation in which petitioner now finds itself. We are bound by the statute, and must decide this case accordingly. Where Congress has said “taxable year beginning after December 31, 1946” it would constitute legislation, not interpretation, were we to substitute “September 6, 1946” for the date specified in the statute. The relief sought by this petitioner can come only from Congress. Cf. Riley Co. v. Commissioner, 311 U. S. 55. Petitioner cites United States v. Pleasants, 305 U. S. 357, and Meyer's Estate v. Commissioner, 200 F. 2d 592 (C. A. 2). Doth are distinguishable. In the Pleasants case the term “net income” for the purposes of the then maximum allowable charitable deduction was held to constitute net income without, diminution by reason of net capital loss. That term was thought to be susceptible of at least two reasonable interpretations, whereas in the instant proceeding there is no possible interpretation of “taxable year beginning after December 31,1946” except that it means what it plainly says. In the Meyer case stockholders who had elected to have gains realized upon liquidation of a corporation taxed in one of two possible ways were permitted to abandon their election because it had been made in reliance upon a material mistake of fact. Petitioner argues here that since its loss for the fiscal year ending August 31,1947, was in fact incurred after December 31, 1946, it would have elected to report income on the calendar year basis had it known at the end of 1946 that section 122 (b) (2) (D) would be added to the Code at a later date. However, unlike the taxpayers in the Meyer case, petitioner does not ask that it be permitted to disaffirm the election. Indeed, the very deficiency before us is based upon a fiscal year ending August 31,1950, and petitioner has made no suggestion whatever that it desires to recast all of its income tax returns upon a calendar year basis. What we have just said is not intended to mean that any such request could be approved under the statute, but it is sufficient to show that the Meyer case presents an entirely different situation. Had petitioner elected to report its income on a calendar year basis it might well have been entitled to the deduction claimed. Unfortunately for petitioner, it did not do so and must now accept all consequences of its choice, both good and bad, however fortuitously such choice may have been made. While such factors may bolster petitioner’s equitable position, they may validly be considered by Congress, but not by this Court. Section 122 (b) (2) (D) can apply only to a taxable year commencing after December 31, 1946. Since the taxable period of the petitioner which began on September 6, 1946, does not satisfy that condition, the respondent’s determination must be sustained. Decision will be entered for the respondent.	01-04-2023	01-16-2020
https://www.courtlistener.com/api/rest/v3/opinions/4477131/	OPINION. Bettce, Judge: The entire controversy turns upon whether the partnership, comprised of two of the petitioners, properly accrued as income in 1938 certain claims against the Government arising out of the partnership’s contract to build a library at Howard University. The library building had been substantially completed in 1938 and the Government had been billed for all but $2,500 of the contract price. At the end of that year the partnership accrued the $2,500 together with $25,700 which it estimated was the amount of its claim for damages as a result of delays in the work which it contended were caused by the Government. Petitioners’ contention that these accruals were proper is controverted by the respondent. The partnership computes its income on the completed contract basis.1 Such method of accounting contemplates proper accrual of all unpaid billings, accounts receivable, and accounts payable in the year the contract is substantially completed, which in the instant case was 1938. V. T. II. Bien, 24 T. C. 49; Ehret-Day Co., 2 T. C. 25. The only exception to the rule requiring the accrual of outstanding items in the year of completion is made in the case,, of outstanding items which are “contingent and uncertain.” National Contracting Co., 37 B. T. A. 689, 702, affd. (C. A. 8) 105 F. 2d 488; Edward J. Hudson, 11 T. C. 1042, affd. (C. A. 5) 183 F. 2d 180. We must therefore determine whether the items in question came within this exception. In his brief the respondent does not mention the $2,500 balance due on the contract price which was accrued in 1938 and recovered as part of the judgment in 1946. We, therefore, are unaware of the respondent’s reasons for determining that the $2,500 was not properly accruable until 1946. At no time did the Government contest the partnership’s rights to the $2,500. At the end of 1938 there was no reasonable uncertainty with regard to its ultimate payment; and in our opinion the item was properly accrued in 1938. Cf. Edward J. Hudson, supra. When the partnership disputed and refused to pay two bills aggregating $741.01 with which it was presented in 1939, the Government withheld the $2,500 with the idea of effecting a set-off. The possibility of a set-off, however, did not affect the propriety of the accrual of the partnership’s undisputed claim to the $2,500. Rosa Orino, 34 B. T. A. 726, 731. Whether the partnership’s estimated claim for damages in the amount of $25,700 was sufficiently fixed at the end of 1938 to warrant its accrual is the principal matter in dispute. It was well settled that the partnership as a contractor was entitled to recover as damages the amount of its expenses incurred by reason of delays caused by the Government. Phoenix Bridge Co. v. United States, 85 Ct. Cl. 603, 628. Here there had been a number of delays due to no fault of the partnership. The partnership was of the opinion that six of those delays were caused by the Government, and at the end of 1938 there was nothing to indicate that there would be any controversy as to the Government’s liability with respect to those delays. However the partnership had never billed the Government or made a precise claim for the $25,700 up to the end of 1938, and thS amount then accrued by the partnership was a mere estimate on its part. While the partnership had good reason to believe that the Government was liable for some of the sis delays, the amount of the liability was by no means certain. The number of days lost due to delays caused by the Government could only be estimated. At the end of 1938 the partnership had been granted extensions totaling 200 days by reason of delays for which it considered the Government liable, but in computing its proposed claim the partnership had used 257 days. Also in doubt was the amount of the partnership’s damages for each day lost. For example, over one-half of the $25,700 accrual consisted of a pro rata portion of partnership’s central office overhead. At the end of 1938 there was no legal precedent for including central office overhead in computing a contractor’s damages. The first case allowing a pro rata portion of a contractor’s central office overhead in computing his damages appears to have been Brand Investment Co. v. United States, 102 Ct. Cl. 40, 58 F. Supp. 749, which was decided June 5, 1944, 5y2 years after the accrual here in question. Unlike the cases cited by petitioners, the amount of the liability was extremely uncertain and could neither be reasonably estimated nor ascertained by a mere computation. The accrual in 1938 in the amount of $25,700 was therefore improper. United States v. Anderson, 269 U. S. 422, 441; Security Flour Mills Co. v. Commissioner, 321 U. S. 281; Globe Corporation, 20 T. C. 299. The amount of the 1946 judgment in excess of $2,500, or the damages for delays less the amount of the disputed bills ($10,415.66), was includible in the partnership’s 1946 taxable income and the claimed bad debt loss was properly disallowed. Decisions will be entered under Rule 50. Regs. 101. Chapter VII. Accounting Periods and Methods. Part IV — Accounting Periods and Methods of Accounting. ART. 42-4. Long-term contracts. — Income from long-term contracts is taxable for the period in which the income is determined, such determination depending upon the nature and terms of the particular contract. As used in this article the term “long-term contracts” means building, installation, or construction contracts covering a period in excess of one year. Persons whose Income Is derived In whole or In part from such contracts may, as to such income, prepare their returns upon either of the following bases : " * * * * * * * (b) Gross income may be reported for the taxable year in which the contract is finally completed and accepted if the taxpayer elects as a consistent practice so to treat such income, provided such method clearly reflects the net income. If this method is adopted there should be deducted from gross income all expenditures during the life of the contract which are properly allocated thereto, taking into consideration any material and supplies charged to the work under the contract but remaining on hand at the time of completion.	01-04-2023	01-16-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625489/	PERCIVAL PARRISH, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Parrish v. CommissionerDocket No. 103406.United States Board of Tax Appeals44 B.T.A. 144; 1941 BTA LEXIS 1379; April 9, 1941, Promulgated 1379 A taxpayer who, separated from his wife, is the sole support of his aged mother and sisters in a home in another city where they have lived for many years, held, entitled as the head of a family to a personal exemption of $2,500. Charles S. Jacobs, Esq., and William R. Spofford, Esq., for the petitioner. Paul E. Waring, Esq., for the respondent. STERNHAGEN 145 The Commissioner determined a deficiency of $541.22 in petitioner's income tax for 1936. He disallowed a personal exemption of $2,500 as the head of a family and substituted a personal exemption of $1,000. The facts are mostly stipulated and are so found. FINDINGS OF FACT. The petitioner, an individual residing in Haverford, Pennsylvania, is engaged in the securities brokerage business in Philadelphia. He and his wife were formally separated in 1933 and in 1936 lived apart. He contributed substantially to her support. His son, who is over twenty-one and employed, lives with petitioner in an apartment. For more than fifty years petitioner's parents and two sisters, one an invalid, lived in Newport, Rhode Island. The father, who had been employed in the Government1380 and later pensioned, died in 1935. Until then petitioner contributed materially to the family support, and thereafter he was the sole support of his mother, over eighty, and his-two sisters, each over sixty. They were without other means, and continued to live in the Newport house. Petitioner paid the rent, and in 1936 also contributed more than $4,980 to their support. It was impractical for petitioner, whose business and social interests were in Philadelphia, to live with his mother and sisters in Newport; and their age and physical condition precluded his bringing them to Philadelphia to live with him. The invalid sister had the attendance of a trained nurse and petitioner defrayed the expense. OPINION. STERNHAGEN: The petitioner claims to have been the head of a family in 1936, and demands the personal exemption of $2,500 allowed by the Revenue Act of 1936, section 25(b)(1). The term "head of a family" is not defined in the act, but its scope is to some extent indicated in the regulations, 1 and these have been frequently adopted as the pattern for construction. 21381 146 Petitioner, recognizing a moral or legal obligation, supported and maintained his aged mother and sisters, who had no other means of support. They were not in the same household, but the circumstances explain this and show it to be entirely reasonable. Clearly petitioner, whose established business was in Philadelphia, could not reasonably be expected to live with his mother in Newport; and his mother and sisters, having lived for more than fifty years in Newport, could not reasonably be required to live with him in Philadelphia. Where the separate homes are thus justified, they do not preclude the statutory exemption, ; ; ; ; , although an unjustified separation may do so, cf. ; . The fact that petitioner was the sole support of the Newport household may itself be fairly regarded as giving him the right to exercise family control, and1382 the suggestions which he occasionally made of household economies and the consultation as to financial matters, although very slight, are some indication that some control was recognized - enough in a harmonious family to have significance. Cf. . The determination is reversed. Decision will be entered for the petitioner.Footnotes1. ART. 25-4. [Regulations 94.] Personal exemption of head of family.↩ - A head of a family is an individual who actually supports and maintains in one household one or more individuals who are closely connected with him by blood relationship, relationship by marriage, or by adoption, and whose right to exercise family control and provide for these dependent individuals is based upon some moral or legal obligation. In the absence of continuous actual residence together, whether or not a person with dependent relatives is a head of a family within the meaning of the Act must depend on the character of the separation. If a father is absent on business, or a child or other dependent is away at school or on a visit, the common home being still maintained, the additional exemption applies. If, moreover, through force of circumstances a parent is obliged to maintain his dependent children with relatives or in a boarding house while he lives elsewhere, the additional exemption may still apply. If, however, without necessity the dependent continuously makes his home elsewhere, his benefactor is not the head of a family, irrespective of the question of support. A resident alien with children abroad is not thereby entitled to credit as the head of a family. As to the amount of the exemption, see article 25-3. 2. Estate of grace ↩; ; , dismissed, .	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625490/	ALAN D. WEINER and PHYLLIS F. WEINER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent; ROBERT S. SCHULL and ROSALIND SCHULL, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentWeiner v. CommissionerDocket Nos. 5193-79, 5194-79.United States Tax CourtT.C. Memo 1984-163; 1984 Tax Ct. Memo LEXIS 511; 47 T.C.M. (CCH) 1414; T.C.M. (RIA) 84163; April 2, 1984. 511 Radiology is a Subchapter S corporation. Shortly after forming Radiology, Ps transferred all of the company's stock to their children. Held, the transfers were not bona fide. Ps are the true owners of Radiology's stock and the company's income is taxable to them and not to their children.Held further, certain claimed losses on a purported investment in a movie partnership are not deductible for lack of substantiation. Jack Calechman and Richard Doppelt, for the petitioners. John O'Brien and Robert Dugan, for the respondent. NIMSMEMORANDUM FINDINGS OF FACT AND OPINION NIMS, Judge: In these consolidated cases, respondent determined deficiencies in petitioners' Federal income tax as follows: Docket No.PetitionerYearDeficiency5193-79Alan D. Weiner and1975$31,410.95Phyllis F. Weiner5194-79Robert S. Schull and197532,699.80Rosalind Schull512 The issues for decision are (1) whether transfers of stock by petitioners to their children were bona fide, and (2) whether petitioners are entitled to deduct losses resulting from a purported investment in a movie partnership. FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulation of facts and attached exhibits are incorporated by this reference. Petitioners Alan D. Weiner (Dr. Weiner) and Phyllis F. Weiner and Robert S. Schull (Dr. Schull) and Rosalind Schull resided in Brockton, Massachusetts, at the time their petitions were filed. Issue 1. Stock TransfersDrs. Weiner and Schull are orthopedic surgeons engaged in the private practice of medicine in Brockton, Massachusetts. In 1970, they formed a professional association entitled Drs. Alan D. Weiner and Robert S. Schull, Inc. (hereinafter "Doctors Association"). In 1971, Drs. Weiner and Schull caused a second corporation to be formed which established a radiology office to take X-rays. This corporation was called Center Radiology (hereinafter "Radiology") and occupied the same premises as Doctors Association. The two offices were, however, physically separate. The properties513 occupied by Doctors Association and Radiology were owned 50 percent by Dr. Schull and 50 percent in trust by the children of Dr. Weiner. Radiology was incorporated on January 14, 1971. Drs. Weiner and Schull each received 300 shares of no-par common stock issued by Radiology. One week later, on January 21, 1971, Drs. Weiner and Schull transferred all of their stock to their children. The names, number of shares owned, and ages of the children in 1975 were as follows: NameNo. SharesAge in 1975Martin Weiner15017Jill Weiner15013Elizabeth Schull10012David Schull10010Jennifer Schull1006600No custodian was named for any of the children in connection with these transfers of stock. From the time of incorporation in 1971 to the time of the trial of this case, Dr. Schull served as president of Radiology and Dr. Weiner served as treasurer. The doctors and their wives served as directors of the corporation during that period as well, with one exception. 1In 1973, petitioners filed an election to have Radiology classified as a small business corporation514 under Subchapter S of the Internal Revenue Code of 1954. Throughout the existence of Radiology, Drs. Weiner and Schull have controlled the affairs of the corporation. They determined who the directors would be. They hired Radiology's office manager, Anne Rosenthal, 2 and X-ray technician, Walter Dooley, and determined their salaries. They retained an accountant for Radiology (who also did the accounting work for Doctors Association). They signed checks and made payments for the expenses and obligations of Radiology. They negotiated the rental agreement for the space occupied by Radiology. They arranged for bank loans to finance the purchase of X-ray equipment for Radiology. They also made the initial capital contributions to the corporation. Aside from these activities, Radiology required very little daily attention from Drs. Weiner and Schull. They rarely, if ever, visited the premises. The office manager, Ms. Rosenthal, set the fees and billed the patients. The X-ray technician, Mr. Dooley, was paid through an outside agency515 called Professional Staff Association. The children of Drs. Weiner and Schull never played a role in voting the stock held in their name and never exercised any influence in the operation of the corporation. Indeed, in 1975 the children were not aware that they were stockholders of Radiology. During 1975, Radiology made distributions and extended what was characterized as loans to the children as follows: NameDistributionLoansMartin Weiner$9,000$1,878.75Jill Weiner9,0001,878.75Elizabeth Schull6,0001,252.50David Schull6,0001,252.50Jennifer Schull6,0001,252.50The loans were never repaid. While patients of Drs. Weiner and Schull were never under obligation to patronize Radiology to obtain their X-rays, the bulk of Radiology's business has always consisted of referrals from Doctors Association. Dr. Weiner's wife served part-time as bookkeeper for Radiology. An entry in Radiology's cash disbursements journal for 1974 indicates a payment of $120.00 to Dr. Weiner's mother-in-law. Issue 2. Deduction of LossesSometime in 1975, Dr. Weiner was approached by a man named Rogers who solicited Dr. Weiner to invest in516 a film in which Mickey Rooney, Hal Holbrook and Beau Bridges were to star. Drs. Weiner and Schull each claim to have invested $7,500 in the film as partners in "G. L. Rogers et al." They each claim to have made payment by checks dated December 26, 1975, to "NALMCO" in the amount of $4,000 and to "Enthusiasm for Youth Foundation" in the amount of $3,500. Drs. Weiner and Schull assert that they never received any return on their purported investment. It appeared that no movie was ever made. Dr. Weiner subsequently learned that Mr. Rogers had previously been indicted and charged with promoting fraudulent tax shelters involving movies. OPINIONIssue 1. Stock TransfersThis case involves an attempt by two families to distribute the stock of a Subchapter S corporation among their children to achieve a division and splitting of the corporation's income. Respondent argues that the transfers of stock to the children were not bona fide and that the corporation's income and purported loans should instead be taxed to the parents who are the true shareholders. We agree. Respondent relies upon the following language of the regulation implementing section 1373: 3Only517 those persons who are shareholders of the corporation on the last day of the taxable year of the corporation are required to include in their gross income the [undistributed taxable income of the corporation] * . A donee or purchaser of stock in the corporation is not considered a shareholder unless such stock is acquired in a bona fide transaction and the donee or purchaser is the real owner of such stock. The circumstances, not only as of the time of the purported transfer but also during the periods preceding and following it, will be taken into consideration in determining the bona fides of the transfer. Transactions between members of a family will be closely scrutinized. Section 1.1373-1(a)(2), Income Tax Regs.Courts have developed a four-factor analysis to determine whether an intra-family transfer of stock is bona fide. The four factors are: (1) whether the transferees within the family were able to effectively exercise ownership rights518 of their shares; (2) whether the transferor continued to exercise complete dominion and control over the transferred stock; (3) whether the transferor continued to enjoy economic benefits of ownership after conveyance of the stock; and (4) whether the transferor dealt at arm's length with the corporation involved. Speca v. Commissioner,630 F.2d 554">630 F.2d 554, 556 (7th Cir. 1980), affg. a Memorandum Opinion of this Court. See Beirne v. Commissioner,61 T.C. 268">61 T.C. 268 (1973); Beirne v. Commissioner,52 T.C. 210">52 T.C. 210 (1969); Duarte v. Commissioner,44 T.C. 193">44 T.C. 193 (1965). 4Guided by these factors, we must determine the true owners of Radiology's stock. Ownership of property for Federal income tax purposes is a question of fact to be determined from all the circumstances. Schoenberg v. Commissioner,302 F.2d 416">302 F.2d 416 (8th Cir. 1962); Synder v. Commissioner,66 T.C. 785">66 T.C. 785 (1976). Beneficial ownership, not merely legal title, determines who is the true owner of corporate stock. Hook v. Commissioner,58 T.C. 267">58 T.C. 267 (1972). 5 The519 substance, not the form, of a transaction governs its tax consequences. Commissioner v. Court Holding Co.,324 U.S. 331">324 U.S. 331 (1945). Transfers of property between family members are "subject to special scrutiny in order to determine if they are in economic reality what they appear to be on their face." Fitz Gibbon v. Commissioner,19 T.C. 78">19 T.C. 78, 84 (1952). The burden of proving the economic reality of the transfers of stock is on petitioners. Duarte v. Commissioner,44 T.C. 193">44 T.C. 193 (1965); Rule 142(a). We now proceed to apply the above-mentioned factors to the facts before us: (1) Were the children of Drs. Weiner and Schull able to effectively exercise the ownership rights of their shares? We conclude that they were not. In 1975, all the children were minors and too immature to participate in the management of the corporation. 6 Indeed, petitioners stipulated that none of the children "ever played any role in voting the stock held in their name or in any way exercised any influence in the operation of the corporation." In 1975, none of the children even knew that520 they were stockholders of Radiology.Nevertheless, the appointment and active supervision of a custodian might have insured an effective transfer of ownership rights in the Radiology stock. Duarte v. Commissioner,44 T.C. at 197. Here, however, no custodian was appointed for the children. The absence of a custodian weighs heavily against the petitioners' contention that the stock transfers were bona fide. Speca v. Commissioner,630 F.2d at 557. 7(2) Did Drs. Weiner and Schull continue to exercise complete dominion and control over the transferred stock? We are persuaded that they did. We recognize that Drs. Weiner and Schull were officers of the corporation and that the management activities of officers should not be confused with the dominion and control of shareholders.We are convinced, however, that Drs. Weiner and Schull exercised a control over the affairs of Radiology that went beyond their role as executives and amounted to the conduct of owners. None of the children has ever521 voted his or her shares of Radiology. It is not likely that the children felt that they could effectively challenge their fathers' judgment.Indeed, petitioners stipulated that "[f]rom the time of incorporation of Radiology to the present, Drs. Alan D. Weiner and Robert S. Schull have determined who the directors of Radiology would be." This ordinarily is the domain of stockholders, not officers. At trial, testimony by Dr. Weiner implied that he and Dr. Schull viewed Radiology from an owner's perspective. When asked why Radiology was separately incorporated, Dr. Weiner answered that one of the reasons was the opportunity for the doctors to leave a business to their children, because "[t]here is very little that a professional man can otherwise leave to his children." Moreover, when asked what he did to promote the growth and increase the profits of Radiology, Dr. Weiner responded: "We did very little to increase the profit and the growth because we really were not terribly interested in using it as a vehicle to accrue tremendous profits." (3) Did Drs. Weiner and Schull continue to enjoy economic benefits of ownership after conveyance of the stock? The record reveals that they522 did. The children were unaware of distributions and loans made by Radiology to them; this money was controlled by petitioners. The funds were used by petitioners to defray expenses relating to the children that otherwise would have been borne by petitioners. 8 Mrs. Weiner testified that the increased after-tax income flowing from the children's ownership of stock enabled the children to go to private school and "to the camp that we picked for them." These are the economic obligations of parents, not those of minor children. (4) Did Drs. Weiner and Schull deal at arm's length with Radiology? Although Drs. Weiner and Schull refrained from some of the more flagrant abuses described in similar cases previously decided by this Court, 9 there is nevertheless evidence that petitioners did not always deal at arm's length with Radiology.On one occasion in 1974, Radiology made a payment to Dr. Weiner's mother-in-law that neither Dr. Weiner nor Mrs. Weiner could explain. Moreover, Dr. Weiner hired his sister as Radiology's office manager and later made her a director. Drs. Weiner and Schull did not appoint523 a custodian to protect the children's interests in these matters. Taken together, the evidence bearing on the four factors discussed above reveals that the true beneficial owners of the Radiology stock were Drs. Weiner and Schull. We therefore conclude that Radiology's undistributed taxable income and distributions in 1975 must be taxed to Drs. Weiner and Schull.We further conclude that Radiology's so-called loans to the children must be taxed to Drs. Weiner and Schull as well. Petitioners have the burden of proving that the purported loans were not dividend income taxable to the true owners of Radiology stock. Rule 142(a). Petitioners have not, however, offered any evidence to dispute respondent's recharacterization of the loans as dividends. Indeed, 524 the record reveals (1) that the loans were never repaid, (2) that Mrs. Winer, despite being Radiology's bookkeeper during the time in question, could not recall whether the payments "were put as loans-- whether their dividend was called a loan or not," and (3) that Mrs. Weiner never felt there was an obligation to repay Radiology. Issue 2. Deduction of LossesDrs. Weiner and Schull each claim to be entitled to a deduction in 1975 for losses allegedly sustained in the amount of $7,500. These losses purportedly arise out of the doctors' investment in a movie production partnership called "G. L. Rogers et al." The fact that the investment was made is substantiated only by checks made out to two entities called "NALMCO" and "Enthusiasm for Youth Foundation." Petitioners have the burden of proving entitlement to any claimed deduction that respondent has disallowed. Rule 142(a). "Since deductions have been generally interpreted as being matters of legislative grace, the burden of proof rule has been applied with inexorable force to loss claims." Stivers v. Commissioner,360 F.2d 35">360 F.2d 35, 41 (6th Cir. 1966). A threshold requirement for meeting this burden is, of*525 course, proof that the asserted transaction purportedly giving rise to the loss actually occurred. Bear Film Co. v. Commissioner,18 T.C. 354">18 T.C. 354 (1952), affd. without discussion on this point, 219 F.2d 231">219 F.2d 231 (9th Cir. 1955). Petitioners have failed to meet their burden. Nowhere in the record or briefs have petitioners explained the nature of "NALMCO" and "Enthusiasm for Youth Foundation," much less drawn a connection between these payees and the partnership "G. L. Rogers et al." We are unable to conclude from this record that petitioners' investment took place. 10 Accordingly, the claimed deduction for losses must be denied. Decisions will be entered for the respondent.Footnotes1. Phyllis Weiner served as director only from 1971 until 1978.↩2. Ms. Rosenthal is Dr. Weiner's sister. She replaced Mrs. Weiner as a director of Radiology, following the divorce of Dr. and Mrs. Weiner.↩3. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954, as in effect for the year in issue. All references to Rules are to the Tax Court Rules of Practice and Procedure, except as noted.↩4. Bell v. Commissioner,T.C. Memo. 1982-660↩.5. Hume v. Commissioner,T.C. Memo. 1982-525↩.6. See Barrier v. Commissioner,T.C. Memo. 1983-258↩.7. See also Borkowski v. Commissioner,T.C. Memo. 1982-87↩.8. See Borkowski v. Commissioner,T.C. Memo. 1982-87↩.9. See Beirne v. Commissioner,52 T.C. 210">52 T.C. 210 (1969) (father availed himself of large unsecured loans from the corporation for his personal use). See also Borkowski v. Commissioner,T.C. Memo. 1982-87 (large unsecured loans); Fundenberger v. Commissioner,T.C. Memo. 1980-113 (large unsecured loans). Compare Kirkpatrick v. Commissioner,T.C. Memo. 1977-281↩.10. We therefore find it unnecessary to address petitioners' other arguments, all of which assume that the movie investment actually occurred.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625492/	JACOBUS BROTHERS & CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Jacobus Bros. & Co. v. CommissionerDocket No. 24498.United States Board of Tax Appeals17 B.T.A. 36; 1929 BTA LEXIS 2367; July 31, 1929, Promulgated 2367 1. Where $95,000 was paid in 1922 in compromise of proposed additional assessments of income and profits taxes for 1917 to 1920, inclusive, invested capital for 1921 should be adjusted by the amount of the compromise payment. 2. Special assessment denied. Hugh Satterlee, Esq., I. Herman Sher, Esq., and Henry F. Wolff, Esq., for the petitioner. John E. Marshall, Esq., for the respondent. MORRIS36 This proceeding is for the redetermination of a deficiency of $3,314.71, income and profits taxes for 1921. The petitioner alleges that respondent erred: (a) In excluding from invested capital for 1921 the sum of $3,750, representing the cost of good will to the extent of 25 per cent of the par value of capital stock outstanding at the beginning of 1921; (b) In excluding from invested capital for 1921 the sum of $95,000, representing the amount paid by petitioner on its own account and the account of others in 1922, in compromise of all taxes, interests and penalties claimed by respondent to have been due from the petitioner, the Hamilton Garment Co., and the Kleva Klad Dress Co., for the years 1917 to 1920, inclusive. At the hearing2368 petitioner waived the error assigned in (a) with respect to the good will item, and amended its petition by alleging that respondent erred, (c) In denying petitioner the benefit of special assessment under sections 327 and 328 of the Revenue Act of 1921, for the reason that 37 within the meaning of section 327(a), the respondent is unable to determine petitioner's invested capital. FINDINGS OF FACT. The petitioner, the Hamilton Garment Co., and the Kleva Klad Dress Co., are New York corporations organized under the laws of that State in 1910, 1915, and 1918, respectively. On March 17, 1922, the respondent addressed a letter to petitioner wherein he stated that after an examination of petitioner's returns and the returns of its affiliated companies, the Kleva Klad Dress Co. and the Hamilton Garment Co., for the years 1917 to 1920, inclusive, he proposed to assess against and collect from these corporations additional income and profits taxes and penalties for the years 1917 to 1920, inclusive, aggregating the sum of $410,420.36. Respondent's computation of net income for each of the affiliated companies for the years 1917 to 1920, inclusive, is shown in the letter2369 of March 17, 1922, as follows: 1917191819191920Petitioner$80,236.55$63,451.74$162,467.57$143,889.12Hamilton Garment Co5,056.2710,408.442,821.17956.49Kleva Klad Dress Co17,567.6044,623.4016,223.16Total85,292.8291,427.78209,912.14161,068.77The taxes and penalties proposed in the letter of March 17 were as follows: 1917Additional taxes claimedPenalties assertedTotalPetitioner$36,607.08$36,607.08$73,214.16Hamilton Garment Co289.37303.38592.75Total for 191736,896.4536,910.4673,806.91AS A CONSOLIDATED GROUP191865,130.3132,565.1697,695.47191989,839.9844,919.99134,759.97192069,438.6734,719.34104,158.01Total for all years261,305.41149,114.95410,420.36On the same date respondent addressed a letter to the Hamilton Garment Co., wherein he proposed the assessment against and collection from the said company of additional income and profits taxes and penalties for the year 1917 in a total amount of $592.85. Under date of July 10, 1922, the petitioner, the Hamilton Garment Co. and the Kleva Klad Dress Co., addressed a letter to respondent2370 in care of the Collector of Internal Revenue for the Second District 38 of New York, wherein they offered to pay $95,000 in compromise of all claims for additional taxes, penalties, and interest against the said companies. The concluding paragraph of this letter, which was signed by the officers of the three corporations, reads as follows: This offer is made without prejudice and upon the understanding that it is not intended to and shall not constitute an admission, directly or indirectly, of any wrongful or unlawful act on the part of the taxpayers and/or any of them, or the validity of any of the claims made against them and/or any of them. This offer in compromise was accompanied by the payment to respondent of the $95,000. Under date of August 28, 1922, the respondent, with the advice and consent of the Secretary of the Treasury, duly accepted said offer in compromise and said $95,000 "in settlement and compromise of all income tax, interest and penalties in question for the years 1917, 1918, 1919, and 1920." (Signed) "Carl A. Mapes, Solicitor of Internal Revenue." Thereafter and on September 15, 1922, counsel for the petitioner, the Hamilton Garment Co., and2371 the Kleva Klad Dress Co., addressed a letter to the Solicitor of Internal Revenue acknowledging receipt of his letter dated August 28, 1922, wherein counsel confirmed the acceptance of the offer in compromise contained in their letter of July 10, 1922, and stated that "we take it that the case is finally closed accordingly without further action on the part of our clients or ourselves." To this letter of September 15, 1922, the Solicitor on September 22, 1922, replied as follows: Reference is made to your letter of September 15th, 1922, and it is advised that you are correct in your conjectures that the case, above mentioned, is finally closed, and that the offer in compromise was accepted in the terms presented by your clients. Your letter will be placed with the files. (Signed) CARL A. MAPES, Solicitor.No notice of any determination by the respondent of additional income and profits taxes, penalties, or interest for the years 1917 to 1920, inclusive, against the petitioner or its affiliated companies, other than the determination found in respondent's letters of March 17, 1922, was ever received by the petitioner, the Hamilton Garment Co. and the Kleva Klad Dress Co. 2372 The amounts of deficiencies shown in the notice mailed to the petitioner and the Hamilton Garment Co. on March 17, 1922, were assessed by the respondent in September, 1922. Subsequently, these assessments were canceled by the collector on the filing of claims for abatement, and the assessments were removed from the list. The offer in compromise was accepted by respondent prior to placing the amounts of the proposed deficiencies for the years 1917 to 1920, inclusive, on the assessment list. No notice of assessment was given 39 and no demand for payment was made with respect to any of the aforementioned proposed deficiencies by the collector. The petitioner filed its income and profits-tax return for 1921 and reported therein a taxable net income and invested capital of $26,781.32 and $148,141.76, respectively. The total tax computed on the return was $4,801.78. The respondent held that the petitioner was not affiliated with the Hamilton Garment Co. or the Kleva Klad Dress Co. during 1921. He excluded from its invested capital for that year the $95,000 paid under the compromise agreement, and determined the petitioner's taxable net income and invested capital for2373 1921 to be $26,781.32 and $49,391.76, respectively. He determined the total income and profits tax to be $8,116.49, of which $4,801.78 had been previously assessed, leaving a deficiency of $3,314.71. OPINION. MORRIS: Petitioner's contention in regard to the reduction of invested capital by the amount of the compromise settlement is that section 1207 of the Revenue Act of 1926 and article 845 of Regulations 62 relate to adjustments of invested capital for income and profits taxes for the year immediately preceding the taxable year and that no additional income and profits taxes have been established at any time to be due from or payable by the petitioner for any of the years 1917 to 1920, inclusive, and no such additional taxes were paid for said years, the payment of an amount in compromise not being the payment of a tax. It is difficult to see any distinction in principle between this case and our decision in the , wherein we expressly held that the adjustment of invested capital by reason of income and profits taxes for the preceding years, when made in accordance with the regulations, must be approved. Obviously, 2374 the payment which petitioner made precluded the collection of the proposed taxes. It offered a lump sum in accord and satisfaction of any liability for additional taxes which were then due or might subsequently be determined to be due. It can not be said that we are going behind the terms of the compromise agreement, since we are not concerned with taxes for any one of the years 1917 to 1920, inclusive. Our concern is directed to the determination of whether an amount paid in satisfaction of proposed tax assessments can be included in petitioner's statutory invested capital. The principal distinguishing element between these facts and the majority of tax cases is that petitioner was able to settle the question of its tax liability through the acceptance of an offer in compromise prior to an actual assessment. 40 No payment in this case was made, because of any contract right or obligation, or because of a judgment, or in satisfaction of damages inflicted, but in order to satisfy the burden or charge imposed on income by the Federal taxing statute. The fact that the proposed taxes had not been reduced to judgment, or that no notice and demand had been made, or that2375 no suit or proceeding had been initiated to collect the proposed taxes, can not alter the fact that the $95,000 was paid in satisfaction of a statutory tax liability. No other reason can be advanced for the payment of this $95,000 than the satisfaction of the proposed tax assessments. Whether the amount paid completely discharged the burden imposed by the taxing statute for each of the years 1917 to 1920, is immaterial, since the respondent, with the advice and consent of the Secretary of the Treasury, had the authority to accept an offer in compromise. Had there been proof that the true additional tax liability was less than the amount of the compromise payment, an interesting question would have arisen as to the extent of the reduction of invested capital for the taxable year in question, but no such showing was made. The petitioner's offer in compromise was accepted, and thereby whatever tax liability that might or might not have been ultimately determined was eliminated from further consideration. This amount was actually paid out in settlement of a tax liability and, regardless of bookkeeping entries, surplus should be reduced in the amount of such payment. Nor do we think2376 that the time element is material. Invested capital is a creature of the statutes, and as errors made in reporting income for prior years are corrected, it necessarily follows that these corrections are often reflected by adjustments to invested capital for subsequent years. The true tax liability for any particular year or any amount paid in satisfaction thereof, even though discovered or paid in later years, must be reflected in an adjustment to invested capital for the next succeeding taxable year. See section 1207 of the Revenue Act of 1926 and article 845 of Regulations 62. The second issue raises the question whether petitioner is entitled to special assessment for the reason that the respondent is unable to determine its invested capital. The argument advanced is that, since the respondent has held the companies were not entitled to affiliation for 1921, and since the $95,000 compromise payment was for the affiliated group, and because of the nature of the compromise agreement, there is no basis upon which a division of the $95,000 may be made among the three companies. The $95,000 was paid in compromise of proposed tax liabilities. We are not satisfied that a division2377 of this payment could not be made either on the basis of an agreement between the companies *41 or upon the basis of net income. We are of the opinion the petitioner has failed to sustain the burden of showing that invested capital can not be determined. It is, therefore, not entitled to have its tax computed under section 328 of the Revenue Act of 1921. Judgment will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625494/	OREGON TRAIL MUSHROOM COMPANY, PAUL H. RUTTEN, TAX MATTERS PARTNER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentOregon Trail Mushroom Co. v. CommissionerDocket No. 5657-89United States Tax CourtT.C. Memo 1992-293; 1992 Tax Ct. Memo LEXIS 317; 63 T.C.M. (CCH) 3045; May 19, 1992, Filed 317 Decision will be entered under Rule 155. O, which operates a large commercial mushroom production facility, claimed an investment tax credit in 1984 for its entire facility. The Commissioner allowed the credit in full for some of the assets in 1984, allowed the credit as to other assets partly in 1984 and the remainder in 1985, and disallowed the credit altogether as to other assets. She disallowed the credit in full on certain assets because they were not "section 38 property". O also claimed an energy tax credit with respect to certain assets which utilized geothermal energy available on site. The Commissioner disallowed some of this credit. The Commissioner disallowed certain deductions claimed by O for legal and accounting expenses in its first year of operation. 1. Held, some of the assets for which the Commissioner disallowed the investment tax credit are sec. 38 property because they are part of a single purpose horticultural structure or because they qualify as tangible property used as an integral part of manufacturing or production. 2. Held, further, the Commissioner erroneously disallowed the energy tax credit on some of O's assets because those assets use318 or distribute geothermal energy. 3. Held, further, O is not entitled to deduct legal and accounting expenses in the year those expenses were incurred, but must add those expenses to the cost of its facility and amortize the expenses over the life of the facility. Commissioner v. Idaho Power Co., 418 U.S. 1 (1974). James H. Stethem, James A. Comodeca, and Michael R. Nelson, for petitioner. Tim A. Tarter and Randall G. Durfee, for respondent. GOFFEGOFFEMEMORANDUM FINDINGS OF FACT AND OPINION GOFFE, Judge: The Commissioner proposed adjustments to partnership items of Oregon Trail Mushroom Co. (OTM) pursuant to the partnership audit and litigation procedures of sections 6221-6233 with respect to taxable years 1984 and 1985. The proposed adjustments are as follows: Partnership Item19841985Depreciation$ 248,767$ 178,340 Start-up expenditures110,634(4,834)Investment tax credit3,013,022(1,708,109)Energy tax credit3,335,0091,026,917 Investment tax credit recapture166,220 Energy tax credit recapture76,500 The petition herein was filed by Paul H. Rutten, tax matters partner, hereinafter referred to as petitioner. 319 After concessions, the issues presented for our decision are: (1) Whether OTM is entitled to an investment tax credit for certain assets used in the commercial production of mushrooms; (2) whether OTM is entitled to an energy tax credit for certain assets used at its mushroom producing facility; (3) in what year were the assets placed in service, as defined in section 46; and (4) whether OTM is entitled to a deduction in 1984 for legal and accounting expenses, or whether those expenses must be amortized over a longer period. Unless otherwise indicated, all section references are to the Internal Revenue Code for the years at issue. All Rule references are to the Tax Court Rules of Practice and Procedure. FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. The stipulation of facts and attached exhibits are incorporated herein by this reference. OTM is an Oregon limited partnership located in Vale, Oregon. It files its partnership returns (Forms 1065) on a calendar year basis and began the operation of an active trade or business on May 1, 1984. OTM is a state-of-the-art mushroom growing facility designed to yield 3,150,000 pounds of mushrooms320 annually. It began construction of its mushroom facility in 1984. By the end of 1984, two of the grow rooms were planted and harvested. By December 1985, construction of all phases of the facility was complete. OTM utilizes a six-step process modeled after the Dutch tunnel system, a system designed to provide a consistently high yield of mushrooms. The process may be summarized as follows: First, the compost is prepared at the mix and storage site by use of a special compost recipe consisting mainly of chicken manure and straw. The chemical balance of the compost is critical in providing the proper growing medium for mushrooms. The mix and storage site is approximately 5 miles from the main facility at Vale, Oregon. The compost is then transported to the compost wharf located at the main facility. At the compost wharf, the compost is allowed to grow bacteria under controlled conditions so as to be suitable for mushroom growing. After the compost has developed the proper amounts of bacteria in the compost wharf, it is placed in a pasteurizing structure to kill foreign pathogens. This is accomplished in tunnels where filtered geothermally heated air is injected into the tunnels321 for approximately 10 to 12 hours. The compost is then removed from the tunnel units and mushroom spawn are sprinkled in the compost. The compost and spawn are then transported by overhead conveyor to one of 40 grow rooms enclosed within a single growing structure. The grow rooms are pressurized, airtight enclosures which are computer monitored in order to maintain the proper ambient air temperature, humidity, and carbon dioxide levels. Once the compost and spawn mixture is in the grow room, it is placed on specially designed mushroom grow racks and encased with peat moss. The mushrooms are then allowed to grow in these grow rooms under controlled conditions. After the mushrooms have grown to the desired size, they are harvested by hand, sorted, packaged, and then shipped to OTM's customers. The compost and spawn mixture remains on the grow racks for four to six more weeks to allow for the harvesting of three or four additional crops. Each grow room is expected to produce five to six crops per year. The first mushrooms planted by OTM in 1984 utilized compost and spawn from a similar mushroom facility, Treasure Valley Mushrooms. Treasure Valley Mushrooms was a pilot project322 for OTM and used the same technology as OTM, but on a smaller scale. The mix and storage site, where the compost is initially mixed, includes a roofed storage bin which is used to keep the compost mixture dry, water wells, fencing, pumps, storage tanks, and several paved surfaces, including the mixing pad, the turnaround pad, straw storage area, and bale storage area. The primary function of the mix and storage site is to store the compost materials. OTM claimed an investment tax credit (ITC) for the entire mix and storage site. The Commissioner allowed the credit for the paved surface area, but disallowed the credit for the remainder of the mix and storage site. The compost wharf, where the compost is allowed to grow bacteria under controlled conditions so as to be suitable for mushroom growing, consists of a metal frame structure with a concrete foundation and floor. The structure is necessary to protect the compost from the severe cold weather. The concrete floor is sloped to allow for drainage. It contains a heating, ventilation, and air conditioning (HVAC) system to control the heat and humidity in the compost wharf. The HVAC systems in the compost wharf and throughout323 the facility consist of a coil through which geothermally heated water passes, and fans which blow the heat from the coil into the area of the facility requiring heat. The compost wharf was specifically designed for the commercial production of mushrooms. It has insulated walls, with plywood placed above the floor to prevent compost buildup on the sides of the walls. Its beams are made of galvanized steel, and it contains enough space to allow workers to turn and properly maintain the mixture. The floor of the compost wharf contains a forced air system which allows the distribution of hot air under the compost. The compost wharf was not used until 1985. It was used exclusively in the commercial production of mushrooms. The pasteurization tunnel unit, where the compost is pasteurized to kill foreign pathogens, consists of a metal frame structure with three tunnel units and was specifically designed for the commercial production of mushrooms. The metal frame structure provides workspace for transporting and monitoring the compost and it protects the tunnel units from the elements which would impede the pasteurization process. The metal frame structure was constructed with hot324 dipped galvanized steel beams. The pasteurization unit was exclusively used in the commercial production of mushrooms. The pasteurization unit, its tunnels, and its HVAC's were first placed in service in 1984. The grow unit, which houses 40 individual grow rooms, is where the mushrooms are allowed to grow until harvesting. Each grow room is equipped with an HVAC and two grow racks. The HVAC's distribute geothermal energy through the grow rooms and the grow racks are equipped with metal piping designed to distribute geothermal energy. However, the piping was never used. The grow rooms are specially designed airtight rooms where the temperature, humidity, and carbon dioxide levels are controlled by computer to maximize mushroom production. The cement floors are slanted for drainage. The metal frame structure housing the grow rooms is painted with a zinc chromate primer with 4-mil thickness and is insulated to maintain the proper temperature for growing mushrooms. The grow unit was specifically designed for, and exclusively used in, the commercial production of mushrooms, and all of the activities in the unit were to that end. The 40 grow rooms were completed by the end of325 1984. Only two of the grow rooms, including their grow racks and HVAC's, were placed in service in 1984; the remainder of the grow rooms were placed in service in 1985. The waste water and sewage system is used to dispose of unwanted water from the geothermal wells, restrooms, and drinking fountains. OTM erected a chain link fence which partially encircles the main facility except that portion bounded by a river. The fence was erected to protect the facility from thieves, vandals, and stray animals. Adjacent to the compost wharf is the mechanical unit which encloses the heat exchanger and tanks, two boilers, and a geothermally powered chiller. OTM chose Vale, Oregon, to build its facility because of the availability of geothermal energy at the site. The mushroom facility utilizes hot water from a geothermal reservoir having a temperature exceeding 50 degrees Celsius. OTM does not convert any geothermal energy into electricity. Rather, the mushroom facility utilizes geothermal energy in conjunction with electricity and propane to maintain critical air temperature and humidity requirements within the mushroom facility. Of all the energy utilized by the plant, 81.9 percent 326 is derived from geothermal energy. Geothermal water is pumped from a well to a heat exchanger, where the heat is transferred to distilled water and geothermal water itself is also routed through the chiller. The geothermal water is then injected into the ground. Because of the corrosive nature of the geothermal water it is not feasible to circulate it through the plant; therefore, by means of the heat exchanger, the heat is transferred to distilled water which is circulated throughout the plant. The facility utilizes geothermal energy in the compost wharf, which has heating coils and pipes that run through the floor; the pasteurization tunnels, which use geothermal energy to pasteurize the compost mixture; the pasteurization unit, which employs geothermal energy to provide a constant temperature within the structure; and the grow racks, which utilize geothermal energy to foster the growth of the mushrooms. OTM incurred start-up expenses of $ 744,592, which it elected to amortize over a 60-month period under sections 709 and 195. OTM also incurred legal and accounting expenses of $ 24,168 after its May 1, 1984, starting date. These expenses were incurred in connection with the327 construction and initial operation of the Vale facility. OTM claimed the entire cost of the compost wharf as investment in property qualifying for an ITC. The Commissioner allowed only the cost of the HVAC system and the forced air system as an investment in property qualifying for an ITC. OTM claimed an ITC on the entire pasteurization unit. The Commissioner denied the credit for the structure and only allowed a credit on 33 percent of the cost of the tunnels in 1984, while allowing the remaining 67 percent in 1985. The Commissioner disallowed the cost of the metal framed structure which encloses the 40 grow rooms as an investment in property not qualifying for an ITC. Since only two of the grow rooms were planted by the end of 1984, the Commissioner determined that only 5 percent (2 of 40) of the grow rooms were property eligible for an ITC in 1984. The remaining cost of the other grow rooms was allowed as an investment in property qualifying for an ITC in 1985. Likewise, the Commissioner allowed only 5 percent of the cost of the grow racks in 1984 as property eligible for the ITC, and allowed the other 95 percent of the total costs of the grow racks in 1985. OTM claimed328 ITC's of $ 240,081 in 1984 and $ 489,837 in 1985 for the HVAC's in the grow rooms. The Commissioner disallowed all but 5 percent of the total cost of the HVAC's for 1984 and allowed the remaining 95 percent of the total cost in 1985. OTM claimed ITC's in the amount of $ 23,965 in 1984 and $ 41,509 in 1985 for the HVAC in the three tunnel rooms. Respondent concedes 33 percent of the total costs in 1984 and the other 67 percent in 1985. OTM also claimed an ITC for costs incurred in the construction of a truck roadway which encircles the mushroom plant. The Commissioner allowed approximately 10 percent of those costs for 1984 and 1985. OTM claimed the entire cost of the waste water and sewage system as property qualifying for an ITC. The Commissioner disallowed the portion of the cost of the waste water and sewage system allocable to the restrooms and drinking fountains. The Commissioner also denied an ITC that OTM claimed for the fence which was erected around the perimeter of the main Vale, Oregon, facility. OTM claimed an ITC for the structure, foundation and miscellaneous other costs of the mechanical unit. The Commissioner disallowed the ITC taken except for the amount329 allocable to "other costs". Because of its use of geothermal energy, OTM claimed the entire cost of the following assets as property qualifying for an energy tax credit (ETC): For 1984AssetCostCompost wharf$ 424,745Tunnel unit379,552Grow unit2,085,899Sewage system106,328HVAC-grow rooms240,081HVAC-tunnel rooms23,965Grow racks74,439Total$ 3,335,009For 1985AssetCostHVAC-grow rooms$ 489,837HVAC-tunnel rooms41,509Grow racks368,035Addl. heating coils10,598Grow structure modification49,098Compost wharf modification11,841Ref. equipment14,423Isoloc cooler35,089Cooling tower15,228Chiller65,865Total$ 1,101,523The Commissioner allowed 92 percent of the cooling tower and chiller costs (i.e., 92 percent of $ 81,093, or $ 74,606) as property qualifying for an ETC. She also allowed 100 percent of the cost of the following assets which OTM claimed as property qualifying for an ETC: 19841985Geothermal costs$ 891,819$ 54,109Geothermal equipment23,8569,148Total$ 915,675$ 63,257The Commissioner disallowed the cost of all other assets, determining330 that those assets were property not qualifying for an ETC. OTM deducted the $ 24,168 of initial accounting and legal fees in 1984 as ordinary and necessary business expenses. The Commissioner determined that these expenses should be treated as start-up expenses and, thus, should have been amortized over a 60-month period beginning May 1, 1984. OPINION It is worth noting before proceeding further that the provisions of section 48 (relating to the investment tax credit and the energy tax credit) applicable to 1984 and 1985, the years in question, were struck out by the Omnibus Budget Reconciliation Act of 1990, Pub. L. 101-508, section 11813(a), 104 Stat. 1388-536, which amended section 48, now entitled Energy Credit; Reforestation Credit. First, we examine whether the assets qualify for the ITC, then whether they qualify for the ETC, and then, if qualified, we decide which year the assets should be deemed placed in service in order to decide the extent of the credit allowable for each year. Finally, we decide whether legal and accounting expenses which OTM deducted in 1984 are allowable in the year they were incurred or must be amortized. In his petition, petitioner alleged 331 that the Commissioner improperly issued two FPAA's in violation of the TEFRA partnership procedures of sections 6221-6233. Petitioner did not argue that issue on brief and it is, therefore, deemed to be conceded. Remuzzi v. Commissioner, T.C. Memo 1988-8">T.C. Memo. 1988-8, affd. without published opinion 867 F.2d 609">867 F.2d 609 (4th Cir. 1989). The Commissioner also partially disallowed depreciation expenses. The parties disagree as to the useful life of certain assets on which depreciation was claimed. The parties agree that the cost basis of the property (or, where appropriate, a portion thereof) held to be part of a single purpose horticultural structure qualifying for an ITC should be depreciated over a 5-year life, while depreciable assets that are determined not to be part of a single purpose horticultural structure should be depreciated over an 18-year life. I. Investment Tax CreditThe Commissioner disallowed an ITC for the structures which house the grow unit, the pasteurization unit, the compost wharf, the mix and storage site, and the mechanical unit. She also disallowed an ITC on portions of the waste water and sewage system, fences, and truck roadways. 332 Respondent's determinations are presumed correct. Rule 142(a). Whether OTM is entitled to an ITC depends on whether any of the property may be characterized as "section 38 property" which is eligible for credit against Federal income tax. Section 38 allows a credit equal to 10 percent of the value of section 38 property. See sec. 46(a) and (b)(1). Section 48(a), in defining section 38 property, provides: (1) In General. -- Except as provided in this subsection, the term "section 38 property" means -- (A) tangible personal property (other than an air conditioning or heating unit), or (B) other tangible property (not including a building and its structural components) * * * * * * (D) single purpose agricultural or horticultural structures * * Thus, in order for OTM to be able to take an ITC on its various assets, the assets must be either tangible personal property, other tangible property, or part of a single purpose agricultural or horticultural structure. A. Single Purpose Horticultural StructureSection 48(p)(3) defines "single purpose horticultural structure" as: (A) a greenhouse specifically designed, constructed, and used for the commercial333 production of plants, and (B) a structure specifically designed, constructed and used for the commercial production of mushrooms. [Emphasis added.]Petitioner argues that all of the assets of OTM are eligible for an ITC because they are part of a single purpose horticultural structure. Respondent, on the other hand, argues that only the grow rooms are used in growing mushrooms and are, thus, the only assets that fall under the definition of single purpose horticultural structure. The rest of the assets must then fall under one of the more general definitions of section 38 property. Hence, argues respondent, to determine whether the assets involved in this case are entitled to an ITC we must first determine which, if any, assets are part of a single purpose horticultural structure. The regulations list a series of tests which an asset or structure must satisfy before it can be considered part of a single purpose horticultural structure. We will first discuss each of the tests, and then apply those tests to each asset. Section 1.48-10(c), Income Tax Regs., sets out the requirements which a structure must meet to qualify as a single purpose horticultural structure. It334 must be: (1) A greenhouse or other structure; (2) "specifically designed and constructed" in the manner described in section 1.48-10(d), Income Tax Regs.; (3) for "permissible purposes" as defined in section 1.48-10(c)(2), Income Tax Regs.; and (4) "specifically used", as defined in section 1.48-10(e), Income Tax Regs.There is no dispute as to whether the structures housing the assets involved satisfy the first test of the above regulation; it is agreed that the structures qualify as "other structures". As for the second requirement, section 1.48-10(d), Income Tax Regs., provides: (d) Specifically designed and constructed. A structure is specifically designed and constructed if it is not economic to design and construct the structure for the intended qualifying purpose and then use the structure for a different purpose. * The third requirement, that the structure be for "permissible purposes", is defined in section 1.48-10(c)(2), Income Tax Regs., and includes the commercial production of mushrooms. Finally, the structure must be "specifically used" under the tests contained in section 1.48-10(e), Income Tax Regs. There are two parts to the test: the exclusive use335 test and the actual use test. The Exclusive Use TestThe structure must be exclusively used for a permitted purpose, in this case the commercial production of mushrooms. This means that the structure cannot be used to process or market the product and can only be used to store materials such as feed if the storage is "incidental" to the permitted purpose. A storage function will be presumed not to be incidental if more than one-third of the structure is devoted to storage. Sec. 1.48-10(e)(1)(iii), Income Tax Regs.The Actual Use TestUnder this test, not only must a structure be designed and constructed for a permissible purpose, it must also be used for that purpose in the given year. This is basically the same as requiring the structure be put in service for the year at issue. Sec. 1.48-10(e)(2), Income Tax Regs. Because the "actual use" test is similar to the issue of what year the assets in this case were put in service, we will decide whether the actual use test has been met when we discuss the "placed in service" issue. Thus, an asset meeting all of the other requirements will be available for the ITC in the year the asset was placed in service. In applying336 the regulations to the assets in the instant case we first examine the grow unit. Respondent disallowed an ITC for the structure surrounding the grow rooms. The structure that houses the 40 grow rooms is a metal frame structure painted with zinc chromate primer, having specially placed columns to accommodate the equipment and grow rooms; it is insulated to maintain the correct temperature and humidity; and its floor is slanted to allow for drainage. Because of its unique features tailored to the specific needs of the mushroom growing process, we hold that this structure satisfies the requirement that the structure be specifically designed and constructed for the production of mushrooms. The grow unit structure also satisfies the third requirement, the permissible purpose requirement: the grow unit is used to produce mushrooms, and all of the activities, from maintaining the units to harvesting the mushrooms, are to that end. Since all of the activity in the grow unit was for the commercial production of mushrooms, the structure was exclusively used for the production of mushrooms, thus satisfying the last requirement -- the exclusive use test. Therefore, OTM is entitled to take337 an ITC for the grow unit structure. Next we consider the pasteurization unit. The Commissioner disallowed an ITC for the structure surrounding the three pasteurization tunnels. We disagree, and hold that OTM is entitled to an ITC for the pasteurization unit building. The structure was specifically designed and constructed for the growing of mushrooms. Without the pasteurization of the compost, the mushroom growth would be seriously inhibited by competing with unrelated organisms. The function of pasteurization is to kill all organisms so that only mushrooms will grow. The structure over the pasteurization tunnels is necessary to protect the tunnels from the harsh and changing weather conditions of Vale. The structure is made with hot dipped galvanized steel beams, and the floors are specially designed to accommodate pressure requirements. Accordingly, we hold that the pasteurization unit structure was specifically designed and built for the production of mushrooms. We next must decide whether the pasteurization unit passes the permissible purpose test. Respondent argues that mushroom production only occurs in the grow rooms and that the activity in the pasteurization unit338 fails to satisfy the permissible purpose test. She argues that mushroom growing is the only permissible purpose in this case, and pasteurization of compost is not within that definition. Respondent takes too narrow of a view of the definition of mushroom production. Section 48(p) defines "single purpose horticultural structure" to include those structures used in the commercial production of mushrooms. Nowhere does that definition state that the ITC should be limited to the structures where the mushrooms actually grow. OTM was designed to be a state-of-the-art facility producing a consistently high yield of mushrooms. No step in the process is unnecessary, and to eliminate one would reduce or destroy the mushroom crop. Therefore, we hold that the pasteurization unit was used in the production of mushrooms and satisfies the permissible purpose requirement. We must next determine whether the pasteurization unit was exclusively used for the production of mushrooms. The activities in the pasteurization unit include the pasteurization of the compost and the operation and maintenance of the tunnel units. Therefore, the pasteurization unit is used exclusively for the production339 of mushrooms. Since the pasteurization unit has met all of the tests, OTM is entitled to an ITC for that structure. Next we consider the compost wharf. The compost wharf was specifically designed and constructed for the mixture and fermentation of compost, a necessary first step in the raising of mushrooms. Its beams are made of galvanized steel to protect it from the corrosive effects of the compost. Likewise, the lower portions of the walls are covered with plywood to protect them from the compost. The concrete floor is slanted to allow for drainage. OTM designed and built this structure with the preparation of compost in mind. It is not, as respondent argues, merely a generic structure that OTM decided to use for the preparation of compost. As to the permissible purpose requirement, respondent argues that the compost wharf is not used for a permissible purpose since the preparation of compost and the growth of bacteria is not a permissible purpose. As we held with regard to the pasteurization unit, since the proper fermentation of the compost is a necessary component in the production of mushrooms, the compost wharf is used for a permissible purpose within the meaning340 of section 1.48-10, Income Tax Regs. Since the compost wharf is used exclusively for that purpose it also passes the exclusive use test. Accordingly, OTM is entitled to an ITC for the compost wharf in the year that it was placed in service. For the mix and storage site, the Commissioner allowed an ITC only for certain paved surfaces. We agree with that determination and hold that the mix and storage site is not part of a single purpose horticultural structure. The mix and storage site was not specifically designed with special features, but is merely a structure which houses a large concrete slab that is used to store and mix the straw, manure, and chemicals. Petitioner has failed to show that OTM could not economically adapt the mix and storage site to another purpose, and it therefore does not meet the "specifically designed and constructed" requirement of section 1.48-10(d), Income Tax Regs. Thus, we sustain respondent's determination as to the mix and storage site. The Commissioner disallowed an ITC for the structure and foundation of the mechanical unit. Petitioner argues that this determination was erroneous in that the mechanical unit, which houses the equipment that341 heats the buildings, is part of the single purpose horticultural structure. While petitioner may be correct that the mechanical unit is used in the production of mushrooms, he has failed to show that the mechanical unit structure is not economically adaptable to another use. The mechanical unit is used to convert the geothermal energy and to heat the other parts of the facility. If the facility were to be converted to a warehouse, for example, the mechanical unit would be equally useful in heating a warehouse. Thus, petitioner has failed to show that the mechanical unit could not be economically converted for a use other than the production of mushrooms. This reasoning can also be applied to the disallowed portion of the sewage system and the roadway. Therefore, we hold that OTM is not entitled to an ITC on the mechanical unit, the disallowed portion of the sewage system, or the roadway. Respondent argues in support of the disallowance of ITC's for the various structures involved that the structures are economically adaptable to other uses and, thus, they fail the specifically designed and constructed requirement. An example in the regulations provides a different interpretation: 342 A constructs a rectangular structure for use as an egg-producing facility. The structure has no windows. The walls and roof are made of corrugated steel and there is a door which is 4 feet wide and 8 feet tall at each end of the structure. At the end of each wall are louvered openings approximately 4 feet high and 8 feet long. These openings house thermostatically controlled fans. In the center of the walls are manually operated fresh-air openings. Corrugated steel "curtains" hang from the top of the openings so that the openings can be completely closed in cold weather, but the curtains can be propped open to admit fresh air. The building is well insulated. A has reinforced the roof with extra trusses and rafters and reinforced the buildings with extra wall studs. Two rows of cages are suspended from the rafters by thin steel girders and wires. The floor of the structure is a sloping concrete slab pierced with long troughs which run the length of the structure beneath the cages. The troughs are used for collection and disposal of chicken wastes. When this structure is placed in service it will qualify for an investment credit under this section. [Sec. 1.48-10(j), 343 Example (1), Income Tax Regs.]This example illustrates that a facility which is specially built for an agricultural or horticultural process, with features that are unique to that process, and one that is used exclusively for that process, is entitled to an ITC under the definition of single purpose horticultural system. OTM's facility, with its specially designed and constructed buildings, serves one purpose, the commercial production of mushrooms. We think respondent adopted an unreasonable interpretation of the regulations in this case. The type of facility OTM constructed at Vale, Oregon, is within the ambit of the example quoted above. It is also within the definition set by Congress, when it stated "for the commercial production of mushrooms." The Senate Finance Committee, in enacting the applicable version of section 48, stated in its report: When the investment tax credit was restored in 1971 it was the intention of the committee, as expressed in its report on the Revenue Act of 1971, to make it clear that the credit as restored was to apply to special purpose agricultural structures. Despite this expression of intent, the Internal Revenue Service has344 denied the credit to special purpose agricultural structures and enclosures used for raising poultry, livestock, horticultural products or for producing eggs. Taxpayers' litigation to establish their right to these credits is both expensive and troublesome, particularly in cases involving small farmers with limited amounts of eligible property. As a result of this continuing controversy, the committee has decided to specifically provide that these agricultural structures are eligible for investment credit. [S. Rept. 95-1263 (1978), 1978-3 C.B. (Vol. 1) 414.]We think Congress intended a broad application of the ITC to agricultural and horticultural structures, and the Commissioner's continuing resistance in this area frustrates clear congressional policy. B. Other Tangible PropertyPetitioner argues that if we decide that certain property does not qualify for an ITC because it is not part of a single purpose horticultural structure, we should find that it is still eligible for an ITC because it is "other tangible property". Because we have held that the structures housing the compost wharf, pasteurization unit, and grow unit are part of a single 345 purpose horticultural structure, we need not consider whether they meet the definitions of other tangible property. However, since we have also held that the mix and storage site and mechanical unit were not part of a single purpose horticultural structure, we must examine whether they qualify as "other tangible property". As indicated, section 48(a) in defining section 38 property provides: (1) In General. -- Except as provided in this subsection, the term "section 38 property" means -- * * * (B) other tangible property (not including a building and its structural components) but only if such property -- (i) is used as an integral part of manufacturing, production or extraction * * Thus, in order for the mix and storage site structure and the mechanical unit structure to be "other tangible property", they must not be a building and they must be an integral part of manufacturing or production. Elaborating on the requirement that the asset not be a building, section 1.48-1(e), Income Tax Regs., defines "building" as: (1) Generally buildings and structural components thereof do not qualify as section 38 property. * * The term "building" generally means any 346 structure or edifice enclosing a space within its walls, and usually covered by a roof, the purpose of which is, for example, to provide shelter or housing, or to provide working, office, parking, display, or sales space. The term includes, for example, structures such as apartment houses, factory and office buildings, warehouses, barns, * The regulation defines "building" in terms of two tests: the appearance test and the functional test. The appearance test has its genesis in the portion of section 1.48-1(e)(1), Income Tax Regs., which provides that a building "generally means any structure or edifice enclosing a space within its walls, and usually covered by a roof". The functional test inquires into whether the purpose of the structure at issue is of the same nature as the purpose described by example in the regulations. Consolidated Freightways, Inc. v. Commissioner, 708 F.2d 1385">708 F.2d 1385, 1388 (9th Cir. 1983), affg. on this issue and revg. in part 74 T.C. 768">74 T.C. 768 (1980). The regulations provide that the function or purpose of a building is "to provide shelter or housing, or to provide working, office, parking, display, or sales space", or 347 to provide a similar function. Munford, Inc. v. Commissioner, 87 T.C. 463">87 T.C. 463, 479 (1986), affd. 849 F.2d 1398">849 F.2d 1398 (11th Cir. 1988); sec. 1.48-1(e)(1), Income Tax Regs. The Court of Appeals for the Ninth Circuit, to which this case is appealable, has rejected the appearance test in favor of the functional test. Consolidated Freightways, Inc. v. Commissioner, supra at 1387. In the instant case, the function of the mix and storage site was essentially to store the compost materials, individually and as a mixture. We think that the mix and storage site functions as a warehouse or barn, and is thus within the explicitly enumerated examples of "building". Having come within the definition of building, it cannot qualify as other tangible property. Petitioner argues that the mechanical unit is not a building under the above regulation because it merely houses equipment. Section 1.48-1(e)(1), Income Tax Regs., does provide that the term building does not include "a structure which is essentially an item of machinery or equipment". However, a structure is not outside the definition of building because it houses items of machinery. 348 Under the exception set forth in the regulation, a structure will not be considered a building only if it is an item of machinery or equipment. In this case, the mechanical unit is not an item of machinery such as a furnace or oven. Rather, it is more like a barn or warehouse because it houses equipment used by the facility. Therefore, we hold petitioner's argument that the mechanical unit is essentially an item of machinery or equipment unpersuasive and hold that the mechanical unit is within the definition of building. As such, it cannot qualify as other tangible property. OTM erected a chain link fence on its property. Petitioner argues that the fence is an integral part of the production of mushrooms because it keeps vandals and animals out of the facility and is, thus, within the definition of other tangible property. We have held previously that fences erected to deter theft are an integral part of manufacturing and production and therefore qualify for an ITC as other tangible property. Consolidated Freightways Inc. v. Commissioner, 74 T.C. 768">74 T.C. 768, 799 (1980), affd. in part and revd. in part on another issue 708 F.2d 1385">708 F.2d 1385 (9th Cir. 1983);349 Spalding v. Commissioner, 66 T.C. 1017">66 T.C. 1017 (1976). In the instant case, the fence was erected to protect the facility from thieves, vandals, and stray animals which could damage the facility and the mushroom crop. Therefore, we hold that the chain link fence is property used as an integral part of manufacturing or production and thus qualifies as other tangible property. However, as to the portion of the water and sewage system that the Commissioner disallowed, we hold that those assets are not an integral part of OTM's mushroom facility. The disallowed portion of the water and sewage system pertains only to employee use and is only incidental to production and manufacturing; therefore, those assets are not an integral part of manufacturing or production and OTM is not entitled to an ITC for those assets. The Commissioner disallowed part of the costs related to the roadway surfaces. Petitioner did not offer sufficient evidence to show that this determination was incorrect, and thus has not met his burden of proof on that issue. II. Energy Tax CreditOTM claimed an energy tax credit (ETC) for nearly all of its assets in 1984 and 1985 because it utilizes350 geothermal energy at its Vale, Oregon, site. The Commissioner, in the FPAA, partially allowed the costs as basis in property qualifying for an ETC as follows: 19841985Basis of property claimed for ETC$ 3,335,009$ 1,101,523Basis of property allowed for ETC074,606The Commissioner also allowed the following costs which OTM claimed as basis in property qualifying for an ETC: Asset19841985Geothermal costs$ 891,819$ 54,109Geothermal equipment23,8569,148Total$ 915,675$ 63,257(Geothermal costs include the following: source wells, transfer mechanical, injection wells, geological and testing, and engineering expenses.)OTM utilizes geothermal energy by distributing heat through metal pipes in the floor in its compost wharf. Geothermal energy is used in the pasteurization unit, both in the unit itself to provide heat for workers and to maintain a constant temperature for the tunnels, and also in the tunnels to pasteurize the compost mixture. The grow rooms utilize geothermal energy in maintaining the proper atmosphere for mushroom growing. Section 38, in addition to allowing an investment tax credit, also allows an ETC351 on "energy property". Section 48(1) defines energy property as property which is, among other things, equipment used to produce, distribute, or use energy derived from a geothermal deposit. Sec. 48(1)(3)(A)(viii). For purposes of the ETC, all property which otherwise meets the definition of energy property is treated as meeting the requirements for section 38 property. Thus, buildings and structures which would otherwise not be eligible for the investment tax credit under section 38 are eligible for the ETC. Sec. 48(l)(1). The regulations under section 48 further define geothermal equipment. The regulations echo the statutory definition in providing that it is equipment that "produces, distributes, or uses energy derived from a geothermal deposit". Sec. 1.48-9(c)(10), Income Tax Regs. Geothermal production equipment is defined as "equipment necessary to bring geothermal energy from the subterranean deposit to the surface". Distribution equipment is defined as "equipment that transports geothermal steam or hot water from a geothermal deposit to the site of ultimate use." Finally, geothermal equipment includes equipment that "uses energy derived both from a geothermal deposit352 and from sources other than a geothermal deposit", as long as the use of energy from sources other than geothermal sources does not exceed 25 percent, and only to the extent of the geothermal energy used. Sec. 1.48-9(c)(10)(ii)-(iv), Income Tax Regs.The regulations do not define in detail what "equipment that uses geothermal energy" means. However, examples in the regulations provide some guidance: Example (1). On October 1, 1979, corporation X * * places in service a system which heats its office building by circulating hot water heated by energy derived from a geothermal deposit through the building. Geothermal equipment includes the circulation system, including the pumps and pipes which circulate the hot water through the building. * * * Example (4). Corporation Y acquires a commercial vegetable dehydration system in 1981. The system operates by placing fresh vegetables on a conveyor belt and moving them through a dryer. The conveyor belt is powered by electricity. The dryer uses solely energy derived from a geothermal deposit. The dryer is geothermal equipment * * . [Sec. 1.48-9(c)(10)(vi), Income Tax Regs.; emphasis added.]These353 examples illustrate that even though a structure may utilize geothermal energy in a general sense like the office building in Example (1), the entire structure is not necessarily entitled to an ETC. The regulations require that we examine a facility to determine which assets within that facility actually distribute geothermal energy throughout the facility or use geothermal energy in the operation of the equipment. OTM's compost wharf utilizes geothermal energy to maintain the proper temperature in the structure. Petitioner argues that OTM is entitled to an ETC for the entire compost wharf because it uses geothermal energy. We disagree. In the compost wharf, only the system which actually delivers the heat from geothermal sources, for example the pipes that carry the heated water, is eligible for the ETC. As in Example (1), supra, the entire structure is not entitled to the ETC. This reasoning is also applicable to the pasteurization unit structure. While the entire pasteurization unit utilizes geothermal energy to maintain comfortable conditions,only the delivery system for the heated water is eligible for an ETC as equipment that uses geothermal energy354 within the meaning of the statute and regulations. The pasteurization tunnels utilize geothermal energy to raise the temperature of the compost in the pasteurization process. We hold that the pasteurization tunnels are more like the dryer unit in Example (4), supra, and we therefore hold that the tunnel units are equipment which uses geothermal energy. Using the above analysis, OTM is entitled to an ETC for some of its assets in the grow unit. The structure which houses the grow unit is not entitled to an ETC because it is not equipment that uses geothermal energy. By inference section 1.48-9(c)(10)(vi), Example (1), Income Tax Regs., excludes a housing structure from eligibility for an ETC. The grow rooms, on the other hand, utilize geothermal energy distributed by each room's HVAC system. The grow rooms are air-tight structures that require the heated air to provide the proper environment for mushrooms. We hold that the grow rooms are equipment that uses energy from a geothermal deposit. Sec. 1.48-9(c)(10)(vi), Example (4), Income Tax Regs. As to the grow racks, petitioner did not show that the system designed to distribute geothermal energy355 was ever used, and we therefore hold that it cannot be equipment which uses geothermal energy. Geothermal equipment also includes "equipment that transports geothermal steam or hot water from a geothermal deposit to the site of ultimate use * * * [and] * * * includes components of a heating system, such as pipes and ductwork that distribute within a building the energy derived from the geothermal deposit." Sec. 1.48-9(c)(10)(iii), Income Tax Regs. Petitioner argues that its HVAC systems, which helps to distribute the geothermally heated water, is equipment which distributes geothermal energy. We agree. The HVAC system was the vehicle OTM used to distribute the geothermally heated water throughout the facility. While some of the components of the HVAC, such as the fan, may have used electricity, that does not put the HVAC systems outside the definition of equipment which distributes geothermal energy. Section 1.48-9(c)(10), Income Tax Regs., provides that an asset need not use solely geothermal energy to qualify as equipment that uses geothermal energy. The regulations allow up to 25 percent of the energy sources to come from nonalternative energy sources. However, equipment356 will be considered as equipment that uses geothermal energy "only to the extent of its basis or cost allocable to its use of energy from a geothermal deposit". Sec. 1.48-9(c)(10)(iv), Income Tax Regs. In the instant case, OTM's facility derives 81.9 percent of its energy usage from geothermal sources; thus, its assets can qualify as geothermal equipment even though they also use electricity and propane. However, because only that portion of the cost of the equipment which relates to geothermal energy use can be eligible for an ETC, and because petitioner has not shown the geothermal energy usage of individual assets, OTM is only entitled to an ETC on 81.9 percent of the cost of its assets that otherwise qualify for the ETC. Petitioner has not shown that any of the rest of its assets are eligible for the ETC. Because petitioner has the burden of showing that the Commissioner's determinations are erroneous, we sustain the determinations with respect to the eligibility for an ETC on the remainder of OTM's property. Rule 142(a). Respondent argues that even if we find that the assets are geothermal equipment and that they use geothermal energy, the assets still do not qualify for357 an ETC because petitioner has not established that each asset's use of geothermal energy exceeds 75 percent of its total energy use. Respondent interprets section 1.48-9(c)(10)(iv), Income Tax Regs., as requiring that a taxpayer who seeks to qualify certain dual use property (i.e., property that uses both geothermal energy and electricity) to show, through separate energy studies, the percentage of geothermal energy used for each asset. Section 1.48-9(c)(10)(iv), Income Tax Regs., provides: (iv) Geothermal equipment includes equipment that uses energy derived both from a geothermal deposit and from sources other than a geothermal deposit (dual use equipment). Such equipment, however, is geothermal equipment (A) only if its use of energy from sources other than a geothermal deposit does not exceed 25 percent of its total energy input in an annual measuring period and (B) only to the extent of its basis or cost allocable to its use of energy from a geothermal deposit during an annual measuring period. * * * The allocation of energy use required for purposes of paragraph (c)(10)(iv)(A) and (B) of this section may be made by comparing, on a Btu basis, energy input to dual use equipment358 from the geothermal deposit with energy input from other sources. * Nowhere do we find the regulations requiring that a separate energy use study be made as to each asset. The purpose of the ETC is to encourage the use of alternative sources of energy and thereby to reduce the country's dependence on traditional forms of energy. S. Rept. 95-529 (1977), 1978-3 C.B. (Vol. 2) 199, 205. In the instant case, OTM derives 81.9 percent of its energy from geothermal energy. OTM was built at the Vale, Oregon, site because geothermal energy was available. Thus, while OTM uses propane and electricity in its facility, it has met the requirements of the regulations set out above, and it satisfies the purposes of the statute. Therefore, respondent's arguments are without merit. III. Placed in ServiceHaving determined that certain of OTM's assets are eligible for an ITC and/or an ETC, we must now determine in what year the assets were placed in service. Although we have held that certain assets of OTM are entitled to a credit, section 38 allows a credit (including an ITC and an ETC) on section 38 property only in the year that such property was placed in359 service. Section 1.46-3(d), Income Tax Regs., provides: (d) Placed in service. (1) For purposes of the credit allowed by section 38, property shall be considered placed in service in the earlier of the following taxable years: (i) The taxable year in which, under the taxpayer's depreciation practice, the period for depreciation with respect to such property begins; or (ii) The taxable year in which the property is placed in a condition or state of readiness and availability for a specifically assigned function * * Thus, in order for an asset to be placed in service in a given year, it need not actually be used, but must only be in a state of readiness for a specifically assigned function. Piggly Wiggly Southern, Inc. v. Commissioner, 84 T.C. 739">84 T.C. 739, 746 (1985), affd. 803 F.2d 1572">803 F.2d 1572 (11th Cir. 1986). To decide the placed in service issue, we must go through each of the facility's assets and apply the above test to each of them. Respondent agrees that the structures surrounding the pasteurization unit and the grow unit were placed in service in 1984. Therefore, we must determine the year in which the compost wharf, the pasteurization360 tunnels, and the HVAC's used in the pasteurization unit, as well as the grow rooms, grow racks, and the HVAC systems were placed in service. At trial, petitioner and respondent offered conflicting testimony as to when the compost wharf was actually completed and available for use. The burden of establishing the year an asset was placed in service is on petitioner. Rule 142(a). We hold that petitioner has not met his burden of showing that the compost wharf was placed in service in 1984. The compost wharf was not used until 1985, and the evidence as to whether it was even completed before 1985 is conflicting. Petitioner introduced evidence that the compost wharf was available to be used by the end of 1984, but one of OTM's employees testified that the compost wharf was not completed until 1985. Thus, although an asset need not actually be used, it must only be ready for use in a given year, we hold that petitioner has not met his burden of showing that the compost wharf was in a state of readiness before 1985. Petitioner argues that the pasteurization unit and all of the assets used in it were placed in service in 1984. The pasteurization unit was not used in 1984. Instead, 361 pasteurized compost was brought from Treasure Valley Mushrooms for use at the OTM site in 1984. Despite this, the Commissioner allowed 33 percent of the pasteurization tunnels and the HVAC systems used in the pasteurization unit in 1984, and admitted that the structure surrounding the pasteurization unit was placed into service in 1984. Petitioner introduced evidence that the entire pasteurization unit, including all of the tunnels and the HVAC, were in a state of readiness in 1984. Respondent introduced no evidence to contradict this, and offered no indication as to why only 33 percent, as opposed to 100 percent or nothing, was allowed. Therefore, we hold that petitioner has established that the pasteurization unit, including the three pasteurization tunnels and the HVAC's, were placed in a state of readiness, and thus placed in service in 1984. OTM contends that the entire grow unit was placed in service in 1984. Only two of the grow rooms were actually used in 1984. The Commissioner, therefore, determined that only 5 percent of the grow rooms, grow racks, and HVAC systems were placed in service in 1984. There is conflicting evidence as to the availability for use of the362 other 38 grow rooms including their grow racks and HVAC's in 1984. Petitioner testified that all of the grow rooms were available for use in 1984. However, an employee of OTM, who is familiar with the initial operations of the facility testified that no more than a few of the grow rooms and their HVAC's were completed and available for use in 1984. In light of this conflicting testimony, we find that petitioner has not met his burden in establishing that more than 5 percent of the grow rooms, grow racks, and grow unit HVAC's were placed in service in 1984. Thus, while OTM is entitled to an ITC for the entire grow unit, as to the grow rooms, grow racks, and HVAC's, it may take only 5 percent of the credit in 1984 and must take the remaining 95 percent in 1985. IV. Legal and Accounting ExpensesOTM deducted legal and accounting expenses as ordinary and necessary expenses of an active trade or business in 1984. Respondent disallowed the deduction and determined that the expenses were start-up expenses and should be amortized over a 60-month period pursuant to sections 195 and 709. Ordinary and necessary expenses of an active trade or business are deductible in the year363 in which the expense is incurred. Sec. 162. Start-up expenditures are generally not deductible, but the taxpayer may elect to amortize those expenses over a 60-month period. Sec. 195(a) and (b). Start-up expenditures are expenses which are incurred by the taxpayer after a decision to acquire or establish a particular business and prior to its actual operation, and they would generally be deductible if they were incurred after the commencement of the particular operation. S. Rept. 96-1036 (1980), 2 C.B. 723">1980-2 C.B. 723. In the instant case, OTM began an active trade or business on May 1, 1984. The legal and accounting fees at issue were incurred after the date OTM began active operation of its mushroom facility. Thus, the expenditures are not "start-up expenditures" within the meaning of section 195(a) and (b). The tax treatment to be accorded the expenditures at issue therefore involves the interaction of section 162, which allows a deduction for "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business," and section 263, which generally precludes a deduction for expenditures capital in nature. The application364 of section 263 takes precedence over section 162. Secs. 161, 261; Commissioner v. Idaho Power Co., 418 U.S. 1">418 U.S. 1, 17 (1974). The Supreme Court stated in Commissioner v. Idaho Power Co., supra at 13, that "when wages are paid in connection with the construction or acquisition of a capital asset, they must be capitalized and are then entitled to be amortized over the life of the capital asset so acquired." In the instant case, some of the legal and accounting expenses were incurred after OTM began the active conduct of its trade or business and would, therefore, be deductible in 1984. However, some of the expenses at issue were incurred in the construction of OTM's facility. Those expenses must be added to the cost of the facility and amortized over the life of OTM's mushroom production plant. Petitioner has not shown which of the accounting and legal expenses are attributable to the construction of the facility and which of the expenses are attributable to the conduct of the business. Hence, petitioner has not met his burden in establishing that the legal and accounting expenses are currently deductible, and thus the expenses must be *365 included in the cost of the mushroom facility and amortized over the life of that facility. Commissioner v. Idaho Power Co., supra.V. SummaryIn summary, as to the assets in dispute, we hold that OTM is entitled to an ITC in 1984 for the pasteurization unit, its three tunnels and HVAC's, the structure surrounding the grow unit, and 5 percent of the grow rooms, grow racks, and grow room HVAC's. OTM is entitled to an ITC in 1985 for the compost wharf and 95 percent of the assets within the grow unit structure. For the assets at issue with respect to the ETC, we hold that OTM is entitled to an ETC on the grow rooms and their HVAC's, the pasteurization tunnels and the unit's HVAC's, and the HVAC system of the compost wharf. We hold that OTM is not entitled to deduct the legal and accounting expenses for 1984, but must add those expenses to the cost of its facility and amortize the expenses over the life of the facility. To reflect the foregoing, Decision will be entered under Rule 155.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625496/	David W. Murray, Jr. and Gretchen Murray v. Commissioner.Murray v. CommissionerDocket No. 86468.United States Tax CourtT.C. Memo 1962-2; 1962 Tax Ct. Memo LEXIS 305; 21 T.C.M. (CCH) 7; T.C.M. (RIA) 62002; January 4, 1962305 Walter J. Murray, Esq., 3965 Penobscot Bldg., Detroit, Mich., for the petitioners. J. P. Graham, Esq., for the respondent. FAYMemorandum Findings of Fact and Opinion FAY, Judge: The Commissioner determined a deficiency of $18,063.83 in the petitioners' income tax for the taxable year 1956. The sole question for decision is whether the petitioners are entitled to deduct as a casualty loss the amount of $30,334.35 which was claimed by them but disallowed by the Commissioner. Findings of Fact Some of the facts are stipulated and are found as stipulated. The petitioners are husband and wife. They filed their joint Federal income tax return for the year 1956 with the district director of internal revenue at Cleveland, Ohio. On May 27, 1954, the petitioners purchased a house and lot located at 21050 Avalon Road, Rocky River, Ohio, for $54,000. The property had been offered for sale for over a year prior to this purchase, and the price of $54,000 was a highly advantageous one to the petitioners. The property was approximately 2 1/2 to 3 acres in size and fronted on Lake Erie. It was improved by a large and handsome brick dwelling, an adjoining large garage with306 living quarters above, a beach house and a pier. Easy access was provided from the dwelling to the beach house by means of an elevator and a tunnel. There was also a lighted tennis court adjacent to the beach. The property was assessed at $73,000 for purposes of property taxes for the year 1954 and this represented approximately 40 percent of its fair market value. The property was not level; in fact, the dwelling was located on raised land which fell off rather steeply toward the lake a short distance landward of the beach. The earth on this slope was held back from the beach level by a concrete retaining wall, the eastern portion of which was located landward of the tennis court. At the time the petitioners purchased the property this portion of the wall was cracked and leaning outward toward the tennis court along a part of its length. The bank of soil which this wall held back rose to a height of about 12 feet behind the wall and slanted upward from there in the direction of the307 house at an angle of 45 degrees. The wall rose 2 to 3 feet above the soil in contact with it. The improvements to the land had been constructed in 1941. The property also contained a number of large ornamental trees. Some of these trees grew on an embankment and served to hold the soil in place. On March 1, 1956, strong, gusty winds that began in the late forenoon continued throughout the afternoon and evening. A squall line passed through the Cleveland area shortly after 8:00 p.m. The wind from the southwest reached momentary gusts of 75 miles per hour and was accompanied by light rain which began at 7:50 p.m. and continued past midnight. As a result of the storm the retaining wall along the tennis court fell over onto the court, and the soil which it had retained was released and spilled forward over the toppled wall. This damage reduced the fair market value of the property by $4,000. On May 12, 1956, a severe thunderstorm, accompanied by high winds, struck the Cleveland area. Heavy rains from this storm so loosened the soil that a number of trees on the petitioners' property were blown over. Other trees were damaged by the wind, and falling trees and limbs damaged the house. 308 The petitioners recovered $6,650.83 in insurance as a result of the damage to the house. The trees were not insured. The trees destroyed were of the following diameters: 3 at 14 inches, 5 at 16 inches, 1 at 20 inches, 2 at 22 inches, 1 at 24 inches, 1 at 26 inches and 1 at 28 inches. Two of the trees destroyed by the storm which were in excess of 20 inches in diameter were located an even distance from the front door of the house and framed the colonnaded colonial entryway which occupied a large part of the front of the house. These trees provided shade for the entire front of the residence. They were replaced by the petitioners shortly after the storm with trees 12 inches and 13 inches in diameter at a cost of $100 an inch. The loss of these two trees plus that of the other trees reduced the fair market value of the property in the amount of $14,299.47. This figure includes $13,200 for the decrease in value of the property due to the loss of the trees and $1,099.47 for the cost of removing the debris left by the storm. On their return for the year 1956 the petitioners deducted the amount of $33,834.35 as a casualty loss resulting from these two storms. This amount was made up309 as follows: Damage to house, not reim-bursed by insurance$ 934.88Value of trees destroyed13,200.00Cost of removing debris1,099.47Loss of retaining wall18,600.00The Commissioner disallowed this deduction for lack of substantiation except to the extent of $3,500. Opinion A taxpayer is entitled to a deduction for a casualty loss occurring to property not used in a trade or business. The amount of the loss allowable is the difference in value of the property immediately before and immediately after the casualty, but not more than the adjusted basis of the property. . We have found that the petitioners' retaining wall was destroyed by reason of a windstorm. In addition to some evidence as to the decrease in the value of the property as a whole due to the casualties, the petitioners presented evidence that the replacement cost of the wall would be $20,000. However, there was also evidence that the wall was cracked and in a weakened condition for some time prior to the casualty. The wall was 15 years old at the time it fell; thus, it was worth substantially less than its replacement value immediately310 prior to its fall. Taking into consideration the value of the wall as it stood, plus the damage caused by the release of the soil it retained, we find that the loss in value due to the collapse of the wall was $4,000. There can be no doubt that the decrease in the value of the property brought about by the loss of 14 large trees was substantial. This loss is not susceptible of precise demonstration. The petitioners' evidence tended to show that the loss was even greater than the deduction claimed by them. Therefore, the petitioners are entitled to a loss with respect to the trees in the amount claimed by them. . The record adequately supports the sum of $1,099.47 claimed for clearing the property of debris. We hold it is allowable. The petitioners claimed a deduction of $934.88 for repairs to the dwelling in excess of their insurance recovery. We do not believe that the petitioners presented sufficient evidence to show that the claimed repairs did not include capital improvements. Therefore, the respondent is upheld on this item. Decision will be entered under Rule 50. Footnotes. The first sentence of the paragraph was deleted and the first two sentences of the paragraph were added by an official order of the Tax Court dated February 19, 1962 and signed by Judge Fay.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4512673/	IN THE COURT OF APPEALS OF IOWA No. 19-1995 Filed March 4, 2020 IN THE INTEREST OF R.B., Minor Child, B.D., Mother, Appellant. ________________________________________________________________ Appeal from the Iowa District Court for Fayette County, Linnea M.N. Nichol, District Associate Judge. A mother appeals the termination of her parental rights concerning her daughter. AFFIRMED. Nicholas E. Hay of Hay Law, P.L.C., Decorah, for appellant mother. Thomas J. Miller, Attorney General, and Ellen Ramsey-Kacena, Assistant Attorney General, for appellee State. Andrew Thalacker, Waterloo, attorney and guardian ad litem for minor child. Considered by Tabor, P.J., and Mullins and Schumacher, JJ. 2 SCHUMACHER, Judge. R.B. is a one-year-old female child who was born in July 2018 with methamphetamine and amphetamine in her system. Following thirteen months of reunification services provided by the Iowa Department of Human Services (DHS), the district court terminated the mother’s parental rights pursuant to Iowa Code section 232.116(1)(h) (2019).1 The mother’s appeal follows. I. Standard of Review We review termination-of-parental-rights actions de novo. In re P.L., 778 N.W.2d 33, 40 (Iowa 2010). Although we are not bound by them, we give weight to the trial court’s findings of fact, especially when considering credibility of witnesses. Iowa R. App. P. 6.904(3)(g); In re M.M.S., 502 N.W.2d 4, 5 (Iowa 1993). The primary interest in termination proceedings is the best interests of the child. Iowa R. App. P. 6.904(3)(o); In re R.K.B., 572 N.W.2d 600, 601 (Iowa 1998); In re Dameron, 306 N.W.2d 743, 745 (Iowa 1981). II. Background Facts and Prior Proceedings R.B. came to the attention of DHS on August 2, 2018, when they received the results of newborn R.B.’s umbilical-cord test, which was positive for methamphetamine and amphetamine. A safety plan was implemented by DHS, and newborn R.B. was allowed to remain in her mother’s custody based on the mother’s representation that she had not used methamphetamine since March 2018. Results of a hair stat test for the mother received on August 15 were inconsistent with the mother’s last reported use, and DHS requested a removal of 1 The father’s parental rights were also terminated. He does not appeal. 3 R.B. R.B. was removed from parental custody on August 15, 2018, and has remained out of parental custody since that time. There has not been a trial period at home. Following removal, R.B. was placed in relative care. The mother was allowed to reside with the relatives and R.B. provided she complied with the safety plan. As a result of another positive drug screen and an argument with the relative placement, the relatives requested that R.B. be removed from their home. R.B., then five-months old, was placed in family foster care and has remained in this same foster home since January 2019.2 R.B. was adjudicated to be a child in need of assistance on September 20, 2018. Her child-in-need-of-assistance status was confirmed in a dispositional hearing order of October 26, 2018. A permanency hearing was held on March 22, 2019, wherein the district court ordered that the State initiate termination proceedings. On that same date, the State filed a petition for termination of parental rights. While the termination hearing was originally scheduled for May 31, the hearing was continued on four separate occasions and ultimately took place on September 6. The mother inconsistently participated in random drug testing as requested by DHS. However, as noted by the district court, the mother “consistently tested positive for methamphetamine.” The mother provided positive drug screens in July, August, September, and November 2018, and January, February, April, and 2R.B. has two siblings who are separately placed outside of the mother’s custody. Neither sibling was subject to the underlying child-in-need-of-assistance proceeding nor this termination proceeding. 4 August 2019. The most recent positive hair stat test for the mother was August 28, 2019, just over a week prior to the termination hearing. The mother also struggled to separate from R.B.’s father, in spite of repeated instances of domestic violence. On one occasion, the mother reported she was assaulted on July 26, 2019, with R.B.’s father pulling her into his house by her hair and striking her on the head. Less than three weeks later, she and the father met with a worker from DHS. The mother indicated they were a couple presenting a “united front.” Just prior to this joint meeting with DHS, the father was arrested for felony-level domestic violence against his sister. R.B.’s mother testified at the termination hearing she did not believe she would survive several of the domestic violence assaults perpetrated by R.B.’s father. Despite that recognition, she has been unable to end this tumultuous relationship. III. Analysis The mother does not contest that the statutory elements of section 232.116(1)(h) were proved. She argues the district court erred in finding an additional period of time would not correct the situation that led to the adjudication and removal of R.B., termination is not in the child’s best interest under section 232.116(2), and section 232.116(3)(c) should prevent termination. Because the mother does not contest the statutory grounds of section 232.116(1)(h), we affirm the district court’s findings as to the ground supporting termination. We will address the mother’s arguments in turn. A. Additional-Time Request In order to grant a six-month extension, the court must be able to “enumerate the specific factors, conditions, or expected behavioral changes” 5 providing a basis to determine the children will be able to return to the parent at the end of the additional six months. Iowa Code § 232.104(2)(b). The court needs evidence to support a finding the mother would be able to care for R.B. within six months in order to grant an extension. “The judge considering [a six-month extension] should however constantly bear in mind that, if the plan fails, all extended time must be subtracted from an already shortened life for the children in a better home.” In re A.A.G., 708 N.W.2d 85, 92 (Iowa Ct. App. 2005) (citation omitted). Following the entry of the removal order, the family was provided family safety, risk, and permanency services; substance-abuse evaluations; assistance in complying with recommendations of the substance-abuse evaluations; random drug testing, individual mental-health counseling; transportation; relative placement; a family team meeting; visitation; referral to domestic violence advocacy agencies; and housing referral assistance. The mother received a de facto four-month extension by way of the continuation of the termination hearing on four occasions. Despite that additional time, the mother testified positive for methamphetamine only a week prior to the September 2019 termination hearing. Her consistent participation in outpatient substance-abuse treatment began just weeks prior to the termination hearing. R.B. has been out of parental custody her entire life with the exception of sixteen short days following her birth. The mother was provided thirteen months to take steps toward reunification and failed to make use of the services offered. She has maintained a relationship with R.B.’s father, a relationship that is dangerous to both her daughter and to herself. The mother’s ongoing positive drug screens, her 6 inability to separate from R.B.’s father, and the length of time R.B. has been out of parental custody all weigh against finding another six months would eliminate the need for the removal. See id. at 93. We find a six-month extension is not warranted. B. Best Interest of R.B. The child affected by these proceedings has been has been out of parental custody for over a year. She is very young. Her mother has been unable to address the issues that brought the child to the attention of DHS and the district court, namely substance abuse, domestic violence, and safe housing. The child has been placed in a pre-adoptive home and is bonded to that family. Though provided appropriate time and opportunities, the mother failed to show progress. The record reflects repeated positive drug screens and a continued unhealthy and unsafe relationship with R.B.’s father. At the time of the termination hearing, she was without appropriate housing. We affirm the district court’s finding that termination is in R.B.’s best interest. See Iowa Code § 232.116(2). C. Permissive Exceptions Under Iowa Code section 232.116(3), a termination, otherwise warranted, may be avoided under the exceptions in this section. In re D.E.D., 476 N.W.2d 737, 738 (Iowa Ct. App. 1991). The factors under section 232.116(3) have been interpreted by the courts as being permissive, not mandatory. In re C.L.H., 500 N.W.2d 449, 454 (Iowa Ct. App. 1993). The words “need not terminate” are clearly permissive. Id. The court has discretion, based on the unique circumstances of 7 each case and the best interests of the child, whether to apply the factors in this section to save the parent-child relationship. Id. After a careful review of the record, we also agree with the district court that the exception argued by the mother in section 232.116(3)(c) should not preclude termination in this case. The mother contends her parental rights should not be terminated because she has a bond with her daughter. We do not question the bond between the mother and R.B., which was described by the family’s care coordinator as “very strong.” However, based on the mother’s testimony, she remains at an indecisive stage with respect to her sobriety and the relationship she has with R.B.’s father, and, as such, we do not find that termination would be detrimental to R.B. because of the closeness of the parent-child relationship. Over a year has passed with none of the critical barriers to reunification successfully overcome by the mother. Bearing in mind that our primary concern must remain what is in R.B.’s best interest, we agree with the district court’s decision in declining to utilize an exception to termination pursuant to Iowa Code Section 232.116(3). 3 3 Under section 232.116(3), the court need not terminate the relationship between the parent and child if the court finds any of the following: a. A relative has legal custody of the child. b. The child is over ten years of age and objects to the termination. c. There is clear and convincing evidence that the termination would be detrimental to the child at the time due to the closeness of the parent-child relationship. d. It is necessary to place the child in a hospital, facility, or institution for care and treatment and the continuation of the parent- child relationship is not preventing a permanent family placement for the child. e. The absence of a parent is due to the parent’s admission or commitment to any institution, hospital, or health facility or due to active service in the state or federal armed forces. 8 IV. Conclusion We agree with the district court that a six-month extension was not warranted based on the lack of progress by the mother. We further agree that termination is in R.B.’s best interest and there is a lack of evidence to show that termination should not occur due to the existence of a permissive exception set forth in Iowa Code section 232.116(3). Accordingly, we affirm. AFFIRMED.	01-04-2023	03-04-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625456/	Estate of Harry Holmes, Deceased, Lucy B. Holmes, Independent Executrix, Petitioner, v. Commissioner of Internal Revenue, RespondentHolmes v. CommissionerDocket No. 2943United States Tax Court3 T.C. 571; 1944 U.S. Tax Ct. LEXIS 153; April 5, 1944, Promulgated 153 Decision will be entered under Rule 50. Decedent in 1935 executed a trust indenture by which he irrevocably conveyed to himself as trustee certain corporate stocks to be held in trust for his three sons. The period of the trust was to be 15 years and under certain conditions was to continue for a longer term. At the termination of the trust the trust estate then remaining in the hands of the trustee was to be distributed to the respective beneficiaries. The grantor retained for himself while acting as trustee the right to terminate the portion of the trust given to any son, or all of them, and to distribute the principal thereof to the person or persons entitled to receive the same under the terms of the trust. The decedent retained no power to revest in himself or his estate the trust corpus or to change in any manner the portions of the trust estate which the beneficiaries were to receive. The decedent died in 1940 without having exercised his power to terminate the trust. Held, that the value of the trust's corpus at decedent's death to the extent of the decedent's community property interest therein is not includible in his estate under the provisions of section 154 811 (d), Internal Revenue Code. J. E. Price, Esq., for the petitioner.Frank B. Schlosser, Esq., for the respondent. Black, Judge. BLACK 571 OPINION.The Commissioner has determined a deficiency in estate tax against the estate of Harry Holmes, deceased, of $ 13,491.38. The deficiency is due to six adjustments made by the Commissioner to the estate tax return filed for the estate by the executrix. Only one of these adjustments is contested. It is the one by which the Commissioner added to the value of the property reported by the executrix in the estate tax return an item of $ 91,593.17 designated as "transfers." This item is explained in the deficiency notice as follows:Pursuant to the provisions of Section 811 (d) of the Internal Revenue Code, it is held that the transfers made by the decedent to a trust executed under date of January 20, 1935, for the benefit of his three sons and certain other contingent beneficiaries, are properly includible in the gross estate of the decedent, that is to the extent of the decedent's community property interest therein. * Petitioner by appropriate assignments of error contests the correctness of the foregoing adjustment155 made by the Commissioner.The facts have been stipulated and they are adopted as our findings of fact. The following summary of these facts will suffice for the purposes of this opinion.Petitioner is the duly qualified and acting independent executrix of the estate of Harry Holmes, her husband. A timely estate tax return 572 was filed with the collector of internal revenue for the first district of Texas at Austin, Texas.Harry Holmes of Houston, Texas, on January 20, 1935, executed an instrument, signed "Harry Holmes, Grantor and Trustee," which was duly acknowledged by him and recorded in the deed records of Harris County, Texas. In this instrument he created a trust in favor of his three sons, respectively, Harry Holmes, Jr., John B. Holmes, and Thomas J. Holmes, and he conveyed to himself, Harry Holmes, trustee, and successor trustee provided for, for each of the sons, ten shares of stock in the Quintana Petroleum Co., a Texas corporation. This corporation was thereafter liquidated and the pro rata part of the corporation's assets was conveyed to Harry Holmes, trustee, under and by virtue of the above mentioned trust instrument. Harry Holmes died on October 5, 1940, 156 five years and eight and one-half months after he had executed this instrument and without terminating the trust.The trust indenture contained, among others, the following provisions:FIRSTThat I, Harry Holmes, for and in consideration of One ($ 1.00) Dollar lawful money of the United States of America, and other good, valuable and sufficient consideration to me moving, receipt whereof is hereby acknowledged, do hereby irrevocably give, grant, convey, assign, transfer, set over and deliver said stock unto Harry Holmes, Trustee, during my lifetime, -- unless sooner terminated, as hereinafter provided, -- and upon my death, unto my sons, Harry Holmes, Jr., John B. Holmes and Thomas J. Holmes, as Joint-Trustees, or such of them as shall have reached the age of twenty-one (21) years, or shall have had their disabilities of minority removed, or the survivor or survivors of them, or to such other Trustee as may be appointed, as hereinafter provided; * * * for the use and benefit of my sons, Harry Holmes, Jr., John B. Holmes and Thomas J. Holmes, in equal shares, and such other beneficiaries and for such other purposes as hereinafter provided, * * . * * The term "Trustee", as herein157 used, shall be construed as referring to myself while I act as Trustee hereunder, and thereafter to each and all of the Joint-Trustees named or provided for, as, if and when they act as such.* * * THIRDThe Trustee shall, upon the execution hereof, divide or allocate the Trust Estate into three equal shares or separate trusts, one share or trust for my son, Harry Holmes, Jr., his surviving issue, if any, and such other beneficiaries and for such other purposes, as hereinafter provided; one share or trust for my son, John B. Holmes, his surviving issue, if any, and such other beneficiaries and for such other purposes, as hereinafter provided; and one share or trust for my son, Thomas J. Holmes, his surviving issue, if any, and such other beneficiaries and for such other purposes as hereinafter provided.In the fourth, fifth, and sixth paragraphs of the trust indenture, each paragraph relating to a separate son, it was provided that during 573 the lifetime of the named son and prior to the termination of the trust, the trustee should distribute the net income from the share so allocated to the respective son in convenient installments, preferably monthly. It was also provided158 that the trustee might withhold distribution of any portion of said net income should he determine it for the best interest of his son. Any portion of this net income so withheld was to be accumulated for the benefit of the named son and added to his part of the trust corpus and turned over to him at the termination of the trust.It was also provided in the fourth, fifth, and sixth paragraphs of the trust instrument that should all of the settlor's sons die without leaving surviving issue prior to receipt and distribution of all of the residue of the trust estate, then such residue should be distributed to the settlor's wife, Lucy B. Holmes, if living, and if she be not living, said residue should be distributed to the persons who would be her legal heirs under the laws of descent and distribution of the State of Texas.The trust instrument further provided:SEVENTHThe Trustee is hereby vested with full and complete legal and equitable title to all of the funds, property and estate embraced within the trusts hereof, both as to principal and income therefrom, subject only to the execution of the respective trusts herein created; and neither principal or the income of the Trust Estate159 or of any trust herein created shall be liable for the debts of any beneficiary hereof, nor shall the same be subjected to seizure by any creditor of any beneficiary under any writ or proceeding at law, or in equity, and no beneficiary hereunder shall have any power to sell, assign, transfer, encumber or in any other manner anticipate or dispose of his or her interest in the Trust Estate, or the income produced thereby, prior to its actual receipt by such beneficiary.* * * ELEVENTHGrantor, during his lifetime, and my son or sons herein named, while acting as Trustee hereunder, may, if deemed advisable by them as Trustee, distribute to either of Grantor's children, the whole or any part of the principal of their respective trusts, and their interests hereunder. And Grantor may, during his lifetime, if deemed advisable by him, and my son or sons herein named, while acting as Trustee hereunder, may, if deemed advisable by them as Trustee, terminate either or all of said trusts herein created for the respective benefit of my said sons, and distribute the principal of the trust to the persons entitled to receive the same under the terms hereof on the date of such termination. * 160 THIRTEENTHThe several trusts herein created shall continue and exist and be administered by the Trustee as herein provided (unless distributed by Grantor prior to his death, or distributed by Harry Holmes, Jr., John B. Holmes or Thomas J. Holmes, while they are acting as Trustee, as hereinbefore provided), for the period of fifteen (15) years from this date, provided that if, at the expiration of fifteen years, the trust shall be continued as to such beneficiaries' share or portion of 574 such Trust Estate until such beneficiaries shall reach the age of twenty-one (21) years, or shall die, in either of which events, the trust as to such portion shall terminate, and provided further, and it is hereby made an express condition of this trust, that the same shall terminate twenty-one (21) years after the death of the last survivor of my said sons.Upon the termination of the trust herein created or of said respective trusts, as herein provided, the entire Trust Estate then remaining in the hands of the Trustee, whether principal or accumulated income, shall be immediately divided, distributed and paid over to the persons who are entitled to receive the same in the proportions161 and according to the provisions of this agreement.The question which we have to determine in this proceeding is whether the value at date of death of decedent of certain property transferred by him under the terms of the trust indenture executed January 20, 1935, is includible in his gross estate under the provisions of section 811 (d) of the Internal Revenue Code, printed in the margin. 1162 The applicable regulation is section 81.20 of Treasury Regulations 105, printed in the margin. 2163 575 Paragraph (d) (1) of section 811, Internal Revenue Code, applies to "transfers after June 22, 1936." Paragraph (d) (2) of said section 811 applies to "transfers on or prior to June 22, 1936" and is the only part of section 811 (d) that applies to the instant case. If the value of the trust corpus here involved is not includible in decedent's estate under the last named provision, then it is not includible at all. We are cited to no other section of the statute under which it would be includible.In support of his contention that the decedent, grantor of the trust, retained such powers as to bring them within the provisions of section 811 (d) (2), printed in the margin, the Commissioner relies strongly on Mellon v. Driscoll, 117 Fed. (2d) 477; certiorari denied, 313 U.S. 579">313 U.S. 579. We do not think that this case supports the Commissioner's determination, but that, on the contrary, it is distinguishable on its facts. In that case in 1917 the settlor executed two deeds of trust for the benefit of his two minor children, a son Thomas and a daughter Lucille. Each of these instruments gave them the income from 150 $ 1,000164 par value of bonds for life, with power of appointment by will. After the death of decedent the Commissioner included the value of the trust corpus as a part of decedent's taxable estate, and the taxpayer estate took the position that in the two trust indentures there involved the decedent had not reserved the power to alter, amend, or revoke the trust, but that, instead, although using the word "revoke," he had really merely reserved the right to "terminate" the trust and not to "revoke" it and that the word "terminate" was not added to section 302 (d) until the Revenue Act of 1936 and therefore was not applicable to the trust indentures which the decedent had executed in 1917 in behalf of his two children, Thomas and Lucille Mellon, the decedent having died in 1934. The pivotal language of the trust indenture involved in Mellon v. Driscoll, supra, was as follows:The party of the first part hereby reserves the right after six months written notice of his intention so to do, served on the party of the second part, to revoke this trust, whereupon the principal of the trust fund shall be distributed to Thomas Mellon, S. Lucille Mellon Grange, and165 the trust shall end.The court overruled the contention of the taxpayer and held that the word "revoke" as contained in the statute prior to the 1936 amendment was broad enough to include the right to terminate the trust and that the addition of the word "terminate" to section 302 (d) (1) by the 576 Revenue Act of 1936 did not change existing law, but was merely declaratory of what was already the law. If the word "terminate" is understood to have the meaning that the court gave it in Mellon v. Driscoll, then we agree that it is embraced by the word "revoke" as the statute existed prior to its amendment in the 1936 Act, passed June 22, 1936.Webster's New International Dictionary, Second Edition, Unabridged, defines the word "revoke" as follows: "To recall, to annul by recalling or taking back; to repeal, to take back, to reassume, to recover, to draw back, to restore to use or operation." It was evidently in this sense that the court in Mellon v. Driscoll said that the word "terminate" was embraced within the meaning of the word "revoke." The Treasury in its own regulations recognizes that the word "terminate" in order to be embraced in the word "revoke" prior166 to the amendment of section 302 (d) by the Revenue Act of 1936 must be interpreted to mean what the court said it meant in Mellon v. Driscoll, for in section 81.20, Regulations 105, printed in the margin, supra, it is said:* * * A power to terminate capable of being so exercised as to revest in the decedent the ownership of the transferred property or an interest therein, or as otherwise to inure to his benefit or the benefit of his estate, is, to that extent, the equivalent of a power to "revoke", and when otherwise so exercisable as to effect a change in the enjoyment, is the equivalent of a power to "alter."The word "terminate" ordinarily does not have as broad and comprehensive a meaning as the word "revoke." The word "terminate" is defined in Webster's New International Dictionary, Second Edition, Unabridged, to mean "To put an end to, to make to cease; to end, to come to a limit in time; to end; close; to have its end; final part, or outcome." Only by giving the word "terminate" the meaning which it is said to have in the Treasury regulations from which we have quoted above do we think the Treasury would be justified in saying, as it does, that the word "terminate" 167 was included in the word "revoke" prior to the amendment of June 22, 1936, and that the addition of such word by the amendment was only declaratory of what was already existing law. Therefore, in the light of the above discussion, we think Mellon v. Driscoll, supra, is distinguishable from the instant case because when the settlor, Mellon, created his trust he gave his son and daughter a life estate in the income only from certain property conveyed to the trustee. The two beneficiaries of the trust had no interest whatever in the remainder of the trust except to exercise the power of appointment by will and they could never get any interest therein, unless the grantor exercised the power to revoke or terminate the trust and then conveyed to them the title of the corpus of the trust, which would revert to him by revocation or termination. Clearly it seems to us that under those circumstances that would have been making another gift of property to those two beneficiaries, the grantor's 577 children. It would have been "a change in the amounts they are to take," because if the settlor did not exercise the power to terminate the trusts 168 his two children would receive only the income of the trust for life and would never receive any of the corpus of the trust, and they would have only the power to appoint the trust estate by will.Paul, in his Federal Estate and Gift Taxation, vol. 1, sec. 7.09, dealing with "Trusts Subject to the Grantor's Power to Shift the Interests of the Beneficiaries," refers to the case of Mellon v. Driscoll, as follows: "And it has been held that a power to revoke which would change the beneficiaries' interests from life estates to absolute ownership make the grantor's estate taxable."Thus in Mellon v. Driscoll the exercise of the power of revocation or termination meant a new conveyance of the corpus to the beneficiaries. In the instant case the remainder interests in the trust corpus, as well as the right to receive the income during the term of the trust, subject to the right of the trustee to either distribute or accumulate the income for the named beneficiaries, were irrevocably vested in the three beneficiaries by the trust indenture itself, and an exercise by the settlor of his power to terminate the trust meant only an acceleration of the time of enjoyment. The settlor169 reserved no power whatsoever to change the portions of the corpus which each beneficiary was to receive.It is of course true, as respondent argues, that the mere fact that the settlor could not revest in himself or his estate any of the economic benefits of the property is of no importance. If under the power retained to terminate the trust he had also retained the power to alter or change the portions of the corpus which each beneficiary was to receive, then the value of the trust corpus over which he retained the power of change and alteration would have been includible as a part of his estate. Porter v. Commissioner, 288 U.S. 436">288 U.S. 436, and many other cases which can be cited on that point. And it would have been unimportant whether this power had been retained by Holmes as settlor or only exercisable by him as trustee. Welch v. Terhune, 126 Fed. (2d) 695; certiorari denied, 317 U.S. 644">317 U.S. 644.But in transfers made on or prior to June 22, 1936, where the settlor has retained only a power to terminate the trust and has retained no power to revest in himself or in his estate any part of the170 trust corpus or to change or alter the disposition of the trust corpus already given to the beneficiaries under the terms of the trust indenture, but only to accelerate the time of its enjoyment, we do not think the value of the trust corpus is includible under section 811 (d) (2), Internal Revenue Code, or any other provision of the Internal Revenue Code. As to whether such transfers with such a power to "terminate" as we have here made after June 22, 1936, will be includible in a decedent's estate under section 811 (d) (1), Internal Revenue Code, 578 we express no opinion. We do not have that state of facts before us.In consideration of the question we have here to decide it is appropriate that we consider that the gift tax and the estate tax are closely related. See Sanford's Estate v. Commissioner, 308 U.S. 39">308 U.S. 39; Higgins v. Commissioner, 129 Fed. (2d) 237; certiorari denied, 317 U.S. 658">317 U.S. 658.It seems clear under Treasury Regulations 108, relating to the gift tax, that when decedent executed the trust indenture January 20, 1935, by which he conveyed the shares of stock in trust171 for the benefit of his three sons, he made a completed gift to each son and that such gifts were taxable in that year to the donor to the extent of their full value. It also seems clear that his reservation of the power to terminate the trust as to any son under paragraph eleventh thereof, but not to change the beneficiaries or to change the respective interests which they were to receive, did not render the gifts incomplete. The Treasury regulations so provided. A part of sec. 86.3, Regulations 108, relating to "Cessation of Donor's Dominion and Control," reads:A gift shall not be considered incomplete, however, merely because the donor reserves the power to change the manner or time of enjoyment thereof. Thus, the creation of a trust the income of which is to be paid annually to the donee for a period of years, the corpus being distributable to him at the end of the period, and the power reserved by the donor being limited to a right to require that, instead of the income being so payable, it should be accumulated and distributed with the corpus to such donee at the termination of the period, constitutes a completed gift.Suppose that decedent in the year of his death and prior172 thereto had by a formal instrument in writing relinquished his right to terminate the trust which was reserved in paragraph eleventh thereof, would such a relinquishment have been the occasion for the imposition of a gift tax? We think not. There would have been by such act no new gift or the completion of a tentative gift already made to justify the imposition of a gift tax on such a relinquishment. If there would have been no imposition of the gift tax on his voluntary surrender of the right to terminate because there would have been no sufficient transfer of property to justify the tax, it is difficult to see how an estate tax would have been imposed upon his involuntary cessation of such right by death, and, for the reasons we have already stated, we think an estate tax would not have been imposed.Another case upon which the Commissioner relies is Welch v. Terhune, supra. We think that case is also distinguishable on its facts. The pivotal clause of the trust indenture involved in Welch v. Terhune was as follows:This Trust may be terminated or amended at any time, but only with the written consent of the three Trustees herein named, 173 and of any Trustee appointed by William L. Terhune under clause 14 hereof, or the survivors or survivor of them, and of the then surviving children of the said William L. Terhune.579 The decision in the Terhune case turned on the fact that Terhune reserved the right to amend the trust in conjunction with the power to terminate it. This fact we think is shown from the following quotation from the court's opinion in the Terhune case:In the trust instrument there was also given the power to "amend." The plaintiffs contend that this power must be strictly construed so as to refer only to the minor changes in the mechanics of the operation or management of the trust and not to permit any amendment which would materially vary the respective property interests of the beneficiaries. * * We are sure that these powers to terminate or amend, taken in conjunction, would authorize changes to be made in the enjoyment of the property interests at least as broad as those we held sufficient in Chickering v. Commissioner, 118 F. 2d 254, * . And see Commissioner v. Chase National Bank, 82 F. 2d 157 * 174 . How much further these granted powers might extend we need not now inquire.As we have already pointed out, the trust indenture here involved reserves the right to the grantor neither as an individual nor as a trustee to alter or amend the trust. He had only the right to terminate it and thereby accelerate the time that the beneficiaries might enjoy the corpus of the trust, which had already been irrevocably given to them in the trust indenture.For reasons which we have stated above, we hold that the Commissioner erred in adding to the value of decedent's estate the item of $ 91,593.17 which he designated in his deficiency notice as "transfers."Decision will be entered under Rule 50. Footnotes1. SEC. 811. GROSS ESTATE.The value of the gross estate of the decedent shall be determined by including the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated, except real property situated outside of the United States --(a) Decedent's Interest. -- To the extent of the interest therein of the decedent at the time of his death;* * * (d) Revocable Transfers --(1) Transfers after June 22, 1936. -- 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, where the enjoyment thereof was subject at the date of his death to any change through the exercise of a power (in whatever capacity exercisable) by the decedent alone or by the decedent in conjunction with any other person (without regard to when or from what source the decedent acquired such power), to alter, amend, revoke, or terminate, or where any such power is relinquished in contemplation of decedent's death;(2) Transfers on or prior to June 22, 1936. -- To the extent of any interest therein of which the decedent has at any time made a transfer, by trust or otherwise, where the enjoyment thereof was subject at the date of his death to any change through the exercise of a power, either by the decedent alone or in conjunction with any person, to alter, amend, or revoke, or where the decedent relinquished any such power in contemplation of his death, except in case of a bona fide sale for an adequate and full consideration in money or money's worth. Except in the case of transfers made after June 22, 1936, no interest of the decedent of which he has made a transfer shall be included in the gross estate under paragraph (1) unless it is includible under this paragraph;(3) Date of existence of power. -- For the purposes of this subsection the power to alter, amend, or revoke shall be considered to exist on the date of the decedent's death * .↩2. Sec. 81.20. Transfers with power to change the enjoyment. -- (a) Transfers included. -- Subsection (d) of section 811 embraces a transfer by trust or otherwise (if not amounting to a bona fide sale for an adequate and full consideration in money or money's worth) when at the time of decedent's death the enjoyment of the transferred property, or some part thereof or interest therein, was subject to any change through a power exercisable either by the decedent alone, or by him in conjunction with some other person or persons, to alter, or amend, or revoke, or terminate. (See section 81.15.)The addition to subdivision (d) (1) of the Revenue Act of 1926, by section 805 of the Revenue Act of 1936, of the phrase to the effect that it is not material in what capacity the power was subject to exercise by the decedent or by the other person or persons in conjunction with the decedent (which phrase is also embodied in subsection (d) (1) of section 811 of the Internal Revenue Code), is considered merely declaratory of the meaning of the subdivision prior to the addition of the phrase. * * *The third change made in the subdivision by the Revenue Act of 1936 (which is also embodied in subsection (d) (1) of section 811 of the Internal Revenue Code↩) consists of the addition of the words "or terminate" following the words "to alter, amend, revoke." Such addition is considered but declaratory of the meaning of the subdivision prior to the amendment. A power to terminate capable of being so exercised as to revest in the decedent the ownership of the transferred property or an interest therein, or as otherwise to inure to his benefit or the benefit of his estate, is, to that extent, the equivalent of a power to "revoke," when otherwise so exercisable as to effect a change in the enjoyment, is the equivalent of a power to "alter."	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625457/	Neil J. Driscoll and Regina G. Driscoll v. Commissioner.Driscoll v. CommissionerDocket No. 3882-70.United States Tax CourtT.C. Memo 1972-105; 1972 Tax Ct. Memo LEXIS 150; 31 T.C.M. (CCH) 418; T.C.M. (RIA) 72105; May 8, 1972, Filed. Neil J. Driscoll, pro se, 20980 Costanso St., Woodland Hills, Calif.Jonathan Brod, for the respondent. SCOTTMemorandum Opinion SCOTT, Judge: Respondent determined deficiencies in petitioners' income taxes for the calendar years 1965 and 1966 in the amounts of $3,786.00 and $143.68, respectively. On August 6, 1971, respondent filed a motion for leave to file an amendment to answer raising the issue of collateral estoppel and a motion for "Hearing in the First Instance" on the issue of collateral estoppel. Both motions were granted. The amendment to answer raising the issue of collateral estoppel was filed on October 6, 1971, and this case was tried on the severed issue of collateral estoppel. Therefore, the sole issue now for decision is whether petitioners are collaterally151 estopped by a decision involving the year 1964 of the United States District Court for the Central District of California from litigating for the years 1965 and 1966 the question of whether a valid partnership existed between petitioner Neil J. Driscoll and his nine minor children, and if a valid partnership did exist, whether the income from royalty payments received from that partnership was taxable as ordinary income or capital gain. Most of the facts were stipulated and are found accordingly. Petitioners are husband and wife who resided in Woodland Hills, California at the time of the filing of the petition herein. Petitioners filed joint Federal income tax returns for the calendar years 1965 and 1966 with the district director of internal revenue, Los Angeles, California. In their petition, petitioners made the following assignments of error and allege the following facts: 4. The determination of taxes set forth in the Notice of Deficiencies is based upon the following errors: (a) In determining the taxable income of the petitioners for the year 1965, the 419 Commissioner erroneously included, in the determination of said taxable income, full partnership profit152 from Colonial Electric and Specialty Co. in the amount of $14,422.88 before partnership distribution * * * (b) In determining the taxable income of the petitioners for the year 1965, the Commissioner erroneously included, in the determination of said taxable income, realized capital gain from patent royalties in the total amount of $4,904.00 before capital gains deductions * * * (c) In determining the taxable income of the petitioners for the taxable year 1965, the Commissioner erroneously only allowed a medical deduction of $485.00 rather than the $776.00 claimed by petitioners, thus increasing petitioners' taxable income in the amount of $291.00 * * * (d) In the alternative, in determining the taxable income of the petitioners for the year 1965, and refusing to recognize petitioners' family partnership with their children * * * the Commissioner erroneously included, in the determination of said taxable income, an amount of $7,261.44 which represents a reasonable fair market value rental for the use of the capital property (tools, dies, jigs, fixtures, office equipment, etc.) actually paid to the owners of fifty percent of that capital, i.e., the children of the petitioners, 153 by Colonial Electric and Specialty Co. (e) In determining the taxable income of petitioners for the year 1966, the Commissioner erroneously refused to allow partnership distribution of $4,897.62 paid by Colonial Electric and Specialty Co. to petitioners' children (i.e., partners) and erroneously included in the determination of said taxable income, full partnership profit in the amount of $9,795.24 before partnership distribution * * (f) In determining the taxable income of petitioners for the year 1966, the Commissioner erroneously refused to allow, in the determination of said taxable income, realized capital gains from patent royalties in the amount of $3,493.04 before capital gains deductions * * * (g) In determining the taxable income of petitioners for the year 1966, the Commissioner erroneously refused to allow, in the determination of said taxable income, a medical deduction of $2,505.36 and only allowed a medical deduction of $2,306.03, thus increasing petitioners' taxable income in the amount of $199.33 * * * 1(h) In the alternative, in determining the taxable income of the petitioners for the year 1966, 154 and refusing to recognize petitioners' family partnership with their children * * the Commissioner erroneously included in the determination of said taxable income, an amount of $4,235.00 which represents a reasonable fair market value rental for the use of the capital property (tools, dies, jigs, fixtures, office equipment, etc.) actually paid to the owners of fifty percent of that capital, i.e., the children of the petitioners, by Colonial Electric and Specialty Co. 5. The facts upon which the petitioners rely as the basis of this case are as follows: (a) Petitioner, Neil J. Driscoll, in about 1960, designed and filed patent applications on electrical switches and organized a company to manufacture the switches, i.e., Colonial Electric & Specialty Co. as a proprietorship (hereinafter referred to as "Colonial"). (b) Subsequent to 1960 and prior to March 15, 1963, capital property (tools, dies, jigs, fixtures, equipment, etc.) were acquired to facilitate manufacture and acquire inventory. (c) On March 15, 1963, Neil J. Driscoll conveyed, in writing, a fifty percent interest in said capital property to his nine minor children, to hold in their own right in equal shares. 155 (d) On or about February 6, 1964, Colonial made application to the Federal government and the State of California for employment numbers and stated therein that the Colonial company was a partnership and listed petitioner Neil J. Driscoll and his nine minor children as partners. (e) In 1965, for the calendar year 1964, a partnership return was filed for Colonial and partnership profit was distributed in the following manner: $5,034.21 to petitioner Neil J. Driscoll and $5,034.21 to petitioners' nine minor children in equal shares. * * (h) In 1966, for the calendar year 1965, a partnership return was filed for Colonial and partnership profits were distributed in the following manner: $7,161.44 to the petitioner Neil J. Driscoll and $7,161.44 to petitioners' nine minor children in equal shares. * * * (k) In April 1966, when the property interest of the petitioners' nine minor children exceeded $2,000.00 each (as required by California Probate Code, Chapter 2, Section 1430) guardianship was promptly petitioned and the children's property interest placed under the control of the California Superior Court. 420 (l) In 1966 a California corporation was formed under the style156 of Colonial Electric & Specialty Co., Inc. and the capital property used by Colonial was transferred thereto, the nine minor children of petitioners receiving fifty percent of the capital stock of said corporation in consideration of their interest. The corporation assumed the Colonial business as of August 1, 1966. (m) In 1967, for the calendar year 1966, a partnership return was filed for Colonial and partnership profits due and owing petitioner Neil J. Driscoll in the amount of $4,897.62 and $4,897.62 due and owing petitioners' nine minor children were retained in the Colonial corporation. These amounts were subsequently repaid by the corporation with interest to the receivers at the rate of 5 1/4%. (n) There is a valid family partnership qualifying under Title 26 USC (1954 I.R.C.) Section 704(e). (o) Petitioner Neil J. Driscoll received patent royalties in the amount of $3,493.00 from Colonial for the calendar year 1966. (p) Reasonable fair market rental values should be paid to the owners of property used in a viable business. Respondent determined deficiencies in petitioners' Federal income tax in the amount of $2,252.72 for calendar year 1964. 157 Petitioners paid the deficiency on or about April 7, 1967, and filed a suit for refund in the United States District Court for the Central District of California. This case was decided adversely to petitioners on July 7, 1969. Driscoll v. United States, an unreported case ( C.D. Cal. 1969, 69-2 USTC 9536, 24 AFTR 2d 69-5249). In a pre-trial conference order, the United States District Court for the Central District of California, found the following facts, among others, to be admitted and require no proof: H. That on March 15, 1963, plaintiff executed a document which purported to conduct the business of Colonial as a partnership between plaintiff and his nine children, plaintiff to have a fifty percent interest in capital and profits of the partnership and each child to have a one-eighteenth interest in same. I. That the March 15, 1963 document was executed by plaintiff and by Regina G. Driscoll, the latter as trustee for the children. J. That attached to the document were nine separate documents, all in the following form: GIFT UNDER THE CALIFORNIA UNIFORM GIFTS TO MINORS ACT. I, NEIL J. DRISCOLL, hereby deliver to Regina F. Driscoll, as custodian for under158 the California Uniform Gifts to Minors Act, the following security, a 1/18th interest in the business known as Colonial Electric & Specialty Co. Regina F. Driscoll hereby acknowledges receipt of the above-described security as custodian for the above minor under the California Gifts to Minors Act. Dated: March 15, 1963. The security referred to above is evidenced by a Partnership agreement of even date herewith. K. That also attached to the March 15, 1963 document was an assignment of plaintiff's patent rights to the partnership, in consideration for which plaintiff was to receive a percentage of the gross receipts from the sale of switches by the partnership. L. That in March of 1963 the cash value of the assets of Colonial was approximately $3,500 to $4,000. At that time plaintiff's youngest child was approximately one month old and his oldest was thirteen years old. M. That on or abount February 6, 1964 plaintiff filed applications for employment numbers with the Department of Employment, State of California and the Internal Revenue Service, United States of America, in the business name of Colonial indicating therein that the owners were plaintiff and his nine minor children.159 N. That on December 30, 1964 savings accounts were established for each of plaintiffs' nine children under the account title of "Neil J. and Regina Driscoll, as trustees for [name of child]." The opening balances in each account were $550. O. That on December 31, 1965, new accounts were opened at the same bank with a deposit of $590 for each child under the account Title of "Regina Driscoll, as custodian for [name of child] under California Uniform Gifts to Minors Act." The old accounts were closed January 17, 1966 and the principal and interest from each old account were withdrawn and deposited in the new accounts. P. That on April 26, 1966, petition to have Regina Driscoll appointed legal guardian for the nine children and to have the court supervise the savings accounts was filed by plaintiffs with the Los Angeles Superior Court. 421 Q. That on May 13, 1966 the Court issued its order directing deposit of the amounts in the bank accounts in blocked accounts. The District Court stated the issues before it to be: (1) Was Colonial Electric and Specialty Company (hereafter referred to as Colonial) a partnership in 1964 which qualified under Section 704(e), Internal Revenue Code160 or was it a sole proprietorship? (2) If a partnership was established during the year 1964, as claimed by plaintiffs, should royalty payments for that year from patents transferred by plaintiff, Mr. Driscoll, to Colonial be taxed as capital gains or as ordinary income? The District Court made the following findings of fact and conclusions of law: Findings of Fact 1. Plaintiff Neil J. Driscoll did not make in 1962 an oral transfer or binding agreement to transfer any part of Colonial Electric & Specialty Company to any member of his family, either in personal or representative capacity. 2. Plaintiff Neil J. Driscoll did not make an effective transfer of any interest in Colonial Electric & Specialty Company to either his wife or to any child under the Uniform Gifts to Minors Act in 1963. 3. Plaintiff Neil J. Driscoll did not make an effective gift or transfer of a partnership interest in Colonial Electric & Specialty Company to his wife, individually or in a representative capacity, or to any of his children in 1963, by means of the document entitled "partnership agreement." 4. No interest in Colonial Electric & Specialty Company vested in Neil J. Driscoll's wife in a161 representative, fiduciary capacity for the children, or in any of the children at any time before or during 1964. 5. Plaintiff's children did not own an interest in the Colonial Electric & Specialty Company at any time during the year 1964. 6. Plaintiff did not create a trust in his wife to hold any interest in Colonial Electric & Specialty Company for the benefit of their children. 7. Plaintiff Regina G. Driscoll did not act under judicial supervision at any time prior to her appointment as guardian in 1966. 8. Plaintiff Neil J. Driscoll did not intend to transfer an interest in Colonial Electric & Specialty Company to his wife in trust for the children. 9. Any assignment of income from Colonial Electric & Specialty Company by plaintiffs to their children was a gift to the children of income previously included in plaintiffs' income. 10. At all times prior to incorporation of Colonial Electric & Specialty Company, plaintiff Neil J. Driscoll managed and operated the business. 11. Neither Regina G. Driscoll nor any of the children participated in the management of Colonial Electric & Specialty Company, and any consultations between plaintiff Neil J. Driscoll and plaintiff162 Regina G. Driscoll concerning business matters was superficial. 12. Plaintiffs' children during the year in question lacked sufficient independence or maturity to be free to liquidate, to sell or withdraw a capital interest from the business. 13. Plaintiff Regina G. Driscoll lacked necessary independence to liquidate, to sell or withdraw any interest in the business held for the benefit of the children. 14. Plaintiff Neil J. Driscoll did not treat Colonial Electric & Specialty Company as a partnership in his business records and dealings, except to a minimal extent, during the year in question. 15. Any conclusion of law deemed as, or properly constituting, a finding of fact, is hereby adopted as a finding of fact. Conclusions of Law 1. The Court has jurisdiction over the subject matter and the parties hereto. 2. Plaintiff Neil J. Driscoll did not accomplish a gift of an interest in Colonial Specialty & Electric Company to any of his children either before or during the year in question, to wit, 1964. 2163 3. Plaintiff Neil J. Driscoll did not transfer an interest in Colonial Electric & Specialty Company to his wife in trust for the benefit of the children. 4. The children in the year in question did not own any interests in Colonial Electric & Specialty Company. 5. Plaintiff Neil J. Driscoll did not transfer an interest to his children in Colonial Electric & Specialty Company by means of the California Uniform Gifts to Minors Act. 422 6. In the year in question, Colonial Electric & Specialty Company was a sole proprietorship of plaintiff Neil J. Driscoll. 7. Although a partnership is created under state law, it does not necessarily qualify for tax treatment as a partnership under the Internal Revenue Code. 8. To create a family partnership qualifying under Section 704(e) of the Internal Revenue Code, the complete transfer of an interest to the donee by way of a bona fide transaction is required, and such transfer must vest dominion and control of the partnership interest in the transferee. 9. There was no partnership created which qualified under Section 704(e) of the Internal Revenue Code. 10. Any finding of fact deemed164 as or properly constituting a conclusion of law is hereby adopted as a conclusion of law. Judgment shall hereby be entered accordingly. The Memorandum Opinion of the District Court stated in part as follows: Mr. Driscoll admits that the alleged gifts to his children do not comply with the requirements of the California Uniform Gifts to Minors Act (Paragraph 4, Ex. 1) because such Act requires that where the gift is a security, gift thereof is not accomplished where the donor is the issuer. Sections 1155 and 1156, California Civil Code. Further, it does not appear that Mrs. Driscoll was properly appointed a "custodian", under said Gifts to Minors Act, of the alleged interests of the respective children and, therefore, she was not a fiduciary. It would follow that no partnership was created. Mr. Driscoll admits no partnership was created in 1962, as might be inferred from paragraph 1 of the Agreement because no effective delivery of any property interest was made to his children. The position of Mr. Driscoll, who is a lawyer, that the said Agreement vested legal title in the children is inconsistent with the provisions of the Agreement and with his statement attached to the165 petition for guardianship, dated April 26, 1966, wherein he says the share interest of the minors vested in the mother as a fiduciary. The Court concludes that the application for guardianship indicates that Mr. Driscoll intended the legal interest to vest in the mother for the beneficial interest of the children. If no trust was created by Mr. Driscoll, and that is his contention, the alleged gifts to the children were not accomplished. * * * Plaintiffs take the position that there was no requirement for the appointment of a guardian for the children until 1966 because the property of each minor was of a value less than $2,000.00, citing California Probate Code Section 1430. The evidence does not show compliance with this Section on the part of Mrs. Driscoll nor does it appear the value of the children's respective interests was less than $2,000.00. The evidence does not support plaintiffs' contention that valid, completed gifts were made to the children and that they owned an interest in the partnership during the year 1964, the period in issue. It is to be noted that there is no evidence that a Federal or State Gift Tax Return was ever filed by plaintiffs, 166 or either of them. The Court concludes that the Agreement of 1963 failed to accomplish the gift as alleged. Plaintiffs deny that the interests were placed in trust for the benefit of the children, which conclusively shows the lack of one of the required elements for the creating of a trust, to wit, intent. Furthermore, it does not appear Mrs. Driscoll was acting under judicial supervision until she was appointed the children's guardian in 1956. Any assignment to the children of income from the business would have been gifts under the California Uniform Gifts to Minors Act but would have been previously included in the income of Mr. Driscoll since there is a failure of attempted gifts of business interests to the children in 1963. Mr. Driscoll obviously thought he had complied with the California Uniform Gifts to Minors Act by his Agreement, as evidenced by paragraph 4 thereof. The Judgment of the Court was entered on July 7, 1969, dismissing petitioners' complaint before the United States District Court. Petitioners filed a notice of appeal, appealing the decision of the United States Court for the Central District of California to the United States Court of Appeals for the167 Ninth Circuit. The appeal was dismissed with prejudice to the plaintiffs therein by stipulation of the parties on September 22, 1969. Where a taxpayer's liability relating to a particular tax year is litigated before a court of competent jurisdiction, a judgment, on the merits is res judicata in any subsequent proceeding involving the same cause or demand and the same taxable year. Commissioner v. Sunnen, 333 U.S. 591">333 U.S. 591 (1948). A judgment rendered with respect to a taxpayer's liability for taxes in one year is not res judicata as to 423 his tax liability for another taxable year since each taxable year is the origin of a new tax liability and a separate cause of action. Commissioner v. Sunnen, supra.However, under the principle of collateral estoppel, the parties are bound in a subsequent proceeding by a determination in a prior suit "when the matter raised in the second suit is identical in all respects with that decided in the first proceeding and where the controlling facts and applicable legal rules remain unchanged." Commissioner v. Sunnen, supra. In Theodore B. Jefferson T.C. 963, 967 (1968), we observed: Collateral estoppel "rests168 upon considerations of economy of judicial time" and operates "to relieve the government and the taxpayer of 'redundant litigation of the identical question of the statute's application to the taxpayer's status.'" Commissioner v. Sunnen, 333 U.S. 591">333 U.S. 591, 597, 599 (1948). In other words, a taxpayer should have his "day in court," but if he fails to establish his claim, he should not be afforded another opportunity in subsequent litigation, provided, of course, as stated above, that his adversary properly objects, to shore up deficiencies in the evidence which defeated his claim. * * Petitioners herein litigated before the United States District Court for the Central District of California in a case involving the taxable year 1964, the questions of (1) whether an effective transfer to petitioners' children of any interest in Colonial Electric and Specialty Co. (hereinafter referred to as Colonial) occurred so as to result in a valid family partnership which was recognizable for tax purposes, and (2) whether certain royalty income was taxable to petitioners as capital gains or ordinary income. Both issues were decided adversely to petitioners. The second issue was dependent169 on the first since capital gains from the royalty income was claimed by petitioners in that suit as in this one, only if there was a valid partnership between petitioner Neil J. Driscoll and his children to which Driscoll's patents had been assigned. Petitioners are not entitled to relitigate herein the issues litigated before the United States District Court as to the year 1964, absent a change in the controlling facts or the applicable law. Petitioners assert that their continuing course of action in recognizing the gift of the interest in Colonial to their nine minor children, the filing of partnership returns in 1965 and 1966, and the petitioning for guardianship in the California Superior Court in April 1966 present a different factual situation from that which was presented to the United States District Court. We do not agree. Neither petitioners' continuing course of conduct in recognizing the family partnership nor the fact that partnership returns were submitted in taxable years subsequent to the year under consideration in the prior proceeding, is indicative of a "change" in the factual situation. Leininger v. Commissioner, 86 F. 2d 791 (C.A. 6, 1936), affirming170 29 B.T.A. 874">29 B.T.A. 874 (1934). The fact that the guardianship was petitioned for in the California Superior Court in 1966 was before the United States District Court in the prior proceeding. However, neither in that case nor in this case, is the guardianship petitioned for in 1966 the basis on which petitioner contends a partnership with his children exists. Petitioners rely in this case, as they did in the District Court case, on the March 15, 1963, agreement as creating the partnership. Therefore, the creation of the guardianship in 1966 does not cause a change in the controlling facts. Petitioners state that an alternative contention is presented in this case which was not presented in the prior proceedings. Petitioners assert that the amounts which had been treated by petitioners as the distributive share of partnership income of their nine minor children was, in the alternative, "a reasonable fair market value rental for the use of the capital property (tools, dies, jigs, fixtures, office equipment, etc.) actually paid to the owners of 50 percent of that capital, i. e., the children of the petitioners, by Colonial Electric and Specialty Co." Petitioners' alternative position171 is predicated, as is their primary position, on a transfer by petitioner Neil J. Driscoll of a capital interest in the assets of Colonial to his nine children. The findings of fact and conclusions of law announced by the United States District Court state that Neil J. Driscoll did not make an effective transfer of any interest in Colonial to his children. Therefore, petitioners are precluded from litigating the alternative contention raised in their petition by the findings of fact and conclusion of law of the United States District Court in the prior proceeding. The claim by petitioners that Neil J. Driscoll made a transfer of a capital interest in Colonial to his children raised the identical question of fact raised in the prior case. Since determination of 424 that question of fact was essential to the judgment in that case, petitioners are barred by the doctrine of collateral estoppel from litigating their alternative contention. See Morrisdale Coal Mining Co. 19 T.C. 208">19 T.C. 208, 227 (1952). There are no facts alleged in this case which did not exist and were not presented in the prior proceeding before the United States District Court. Since the applicable and controlling172 facts have remained the same, Jones v. Trapp, 186 F. 2d 951, 954 (C.A. 10, 1950), and the substantive law has remained unchanged, Fairmont Aluminum Co., 22 T.C. 1377">22 T.C. 1377 (1954) aff'd. 222 F 2d 622 (C.A. 4, 1965), the doctrine of collateral estoppel by judgment is applicable in this case. Therefore, petitioners are estopped from denying that no valid partnership existed between petitioner Neil J. Driscoll and his minor children and that petitioners' children had no capital interest in Colonial. We therefore conclude that because petitioners are estopped to deny the ultimate facts decided adversely to them by the United States District Court and no other issues are raised by the pleadings in this case, the deficiencies as determined by respondent should be sustained. Decision will be entered for respondent. Footnotes1. These issues are purely questions of computation.↩2. The year recited in finding of fact Nos. 4 and 5 was changed by stipulation of the parties and Order of the Court. The year recited in conclusion of law No. 2 was changed by stipulation of the parties and Order of the Court. Those changes were not reflected as reported at 24 A.F.T.R.2d (RIA) 69">24 A.F.T.R. 2d 69-5249 and 69-2 USTC 9536↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625436/	Estate of Josephine S. Barnard, Deceased, City Bank Farmers Trust Company, Executor v. Commissioner.Estate of Josephine S. Barnard v. CommissionerDocket No. 9180.United States Tax Court1947 Tax Ct. Memo LEXIS 91; 6 T.C.M. (CCH) 1034; T.C.M. (RIA) 47257; September 18, 194791 BLACKOrder Denying Motion for Rehearing and Reconsideration BLACK, Judge: For reasons stated in the memorandum to accompany this order, petitioner's motion for rehearing and reconsideration filed herein August 13, 1947, is hereby denied. Memorandum To Accompany Order Denying Motion for Rehearing, Further Hearing or Reconsideration BLACK, Judge: On July 16, 1947 [, this Court promulgated its opinion in this proceeding and directed that decision be entered under Rule 50. On August 13, 1947, petitioner filed its motion for rehearing, further hearing or reconsideration of that part of the Court's opinion which holds that the petitioner is liable for gift tax with respect to the $50,000 transferred by the decedent on or about October 25, 1943, to a pre-existing irrevocable trust of which Henry H. Barnard is the life beneficiary. Petitioner attached to its said motion a memorandum containing arguments and cited authorities in support thereof. All of this has been carefully read and considered but it is not believed that said motion should be granted. The arguments made in petitioner's memorandum do not impress us as being different in substance than92 those made by petitioner in its brief and reply brief. These were fully considered by us in arriving at our decision embodied in the opinion of July 16, 1947. Our decision as to the payment of $50,000 made by Mrs. Barnard to the trust on October 25, 1943 was stated in our opinion as follows: "Petitioner in its reply brief contends that this Court must infer from the stipulated facts 'that the transfer of the $50,000 to the pre-existing trust was part and parcel of the entire separation agreement between the parties and that it was part of the price paid by Mrs. Barnard for the relinquishment by Mr. Barnard of all of his rights in her estate.' We do not feel justified in making such an inference. There was no reference whatsoever made in the written separation agreement entered into on August 12, 1943, concerning the possible transfer of $50,000 to the pre-existing trust. There is no evidence that the Nevada court knew anything about this possible transfer that the parties had orally agreed would be made 'when and if' the divorce was granted. That court in its decree referred only to the written separation agreement as 'settling the property rights of the plaintiff and the defendant, 93 and all matters concerning the care, custody and control of the minor children of said parties' and the said agreement was by that court 'ratified, adopted and approved in all respects' and 'declared to be fair, just and equitable to the plaintiff, to the defendant, and to the said minor children.' The transfer to the trust on or about October 25, 1943, was something over and above what the divorce court declared to be fair, just and equitable. If there was a consideration for the transfer of the $50,000 to the trust there is no direct or explicit statement in the record of what that consideration consisted. The respondent has determined that the transfer was a taxable gift. It was incumbent upon the petitioner to overcome that determination by a showing that Mrs. Barnard received 'an adequate and full consideration in money or money's worth' for the transfer. This we think petitioner has failed to do and we must, therefore, sustain the respondent's determination as to this transfer. * " Since our opinion was promulgated July 16, 1947, the Second Circuit has decided , affirming . There is nothing94 in that decision, as we construe it, which would change our decision as to the $50,000 transferred by Mrs. Barnard to the trust on October 25, 1943. The gist of that opinion, we think, is found in the concluding paragraph thereof which says: "* * * Where, as here, there was the discharge of a money judgment which, had it remained unpaid until it became a debt against the respondent's estate, would have been allowed as a deductible claim in computing an estate tax, the transfer which discharged that debt during the respondent's life is not taxable as a gift. On the contrary it was the payment of a liquidated debt created by the judgment and the discharge thereby of the respondent's obligation to pay that debt was an adequate and full consideration in money or money's worth for the transfer." As we pointed out in our opinion the payment of the $50,000 here in question was not a part of the court's decree granting Mrs. Barnard a divorce and approving the property settlement which had been embodied in the written separation agreement. It is nowhere mentioned in the decree and there is no reason to believe or infer that the court knew anything about it whatever. We think petitioner's*95 motion for rehearing and reconsideration should be denied. An order will be entered to that effect.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625438/	FRANCIS L. BURNS AND LILLIAN BARRY, EXECUTORS, ESTATE OF MICHAEL F. BURNS, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Burns v. CommissionerDocket Nos. 14986, 21389.United States Board of Tax Appeals13 B.T.A. 293; 1928 BTA LEXIS 3276; September 5, 1928, Promulgated 3276 1. A limited partnership of New York is a partnership under section 218, Revenue Act of 1921. 2. The failure of such a partnership to comply with statutory requirements of recording and publication does not take from the limited partner his liability for income tax as a partner. Harry Cohen, Esq., and Louis H. Moos, Esq., for the petitioners. Arthur H. Fast, Esq., for the respondent. STERNHAGEN 294 These proceedings were consolidated and involve deficiencies for the calendar years 1920 and 1923 and for the period from January 1 to April 28, 1924. The deficiency for 1920 has been conceded by petitioner. Respondent treated as decedent's income from a partnership during 1923 amounts received by decedent in subsequent periods, and petitioners attack this determination on the ground that decedent was not a member of a partnership and therefore not taxable in respect of these amounts until they were received. FINDINGS OF FACT. Under date of April 21, 1923, the decedent, Michael F. Burns, entered into the following agreement: AGREEMENT made this 21st day of April, 1923, between JAMES M. CURRAN, of 78 Clinton Avenue, Montclair, 3277 New Jersey, and BARTHOLOMEW J. BARRY of 16 East 63rd Street, New York, N.Y., hereinafter described as the General Partners, and MICHAEL F. BURNS of 16 East 63rd Street, New York, N.Y., hereinafter described as the Limited Partner: WITNESSETH. - 1. Said parties hereby form a limited partnership for the purpose of conducting a general business in cotton goods and all business incidental thereto, under the firm name and style of CURRAN & BARRY, said partnership to have its principal place of business in the City, County and State of New York. 2. Said partnership shall commence on the 16th day of April, 1923, and shall terminate at the close of business, on the 15th day of April, 1928. 3. The Limited Partner contributes to the capital of the partnership the sum of Two hundred and fifty thousand ($250,000.) Dollars in cash. 4. The Limited Partner shall receive by reason of his contribution a sum equal to one (1%) per cent of the net business invoiced by the partnership during the term thereof specified in Clause "2" of this agreement. The phrase "the net business invoiced" is defined by the parties as meaning the gross or total amount of business invoiced minus trade and3278 cash discounts allowed, mill agents' selling commissions, allowances for goods returned if any, and other incidental deductions customarily made or occurring in the cotton goods business. Payment under this clause shall be made on or about the 15th of each month covering the net business invoiced during the preceding month. 5. The General Partners at all times during the continuance of this copartnership shall devote their and each of their best endeavors to the partnership business and for the joint interest and advantage of the partnership. 6. The Limited Partner shall not have any liability to the creditors of the partnership other than by reason of his capital contribution above specified. as between the parties hereto, all losses, if any, incurred by the partnership shall be borne by the General Partners to the extent of and until their capital contributions to the partnership shall be exhausted; in the latter event, and then only, shall be losses incurred by the partnership be chargeable to the capital contribution of the Limited partner above specified. 7. The General Partners shall at all times during the term of the partnership keep accurate and complete books3279 of account of the partnership business and all the transactions thereof, to which books the Limited Partner shall at all times have free and ready access. 295 8. The General Partners agree that without the written consent of the Limited Partner, they will not either sell, assign, mortgage or in any manner dispose of the business of the copartnership; nor of its assets except in the regular course of business. 9. No withdrawals shall be made by the General Partners, or either of them, which shall make inroad upon the capital contribution of the Limited Partner above specified. 10. Upon the dissolution of the partnership, under operation of law or by agreement of the parties, the Limited Partner shall be entitled to the return of his capital contribution in cash, as soon as the liquidation of the partnership accounts will permit and in no event later than six months after such dissolution; with absolute priority of payment in full, before any payments shall be made to the General Partners. 11. The death of the Limited Partner during the term of the partnership shall not operate to dissolve the partnership, but the legal representatives of the Limited Partner shall3280 become the substituted Limited Partner under all the terms and conditions of this agreement. IN WITNESS WHEREOF, the parties hereto have hereunto set their hands and seals the day year first above written. J. M. CURRAN. [L.S.] B. J. BARRY. [L.S.] M. F. BURNS. [L.S.] On January 15, 1924, Burns received from Curran and Barry for December, 1923, the sum of $6,001.20, pursuant to the above agreement and computed in accordance with paragraph 4 thereof. Burns died on April 28, 1924, and petitioners are the executors of his estate. On May 20, 1924, the estate of the decedent received from Curran and Barry for April, 1924, the sum of $5,781.68, pursuant to the above agreement and computed in accordance with paragraph 4 thereof. The decedent and his estate kept their books and made their returns on a cash basis. The estate filed returns on the basis of fiscal years ended April 30 of each year. In his return the decedent reported the amounts received from Curran and Barry pursuant to this agreement as "income from partnerships * ." OPINION. STERNHAGEN: The Commissioner, acting under section 218(a), Revenue Act of 1921, 1 determined that the item of3281 $6,001.20 was part of the distributive share of Burns as a partner in the income 296 of the partnership of Curran and Barry in 1923. If this provision of the statute applies, it is immaterial that the amount was actually received in 1924, even though Burns made his individual return on the basis of actual receipts. The petitioners contend, however, that Burns was not a partner and therefore section 218 is not applicable. They concede that if a partnership existed the deficiency is correct. That a New York limited partnership is within section 218, as stated in article 1505, Regulations 62, 2 is not disputed. 3282 The agreement sets forth that the parties form a limited partnership. Its terms are those prescribed by the Limited Partnership law of New York, Cons. Laws, ch. 39, art. 8, which are those of the uniform partnership law. It is suggested by petitioners that it does not appear that the State requirements of recording and publication have been fulfilled. The burden of proof being on petitioners, we apply the omission against them and assume the performance of these formal statutory requirements. Were they not performed, authority is lacking to establish that such omission is ipso facto so substantial as to make the relation invalid as a limited partnership. Assuming, however, as petitioners urge, that these formal matters are requisite and that they have been omitted, the effect would have been not to destroy the partnership relation, but rather to have deprived the decedent of his limitation of liability and to have left him a general partner. We have considered the petitioners' argument seeking to demonstrate that this was in no event a partnership and that decedent was a mere lender with no interest in the profits. We can not adopt petitioners' reiterated notion that*3283 decedent had no proprietary interest in the firm. Looking at the evidence, we find only the bare terms of the agreement, the fact of payment and the fact that both decedent during his lifetime and the firm prior to and after his death stated on their income-tax returns that this was a partnership of which Burns and his estate were members, and that the amount received by Burns and his estate were their shares of partnership income. From the evidence we are of opinion that a partnership existed within the meaning of section 218, and the respondent's determination upon that hypothesis was correct. Judgment will be entered for the respondent.Footnotes1. SEC. 218. (a) That individuals carrying on business in partnership shall be liable for income tax only in their individual capacity. There shall be included in computing the net income of each partner his distributive share, whether distributed or not, of the net income of the partnership for the taxable year, or, if his net income for such taxable year is computed upon the basis of a period different from that upon the basis of which the net income of the partnership is computed, then his distributive share of the net income of the partnership for any accounting period of the partnership ending within the fiscal or calendar year upon the basis of which the partner's net income is computed. ↩2. ART. 1505. Limited partnership as partnership.↩ - So-called limited partnerships of the type authorized by the statutes of New York and most of the States are partnerships and not corporations within the meaning of the statute. Such limited partnerships, which can not limit the liability of the general partners, although the special partners enjoy limited liability so long as they observe the statutory conditions, which are dissolved by the death or attempted transfer of the interest of a general partner, and which can not take real estate or sue in the partnership name, are so like common law partnerships as to render impracticable any differentiation in their treatment for tax purposes. Michigan and Illinois limited partnerships are partnerships. A california special partnership is a partnership.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625439/	The West End Co., Petitioner, v. Commissioner of Internal Revenue, RespondentWest End Co. v. CommissionerDocket No. 47182United States Tax Court23 T.C. 815; 1955 U.S. Tax Ct. LEXIS 256; January 31, 1955, Filed 256 Decision will be entered for the respondent. 1. Interest received on mortgage constituted personal holding company income because the property covered by mortgage was held by petitioner for investment purposes and not for sale in the ordinary course of its trade or business.2. For the failure to file personal holding company income tax returns the 25 per cent penalty under section 291 (a) of the Internal Revenue Code of 1939 is approved. Monroe H. Collenburg, Esq., for the petitioner.Donald J. Fortman, Esq., for the respondent. Arundell, Judge. ARUNDELL816 257 This proceeding involves deficiencies in income tax and penalties under section 291(a) of the Internal Revenue Code of 1939 as follows:YearDeficiencyPenalty1948$ 766.12$ 191.531949857.69214.42The deficiencies in income tax occur because the respondent has determined that the petitioner was a personal holding company during the years 1948 and 1949 and that the interest received by the petitioner during these years constituted personal holding company income within the meaning of section 502 (a) of the Internal Revenue Code of 1939. Penalties were attached because the petitioner failed to file personal holding company returns for the 2 years involved.Most of the facts have been stipulated.FINDINGS OF FACT.Petitioner is a corporation organized in New Jersey on May 16, 1912. Its corporation income tax returns for the calendar years 1948 and 1949 were timely filed with the collector of internal revenue for the third district of New York.The corporate purposes set forth in petitioner's certificate of incorporation, as amended by a certificate of amendment filed February 26, 1924, were and are as follows:THIRD. The objects for which this corporation is formed258 are:a. To purchase, lease, hire or otherwise acquire real and personal property, improved and unimproved, of every kind and description, and to sell, dispose of, lease, convey and mortgage said property, or any part thereof: To acquire, hold, lease, manage, operate, develop, control, build, erect, maintain for the purposes of said company, construct, re-construct or purchase, either directly or through ownership of stock in any corporation, any lands, buildings, offices, stores, warehouses, mills, shops, factories, plants, machinery, rights, easements, permits, privileges, franchises and licenses, and all other things which may at any time be necessary or convenient in the judgment of the Board of Directors for the purposes of the company. To sell, lease, hire, or otherwise dispose of the lands, buildings or other property of the company, or any part thereof.* * * FIFTH. The corporation shall also have power to conduct its business in all its branches, have one or more offices, and unlimitedly to hold, purchase, mortgage and convey real and personal property in any of the states, territories, possessions and dependencies of the United States, the District of Columbia and foreign259 countries.* * * TENTH. The period of existence of this corporation is unlimited.By a deed dated June 7, 1924, and recorded in the Monmouth county clerk's office, New Jersey, on August 8, 1924, in Book 1268 of Deeds, page 43, petitioner acquired title from Simon Hess of New York City, its principal stockholder, to the following premises:817 ALL that certain tract or parcel of land and premises, hereinafter particularly described, situate, lying and being in the City of Long Branch, in the County of Monmouth, and State of New Jersey, bounded and described as follows:BEGINNING in the middle of Brighton Avenue at the intersection of Brighton and Ocean Avenues; running thence along the middle of Ocean Avenue in a southwesterly direction, two hundred and eleven (211) feet and twenty one-hundredths (20/100) of a foot; thence along a line parallel with Brighton Avenue in a southwesterly direction, six hundred and fifty (650) feet and ten one hundredths (10/100) of a foot; thence along a line on Second Avenue, parallel to Ocean Avenue in a northeasterly direction, two hundred and eighteen (218) feet and forty-six one-hundredths (46/100) of a foot; thence along the middle of Brighton260 Avenue in a northeasterly direction six hundred and twenty-seven (627) feet to the point or place of Beginning.When petitioner acquired title to the premises referred to above, there were on the premises the following structures:1 -- three story brick apartment house containing ten apartments and two stores7 -- stores in a one-story tax-payer1 -- gasoline station4 -- single bungalows, one-story4 -- double bungalows, two-storyOn August 8, 1925, the petitioner entered into a contract with the Jefferson Corporation, a New York corporation, for the sale of part of the premises referred to above at a price of $ 82,000 and received as a deposit on account thereof the sum of $ 1,500. The Jefferson Corporation thereafter refused to fulfill its agreement and take title to the premises, and petitioner thereupon kept the deposit of $ 1,500. William Kirch of West End, New Jersey, was the broker on this transaction.On July 27, 1928, petitioner sold and conveyed the part of the premises which was unimproved to Evander Realty Corporation, a New York corporation.On May 3, 1946, petitioner entered into an agreement for the sale of the remainder of the premises referred to above to the West261 End Corporation, a New Jersey corporation, for the sum of $ 55,000 and, in connection with the sale, agreed to take back a purchase money mortgage on the premises in the sum of $ 35,000, the balance of the purchase price to be paid in cash to the petitioner. At the time of this sale, there were on the premises the structures listed above, and also the following structures:1 -- two-car garage1 -- six-car garageOn July 2, 1946, the sale was completed by the delivery of a deed to the remainder of the premises to West End Corporation and a payment by the latter of $ 20,000 in cash and the delivery of the purchase money mortgage in the sum of $ 35,000. The purchase money mortgage provided for the payment of $ 116.67 per month, plus interest at 4 per cent 818 per annum until July 1, 1956, at which time the entire balance was to be paid. It further provided for prepayment at the mortgagee's option in multiples of $ 500, or the entire balance, on any interest date.During the calendar years 1948 and 1949, the petitioner received income in the amounts of $ 1,294.74 and $ 1,238.58, respectively. Such income consisted solely and exclusively of the interest payments made to the262 petitioner on the $ 35,000 purchase money mortgage referred to above. Those amounts of $ 1,294.74 and $ 1,238.58 are the items referred to as "the items of interest" in the statutory notice of deficiency mailed to the petitioner on December 9, 1952. No distributions of such income of the petitioner were made to the stockholders of the petitioner during the calendar years 1948 and 1949.The total issued stock of the petitioner is 100 shares of a par value of $ 100 per share. The 100 shares were originally issued on August 1, 1928, as follows:80 shares to Simon Hess10 shares to Elizabeth Hess10 shares to Maud HessSimon Hess died on January 25, 1933, and the 80 shares issued to him passed under his last will to a trust of which Maud Hess and Elizabeth Hess are the sole beneficiaries and trustees. Maud Hess was the daughter of Simon Hess and Elizabeth Hess was the daughter-in-law of Simon Hess.Petitioner's principal source of income from 1924 through 1945 was the rents on the structures on the property. Petitioner operated at a loss except for the years 1930 and 1931.During the years 1948 and 1949, petitioner's only source of income was the interest payments received in connection263 with the sale of the remainder of the real property in 1946.From 1924, the date of the acquisition of the real property from Simon Hess, until 1946, the petitioner made only one sale of its real property. That sale comprised the unimproved section of its property which was sold in 1928.No expenditures were ever made for advertising the remainder of the tract for sale. The property was never listed with a broker and an acceptable price for the property was never determined by petitioner's officers.During the years between 1928 and 1946, there was no market for the remainder of the tract which the petitioner owned and the property was held to await an increase in real estate values in the area. During this period, the property was not held primarily for sale to customers in the ordinary course of petitioner's trade or business.The interest income received by petitioner during 1948 and 1949 was not interest on a debt representing the price for which real property 819 held primarily for sale to customers in the ordinary course of a trade or business was sold.The petitioner failed to file personal holding company returns for the calendar years 1948 and 1949 and such failure264 to file was not due to reasonable cause but to willful neglect.OPINION.The petitioner's total income during the years 1948 and 1949 was interest received on a purchase money mortgage which was given when petitioner disposed of all of its real estate holdings in 1946. The income received was clearly personal holding company income within the meaning of section 502 (a) of the Internal Revenue Code of 1939, unless the purchase money mortgage from which the interest flowed was given in connection with the disposal of property held primarily for sale to customers in the ordinary course of business. (Section 502 (g) of the Internal Revenue Code of 1939.) 1 We have held in our findings that the property was not so held at the time of its sale in 1946.265 The record in this case is not too satisfactory. We do not know when Hess, who transferred the property to the corporation in 1924, first acquired it or built it and the circumstances surrounding this transaction. We do not know the circumstances surrounding the transfer of the property to petitioner or why it was transferred. We do know that between 1928 and 1946 the bottom was out of the real estate market in this area and even the rents were insufficient in most years to pay the expenses of operation. During these years, what the petitioner did was to retain its holdings and hope for a better day. During this period, it did not list the property for sale, fix a price it would take for it, or advertise it to interest would-be buyers. It sat passively by until 1946 when two prospective buyers appeared and accepted the better of the two offers it then received. Petitioner's entire holdings were disposed of at this time in one transaction. The purchase price was $ 55,000, $ 20,000 was paid in cash and a purchase money mortgage of $ 35,000 executed by the buyers. These facts do not warrant a finding that the property in question was held 820 primarily for sale to customers266 in the ordinary course of petitioner's business. In fact, they require a holding to the contrary.It follows that the interest received by petitioner during 1948 and 1949 constitutes personal holding company income and petitioner is required to file and pay the personal holding company tax imposed by section 502.There remains only the question of whether the petitioner is liable for the penalty under section 291 (a)2 for its failure to file personal holding company returns for the years 1948 and 1949. The foregoing provision provides for a penalty for failure to file a personal holding company return "unless it is shown that such failure is due to reasonable cause and not due to willful neglect." The burden of establishing reasonable cause is on the petitioner.267 Nothing was said on this issue by the petitioner except its basic contention that it was not liable for the personal holding company surtax because it had no personal holding company income. However, it has not been shown how petitioner's officers arrived at this conclusion. There is nothing to indicate that this conclusion was based upon the opinion of reputable counsel or of other expert tax advisors who had been given all the facts regarding petitioner's debatable status. In fact, there is nothing to indicate that petitioner's officers even considered the possibility of liability for the personal holding company surtax until it was suggested by the respondent's claims. In such circumstances we cannot find that petitioner's officers exercised the necessary business prudence to constitute reasonable cause for failure to file the required returns. Wm. J. Lemp Brewing Co., 18 T. C. 586. Therefore, we hold that the penalty determined by the respondent is appropriate.Decision will be entered for the respondent. Footnotes1. SEC. 502. PERSONAL HOLDING COMPANY INCOME.For the purposes of this subchapter the term "personal holding company income" means the portion of the gross income which consists of:(a) Dividends, interest (other than interest constituting rent as defined in subsection (g)), royalties (other than mineral, oil, or gas royalties), annuities. * * (g) Rents. -- Rents, unless constituting 50 per centum or more of the gross income. For the purposes of this subsection 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 * *↩2. SEC 291. FAILURE TO FILE RETURN.(a) In case of any failure to make and file return required by this chapter, within the time prescribed by law or prescribed by the Commissioner in pursuance of law, unless it is shown that such failure is due to reasonable cause and not due to willful neglect, there shall be added to the tax: 5 per centum if the failure is for not more than thirty days with an additional 5 per centum for each additional thirty days or fraction thereof during which such failure continues, not exceeding 25 per centum in the aggregate. The amount so added to any tax shall be collected at the same time and in the same manner and as a part of the tax unless the tax has been paid before the discovery of the neglect, in which case the amount so added shall be collected in the same manner as the tax.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625440/	I. A. Wyant, Petitioner, v. Commissioner of Internal Revenue, RespondentWyant v. CommissionerDocket No. 4658United States Tax Court6 T.C. 565; 1946 U.S. Tax Ct. LEXIS 254; March 25, 1946, Promulgated 254 Decision will be entered under Rule 50. Taxpayer in 1934 and 1935 created 8 trusts for the benefit of his 8 children, of whom 7 were minors. In each case a banking corporation was named as trustee. The trusts for the minor children were declared to be for the education, care, and maintenance of the beneficiaries. Income was to be accumulated during the minority of the beneficiaries unless otherwise directed by the taxpayer or his wife. The trustee was authorized to make "emergency" payments out of principal for the education, support, care, maintenance, and general welfare of the beneficiaries. Petitioner retained the right to alter or amend the manner of distribution to the beneficiaries, except that the term of the trust could not be extended nor the beneficiary be deprived of the principal thereof. Held:(1) Petitioner is taxable under section 22 (a) upon the income of the trusts for the minor children.(2) The powers retained by the petitioner over the trust for the benefit of his adult son were not sufficient to warrant taxing to him the income therefrom under section 22 (a). Allin H. Pierce, Esq., for the petitioner.William F. Robinson, Esq., for the respondent. Van Fossan, Judge. VAN FOSSAN 565 The respondent determined deficiencies in income tax against I. A. Wyant for the years 1940 and 1941 in the respective amounts of $ 2,119.86 and $ 6,411.97.The sole issue is whether the respondent erred in determining that the petitioner, as grantor, is taxable under section 22 (a) of the Internal Revenue Code upon the income of eight inter vivos trusts created for the benefit of his eight children.FINDINGS OF FACT.The petitioner is an individual residing in North Muskegon, Michigan. His returns for the years in controversy were filed with the collector of internal revenue for the district of Michigan.566 The petitioner is the father of eight children, the names and dates of birth of whom are as follows:Name and date256 of birthMichael J. Wyant, Dec. 30, 1913Mary Josephine Wyant, Aug. 10, 1922Emma Jean Wyant, July 7, 1923Ira A. Wyant, Jr., Oct. 8, 1926Name and date of birthJane Catherine Wyant, Oct. 26, 1927Gregory Wyant, Feb. 25, 1929Bruce Jerome Wyant, Aug. 15, 1930Suzanne Wyant, Oct. 31, 1934With the exception of Michael J. Wyant, all of the petitioner's children were minors when the trusts hereinafter described were created, and also during the taxable years here involved.On December 31, 1934, the petitioner created six trusts by separate instruments for the benefit of his children, Bruce Jerome Wyant, Mary Josephine Wyant, Jane Catherine Wyant, Gregory Wyant, Emma Jean Wyant, and Ira A. Wyant, Jr. The corpus of each trust consisted of 1,000 shares of the capital stock of Campbell, Wyant & Cannon Foundry Co.On December 1, 1935, the petitioner created two additional trusts, also by separate instruments, naming as beneficiaries his two remaining children, Michael J. Wyant and Suzanne Wyant. The corpus of each of these trusts consisted of 800 shares and 1,000 shares, respectively, of the capital stock of Campbell, Wyant & Cannon Foundry Co.The Hackley Union National Bank of257 Muskegon, Michigan, was named as trustee of all eight trusts.The trusts for the minor children were identical, except for the names of the beneficiaries. The trustee was granted broad powers, including the power to care for, manage, control, and dispose of the property; to take and hold legal title thereto, "granting to said Trustee the same powers and authority that the Donor has heretofore possessed with reference to said property"; to vote, in person or by proxy, upon all corporate stocks held by it; to unite with owners of similar property in carrying out any plan for the reorganization of any corporation or company whose securities at any time form a part of the trust and to exchange, upon such terms as the trustee should deem proper, the securities or stocks of any such corporation for other securities or stocks issued by it or by any other corporation; to assent to the consolidation, merger, or liquidation of any corporation whose stocks and securities are held as part of the trust estate, and to exchange the stocks and securities so held for the stocks or securities issued in connection with such merger, consolidation, or liquidation; to exercise generally, in respect to258 all stocks, securities or other properties held by the trustee, all such rights and powers as are, or lawfully may be, exercised by persons owning similar property in their own right.567 The trustee was also empowered to collect the proceeds of the stocks, securities, or other properties included in the trust; to borrow money for the protection of the trust estate or the interest of the beneficiary therein; to issue its note or other evidence of indebtedness therefor; and to assign, pledge, hypothecate, or mortgage any of the trust properties in order to secure repayment of any sum borrowed; to institute suits or legal proceedings to enforce any right with respect to any matter or thing embraced within the terms of the trust; and to pay all taxes and assessments upon the trust estate.Other material powers of the trustee were as follows:(c) To Invest. To invest and reinvest in interest-bearing or income-producing notes, bonds, mortgages, corporate stocks or other securities or personal properties the moneys belonging to the principal of the trust estate hereby created, including such sums of money, if any, as the Donor may from time to time deposit with the Trustee to259 be embraced in this trust, as well as the proceeds of the collection of notes, bonds and securities when the same are paid or sold. In the investment and reinvestment of trust funds the Trustee shall not be confined to those securities or properties specified by any statute or common law rule now in force or hereafter enacted or promulgated in the State of Michigan. The Trustee shall, however, have power and authority to invest the moneys belonging to the trust hereby created in such income-producing notes, bonds, securities, corporate stocks or other property as the said Trustee shall in its discretion deem to be for the best interests of the trust estate or the beneficiary thereof; provided, however, that during the Donor's lifetime the Trustee shall consult with him relative to any intended sale or purchase of securities or properties as an investment of trust moneys hereunder and secure his written approval therefor, unless it is impracticable so to do, and following the death of the Donor sales or purchases as hereinabove defined shall be made only with the written assent of the then Trust Committee supervising investments of the Trust Department, and such investments shall260 be in listed securities only of any acknowledged stock exchange and of investment rating and quality approved by said Trust Committee; and provided further, that the Donor reserves the right during his lifetime to direct the sales or purchases of securities or properties at any time comprising a part or portion of the trust estate.(d) To Sell. To sell, substitute, exchange or otherwise dispose of all or any part of the notes, bonds, mortgages, corporate stocks, or other properties now or hereafter embraced in this trust, at such times and for such prices and upon such terms as the Trustee may deem to be for the best interests of the trust hereby created, or to carry out the terms and conditions of this instrument; provided, however, that during the lifetime of the Donor the Trustee shall, whenever practicable, consult with him relative to any intended sale of any of the property or properties included in the trust estate, and after the death of the Donor, the Trustee shall, whenever practicable, consult with the said Donor's wife, Emma Wyant, if living, otherwise with the Beneficiary, relative to any sale of any of the trust properties. In case real property shall be or in 261 any manner become a part of the trust estate, the Trustee is hereby instructed to sell and convert the same into personal property (as soon as reasonable prices can be obtained therefor), and all of the properties comprising the trust estate hereby created shall be personal property.568 The trustee was required to keep accounts and to render semiannual statements to the petitioner during his lifetime and, after his death, to the beneficiary entitled to the net income of the trust.Each trust provided that the net income should be remitted to the beneficiary monthly, except that it should be accumulated during the minority only of the beneficiary "unless otherwise directed by the Donor or the Donor's wife during their respective lifetimes and following their decease in the sole discretion of the Trustee. The trust hereby created is for the education, care and maintenance of the said [beneficiary] and the Trustee in the exercise of its discretion shall be so guided by this purpose for which the Donor has so created this trust; provided further, that as and when the said [beneficiary] attains [his or her] majority, the net income of the trust estate shall be paid to [him or her] 262 monthly, as above provided."The trustee was authorized to make payments from principal "to meet such emergency or emergencies, from time to time as they may arise, for the education, support, care, maintenance and general welfare of the said beneficiary, and for said purpose to advance sum or sums of the principal of the trust estate as may be necessary and advisable for the purposes above described."The principal of each trust was to be distributed as follows: One-fourth when the beneficiary reached the age of 25; one-third of the balance of the principal when the beneficiary reached 30; one-half of the balance when the beneficiary reached 35; and the balance of the principal when the beneficiary reached the age of 40, at which time the trust should terminate. In the event the beneficiary died before reaching the age of 40, the trustee was to distribute the principal to the beneficiary's testamentary appointees and, in default of such appointment, to such person or persons as should be entitled to his or her personal estate under the laws of intestate succession of the State of Michigan.The petitioner reserved the right to increase the trust estate by adding thereto moneys, notes, 263 bonds, mortgages, or other securities and properties, as to him might seem best.Provision was made for removal of the trustee from office for malfeasance, misfeasance, or nonfeasance in the performance of its duties by appropriate proceedings in the Circuit Court of the County of Muskegon, Michigan, in Chancery, or any other court having jurisdiction to hear such matters. In the event of such removal its successor was to be appointed by the petitioner during his lifetime and, after his death, by his wife, if living, otherwise, by the beneficiary of the trust.The trusts were declared to be irrevocable, except that the petitioner reserved the right to alter or amend the manner of distribution to the 569 beneficiary, provided that the trust should not be extended beyond the time provided for termination thereof and that the beneficiary should not be deprived of the principal of the trust estate.The trust for the benefit of Michael J. Wyant was, in most respects, identical with those of the minor children. It provided, however, that the net income of the trust should be paid to the beneficiary rather than be accumulated. It provided, further, that the trust should continue264 until the death of Michael J. Wyant, at which time the principal should be distributed to his testamentary appointees, or, in default thereof, to those persons entitled to receive it under the laws of intestate succession of the State of Michigan. It was likewise declared to be irrevocable, except that the petitioner reserved the right to alter or amend the manner of distribution to the beneficiary, provided that the trust should not be extended beyond the lifetime of the beneficiary and that the beneficiary should not "be deprived of the ultimate disposal of the principal of the trust estate."On November 2, 1941, the petitioner executed an amendment to each of the trusts whereby he irrevocably renounced, on behalf of himself and his estate, any possible right, title, or interest which either he or his estate might otherwise acquire by inheritance or bequest from the named beneficiary. He also amended the provision in each trust relating to irrevocability to read as follows:Irrevocability: The trust hereby created is declared to be irrevocable and shall not be set aside during the period as herein stipulated for its duration. The power to alter or amend the manner of distribution265 has never been exercised and is hereby waived.The provision in each of the trusts whereby the petitioner reserved the right to direct the trustee in its sales or purchases of securities was inserted at the suggestion and insistence of the trustee. The trustee believed that the inclusion of such a provision would tend to protect it from possible criticism by bank examiners and others for keeping the trust funds invested in common stocks.The original corpus of each trust, consisting of shares of the capital stock of Campbell, Wyant & Cannon Foundry Co., was sold and disposed of by the trustee on or before February 18, 1936, in accordance with the petitioner's directions. Common stocks listed on the New York Stock Exchange were purchased with the proceeds.The stocks so purchased were acquired at the direction of the petitioner. The petitioner has always directed the purchase and sale of all stocks held in the several trusts and the trustee has always complied with his requests.The voting privileges of the stock held for the several trusts were exercised only by the trustee, which was given this power exclusively by the trust instruments.570 The petitioner is the treasurer266 of the Campbell, Wyant & Cannon Foundry Co. and has held that office during the existence of the trusts. At the time of the hearing he held an additional office due to the death of Campbell, one of the corporation's officers.Fiduciary income tax returns for the years here involved were filed by the trustee on behalf of each of the trusts, showing net income received and amounts distributed to the respective beneficiaries, as follows:19401941Trust for benefit of --Net incomeAmountNet incomeAmountdistributeddistributedMichael J. Wyant$ 571.52$ 896.57$ 696.69$ 1,238.12Mary Josephine Wyant294.11None981.84595.00Emma Jean Wyant294.11470.00939.67485.73Ira A. Wyant, Jr382.95349.00847.91600.24Jane Catherine Wyant382.95432.04840.20690.25Gregory Wyant391.27None869.86NoneBruce Jerome Wyant403.11None878.1950.00Suzanne Wyant532.32None1,053.28NoneIncome taxes were paid upon the amount remaining after deducting the "amounts distributed" from the "net income."The amounts so distributed to the beneficiaries, other than Michael J. Wyant, were expended for medical expenses, educational267 expenses, and travel incident to education, upon the direction of the petitioner's wife. The amounts distributed to Michael J. Wyant were used by him in purchasing a home.The petitioner filed individual income tax returns for the years 1940 and 1941, reporting thereon net income of $ 68,901.13 and $ 78,992.07, respectively.The respondent determined that the petitioner was taxable upon the net income of each of the trusts created by him and asserted the above mentioned deficiencies.OPINION.The issue raised by the pleadings, and as stated by the parties at the hearing, is confined to the question of whether or not the petitioner is taxable, under section 22 (a) of the Internal Revenue Code and the rule of Helvering v. Clifford, 309 U.S. 331">309 U.S. 331, upon the income of the trusts created by him in 1934 and 1935.The respondent has determined, and here contends, that the petitioner never parted with the economic control of the corpora of the several trusts; that he remained in substance the owner thereof; and that the income arising therefrom is consequently taxable to him.The answer to the question involved requires an analysis of the terms of the trusts268 and a consideration of all the circumstances attendant 571 on their creation and operation. Helvering v. Clifford, supra. If the powers retained by the grantor over the trust are so substantial that he remains in effect the owner thereof, the trust income is taxable to him as his own.In so far as the stated question relates to the trusts for the minor children, we think it must be answered affirmatively. That the primary purpose of each of these trusts was to discharge the legal obligations of the petitioner can not well be doubted. The trusts were declared to be for the education, care, and maintenance of the respective beneficiaries. In order to carry out this purpose the petitioner retained complete control over the accumulation and distribution of the trust income. The trust instruments provided that the income should be accumulated during the minority of the beneficiaries, unless otherwise directed by the petitioner or his wife during their respective lifetimes and, after their deaths, in the sole discretion of the trustee. The trustee, however, had no discretion during the life of the petitioner or his wife, but was bound to distribute269 the income whenever so directed by either of them. The petitioner, therefore, had plenary power over the trust income during the minority of his children and could have it distributed for any purpose whatsoever or accumulated at will. Such sums as were distributed at his direction or that of his wife, who had no adverse interest, were, in accordance with the declared purpose of each trust, to be used to discharge the petitioner's legal obligations toward his children.In this respect the instant case is closely similar to Whitely v. Commissioner, 120 Fed. (2d) 782. There, as here, the donor created separate trusts for his minor children, naming a banking corporation as trustee. Each trust provided that the trustee should pay the income to the donor if and when so ordered by him during the minority of the child, to be used solely for the support, maintenance, education, and enjoyment of the child. If not called for, the income was to be reinvested. During the taxable year there involved none of the trust income was used for the maintenance of the beneficiaries. It was held, however, that the donor was taxable upon the income of the trusts under270 section 22 (a), the court saying that he could have received the trust income and applied it to the support of his minor children; that he did not do so, but left it to accumulate for them; and that he "controlled the use of the money and had the same non-material satisfaction as the taxpayer in the Horst case." ( Helvering v. Horst, 311 U.S. 112">311 U.S. 112.)The powers retained by the petitioner here were equally as broad as those retained in the Whiteley case. The petitioner points out that in the Whiteley case the income was to be paid directly to the grantor of the trusts, whereas in the instant case such amounts as are distributable are to be paid directly to the beneficiary. While the 572 language of the trusts seems to support the petitioner in this, the fact is not controlling. We have here an intimate family group, such as was present in the Clifford case, supra, and it may fairly be presumed that the minor children would be amenable to their father's wishes with respect to the application of the income.Other controls were retained over the trusts by the petitioner which further evidence his ownership thereof. In addition271 to the provisions relating to income, the trust instruments authorize the trustee to make "emergency" payments out of principal for the education, support, care, maintenance, and general welfare of the beneficiaries, thus subjecting the corpora of the trusts to the discharge of the petitioner's legal obligations. Cf. Frederick B. Rentschler, 1 T.C. 814">1 T. C. 814.During most of the period here involved the petitioner had also the power to alter or amend the manner of the distribution to the beneficiary. This power was limited only by provision that the trust should not be extended beyond the time when the beneficiary should reach the age of 40 and that the beneficiary should not be deprived of the principal of the trust estate. Until such time elapsed, however, the petitioner had complete control over the distribution of both the income and corpus and could withhold from the beneficiary or make distributions to him as he saw fit. This power over the corpus of each of the trusts is tantamount to a power to terminate the trust and to distribute the corpus to the beneficiary at will. We held in Lorenz Iversen, 3 T. C. 756, that272 such a power adds materially to the "bundle of rights" under which a grantor's liability under section 22 (a) is imposed.The cumulative effect of the rights retained by the petitioner compels the conclusion we have reached. We hold, therefore, that the respondent did not err in his determination in so far as that determination applies to the trusts of the petitioner's minor children.With respect to the trust for the benefit of Michael J. Wyant, however, we are of the opinion that a different result is required. That trust was not for the benefit of a minor child of the petitioner. The beneficiary had already reached his majority at the time the trust was created. The trust made no provision for accumulation of income, but provided that such income should be paid to the beneficiary at monthly intervals for life. The petitioner had no right or power to receive the trust income or to have it applied in satisfaction of his own obligations. Thus he could not receive the economic benefits from this trust which he might derive from the trusts for the benefit of the minor children.It is true that the petitioner retained the power by amendment to alter or amend the manner of distribution273 to the beneficiary. We do not think, however, that this is sufficient to warrant taxing the income of the trust to the petitioner. He did not have the power, as did 573 the grantor in Commissioner v. Buck, 120 Fed. (2d) 775, "freely to sprinkle the income about among any beneficiaries he may select," since here Michael J. Wyant was the sole beneficiary of the trust. Furthermore, he could not withhold all beneficial interest from the beneficiary and distribute it to the remaindermen, since it was provided that under no amendment to the trust could the beneficiary be deprived of the ultimate disposal of the principal of the trust estate. This circumstance distinguishes the instant case from Stockstrom v. Commissioner, 148 Fed. (2d) 491. In this respect the case at bar is more closely akin to Hall v. Commissioner, 150 Fed. (2d) 304.We hold, therefore, that the petitioner did not retain such dominion or control over the trust for Michael J. Wyant as to render him taxable on the income thereof under section 22 (a).Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625441/	Buddy Schoellkopf Products, Inc., Petitioner v. Commissioner of Internal Revenue, RespondentBuddy Schoellkopf Products, Inc. v. CommissionerDocket No. 8117-73United States Tax Court65 T.C. 640; 1975 U.S. Tax Ct. LEXIS 2; December 31, 1975, Filed 2 Decision will be entered under Rule 155. Petitioner is a Texas corporation engaged in the development, manufacture, and sale of various products for the outdoorsman. During the 1968 fiscal year, petitioner paid legal fees in connection with the acquisition of assets from Brunswick Corp. These assets included inventory, equipment, and trade names. Held, the portion of legal fees incurred by petitioner which is attributable to trade names must be capitalized. The remainder of these fees are currently deductible.In order to finance the acquisition from Brunswick, petitioner secured a loan from Prudential. Petitioner had a loan with Prudential outstanding (first loan), and the new loan agreement provided that the first loan would be repaid from the proceeds of this new loan. Held, since the two loan transactions were sufficiently distinct to consider the cancellation of the first note a repayment, petitioner is entitled to deduct loan expenses incurred in connection with the first Prudential loan.In 1964, petitioner purchased a used airplane. In depreciating the airplane, petitioner used the double declining balance method of depreciation. Both parties agree the 3 rate used was improper. Respondent computed the depreciation for the years in issue using straight line depreciation, while petitioner seeks to use the 150-percent declining balance method. Held, petitioner is entitled to compute depreciation under the 150-percent declining balance method. Silver Queen Motel, 55 T.C. 1101">55 T.C. 1101 (1971), acq. 2 C.B. 3">1972-2 C.B. 3, followed.Two trusts, one with petitioner's president as trustee, and the other with petitioner's vice-president as trustee, leased land to a foundation for a 15-year term. The foundation in turn leased the land to petitioner for the same period. Although in form the lease contained a fixed term, in substance the lease term was of indefinite duration. Held, petitioner must amortize the cost of leasehold improvements over the estimated useful life of the improvements, rather than the shorter formal lease period.Held, travel expenses claimed by petitioner are disallowed for lack of substantiation. Held: Dues paid to hunting and fishing club are not deductible as an ordinary and necessary business expense. Petitioner was unable to show the facility was used 4 primarily for business purposes. Held, further, hunting expedition to Alaska by petitioner's president, the majority shareholder, and his son, is not deductible as an ordinary and necessary business expense since the trip was primarily personal; the incidental business benefit does not make the expenses for the trip deductible. William E. Collins, for the petitioner.Charles L. McReynolds, for the respondent. Wilbur, Judge. WILBUR641 Respondent has determined deficiencies in petitioner's Federal income taxes as follows:Year ended Nov. 30 --Amount1968$ 22,171.51196916,435.76The issues remaining for decision are:(1) Whether petitioner was entitled to deduct travel expenses of $ 4,000 for the taxable year ending November 30, 1968.(2) Whether legal fees incurred by petitioner in the acquisition of certain assets from Brunswick Corp. should be deducted in the year of acquisition or capitalized.(3) 7 Whether petitioner was entitled to deduct expenses incurred in obtaining a $ 900,000 loan which was later satisfied from the proceeds of a $ 1,700,000 loan made by the same lender or whether these expenses must be amortized over the original 15-year period of the first loan.(4) Whether petitioner was entitled to compute depreciation on a used airplane under the 150-percent declining balance method for the years in issue.(5) Whether petitioner was entitled to amortize certain leasehold improvements over the remaining life of the leases rather than on the basis of the estimated useful life of the improvements.(6) Whether dues paid by petitioner to a hunting and fishing club were deductible as ordinary and necessary business expenses.(7) Whether petitioner was entitled to deduct as an ordinary and necessary business expense the cost of an expedition to Alaska by petitioner's president (and majority shareholder) and his son.642 Most of the facts have been stipulated and are found accordingly.Buddy Schoellkopf Products, Inc. (hereafter referred to as petitioner), is a corporation with its principal offices in Dallas, Tex. Petitioner maintains its books and records and files8 its income tax returns on the basis of a fiscal year ending November 30. The returns for the fiscal years ended November 30, 1968, and November 30, 1969, were filed with the Internal Revenue Service Center at Austin, Tex.Petitioner engages in the development, manufacture, and sale of various products for the outdoorsman, including gun cases, hunting clothes, sleeping bags, and flotation equipment. Factories for the manufacture of these items are maintained by petitioner in Mineola, Tex., and Dallas, Tex.During the taxable years ended November 30, 1968, and November 30, 1969, Hugo N. Schoellkopf, Jr. (Buddy), was president of petitioner and the owner of 67 1/2 percent of the outstanding capital stock of petitioner; Delbert Chandler was a vice president of petitioner and the owner of 22 1/2 percent of the capital stock of petitioner, and Hugo W. Schoellkopf III (Hugo) was an employee but not an officer of petitioner.Issue 1. Travel ExpensesFINDINGS OF FACTDuring the period December 11, 1967, through June 17, 1968, petitioner paid Buddy the sum of $ 4,000 which was charged on the records of petitioner as travel expenses. Buddy testified that these expenditures were properly9 incurred but petitioner has no records to substantiate the expenditure of these funds. No amount has been allowed by respondent as travel expenses for Buddy during this period. However, during the period February 27, 1967, through August 14, 1967, the amount of $ 3,050 was paid to Buddy for travel expenses and this amount was allowed by respondent. Similarly, the sum of $ 8,000 paid to Buddy was claimed by petitioner and allowed by respondent for the period of October 17, 1968, through August 17, 1969.OPINIONThe first issue is whether the Commissioner erred in disallowing $ 4,000 of travel expenses claimed by petitioner. In order 643 to successfully deduct its travel expenses under Code section 162, 1 petitioner must substantiate these expenditures pursuant to the rules set forth in section 274(d). Section 274(d) provides that no deduction shall be taken for travel, entertainment, or gift expenses unless by either "adequate records" or "sufficient evidence corroborating his own statement" the taxpayer substantiates the essential elements relating to the nature and business character of the expenditure. 2 Among the specific showings required by the statute are the amount10 of the expense, the time and place of the travel, and the business purpose of the expenditure.11 The substantiation requirements are clarified and explained in detail by the regulations. 3The Treasury regulations under section 274 state that to meet the "adequate records" requirements the taxpayer must maintain "an account book, diary, statement of expense or similar record * * and documentary evidence * * * which, in combination, are sufficient to establish each element of an expenditure" specified in the statute and regulations. 4Petitioner concedes that the adequate records requirement is not met here. Petitioner argues, however, that it has met the alternative standard of substantiation; viz., sufficient evidence corroborating petitioner's own12 statement. In addition to the testimony of petitioner's president, Hugo N. Schoellkopf, Jr., petitioner cites similar travel expenses which were substantiated and allowed by the respondent for periods both before and after 644 the time frame in question. Unfortunately for petitioner, the existence of these allowed expenditures, without more, is not enough to satisfy the other "sufficient evidence" requirement. In discussing other "sufficient evidence" the regulations provide that if the taxpayer is unable to meet the "adequate records" requirement, then he must establish each element 5 of the expenditure:13 (i) By his own statement, whether written or oral, containing specific information in detail as to such element; and(ii) By other corroborative evidence sufficient to establish such element. 6The regulations go on to state that the taxpayer lacking adequate records must corroborate his own testimony with respect to the amount, time, and place of an expenditure by direct evidence obtained from one other than the taxpayer. The business purpose of an expenditure may be established by circumstantial evidence.The regulations thus envision specific evidence about the activities that gave rise to an expense. 7 The record here is devoid of such specifics. In fact, no evidence of any particular individual travel expense appears in the record.Not only did petitioner's corroborating evidence fail to shed any light on specific expenses incurred within the contested period, even the testimony of Buddy was only of a general nature. Under these circumstances, we must disallow any deductions for travel expenses for the period December 11, 1967, through June 17, 1968.The existence of allowable14 travel expenses for the periods prior to and subsequent to the period under examination here, may 645 admittedly suggest that some legitimate travel expenses were incurred during this period. Nevertheless, we must disallow petitioner's claimed travel expenses in full. Section 274 was specifically designed to overturn, in this area, the rule in Cohan v. Commissioner, 39 F. 2d 540 (2d Cir. 1930), which permitted a court to make as close an approximation of the amount of the expenditures as it could, and allow the deductions therefor pro tanto. 8 Since petitioner was unable to substantiate its travel expenses, either by adequate records or by other sufficient evidence, corroborating its own statement, and we are not at liberty to estimate what those expenses might have been, respondent's determination must be sustained.15 Issue 2. Attorney Fees on AcquisitionFINDINGS OF FACTDuring the 1968 fiscal year, petitioner paid attorney fees in the amount of $ 4,500 in connection with the acquisition from Brunswick Corp. of certain assets related to the Red Head line of products.At one time Red Head was a highly successful family-operated company engaged in much the same business as petitioner -- the sale of certain products for the outdoor sportsman. The company was well established and the Red Head brand enjoyed a fine reputation in its field. In the early 1960's Red Head was bought out by Brunswick Corp. During the next 7 years, the company was not operated at a profit, and Red Head's status in the market diminished considerably.By an agreement of sale and purchase dated August 30, 1968, petitioner acquired from Brunswick assets related to the Red Head line of products. The total purchase price of all assets acquired from Brunswick by petitioner was computed and allocated pursuant to the agreement as follows: 646 Inventory of raw materials$ 490,479.85Inventory of finished goods1,788,588.32Equipment45,594.05Total2,394,932.22Petitioner paid Brunswick the "standard16 cost" for the finished goods and raw material and the depreciated book value of machinery and equipment. There were no goods in process. In addition, petitioner received the trademarks and trade names of Red Head, Drybak, and Blue Bill. No part of the purchase price was allocated to these trade names in the sales agreement. The names "Drybak" and "Blue Bill" were never used by petitioner.Customer dissatisfaction with Red Head's merchandise and service during recent years had substantially diminished Red Head's reputation. Nevertheless, petitioner did successfully utilize the Red Head trade name. Petitioner retained the Red Head sales organization with some modifications, and kept this line as a separate entity. This gave petitioner an additional marketing advantage because petitioner could sell both his own brand and the Red Head brand in the same area. This additional marketing opportunity was recognized by petitioner prior to the acquisition, and in part provided the incentive for the purchase.Red Head Brand Corp. was incorporated as a wholly owned subsidiary of petitioner on September 5, 1968. On September 26, 1968, petitioner transferred as a capital contribution to17 Red Head Brand Corp. all of its interest in trademarks or trade names which had been acquired from Brunswick Corp. This subsidiary did not manufacture goods but was utilized solely as a sales outlet for products manufactured by petitioner. These products were marketed through Red Head Corp. under trade names used solely by that corporation.OPINIONRespondent argues that the $ 4,500 in legal fees incurred in connection with the acquisition of assets from Brunswick is attributable to goodwill or trademarks and therefore should be capitalized. See Woodward v. Commissioner, 397 U.S. 572 (1970). Respondent has stipulated that in the event these legal fees are not allocable to nonamortizable capital assets, then those expenditures will be allowed as a current business deduction.647 It is clear at the outset that this Court is not bound by the allocation of values made in a purchase contract. Copperhead Coal Co. v. Commissioner, 272 F.2d 45 (6th Cir. 1959); Sidney V. LeVine, 24 T.C. 147">24 T.C. 147 (1955). At the same time we note that the tax treatment of ancillary expenses in the acquisition of18 property, such as legal expenses, must be determined by reference to the character of the assets acquired. See Woodward v. Commissioner, supra;George Eisler, 59 T.C. 634">59 T.C. 634 (1973). Thus, to the extent that we find the purchase price represented payment for trade names or goodwill, we will allocate a proportionate share of petitioner's legal fees to the acquisition of intangibles and capitalize the fees accordingly. 9Our task, therefore, is to examine the record and determine as best we can how much of the purchase price, if any, was properly attributable to goodwill and trade names. In order to sustain respondent's position that the entire $ 4,500 should be capitalized we would have to conclude that the full $ 2,394,932.22 purchase price was tendered solely for these intangibles. This we cannot do. The evidence indicates that petitioner received a great deal of valuable19 merchandise in the purchase from Brunswick. The purchase price for the inventory was not inflated and indeed was based primarily on the cost to the seller.We are also inclined to agree with petitioner that Red Head had lost much of its fine reputation of years past. Nevertheless, we recognize that although the sale agreement did not specifically allocate part of the purchase price to the trade names, the use of the Red Head label and sales organization also represented a valuable part of what was transferred in the sale. This is made most clear by the testimony of Buddy Schoellkopf:Here we've got an opportunity to acquire two million dollars worth of merchandise. * * * And, we have an opportunity to go into an entirely different marketing circumstance, with their salesmen, and to ease it into a circumstance that would be competitive to ours, but not competitive to ours. We wanted another brand, we wanted another name, so that we can sell neighbors, so that -- and keep them happy -- so we can sell a Black Sheep customer and a Red Head customer across the street, and both of them be happy. Where as it was now, we'd sell the Black Sheep customer and we'd go across the street20 and he'd say, "No, I don't want any of that Black Sheep, because the guy across the street's got it. I want something different". So he would buy from a competitor. [Emphasis added.]648 After a careful examination of this and other factors appearing in the record, we conclude that 10 percent of the purchase price was properly attributable to goodwill and trade names. Cohan v. Commissioner, 39 F.2d 540 (2d Cir. 1930). Accordingly, we find that 10 percent of the attorney fees were ancillary to the acquisition of these intangibles and should be capitalized.On that basis, we hold that of the $ 4,500 incurred for legal fees, $ 4,050 is deductible in the year of sale and $ 450 must be capitalized.Issue 3. Loan ExpensesFINDINGS OF FACTIn the taxable year ended November 30, 1968, petitioner incurred costs totaling $ 5,168.51 in obtaining a $ 900,000 loan (hereafter referred to as first loan) from Prudential Insurance Co. of America (Prudential). This loan was evidenced by a promissory note dated January 5, 1968, bearing interest at a rate of 7 percent per annum with a due date of January 1, 1983. During 1968 petitioner entered into negotiations21 with Brunswick for the acquisition of certain assets related to the Red Head line of products. Under the terms of the agreement between Brunswick and petitioner, petitioner was obligated to secure a loan of additional funds.On October 1, 1968, petitioner entered into a second loan agreement with Prudential. Pursuant to this agreement petitioner borrowed from Prudential the sum of $ 1,700,000 (hereafter referred to as second loan) evidenced by a promissory note in that amount bearing interest at the rate of 7.8 percent with a due date of March 1, 1984. The October 1, 1968, loan agreement also provided that the $ 900,000 note would be paid out of the proceeds of the $ 1,700,000 loan. The agreement further provided that Prudential would deliver to petitioner a check for $ 1,700,000 less the $ 900,000 representing the promissory note which would be canceled and accrued interest thereon, to the date of closing. Accordingly, the $ 900,000 note was canceled by Prudential on December 10, 1968.OPINIONThe question presented by these facts is whether petitioner was entitled to deduct expenses of $ 5,168.51 incurred in obtaining 649 the first loan in the year that loan was canceled. 22 Respondent argues that these expenses must be amortized over the 15-year period of the first loan.It is well settled that expenses incurred in connection with securing a loan must be amortized and deducted over the life of the loan. Julia Stow Lovejoy, 18 B.T.A. 1179">18 B.T.A. 1179 (1930); Anover Realty Corp., 33 T.C. 671">33 T.C. 671 (1960). This Court has long recognized, however, that when the loan has been repaid prior to maturity, the unamortized expenses may be fully deducted in the year of repayment. S. & L. Building Corp., 19 B.T.A. 788 (1930), revd. on other grounds, 60 F.2d 719">60 F.2d 719 (2d Cir. 1932), revd. 288 U.S. 406">288 U.S. 406 (1933); Longview Hilton Hotel Co., 9 T.C. 180">9 T.C. 180 (1947); Anover Realty Corp., supra.Respondent accepts these principles but contends that there was no repayment of the $ 900,000 note but only an $ 800,000 increase in the same loan. If the second loan was in substance merely an increase of indebtedness pursuant to the first loan, then we agree that the expenses incurred in obtaining 23 the initial outlay must continue to be amortized. The critical factual inquiry, therefore, is whether the two loan transactions were sufficiently distinct to consider the cancellation of the first note a repayment.While we acknowledge that this is a close question, we find that the second loan was separate and independent from the first loan and that the first loan could properly be characterized as repaid. This was not simply a refinancing operation, but arose from petitioner's need for new funds to purchase assets from Brunswick Corp. This required a second loan whose terms were separately and newly bargained for. As a result of this new bargaining there was a change in both the interest rate (7 percent in the first loan, 7.8 percent in the second loan) 10 and the maturity date.24 If the first loan were paid out of funds borrowed from another lender, the deductibility of these unamortized expenditures 650 would be unquestionable. Where the first loan is paid out of the proceeds of a second independent loan from the same lender we believe the result should be no different. The taxpayer should not be penalized when, for business reasons, he places another loan with the same lender. Petitioner acknowledges that it must amortize the new expenses incurred in obtaining the second loan. 11We also note that the discharge of the first loan occurred in the ordinary course of business, as a consequence of the purchase from Brunswick. In fact, both loan agreements contain provisions for the discharge of certain outstanding debts of the borrower.It may well be that petitioner could have added new indebtedness25 to the first loan and modified the terms of that loan. But it is clear from the bargained-for results that a change in the maturity date and in the interest rate -- as well as the principal amount -- would have been required. It would then have been arguable that the amended first note was in substance a new note. This format was, of course, not followed, but it is useful in illustrating the substance of the transaction regardless of how it was packaged.Finally, respondent argues that the expenses at issue cannot be deducted because there has been no shifting of the burden for repayment of the loan. Respondent relies on cases in which, for example, the loan is secured by a mortgage which is taken over by a purchaser or otherwise assumed by a third party. See S. & L. Building Corp., supra;Longview Hilton Hotel Co., supra. Respondent's argument is misplaced, however, since a shifting of the burden of repayment is not required when the outstanding loan has been fully satisfied.We therefore hold that petitioner is entitled to deduct the $ 5,168.51 incurred in connection with the first loan, in petitioner's taxable year 26 ending November 30, 1969.Issue 4. Depreciation on AirplaneFINDINGS OF FACTOn January 23, 1964, petitioner purchased a used Cessna 310-D airplane for $ 41,931.14. In depreciating the airplane, which had a salvage value of $ 10,000, petitioner originally used the 200-percent (double) declining balance method of depreciation. 651 On November 30, 1967, the airplane had an estimated remaining life of 52 months and the depreciation reserve thereon was $ 25,607.38. Petitioner claimed deductions for depreciation on the airplane in the amount of $ 5,549.96 in each of the taxable years ended November 30, 1968, and November 1969, computed by the double declining balance method.Both parties now agree that the use of the double declining balance method was improper. Respondent recomputed the depreciation for the years in issue (fiscal years 1968 and 1969) using straight line depreciation. Petitioner seeks to use the 150-percent declining balance method for those years.OPINIONSection 167 allows as a depreciation deduction a reasonable amount for the exhaustion, wear, and tear of property used in a trade or business or held for the production of income. 12 This section further27 provides that the term "reasonable allowance" includes but is not limited to an allowance computed in accordance with prescribed regulations under any one of four enumerated methods. Among those methods are the declining balance method and the straight line method. 1328 Section 167(c), however, restricts the use of certain declining balance method, to property, the original use of which commenced with the 652 taxpayer. 14 Since petitioner here is depreciating used property, it is clear that the double declining balance method is not available to it.In disallowing depreciation deductions for the years in issue, respondent utilized the straight line method to recompute the allowable depreciation on petitioner's plane. While petitioner concedes that its use of the double declining balance method was improper, petitioner claims it is still entitled to depreciate the plane on the basis of the 150-percent declining balance method of depreciation, 15 which respondent's regulations make available in the case of used property. The issue, therefore, is whether petitioner may now elect the 150-percent declining balance method or whether it is restricted to the use of the straight line method in computing its depreciation.29 Respondent contends that petitioner's change in computing depreciation from double declining balance to 150-percent declining balance represents a change of accounting method under section 446(e) requiring the prior consent of the Commissioner. Since such consent has neither been sought nor given, respondent argues, petitioner cannot freely elect the 150-percent declining balance method. 1630 653 We disagree. This case is similar in many respects to Silver Queen Motel, 55 T.C. 1101">55 T.C. 1101 (1971), acq. 2 C.B. 3">1972-2 C.B. 3 (see also Rev. Rul. 72-491, 2 C.B. 104">1972-2 C.B. 104), which also involved the erroneous election of the 200-percent declining balance method for used property. In Silver Queen Motel, the respondent challenged this error beginning with the first year the property in question was subject to depreciation, and sought to limit the taxpayer to straight line depreciation. We nevertheless held that the taxpayer was entitled to use the 150-percent declining balance method, noting that:if respondent's contention were to prevail, a taxpayer attempting initially to elect the accelerated depreciation methods of section 167(b) would be put to an "all or nothing" decision the dampening effect of which upon the taxpayer's choice would significantly detract from the liberalizing influence which was obviously intended by the enactment of sections 167(b) and 167(c).We believe the reasoning of Silver Queen Motel is applicable to the instant case. As in Silver Queen, respondent31 does not here suggest that the 150-percent declining balance method would fail to produce a reasonable allowance over the remaining useful life or that the initial error was not made in good faith; indeed, there is every reason to believe (and respondent in no way suggests the contrary) that petitioner would be permitted to select the 150-percent declining balance method but for his prior error. There is only one difference between the two cases: in Silver Queen Motel the error could be corrected beginning with the first year the property was placed in service; in the case before us the statute of limitations apparently precludes correcting the error during the 654 first 3 years the property was utilized, and the error can only be corrected beginning with the fourth and subsequent years.We do not believe that this is a sufficient reason for failing to apply the principle of Silver Queen Motel. Undoubtedly, depreciation was taken in years not before the Court at a rate not warranted by the statute, and these years are apparently beyond the statute of limitations. But this is no reason to compensate for excessive acceleration in the early years by excessive deceleration32 in the remaining years. The issue we face is the proper rate of depreciation allowable for the years before the Court, and we cannot resolve that issue by assuming that there is some quantitative correlation between the error in the closed year and the departure from normal practice in the other direction that respondent seeks to impose on petitioner in the years before the Court.We note that our conclusion is completely consistent with the manner in which respondent prospectively adjusts the rate of depreciation resulting from changes in estimated useful life. 1733 Issue 5. Amortization of Leasehold ImprovementsFINDINGS OF FACTIn 1956 certain land in Mineola, Tex. was acquired equally by two trusts, one for the benefit of the children of Hugo W. Schoellkopf, Jr. (Schoellkopf trust), and one for the benefit of the children of Delbert W. Chandler (Chandler trust). 18 Hugo Schoellkopf, Jr., was the trustee for the Schoellkopf trust and Delbert Chandler was the trustee for the Chandler trust. The terms of the two trusts were nearly identical. Under the heading "Trustee's Powers and Duties" each instrument contained the following provision:655 (b) The trustee shall have full power to sell, convey, exchange, lease for a term of years ending prior to or after the termination of this trust, mortgage, pledge, partition, distribute or otherwise dispose of any or all of said trust estate and properties or any part thereof at such time and in such manner as the trustee shall deem advisable. The trustee is given specific authority to purchase real estate, improved or unimproved, and to execute leases with respect to any property so acquired. * * *34 Pursuant to the power to execute leases, the trustees, on November 30, 1956, leased their recently acquired land to the Mineola Industrial Foundation. 19 The term of the lease was for a period of 15 years beginning with the completion of a factory building to be erected by the foundation. The foundation, in turn, leased the land to petitioner for the same period. 20 The lease running to petitioner was also executed on November 30, 1956. Neither lease contains a renewal option.35 The building on the leased land was constructed during 1956 and 1957 at the foundation's expense, and was built to the specifications of petitioner. The foundation also made subsequent additions to the building. By the terms of the leases all improvements constructed on the leased premises became the property of the Schoellkopf and Chandler trusts. The buildings have a longer useful life than the initial lease term.In 1965, petitioner expended the sum of $ 82,154.45 for improvements on the leased premises. The principal items of improvement were the air conditioning of manufacturing space at a cost of $ 35,000 and a fire sprinkler system at a cost of $ 45,000. In petitioner's judgment, the installation of air conditioning was required to maintain petitioner's work force. Installation of the sprinkler system was required to retain insurance coverage.On its book and records, petitioner amortized all improvements over the remaining term of the lease, i.e., from the date of acquisition until April 1972, when the lease term was due to 656 expire. Accordingly, petitioner took the amounts resulting from such amortization as deductions on its income tax returns. Respondent36 has disallowed these amortization deductions, and has sought to have petitioner depreciate the improvements over their useful lives. The useful life of the air conditioning in the Mineola plant is 10 years and the useful life of the fire sprinkler system in that plant is 25 years.OPINIONThe issue presented for our decision is whether the cost of improvements made by petitioner should be amortized over the remaining lease term, as petitioner contends, or over the useful lives of the improvements as contended by the respondent.It is well established that where the tenancy of the lease is for an indefinite period of time, the lessee must depreciate the cost of improvements over their useful lives. James L. Stinnett, Jr., 54 T.C. 221 (1970); Kerr-Cochran, Inc., 30 T.C. 69 (1958); Standard Tube Co., 6 T.C. 950">6 T.C. 950 (1946). Conversely, where the lease term is for a definite period, improvements are generally amortizable over the useful life of the improvement or the remaining period of the lease, whichever is shorter. Sec. 1.162-11(b), Income Tax Regs. Whether the lease term is of definite or 37 indefinite duration is a question of fact to be gleaned not only from the lease itself but also from the surrounding facts and circumstances. James L. Stinnett, supra;G. W. Van Keppel Co. v. Commissioner, 295 F.2d 767">295 F.2d 767 (8th Cir. 1961). We have concluded on the basis of the facts before us that petitioner's lease of the Mineola property was of indefinite duration and therefore petitioner's improvements thereon should be depreciated over their useful lives.The lease between the two trusts and the Mineola Industrial Foundation provided that any improvement placed on the property at the expense of the lessee would become the property of the trusts at the termination of the lease. Thus, as trustees of the trusts, Hugo Schoellkopf, Jr., and Delbert Chandler (also sole shareholders of petitioner) effectively controlled any action that might be taken by the foundation. Given the fact that the terms of the two leases were concurrent, if the foundation chose not to renew its lease with petitioner, the trustees could likewise decline to renew its lease with the foundation. Under such circumstances, the trusts could lease directly 38 to petitioner giving petitioner uninterrupted 657 enjoyment of the leased premises. In short, petitioner could continue to occupy the leased property for as long as its two shareholders considered it advantageous to do so. This kind of flexibility is characteristic of an indefinite lease. Highland Hills Swimming Club, Inc. v. Wiseman, 272 F.2d 176">272 F.2d 176 (10th Cir. 1959).We are aware that the period provided for in the lease was of a fixed term, but we must also account for the economic realities surrounding the leasing transaction. It is a fundamental principle of tax law that form must give way to substance. Commissioner v. Court Holding Co., 324 U.S. 331">324 U.S. 331 (1945). In the application of this principle it is clear that lease terms may be disregarded. Highland Hills Swimming Club, Inc., supra, and the cases cited therein.Other factors appearing in the record also suggest petitioner will continue to occupy the subject property beyond the stated lease term. We note that the initial building was constructed to the specifications of petitioner and that this building had a longer life than39 the original 15-year term. Another indication of intent to remain on the leased premises was the installation of expensive equipment, viz., the air conditioning and sprinkler system, which had substantially longer useful lives than the short period remaining in the lease.Finally, we observe that the rule allowing a lessee to amortize improvements over a lease term shorter than the estimated life of the improvements contemplates an arm's-length situation in which the lessee will only have the use of those improvements during the shorter period. In such a situation, a rule which accounts for the more limited period of actual use by the lessee is appropriate. The facts here persuade us that these improvements will be utilized well beyond the expiration of the current lease term.Petitioner contends we have a renewal situation here which should be governed by section 178. While section 178 is analogous and the factors entering into our decision are similar to those applied under section 178 in a renewal determination, we do not believe section 178 to be directly applicable. Since the facts here indicate that the lease term is of indefinite duration, it is unnecessary to consider40 the question of a renewal after the expiration of a fixed lease term. G. W. Van Keppel Co. v. 658 , 295 F.2d at 770. In any event, had we decided the issue under section 178 the result would be the same.We hold that petitioner must depreciate the cost of the improvements over their useful lives.Issue 6. Little Sandy Hunting and Fishing Club DuesFINDINGS OF FACTIn the taxable years ending November 30, 1968, and November 30, 1969, petitioner expended the amounts of $ 420 and $ 540, respectively for dues paid to Little Sandy Hunting and Fishing Club (Little Sandy) in Hawkins, Tex. The dues were paid by petitioner to maintain the individual membership of Hugo W. Schoellkopf, Jr.Little Sandy is a private recreational facility consisting of a modest clubhouse and four lakes, and is used primarily for hunting and fishing. The club has rules which strictly limit the use of the facility by guests. Petitioner, therefore, did not use Little Sandy to entertain customers or suppliers.Petitioner's president testified that membership in the club was maintained in order to have continued access to Little Sandy's facilities for the testing41 of its products. In addition, he stated that the comments and criticisms of Little Sandy's members on hunting and fishing equipment were helpful to petitioner's business.OPINIONThe issue raised by these facts is whether the dues paid to maintain Buddy's membership in Little Sandy are deductible by petitioner as an ordinary and necessary business expense under section 162. Since the parties have largely directed their attention toward the disallowance provisions of section 274, we will first determine the applicability of that section.Under section 274 a deduction will be disallowed for expenses incurred with respect to an entertainment, amusement, or recreational facility unless the facility was used primarily in furtherance of the taxpayer's trade or business and the expenditure was directly related to the active conduct of such trade or business. 21 Facilities used in connection with entertainment 659 include yachts, country clubs, swimming pools, tennis courts, hunting lodges, and fishing camps. Sec. 1.274-2(e)(2)(i), Income Tax Regs. Dues paid to any social, athletic, or sporting clubs are considered expenditures with respect to an entertainment facility.42 Petitioner argues that the dues paid to Little Sandy are not paid with respect to an entertainment facility since no guests of petitioner were entertained there. The regulations make it clear, however, that an expenditure may be for entertainment within the meaning of section 274, even though the expenditure relates solely to the taxpayer. The regulations specifically reject the notion that entertainment means only the entertainment of others. Sec. 1.274-2(b)(1)(ii), Income Tax Regs. We therefore conclude that Little Sandy constituted an entertainment facility.Petitioner next contends that even if Little Sandy were generally considered to be an entertainment facility, it could not be regarded as such a facility with respect to petitioner since Buddy's activities there were business and not recreational in nature. The regulations establish an objective test in determining whether an activity will constitute entertainment for a particular taxpayer. In making this determination the taxpayer's trade or business shall be taken into account.Thus, although attending a theatrical performance would generally be considered entertainment, it would not be so considered in the case of43 a professional 660 theater critic, attending in his professional capacity. Similarly, if a manufacturer of dresses conducts a fashion show to introduce his products to a group of store buyers, the show would not be generally considered to constitute entertainment. However, if an appliance distributor conducts a fashion show for the wives of his retailers, the fashion show would be generally considered to constitute entertainment. [Sec. 1.274-2(b)(1)(ii), Income Tax Regs.]Based on the facts before us, we must conclude that the hunting and fishing facilities provided by Little Sandy did constitute entertainment to Buddy. As president of petitioner Buddy was not a professional hunter or fisherman, but a seller and manufacturer of sporting equipment. As such, Buddy's participation in Little Sandy's activities more closely resembled recreation than it did performance of professional duties. The record, moreover, makes it clear that these outdoor activities were an important part of Buddy's recreational life.Despite our finding that Little Sandy was a recreational facility within the meaning of section 274, petitioner need not suffer disallowance of its dues expense if it44 can establish that the facility was used primarily in furtherance of petitioner's trade or business or that the expense was related to the active conduct of such trade or business. Sec. 274(a)(1)(B). In this vein petitioner argues that the primary function of Little Sandy was as a testing ground for petitioner's products. We have not been so persuaded.Other than the relatively vague testimony of Buddy on this matter, petitioner has failed to present any evidence which would establish petitioner's use of Little Sandy as a testing site. No documents, records, or similar material have been produced by petitioner. In the absence of any such evidence, we cannot find that petitioner has carried his burden of proving the business nature of the facility. 2245 Finally, we do not believe that the incidental business benefit petitioner may have derived from the comments of club members on its products was sufficient to satisfy the business-use requirement of section 274 and the regulations thereunder.While the substantiation requirements of section 274(d) are applicable to the present issue, we need not consider the more rigorous standards of section 274(d) since the sum of petitioner's 661 evidence falls short of establishing that the primary use of Little Sandy was for business purposes. Ford S. Worthy, Jr., 62 T.C. 303">62 T.C. 303 (1974). Moreover, since petitioner's deduction for Little Sandy dues must be disallowed under the terms of section 274(a)(1)(B), we do not reach the question of whether the dues paid by petitioner are ordinary and necessary business expenses under section 162.Issue 7. Alaskan Arctic HuntFINDINGS OF FACTIn September 1969, Buddy and his son, Hugo, flew to Alaska in order to make an Arctic hunt. Their guide on this venture was Herman (Bud) Helmericks, a prominent Alaskan pioneer and guide. Bud and Buddy had known each other for almost 15 years and the Schoellkopf and Helmericks46 families were good friends. In fact, Hugo was the best man at the wedding of Bud's son, Jim.The arrangements for the Alaskan hunting trip were handled principally through a series of letters between the Schoellkopf and Helmericks families. The letters were written at relatively frequent intervals and exhibited a strong personal tone. Great enthusiasm was expressed for the forthcoming hunt. 2347 A guide-client contract was signed by both parties to formalize the venture. The contract stated that the hunt would be for sheep, moose, caribou, bear, birds, and fish. Trophies were to be prepared and packed by the Helmericks. The price for the hunt as set in the agreement was $ 6,000. 24 The 3-week hunt into the remote regions of the Arctic was expensive largely because two planes were necessary to transport the hunters wherever they traveled. The total cost of the trip was $ 9,969 and this amount 662 was claimed by petitioner as a deduction and disallowed in full by the respondent.Buddy's stated objective in making the Alaskan hunting trip was his desire to test, under field conditions, cold weather hunting equipment. Petitioner attributes 48 its success within the industry in large part to the participation by executive level personnel in the hunting and fishing activities for which petitioner's products are manufactured. Buddy testified that the Alaskan trip had taught him a number of things that would be useful to petitioner. 25 However, no detailed notes of facts and figures pertaining to the equipment were maintained with regard to the quality or quantity of performance of any specific equipment carried or utilized. Moreover, no diary or detailed memoranda of activity was kept on the trip.49 Subsequent to the Alaskan trip, petitioner produced certain extremely cold weather items that had not been part of petitioner's product line prior to the trip. Examples of these items are down sleeping bags, certain types of down clothing, and down backpacks. The first of these new products was sold in late 1971. By fiscal 1973, the sale of these items totaled almost $ 2 million out of a total sales figure of $ 17 million.OPINIONThe final issue presented for decision is whether petitioner's expenditures incurred in connection with the Arctic hunt are deductible under sections 162 and 274. Whether an expenditure is deductible as an ordinary and necessary business expense is chiefly a question of fact. Commissioner v. Heininger, 320 U.S. 467">320 U.S. 467 (1943). The taxpayer has the burden of demonstrating that the purpose of the expenditure was primarily business rather than social or personal. Vaughn V. Chapman, 48 T.C. 358">48 T.C. 358 (1967); James Schulz, 16 T.C. 401">16 T.C. 401 (1951).663 As previously noted, an expenditure otherwise allowable as an ordinary and necessary business expense under section 162, 50 may nevertheless be disallowed under section 274. Section 274(a) provides in relevant part that no deduction shall be allowed for an entertainment activity "unless the taxpayer establishes that the item was directly related to * * the active conduct of the taxpayer's trade or business." In detailing the elements of this requirement, the regulations provide that the principal character or aspect of combined business and entertainment activities must be the active conduct of the taxpayer's trade or business. Sec. 1.274-2(c)(3), Income Tax Regs. The regulations further provide as follows:The active conduct of trade or business is considered not to be the principal character or aspect of combined business and entertainment activity on hunting or fishing trips or on yachts and other pleasure boats unless the taxpayer clearly establishes to the contrary. [Sec. 1.274-2(c)(3)(iii), Income Tax Regs. Emphasis added.]Respondent has taken the position that the Arctic hunt expenses were personal expenses under section 262 and therefore not deductible as ordinary and necessary business expenses, and further, that the petitioner has failed to meet the requirements of section 274. 51 According to petitioner, the purpose of the trip was to test and research cold weather equipment. Yet, in the considerable correspondence arranging the trip there is virtually no mention of this objective. Furthermore, we have no records, notes, or other evidence that would show that any attention was given to testing and research during the hunt itself. In fact, all we have is the uncorroborated testimony of Buddy to the effect that the hunt was for business purposes. In the absence of anything more, we cannot say that petitioner has carried its burden of proof.It is true that a few years after the hunt, petitioner began to market cold weather clothing. This factor, while weighing heavily in favor of petitioner, is not decisive. First, petitioner has not adduced any real evidence which establishes a link between the purposes of the Arctic hunt and the subsequent production of the cold weather line. We cannot base a deduction merely on the juxtaposition of these two events. Second, our focus is on the Arctic hunt itself. If the hunt was primarily personal, then no incidental business benefit can turn the hunt-related expenditures 664 into items directly related to 52 the active conduct of a trade or business.In sum, while the hunt may have been prompted by mixed business and personal motives, and might have produced some business benefit, we are nevertheless convinced on the evidence that the primary purpose of the trip was personal. Since petitioner's case falls short of the statutory requirements for deductibility under either section 162 or 274, we must sustain respondent's disallowance.Decision will be entered under Rule 155. Footnotes1. All references are to the Internal Revenue Code of 1954 unless otherwise indicated.↩2. SEC. 274. DISALLOWANCE OF CERTAIN ENTERTAINMENT, ETC., EXPENSES.(d) Substantiation Required. -- No deduction shall be allowed -- (1) under section 162 or 212 for any traveling expense (including meals and lodging while away from home),(2) for any item with respect to an activity which is of a type generally considered to constitute entertainment, amusement, or recreation, or with respect to a facility used in connection with such an activity, or(3) for any expense for gifts,↩unless the taxpayer substantiates by adequate records or by sufficient evidence corroborating his own statement (A) the amount of such expense or other item, (B) the time and place of the travel, entertainment, amusement, recreation, or use of the facility, or the date and description of the gift, (C) the business purpose of the expense or other item, and (D) the business relationship to the taxpayer of persons entertained, using the facility, or receiving the gift. * 3. Sec. 1.274-5, Income Tax Regs. The validity of the substantiation regulations was upheld by this Court in William F. Sanford, 50 T.C. 823">50 T.C. 823 (1968), affd. per curiam 412 F.2d 201">412 F.2d 201 (2d Cir. 1969), cert. denied 396 U.S. 841">396 U.S. 841↩ (1969).4. Sec. 1.274-5(c)(2)(i), Income Tax Regs.↩5. Sec. 1.274-5. Substantiation requirements.(b) Elements of an expenditure -- * (2) Travel. The elements to be proved with respect to an expenditure for travel are --(i) Amount. Amount of each separate expenditure for traveling away from home, such as cost of transportation or lodging, except that the daily cost of the traveler's own breakfast, lunch, and dinner and of expenditures incidental to such travel may be aggregated, if set forth in reasonable categories, such as for meals, for gasoline and oil, and for taxi fares;(ii) Time. Dates of departure and return for each trip away from home, and number of days away from home spent on business;(iii) Place. Destinations or locality of travel, described by name of city or town or other similar designation; and(iv) Business purpose↩. Business reason for travel or nature of the business benefit derived or expected to be derived as a result of travel.6. Sec. 1.274-5(c)(3), Income Tax Regs.↩7. See also Hughes v. Commissioner, 451 F.2d 975">451 F.2d 975, 979↩ (2d Cir. 1971), affg. a Memorandum Opinion of this Court: "the corroborative evidence must nevertheless establish each statutory element -- amount, time, place and purpose -- of the expenditure with precision and particularity."8. The committee reports made this intention quite clear:"This provision is intended to overrule, with respect to such expenses the so-called Cohan rule. In the case of Cohan v. Commissioner, 39 F. 2d 540 (C.A.2d, 1930), it was held that where the evidence indicated that a taxpayer had incurred deductible expenses but their exact amount could not be determined, the court must make 'as close an approximation as it can' rather than disallow the deduction entirely. Under your committee's bill, the entertainment, etc., expenses in such a case would be disallowed entirely."H. Rept. No. 1447, 87th Cong., 2d Sess. 23 (1962), 3 C.B. 405">1962-3 C.B. 405, 427. The same language is contained in S. Rept. No. 1881, 87th Cong., 2d Sess. 35 (1962), 3 C.B. 707">1962-3 C.B. 707↩, 741.9. Respondent has apparently not attempted to capitalize any of the purchase price itself.↩10. Respondent argues that the interest rate of the second loan really amounts to an average of 7 percent on the first $ 900,000 and 8.75 percent on the additional $ 800,000. This bootstrap operation by respondent is pure conjecture. Respondent has apparently simply performed the calculations based on the assumption of a consolidated loan and an average interest rate; having two knowns (the 7-percent and the 7.8-percent rate) he has calculated the unknown quantity associated with his assumption and arrived at an 8.75-percent interest rate. The subtle aura of certitude associated with quantitative conclusions cannot hide the respondent's failure to introduce one shred of evidence that interest rates in fact increased by 1.75 percentage points in such a time.↩11. Petitioner incurred costs of $ 750 in the taxable year ended Nov. 30, 1968, and $ 1,500 in the taxable year ended Nov. 30, 1969, in connection with obtaining the $ 1,700,000 loan.↩12. SEC. 167. DEPRECIATION.(a) General Rule. -- There shall be allowed as a depreciation deduction a reasonable allowance for the exhaustion, wear and tear (including a reasonable allowance for obsolescence) -- (1) of property used in the trade or business, or(2) of property held for the production of income.↩13. SEC. 167. DEPRECIATION.(b) Use of Certain Methods and Rates. -- For taxable years ending after December 31, 1953, the term "reasonable allowance" as used in subsection (a) shall include (but shall not be limited to) an allowance computed in accordance with regulations prescribed by the Secretary or his delegate, under any of the following methods: (1) the straight line method,(2) the declining balance method, using a rate not exceeding twice the rate which would have been used had the annual allowance been computed under the method described in paragraph (1),(3) the sum of the years-digits method, and(4) any other consistent method productive of an annual allowance which, when added to all allowances for the period commencing with the taxpayer's use of the property and including the taxable year, does not, during the first two-thirds of the useful life of the property, exceed the total of such allowances which would have been used had such allowances been computed under the method described in paragraph (2).↩Nothing in this subsection shall be construed to limit or reduce an allowance otherwise allowable under subsection (a).14. SEC. 167. DEPRECIATION.(c) Limitations on Use of Certain Methods and Rates. -- Paragraphs (2), (3), and (4) of subsection (b) shall apply only in the case of property (other than intangible property) described in subsection (a) with a useful life of 3 years or more -- * (2) acquired after December 31, 1953, if the original use of such property commences with the taxpayer and commences after such date.↩15. The statutory basis for the use of the 150-percent declining balance method is the authorization given in sec. 167(a) for a "reasonable allowance" for depreciation. This method is independent of those specifically authorized in sec. 167(b). The characterization of the 150-percent declining balance method as one likely to produce a reasonable allowance under sec. 167(a) is supported by the regulations:Sec. 1.167(b)-0. Methods of computing depreciation.(a) In general. * (b) Certain methods. Methods previously found adequate to produce a reasonable allowance under the Internal Revenue Code of 1939 or prior revenue laws will, if used consistently by the taxpayer, continue to be acceptable under section 167(a). Examples of such methods which continue to be acceptable are the straight line method, the declining balance method with the rate limited to 150 percent of the applicable straight line rate * See Robert M. Foley, 56 T.C. 765">56 T.C. 765 (1971).The use of the 150-percent declining balance method may not always produce a reasonable allowance under section 167(a). Computing & Software, Inc., 64 T.C. 223↩ (1975). Respondent has not raised the issue of whether the 150 percent declining balance method yields a reasonable allowance here.16. Sec. 446(e) states that "a taxpayer who changes the method of accounting on the basis of which he regularly computes his income in keeping his books shall, before computing his taxable income under the new method, secure the consent of the Secretary or his delegate."The regulations under sec. 167 state that "Any change in a method of computing the depreciation allowances with respect to a particular account * * is a change in method of accounting" (emphasis added) requiring prior consent under sec. 446. See sec. 1.167(e)-1(a), Income Tax Regs.Sec. 167(b)(2) states that depreciation may be computed under "the declining balance method, using a rate not exceeding twice the [straight line] rate." (Emphasis added.) Regardless of the rate taken, "the declining balance method" appears to be one method distinct from other methods, such as the straight line method, or the sum of the digits method. Yet the regulations treat a change from a 200-percent to a 150-percent rate under the same declining balance method as a change in the method of computing depreciation and therefore a change of accounting method requiring prior consent under sec. 446(e), while nevertheless permitting a taxpayer to change from the 200-percent declining balance method to the straight line method without prior consent. Compare secs. 1.167(e)-1(b) and 1.167(e)-1(a), Income Tax Regs.↩ Compare also S. Rept. No. 1622, 83d Cong., 2d Sess. 200 and 201 with 300 (1954). We need not deal with these apparent inconsistencies in the regulations, since for the reasons noted we believe petitioner is entitled to use the 150-percent declining balance method even assuming it involves a change in accounting method.17. Sec. 1.167(b)-2(c), Income Tax Regs., provides:(c) Change in estimated useful life↩. In the declining balance method when a change is justified in the useful life estimated for an account, subsequent computations shall be made as though the revised useful life had been originally estimated. For example, assume that an account has an estimated useful life of ten years and that a declining balance rate of 20 percent is applicable. If, at the end of the sixth year, it is determined that the remaining useful life of the account is six years, computations shall be made as though the estimated useful life was originally determined as twelve years. Accordingly, the applicable depreciation rate will be 16 2/3 percent. This rate is thereafter applied to the unrecovered cost or other basis.18. The Schoellkopf trust was established on Nov. 22, 1956. The Chandler trust was also set up in 1956, but the exact day and month are not in evidence. The record suggests, however, that the two trusts were established on the same day.↩19. Although the record contains no evidence as to the nature of the Mineola Industrial Foundation and its leadership, the parties have stipulated that neither petitioner nor any of its officers or directors have ever owned any interest in or been an officer, director, or employee of this organization.↩20. The lease between the trusts and the foundation calls for a total rental of $ 3,000 payable at the rate of $ 200 per year at the end of each 12-month period. For the same term, the lease between the foundation and petitioner, called for a total payment of $ 99,000 payable at the rate of $ 550 per month↩ in advance. The foundation was to erect a factory building on the leased premises at its own cost. During 1968 and 1969, petitioner's fixed net rental under the lease was $ 2,705 per month.21. SEC. 274. DISALLOWANCE OF CERTAIN ENTERTAINMENT, ETC., EXPENSES.(a) Entertainment, Amusement, or Recreation. -- (1) In general. -- No deduction otherwise allowable under this chapter shall be allowed for any item -- (A) Activity. -- With respect to an activity which is of a type generally considered to constitute entertainment, amusement, or recreation, unless the taxpayer establishes that the item was directly related to, or, in the case of an item directly preceding or following a substantial and bona fide business discussion (including business meetings at a convention or otherwise), that such item was associated with, the active conduct of the taxpayer's trade or business, or(B) Facility. -- With respect to a facility used in connection with an activity referred to in subparagraph (A), unless the taxpayer establishes that the facility was used primarily for the furtherance of the taxpayer's trade or business and that the item was directly related to the active conduct of such trade or business, and such deduction shall in no event exceed the portion of such item directly related to, or, in the case of an item described in subparagraph (A) directly preceding or following a substantial and bona fide business discussion (including business meetings at a convention or otherwise), the portion of such item associated with, the active conduct of the taxpayer's trade or business.(2) Special rules. -- For purposes of applying paragraph (1) -- (A) Dues or fees to any social, athletic, or sporting club or organization shall be treated as items with respect to facilities.(B) An activity described in section 212↩ shall be treated as a trade or business.22. The taxpayer can satisfy the statutory requirements of sec. 274(a)(1)(B) by establishing that more than 50 percent of the actual use of the facility took place during days of business use. Sec. 1.274-2(e)(4), Income Tax Regs. Since there are no existing records to show the actual use of the facility, it must be presumed that the use of the facility was primarily personal. Sec. 1.274-5(c)(6), Income Tax Regs.↩23. In addition to the hunting trip, two other reasons were expressed in the letters for Buddy's desire to go to Alaska at that time. The first of these was the expression by the Schoellkopfs that they were investigating the possibility of purchasing property at Walter Lake in the Arctic to use as a family resort or vacation area. The property contemplated for purchase was an outpost haven accessible only by air. The record indicates that the purchase was largely Bud's idea, prompted by his desire to have a neighbor in that isolated region. We have concluded that the purchase was never seriously considered and Buddy did not go to Walker Lake during the trip in order to look over the property.Secondly, the letters frequently discussed a personal investment in a potential Alaskan oil field. Although Buddy and Hugo invested a total of $ 7,500 in this venture, there is no evidence to suggest that Buddy or his son spent any of their time in Alaska investigating the oil deal.↩24. Although Bud felt somewhat uneasy about taking the money, it was one of the few ways in which he earned a living. Besides hiring himself out as a guide and consultant, Bud supplemented his income by lecturing in the "lower 48" during the dark Arctic winter.↩25. Among the specific teachings of the trip, according to Buddy's testimony, were the following:(1) Pockets should be especially large on an extreme cold weather coat because they must be large enough to accommodate a mitten with a gauntlet.(2) To keep the hunter's hands warm, he should wear a knitted wristlet to protect a certain artery leading to the hand.(3) In extremely cold weather, the down sleeping bags should be equipped with special head gear to protect the head.(4) Metal snaps should not be put on extremely cold weather clothing because metal can carry such a low temperature that the metal may stick to the hunter's flesh if the snaps come in contact with the skin.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625443/	MARY D. MOORE HOLIFIELD, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Holifield v. CommissionerDocket No. 10089.United States Board of Tax Appeals7 B.T.A. 1302; 1927 BTA LEXIS 2971; September 7, 1927, Promulgated 2971 A minor has the right to deduct from her gross income amounts used by her guardian to reimburse a third person who had paid claims of a former guardian, and an administratrix who, under the law of Texas, had the management of her estate. Gillis A. Johnson, Esq., and Warren Scarborough, Esq., for the petitioner. George G. Witter, Esq., for the respondent. MILLIKEN 1303 This proceeding involves a deficiency in income tax for the year 1920 in the amount of $1,989.52. This deficiency arises from the refusal of respondent to permit the deduction from the gross income of petitioner for the year 1920, of certain amounts paid to an administrix of the estate of the mother of petitioner and to her former guardian. FINDINGS OF FACT. Willie Mae Jackson died intestate April 26, 1916, leaving surviving her, as her only heirs, two daughters by a former marriage, Ella Louise Moore and Mary Davis Moore, then minors. On July 2, 1916, Mrs. S. M. Drew was appointed administratrix of the decedent's estate. On July 22, 1919, by an order of the county court having jurisdiction of the matter, the time for closing the administration was extended to July 2, 1920, and2972 it was ordered that Mrs. Drew continue as administratrix until that date. In July, 1916, Vincent Jarvis was appointed guardian of the persons of the two infants and he then applied for the guardianship of their estates. This right was granted and thereafter contested. This contest was appealed to the district court which confirmed the appointment but did not make proper entry of its order. In this state of affairs, Jarvis, as guardian of the estate of the infants, made application to the county court to withdraw the estate from administration. This proceeding was appealed, first to the district court, then to the Court of Civil Appeals of Texas, and finally reached the Supreme Court of Texas on questions certified to the latter court. See ; . The final result was that the Supreme Court, on November 19, 1919, held that on the record as it then stood, Jarvis should not prevail, but pointed out the steps he could take in the lower court which would give him the right to prosecute his action. Ella Louise Moore, in October, 1919, married W. B. West, Jr. Soon after his marriage, West began to investigate2973 his wife's affairs and became convinced that not only were large amounts being paid out in litigation which had for its purpose only the question of which person was to manage the estate, but that the estate was being mismanaged by the administratrix. He at once requested the resignation of both the administratrix and the guardian. The administratrix refused, pointing out that her appointment ran until the next July, and that she had incurred certain extraordinary expenses, including fees due to her attorneys, which should be settled. Jarvis demanded and threatened suit to recover amounts including fees due to his attorneys which he claimed were owing him as guardian. His claim as a whole was not conceded. These matters were both compromised 1304 and West and his wife agreed to pay the administratrix and her attorneys $14,623.33 in settlement of their claims and in consideration of her immediate resignation. This settlement was made in December, 1919. West and his wife paid the full amount to the administratrix and to her attorneys. Of this amount they borrowed $12,500, from banks on their joint note. This note was paid in March, 1920. The guardian agreed to accept2974 in full settlement of his claims, including amounts due his attorneys, the sum of $5,457.13, and to resign as guardian of petitioner. Jarvis then resigned. In the latter part of 1919, Ella Moore West qualified as temporary guardian of the estate and person of petitioner. On December 23, 1919, the county court entered an order directing the administratrix to turn over all the property of the estate of every kind to Ella Moore West, for herself and as guardian of petitioner. During 1920, Ella Moore West and her husband were paid out of the income of the estate, the moneys they advanced to the administratrix, and during the same year Ella Moore West individually and as guardian paid, out of her share of the estate and out of petitioner's share thereof, to Jarvis, $5,457.13. These disbursements were reported to the county court by Ella Moore West, who in the meantime had been appointed permanent guardian, in her first annual account. This account was duly approved by order of said court. The estate of Willie Mae Jackson consisted of real estate in Fort Worth, Tex. This real estate was rental property. The receipts and disbursements of the estate, from July 1, 1916, to and2975 including the calendar year 1921, were: PeriodReceiptsDisbursementsJuly 1 to December 31, 1916$36,821.88$24,660.81Exceptional items which were not income or expense, included in totals10,000.001,000.0026,821.8823,660.81Calendar year 191759,000.1373,607.60Exceptional items included in totals, which were not income or expense2,036.7012,000.0056,963.4361,607.60Calendar year 191867,075.2364,599.21Exceptional items included in totals, which were not income or expense6,187.6712,111.4060,887.5652,487.81Calendar year 1919162,932.70139.283.78Exceptional items included in totals, which were not income or expense93,306.3528,900.0069,626.35110,383.781305 During the administration of W. B. West, Jr., and wife, receipts and disbursements were as follows: PeriodReceiptsDisbursementsCalendar year 1920$140,203.43$120,348.78Exceptional items included in totals, which were not income or expense40,466.1783,311.8499,737.2637,036.94Calendar year 192197,946.0358,410.23Exceptional items included in totals, which were not income or expenseNone.3,542.9197,946.0354,867.322976 Petitioner married Holifield in August, 1921. OPINION. MILLIKEN: The payments to the administratrix and to the former guardian appear to have been eminently justifiable from a business standpoint. They relieved the estate of unnecessary litigation which involved only the question of conflict of management, and brought it under the control of petitioner's guardian, who was her sister, and of the sister in her individual capacity. The wisdom of these expenditures is further shown by the increase in the net income of the estate after the change in management. If there remains any further doubt, it is removed by the action of the county court in approving the action of the new guardian in deducting one-half of the expenditures from the income of petitioner. The estate consisted of realty. While the administratrix had during administration the control of the realty and the right to lease it (arts. 3312, 3314, 3545, Vernon's Ann. Tex. Civ. Stats., vol. 9), the title thereto vested in petitioner and her sister from the date of their mother's death. See 2977 . While the guardian would have had the same rights as to the realty as the administratrix (Arts. 4164-4166, 4176, Vernon's Ann. Tex. Civ. Stats., vol. 13) if he had prevailed in his action against the administratrix, the title to the estate would have vested in the petitioner and her sister and the income therefrom was their individual income. With both the legal and beneficial title of her share in petitioner, it follows that the gross income therefrom was her individual income and further, that she is entitled to the same deductions as any individual taxpayer. Like any other person engaged in the business of renting property, she is entitled to deduct a loss incurred in getting rid of an incompetent manager. The payments to the 1306 administratrix and to the former guardian were essentially ordinary business expenditures. The remaining question is, in what year these expenditures are deductible. The settlement between the administratrix and West and wife was made in December, 1919, and it is probable that the payment was made at that time. The money paid was that of West and wife2978 and not that of petitioner. She was not a party to the agreement. She was then a minor. She was not brought into the matter until one-half of the payment was deducted from her share of the income. This occurred in 1920, the year in question. The situation would not have been different from a legal standpoint if the administratrix had continued in charge and had withdrawn in 1920 the same amount to pay her commissions and attorneys' fees. By virtue of the order of the county court, the administration of the estate would have ceased on July 2, 1920, so that the deduction was made from the income of petitioner in the same year in which the administration would have ceased by virtue of the order of the county court. We hold that $7,311.66, which is one-half of the amount paid the administratrix, is deductible from petitioner's gross income for 1920. It does not appear that the amount paid Jarvis was in compromise of his future rights, but was in settlement of what he claimed were then existing liabilities. The marriage of Ella in 1919, terminated the guardianship as to her (art. 4128, Vernon's Ann. Tex. Civ. Stats., vol. 13). For this reason, the payment to Jarvis can not be*2979 attributed as to this portion of the estate, as in compromise of any of his future rights. From all that appears in the record, it would seem that petitioner had, in 1920, the right to choose her guardian (art. 4126, Vernon's Ann. Tex. Civ. Stats., vol. 13). But, however this may be, there is nothing in the record which indicates that the amount paid Jarvis had anything to do with his resignation, except that he would not resign until he had been paid or his rights had been acknowledged. If he had been successful in his action against the administratrix to secure possession of the estate and had deducted from the income the amount of his claim, there is no doubt petitioner would be entitled to take such payment as a deduction in the year in which it was deducted from her income. The fact that this amount was deducted from her income by her second guardian, does not alter the case. She should be permitted to deduct $2,728.56, which is one-half of the $5,457.13 paid to her former guardian. Reviewed by the Board. Judgment will be entered on 15 days' notice, under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625444/	ALVIS and ALEITA KACZMAREK, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent.Kaczmarek v. CommissionerDocket No. 5850-73.United States Tax CourtT.C. Memo 1975-358; 1975 Tax Ct. Memo LEXIS 18; 34 T.C.M. (CCH) 1551; T.C.M. (RIA) 750358; December 18, 1975, Filed L. Cuttone, for the petitioner. T. G. Schleier, for the respondent. HALL MEMORANDUM FINDINGS OF FACT AND OPINION HALL, Judge: Respondent determined deficiencies in petitioners' Federal income tax as follows: YearAmount1965$5,458.0019664,414.131968319.0019692,121.31 1/Other issues having been disposed of by mutual agreement, the two issues remaining for decision are: (1) whether funds advanced by petitioner to his closely held corporation qualify as business bad debts in 1968 under section 166, 2 and (2) whether petitioner is entitled to deduct as a business loss under section 165 the loss on the sale of his Itasca residence in 1968. 20 FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. Petitioners, Alvis and Aleita Kaczmarek, filed joint income tax returns for the years 1965, 1966, 1968 and 1969. Petitioners resided in Lisle, Illinois at the time they filed their petition. Aleita Kaczmarek is a party only by virtue of having filed a joint income tax return with her husband. Alvis Kaczmarek will be referred to herein as petitioner. 1. Loans to National.Petitioner played soccer in Europe in his youth, and his interest in soccer continued after he moved to the United States in 1949. Subsequently, he played, coached, managed and was president of local Chicago amateur soccer teams. At various times he also promoted the tours of visiting international soccer teams. Prior to 1967 petitioner worked as a salesman and estimator of structural and ornamental steel, and eventually owned and operated his own small specialty steel company which he sold in 1966. In 1966 petitioner became interested in organizing a professional soccer league in the United States. In August of 1966 petitioner and a Mr. William Cutler organized an Illinois corporation named the Chicago National Professional21 Soccer League Club, Inc. ("National"). Its principal business activity was the operation of a professional soccer team called the Chicago Spurs. Initial plans called for Mr. Cutler to buy 400 shares in National, a Mr. Michael Butler 400 shares, another individual 100 shares, and petitioner 100 shares. Butler and the third individual, however, decided to withdraw. Cutler bought his allotted number of shares for which he paid $80,000, and petitioner increased his subscription to 200 shares, for which he paid $40,000. Petitioner also paid, in proportion to his stock ownership, a certain amount of the league franchise fee, the requisite performance bond, and other expenses of formation. In the following year, the corporation drafted and distributed at least one prospectus encouraging additional individuals to become shareholders. However, no more stock was sold. Petitioner did not buy additional shares, due to a shortage of funds. From August 1966 until December 1967 petitioner worked to create a functioning soccer team. He rented an office, hired office personnel, hired players, rented a stadium, trained the team, and performed various other duties in his role as general manager, 22 coach, and president of National. The Chicago Spurs won the league championship in 1967. Petitioner had an oral employment agreement with National, the substance of which is unclear. From August to December, 1966, National paid petitioner $6,250. For the taxable year 1967, the corporation paid petitioner $13,750. Petitioner had received compensation of $24,150 in 1965 from his previous employment. On January 20, 1967, petitioner advanced $50,000 to National. This advance was evidenced by a promissory note signed on behalf of the corporation by William Cutler and petitioner. The purpose of the $50,000 advance was to satisfy National's current lbligations and thereby insure its continued existence, at least until the commencement of the soccer season in April 1967. Between January 20 and December 31, 1967, petitioner made additional advances to National totaling $19,646.05. In the latter part of 1967, certain individuals representing the Kansas City Soccer Club, Incorporated, ("Kansas City Soccer") a Missouri corporation with its offices located in Kansas City, Missouri, contacted petitioner and Cutler and offered to purchase National's stock with the intention of bringing the23 Chicago team to Kansas City. Due to the severe financial problems which confronted National, petitioner and Cutler agreed to sell National's stock to Kansas City Soccer. For their stock, Cutler received cash, and petitioner received a four-year employment contract with Kansas City Soccer, commencing January 1, 1968. He was to act as general manager of the Kansas City Spurs at an annual salary of $25,000, plus 20 percent of net profits. However, due to certain problems between petitioner and the new management, he worked for them for only part of 1968. The total compensation petitioner received from Kansas City Soccer was $10,764. In subsequent years petitioner began a new employment. He traveled to Europe ona part-commission part-salary basis, to hire skilled workers for American employers and h3ckey players for the Chicago Blackhawks. His combined compensation was greater than his salary from National. Petitioner's $50,000 advance to the corporation on January 20, 1967, and his numerous other advances to the corporation made between January 20 and December 31, 1967, aggregating $19,646.05, all became worthless on January 1, 1968. Petitioner in his 1968 income tax return claimed24 a business bad debt deduction for his loans to National. Respondent allowed the claim only as a nonbusiness bad debt. 2. Sale of Itasca Residence.Prior to 1965 petitioner had owned, jointly with his brother, two ten-unit apartment buildings. His brother wished to withdraw from the arrangement and persuaded petitioner to sell the buildings. However, they were able to find only one purchaser, and this individual was only interested in an exchange of properties. In May 1965, petitioner and his brother traded their two buildings for a parcel of land in Florida, a house in Itasca, Illinois, and some notes. The Itasca residence was old and in need of renovation, but it possessed a desirable location fronting on a golf course and was near petitioner's place of employment. The fair market value of the residence at the time of the exchange was approximately $55,000. Petitioner, acting as his own general contractor, commenced renovation in May 1965, completing the work in November 1966. The renovation, including the construction of a heated swimming pool, cost $24,861. Petitioner and his family moved into the house in October 1965. Vandals had inflicted some damage to the residence25 prior to October 1965, and petitioner hoped to stop such destruction by occupying the house. Even before beginning the renovation, petitioner had discussed the possibility of sale with several brokers. The property was first listed for sale in May 1966, and in September 1967 the property was listed with a large real estate firm at a selling price of $79,000. In February 1968 the firm found a buyer who would pay $69,000, and a sales contract was signed. Closing costs totaled $5,009. Petitioner's loss on the sale of the house was $15,870. Petitioner's family remained in the house until September 1968. Petitioner himself had moved to Kansas City, Missouri in the fall of 1967 to begin new employment. Petitioner did not attempt to rent the Itasca residence at any point during his period of ownership. Although petitioner claimed depreciation deductions on his tax returns for certain apartment buildings in 1966, he did not claim any such deduction for the Itasca residence for the taxable years 1965, 1966 and 1968. 2aPetitioner claimed as a deduction on his 1968 return the loss on the sale of the Itasca26 residence. Respondent disallowed the claimed loss in its entirety. ULTIMATE FINDINGS OF FACT Petitioner's predominant motive in advancing funds to National during the calendar year 1967 was to protect his investment in National rather than to protect the salary he would receive as an employee of National. Petitioner did not acquire the Itasca property in a profit-motivated transaction, nor did he subsequently convert the property to profit-oriented uses. OPINION 1. Loans to National.Petitioner and one William Cutler formed the Chicago National Professional Soccer League Club, Inc. in August 1966. The corporation's principal business was the operation of a professional soccer team called the Chicago Spurs. Cutler owned two-thirds of National's stock, and petitioner owned the remaining one-third, for which he paid $40,000. Petitioner as president of National was a salaried employee. During 1967 petitioner advanced $69,646 to National. This debt became worthless in 1968, and on petitioner's and his wife's joint return for 1968 they deducted the advances as business bad debts. Respondent contends that the advances petitioner made to National during 1967 are nonbusiness27 bad debts within the meaning of section 166(d), and we agree. Section 166(a) 3 allows a deduction for any debt that becomes worthless within the taxable year. However, section 166(d) 4 provides that in the case of an individual taxpayer, section 166(a) shall not apply to a nonbusiness bad debt. Instead the loss from a nonbusiness bad debt shall be considered a loss from the sale or exchange of a capital asset held for not more than 6 months (i.e., a short term capital loss). 28 Section 166(d)(2) defines a nonbusiness bad debt as a debt other than (1) a debt created or acquired in connection with a trade or business of the taxpayer, or (2) a debt the loss from the worthlessness of which is incurred in the taxpayer's trade or business. In this case petitioner occupied a dual status with respect to National. He was both an employee and a shareholder. His employee status constitutes a trade or business so that a loss proximately related to his employment would constitute a fully-deductible business loss. Section 1.166-5, Income Tax Regs. However, shareholder status does not constitute a trade or business, so advances made to protect petitioner's investment would, on becoming worthless, be nonbusiness bad debts deductible only as short term capital losses. Whipple v. Commissioner,373 U.S. 193">373 U.S. 193, 202 (1963). "In determining whether a bad debt has a 'proximate' relation to the taxpayer's trade or business * , the proper measure is that of dominant motivation, and * * significant motivation is not sufficient." United States v. Generes,405 U.S. 93">405 U.S. 93, 103 (1972). We have found as a fact that petitioner's dominant motive29 in advancing funds to National was to protect his investment. In reaching our conclusion we have considered all the facts and circumstances. For example, petitioner's gross salary from National was $6,250 in 1966 and $13,750 in 1967. 5 Yet in 1967 he advanced a total of $69,646, an amount substantially in excess of his total salary from National, and claims he did so to retain his job, not to protect his $40,000 investment. Petitioner was able to find other employment after he left the Kansas City Spurs outside the field of soccer, and did so at a salary higher than he had earned from National. Before becoming president of National he was a salesman and estimator of costs of30 structural and ornamental steel, and even owned and operated his own small speciality steel company. After leaving the Kansas City Spurs, he traveled in Europe hiring skilled workers for American employers and hockey players for the Chicago Blackhawks. Petitioner thus was not in the position of having to make loans to National to save his only possible job. Cf.GeraldineR. Mann,34 T.C.M. (CCH) 377">34 T.C.M. 377, - P-H Memo. T.C. par. - (1975), and Charles J. Haslam,33 T.C.M. (CCH) 482">33 T.C.M. 482, 43 P-H Memo. T.C. par. 74,097 (1974). We recognize that the salary from National was petitioner's only income at the time he was working for the company. This fact alone is not enough to prove that his dominant motive in making the loans was to protect his job. Roy E. Knoedler,33 T.C.M. (CCH) 443">33 T.C.M. 443, 448, 43 P-H Memo. T.C. par. 74,085 at 74-417 (1974). While the question is not free from doubt, based on the record as a whole we conclude that petitioner has failed to carry his burden of proving that his dominant motive in making loans to National was to preserve his job rather than to preserve his investment. 2. Sale of Itasca Residence.In May 1965 petitioner31 acquired a residence in Itasca, Illinois, in trade for some apartment buildings he owned. Petitioner renovated the residnce, including installing a swimming pool, and sold it in 1968 for a $15,870 loss. Petitioner's family occupied this house as their residence from October 1965 until September 1968. Petitioner claimed an ordinary loss deduction on his 1968 return for the loss on the sale of the residence. Respondent contends the loss is a nondeductible personal loss, and we agree. Section 165(a) allows "as a deduction any loss sustained during the taxable year and not compensated for by insurance or otherwise." Section 165(c) 6 limits the loss deduction in the case of individuals to losses incurred in a trade or business, losses incurred in any transaction entered into for profit, and casualty losses. 32 Petitioner claims that the loss he experienced on the sale of the Itasca property arose from a transaction entered into for profit. He claims he acquired the property in trade for business property, that he intended to renovate the property to sell it at a profit, and that the reason his family moved into the house was simply to protect it from vandals. Presumably most home buyers eventually plan to resell their house for a profit. Dupuy G. Warrick,44 B.T.A. 1068">44 B.T.A. 1068 (1941). The question is whether petitioner's profit motive was dominant when he purchased and occupied the house or whether it was acquired and held primarily for a residence. Austin v. Commissioner,298 F. 2d 583, 584 (2d Cir. 1962), affg. 35 T.C. 221">35 T.C. 221 (1960). Petitioner, who has the burden of proof, has not established that his acquisition and retention of the Itasca property were primarily prompted by a concern for profit. The mere fact that petitioner acquired the residence in trade for property held for a profit does not convert a residence into for-profit property. Petitioner has not established that the residence was continuously listed for sale. Petitioner33 at no time attempted to rent the premises. There is no showing that the renovations were made for resale as opposed to adapting the home to the needs and desires of petitioner's wife and children. Petitioner's family apparently permanently abandoned their prior home when they moved into the Itasca property, and the Itasca property remained their sole residence for approximately 3 years. Petitioner contends his family lived in the home solely to prevent vandalism. However, renting the property would also have deterred vandalism and would have been a course of action more consistant with a profit motive than occupying the house personally. The record does not indicate the extent or type of vandalism petitioner had to contend with. Finally, petitioner never took any depreciation deductions on the Itasca premises, although he did on other for-profit property. Phipps v. Helvering,124 F. 2d 292, 295 (D.C. Cir. 1941), affg. a Memorandum Opinion of this Court. We conclude on the record as a whole that petitioner held the property primarily as a residence at the time of sale, and the loss from the sale is a nondeductible personal expense. Decision will be entered34 under Rule 155.Footnotes1. Respondent also determined additions to tax under section 6651(a) of $79.75 for 1968 and $248.66 for 1969. Petitioner has not contested these adjustments, and therefore they are deemed conceded.↩2. All section references are to the Internal Revenue Code of 1954, as in effect during the years in issue.↩2a. Petitioner's 1967 income tax return was not submitted into evidence.↩3. Section 166(a) provides: (1) Wholly worthless debts.--There shall be allowed as a deduction any debt which becomes worthless within the taxable year. (2) Partially worthless debts.--When satisfied that a debt is recoverable only in part, the Secretary or his delegate may allow such debt, in an amount not in excess of the part charged off within the taxable year, as a deduction. ↩4. Section 166(d) provides: (1) General rule.--In the case of a taxpayer other than a corporation-- (A) subsections (a) and (c) shall not apply to any nonbusiness debt; and (B) where any nonbusiness debt becomes worthless within the taxable year, the loss resulting therefrom shall be considered a loss from the sale or exchange, during the taxable year, of a capital asset held for not more than 6 months. (2) Nonbusiness debt defined.--For purposes of paragraph (1), the term "nonbusiness debt" means a debt other than-- (A) a debt created or acquired (as the case may be) in connection with a trade or business of the taxpayer; or (B) a debt the loss from the worthlessness of which is incurred in the taxpayer's trade or business.↩5. Petitioner stated that his oral employment agreement provided in addition to salary a guarantee of "20 percent of the gross profit on the gate." There apparently was no gross profit. We conclude there is insufficient evidence to establish the 20 percent guarantee. Petitioner did not call Cutler to testify. Petitioner's testimony was imprecise and sometimes contradictory. We conclude that petitioner, who had the burden of proof, has failed to establish this aspect of the oral employment agreement.↩6. Section 165(c) provides: Limitations on Losses of Individuals.--In the case of an individual, the deduction under subsection (a) shall be limited to-- (1) losses incurred in a trade or business; (2) losses incurred in any transaction entered into for profit, though not connected with a trade or business; and (3) losses of property not connected with a trade or business, if such losses arise from fire, storm, shipwreck, or other casualty, or from theft. A loss described in this paragraph shall be allowed only to the extent that the amount of loss to such individual arising from each casualty, or from each theft, exceeds $100. * * * ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625445/	EVELYN B. BLOCK, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentBlock v. Comm'rNo. 5676-02 United States Tax Court120 T.C. 62; 2003 U.S. Tax Ct. LEXIS 4; 120 T.C. No. 4; RIA TM 55026; January 23, 2003, Filed 4 The court determined that it lacks jurisdiction to decide a proposed amended petition, and an order denying leave to amend the petition will be issued. P requested relief from joint and several income tax liability pursuant to sec. 6015, I.R.C., regarding taxes that had been previously assessed for the taxable years 1983 and 1984. R issued a notice of determination denying P's request, and pursuant to sec. 6015(e), I.R.C., P filed a timely petition seeking review of R's determination. Thereafter, P moved to amend her petition pursuant to Rule 41(a), Tax Court Rules of Practice and Procedure, in order to claim that "The statute of limitation bars the assessment of the underlying income tax liabilities for 1983 and 1984." R opposed the amendment, arguing that sec. 6015(e), I.R.C., grants this Court jurisdiction to determine whether R's denial of relief from joint and several tax liability, as provided in sec. 6015, I.R.C., was erroneous. R argues that since the expiration of the period of limitations to assess the underlying tax is not a ground5 for relief under sec. 6015, I.R.C., this Court is without jurisdiction to determine the issue. Held: Our jurisdiction under sec. 6015(e), I.R.C, is limited to reviewing R's denial of relief available under sec. 6015, I.R.C., from an otherwise existing joint and several tax liability. In an action brought under sec. 6015(e), I.R.C., we lack jurisdiction over whether the underlying assessment was barred by the statute of limitations. Held, further, Since the Court is without jurisdiction to decide whether the expiration of the period of limitations bars the assessment of the underlying tax liability, the proposed amendment to the petition is improper, and P's motion for leave to amend is denied. Barry A. Furman, for petitioner.James N. Beyer, for respondent. Ruwe, Robert P.RUWEOPINION63 RUWE, Judge: This matter is before the Court on petitioner's motion for leave to amend petition pursuant to Rule 41(a). 1 Petitioner timely filed her petition with6 this Court pursuant to section 6015(e) seeking relief from her previously assessed joint and several income tax liabilities for 1983 and 1984. 2 The petition was filed after respondent issued a "Notice of Determination" denying her request for relief. 3Section 6015(e) "allows a spouse who has requested relief to petition the Commissioner's denial of relief, or to petition the Commissioner's failure to make a timely determination. Such cases are referred to as 'stand alone' cases, in that7 they are independent of any deficiency proceeding." Ewing v. Commissioner, 118 T.C. 494">118 T.C. 494, 497 (2002) (quoting Fernandez v. Commissioner, 114 T.C. 324">114 T.C. 324, 329 (2000)). 4Petitioner seeks to amend the petition to include the following paragraph: "The statute of limitation bars the assessment of the underlying income tax liabilities for 1983 and 1984." Petitioner claims the bar of the statute of limitations 64 on assessment as an affirmative legal defense against the underlying assessment. 58 In Robinson v. Commissioner, 57 T.C. 735">57 T.C. 735, 737 (1972), we held that "The statute of limitations is a defense in bar and not a plea to the jurisdiction of this Court." See Badger Materials, Inc. v. Commissioner, 40 T.C. 1061">40 T.C. 1061 (1963). Section 7459(e) provides: SEC. 7459(e). Effect of Decision That Tax Is Barred by Limitation. -- If the assessment or collection of any tax is barred by any statute of limitations, the decision of the Tax Court to that effect shall be considered as its decision that there is no deficiency in respect of such tax.6See Genesis Oil & Gas v. Commissioner, 93 T.C. 562">93 T.C. 562 (1989); Rodgers v. Commissioner, 57 T.C. 711">57 T.C. 711 (1972). For the reasons stated below, we deny petitioner's motion to amend the petition. 79 Rule 41(a) provides that leave to amend "shall be given freely when justice so requires." In exercising its discretion, the Court may deny petitioner's motion for leave to amend if permitting an amended petition would be futile. Klamath-Lake Pharm. Association v. Klamath Med. Serv. Bureau, 701 F.2d 1276">701 F.2d 1276, 1293 (9th Cir. 1983); Estate of Ravetti v. Commissioner, T.C. Memo 1992-697">T.C. Memo. 1992-697.Petitioner contends that once this Court's jurisdiction has been properly invoked under section 6015(e), we also have jurisdiction to decide whether the period of limitations for assessing tax has expired. Respondent opposes petitioner's motion contending that when the Court's jurisdiction is based on section 6015(e), the Court's jurisdiction is limited to 65 whether the taxpayer is entitled to relief from an existing joint and several liability on the basis of the specific relief provisions contained in section 6015.It is axiomatic that we are a Court of limited jurisdiction and may exercise our power only to the extent authorized by Congress. Gati v. Commissioner, 113 T.C. 132">113 T.C. 132, 133 (1999); Naftel v. Commissioner, 85 T.C. 527">85 T.C. 527, 529 (1985). In her "stand10 alone" petition, petitioner invoked our jurisdiction pursuant to section 6015(e) to review the Commissioner's denial of her request for relief from joint and several liability. Section 6015(e)(1) provides in pertinent part:SEC. 6015(e). Petition for Review by Tax Court. -- (1) In general. -- In the case of an individual against whom a deficiency has been asserted and who elects to have subsection (b) or (c) apply --(A) In general. -- In addition to any other remedy provided by law, the individual may petition the Tax Court (and the Tax Court shall have jurisdiction) to determine the appropriate relief available to the individual under this section if such petition is filed -- * * * [Emphasis added.]We agree with respondent that the plain language of section 6015(e)(1) limits our jurisdiction to review the Commissioner's denial of the specific relief contemplated under section 6015. 8 See Ewing v. Commissioner, supra at 499; Butler v. Commissioner, 114 T.C. 276">114 T.C. 276, 290 (2000);11 Brown v. Commissioner, T.C. Memo. 2002-187 (jurisdiction limited to relief contemplated under section 6015). Petitioner's amendment would allow her to go beyond the specific relief contemplated by section 6015 and question the viability of the tax liabilities from which she seeks relief. As previously stated, a finding that the period of limitations has expired is a complete legal bar to the assessment of the unpaid tax liability. See sec. 7459(e); Genesis Oil & Gas v. Commissioner, supra; Whirlpool Corp. v. Commissioner, 61 T.C. 182">61 T.C. 182 (1973).Section 6015 provides qualifying taxpayers with three distinct avenues of relief from joint and several tax liability. Section 6015(b) requires that the return from which the 66 electing taxpayer seeks relief shows "an understatement of tax attributable to erroneous items of one individual filing the joint return". Sec. 6015(b)(1)(B). In addition, the electing taxpayer must show that "taking into account all the facts and circumstances, it is inequitable to hold the other individual liable for the deficiency in tax for such taxable year attributable to such understatement". Sec. 6015(b)(1)(D). Thus, a prerequisite12 to seeking relief under section 6015(b) is the existence of a tax deficiency.In a similar vein, a taxpayer may seek relief pursuant to section 6015(c) for an "individual's liability for any deficiency which is assessed with respect to the return". Sec. 6015(c)(1). The electing taxpayer bears the burden of proving "the portion of any deficiency allocable to such individual." Sec. 6015(c)(2). With respect to the allocation of the deficiency, section 6015(d)(1) instructs that The portion of any deficiency on a joint return allocated to an individual shall be the amount which bears the same ratio to such deficiency as the net amount of items taken into account in computing the deficiency and allocable to the individual under paragraph (3) bears to the net amount of all items taken into account in computing the deficiency.Section 6015(c) clearly contemplates the existence of a joint tax deficiency from which relief is sought.Section 6015(f) grants equitable relief to taxpayers who cannot otherwise qualify under subsections (b) or (c). However, this avenue requires the existence of an "unpaid tax or any deficiency". Sec. 6015(f)(1). 13 9Section 6015(f) presupposes the existence of a deficiency or unpaid tax liability. Thus, section 6015(f) does not provide a platform upon which a taxpayer can prevail by merely using the strictly legal argument that the assessment of the underlying liability is barred. When a taxpayer disputes the Commissioner's determination regarding relief sought pursuant to section 6015(f), the issue we have jurisdiction to address in a "stand alone" petition under section 6015(e) is whether the Commissioner erroneously67 denied equitable relief from an existing joint and several tax liability.14 In support of her motion, petitioner cites our opinion in Neely v. Commissioner, 115 T.C. 287">115 T.C. 287 (2000). In Neely, a taxpayer invoked our jurisdiction by filing a petition pursuant to section 7436 seeking to review the Commissioner's adverse determination of worker classification. One of the issues raised by the taxpayer in the petition was whether the assessment of taxes related to the Commissioner's determination of worker classification was barred by the period of limitations. Id. at 289. The Commissioner argued that we lacked jurisdiction to address matters relating to the period of limitations on assessments in the worker classification context. We disagreed and explained that section 7436(a) provides the Court with jurisdiction to determine worker classification and whether a taxpayer is entitled to "safe harbor" relief. 10Id. at 291. With respect to the statute of limitations issue, we stated that " Once our jurisdiction has been properly invoked in a case, we require no additional jurisdiction to render a decision with respect to such an affirmative defense." Id. at 292. Thus, we held that where the parties were properly before15 the Court in an action brought under section 7436, the Court had jurisdiction to decide whether the period of limitations barred an assessment based on respondent's worker classification determination. Id. at 292-293.Neely is distinguishable. In Neely, we reasoned that where the Court had jurisdiction to review the Commissioner's preassessment determination of worker classification, we likewise had jurisdiction to determine whether the Commissioner was barred from assessing employment taxes by the expiration of the period of limitations. Section 7436(a) granted us jurisdiction to "determine whether such a [worker classification] determination by the Secretary is correct". Like the deficiency procedures, the procedure set forth in section 7436 provides a preassessment16 forum for employment tax issues. In a preassessment proceeding it is logical to decide whether the proposed assessment is barred by the statute of limitations, and it is clear that we have jurisdiction68 in a deficiency proceeding to decide whether assessment of the deficiency is barred by the statute of limitations. See Woods v. Commissioner, 92 T.C. 776">92 T.C. 776 (1989); Worden v. Commissioner, T.C. Memo 1994-193">T.C. Memo. 1994-193; Ruff v. Commissioner, T.C. Memo. 1990- 521. Section 7436(d)(1) specifically provides that the "principles * * [of the sections governing deficiencies] shall apply to proceedings brought under this section in the same manner as if the Secretary's determination described in section 7436 subsection (a) were a notice of deficiency."In contrast to section 7436, section 6015 provides relief from an otherwise existing joint tax liability. The relief from joint and several liability available in a section 6015(e) "stand alone" petition does not incorporate preassessment procedures. Section 6015 assumes that the electing taxpayer is to be relieved from an existing joint tax liability, not whether the underlying joint tax liability exists. 17 Section 7436, on the other hand, concerns whether a tax liability exists. A section 6015(e) "stand alone" petition provides us with jurisdiction to determine whether the postassessment relief provided in section 6015 is appropriate.Petitioner has not raised, and we do not address, whether the alleged expiration of the period of limitations on the assessment of the underlying deficiency or liability might be a "factor" in determining whether it would be inequitable under section 6015(f) to deny petitioner relief. If petitioner wishes to argue that the alleged expiration of the period of limitations is a "factor" to consider in weighing the equities under section 6015(f), petitioner should move this Court to amend her petition to assert that specific allegation. Respondent, of course, would then be given an opportunity to challenge petitioner's motion.Pursuant to the plain statutory language contained in section 6015, our jurisdiction in a "stand alone" case brought pursuant to section 6015(e) is limited to reviewing respondent's denial of relief from an existing joint and several tax liability under subsections (b), (c), and (f) of section 6015. The timeliness of the assessment of the underlying18 liability is not an independent ground for relief under section 6015. We have no jurisdiction over the issue petitioner wants to raise in her proposed amendment to the petition. Accordingly, *69 her motion for leave to amend her petition is denied.An appropriate order denying petitioner's motion for leave to amend her petition will be issued. Footnotes1. All Rule references are to the Tax Court Rules of Practice and Procedure, and unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the years at issue.↩2. The parties allege that deficiencies were previously assessed pursuant to the partnership provisions contained in secs. 6221 through 6234.↩3. Petitioner seeks relief from joint and several liability pursuant to sec. 6015(b) or 6015(f). She does not contend that she is entitled to separate liability relief under sec. 6015(c)↩.4. A claim for relief from joint and several liability may also be raised as an affirmative defense in a timely petition based on a notice of deficiency. Butler v. Commissioner, 114 T.C. 276">114 T.C. 276, 287-288↩ (2000). The petition in the instant case was not based upon a notice of deficiency.5. In Petitioner's Motion for Leave to Amend Petition, petitioner argues:3. Petitioner proposes to amend her Petition to raise the affirmative defense of statute of limitations. The proposed Amendment to Petition accompanies this Motion.4. The Court has jurisdiction to decide whether the statutes of limitations on the underlying joint and several liabilities have expired. The Court has held that "once our jurisdiction has been properly invoked in a case, we require no additional jurisdiction to render a decision with respect to such an affirmative defense [statute of limitations]." Genesis Oil & Gas, Ltd. v. Commissioner, 93 T.C. 562">93 T.C. 562, 564 (1989).5. In Neely v. Commissioner, 115 T.C. 287">115 T.C. 287 (2000), an analogous case, the Court held that it had jurisdiction to decide an affirmative defense raised by the petitioner in a section 7436↩ case (Proceedings for Determination of Employmen Status).6. "If the Tax Court finds that the assessment or collection of a tax is barred by the statute of limitations, such a finding constitutes a decision that there is no deficiency with respect to such tax." Whirlpool Corp. v. Commissioner, 61 T.C. 182">61 T.C. 182, 184↩ (1973). 7. Petitioner has not alleged in her petition or proposed amendment that the expiration of the period of limitations is a "factor" to be considered in deciding whether she is entitled to equitable relief under sec. 6015(f)↩.8. "The plain meaning of legislation should be conclusive, except in the 'rare cases [in which] the literal application of a statute will produce a result demonstrably at odds with the intentions of its drafters.'" United States v. Ron Pair Enters., Inc., 489 U. S. 235, 242, 103 L. Ed. 2d 290">103 L. Ed. 2d 290, 109 S. Ct. 1026">109 S. Ct. 1026 (1989) (quoting Griffin v. Oceanic Contractors, Inc., 458 U.S. 564">458 U.S. 564, 571, 73 L. Ed. 2d 973">73 L. Ed. 2d 973, 102 S. Ct. 3245">102 S. Ct. 3245↩ (1982)).9. In Fernandez v. Commissioner, 114 T.C. 324">114 T.C. 324 (2000), and Butler v. Commissioner, 114 T.C. 276">114 T.C. 276 (2000), we held that this Court has jurisdiction to review denials of requests for relief from joint and several liability pursuant to sec. 6015(f) in both deficiency and "stand alone" proceedings. Ewing v. Commissioner, 118 T.C. 494">118 T.C. 494 (2002). In Ewing, we held that this Court has jurisdiction, despite the absence of an asserted deficiency, to determine whether a taxpayer is entitled to equitable relief pursuant to sec. 6015(f). This holding was predicated upon the language of sec. 6015(f)(1)↩ providing for equitable relief from "any unpaid tax or any deficiency".10. The statute has since been amended giving us the jurisdiction to also determine "the proper amount of employment tax under such determination". Consolidated Appropriations Act, 2001, Pub. L. 106-554, sec. 314(f), 114 Stat. 2763A-643.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625446/	E. G. ROBERTSON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Robertson v. CommissionerDocket No. 28867.United States Board of Tax Appeals19 B.T.A. 534; 1930 BTA LEXIS 2378; April 9, 1930, Promulgated 2378 The real estate transactions of the petitioner based on a so-called lease option contract were sales on the installment plan and income therefrom should be computed on the installment basis. Harry W. Hart, Esq., for the petitioner. L. A. Luce, Esq., for the respondent. LANSDON 534 The respondent asserted deficiencies in income tax against the petitioner for the years 1920, 1921, 1922, 1923, and 1924, in the respective amounts of $1,190.67, $568.35, $1,913.07, $963.22, and $318.06, only a portion of which is in dispute. In support of his appeal the petitioner alleges that the respondent committed error in treating certain payments received by him in each of the taxable years upon real estate transactions as rentals from real estate leases and, therefore, income to him for the year received; that, in fac, the major portion of such payment constituted part payments upon outstanding contracts for the sale of real estate between himself and clients, and formed no part of his taxable income when received. FINDINGS OF FACT. The petitioner is a resident of Wichita, Kans., and engaged in real estate operations in that city. A large part of2379 his business consists in the marketing of new, moderate priced residence property acquired and developed by him in his own name. On account of the redemption laws of the State of Kansas, which make it possible for a purchaser in possession of property, either under a deed or contract of purchase, to hold the same for a period of eighteen months after 535 default, without cost or obligations, the petitioner adopted a plan of makreting his properties through the employment of a lease and option contract in part as follows: THIS LEASE, Made and entered into this 23rd day of May, 1922, by and between G. C. Robertson and E. G. Robertson, parties of the first part, hereinafter called Lessor, and M. E. Loder and Florence I. Loder, his wife, parties of the second part, hereinafter called Lessees. WITNESSETH, That the said Lessor, in consideration of the rents, covenants and agreements of said Lessees hereinafter set forth, do by these present lease and rent to the said Lessees the following described property situated in Sedgwick County, State of Kansas, to-wit: Lots number Eighty-two (82) and Eighty-four (84) on Ellis Avenue, McCormicks addition to the City of Wichita. 2380 TO HAVE AND TO HOLD THE SAME unto the said Lessees from the Twenty-fourth day of May, 1922, to the 24th day of May, 1927, and the said Lessees as part of the rent from the leasing of the said premises as above set forth, herewith pays the said Lessor the sum One Hundred ($100.00) Dollars the receipt of which is hereby acknowledged by said Lessor, and said Lessees covenants and agrees to pay said Lessor, its successors or assigns as the remainder of the rent for such leasing of the premises aforesaid the insurance, taxes, and assessments duly levied against said property commencing with the taxes and assessments due and payable November First, 1922, and all the taxes duly levied and assessed against said property during the lifetime of this lease, also the sum of Twenty-one Hundred Fifty ($2150.00) Dollars to be paid as follows: * * Hereby waiving the benefit of the exemption, valuation and appraisement laws of the said State of Kansas to secure the payment thereof. The said Lessees further covenant with the said Lessor that at the expiration of this lease, by forfeiture or otherwise, they will give peaceful possession of the said premises to the said Lessor in as good condition2381 as they are now, the usual wear, inevitable accidents and losses by fire excepted, and will then leave in place on said premises all fixtures and improvements added by said Lessees or assigns, and will not make or suffer any waste thereof, nor lease nor permit any other person to occupy the same, or make or suffer to be made any alterations therein without the consent of the said Lessor in writing, having been first obtained, and not use or occupy the said premises for any business or thing deemed extra hazardous on account of fire; and upon the non-payment within thirty days after the maturity of any of the payments of rent aforesaid, the said Lessor may at their election either distrain for said rent due, or declare this lease at an end and recover the said premises as if held by forcible detainer, the said Lessees hereby waiving any notice of said election or any demand for the possession of said premises, provided that a penalty charge of 4% of the amount due shall be charged by Lessor if Lessees do not make payments promptly on the dates when said payments are due, but are made within the thirty days aforesaid. It is further stipulated and agreed between the parties hereto2382 that the reception by the Lessor of any one or more of the said rental payments after the expiration of the said thirty days after maturity thereof shall be considered in no wise as a waiver of the rights of forfeiture as set out above by reason of the non-payment according to this lease of any of the other rental payment aforesaid. 536 It is further agreed as a part of this Lease that in case said Lessees or Assigns or anyone claiming through or under them or any of them do or cause anything to be done that casts a could upon said title, such could is to be removed by Lessees or Assigns without delay, and in case a deed be made hereunder, said Lessor may make said deed subject to said cloud, if the same be not removed prior thereto as stated above. It is further understood and agreed between the parties hereto that the covenants herein made shall extend to and be binding upon the heirs, executors and administrators of the respective parties hereto. OPTION TO PURCHASE It is further stipulated and agreed between the parties hereto that if the said Lessees shall have promptly kept all of the covenants and agreements set out in this lease, then at the expiration of2383 the term of this lease the said Lessees shall have the option of purchasing the said property, applying the rental payments so paid as stipulated above on the purchase price and paying in addition thereto the cash sum of Three Hundred Seventy-Six and 91/100 Dollars, and assuming the First Mortgage now thereon of One Thousand ($1000.00) Dollars, with interest thereon at seven per cent per annum from date of deed with privilege of paying principal at any interest maturity, and the second Mortgage of Fifty Dollars ($50.00) which is one per cent on the First Mortgage paid as commission, but it is expressly stipulated and agreed that in order that the said Lessees may be able to have and exercise the said option they must give to the said Lessor thirty days written notice immediately previous to the time when the said option can be exercised as aforesaid, and said Lessees having so exercised said option and paid the additional money as stipulated above shall be entitled to a Warranty Deed to said property from said Lessor, subject to and assuming said mortgages (and it is further agreed that in case said option so obtained is exercised to purchase said property, then the said Lessees shall2384 accept the title of said Lessor, provided the same is as good as it now is, the same having been examined and approved at the date of the execution of this lease. PRIVILEGE TO PAY OFF It is further agreed and stipulated that, if at any time after the date of this lease, the said Lessees having previously complied with all the terms of this lease promptly desires to buy said property and pay all cash therefor, he shall, by giving thirty days written notice to the Lessor as aforesaid have the option of so purchasing, upon the payment of a sum equal to the amount that he has paid and would otherwise pay under the terms of this lease, as set out above, adding thereto the amount to be paid upon the delivery of the deed as set out above, but crediting upon the said sum all rents previously paid, and estmating and crediting the present value computed at 8 per cent per annum of all the rental payments remaining unpaid and of the said sum of $376.91. Said Lessee in addition thereto assuming said mortgages with interest from date of deed as above, according to the terms thereof. It is, however, expressly understood and agreed by and between the parties hereto that time is of the essence2385 of this lease, that if each rental payment stipulated for herein is not promptoly and punctually paid then any and all option or options or rights given to said Lessee by this lease in and to said property shall be forever cut off and barred, and said Lessor shall have immediate right to re-enter upon said property, and retain all previous payments 537 made to him as Lessor, as rent, as well as said payments of taxes as stipulated above, and all improvements made upon said property by said Lessees. IN WITNESS WHEREOF, The said parties have hereunto set their hands this 23rd day of May, 1922. (Signed) G. C. ROBERTSON BY E. G. ROBERTSON E. G. ROBERTSON M. E. LODER FLORENCE I. LODER Under similar contracts prospective purchasers were given possession of the property they desired to acquire, and, upon the making of all payments and fulfillments of other requirements of their respective contracts, received deeds thereto. In each instance, preceding the execution of a lease-option contract, there was a verbal agreement had between the parties for a sale of the property effected. This agreement predetermined all details of the transaction which were thereafter to2386 be carried out in effecting the sale. It fixed the total sale price for the property; the amount that should be paid before execution of the deed and the terms of such payment; the interest to be paid upon deferred payments, and the amount that should be carried over and secured, after conveyance, by note and mortgage back on the property. The prices at which the petitioner marketed his various properties, under the system adopted, ranged from $2,500 up to $6,000, and the terms of payments were determined in accordance with the requirements of each individual case without regard to the rental value of the property sold. In all contracts, after first deducting the initial payment which varied according to the circumstances of each case from $25 to $2,000, the balance of the part to be paid before execution of the deed was spread over a period of five years through provisions in the rental clause of the lease. The balance of the purchase price, to be paid after conveyance, was provided for in the "option" feature of the contract and fixed as the amount to be paid upon the exercising of the option. During the years involved, the petitioner collected from ninety or more of these contracts, 2387 as first payments, rents and otherwise, amounts in the aggregate as shown in the following column: RentRent bonusTotal1920$13,410.00$6,925.00$20,335.00192119,682.853,896.7523,579.60192221,762.104,013.7525,775.85192324,314.841,125.0025,439.84192422,440.121,175.0023,615.12The respondent determined that the petitioner derived taxable income in the amount collected, as shown above, parts of which the petitioner now concedes. These amounts, as claimed by the respondent 538 and conceded by the petitioner, are shown for the years as follows: YearRespondent's determinationConceded by petitionerAmount disputed1920$15,831.54$2,565.13$13,266.41192110,589.1910,373.70205.49192221,876.6510,523.9311,352.72192318,373.3417,284.801,088.50192413,495.6015,626.44It is stipulated that the difference, as shown above, between the amounts determined by the respondent and those conceded by the petitioner, is the amount of taxable income in dispute, and that the differences arise by reason of the Commissioner including and charging as rents received the sums received2388 by the petitioner in connection with the sale of real estate under contracts as hereinabove set forth. OPINION. LANSDON: The respondent contends that the instruments used by the petitioner in his real estate transactions were plan leases, coupled with options to purchase the property described therein; and that, for this reason, the payments in controversy which were made under them must be regarded as income from leased property and for the year received. The petitioner contends that these instruments, in view of the purposes for which they were employed and the prior understandings which formed the inducement for their execution, must be regarded as contracts of sale for the property described therein, and that collections thereunder, otherwise called rent, except in cases of their forfeiture through default or abandonment and to the extent of which they are interest, must be regarded as payments upon the purchase price. If the issues here could be determined by a narrow construction of the bare contract in evidence, the decision would be simple, since we consider the law too well settled to admit of an extension of its provisions beyond their plain written terms. Such2389 instruments are lease-option contracts and not contracts for sale of real estate, ; ; ; . The question, however, as to what constitutes taxable income is one of fact and can not be determined alone by a mere regard to the form of instrument under which it was collected. It is the character of the transaction which produced the funds collected, as governed by the intent of the parties in carrying it out, that must determine the character of such funds in the hands of the taxpayer. 539 In the cases involved here, if the parties to the lease-option contracts, by their acts, intended in each instance to effect nothing more than a lease of the properties described to the lessee named for the period designated, with no thought of committing themselves to a sale, except as provided for in the option feature of the contract, then their relationship throughout was one of landlord and tenant and the payments were rent under the lease. If, however, as claimed by the petitioner, a verbal agreement of sale of the property involved2390 preceded the execution of each of these contracts, and the parties in so executing and carrying them out at all times intended to accomplish a sale of the property described in the lease from the lessor to the lessee, and the lessor and lessees intended that the payments made by the latter to the former under the rental provisions of the leases should be credited upon the purchase price of such property, then such payments must be regarded as purchase-price payments and only so much thereof as represents profit to the lessor, when ascertained, may be attributed to taxable income. The record here shows that the petitioner, who for many years has been engaged in real estate operations, acquired each of the properties involved in these considerations for the purpose of development and sale on a deferred payment plan to persons of moderate circumstances. That because of the small advance payments required of his buyers upon their taking possession of the property, and owing to the liberal provisions of the Kansas redemption laws in favor of such buyers once in possession, the petitioner considered that the plan most commonly employed in selling homes on the installment plan failed2391 to afford him adequate protection against defaulting purchasers, and for this reason he brought into use the lease-option contract system as shown. None of these leases were executed by the petitioner except in favor of parties who had first agreed to purchase the property involved and in accordance with terms of payments on the purchase price in amounts and at dates as set forth in the lease under the rental and option provisions. In other words, a bona fide agreement of sale was in fact first made between the parties, complete in every respect except for the writing. Under such circumstances, the sale was effective without the writing upon delivery of possession of the property, but under the Kansas redemption laws such possession could be held by the purchaser for a period of eighteen months, without further payments, and it was to prevent such an adverse holding that the system here shown was called into play. We think the record here supports the hypothesis last suggested. The only evidence as to the intent of the parties in entering into the contracts under consideration is the testimony of the petitioner, 540 who states that in each and every case a sale of the2392 property affected was intended, and that deeds were invariably issued conveying the same to the lessee named upon a full compliance with the terms. He also stated that, although he carried on a regular rental business of other properties, none of the properties involved in the transactions under consideration were either acquired, developed, or held by him except for purposes of sale, and that in effecting these sales, with the consent of the purchasers, the lease-option form was employed because it would enable him more easily to recover possession of the property in case of default. This testimony is consistent with other attending circumstances and, being in no way contradicted, must be accepted as proof of the intent of the parties in carrying out the transactions which gave rise to the revenues in dispute. The intent of the parties to these transactions being to accomplish sales, we think the law must give such effect to them regardless of the forms employed. In thus interpreting these several transactions, we make no attempt to ignore or vary the terms of the written instruments or to declare them to be something different from what they purport to be, but since such instruments2393 evidence only a part of the agreements between the parties, we take notice of the objects sought to be accomplished and the agreements which induced their execution, ; ; . In the transactions between the petitioner and his clients they were selling and purchasing real property and we must so hold, , and although in the interim between the signing of the contract and the final payment under the option, their relationship was that of landlord and tenants, yet, by virtue of the options, these purchasing tenants acquired valuable rights over and above a leasehold estate in the properties. These interests included the exclusive right to acquire complete ownership of the property and to take credit upon the agreed purchase price for all of the payments made by them under the rental clauses in said contracts. ; 2394 ; ; ; ; ; ; . Correspondingly, by these contracts the petitioner parted with the interests acquired by his tenants and, in each case, was bound to hold all payments in excess of interest charges made by them for credit upon the agreed purchase price of the property. It is true that in case of default or abandonment of any of these contracts by the purchasing tenants, all payments made by them became income to the petitioner, but these are matters entirely within the control of the tenant and not the petitioner, and since the record here shows 541 that no such contingencies have affected the status of any part of the funds in dispute, we must treat them as intended by the parties. Our decision that the transactions here involved were, in fact, sales of real estate leaves open the question as to the correct rule for determining and taxing the income resulting therefrom. There are two*2395 well established methods for computing the taxes on income included in payments received from real estate sales, viz., the completed sales and installment bases. The method proposed by the petitioner conforms to neither, but it is contended that it is the only way in which the true income and tax liability resulting from the transaction here involved can be computed. We are not convinced that this is true. In our opinion the deals in question were sales of real estate on the installment plan, and the income realized therefrom should be reported on the installment basis. 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/4625447/	ALBERT CASSUTO, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentCassuto v. CommissionerDocket Nos. 1661-82; 21546-87.1United States Tax CourtT.C. Memo 1989-62; 1989 Tax Ct. Memo LEXIS 62; 56 T.C.M. (CCH) 1230; T.C.M. (RIA) 89062; February 13, 1989. Thomas LoPresti, for the respondent. WELLSMEMORANDUM OPINION WELLS, Judge: The instant case is before us on respondent's Motion to Dismiss for Lack of Prosecution. Respondent determined by separate notices of deficiency for each taxable year the following deficiencies in and additions to the Federal income tax of petitioner: Taxable YearDeficiency6651(a)(1)1980$ 7,813.24$ 402.12198313,144.003,286.00Additions to Tax Under Sections 2Taxable Year6653(a)6653(a)(1)6653(a)(2)6654(a)66611980$ 390.66N/AN/AN/AN/A1983N/A657.20 $ 793.00$ 3,286.0063 The notices of deficiency were based primarily on respondent's determination that petitioner had underreported his income, notwithstanding petitioner's vow of poverty. On August 11, 1983, respondent filed a Motion for Leave to File Amendment to the Answer in docket number 1661-82 and the Amendment to Answer. The motion was granted. The amendment increased the deficiency for the taxable year 1980 from $ 7,813.24 to $ 9,520.67. That increase was based on unreported dividend and interest income. Based on the increased deficiency, the additions to tax for taxable year 1980 under sections 6651(a)(1) and 6653(a) were increased from $ 402.12 and $ 390.66 to $ 830.97 and $ 476.03, respectively. Petitioner resided in Brooklyn, New York, at the time he filed his petitions in the instant case. On June 30, 1983, respondent sent petitioner a request for admissions which included a request that petitioner admit that he earned the interest and64 dividend income that resulted in the increased deficiency and additions to tax for taxable year 1980. Petitioner never responded to the request for admissions; thus, the admissions requested are deemed admitted pursuant to Rule 90(c). The increased deficiency based on the unreported interest and dividend income, along with the corresponding increased additions to the tax for taxable year 1980, are the only issues on which respondent has the burden of proof. Rule 142(a). The instant case was scheduled for the December 7, 1987, Westbury, New York trial calendar. Petitioner failed to appear at the call of that calendar, and respondent moved to dismiss the instant case and impose damages pursuant to section 6673. The Court received correspondence from petitioner and issued an order on December 21, 1987, directing petitioner to show cause in writing on or before January 11, 1988, why respondent's motion should not be granted. On January 12, 1988, petitioner filed a reply along with a doctor's note. The Court then denied respondent's motion to dismiss and changed the place of trial to New York, New York. On April 6, 1988, the Court sent petitioner a notice setting the instant case65 for trial at the Trial Session beginning September 6, 1988, in New York, New York. That notice contained the following warnings: The calendar for that Session will be called at 10:00 A.M. on that date and both parties are expected to be present at that time and be prepared to try the case. YOUR FAILURE TO APPEAR MAY RESULT IN DISMISSAL OF THE CASE AND ENTRY OF DECISION AGAINST YOU. Your attention is called to the Court's requirement that, if the case cannot be settled on a mutually satisfactory basis, the parties, before trial, must agree in writing to all facts and all documents about which there should be no disagreement. Therefore, the parties should contact each other promptly and cooperate fully so that the necessary steps can be taken to comply with this requirement. YOUR FAILURE TO COOPERATE MAY ALSO RESULT IN DISMISSAL OF THE CASE AND ENTRY OF DECISION AGAINST YOU. Respondent tried to contact petitioner by telephone at various times, but there was never any answer. On August 10, 1988, a letter was sent to petitioner at 1000 Ocean Parkway, Apt. 6A, Brooklyn, New York, 11230, informing him of the trial date and requesting a meeting for the purpose of stipulating facts. 66 The letter was returned with the address crossed out and a Canadian address written in its place. On August 18, 1988, letters and proposed decision documents for taxable years 1980 and 1983 were sent to petitioner at both the Brooklyn address (by certified mail), and the Canadian address, 1240 Bay Street, Toronto, Ontario M5R2A7. The instant case was called for trial at the trial session of this Court on September 6, 1988, at New York, New York. Counsel for respondent appeared and announced that he was ready for trial. No appearance was made by or on behalf of petitioner. Respondent filed the instant motion to dismiss for lack of prosecution and moved for an award of damages pursuant to section 6673. The record in this case discloses not only that petitioner did not appear for the trial 3 of his case when it was called, but also that he has totally failed to cooperate with respondent in preparing the case for trial. Dismissal of a case is a sanction resting in the discretion of the trial court. ;67 . We grant respondent's motion to dismiss as to the deficiencies and the additions to tax determined in the notices of deficiency. Rules 123, 149(a). 4 With respect to the increases in the deficiency and additions to tax for taxable year 1980 sought in respondent's amended answer in docket No. 1661-82, we have carefully reviewed the allegations in that answer and are satisfied that they are well-pleaded. We therefore grant respondent's motion to dismiss with respect to such increased deficiency and additions to tax. . With respect to respondent's motion for damages, section 6673 provides for an award of damages to the United States when it appears to us that the proceedings have been instituted or maintained by the taxpayer before this Court primarily for delay or that the taxpayer's position in these proceedings is frivolous or groundless, or that the taxpayer unreasonably failed to pursue68 available administrative remedies. We have repeatedly awarded damages under section 6673 in cases which have been dismissed due to a taxpayer's failure to prosecute his case properly. See , affd. by unpublished opinion . See also ; ; ; . Our review of the record in the instant case reveals that petitioner is a protestor, intent on making frivolous, groundless arguments based upon the Constitution of the United States. 5 Moreover, petitioner's refusal to cooperate with respondent and failure to appear at trial convince us that petitioner has instituted and maintained these proceedings primarily for the purpose of delay. We therefore will award damages to the United States in the amount of $ 5,000. 69 An appropriate order and decision will be entered.Footnotes1. These cases were consolidated by Order of the Court on October 13, 1986. For convenience, except where otherwise noted, these consolidated cases shall hereinafter be referred to as "the instant case."↩2. All section references are to the Internal Revenue Code, of 1954, as amended and in effect for the years in issue and all Rule references are to the Tax Court Rules of Practice and Procedure. * 50 percent of the interest on $ 13,144.↩3. The Court has received no communication from petitioner explaining his failure to appear when the case was called for trial.↩4. A decision may be entered against a defaulting party pursuant to Rule 123(a) or against a taxpayer who fails to appear at trial pursuant to Rules 149(a) and 123(b).↩5. Such arguments appear in the petition, petitioner's reply to the amendment to the answer, and petitioner's motion for summary judgment.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625448/	EMILY ANNETTE AGNUS LESER, EXECUTRIX, ESTATE OF ANNIE E. AGNUS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Leser v. CommissionerDocket No. 21293.United States Board of Tax Appeals17 B.T.A. 266; 1929 BTA LEXIS 2323; September 17, 1929, Promulgated 2323 Under a deed of trust executed by her father in 1883 the petitioner's decedent was granted a general power of appointment to designate the persons to whom certain property should pass upon her decease. The power of appointment was exercised. The decedent died March 29, 1922. Held, that the value of the appointed property was includable in the gross estate of the decedent for the purpose of determining the amount of the estate tax. Oscar Leser, Esq., for the petitioner. Harold Allen, Esq., for the respondent. SMITH 266 The taxes in controversy in this proceeding are estate taxes in the amount of $5,970.34 representing the difference between the amount of the tax determined by the Commissioner ($6,294.48), and the amount of tax paid by the petitioner ($324.14). The question in issue is whether the value of certain property over which the decedent had a power of appointment, and which she exercised, was properly includable in her gross estate under section 402(e) of the Revenue Act of 1921, the decedent having died March 29, 1922. 267 FINDINGS OF FACT. Petitioner's decedent (who is styled "Anne E. Agnus" in the deed of trust, 2324 but otherwise as "Annie E. Agnus") died March 29, 1922. As administratrix pendente lite the petitioner filed a return for estate tax on March 29, 1923, which contained the following statement: Under a deed of trust executed April 9, 1883, by Charles C. Fulton (recorded among the Land Records of Baltimore City in Liber R.T.A. No. 962, folio 9 etc.) a power of appointment over a certain portion of the trust property was conferred on the decedent. At her death several paper writings were filed in Orphans' Court purporting to exercise said power. Caveats to said writings have been filed, and are still undetermined, by reason of which there has been no probate of any will. It will therefore be impossible to report whether or not any property has passed under a power of appointment until after these contests are concluded. The undersigned, who was appointed administratrix pendente lite on May 16, 1922, also contends that if any property should pass under appointment in this case, the same is not within the purview of the Estate Tax act; and also that said act is invalid so far as it purports to affect such property by including it in the gross taxable estate of the decedent. 2325 The other property of the decedent was returned at a valuation of $87,009.73, which, after allowable deductions, produced a "net estate for tax," as reported by petitioner, of $32,413.99 on which a tax of $324.14 was duly paid. On withdrawal of the caveats, the will and codicils were admitted to probate, and on October 2, 1924, the petitioner qualified as sole executrix. Thereafter, on June 26, 1926, the respondent issued a 30-day letter, reporting certain tentative determinations, all but one involving minor charges (none of which are here in dispute); the exception being the addition of $238,194.03 to the gross estate, comprising "transfers, powers of appointment." This $238,194.03 is shown by the 30-day letter as consisting of the following: Powers of appointmentReturnedTentatively determinedDecedent's one-sixth interest in the American Buildinglocated on southwest corner of Baltimore and SouthStreets, Baltimore, Md., valued at net $546,500$0.00$91,083.34Decedent's one-eighth interest in the undivided surplusof the Baltimore American and Commerical Advertiser,newspaper business, Baltimore, Md..00141,377.81Property at 1916 Eutaw Place, Baltimore, Md.005,732.882326 The same values were used by the Commissioner in determining the deficiency in estate tax of $5,970.34, of which the petitioner was advised in the deficiency notice of September 15, 1926. Under a deed of trust executed on April 9, 1883, by decedent's father, Charles Carroll Fulton, then owner of the Baltimore American268 newspaper, all of the property of said Fulton was conveyed to Felix Agnus (husband of Annie E. Agnus) in trust to pay the income to the settlor for life and on his death (which occurred June 7, 1883) to administer the trust further as follows: A residence property on Eutaw Place in Baltimore (in which the settlor held a leasehold interest subject to an irredeemable ground rent - which leasehold interest, under the law of Maryland, is personal property) was directed to be held "in trust for the sole and separate use of the said Annie E. Agnus, so that she be suffered and permitted at all times to receive and take the clear rents, issues, income and annual produce of the said trust property," or to occupy the property as she might see fit. The deed gave her full power to sell and dispose of the property and retain the proceeds. Neither the corpus nor2327 the income were to be subject to the control of her husband nor liable for his debts or engagements. If not disposed of during her lifetime, then the property was to be held by the trustee "for the use and benefit of such person or persons as she, by last will and testament or by any instrument of writing in the nature or purporting to be last will and testament, appropriately executed, shall have named, limited and appointed to take and have the same." In default of testamentary disposition, the property, if undisposed of in her lifetime, was given in trust for the use, benefit and behoof of her children - or descendants, per stirpes; or to her heirs at law, if there were no descendants. This item of property remained undisposed of at the time of Mrs. Agnus' death, and is the same piece of property which was included by the respondent as a part of her estate at a valuation of $5,732.88. The principal part of the estate of Charles Carroll Fulton, the settlor, consisting then (in 1883) of a newspaper plant and building, was, after his death, held by the trustee in trust to pay an annuity to the settlor's widow and to distribute the income from the remainder among the four children2328 of the settlor. As to three of the children the deed of trust gave simple life estates with remainders over. As to the fourth child - Annie E. Agnus, the petitioner's decedent, it gave a life estate in the income and provided: And upon the decease of the said Anne E. Agnus, and as to one-half of the part or share or portion of said principal estate property and subject out of which her said portion or part of the rents, issues, income and annual produce arises, together with one-half of her said part or portion of the income and annual produce aforesaid, in trust for the use and behoof of such person or persons as she, by her last will and testament or by any instrument of writing in the nature of or purporting to be a last will and testament, appropriately executed, shall have named, limited and appointed to take and have the same, which will or testament or instrument of writing she is declared competent and is hereby authorized and empowered to make and execute, whether she be sole or covert. 269 Under the deed of trust, the remaining one-half portion of the corpus, the income from which was payable to Mrs. Agnus during her lifetime, was given, on her death, to her2329 children and descendants, who were also to receive the other one-half portion thereof in the event of the failure of Mrs. Agnus to exercise the power of appointment. The items of $91,083.34 and $141,377.81, set forth in the respondent's deficiency letter, under "Powers of Appointment," aggregating $232,461.15, comprise so much of the monies and other property of the Fulton Trust Estate as was appointed by the will of the petitioner's decedent, Annie E. Agnus under the last above quoted clause of the deed of trust. The power of appointment given to Mrs. Agnus by her father in his deed of 1883 was referred to in her testamentary writing of November 4, 1912. After describing the source of the power, the will provides: Now, therefore, in the exercise of said power and authority and of every other power, authority or right, to the full extent as conferred upon me or possessed by me, I do give, devise, bequeath and appoint to my said two daughters, Elise Carrol Agnus and Emily Annette Agnus Leser, in equal shares so much of the corpus of the said Trust Estate conveyed by or held under said Deeds of Trust, or any of them, and of the rents, issues, income and annual produce thereof, 2330 as I have the right or power to appoint or dispose of as aforesaid or in any manner; and I hereby nominate, limit and appoint my said two daughters to take and receive the same in equal shares as aforesaid, it being my intention hereby to exercise all power and right whatever which I have to dispose of any part of the corpus, rents, issues, income, annual produce and profits of the Trust Estate conveyed by or held under all or any of said Deeds of Trust, and of any interest or estate therein. By her codicil of 1916, the decedent testatrix modified the provisions of the 1912 will by converting the absolute one-half interest of each daughter, to a life estate, with remainder over. In item 4, the codicil provided: 4. I may add that I intended my last will and testament as modified by this codicil, to operate as a disposition and appointment not only of all my own estate, but of all and every part of the property of every kind conveyed by or referred to in each of the deeds of trust mentioned in my last will and testament, of which I have or may have the right to dispose, and of all property of every kind of which I have or may have, by any instrument, the right or power to dispose. 2331 Both the will of 1912 and the codicil of 1916 were republished by the codicil of November 4, 1921, which, after making certain new bequests contained this provision: 5. I hereby confirm and republish my last will and testament dated the fourth day of November, 1912, as modified by said codicil of April 19th, 1916, and by this codicil, with the exception and explanation that my intentions as to the 270 estate which I intend my daughter Elise Carroll Daingerfield to take thereunder in the share or shares I have in my said will and in said codicil of April 19th, 1916, given and appointed to her, is a life estate only for her own life; and I hereby revoke all other wills, codicils and testamentary papers heretofore made by me intending my said last will and testament of November fourth, 1912, my said codicil of April 19th, 1916, and this codicil to express my final will. All the property included by the respondent as part of decedent's gross estate, because passing by power of appointment exercised by decedent in her will, had its situs in Maryland at the time of the death of the testatrix; and none of it was included in the inventory of the estate of the testatrix filed2332 in the Orphans' Court of Baltimore; nor was it administered upon by her executrix, the petitioner. OPINION. SMITH: The question raised by this proceeding is whether the value of the property with respect to which the decedent exercised a testamentary power of appointment constituted a part of the gross estate of the decedent for the purpose of the estate tax. The applicable statute is section 402 of the Revenue Act of 1921, which provides, so far as material: That 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 - * * (e) To the extent of any property passing under a general power of appointment exercised by the decedent (1) by will, or (2) by deed executed in contemplation of, or intended to take effect in possession or enjoyment at or after, his death, except in case of a bona fide sale for a fair consideration in money or money's worth. No question is raised by this proceeding as to the values of the appointed property determined by the respondent, provided such appointed property is includable as a part of the gross estate2333 of the decedent. The petitioner contends: (1) That as to the bulk of the property which passed by appointment ($232,461.15), the power was not a "general" one, but was particular or special, because the donee had no power to appoint to herself in her lifetime. (2) That under the law of Maryland, which is controlling, none of the property - even including the leasehold estate on Eutaw Place, as to which there was a general power - passed under the power of appointment exercised in 1922; but that it passed under the deed of trust of 1883, which created the power. (3) That if section 402(e) of the Revenue Act of 1921 be construed as reaching the property in question, it is unconstitutional and void, so far as it affects this estate. 271 With respect to the first objection made to the inclusion of the value of the appointed property in the gross estate, it is argued that the power given to the decedent by the deed of trust executed on April 9, 1883, was not a general power of appointment, since the decedent could exercise the power only by will, and, further, that she could not have brought the property into the market whenever her necessities or wishes led2334 her to do so. This is substantially the same argument which was made before the Distric Court for the Eastern District of Pennsylvania in Whitlock-Rose v. McCaughn, 15 Fed.(2d) 591, in which it was stated: * * As before stated, it is urged upon us by the plaintiff that the power is not a general one, because it is restricted in the mode of its exercise to the one method of a will. We have been referred to no case (except the one before mentioned and next discussed) as so deciding. A number of authorities have been brought to the support of the contrary doctrine. Without going into these, it seems clear that the word "general" is not defined by the mode or manner of the exercise of the power, but by the absence of limitations of the power when exercised in the prescribed manner. * * * It was there held that a power may be general though it may be exercised only by will. This decision was affirmed in 21 Fed.(2d) 164, in which it was said: * * * A power is regarded as "general" when it is not restricted by the donor to particular objects or beneficiaries, though the method of exercising it may be restricted and limited to a testamentary2335 paper. Tucker v. Alexander (C.C.A.) 15 F.(2d) 356; Hume v. Randall,141 N.Y. 499">141 N.Y. 499, 503, 36 N.E. 402">36 N.E. 402; Greenway v. White,196 Ky. 745">196 Ky. 745, 246 S.W. 137">246 S.W. 137, 32 A.L.R. 1385">32 A.L.R. 1385. "A general power of appointment by will enables the donee to devise the property of [to] any person who may have the capacity to take." Underhill on the Law of Wills. To the same effect is Fidelity Trust Co. v. McCaughn, 1 Fed.(2d) 687. In the light of the foregoing decisions, we are of the opinion that it is immaterial that the decedent in the proceeding at bar could not exercise the power for her own benefit during her lifetime. The second objection to the inclusion in the value of the appointed property in the gross estate is that under the Maryland law no property passed under the power of appointment exercised by the decedent in 1922, but that it passed directly from the donor of the power to the appointee. Reference is made to Galard, etc., v. Winans,111 Md. 434">111 Md. 434; 2336 74 Atl. 626, in which it was stated: * * * It is also well settled in this state that in such case the appointee takes title, not under the will making the appointment, but directly from the donor of the power, and "in like manner as if the power and the instrument executing it had been incorporated in one instrument." Conner v. Waring,52 Md. 732">52 Md. 732, 733; Price v. Cherbonnier,103 Md. 107">103 Md. 107, 63 Atl. 209. * * * It is further claimed that under the Maryland law the appointed property was not subject to the debts of the donee of the power and 272 that therefore the donee had no ownership of the appointed property. In support of this latter proposition reference is made to Balls v. Dampman,63 Md. 390">63 Md. 390; 16 Atl. 16, where it was said: * * Mrs. Balls had, under her husband's will, only the power to appoint - that is, to name by will - the person or persons to whom the property should go; and she had no authority to devise it for the payment of her debts, - that is, to incumber or consume it altogether for her own use. The construction insisted on would, if adopted, practically convert her2337 from a mere life tenant into an owner of the fee. She had no right to bind this property for the payment of her debts, or to fasten those debts upon it; and, had such an intention on her part been expressly stated in her will, it could not have been given effect, because not within the scope of her power of appointment. * * See, also, Price v. Cherbonnier,103 Md. 107">103 Md. 107; 63 Atl. 209, and cases cited; also, McClernan v. McClernan,73 Md. 283">73 Md. 283; Welsh v. Gist,101 Md. 606">101 Md. 606. In United States v. Field,255 U.S. 257">255 U.S. 257, it was stated: But the existence of the power does not of itself vest any estate in the donee. Collins v. Wickwire,162 Mass. 143">162 Mass. 143, 144, 38 N.E. 365">38 N.E. 365; Keays v. Blinn,234 Ill. 121">234 Ill. 121, 124, 84 N.E. 628">84 N.E. 628, 14 Ann.Cas. 37; Walker v. Treasurer, etc.,221 Mass. 600">221 Mass. 600, 602, 603, 109 N.E. 647">109 N.E. 647; Shattuck v. Burrage,229 Mass. 448">229 Mass. 448, 451, 118 N.E. 889">118 N.E. 889. See Carver v. Jackson,4 Peters 1">4 Pet. 1, 93, 7 L. Ed. 761">7 L.Ed. 761. In 2338 Chanler v. Kelsey,205 U.S. 466">205 U.S. 466, the Supreme Court had the following to say in sustaining a statute of the State of New York imposing an inheritance tax upon property passing under a general power of appointment: However technically correct it may be to say that the estate came from the donor and not from the donee of the power, it is self-evident that it was only upon the exercise of the power that the estate in the plaintiffs in error became complete. Without the exercise of the power of appointment the estates in remainder would have gone to all in the class named in the deeds of William B. Astor. By the exercise of this power some were divested of their estates and the same were vested in others. It may be that the donee had no interest in the estate as owner, but it took her act of appointment to finally transfer the estate to some of the class and take it from others. Notwithstanding the common law rule that estates created by the execution of a power take effect as if created by the original deed, for some purposes the execution of the power is considered the source of title. It is so within the purpose of the registration acts. A person deriving2339 title under an appointment is considered as claiming under the donee within the meaning of a covenant for quiet enjoyment. 2 Sugden on Powers, 3d ed., 19. In Pennsylvania Co. for Insurance on Lives, etc., v. Lederer,292 Fed. 629, it was stated: * * * It is well settled that under the law of Pennsylvania the appointee of a power takes, when he takes, not under the will of the donee of the power, but under the will of the donor. In other words, the principal of this trust estate, when it passed to the appointees of the daughter, although the exercise of the power of appointment was made by the will of the daughter, none the less passed under the will of the father. 273 It, nevertheless, held that the value of the appointed property was properly includable in the gross estate of the decedent under the provisions of the Revenue Act of 1918, which provided for the inclusion of such property in precisely the same language as the Revenue Act of 1921. The court further stated: * * We can discover in the words of Congress no other meaning than the intention of measuring the tax to be paid by the gross value of all the property of the decedent which2340 passed by will plus the value of all property which passed in practical effect by the same will, although it passed, not by virtue of dominion over property, but by virtue of a power of appointment. The thing done might in respect to the one be called the exercise of a right, and in respect to the other a power, but both were possessed and had a value which could be used as a measure. We are unable to see any insurmountable obstacle to the acceptance of this construction of the act in the criticism that the tax levied is computed by a measure which has no relation to the thing measured. To measure the tax which the estate of one person should pay by the value of the estate of another person deserves as a scheme of taxation all the censure which counsel for defendant has heaped upon it. This is not what Congress has done. Congress, as already noted, has recognized that a person may have the indicated two things of value, and has adopted as its measure the value of that which belonged to the decedent, to which is added as an increment the value of that over which the testator had the power of control to the extent to which that control was exercised. This tax is an excise tax. 2341 It is levied upon the privilege enjoyed by one who makes disposition of property to take effect at his death. How such a tax shall be measured is wholly within the control of Congress. The fact that under the Maryland law the appointed property may not be subjected to the debts of the appointor is, in our opinion, beside the question. The taxing statute requires the inclusion in the gross income of property passing under a general power of appointment. It is unquestionable that the appointor has an interest in the appointed property. The decedent in the proceeding at bar could have directed that the appointed property pass to others than her own daughters. Such property is required by the statute to be included in the gross estate of the decedent and we therefore think it immaterial that under the Maryland law such property is not subject to the debts of the decedent. We now pass to the third contention of the petitioner, that if section 402(e) of the Revenue Act of 1921 should be construed as reaching the appointed property in question, the provision is unconstitutional and void so far as it affects this estate. This situation was also considered by the District Court2342 for the Eastern District of Pennsylvania in Pennsylvania Co. for Insurance on Lives, etc., v. Lederer, supra. It was there stated: * * It follows that this tax, if lawful, may be levied upon the estate of the daughter, but not upon the estate of the father. The consequence is, as already stated, that the upholding of this tax levy takes one-half of the 274 estate of the daughter, and that the whole of the estate proper of the donee of a power, who exercises it, might be taken to pay the tax on that which passed by the exercise of the power, and indeed an estate might be rendered insolvent by being insufficient to pay the tax levied. A retort to the argument implied in such a presentation of the question is ready at hand. It is that the donee of the power (if it be a general power of appointment) has control over such a situation, and can impose the payment of the tax upon the beneficiaries of the exercise of the power, or (at least possibly) may avoid liability to the tax altogether by its nonexercise. The petitioner contends that the situation involved in the instant proceeding is substantially the same as that involved in 2343 Nichols v. Coolidge,274 U.S. 531">274 U.S. 531, in which an effort was made by the Government to collect a tax on a transfer of property passing at the time of death measuring it in part by property which the decedent had to pay irrevocably and in good faith prior to the enactment of the taxing statute. The Supreme Court defines the provision as "arbitrary, whimsical, and burdensome" amounting to confiscation and violation of the Fifth Amendment. We think that the situation in the instant proceeding is substantially different from that which obtained in Nichols v. Coolidge, supra, for here the decedent died subsequent to the effective date of the Revenue Act of 1921, and had the power to change her will up to the date of her death. The situation in the instant proceeding is much the same as that which obtained in Chase National Bank v. United States,278 U.S. 327">278 U.S. 327, in which it was held that transfers subject to the estate tax under the Revenue Act of 1921 include, by virtue of sections 401 and 402(f) thereof, life insurance on the decedent procured after the effective date of that Act and payable to another than his estate or executor, 2344 when the policy reserved to the insured the right to change the beneficiary and the premiums were paid by the insured. It was there stated: * * By § 406 the executor is required to pay the tax, but, if so paid, he is given by § 408 the right to recover from the beneficiaries a part of the tax, and by § 409 they are made personally liable for a share of it if not so paid. * * * It is true, as emphasized by plaintiffs, that the interest of the beneficiaries in the insurance policies effected by decedent "vested" in them before his death and that the proceeds of the policies came to the beneficiaries not directly from the decedent but from the insurer. But until the moment of death the decedent retained a legal interest in the policies which gave him the power of disposition of them and their proceeds as completely as if he were himself the beneficiary of them. The precise question presented is whether the termination at death of that power and the consequent passing to the designated beneficiaries of all rights under the policies freed of the possibility of its exercise may be the legitimate subject of a transfer tax, as is true of the termination by death of any of the2345 other legal incidents of property through when its use or economic enjoyment may be controlled. * * 275 The objection urged by plaintiff under the second question, that the statutory method of fixing the tax and securing its payment infringes the Fifth Amendment, need not detain us. It is said that both the tax on those who share in the decedent's estate and that paid by the beneficiaries is larger than it otherwise would be if the proceeds of the insurance had not been included in the decedent's gross estate. But the increase in the tax to both is a consequence of including the amount of the policies in the gross estate in determining the net which is made the measure of the graduated transfer tax. The objection amounts to no more than saying that if the transfer of the policies or their proceeds be taxed, they should not be included with the other property of the estate in determining the rate of the tax. As it is the termination of the power of disposition of the policies by decedent at death which operates as an effective transfer and is subjected to the tax, there can be no objection to measuring the tax or fixing its rate by including in the gross estate the2346 value of the policies at the time of death, together with all the other interests of decedent transferred at his death. Stebbins v. Riley,268 U.S. 137">268 U.S. 137. The inclusion in the gross estate of gifts made in contemplation of death under § 402(c) has a like effect. For reasons above stated, the constitutionality of section 402(e) of the Revenue Act of 1921, so far as it relates to the instant proceeding, is sustained. Reviewed by the Board. Judgment will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625449/	APPEAL OF STUART W. WEBB.Webb v. CommissionerDocket No. 5591.United States Board of Tax Appeals5 B.T.A. 366; 1926 BTA LEXIS 2896; October 30, 1926, Decided 2896 1. The taxpayer's distributive share of the income of a partnership of which he was a member, from April 1, 1919, to December 31, 1919, determined. 2. Under the Revenue Act of 1918, the basis, in this case the cost, for determining the gain derived or loss sustained upon the sale in 1919 of certain shares of stock, should not be reduced by the amount of a tax-free distribution made in March, 1917. Appeal of Caroline S. McLean,4 B.T.A. 487">4 B.T.A. 487. 3. The taxpayer kept his books and rendered his returns on a cash receipts and disbursements basis, but now claims that his income for the taxable year 1919 should be computed upon the accrual basis, for the reason that the Massachusetts income tax levied upon the income for the year 1919 accrued on December 31 of that year and constituted a proper deduction from gross income for the purpose of Federal tax upon the accrual basis, and that a computation of his income upon the cash receipts and disbursements basis did not clearly reflect his income. Held, that the Massachusetts income tax did not accrue within the year in which the income upon which it was levied was earned, and it can not be said that the method of2897 accounting employed by the taxpayer in keeping his books did not clearly reflect income. James W. Mudge, Esq., for the petitioner. M. N. Fisher, Esq., for the Commissioner. LITTLETON367 This appeal is from the determination of a deficiency of $34,012.69 for the calendar year 1919. It is claimed that (1) the taxpayer's distributive share of the profits of the partnership of Bond & Goodwin from April 1, 1919, to December 31, 1919, was $27,036.27, instead of $60,121.33, as determined by the Commissioner; (2) in determining the profit from the sale in 1919 of certain shares of stock, the Commissioner erred in reducing the cost of said stock by the amount of the dividend paid in March, 1917, out of earnings accumulated prior to March 1, 1913; (3) a computation of the tax for 1919 upon the cash receipts and disbursements basis did not clearly reflect income, for the reason that taxpayer was not thereby permitted to take a deduction from gross income in the amount of the Massachusetts income tax levied in 1920 upon the income for 1919. FINDINGS OF FACT. The taxpayer is a resident of Boston, Mass.During the period from April 1 to December 31, 1919, he2898 was a member of the firm of Bond & Goodwin, a partnership, engaged in the sale of securities. His share of the profits of the partnership during the period from April 1, 1919, to December 31, 1919, was 15 per cent of the amount by which the sale price of securities exceeded the book value thereof on April 1, 1919. The Commissioner determined that the taxpayer's distributive share from this partnership for 1919 was $60,121.33. His distributive share of the partnership profits for the period April 1 to December 31, 1919, was $27,036.27. In March, 1917, the taxpayer purchased 68-6/13 shares of the stock of the Clinton Wire Cloth Co., a Massachusetts corporation, at $554.50 a share, said shares having a par value of $100 each. These shares were purchased through Estabrook & Company, acting as agents for the taxpayer and others, the date of purchase and the entire number of shares purchased for all of the interested individuals being as follows: March 2, 1917, 3,961 shares; March 9, 1917, 33 shares. At a meeting of the directors of the Clinton Wire Cloth Co. held March 10, 1917, a cash dividend of $392 a share was declared from the surplus of the corporation accumulated prior2899 to March 1, 1913, payable to stockholders of record at the close of business on that date. This dividend was paid on March 12, 1917, and was received by Estabrook & Company, acting as agents for the taxpayer and other individuals for whom Estabrook & Company had purchased the stock, and was applied as part payment on the purchase price of such stock. At a meeting of the directors of the Clinton Wire Cloth Co. held March 14, 1917, a stock dividend of 150 per cent was declared 368 against a transfer from surplus to the capital account of $600,000, the taxpayer's holdings of stock being thereby increased to 171-2/13, having a cost per share based upon the $554.50 a share cost of the 68-6/13 shares originally purchased, of $221.80. During the year 1919 he sold the aforementioned 171-2/13 shares at $148 a share. The cash dividend of $392 a share declared on March 10, 1917, was paid from the surplus of the corporation accumulated prior to March 1, 1913, and not from paid-in capital. It was not the proceeds of the sale by the corporation of any of its plant or operating assets. No stock of the corporation was surrendered in connection with or in consideration of the declaration2900 or payment of the dividend. No endorsement of full or partial distribution in liquidation was made upon any of the shares of the corporation's stock in connection with or on consideration of the declaration or payment of the dividend. The corporation continued uninterruptedly in the conduct of the business for which it was organized for several years subsequent to the declaration and payment of the cash dividend. In determining the profit or loss upon the sale of the stock in 1919, the Commissioner reduced the cost thereof by the amount of the tax-free distribution in March, 1917, of $392 a share. This computation resulted in a profit of $14,205.77, instead of a loss of $12,631.15 as claimed by the taxpayer. The taxpayer kept his books and rendered his returns for 1919 and prior years upon the cash receipts and disbursements basis. During 1919 and for many years prior thereto he was a resident of the Commonwealth of Massachusetts and was subject to the Massachusetts income tax. The Massachusetts income tax was payable in October of each year and was measured by the income received during the preceding year. During the years 1917 to 1921, inclusive, the taxpayer's income2901 was inconstant and was subject to extreme fluctuation. The Massachusetts State income tax paid in the years 1917 to 1921, inclusive, and the tax based upon the income during the same years, referred to below as accrued, was as follows: PaidAccrued1917$466.19$2,377.3119182,377.312,765.0619192,765.0620,352.63192020,352.63139.771921139.77420.39The taxpayer's net taxable income for the years 1917 to 1921, inclusive, computed on the cash basis, and on the accrual basis, including the accrual of the Massachusetts income tax in the year in which the income was earned, compare as follows: Cash basisAccrual basis1917$54,758.84$68,903.15191864,382.0567,474.051919280,821.90248,321.56192015,866.4234,561.1119217,084.33 (Loss)18,579.22 (Loss)369 The Federal income tax due for the years 1917 to 1921, inclusive, computed upon the income shown in the preceding tabulation on the cash basis and on the accrual basis, compare as follows: Cash basisAccrual basis1917$3,871.06$6,013.5419189,408.4410,381.701919126,003.14106,502.941920401.992,479.781921None.None.2902 In the administration of the Massachusetts income tax law, the taxing authorities of the Commonwealth permit the accrual of the tax in the year in which the income on the basis of which the tax is computed accrues, which is the year preceding the year in which the tax is assessed and becomes payable. OPINION. LITTLETON: As to the first issue, the parties have stipulated that the taxpayer's distributive share of the income of the partnership of Bond & Goodwin for the period from April 1 to December 31, 1919, was $33,085.06, less than that determined by the Commissioner. In the computation of the deficiency for the taxable year, the income should therefore be reduced by this amount. The second issue is governed by the decision of the Board in the , decided July 29, 1926, in which it was held that the basis - in that appeal the March 1, 1913, value of shares of stock - should not be reduced by the amount of a tax-free distribution made thereon in 1917, in determining the gain derived from the sale of the stock in 1919. General Acts of the Commonwealth of Massachusetts, 1916, chapter 269, imposing a tax upon income2903 received from certain forms of intangible property, provides in section 1 as follows: There shall be levied in the year nineteen hundred and seventeen, and in each year thereafter, a tax upon incomes as hereinafter set forth. Section 2 provides: Income of the following classes received by any inhabitant of this commonwealth during the calendar year prior to the assessment of the tax shall be taxed at the rate of * . See 370 also section 5, containing the same language relating to the tax upon annuities, professions, employments, trade or business. Section 7 provides: Persons who customarily estimate their income and expenditure on a basis other than that of actual cash receipts and disbursements may, with the approval of the tax commissioner, compute upon a similar basis their income taxable under this act. * * * Section 8 relating to estates of deceased persons provides in part as follows: The income received by persons since deceased shall be taxed to their estates. The income received by estates of deceased persons who last dwelt in this commonwealth shall be subject to the taxes assessed by this act, to the extent that the persons to whom such income2904 is payable or for whose benefit it is accumulated are inhabitants of this commonwealth, which shall be assessed to the executor or administrator, and before the appointment of an executor or an administrator such taxes shall be assessed in general terms to the estate of the deceased, and the executor or administrator subsequently appointed shall be liable for the tax so assessed as though assessed to him. * * Section 12 provides "Every individual inhabitant of the commonwealth, including every partnership, association or trust, whose annual income from all sources exceeds two thousand dollars shall annually make a return of his entire income * * ," with certain exceptions not material here. This section further provides as follows: The return shall be made on or before the first day of March in each year, and shall relate to the income received during the calendar year ending on the preceding thirty-first day of December. The return required by this section shall be filed by every person who is at any time between the first day of January and the thirtieth day of June in any year an inhabitant of the commonwealth, if such person has in the preceding year received income2905 taxable hereunder: * * * Every person who is an inhabitant of the commonwealth at any time between the first day of January and the thirtieth day of June, both inclusive, in any year, shall be subject to the taxes imposed by this act. Under the foregoing provisions of the statute, an individual taxpayer is not liable for the tax until he has been an inhabitant of the Commonwealth during some portion of the first six months of the year following the year in which the income was earned. This condition must occur before any liability for the tax comes into existence. At the close of December 31 in any year, there is no liability for the tax. In the opinion of the Board, the Massachusetts income tax is a tax for the year in which it is assessed and becomes payable, in this case for the year 1920, and is measured by the income for the preceding calendar year. 371 The statute of the Commonwealth of Massachusetts levying the tax upon persons who are inhabitants of the Commonwealth in the year succeeding that in which the income was received appears conclusive on this point. It is unnecessary, in view of our conclusion as to the accrual of the tax, to discuss the question2906 of whether the method of accounting employed by the taxpayer correctly reflected his income, since the Massachusetts tax was the only item upon which the taxpayer relied in support of his claim that his income for 1919 should be computed upon the accrual basis. Judgment will be entered on 15 days' notice, under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625451/	COPP COLLINS AND FRANCES T. COLLINS, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentCollins v. CommissionerDocket No. 1591-78.United States Tax CourtT.C. Memo 1979-516; 1979 Tax Ct. Memo LEXIS 8; 39 T.C.M. (CCH) 783; T.C.M. (RIA) 79516; December 27, 1979, Filed 8 Petitioners sold their principal residence and excluded the gain thereon from income under sec. 1034, I.R.C. 1954. While petitioners failed to meet the time requirements of sec. 1034, they argued that they should be execused from these time limits due to difficulties not of their making that they encountered in beginning construction of and occupying their new principal residence. In the alternative, they argued that their gain should be long-term capital gain because they had had an option to purchase their former principal residence for over six months before they sold that house although they exercised this option less than six months before they sold the house. Held: Sec. 1034 must be strictly construed and petitioners' construction problems cannot exempt them from the statute's clear requirements. Held further: Holding period for property does not begin to run until it is actually purchased or otherwise acquired. It does not include the period during which the property could have been acquired under an option to purchase. Copp Collins, pro se. Jerome D. Sekula, for the respondent. STERRETTMEMORANDUM FINDINGS OF FACT AND OPINION STERRETT, Judge: By letter dated November 16, 1977, respondent determined a deficiency in income taxes paid by petitioners for their taxable year ended December 31, 1973 in the amount of $1,997.45. The only issue for our decision is whether petitioners are entitled to the protection of section 1034, I.R.C. 1954, on the sale of their home in 1973. If we should find10 that section 1034 does not apply, then we must determine the nature, as short term or long term, of the capital gain generated by the sale. 1FINDINGS OF FACT Some of the facts were stipulated and are so found. The stipulation of facts and supplemental stipulation of facts, together with the exhibits attached thereto, are incorporated herein by this reference. Petitioners Copp and Frances T. Collins, husband and wife, resided in Great Falls, Virginia at the time they filed their petition. Petitioners' 1973 calendar year cash basis joint Federal income tax return was timely filed with the Internal Revenue Service's Memphis Service Center. Petitioners filed an amended return with respect to their 1973 taxable year on July 8, 1976. Attached to this amended return as a Form 2119, Sale or Exchange of Personal Residence. On this Form 2119 petitioners indicated that they had sold their former residence on May 31, 1973, that they had started to construct their new residence on July 29, 1974, and that they had occupied their new residence on May 15, 1975. Also11 attached to their amended return was a letter detailing the many problems petitioners had encountered in building their new residence which had caused them to fail to meet the time requirements of section 1034. As Frances T. Collins is a party hereto only by virtue of having filed jointly with her husband, "petitioner" as used herein shall refer solely to Copp Collins. Prior to June 1971, petitioner resided in the Washington, D.C. area. In June 1971, petitioner was appointed assistant to the Secretary of the Inteior and field representative for the United States Department of Interior in the Southwest region. He was stationed in Albuquerque, New Mexico. Petitioner moved to Albuquerque in the summer of 1971. Starting in September of 1971 petitioner occupied a house on Eakes Road in Albuquerque (former residence) as his principal residence. Petitioner resided in this house and used it as his principal residence until June of 1973. From October 14, 1971 until March 30, 1973 petitioner occupied his former residence under a lease with an option to purchase granted by Ernest and Henrietta Gurule, the owners of the house. While the Gurules had executed this lease/option agreement12 on October 14, 1971, petitioner did not execute the lease/option agreement until November 11, 1972 when he signed an identical, but separate, copy of the agreement aleady signed by the Gurules. Petitioner purchased his former residence on March 30, 1973. Petitioner sold his former residence on May 31, 1973. In June of 1973 petitioner moved from his former residence to the metropolitan Washington, D.C. area.We have found that petitioner began construction of his new residence on July 29, 1974. Petitioner moved into this new house on May 15, 1975. Construction of petitioner's new principal residence was completed in August of 1975. On or about the May 31, 1973 settlement date for petitioner's sale of the Eakes Road house, petitioner received reimbursement from the American Savings and Loan Association, Albuquerque for 5 months of previously escrowed real estate taxes. This reimbursement represented 3 months of escrowed real estate taxes paid by petitioner and 2 months paid by the Gurules. For his taxable year 1973 petitioner did not include in income any of the gain he realized on the sale of his former residence. In his notice of deficiency respondent included short-term13 capital gain of $8,376.19 in petitioner's 1973 income in respect of his sale of his former residence. The parties have stipulated that, if section 1034 does not apply to petitioner's sale of his former residence, respondent's computation of the amount of gain set forth in his notice of deficiency is correct. OPINION The primary issue before us is whether petitioner is entitled to the benefits of the non-recognition provisions of section 1034 on his sale of the Eakes Road house. As it stood during the taxable year in issue section 1034 provided in relevant part as follows: SEC. 1034. SALE OR EXCHANGE OF RESIDENCE (a) Nonrecognition of Gain.--If property (in this section called "old residence") used by the taxpayer as his principal residence is sold by him after December 31, 1953, and, within a period beginning 1 year before the date of such sale and ending 1 year after such date, property (in this section called "new residence") is purchased and used by the taxpayer as his principal residence, gain (if any) from such sale shall be recognized only to the extent that the taxpayer's adjusted sales price (as defined in subsection (b)) of the old residence exceeds the taxpayer's14 cost of purchasing the new residence. * * (c) Rules for Application of Section.--For purposes of this section: * (5) In the case of a new residence the construction of which was commenced by the taxpayer before the expiration of one year after the date of the sale of the old residence, the period specified in subsection (a), * * shall be treated as including a period of 18 months beginning with the date of the sale of the old residence.The regulations as they stood during the taxable year in issue provided in relevant part as follows: SEC. 1.1034-1. Sale or exchange of residence.--(a) Nonrecognition of gain; general statement. Section 1034 provides rules for the nonrecognition of gain in certain cases where a taxpayer sells one residence after December 31, 1953, and buys or builds, and uses as his principal residence, another residence within specific time limits before or after such sale. * * * * * (c) Rules for application of section 1034.--(1) General Rule; limitations on applicability. Gain realized from the sale (after December 31, 1953) of an old residence will be recognized only to the extent that the taxpayer's adjusted sales price of15 the old residence exceeds the taxpayder's cost of purchasing the new residence, provided that the taxpayer * * * (ii) within a period beginning one year before the date of such sale and ending 18 months after such date uses as his principal residence a new residence the construction of which was commenced by him at any time before the expiration of one year after the date of the sale of the old residence * * . Whether construction of a new residence was commenced by the taxpayer before the expiration of one year after the date of the sale of the old residence will depend upon the facts and circumstances of each case. * * Respondent argues that the stipulated facts show that petitioner simply did not comply with the statute's time limits. Petitioner admits that he failed to comply with the statute's time limits but argues that extenuating circumstances should exculpate his failure. While we sympathize with petitioner's predicament, we must hold for respondent. The law applicable to the taxable year before us is clear. Construction of the new principal residence had to commence before the expiration of 1 year after the date of sale of the old residence. The parties hereto16 have stipulated that petitioner sold his former residence at Eakes Road on May 31, 1973. Construction of petitioner's new principal residence did not commence, however, until July 29, 1974. This is over 1 year from the sale date. Further, petitioner was obligated to "use" his new house as his principal residence within 18 months of the former property's sale date. Petitioner has conceded that he did not move into his new home until May of 1975. Thus petitioner failed, and has conceded that he failed, to meet the 18-months requirement of the statute. The stipulated facts compel but one conclusion: that petitioner has filed to fulfill the requirements set by Congress for obtaining the benefits of section 1034. No provision is made in the statute for extenuating circumstances. The statute must be strictly construed and applied. Elam v. Commissioner, 477 F.2d 1333">477 F.2d 1333, 1335 (6th Cir. 1973), affg. per curiam 58 T.C. 238">58 T.C. 238 (1972). The statute's plan is to allow taxpayers to roll over gain on the sale of a principal residence only if the sale proceeds are reinvested within a relatively short span of time in a new principal residence. We do not have the17 power to move a line Congress has drawn. We hold for respondent on this issue. Next we must decide the short-term or long-term nature of petitioner's gain on this sale of his former residence. In 1973 section 1222 defined long-term capital gain as gain from the sale or exchange of a capital asset held for more than 6 months. Section 1222(3). Short-term capital gain was defined as gain from the sale or exchange of a capital asset held for not more than 6 months. Section 1222(1). Petitioner argues that, while he actually purchased and sold the Eakes Road house within approximately 2 months, we should treat him as if he were the house's owner when he first moved into it under the lease option. Petitioner points out that the lease/option contract provided that all his rental payments would be applied to the sales price of the house should he decide to buy and argues that, as he could have exercised his option on the house at any time, we should treat him as if he had exercised it at the earliest possible date. Clearly an option to purchase property is not itself a purchase of the property. Molbreak v. Commissioner, 61 T.C. 382">61 T.C. 382, 391 (1973), affd. per curiam*18 509 F.2d 616">509 F.2d 616 (7th Cir. 1975). When the Gurules granted petitioner an option, they merely agreed to hold open their offer to sell. They did not actually sell the house. Accordingly, until petitioner purchased the house, he could not sell or exchange it. When he did sell it, he did so afte less than 6 months of ownership. Petitioner's gain on the sale was short-term capital gain. Decision will be entered for the Respondent. Footnotes1. We note that our decision herein will automatically affect petitioners' claimed general sales tax deduction.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625452/	Aaron Greenfeld v. Petitioner.Greenfeld v. CommissionerDocket No. 5622-64.United States Tax CourtT.C. Memo 1966-83; 1966 Tax Ct. Memo LEXIS 201; 25 T.C.M. (CCH) 471; T.C.M. (RIA) 66083; April 20, 1966201 Martin B. Greenfeld, 200 E. Lex., Baltimore, Md., for the petitioner. Charles F. T. Carroll, for the respondent. DAWSONMemorandum Findings of Fact and Opinion DAWSON, Judge: Respondent determined deficiencies in petitioner's income taxes and additions to tax as follows: Additions to TaxSec. 6653(a),YearDeficiencyI.R.C. 19541960$4,086.81$204.3419615,245.20262.2619622,611.06130.55 Petitioner has conceded a $300 mathematical error in the computation of his income for the year 1961. There are two issues for decision: (1) Is petitioner entitled to any claimed gambling losses for the years 1960 through 1962? (2) Is petitioner liable for the additions to tax under section 6653(a), Internal Revenue Code of 1954, due to negligence or intentional disregard of rules and regulations? Findings of Fact Some of the facts were stipulated by the parties and are hereby found accordingly. Aaron Greenfeld (hereinafter called petitioner) resides in Baltimore, Maryland, and during the taxable years 1960, 1961 and 1962 filed his Federal income tax returns with the district director of internal revenue, 202 Baltimore, Maryland. Since 1952 the petitioner's sole occupation has been that of wagering on horse races. During the years here involved he wagered on horses at various race tracks such as Bowie, Laurel and Pimlico in Maryland and at Delaware Park in Delaware. Each time the petitioner visited a race track to wager he purchased a program and entered in it the amounts won or lost on specific races. When he returned home, petitioner would "net" the daily wins and losses and enter the result on master sheets which he kept for each month of the racing season. 1 Except for the months of February and March, 1960, these master sheets were prepared at the beginning of each month. Petitioner would show on each sheet the year and month involved, list the individual racing days down the left side of the page and have two columns, marked "win" and "lose." Most of the entries in the win and lose columns were made on a day-to-day basis, although some of the sheets bear entries in these columns that were made consecutively. The petitioner did not offer in evidence any of the daily programs on which the results of his betting activity were initially entered. He presented no evidence of individual203 wagers, the amounts thereof, the horses involved or any loss tickets. Racing was canceled because of inclement weather at Bowie race track on February 25 and on March 3, 4, 5, 7, 8, 10 and 11 and at Pimlico race track on December 12 and 13 in 1960. Racing was also canceled at Laurel race track on March 6 and 7 in 1961. None of these dates appear on petitioner's master sheets. Petitioner is single, has no dependents and during the years 1960 through 1962 lived in a single room in a Baltimore hotel. His average annual living expenses for the years in issue were $3,075, which is about $500 in excess of his average reported income for Federal tax purposes from wagering and a disability pension. The difference between petitioner's income and his expenses was provided by personal loans from his brother. During the years 1960, 1961 and 1962 the petitioner did not own an automobile, had no assets pledged to204 others, had no bank accounts, life insurance policies or real estate. His assets then consisted of personal clothing, $700 in cash and 200 shares of common stock purchased for $1,800 with money borrowed from his brother. Between the years 1952 and 1959 the petitioner's income tax returns were audited by the respondent in 1954 and again in 1957. On these occasions the respondent's agents inspected petitioner's records but did not disallow the figures shown in the "lose" columns. Petitioner was not told to keep his records in a different fashion. However, in 1963, the respondent informed the petitioner that he should keep more detailed records showing the name of the horse wagered on, the amount bet, and the resulting win or loss. He was also told that he should retain his losing tickets. In preparing his Federal income tax returns for the years in issue, petitioner added all the figures in the "win" columns of his monthly master sheets and subtracted the total of the figures in the "lose" columns. He reported the remainder as income for each year involved. Respondent disallowed all the claimed daily net losses and only allowed the losses entered into petitioner's computation of205 net "win" days. The disallowed deductions for "gambling losses" were $13,688 in 1960, $15,657 in 1961, and $9,894 in 1962. Petitioner incurred losses in his wagering transactions of $10,266 in 1960, $11,743 in 1961, and $7,420 in 1962. Opinion Petitioner first contends that the respondent is estopped from disallowing the daily net losses because he has tacitly approved petitioner's method of recordkeeping by failing to suggest that any changes were necessary during the 1954 and 1957 audits. There is no merit in this contention. Mere acquiescence in a taxpayer's treatment of an item in prior years does not prevent the Commissioner from attacking such treatment in later years. South Chester Tube Co., 14 T.C. 1229">14 T.C. 1229, 1235 (1950); Caldwell v. Commissioner, 202 F.2d 112">202 F. 2d 112, 115 (C.A. 2, 1953); Laura Massaglia, 33 T.C. 379">33 T.C. 379, 386-387 (1959); and Barry Meneguzzo, 43 T.C. 824">43 T.C. 824, 836 (1965). Accordingly, the respondent is not estopped from asserting these deficiencies. We think this case is particularly suited to an application of the so-called Cohan rule (39 F.2d 540">39 F. 2d 540). Petitioner testified in a candid and forthright manner206 about his wagering activities and his method of recording his wins and losses. His testimony was fortified by a statement of his net worth which stands uncontroverted in the record. The respondent, however, introduced the expert testimony of a document examiner for the United States Treasury Department who examined all the master sheets. He stated that a few bore win and loss entries made consecutively (not necessarily on a day-to-day basis) while the majority were completed on a day-to-day basis. 2On the evidence presented we believe the petitioner did sustain losses in excess of those allowed by the respondent. This Court is competent to determine the extent of such losses under the approximation rule laid down in Cohan v. Commissioner, 39 F. 2d at p. 544. See also Jack Showell, 23 T.C. 495">23 T.C. 495 (1954), reversed on other grounds 238 F. 2d 148 (C.A. 9, 1956), on remand T.C. Memo. 1957-22 (January 31, 1957), reversed on other grounds, 254 F. 2d 461 (C.A. 9, 207 1958), on second remand T.C. Memo. 1960-7 (January 29, 1960), affd. 286 F. 2d 245 (C.A. 9, 1961). The facts of this case are close to those in Herman Drews, 25 T.C. 1354">25 T.C. 1354 (1956). There, as here, the record indicated that the taxpayer was a truthful and candid witness who in fact sustained substantial net losses over those allowed by the Commissioner. In applying the Cohan rule, we allowed Drews a net gambling loss of $2,400 compared to $3,140 claimed in his tax return. On the authority of Showell and Drews, we have likewise applied the Cohan rule here and found that the petitioner sustained losses in the amounts set forth in our Findings of Fact. Respondent argues that the petitioner's records do not substantiate these losses because they are merely summaries of daily entries that were destroyed long ago and, without the support of the daily racing program entries, we lack sufficient evidence upon which to make a Cohan determination. In support of his argument the respondent cites Plisco v. United States, 306 F. 2d 784 (C.A.D.C., 1962) and Stein v. Commissioner, 322 F. 2d 78 (C.A. 5, 1963), affirming a Memorandum208 Opinion of this Court. In these circumstances we regard the respondent's reliance on Plisco and Stein as misplaced. In each of those cases a refusal to apply the Cohan rule was upheld in factual situations differing significantly from those in this case. In both Plisco and Stein the taxpayers relied solely on their summarized accounting records in attempting to carry their burden of proof. This petitioner, on the other hand, has supported his summary records with proof of his net worth. In both Plisco and Stein the reliability of the taxpayers' testimony was questionable and the accounting records were found on the whole to be unreliable. Here, by contrast, the petitioner has impressed us with his candor and veracity in such a way as to lend credence to the substantial authenticity of his summary records. Our impression in this respect is borne out to some extent by the testimony of respondent's own expert witness. Hence, on the facts alone, we find the Plisco and Stein decisions distinguishable. Moreover, to accept respondent's position would require us to read into those two cases something which is not there, namely, a prohibition against the exercise of our own judgment in such209 cases in the light of the evidence adduced at trial. It is for us to decide what effect should be given to the petitioner's records which, of course, depends on the facts and circumstances of each case. While we agree generally with the statements made in Plisco and Stein that taxpayers should not be permitted to profit from their inexactitudes, we cannot agree with respondent that these cases create an absolute rule of law converting a basically factual question into a mandatory prohibition against the use of the Cohan rule where the only available data are summary statements rather than records of original entry. Suffice it to say that whatever possible defects these summary records might contain, we will not use them to deny completely the gambling losses claimed by petitioner. In view of our findings with respect to the losses incurred and the summary records kept by petitioner, we hold that he did not intentionally disregard the rules and regulations of the Commissioner, nor was he negligent. Consequently, he is not liable for the additions to tax under section 6653(a). To reflect the conceded adjustments for 1961 and the determinations made herein, Decision will be entered210 under Rule 50. Footnotes1. The months of October and November of each year were combined on a single sheet. No master sheets were prepared for the months of January and August in 1960 and 1962 or for the month of September in all three years because the petitioner placed no wagers during such months.↩2. As to some of the sheets, the expert expressed no conclusive opinion because he felt there were not enough individual entries upon which to form a judgment.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625459/	H. B. MOORE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Moore v. CommissionerDocket No. 3544.United States Board of Tax Appeals8 B.T.A. 749; 1927 BTA LEXIS 2828; October 10, 1927, Promulgated 2828 1. Petitioner's net sales, expenses, and amount of taxes paid, determined for the taxable year. 2. Respondent's determination of the amounts of the allowances for depletion and depreciation, approved. 3. The petitioner's distributive share of partnership net incomh determined in accordance with the findings of fact and conclusions of law made in the appeals of the remaining members of the partnership. 4. The evidence held insufficient to establish a net loss for the year 1919. 5. The action of the respondent in disallowing as a deduction an alleged loss of $3,000 approved for eant of evidence. 6. Deductions claimed by reason of bad debts allowed in part and disallowed in part. Maynard Teall, Esq., for the petitioner. A. H. Murray, Esq., for the respondent. GREEN 749 In this proceeding the petitioner seeks a redetermination of his income tax for the year 1920, for which the Commissioner has determined a deficiency in the amount of $5,434.87. The petitioner alleges errors as follows: (1) The taxpayer erroneously reported $123,695.11 as gross income from the sale of coal, and the Commissioner erroneously determined net2829 sales as $123,695.11. The correct amount is $121,837.39. (2) The Commissioner erroneously determined the aggregate of items for materials and supplies and other expense for the Ruth Mine to be $10,569.13, whereas the correct aggregate of such items was $13,802.65. (3) The Commissioner allowed deductions for taxes only in the amount of $515.06, whereas the correct amount was $692.10. (4) The Commissioner refused to allow as a deduction from gross income the depreciation and depletion sustained by the Ruth Mine property in the year 1920 amounting to $22,224.80. (5) The Commissioner of Internal Revenue erroneously increased the amount of the taxpayer's income received from the Youghiogheny Coal and Coke Company (in which the taxpayer was a partner) by the disallowance of $4,453.10 paid by the partners for Legal Services and $1,000.00 contributed by the partners to the Salvation Army in the year 1920. (6) The Commissioner of Internal Revenue refused to allow a deduction of $14,062.33 in 1920, the loss sustained from the operation of the Ruth Mine in 1919; which deduction taxpayer was entitled to in 1920 because his business operated at a loss in 1918. (7) The Commissioner2830 of Internal Revenue refused to allow as a deduction from gross income the loss of $3,000.00 sustained by the taxpayer through the sale of real estate. 750 (8) The Commissioner of Internal Revenue refused to allow as a deduction from gross income the amount of $5,800.00 representing monies loaned and found to be uncollectible in the year 1920. The amended answer of the respondent contains the following allegations: Alleges that the deficiency letter is in error, in so far as it has allowed a deduction for salaries and wages in the amount of $56,563.17; and alleges further that no amount whatever should have been allowed. Alleges that the deficiency letter is in error, in so far as it has allowed a deduction for bonuses to employees in the amount of $12,567.73; and alleges further that no amount whatever should have been allowed. These affirmative allegations of the answer were not controverted by the petitioner in any pleadings. No proof was offered by either party as to the matters therein set forth. FINDINGS OF FACT. The petitioner is a resident of Dawson, Pa., and during the year in question was engaged in the mining of coal from what is known as the2831 Ruth mine, which mine is located in the vicinity of Dawson. During the preceding years the petitioner had at times operated this mine under the name of the Parkhill Coal Co. In the year 1913 the petitioner purchased all of the coal in what is known as the Freeport vein underlying a certain tract of land containing 119 acres, together with surface rights sufficient for the operation of the mine, at a total cost of $5,000. Subsequent mining operations disclosed that of the 119 acres only 5.84 acres were underlain by the Freeport vein. Immediately contiguous to the property thus acquired by purchase, there was property in which one Rainey owned the Freeport vein of coal, and, at the time of the purchase by the petitioner, Rainey requested the petitioner to mine out the coal owned by him. The mine purchased by the petitioner had theretofore been developed to a small extent. In 1913 he extended the openings and proceeded to the development of the mine and to the erection of tipple, mine buildings, etc., necessary to the operation thereof. Entries, tunnels, etc., made upon the property owned by the petitioner were continued into the property owned by Rainey, and at a time not disclosed2832 by the record, the petitioner commenced to remove coal therefrom. In 1917 the petitioner procured a lease from Rainey covering the Freeport vein, the consideration of which was the payment of a royalty of 10 cents per ton. So far as the record discloses the petitioner had not paid for the coal removed by him from the Rainey property prior to the execution of the lease. All of the coal upon the land owned by the petitioner was mined through what is known as Mine No. 1. Not later than 1915, all the 751 coal having been removed, this mine was abandoned and a new one known as No. 2 opened up some distance away. Facilities other than those within Mine No. 1 were used in connection with Mine No 2. These facilities consisted of the tipple, buildings, etc., above mentioned, and a spur track connecting the mine with the railroad. The record establishes certain developments, expenditures, and costs, which, for reasons appearing in the opinion, we have not set forth in detail. The tonnage of coal removed from the Ruth mine was as follows: Year:Tons.1913(1)19141,693.7519151,295.0319161,103.0919176,853.0519183,673.95191911,921.75192020,381.811921138.211922, to and including October6,283.412833 The coal mined from January 1, 1917, to October, 1922, amounted to 49,252 tons. It is impossible to ascertain from the record at what point of time the petitioner's operations crossed the line between the coal owned in fee and coal acquired under the lease. No estimate can be made as to the amount of coal mined from either source. For the year 1920, the respondent denied all deductions for royalties, depreciation or depletion. The petitioner's gross sales from the Ruth mine were $124,679.47. All the coal from the Ruth mine was sold to the Youghiogheny Coal & Coke Co., a brokerage firm. The gross sales represent the aggregate credit to the petitioner's accounts on the books of the Youghiogheny Coal & Coke Co. There were charges to the petitioner's account during the year, aggregating $498.65, covering allowances and adjustments made in the prices of coal where disputes arose with purchasers. The books of the Youghiogheny Coal & Coke Co. show further charges of $2,065.46 to the petitioner's account during the period from January 19, 1921, to August 16, 1921, covering similar allowances and adjustments on shipments of coal made in 1920. The petitioner's2834 net sales from the Ruth mine in the year 1920 were $124,180.82. In the year 1920, the petitioner expended the sum of $11,827.93 for materials and supplies used by him in the Ruth mine. The evidence does not differentiate expenses and capital expense items, and accordingly no allocation of these amounts can be made. The Commissioner has allowed as a deduction the sum of $10,569.13. During the year 1920, the petitioner owned a one-third interest in a partnership known as Youghiogheny Coal & Coke Co., coal 752 brokers. This partnership was composed of the petitioner, R. D. Henry, and Otto Hass. Beginning with the year 1917, the partnership sold for the petitioner all of the coal mined from the Ruth mine and for such services was paid a commission. In the same year the partnership paid for legal services the sum of $4,453.10 and made a contribution to the Salvation Army in the sum of $1,000. In , the deduction of the above amounts was approved by this Board. The petitioner's returns for the years 1918, 1919, and 1920, were prepared upon the basis of cash receipts and disbursements. For the year 1920, an amended2835 return, upon the accrual basis, was filed. The return for the year 1918 disclosed a loss from the operation of business and profession of $6,641.44. This loss was reduced by other income and increased by other deductions, as set forth in the return, to the sum of $4,093,65. The return for 1918 disclosed a net loss of $1,348.46 resulting principally from a sale in the operation of business in the amount of $1,506.73. Attached to the return for this year is a memorandum of the Commissioner's office, as follows: (1) From (E) not requested. (2) The amount of depletion, if any, would have no bearing on the amount of tax as the taxpayer suffered a loss in this year. (3) It is recommended that the case be audited and closed for 1918. This memorandum was signed by a valuation engineer and approved by the chief of the coal valuation section. The memorandum bears the stamp "Approved for audit, November 24, 1922, Head of Natural Resources Division." Attached to the return is a further memorandum from which it appears that no tax is due for the year 1918, upon which there is stamped, "Reviewed October 16, 1923." There is also attached to this return a waiver signed by the petitioner, 2836 upon which there is a notation "effective until March 15, 1925." In 1905 or 1906, the petitioner acquired a residence property at a cost of $6,000, upon which in 1907 he expended the sum of $3,500 in making improvements. The property was sold in 1920 for $4,000. In the year 1920 the petitioner deposited $800 as margins with a firm of brokers in Uniontown, Pa. In that year the brokerage firm became insolvent and went into bankruptcy and the petitioner's claim against it was wholly worthless. In the year 1920, the petitioner's nephew was in need of money and the petitioner, either as guarantor or surety, joined with his nephew in the execution of a series of notes aggregating $5,000, the entire proceeds of which went to the nephew. When the notes became due, the nephew was unable to pay and the notes were renewed, the petitioner again signing as guarantor or surety. At the end of the renewal period and before the expiration of the year 1920, the petitioner 753 was compelled to pay the notes. The petitioner's nephew at that time was insolvent and stated that he did not think he would be able to pay the notes. OPINION. GREEN: The errors alleged in the petition2837 will be disposed of in the order in which they appeared in the pleadings. The first allegation of error relates to the amount of the gross income received from the sale of coal. The petitioner's accounts were kept on the basis of receipts and disbursements. All of the coal mined in 1920 from the Ruth mine was sold through the Youghiogheny Coal & Coke Co. The sales for such year amounted to $124,679.47. During that year the broker paid $498.65 by way of adjustments to the purchasers of this coal and the parties have stipulated that this amount is a proper deduction from gross income. In 1921, in adjusting disputes with customers, the amount of $2,965.46 was paid out on sales which had been consummated in the year 1920. Such latter amount may not be deducted in the year 1920 inasmuch as the petitioner is upon a cash receipts and disbursements basis and the amounts were not paid out for him or by him during such year. The net sales from the Ruth mine amounted to $124,180.82. The second allegation of error relates to the amount deductible as expense of operating the mine. Inasmuch as there is nothing in the record which enables us to segregate the capital expenditures from2838 the expenses, we approve the determination of the Commissioner in allowing as a deduction on this item the sum of $10,596.13. The third allegation of error is disposed of by our findings of fact that in the year 1920 the petitioner paid taxes in the sum of $962.10. The fourth allegation of error relates to the deduction to be allowed for depreciation and depletion. It is clear from the evidence that, in the year in question, the petitioner mined no coal of which he was the owner. We can not determine from the evidence whether the petitioner had a lease prior to March 1, 1913, or the value thereof on that date if such lease was made prior to that date. It is clear that the lease as such cost the petitioner nothing, so that if acquired subsequent to March 1, 1913, there is no capital expenditure to be returned through the depletion allowance and we therefore hold that he is entitled to no deduction for depletion. It is equally clear from the evidence that the petitioner had expended substantial amounts in tracks, buildings, mine equipment and machinery, all of which, or course, are properly the subject of depreciation. The expenditures in this regard were in part made in Mine2839 No. 1, which was wholly abandoned before the taxable year. We are unable to ascertain the amounts of the expenditures which relate only to Mine 754 No. 1. As relates mining property, there are two common methods of determining how much of the total amount to be recovered through the depreciation allowances shall be allowed in any given year. In one method the physical life of the asset or group of assets to be depreciated is determined and the basis for depreciation divided by the years all live. In the other method the total recoverable tonnage of mineral is ascertained and this amount is divided by the cost or their basis of depreciable property to the end that to each ton is allocated its proper proportion of this cost and the annual deduction obtained by multiplying such factor by the number of tons removed in any given year. The evidence in this case is wholly lacking as to the life of the property, the physical life of the depreciable assets, or as to the recoverable tonnage, and without these factors it is impossible to compute the proper allowance for depreciation. It follows, therefore, that we must approve the action of the Commissioner in disallowing the amount2840 of depletion and depreciation claimed. The fifth allegation of error relates to the net income of a partnership of which the petitioner was a member and to his distributive share of the net income of that partnership. These questions were disposed of in the decision mentioned in the findings of fact, and the net income of the partnership and the petitioner's distributive share thereof should be computed in accordance with that decision. The sixth allegation of error relates to a deduction for 1920 in the amount to which it is alleged the petitioner is entitled by reason of net losses alleged to have been sustained in the operation of the mine in the years 1918 and 1919. The mere introduction of returns, to which in one instance the Commissioner's memorandum was attached, is not sufficient to establish a net loss, particularly where it is apparent that the Commissioner has made no effort to accurately compute the tax for such years, he having proceeded upon the theory that no tax was due, being satisfied as to such fact from the data disclosed on the return. It seems clear that the petitioner does have a net loss but we are wholly unable to ascertain the amount thereof, and2841 accordingly deny the petitioner's claim therefor. As to the issue raised by the seventh allegation of error, we must affirm the Commissioner for the reason that the March 1, 1913, value of the property and the allowable depreciation thereon have not been proven. Without these factors the computation can not be made. The eighth allegation of error involves two questions: First the right to a deduction for an alleged bad debt, and second, the right to a deduction for an alleged loss of $800. After a careful consideration of all the evidence, we are unable to conclude that the petitioner's claim against his nephew was worthless. It is clear that the nephew was insolvent during the year in question, but in view 755 of all of the circumstances surrounding the creation of this obligation, we are not willing to regard a temporary insolvency as proof of worthlessness. The petitioner contends that he is entitled to deduct $800 as a loss sustained as the result of his transactions with the brokerage concern. We think that the loss was sustained, that petitioner's position in this regard is well taken, and that he is entitled to deduct the amount claimed in the year in question. 2842 As to the affirmative allegations of the answer, the respondent offered no proof. A presumption of correctness attaches to his original action upon the two items involved and his present decision with reference thereto can not be said to do more than take away this presumption, and we accordingly conclude that the petitioner is entitled to these deductions as previously allowed by the Commissioner. Judgment will be entered after 15 days' notice, under Rule 50.Considered by STERNHAGEN, ARUNDELL, and LANSDON. Footnotes1. Practically none. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625460/	Ann Edwards Trust, L. C. Edwards, Jr., Trustee, et al., Petitioners, 1 v. Commissioner of Internal Revenue, RespondentEdwards Trust v. CommissionerDocket Nos. 25471, 25472, 30884, 30885United States Tax Court20 T.C. 615; 1953 U.S. Tax Ct. LEXIS 118; June 17, 1953, Promulgated 118 Decisions will be entered under Rule 50. 1. Petitioners made lump-sum sales of citrus groves having growing crops on the trees. Held, that the gain realized, which was attributable to the fruit on the trees, is taxable as ordinary income. Watson v. Commissioner, 345 U.S. 544">345 U.S. 544.2. Held, further, that two of the petitioners may return such ordinary income on the installment basis, under section 44 (b) of the Internal Revenue Code. Chester H. Ferguson, Esq., George W. Ericksen, Esq., and Rex Meighen, C. P. A., for the petitioners.Newman A. Townsend, Jr., Esq., for the respondent. Turner, Judge. TURNER 616 The respondent has determined deficiencies in income tax against the petitioners for the taxable year 1945, as follows:Docket No.PetitionerDeficiency25471Ann Edwards Trust$ 39,982.3425472Nancy Edwards Trust68,412.2830884W. F. Edwards83,374.8330885L. C. Edwards, Jr83,946.80119 The questions to be determined are: (1) whether that part of the gain realized upon sale of a citrus grove, which is attributable to the growing crop on the trees at the time of sale, is taxable as ordinary income or as long-term capital gain, and (2) if that part of the gain realized by the petitioners Ann Edwards Trust and Nancy Edwards Trust, which was properly allocable or attributable to the growing crop, was ordinary income, whether they may return such income on the installment basis under section 44 of the Internal Revenue Code.FINDINGS OF FACT.Some of the facts have been stipulated and are found as stipulated.Petitioners Ann Edwards Trust, L. C. Edwards, Jr., Trustee, and Nancy Edwards Trust, L. C. Edwards, Jr., Trustee, are trusts for which the indicated trustee is the fiduciary, both having their principal office at Tampa, Florida. Petitioners W. F. Edwards and L. C. Edwards, Jr., are individuals and brothers who reside at Dade City, Florida. For the taxable year 1945 fiduciary income tax returns were filed on behalf of the trusts and individual income tax returns were filed by W. F. Edwards and L. C. Edwards, Jr., with the collector of internal revenue for Florida. 120 The two trusts, one for the benefit of each daughter, were created by L. C. Edwards, Jr., in 1940, by gifts of citrus groves as follows: The Pasadena Grove to the Ann Edwards Trust, and the Paris Grove to the Nancy Edwards Trust.The Edwards brothers owned undivided one-half interests in two citrus groves referred to as Fechtig Grove and Thonotosassa Grove.Petitioners sold their respective groves to the Triple E. Development Company on the following dates and for the following lump-sum considerations:PetitionerGroveDate soldConsiderationAnn Edwards TrustPasedenaAug. 9, 1945$ 225,000Nancy Edwards TrustParisAug. 9, 1945200,000W. F. EdwardsFechtigSept. 24, 1945322,500L. C. Edwards, JrThonotosassaOct. 15, 1945200,000The Edwards brothers each received $ 261,250 for their respective undivided interests in their two groves.617 On the respective dates of the sales in question there were growing crops of citrus fruit on the trees which fruit was not then mature and for that reason not then susceptible of being harvested.The consideration of $ 225,000 for the Pasadena Grove was payable to the Ann Edwards Trust, as follows: $ 50,000 within 90121 days and $ 50,000 annually from the date of the transaction. The only payment made to petitioner Ann Edwards Trust during the taxable year 1945 was the amount payable within 90 days.The consideration of $ 200,000 for the Paris Grove was payable to the Nancy Edwards Trust, as follows: $ 25,000 payable in cash, $ 25,000 in 90 days, and $ 50,000 annually from the date of the transaction. The only payments made to petitioner Nancy Edwards Trust during the taxable year 1945 were the cash amount and the amount payable within 90 days.On their income tax returns for the taxable year 1945, the Ann Edwards Trust and Nancy Edwards Trust each elected to treat the above sales in toto as installment sales under section 44 of the Internal Revenue Code.Each of the citrus groves disposed of by petitioners had been held in excess of 6 months.All expenses of cultivation and fertilization and other operating expenses, concerning the groves sold and incurred prior to the date of sale, were taken as deductions against ordinary income by the petitioners in their income tax returns for the taxable year involved.None of the petitioners reserved any right in or any part of the properties sold.Each 122 of the petitioners was engaged in the business of citrus farming and their respective groves were used by them in their citrus farming business. Each petitioner produced and normally sold mature citrus fruit only. Petitioners never inventoried citrus fruit on the trees either before or after maturity.In the above sales petitioners realized gain from the sale of citrus fruit as follows: Ann Edwards Trust, $ 66,831.83; Nancy Edwards Trust, $ 107,150.13; W. F. Edwards, $ 129,415.29; L. C. Edwards, Jr., $ 129,415.29.The citrus crops on the trees in the respective groves at the time the groves were sold were being held by petitioners primarily for sale to customers in the ordinary course of their trades or businesses.OPINION.The issue common to the four petitioners is whether the gain from the sale of the fruit on the trees at the time they sold their respective citrus groves was ordinary income, the fruit at the 618 time of the sale not being mature and not, therefore, ready to be harvested.This question has been recently decided by the Supreme Court, in Watson v. Commissioner, 345 U.S. 544">345 U.S. 544, affirming 197 F. 2d 56123 and 15 T. C. 800. It was held that on the sale of an orange grove with immature fruit on the trees, such part of the gain realized as was attributable to the crop was ordinary income because realized on the sale of property held primarily for sale to customers in the ordinary course of business. That decision controls this issue, and the respondent is sustained.The other issue relates only to the trust petitioners, who contend that they may return such ordinary income on the installment basis under section 44 of the Internal Revenue Code. 2124 On this issue, we think that the petitioners have met the requirements of the statute. If the fruit be regarded as personal property, the facts show that the sales in question were casual sales and not sales in the ordinary course of the petitioners' trade or business, even though the fruit on the trees at the time of the sale was held primarily for sale to customers in the ordinary course of such trade or business. Furthermore, there can be no question, we think, that a growing crop of citrus fruit would not be "property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year." If, on the other hand, the growing crop was realty, the statute carries no conditions or limitations on the right of a taxpayer to report its gain under section 44 (b), other than the limitations as to the amounts and times of the payments, and as to those conditions there is no argument that they have not been met. On this issue we accordingly hold for the petitioners.Decisions will be entered under Rule 50. Footnotes1. Proceedings of the following petitioners are consolidated herewith: Docket No. 25471, Ann Edwards Trust; Docket No. 25472, Nancy Edwards Trust; Docket No. 30884, W. F. Edwards; Docket No. 30885, L. C. Edwards, Jr.↩2. SEC. 44. INSTALLMENT BASIS.(a) Dealers in Personal Property. -- Under regulations prescribed by the Commissioner with the approval of the Secretary, a person who regularly sells or otherwise disposes of personal property on the installment plan may return as income therefrom in any taxable year that proportion of the installment payments actually received in that year which the gross profit realized or to be realized when payment is completed, bears to the total contract price.(b) Sales of Realty and Casual Sales of Personalty. -- In the case (1) of a casual sale or other casual disposition of personal property (other than property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year), for a price exceeding $ 1,000, or (2) of a sale or other disposition of real property, if in either case the initial payments do not exceed 30 per centum of the selling price (or, in case the sale or other disposition was in a taxable year beginning prior to January 1, 1934, the percentage of the selling price prescribed in the law applicable to such year), the income may, under regulations prescribed by the Commissioner with the approval of the Secretary, be returned on the basis and in the manner above prescribed in this section. As used in this section the term "initial payments" means the payments received in cash or property other than evidences of indebtedness of the purchaser during the taxable period in which the sale or other disposition is made.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/1763827/	304 S.W.3d 676 (2009) COMMONWEALTH of Kentucky, Appellant, v. Kevin T. McCOMBS, Appellee. No. 2007-SC-000127-DG. Supreme Court of Kentucky. March 19, 2009. As Modified on Denial of Rehearing March 18, 2010. 677 Jack Conway, Attorney General, Jeffrey Allan Cross, Assistant Attorney General, Office of the Attorney General, Frankfort, KY, Counsel for Appellant. Eric Griffin Farris, Lee Renee Remington, Buckman, Farris & Rakes, PSC, Shepherdsville, KY, Counsel for Appellee. Opinion of the Court by Justice CUNNINGHAM. Appellee, Kevin T. McCombs, and his wife, Lisa, were divorced in September, 2002. Shortly thereafter, McCombs assaulted Lisa's son, Curtis Carney, and a domestic violence order was issued preventing any contact between Curtis and McCombs. The protective order further prevented McCombs from entering Lisa's house. Though McCombs had sought reconciliation, Lisa informed him in December of 2002 that the divorce was permanent and no reconciliation was possible. Later that evening, McCombs went to Lisa's house, intoxicated. He broke into the garage in order to gain entry into the home through a door leading into the kitchen. He also admitted at trial that he cut the outside phone line for the express purpose of disabling the home's alarm system. Krystal Carney, Lisa's daughter, testified that McCombs kicked the garage door open, which struck her in the face. She noticed he had a crowbar in his hand, and he ordered her to be quiet. She ran into her brother's room for help. McCombs followed and began beating Curtis with the crowbar. Krystal fled the room and alerted her mother that McCombs was in the house. She then found her sister, and both girls ran outside to a neighbor's house. Curtis's and Lisa's testimony corroborated this version of events. Curtis further testified that McCombs hit him multiple times with the crowbar before Lisa began striking McCombs with a fire extinguisher. Realizing that McCombs was unfazed by the blow, she retrieved a knife from the kitchen and stabbed him. At this point, Curtis was able to escape the house and flag down a passing motorist. After being stabbed, McCombs calmed down somewhat. Lisa, a registered nurse, attempted to treat McCombs's wounds, but he refused. She then called police. McCombs's version of events differed somewhat. Though admitting he cut the phone line to the house, he claimed that he was in the garage retrieving personal items when Krystal invited him into the home. He further claimed that a quarrel ensued between him and Curtis which developed into a physical altercation, but that he did not remember who threw the first punch. He denied ever using a crowbar. McCombs acknowledged that his presence in the home was in violation of the protective order. A Bullitt County jury found McCombs guilty of first-degree burglary, fourth-degree assault, and violation of a protective order. He was sentenced to fifteen years, one year, and six months, respectively, to 678 be served concurrently. The Court of Appeals affirmed the conviction of violation of a protective order, but reversed the burglary and assault convictions, determining that they constituted double jeopardy. The Court of Appeals further held that the trial court erred when it determined, as a matter of law, that the crowbar was both a deadly weapon and a dangerous instrument. The Commonwealth appealed the decision to this Court and discretionary review was granted. The thrust of McCombs's argument to the Court of Appeals, which the Commonwealth challenges herein, is that the jury instructions were erroneous. McCombs was convicted of first-degree burglary pursuant to the following jury instruction: That in this county on or about the 4th day of December 2002 and before the finding of the Indictment herein, he entered or remained unlawfully in a building owned by Lisa Presley without the permission of Lisa Presley or any other person authorized to give such permission; AND That in doing so, he knew he did not have such permission; AND That he did so with the intention of committing a crime therein; AND That when in effecting entry or while in the building or in immediate flight there from [sic], he: (1) Used or threatened the use of a "crow bar" [sic] against Curtis Carney; OR (2) Was armed with a "crow bar" [sic]; OR (3) Caused physical injury to Curtis Carney. McCombs was convicted of fourth-degree assault pursuant to the following jury instruction: That in this county on or about the 4th day of December 2002 and within twelve (12) months before the finding of the Indictment herein, he caused physical injury to Curtis Carney; AND That in so doing: (1) The Defendant was acting intentionally; OR (2) The Defendant was acting wantonly; OR (3) The Defendant was acting recklessly when he struck Curtis Carney (if he did so) with the "crow bar." [sic] According to McCombs, the trial court erred in determining, as a matter of law, that the crowbar constituted a deadly weapon. Further, McCombs claims the problem was compounded by the fact that the instructions allowed a finding of guilt under multiple theories of first-degree burglary and fourth-degree assault. The Court of Appeals agreed that if the burglary conviction was reached under the "physical injury to Curtis Carney" element, double jeopardy would bar the conviction. The Court of Appeals reasoned that in such circumstances, the fourth-degree assault did not require proof of an additional fact than the burglary conviction; in other words, both could not be based on the injury to Curtis. Of course, this reasoning implicitly rests on the conclusion that the physical injury requirement of burglary requires a finding of an intentional, wanton, or reckless mental state. We turn first to the Court of Appeals' determination that McCombs's convictions for first-degree burglary and fourth-degree assault constitute double jeopardy. Both the Fifth Amendment of the United States Constitution and Section 13 of the Kentucky Constitution protect a criminal defendant from being punished twice for the same offense. Principles of double jeopardy do not, however, prevent a person from being charged with multiple offenses arising from the same course of conduct. "Double jeopardy does not occur 679 when a person is charged with two crimes arising from the same course of conduct, as long as each statute `requires proof of an additional fact which the other does not.'" Commonwealth v. Burge, 947 S.W.2d 805, 809 (Ky.1996), quoting Blockburger v. United States, 284 U.S. 299, 304, 52 S. Ct. 180, 76 L. Ed. 306 (1932). See also KRS 505.020 (codifying Blockburger test). Thus, we apply the Blockburger test to KRS 511.020 (first-degree burglary) and KRS 508.030 (fourth-degree assault). KRS 511.020 states, in pertinent part: (1) A person is guilty of burglary in the first degree when, with the intent to commit a crime, he knowingly enters or remains unlawfully in a building, and when in effecting entry or while in the building or in the immediate flight therefrom, he or another participant in the crime: (a) Is armed with explosives or a deadly weapon; or (b) Causes physical injury to any person who is not a participant in the crime; or (c) Uses or threatens the use of a dangerous instrument against any person who is not a participant in the crime. KRS 508.030 states, in pertinent part: (1) A person is guilty of assault in the fourth degree when: (a) He intentionally or wantonly causes physical injury to another person; or (b) With recklessness he causes physical injury to another person by means of a deadly weapon or a dangerous instrument. When a defendant is convicted of first-degree burglary under the "armed with explosives" theory or the "dangerous instrument" theory, and is convicted of fourth-degree assault, there is clearly no double jeopardy violation. The physical injury required for assault is not required for the burglary conviction, while the unlawful entry requirement for burglary distinguishes it from assault. The issue becomes more complicated when the first-degree burglary conviction rests on a finding that physical injury was inflicted on a non-participant in the crime. We addressed this issue in Butts v. Commonwealth, 953 S.W.2d 943 (Ky.1997), where Butts committed an assault which resulted in physical injury during the course of a burglary. He was convicted of fourth-degree assault and first-degree burglary. Looking to O'Hara v. Commonwealth, 781 S.W.2d 514 (Ky.1989), in which an assault was not permitted to form the basis of both an assault conviction and a robbery conviction; we found a double jeopardy violation in Butts. Focusing on the specific facts alleged in the indictment, we based this conclusion on the fact that the physical injury element which constituted the assault was the same physical injury alleged and proven as an element of the burglary. Upon careful reconsideration, we believe Butts was incorrectly decided. The physical injury element of fourth-degree assault and the physical injury element of first-degree burglary are not one and the same. The assault statute requires a finding that the injury was inflicted with an intentional, wanton, or reckless mental state. The burglary statute requires no such finding; it merely states that the offender "causes physical injury" to a non-participant. Under the burglary statute, the injury could be accidental. Nonetheless, McCombs argues that the physical injury element of burglary has an implied mental state. He also urges that when the same injury in fact forms the basis of both convictions, the culpable mental state will necessarily be the same. Stated otherwise, if the jury believed 680 McCombs acted intentionally with respect to the assault on Curtis, it necessarily believed he acted intentionally with respect to the physical injury underlying the burglary charge. Of course, our focus is directed towards the statutory elements of the offenses, as "[a]n overlap of proof does not necessarily establish a double jeopardy violation." Smith v. Commonwealth, 905 S.W.2d 865, 867 (Ky.1995). We have previously expressed our disagreement with this position: "KRS 511.020(l)(b) requires no culpable mental state to prove the `physical injury' aggravator, and a defendant may be found guilty of burglary first degree upon the physical injury of any nonparticipant if the injury is casually connected, pursuant to 501.060, to his conduct." Grundy v. Commonwealth, 25 S.W.3d 76, 87 n. 36 (Ky.2000). Furthermore, the plain language of the statute belies any contention that the physical injury must be committed with a specific mental state. Rather, we believe it is clearly the intent of the legislature that the basic crime of burglarythat is, the knowing and unlawful entry into a dwellingbe elevated when physical injury results, whether that injury was intended or not. See also Polk v. Commonwealth, 679 S.W.2d 231, 234 (Ky.1984) (finding no double jeopardy where defendant was convicted of first-degree assault and first-degree burglary, because assault conviction required additional finding that physical injury was both intentional and serious). In this case, we have considered "whether a single course of conduct has resulted in a violation of two distinct statutes and, if so, whether each statute requires proof of an additional fact which the other does not." Clark v. Commonwealth, 267 S.W.3d 668, 675 (Ky.2008). Here, fourth-degree assault requires a specific finding of an intentional, wanton, or reckless mental state. The physical injury element of first-degree burglary does not require such a finding and, therefore, McCombs's convictions for both offenses do not violate principles of double jeopardy. To the extent that this holding conflicts with Butts v. Commonwealth, that case is hereby overruled. The Court of Appeals also determined that the trial court erred in determining, as a matter of law, that the crowbar used by McCombs was both a "deadly weapon" and a "dangerous instrument." As noted above, the trial court inserted the term "crowbar" in the jury instructions where the terms "deadly weapon" and "dangerous instrument" are used by the first-degree burglary and fourth-degree assault statutes. We first address the trial court's determination that the crowbar was a deadly weapon. At the time of trial in this case, the question of whether an instrument is a deadly weapon was a matter of law to be determined by the trial court pursuant to Hicks v. Commonwealth, 550 S.W.2d 480, 481 (Ky.1977). Since then, we overruled Hicks and stated that the determination is a mixed question of law and fact properly left to the jury. Thacker v. Commonwealth, 194 S.W.3d 287, 290-91 (Ky.2006). Therefore, although for different reasons, we agree with the Court of Appeals that the trial court erred by not submitting this issue to the jury. Any error in jury instructions is presumed to be prejudicial. Harp v. Commonwealth, 266 S.W.3d 813, 818 (Ky.2008). Nonetheless, this presumption can be successfully rebutted upon a showing that the error was harmless. Id. An erroneous jury instruction that omits an essential element of the offense is subject to the harmless error analysis elucidated in Chapman v. California. Neder v. United States, 527 U.S. 1, 9, 119 S. Ct. 1827, 144 L. Ed. 2d 35 (1999). "That test ... is 681 whether it appears `beyond a reasonable doubt that the error complained of did not contribute to the verdict obtained.'" Neder, 527 U.S. at 15, 119 S. Ct. 1827, quoting Chapman v. California, 386 U.S. 18, 24, 87 S. Ct. 824, 17 L. Ed. 2d 705 (1967). See also Harp, 266 S.W.3d at 818 (noting that presumption of prejudice can be rebutted where error in jury instructions did not "affect" the verdict or judgment). Stated otherwise in Neder: "If, at the end of that examination, the court cannot conclude beyond a reasonable doubt that the jury verdict would have been the same absent the error ... it should not find the error harmless." 527 U.S. 1 at 19, 119 S. Ct. 1827, 144 L. Ed. 2d 35 (applying Chapman principles of harmless error where an element of the offense has been omitted from the jury's consideration). We have thoroughly reviewed the record in this case and conclude that the jury verdict would have been the same if the instructions had used the term "deadly weapon" rather than "crowbar." A "deadly weapon" includes "a billy, nightstick or club." KRS 500.080(4)(d). A club is "a heavy [usually] tapering staff [especially] of wood wielded as a weapon." Merriam-Webster's Collegiate Dictionary, 217 (10th ed.2002). A billyclub or nightstick is a police officer's club, made of steel or wood. Id. A crowbar is a solid iron or steel bar with a wedged end, commonly used as a pry or lever. Id. We believe that a crowbar is very similar to a nightstick or billyclub, particularly when wielded as a weapon. In this case, there was substantial evidence that McCombs used the crowbar as a metal club in his attack on Curtis. Furthermore, there was no evidence that the crowbar was anything other than a standard, metal club with a tapered end. For these reasons, we believe beyond a reasonable doubt the jury would have reached the conclusion that the crowbar was a deadly weapon and, therefore, the error did not affect the verdict. The error in the instructions was harmless. The Court of Appeals further held that the trial court erred by determining, as a matter of law, that the crowbar was a dangerous instrument. Ordinarily, the question of whether an object is a "dangerous instrument" is a jury determination, unless "it is undisputed from the evidence that the instrument employed on the occasion in question is one [capable of causing death or physical injury] and that it was in fact used or attempted or threatened to be used in such a manner[.]" Commonwealth v. Potts, 884 S.W.2d 654, 656 (Ky.1994) (emphasis added). Because McCombs denied ever using the crowbar against Curtis, we agree that the issue should have been submitted to the jury. Again, however, we believe the error is harmless. A "dangerous instrument" is "any instrument... article, or substance which, under the circumstances in which it is used, attempted to be used, or threatened to be used, is readily capable of causing death or serious physical injury[.]" KRS 500.080(3). Again, the crowbar used in this case was the typical solid metal club with a tapered end. A reasonable juror would readily conclude that such an instrument, when swung by an adult male, is readily capable of causing serious physical injury and even death. We are easily convinced beyond a reasonable doubt that the jury would have reached the same verdict, finding the crowbar to be a dangerous instrument, even if the issue had properly been included in the instructions. Any error did not affect the verdict and, therefore, was harmless. We distinguish this case from the recent decisions in Carver v. Commonwealth, 303 S.W.3d 110 (Ky.2010) and Sanders v. Commonwealth, 301 S.W.3d 497 (Ky.2010), 682 where we reversed persistent felony offender convictions because of issues relating to the jury instructions. In Carver, the jury instruction resulted in an improper conviction for first-degree persistent' felony offender because a misdemeanor conviction served as one of the underlying prior offenses. In Sanders, the jury instruction allowed for the crime of possession of drug paraphernalia (KRS 218A.500) to be enhanced to a first-degree persistent felony offender conviction, a result expressly forbidden by KRS 532.080. In both Carver and Sanders there was sufficient evidence in the record for a properly instructed jury to convict either defendant on the charge of being a persistent felony offender. However, reversal was required pursuant to the rationale used in Varble v. Commonwealth, 125 S.W.3d 246 (Ky.2004). In Varble, we reversed a conviction for manufacturing methamphetamine because the jury had actually been instructed on the lesser offense of possession of drug paraphernalia. Id. at 255. Thus, in Carver and Sanders reversal was necessary because the juries in those cases effectively found the defendant guilty under a jury instruction that on its face, constituted no crime. The applicability of Carver and Sanders is therefore limited to those situations where the jury instructions lead the jury to convict the defendant of a crime, but the elements contained in the jury instructions actually establish a different, uncharged crime or no crime at all. Our ruling in this matter follows a different line of cases where the juries are given instructions that are consistent with the charged crime, but where error has occurred regarding one of the elements of the crime. Wright v. Commonwealth, 239 S.W.3d 63 (Ky.2007); Thacker, 194 S.W.3d at 287; Potts, 884 S.W.2d at 656. For these reversal is not mandatory, and a harmless error standard may be applied in the error is preserved. Neder, 527 U.S. at 15, 119 S. Ct. 1827. For the reasons stated herein, that portion of the opinion of the Court of Appeals holding that McCombs's convictions for burglary in the first degree and assault in the fourth degree was double jeopardy is reversed. Further, that portion of the opinion of the Court of Appeals upholding McCombs's conviction for violation of a protective order is affirmed. The trial order and judgment of the Bullitt Circuit Court is hereby reinstated. All sitting. All concur.	01-04-2023	10-30-2013
https://www.courtlistener.com/api/rest/v3/opinions/4477154/	OPINION. Rice, Judge: This proceeding involves the following contested deficiencies in income tax and penalties determined under section 291 (a) of the 1939 Code: Income taco Sec. 291 (a) Year deficiency penalty 1948- $7,083.68 $1,770.92 1949- 18,557. 91 4,639.48 The issues to be decided are: (1) Whether the petitioner, a nonresident alien during the years in issue, was engaged in trade or business in the United States; and if so, (2) whether the respondent erred in determining penalties under section 291 (a) for petitioner’s failure to file United States income tax returns for such years. Concessions have been made with respect to other issues which will be taken into account in a Rule 50 computation. All of the facts were stipulated, are so found, and are incorporated herein by this reference. During the years in issue, petitioner was a Canadian citizen and a resident of Winnipeg, Manitoba, Canada. He filed no United States income tax returns during such years. On October 11,1946, petitioner and one George B. G. Bater entered into a partnership agreement to conduct a livestock dealership in Manitoba, Canada. Petitioner was entitled to 65 per cent of the profits of such partnership; Bater was entitled to 85 per cent. The partnership continued in existence until December 1,1949. Geneseo Sales Company was a partnership whose principal place of business was in Geneseo, Illinois. During the years in issue, it was also engaged in the livestock business. The entire capital interest in such partnership was owned by one R. S. Bollen; the other partner participated in profits because of labor contributed. Sometime during the year 1948, petitioner and Bollen entered into an oral agreement in behalf of their respective partnerships. They agreed that petitioner would purchase cattle in Canada at the lowest possible price and would then ship such cattle to Bollen to be sold in the United States at the highest available price. After petitioner purchased the cattle in Canada, he was empowered by the agreement to draw a draft on Bollen for the purchase price. The cattle were to be shipped in Bollen’s name. The agreement, however, provided that any loss on the cattle, whether én route or after delivery, was to be shared equally by petitioner and Bollen. Profit or loss from the sales of the cattle was to be equally divided between petitioner and Bollen. Pursuant to such agreement, petitioner bought and shipped cattle and Bollen sold them during the years in issue. The sales of the cattle were made from the stockyards of Geneseo Sales Company in Geneseo, Illinois. The Geneseo Sales Company kept a separate account on its books, entitled “Geneseo Sales Co. and W. C. Johnston & Co. Partnership Cattle Acct.” On the partnership information returns for 1948 and 1949, which the Geneseo Sales Company filed, it reported that it was a 50 per cent partner with W. C. Johnston under the above-described agreement for the purchase and sale of cattle. The W. C. Johnston Company’s share of the profits from its partnership with the Geneseo Sales Company was as follows: 1948-$22,050.64 1949- 42,587.33 Petitioner’s share of such profits was $14,332.92 in 1948 and $27,681.76 in 1949. The respondent determined that his share of such profits was taxable to him as income received from sources within the United States by a nonresident alien engaged in business in the United States. Section 211 (a) of the 1939 Code provides special tax treatment for income received from sources within the United States by nonresident aliens who are not engaged in trade or business in the United States. Section 211 (b), however, provides for the taxation of such income of a nonresident alien engaged in a trade or business in the United States without regard to section 211 (a), so that such a nonresident alien is fully taxable on all income received from such trade or business. Section 219 provides that a nonresident alien shall be considered as being engaged in trade or business within the United States if a partnership of which he is a member is so engaged. The substance of the petitioner’s argument that the respondent’s determination of the deficiencies is erroneous is that there was no partnership or joint venture between his Canadian partnership, W. C. Johnston & Co., and Bollen’s American partnership, Geneseo Sales Company. Petitioner argues that the moneys received by him in 1948 and 1949 from the sale of the cattle in question were compensation for his personal services to Bollen for purchasing such cattle in Canada. We think it clear from this record that the agreement between petitioner and Bollen was a partnership agreement in behalf of their two firms (which is to say in behalf of the partners of W. C. Johnston & Co. and the partners of the Geneseo Sales Co.), and that the activities carried on pursuant to that agreement were the activities of a partnership. Petitioner and Bollen in behalf of their firms joined together their money, labor, and skill for the purpose of carrying on the business of buying and selling livestock with a full community of interest in the profits and losses from such business. Commissioner v. Culbertson, 337 U. S. 733 (1949); Commissioner v. Tower, 327 U. S. 280 (1946). The parties stipulated into the record the testimony which Bollen would have given had he been called as a witness at the hearing. His testimony and the treatment of the profits from the venture on the books of the Geneseo Sales Company indicate that he considered the venture with petitioner to be a partnership. Petitioner did not appear at the hearing and we do not have the benefit of his testimony. But despite his arguments on brief to the effect that he was an agent of Bollen or the Geneseo Sales Company, we are satisfied that a partnership did, in fact, exist between the partners of the W. C. Johnston & Co. and the partners of the Geneseo Sales Company. Therefore, under the provisions of section 219, the petitioner by virtue of his membership in the partnership is deemed to have been doing business in the United States. The petitioner advanced a further argument to the effect that the treaty between the United States and Canada of March 4, 1942, 56 Stat. 1399, prohibits the taxation of petitioner’s income here in issue because W. C. Johnston & Co. was a Canadian enterprise as that term is defined in the protocol of the treaty; and, hence, by the terms of the treaty exempt from tax because it had no permanent establishment in the United States. This argument is without merit. We have already indicated that the relationship of the W. C. Johnston & Co. and its partners with the Greneseo Sales Company and its partners was that of a partnership; and by virtue of Geneseo Sales Company’s permanent abode in the United States, W. C. Johnston & Co. and its partners are deemed to have had a permanent place of business in this country.1 We, therefore, conclude that the respondent did not err in determining the deficiencies here in issue. No cause appears in the record excusing petitioner’s failure to file returns. The respondent’s determination of penalties under section 291 (a) is, therefore, upheld. Decision will l>e entered v/nder Bule 50. 56 Stat. 1399, 1400. CANADA — DOUBLE TAXATION — MAR. 4, 1942. Article III. 1. If an enterprise of one of the contracting States has a permanent establishment in the other State, there shall be attributed to such permanent establishment the net industrial and commercial profit which it might be expected to derive if it were an independent enterprise engaged in the same or similar activities under the same or similar conditions. Such net profit will, in principle, be determined on the basis of the separate accounts pertaining to such establishment.	01-04-2023	01-16-2020
https://www.courtlistener.com/api/rest/v3/opinions/4477155/	OPINION. Raum, Judge: While two issues have been separately stated, they are actually different aspects of the same question. Both depend upon the reality of the purported indebtedness evidenced by the notes. It should be noted at the outset that this is not a case involving “hybrid securities,” a term generally used to describe corporate instruments bearing indicia both of evidence of indebtedness and of capital investment, where the problem is one of determining whether the terms of the instrument as read create an effect more like that of an investment or more like that of a debt. See, e. g., Universal Oil Products Co. v. Campbell, 181 F. 2d 451, 476-477 (C. A. 7), certiorari denied 340 U. S. 850; Commissioner v. J. N. Bray Co., 126 F. 2d 612 (C. A. 5); Commissioner v. Palmer, Stacy-Merrill, Inc., 111 F. 2d 809 (C. A. 9); Commissioner v. Proctor Shop, 82 F. 2d 792 (C. A. 9); Mullin Building Corporation, 9 T. C. 350, affirmed per curiam 167 F. 2d 1001 (C. A. 3); Charles L. Huisking & Co., 4 T. C. 595. The form of the notes in the instant case presents no such problem. These notes, standing by themselves, are clear evidences of indebtedness. As we understand respondent’s position, it is that there was no genuine indebtedness underlying the notes, that the consideration purportedly given for the notes was in fact the true risk capital of the corporation and must be treated as reflected in the stock rather than the notes which must be disregarded. In short, it is another way of saying that substance must prevail over form, and the substance of the transaction at issue was that of a capital investment for stock and not a sale for notes. Our analysis of the facts forces us to agree with the conclusions of the respondent. The form of a transaction has some evidentiary value, but it is not conclusive. Gregory v. Helvering, 293 17. S. 465. The same is true- of bookkeeping entries. Doyle v. Mitchell Brothers Co., 247 U. S. 179. The crucial factor here is not the formal characterization of these notes, but, rather, the proper characterization of the underlying transaction and the relationship in fact created thereby. Cf. Gooding Amusement Co., 23 T. C. 408, on appeal (C. A. 6); Kraft Foods Co., 21 T. C. 513, on appeal (C. A. 2); 1432 Broadway Corporation, 4 T. C. 1158, affirmed per curiam 160 F. 2d 885 (C. A. 2). In Kraft Foods Co., supra, we said (21 T. C. at p. 594): we do not have here a case in which the instruments involved had some of the characteristics of both debentures and certificates of stock * * . In the instant case, all of the requirements of form and ritual necessary to make the instruments debentures were meticulously met. They were either evidences of indebtedness and effective as such, or, being purely ritualistic and without substance, were futile and ineffective to make the annual payments interest. The intention of the parties is controlling, and such intention is a fact to be gleaned from the entire record. Cf. Tribune Publishing Co., 17 T. C. 1228; Ruspyn Corporation, 18 T. C. 769; Isidor Dobkin, 15 T. C. 31, affirmed per curiam 192 F. 2d 392 (C. A. 2); Lansing Community Hotel Corporation, 14 T. C. 183, affirmed per curiam 187 F. 2d 487 (C. A. 6); Sam Schnitzer, 13 T. C. 43, affirmed per curiam 183 F. 2d 70 (C. A. 9), certiorari denied 340 U. S. 911; Cleveland Adolph Mayer Realty Corporation, 6 T. C. 730, reversed on another issue 160 F. 2d 1012 (C. A. 6); Joseph B. Thomas, 2 T. C. 193. In United States v. Title Guarantee & Trust Co., 133 F. 2d 990 (C. A. 6), where it was held that under the facts of that case the intention of the parties was to create a true debtor-creditor relationship, the court said at page 993: The essential difference between a stockholder and a creditor is that the stockholder’s intention is to embark upon the corporate adventure, talcing the risks of loss attendant upon it, so that he may enjoy the chances of profit. The creditor, on the other hand, does not intend to take such risks so far as they may be avoided, but merely to lend his capital to others who do intend to take them. * * [Italics in original.] Applying the foregoing criteria to the facts before us, we must conclude that we have here no bona fide intention to effect a true debtor-creditor relationship., The partners at affl times intended to be investors in the corporate business, as they had been in the firm business, to the full extent of all value contributed by them. The cash and other property transferred to the corporation was deemed by them and was in fact necessary for the successful operation of that business. Cf. Hilbert H. Bair, 16 T. C. 90, affirmed 199 F. 2d 589 (C. A. 2). The contributions which petitioner contends created an indebtedness constituted' substantially everything the corporation owned1 and which it required in order to commence doing business and to remain in business. It was at all times intended that the value of such contributions should remain indefinitely at the risk of the going business as part of its permanent capital structure. To be sure, the partners undoubtedly expected, as contended by petitioner, earnings to be sufficiently high that in a relatively short time they would be able to withdraw sums approximating in amount their original capital investment without impairing necessary capital; and subsequent events seem to prove this expectation to have been justified. This, however, does not alter the fact that everything transferred to the corporation in May and June of 1946 was intended to remain therein as part of its permanent capital structure; only surplus earnings, to be subsequently acquired as a result of successful operations of the business, were in fact intended to be withdrawn. Cf. Gregg Co. of Delaware, 23 T. C. 170, on appeal (C. A. 2). Indeed, petitioner’s contention proves too much. It demonstrates plainly to us that the partners intended to use the notes as a device to siphon subsequent earnings from the enterprise while leaving the basic business assets with the corporation. Purported payments upon the notes in such circumstances would be in substance nothing more than the distribution of dividends to the stockholders, who held the notes in the same proportion as their stockholdings. Although the notes in form are absolute, and call for fixed payments, we have no doubt, from a reading of the entire record, that no payment was ever intended or would ever be made or demanded, which would in any way weaken or undermine the business. As we said in Gooding Amusement Co., supra, 23 T. C. at page 418: There is nothing reprehensible in casting one’s transactions in such a fashion as to produce the least tax * * . On the other hand, tax avoidance will not be permitted if the transaction or relationship on which such avoidance depends is a “sham” or lacks genuineness. The concept that substance shall prevail over form has likewise been enunciated in numerous cases. * * In the instant case, in the matter of form, the notes in question present no problem of interpretation. The formal criteria of indebtedness are unquestionably satisfied. The notes on their face are unconditional promises to pay at a fixed maturity date a sum certain and the payment of interest thereon is not left to anyone’s discretion. The instruments in form are pure evidences of indebtedness. But we are not limited in our inquiry to the instruments themselves. We may look at all the surrounding circumstances to determine whether the real intention of the parties is consistent with the purport of the instruments. * * * The most significant aspect of the instant case, in our view, is the complete identity of interest between and among the three note holders, coupled with their control of the corporation * * . It is * * unreasonable to ascribe to the husband petitioner * * an intention at the time* of the issuance of the notes ever to enforce payment of his notes, especially if to do so would either impair tbe credit rating of the corporation, cause it to borrow from other sources the funds necessary to meet the payments, or bring about its dissolution * * * In Mullin Building Corporation, supra, we said (9 T. C. at p. 355) : If the debenture stockholders are entitled to enforce payment * * * upon default * * * and should do so, petitioner’s only income-producing asset * * * would either have to be liquidated or encumbered * * . If the [asset] should be liquidated, the flow of * * income therefrom would cease; or, if the [asset] should be mortgaged * * * petitioner would pay out a large part of its earnings in interest and for retirement of principal to its mortgage creditor * * . Such a course would be too irrational * * to merit * * * contemplation * * . Such a course is not within the realm of sane business practice and we are convinced that it was not intended. Similarly, in the case at bar, in the light of all the surrounding facts and circumstances, it is not reasonable to accept the absoluteness in form of the notes at face value. To do so would be to impute a willingness on the part of the partners to endanger their chief source of livelihood. And see 1432 Broadway Corporation, supra, where we said (4 T. C. at p. 1164): The debentures are in approved legal form, and, if their legal attributes alone were determinative of the character of the interest accruals, there would be little room for doubt that they were the indebtedness they purport to be. [Citing.] But, for tax purposes, their conformity to legal forms is not conclusive. Although a taxpayer has the right to cast his transactions in such form as he chooses, * * the Government is not required to acquiesce in the taxpayer’s election of form as necessarily indicating the character of the transaction upon which his tax is to be determined. * * * The Government is not bound to recognize as the substance or character of a transaction a technically elegant arrangement which a lawyer’s ingenuity has devised. * * * The record before us satisfies us that the partners were in fact investing, and not selling their business for notes. Formal capital was nominal in amount, and grossly inadequate in view of the normal needs of the business operations anticipated. The partners had been in the same business for many years, and we are satisfied that they were well aware of this inadequacy. We do not have to decide here whether inadequate capitalization standing alone justifies the treatment of amounts alleged to represent indebtedness as invested capital. Cf. Erard A. Matthiessen, 16 T. C. 781, affirmed 194 F. 2d 659 (C. A. 2). At any rate, it at least invites close scrutiny. Alfred R. Bachrach, 18 T. C. 479, affirmed per curiam 205 F. 2d 151 (C. A. 2). Here the purported indebtedness arose as a result of pro rata advances by all the shareholders; it was created at the time of incorporation when the need for substantial additional permanently invested capital was apparent to the stockholders; all of the stock of the corporation was closely held by three brothers who had also been partners in the business which was being incorporated; and we can find no business purpose other than hoped-for avoidance of taxes necessitating a predominant debt structure and capital stock of a nominal declared value. Isidor Dobkin, supra; Swoby Corporation, 9 T. C. 887; Edward G. Janeway, 2 T. C. 197, affirmed 147 F. 2d 602 (C. A. 2). Cf. Ruspyn Corporation, supra; Clyde Bacon, Inc., 4 T. C. 1107. In the Dobkin case, supra, we said (15 T. C. at p. 32) : Ordinarily contributions by stockholders to their corporations are regarded as capital contributions that increase the cost basis of their stock, * * * Especially is this true when the capital stock of the corporation is issued for a minimum or nominal amount and the contributions which the stockholders designate as loans are in direct proportion to their shareholdings. Edward G. Janeway, supra. 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 * * * The State of Oregon requires that corporations with no-par stock have at least $1,000 formally designated as invested capital. Ore. Comp. Laws, sec. 77-228. Petitioner admits on brief that one of the purposes of the partners was to “limit the capital of the company to a bare minimum allowed by the corporation laws of the State of Oregon.” While we would have so concluded independently, the above admission makes it even more apparent that the amount of $1,050 formally designated as invested capital was totally unrelated to any estimate of the actual need for capital investment, and was selected as the lowest round figure conveniently divisible into three equal parts which would satisfy State law. That amount bore no relation to the amount the partners knew would have to be permanently tied up in the business, and is not a bona fide measure of their capital investment. As we said in Sam Schnitzer, supra, 13 T. C. at page 62: Tbe testimony of petitioner’s witnesses, * * * that tbe shareholders never intended to invest more than $187,800 in stock is intelligible only as showing an agreement about mere form. Petitioner has attempted to convince the Court that the denominated capitalization was not in fact inadequate by emphasizing the prior history of high earnings and the promising future that faced the business in 1946. The answer to this argument is also found in Sam Schnitzer, supra, where we said at page 61: Petitioners argue that large operation profits were reasonably anticipated * * . In support they stress the mill’s substantial earnings in recent years and the unexpected difficulties which they encountered in erecting it. This argument lacks persuasive force. Even if the corporation had paid oil the balance in its open account with [the partnership] from earnings, such payment would still have partaken of the character of dividend distribution on risked capital invested in the plant. A corporation’s financial structure i> which a wholly inadequate part of the investment is attributed to stock wliib the bulk is represented by bonds or other evidence of indebtedness to stock holders is lacking in the substance necessary for recognition for tax purposes, and must be interpreted in accordance with realities * * * We do not deem it a distinguishing feature that in the Sehnitzer case the expectation of high earnings was initially disappointed whereas in the case at bar it was fully satisfied. The language of that case indicates that such fact would have made no difference, and we agree that it should not. Petitioner has cited John Kelley Co. v. Commissioner, 326 U. S. 521. That case, however, is of no aid to petitioner, for the very important factor of inadequate capitalization was found to be absent there. The Court did allude to just the situation we have here, however, in language which can be of no comfort to petitioner, saying at page 526: As material amounts of capital were invested in stock, we need not consider the effect of extreme situations such as nominal stock investments and an obviously excessive debt structure. See also Ruspyn Corporation, supra, 18 T. C. at p. 777; Swoby Corporation., supra, 9 T. C. at p. 893; Erard A. Matthiessen, supra, 16 T. C. at p. 785; Edward G. Janeway, supra, 2 T. C. at p. 202; R. E. Nelson, 19 T. C. 575, 579; Sheldon Tauber, 24 T. C. 179, is distinguishable, in that the Court there was of the opinion that the facts showed no undercapitalization. The record in the instant proceeding satisfies us that there was no valid business purpose which dictated the gross undercapitalization here present. There seems to be no question that sound reasons existed for forming a corporation to carry on the business, which had been operating up to that time as a copartnership, but every advantage sought through incorporation, except that of the avoidance of taxes, could have been accomplished with equal facility and assurance of success by the more normal method of the issuance of capital stock of a par or declared value more nearly commensurate with the total amount permanently contributed to the corporation, and with which it was expected thereafter to conduct its affairs. In Mullin Building Corporation, supra, the point was disposed of by saying (9 T. C. at p. 358) : Petitioner claims that the purpose * * * was to satisfy James Muffin’s desire to establish a steady income for his family and improve the sales company’s credit position. The creation of petitioner accomplished these purposes just as fully by treating the debenture stock as an investment creating a proprietary interest as by treating it as an evidence of debt. * * * It was not necessary to create a 29 to 1 debt to capital ratio * * * to accomplish these ends. * * * It may be quite true that the discovery of cancer in the decedent motivated the formation of the corporation so as to provide for continuity of the business in the event of death of one of the three brothers or in other circumstances. There was thus adequate business reason for incorporating the enterprise. But there was no business reason apparent on this record that called for such an absurdly low capitalization as petitioner asks us to accept at face. The argument that there was a business reason for incorporating the enterprise is merely a smoke screen that may be calculated to hide the absence of any business reason for attempting to achieve the result in the form that was employed. It has not escaped our attention that the notes in question are secured, and were not expressly subordinated to obligations of other creditors. Viewing, however, as we must, all the surrounding facts, this circumstance is not impressive. This, in our opinion, is again a matter of perfection of form, wherein what was in fact capital investment has been garbed in the raiment of indebtedness. In addition, we have serious doubts as to the extent to which such security would be upheld as against the claims of outside creditors, should the attempt to do so ever have to be made, as in bankruptcy. In Arnold v. Phillips, 117 F. 2d 497 (C. A. 5), certiorari denied 313 U. S. 583, a deed of trust was made in favor of the dominant stockholder as security for advances already made and to be made in the future. The stockholder later foreclosed on his security. Subsequently, the deed of trust and foreclosure were set aside by the bankruptcy court, even in the absence of fraud, on the ground that there was an inadequacy of original capital, of which the stockholder was aware. The advances were treated as stock subscriptions, and payments thereon, designed as interest, were held to constitute dividends. Since we have concluded that there was no indebtedness, it must follow that all payments purportedly made on the notes, including those denominated as payments of principal, must in fact constitute taxable dividends within section 115(a) of the Internal Revenue Code of 1939 to the extent of available earnings and profits. As we said in Gooding Amusement Co., supra, 23 T. C. at page 421: Since the notes did not, in reality, represent creditor interests, the payments made to the stockholders * * * must be considered not as payments of a bona fide indebtedness of the corporation, but as distributions of corporate profits to the stockholders as stockholders and not as creditors. Therefore, we conclude that they constituted dividends under the broad language of Section 115(a) * * * .The fact that the corporation, or rather the petitioner, may have had no intention of distributing earnings under the guise of discharging debts is immaterial. For the foregoing reasons and on the strength of the above authorities, we decide the first issue in favor of the respondent. The second issue is the applicability of section 112 (b) (5) of the Internal Revenue Code of 1939. This issue must be resolved in favor of the respondent for reasons that have already been set forth as determinative of the first issue. We have previously concluded that there was no true debt, and that all the assets transferred to the corporation in May and June of 1946 represented invested capital. The true consideration for this transfer consisted of the shares of capital stock of the corporation, all of which were issued to the transferors in proportion to their respective interests in the property transferred by them. The notes are a mere sham, and have no reality. The transaction, thus viewed, falls squarely within the provisions of section 112 (b) (5). “Since we have found * * * the notes * * * in fact representative of. risk capital invested in the nature of stock, the ‘solely in exchange for stocks or securities’ requirement of section 112 (b) (5) was, in our considered judgment, satisfied.” Gooding Amusement Co., supra, at p. 423. “Property” includes money, so the fact that cash as well as business assets were contributed cannot affect this result. Halliburton v. Commissioner, 18 F. 2d 265 (C. A. 9); George M. Holstein, III, 23 T. C. 923. Section 112(b) (5) is applicable, and the basis of the assets transferred to the corporation is, pursuant to section 113 (a) (8) of the Internal Revenue Code of 1939, the same as that in the hands of the transferors, no gain having been properly recognized with respect thereto on the transfer. Accordingly, the amount of earnings and profits available for distribution as a dividend, and the amount of the deficiency are as asserted by the respondent in his notice. Decisions will ~be entered for the respondent. In form, the $50,000 cash appeared to come from the partners personally. However, the evidence discloses*that the partnership had a substantial amount of cash and that such cash was taken out by the partners prior to the transfer of partnership assets to the corporation. It seems quite clear that the $50,000 cash represented in substance that portion of the partnership cash that the partners regarded as necessary to operate the business.	01-04-2023	01-16-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625461/	HARRY S. BLUMENTHAL, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Blumenthal v. CommissionerDocket No. 75143.United States Board of Tax Appeals34 B.T.A. 994; 1936 BTA LEXIS 617; September 3, 1936, Promulgated 617 Income of the petitioner includes the income of a trust established pursuant to a court decree for the support, maintenance, and education of his minor daughter, but does not include the income of another trust similarly established for his divorced wife, who has since remarried. Solomon Elsner, Esq., for the petitioner. James H. Yeatman, Esq., for the respondent. MURDOCK 995 OPINION. MURDOCK: The Commissioner determined a deficiency of $811.79 in the petitioner's income tax for 1931. The only adjustment made by the Commissioner to the income as reported was the addition of $6,635.97 representing the income of two trusts created pursuant to a court order for the benefit of the petitioner's divorced wife and their child. That action of the Commissioner is assigned as error. The facts were stipulated. The petitioner is an individual, residing in West Hartford, Connecticut. He married Anna J. Maher in 1911. They had a child, Harriel A. Blumenthal, born in 1912. The wife instituted an action against the petitioner in 1923 in Connecticut for a divorce, for custody of the child, and for alimony. A committee, which heard the evidence, 618 recommended to the court that the wife be granted a divorce, custody of the child, and alimony of $132,500, of which $125,000 should be placed in trust for the benefit of the wife and child. The court issued its order in 1923 divorcing the couple, granting custody of the child to the mother, and decreeing alimony as follows: The said defendant pay within ten (10) days from the date hereof, to the plaintiff the sum of Seventy-five Hundred (7500) Dollars, and for the benefit of the plaintiff and said minor child pay to the Hartford-Connecticut Trust Company of Hartford, Connecticut, the sum of One Hundred Thousand (100,000) Dollars, and the sum of Tyenty-five Thousand (25,000) Dollars, respectively, in trust, under the following terms and conditions and for the following uses and purposes: * * The net income of the $100,000 was to be paid to the plaintiff during her life, and thereafter the daughter was to receive all of the income until she became twenty-one years of age, when she was to receive one-half of the principal. The daughter was then to receive the income on the remaining one-half until she became twenty-five years of age, at which time she was to receive the rest619 of the principal. The daughter was to receive the income of the $25,000 trust until the principal was paid to her, one-half when she became twenty-one, and the remainder when she became twenty-five years of age. If the daughter predeceased her mother the $100,000 trust was to terminate at the death of the mother and the property was to be delivered to the defendant or his estate. If the daughter died before receiving all of the $25,000 trust, the remainder was to be delivered to her father or his estate. The trusts were created in accordance with the decree. The divorced wife remarried in 1926. The income of the trusts in 1931 amounted to $6,635.97 ($5,179.97 and $1,456). The trustee paid the income directly to the beneficiaries, both of whom are living. The petitioner has never had any voice in the management of the trusts and has never received any distribution from the trusts. 996 The Commissioner contends that the income of the two trusts is taxable to the petitioner under the general definition of gross income (sec. 22, Revenue Act of 1928) and the decisions in 620 ; ; ; rehearing denied, ; ; and . His theory is that the trust income was used to discharge a legal obligation of the petitioner, it directly benefited him, and, therefore, it is taxable to him. These cases are controlling so far as the income from the trust for the minor child is concerned. Cf. ; rehearing denied, . The obligation of the father to support her continued throughout the taxable year. ; ; ; ; ; ; ;621 ; secs. 5187 and 1717, Gen. Statutes of Connecticut, 1930. But there was no obligation upon the part of the petitioner during the taxable year to support his former wife, who had remarried in 1926. ; . His entire obligation to support her had been discharged prior to 1931. He had only a contingent remainder interest in the trust established for her and was not taxable with the income of that trust. Cf. ; ; ; affd., ; . Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625462/	NANCY B. LaBELLE, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent.La Belle v. CommissionerDocket No. 9773-79.United States Tax CourtT.C. Memo 1984-69; 1984 Tax Ct. Memo LEXIS 602; 47 T.C.M. (CCH) 1078; T.C.M. (RIA) 84069; February 13, 1984. Theodore J. England, for the petitioner. Elaine T. Moriwaki, for the respondent. WILBURMEMORANDUM FINDINGS OF FACT AND OPINION WILBUR, Judge: Respondent determined a deficiency of $290,564.37 and additions to tax of $71,991.59 under section 6651(a)1 and $14,528.22 under section 6653(a) for the taxable year 1973. The issues are (1) whether petitioner intended to file a joint return for 1973, and (2) if the return is considered a joint return whether petitioner qualifies as an innocent spouse under section 6013(e); (3) whether petitioner is liable for an addition to tax under section 6651(a) for failing to file a timely return; and (4) whether petitioner is liable for an addition to tax under section 6653(a) for negligent underpayment of taxes. 604 FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulation of facts and attached exhibits are incorporated herein by this reference. Petitioner resided in Santa Paula, California, at the time of filing the petition in the instant case. During 1973, petitioner was employed by the Santa Paula School District to teach children with emotional learning handicaps, and has been employed in that capacity continuously from 1961 to November 1980. Petitioner married Donald A. LaBelle (Donald) in January 1957. In 1965 or 1966, Donald purchased a used car lot in Santa Paula, California, and did business under the name Don LaBelle's Wholesale Center. Sometime between 1965 and 1971, Donald expanded the business and opened two other used car lots. In 1971, he purchased a new automobile dealership and began doing business under the name Steve Love's Chrysler-Plymouth. Although petitioner did the bookkeeping and taxes for the three used car lots, she did not participate in the new dealership. In early 1973, petitioner separated from Donald and on August 9, 1973, an interlocutory judgment of dissolution of marriage was filed to dissolve their marriage.605 A marital settlement agreement signed by Donald and petitioner and dated June 25, 1973, was incorporated in the interlocutory judgment. The marital agreement provided that the parties would file joint tax returns for taxable years prior to the year in which a final judgment of dissolution was obtained and that the parties would sign and deliver such other documents as may be necessary or desirable to accomplish the agreements provided therein. The agreement further provided that (a) Donald would file the petition for dissolution of marriage; (b) the settlement to petitioner would be $7,000--paid in installments; the furniture and fixtures from the family residence; a $10,000 insurance policy and use of a car; and (c) Donald would retain the family residence and pay all community debts known to him at the time of the execution of said agreement. The final judgment of dissolution of marriage was filed on January 9, 1974. In March 1974, petitioner supplied Donald with her W-2 (Wage and Tax Statement) form from the Santa Paula School District showing a salary of $12,797, Federal taxes withheld of $1,998, and a list of deductions for 1973 so that he could file a return for 1973. 606 In June 1974, petitioner and Donald executed a power of attorney (Department of the Treasury, Internal Revenue Service Form 2848) appointing Peter J. Celeste, Esq. as her attorney-in-fact with respect to all Internal Revenue tax matters for the 1971, 1972 and 1973 tax years. At the time petitioner signed the power of attorney, she thought that the 1973 tax return had been filed. Petitioner did not separately file a tax return for 1973. A Federal income tax return, Form 1040, was filed for 1973 with the Ventura, California, office of the Internal Revenue Service on June 5, 1975. The return was signed by Donald and petitioner's signature was entered by Mr. Celeste pursuant to the 1974 power of attorney. The return did not contain a signature in the preparer's signature line. In August 1980, petitioner first became aware that the return had been filed late and without her signature. Until then, petitioner never inquired of Donald or the Internal Revenue Service as to whether such return had been filed. The 1973 tax return reflected Schedule C expenses for Donald's automobile business (Steve Love's Chrysler-Plymouth) and included the following: (a) Cost of goods sold and/or operations$2,071,997(b) Salaries and wage expenses37,533(c) Advertising expenses20,961(d) Demonstration expenses8,743(e) Travel and entertainment expenses7,336607 In his statutory notice of deficiency, the Commissioner made the following adjustments: (a) Decreased the cost of goods sold (used cars) by$447,137.71(b) Decreased salary and wage expense by4,800.00(c) Decreased advertising expenses by4,700.00(d) Decreased demonstrator expense by1,390.00(e) Decreased travel and entertainment expenses by4,768.00(f) Allowed the standard deductions and exemptionsnot previously claimed on the return.OPINION The central issue for decision is whether petitioner and Donald filed a joint return for the 1973 tax year. It is well settled that a determination of whether income tax returns are joint or separate returns of a husband and wife is a question of fact to be determined by all the evidence. Heim v. Commissioner,27 T.C. 270">27 T.C. 270 (1956), affd. 251 F.2d 44">251 F.2d 44 (8th Cir. 1958). The ultimate determination is the intent of the parties. O'Connor v. Commissioner,412 F.2d 304">412 F.2d 304 (2d Cir. 1969), affg. in part, revg. in part, and remanding with directions a Memorandum Opinion of this608 Court; Hennen v. Commissioner,35 T.C. 747">35 T.C. 747, 748 (1961). We think it is clear that petitioner intended to file a joint return for the 1973 taxable year. The marital settlement agreement signed by petitioner and Donald on June 25, 1973 provided that the tax returns for taxable years prior to the year in which a final judgment for dissolution was obtained would be filed as joint returns. The final judgment of dissolution of their marriage was filed on January 9, 1974. As her testimony indicates, petitioner then contemplated that Donald would file the return jointly. She therefore provided Donald with her W-2 form and all deductions which he needed to fill out the return and assumed that the return would be timely filed. In June 1974, upon Donald's request, petitioner signed a power of attorney which appointed Peter Celeste as her attorney-in-fact with respect to all Internal Revenue tax matters for the 1971, 1972, and 1973 tax years.Approximately 1 year later, a 1973 tax return containing Donald's signature and petitioner's signature which was entered by Mr. Celeste was filed with the Internal Revenue Service. Petitioner conceded in her testimony that her signature609 on the power of attorney was genuine. She argues, however, that she signed the power of attorney upon Donald's representation that their prior years' tax returns were being audited and that they would probably get a refund. She claims that she was never advised that her execution of the power of attorney would entitle the attorney to sign the 1973 tax return on her behalf. Petitioner thus contends that her signature is not valid since it was procured by trickery. Dolan v. Commissioner,44 T.C. 420">44 T.C. 420 (1965). We are of the opinion that petitioner has failed to prove that her signature on the power of attorney was procured by trickery. She was an educated woman familiar with financial matters and should have been aware of its true nature. 2610 It is clear that petitioner intended to file a joint return and that she signed through an attorney does not alter this intent. Indeed, if an intent to file a joint return otherwise exists, it is not fatal that one spouse did not sign the return. Hennen v. Commissioner,supra.Where a husband filed a joint return without objection of the wife, who failed to file a separate return, it may be presumed that the joint return was filed with the consent of the wife. Howell v. Commissioner,10 T.C. 859">10 T.C. 859 (1948), affd. 175 F.2d 240">175 F.2d 240 (6th Cir. 1949). Here, the facts clearly establish that petitioner intended that Donald should file the joint return, and that is the only return filed by or on her behalf for that year.By petitioner's own admission, when Donald asked to sign the power of attorney, she thought that Donald had already filed a joint return for the 1973 tax year. There is thus no question that she then intended that the return be filed jointly. From that time until approximately 1 year later when the return was actually filed, there611 is no indication that petitioner altered her intention that a joint return be filed. And of course, the marital settlement agreement she signed provided for filing a joint return for 1973. Petitioner's testimony that she would not have signed a tax return which obligated her to pay $290,000 in taxes underscores the retrospective nature of petitioner's claim. We thus conclude that the return filed for the 1973 tax year was intended to be the joint return of petitioner and Donald. Our conclusion that the return filed for 1973 was a joint return necessitates consideration of petitioner's contention that she was an innocent spouse entitled to protection from liability for the deficiency determined in 1973 by virtue of section 6013(e). Section 6013(e)(1) requires that three conditions be satisfied to relieve a spouse from joint liability: (A) a joint return has been made under this section for a taxable year and on such return there was omitted from gross income an amount properly includable therein which is attributable to one spouse and which is in excess of 25 percent of the amount612 of gross income stated in the return, (B) the other spouse establishes that in signing the return he or she did not know of, and had no reason to know of, such omission, and (C) taking into account whether or not the other spouse significantly benefited directly or indirectly from the items omitted from gross income and taking into account all other facts and circumstances, it is inequitable to hold the other spouse liable for the deficiency in tax for such taxable year attributable to such omission, * . Section 6013(e)(2)(B) directs us to section 6501(e)(1)(A) in determining whether there has been an omission from gross income for purposes of section 6013(e)(1)(A). Section 6501(e)(1)(A)(i) contains a special definition of gross income which effectively requires us to disregard omissions from gross income resulting from the overstatement of cost of goods sold. That paragraph provides: (i) In the case of a trade or business, the term "gross income" means the total of the amounts received or accrued from the sale of goods or services (if such amounts are required to be shown on the613 return) prior to diminution by the cost of such sales or services, * * . Thus, the overstatement of cost of goods sold giving rise to the deficiency herein is not an omission from gross income for purposes of applying section 6013(e)(1)(A). Resnick v. Commissioner,63 T.C. 524">63 T.C. 524 (1975). The remaining deficiency adjustments involve overstated business deductions (conceded by the petitioner), and would also not constitute an "omission" from income since section 6013(e) does not apply to a tax deficiency resulting from erroneous deductions. Section 1.6013-5(d), Income Tax Regs.; Estate of Klein v. Commissioner,63 T.C. 585">63 T.C. 585, 595 (1975), affd. 537 F.2d 701">537 F.2d 701 (2d Cir. 1976); see Allen v. Commissioner,514 F.2d 908">514 F.2d 908, 915 (5th Cir. 1975), affg. in part, revg. in part, and remanding 61 T.C. 125">61 T.C. 125 (1973). We reluctantly conclude that petitioner is not an innocent spouse entitled to relief pursuant to section 6013(e). Petitioner nevertheless insists that she was the victim of her husband's fraud and that this Court should apply general principles of equity and fairness to relieve614 her from joint liability. 3 We must decline petitioner's request. This case is typical of many that arise involving innocent spouses, and while the result is extremely unfortunate, we are not at liberty to rewrite the statute on an adhoc basis. 615 That the technical rules of section 6501 must determine whether there is an "omission" from gross income is unfortunate since the main thrust of section 6013(e) is concerned with relief for an "innocent spouse." The legislative history of section 6013 makes it plain that the statute was designed to bring government tax collection practices into accord with basic principles of equity and fairness. See United States v. Dioguardi,350 F. Supp. 1177">350 F. Supp. 1177, 1179 (E.D. N.Y. 1972); S. Rept. No. 91-1537 (1970), 1 C.B. 606">1971-1 C.B. 606. In situations such as that confronting Mrs. LaBelle, the purpose of the statute is frustrated by special rules not pertinent to the determination of whether it is fair to impose liability on a spouse who was not involved in, nor benefitted from, any wrongdoing. Estate of Klein v. Commissioner,537 F.2d 701">537 F.2d 701 (2d Cir. 1976), affg. 63 T.C. 585">63 T.C. 585 (1975). But, as the Supreme Court recognized United States v. Mitchell,403 U.S. 190">403 U.S. 190, 206 (1971), "[t]he remedy is in legislation." Without statutory protection, the Supreme Court in Mitchell declined to grant relief to spouses victimized by their616 husbands and the operation of community property laws although it recognized that "these cases are 'hard' cases and exceedingly unfortunate." 403 U.S. at 205. 4 We are likewise compelled to await a Congressional response to the situation. 5 We thus hold that petitioner is jointly and severally liable for the deficiency in income tax for the year 1973. 6617 The next issue is whether petitioner is liable for the additions to tax under section 6651(a)(1) and section 6653(a) for the taxable year 1973. Section 6651(a)(1) provides for an addition to tax for failure to file a return timely, but the addition is not applicable if "it is shown that such failure is due to reasonable cause and not due to willful neglect." The taxpayer has the burden of proving such failure was due to reasonable cause. Electric & Neon, Inc. v. Commissioner,56 T.C. 1324">56 T.C. 1324, 1342 (1971), affd. without published opinion 496 F.2d 876">496 F.2d 876 (5th Cir. 1974). Petitioner contends that she should be excused from the addition since she timely provided Donald with her W-2 form and information relating to her deductions. However, she testified that she never inquired of Donald or the Internal Revenue Service as to whether a return had been filed. Petitioner also testified that she was unsure all along whether she had signed the return, but was assured by Donald that she had. Such reliance on her ex-spouse does not constitute reasonable cause. Bagur v. Commissioner,66 T.C. 817">66 T.C. 817 (1976),618 remanded on a different issue 603 F.2d 491">603 F.2d 491 (5th Cir. 1979); Mitchell v. Commissioner,51 T.C. 641">51 T.C. 641 (1969), revd. on other grounds 430 F.2d 1">430 F.2d 1 (5th Cir. 1970), revd. on other grounds 403 U.S. 190">403 U.S. 190 (1971). If petitioner was in doubt as to whether she signed the return, she should certainly have made further inquiries as to whether it had been filed. On this record, we must conclude that petitioner has not established that her failure to file a timely return was due to reasonable cause. As to the addition to tax under section 6653(a), petitioner must establish that no part of the underpayment for 1973 was due to negligence or intentional disregard of rules and regulations. Bagur v. Commissioner,supra at 824; Rosano v. Commissioner,46 T.C. 681">46 T.C. 681, 688 (1966). For the same reasons that we found that her failure to file a return was not due to reasonable cause, we find that the underpayment of tax for such years was due to negligence. Petitioner made no effort to inquire as to the correctness of any619 return filed. Petitioner may have had little involvement with Donald's business activities or with the preparation of their joint tax return for 1973. Nonetheless, when a joint return is made, the liability with respect to the tax is joint and several. Section 6013(d)(3); Hedrick v. Commissioner,63 T.C. 395">63 T.C. 395, 403-404 (1974). The reference to "tax" includes additions to tax. Section 6662(a)(2). When Congress has intended to relieve an innocent spouse from joint liability regarding jointly reported income, it has done so specifically. See, e.g., section 6653(b)(4) (spouse not liable for fraud addition assessed on joint return unless some part of the underpayment is due to the fraud of such spouse). We have previously determined that a joint return has been filed and that the innocent spouse rules of section 6013 are inapplicable herein. Thus, since petitioner has presented no evidence to show that the negligence addition for the 1973 tax year is unjustified, the imposition of the addition is sustained. 7620 Decision will be entered for the respondent.Footnotes1. All sections references are to the Internal Revenue Code of 1954, as in effect during the tax year in issue, unless otherwise indicated.↩2. On brief, petitioner has cited cases dealing with the defense of duress. E.g., Furnish v. Commissioner,262 F.2d 727">262 F.2d 727 (9th Cir. 1958); Brown v. Commissioner,51 T.C. 116">51 T.C. 116 (1968). However, any claim that her signature was executed under duress is meritless. To establish that her signature was executed under duress, petitioner must prove both (1) that she was unable to resist demands to sign the power of attorney, and (2) that she would not have signed it except for constraint applied to her will. Brown v. Commissioner,supra.↩There is nothing in the record to indicate that petitioner signed the power of attorney in fear of her husband or under any type of pressure which deprived her of contractual volition.Thus, we find that petitioner was able to exercise her free will when she signed the power of attorney.3. Petitioner relies on three opinions of the Sixth Circuit Court of Appeals which indicated that a victimized spouse may be relieved of liability as a result of fraudulent conduct practiced upon her by the other spouse. Sharwell v. Commissioner,419 F.2d 1057">419 F.2d 1057 (6th Cir. 1969), vacating and remanding a Memorandum Opinion of this Court; Huelsman v. Commissioner,416 F.2d 477">416 F.2d 477 (6th Cir. 1969), remanding a Memorandum Opinion of this Court; Scudder v. Commissioner,405 F.2d 222">405 F.2d 222, 226 (6th Cir. 1968), remanding 48 T.C. 36">48 T.C. 36 (1967), rehearing denied, 410 F.2d 686">410 F.2d 686 (6th Cir. 1969). However, the circumstances of those cases were dramatically different from these before us, and even more to the point, these cases arose prior to the enactment of sec. 6013(e). In fact, the Tax Court decision in Scudder was explicitly referred to by the House Ways and Means Committee (H. Rept. No. 91-1734, to accompany H.R. 19774 (Pub. L. 91-679 (1971), p. 2), as well as by the Senate Finance Committee (S. Rept. No. 91-1537 (1970), 1 C.B. 606">1971-1 C.B. 606↩, 607).4. See sec. 66 which was enacted after the decision in United States v. Mitchell,403 U.S. 190">403 U.S. 190↩ (1971). 5. A bill is currently pending before Congress which may provide the needed relief (H.R. 3475, Tax Law Simplification and Improvement Act of 1983). The Joint Committee on Taxation explained the bill as follows: Joint return liability of innocent spouse Under the bill, the innocent spouse rule (sec. 6013(e)) would apply to cases in which the tax liability results from a substantial understatement of tax that is attributable to grossly erroneous items (including claims for deductions or credits, as well as omitted income) of one spouse. Grossly erroneous items would include any item of income that is omitted from gross income, regardless of the basis for omission. A claim for deduction or credit would be treated as a grossly erroneous item only if the claim had no basis in law or fact. The bill would define a substantial understatement as any understatement that exceeds 10 percent of the tax required to be shown on the return or $500, whichever is less.As under present law, relief may be granted only where it would be inequitable to hold the innocent spouse liable. In applying these rules, community property laws would continue to be disregarded in determining to whom an item is attributable. The bill would not specifically require that the determination of whether it would be inequitable to hold the innocent spouse liable include consideration of whether such spouse benefitted from the erroneous item. The omission from income determination may apply notwithstanding that adequate information about the erroneous items was provided on the return. [Staff of Joint Comm. on Taxation, Tax Law Simplification and Improvement Act of 1983 (Comm. Print July 22, 1983).] ↩6. We therefore need not address respondent's alternate theory that petitioner in any event must report one-half of the income under the community property laws of California.↩7. The parties stipulated to the correct amount of adjustments originally in issue, asking the Court to decide whether a joint return was filed and whether the innocent spouse provisions of sec. 6013(e)↩ are applicable. As noted earlier, in view of our decision on these issues, we do not pass on respondent's alternative contention that in any event petitioner would be liable for a substantial portion of the deficiency due to her rights as a spouse in a community property state.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625465/	Dallas Dental Lab, Inc., Petitioner v. Commissioner of Internal Revenue, RespondentDallas Dental Lab, Inc. v. CommissionerDocket No. 2726-77United States Tax Court72 T.C. 117; 1979 U.S. Tax Ct. LEXIS 137; April 12, 1979, Filed 137 Decision will be entered under Rule 155. A qualified profit-sharing plan provided that seasonal employees were not eligible to participate in the plan and defined seasonal employees to include all individuals working less than 5 months in a calendar year. It further provided that a participant did not have to be employed as of the last day of the taxable year in order to participate in the employer's contribution for that year. However, an employee whose employment terminated prior to the end of the taxable year and prior to the completion of 1 year of service had no vested interest in the plan, and any allocation of the employer's contribution for that year to his account was immediately forfeited. Held, compensation paid to individuals employed less than 5 months was not includable in compensation paid to "employees under the * * plan" for purposes of determining the 15-percent-of-compensation limitation on deduction of contributions to a profit-sharing plan. Sec. 404(a)(3)(A), I.R.C. 1954. Held, further, individuals whose employment terminated prior to the end of the taxable year and prior to completion of 1 year of service were not "employees under the * * * 138 plan" for purposes of determining the limitation on deductible contributions. Sec. 404(a)(3)(A). Alfred L. Ruebel, for the petitioner.Genelle F. Schlichting, for the respondent. Tannenwald, Judge. TANNENWALD118 OPINIONRespondent determined deficiencies in petitioner's income tax as follows:TYE June 30 --Deficiency1972$ 197.7219731,140.921974717.26The issue for decision is whether compensation paid to employees whose employment terminated before the end of the taxable year is includable in determining the limitation on the deductibility of contributions to a profit-sharing plan under section 404(a)(3)(A). 1140 This is a fully stipulated case submitted under Rule 122, Tax Court Rules of Practice and Procedure. The facts as stipulated, including those set forth in the attached exhibits, are incorporated herein by this reference and found accordingly.Petitioner Dallas Dental Lab, Inc., is a corporation which had its principal office in Dallas, Tex., at the time the petition herein was filed. It filed corporation income tax returns for its fiscal years ending June 30, 1972, 1973, and 1974, with the Internal Revenue Service Center, Austin, Tex.Petitioner established a profit-sharing trust 2 called the Dallas Dental Lab, Inc., Profit Sharing Plan for Employees (hereinafter the plan), effective January 1, 1971.119 141 The pertinent provisions of the plan 3 are as follows:144 Article IDefinitions* * * 3. Employee shall mean any employee, other than seasonal or part time employees, who is compensated by salary or wage, or by any other means of remuneration, on a consistent basis from period to period. Part time employment is defined as including all employees working less than twenty (20) hours in any calendar week. Seasonal employment is defined as including all employees working less than five (5) months in any calendar year. * * 5. Participant is an Employee of the Employer [the petitioner] who is eligible to be and becomes a Participant as provided in Articles IV and V hereof. * * Article IVEligibility To Participate. All Employees of the Employer, as of January 1, 1971, including any Employee who shall commence employment thereafter, excluding part time and seasonal workers, shall be immediately eligible to participate in the Plan. * Article VParticipation. Every eligible Employee of the Employer may become a participant hereunder by filing his written application with the Trustees. The Trustees acting upon information supplied by the Employer, shall 142 notify an Employee of his impending eligibility * * * upon acceptance for employment, and his written application must be made and filed with the Trustees within thirty (30) days from the date on which he becomes eligible to participate. * * ** * * Article VIIIContributions. Contributions by the Employer shall be made out of current or accumulated profits. The formula for annual contributions shall be equal to a sum not in excess of fifteen percent (15%) of compensation of all Participants in the Plan, as the Employer, by authorization of its Board of Directors prior to the end of the taxable period for which the contribution is made, may elect to contribute to the Trust. * * The Employer's contribution each year shall be 120 credited to the account of the individual Participant in the proportion that each Participant's total compensation bears to the total compensation of all Participants during the year, as of the last day of the year, forfeitures excepted. A participant need not be employed as of the last day of the year in order to participate in the Employer's contribution for that year. Once having become a Participant in the Plan, employment during the year143 is sufficient to qualify for participation in the Employer's contribution for that year. * * Article IXForfeitures. All forfeitures, from whatever cause, shall not act to reduce any Employer's contribution, and shall be allocated as of the end of each year to the accounts of those who were Participants in the beginning of such year and remained Participants until the end of such year. The method of allocating forfeitures shall be in the same proportion that each such Participant's total compensation for such year bears to the total compensation of all such Participants for such year. * * Article XIIDeath, Retirement and Severance Benefits. * * A Participant's right to retain the credits accumulated in the Plan from whatever source shall vest in the following percentages after the applicable period of time commencing with the effective date of the Plan, namely, January 1, 1971:10%after 1 year20%after 2 years * * 90%after 9 years100%after 10 years, termination of employment, retirement,permanent disability or death. 4The fiscal year of the trust, like that of petitioner during the years at issue, was a 12-month period beginning on July 1 and ending on June 30 of the succeeding year. Petitioner made timely contributions to the trust in respect of each of its taxable years. 5For the taxable year ended June 30, 1972, the following individuals were employed by petitioner and received compensation as shown: 121 EmployeeCompensationLength of serviceA. L. Bleeker$ 1,516.503 monthsR. Latterman2,189.2010 monthsJ. Hernandez1,002.002 monthsB. Redden1,283.7510 months5,991.45All four of the above individuals 145 terminated their employment with petitioner prior to the end of petitioner's taxable year. Their total compensation of $ 5,991.45 was used in determining the 15-percent limitation for the petitioner's contribution deduction under section 404(a)(3)(A). The four employees had $ 897.72 allocated to their accounts, which was forfeited to the remaining participants in the plan.For the taxable year ended June 30, 1973, the following individuals were employed by petitioner and received compensation as shown:EmployeeCompensationLength of serviceDuane Fisher$ 4,420.001 year 10 monthsRobert McNair566.7510 monthsR. Acosta385.663 monthsCarole Castleberry137.201 month 5,509.61All four of the above individuals terminated their employment with petitioner prior to the end of petitioner's taxable year. Their total compensation of $ 5,509.61 was used in determining the 15-percent limitation for petitioner's contribution deduction. The four employees had $ 766.62 allocated to their accounts. Robert McNair, R. Acosta, and Carole Castleberry forfeited to the remaining participants the amounts allocated to their accounts. Duane Fisher was a 10-percent vested146 participant and received $ 61.58 from petitioner's contribution for that year, the balance of the amount allocated to Fisher's account from that contribution being similarly forfeited.For the taxable year ended June 30, 1974, the following individuals were employed by petitioner and received compensation as shown: 122 EmployeeCompensationLength of serviceJ. Bradford$ 3,692.501 year 11 monthsD. Fisher400.001 month K. Downs675.002 monthsG. Hargrove3,676.608 monthsK. Maupin1,400.001 year 2 monthsS. Smith547.501 month W. Stotts II4,096.209 monthsC. Taggart1,717.406 monthsH. Willcox1,659.991 year 3 monthsT. Kelso481.001 month J. Houston681.002 months$ 19,027.19All of the above individuals terminated their employment with petitioner prior to the end of petitioner's taxable year. Their total compensation of $ 19,027.19 was used in determining the 15-percent limitation for petitioner's contribution deduction. These employees had $ 2,584.02 allocated to their accounts, which they forfeited to the remaining participants in the plan, with the exception of J. Bradford, K. Maupin, and H. Willcox, who were 10-percent147 vested participants and received a total of $ 94.50 from petitioner's contribution for that year, the balance of the amount allocated to their accounts from that contribution being similarly forfeited.The issue for decision is whether compensation paid to employees whose services were terminated within the taxable year may be included in a determination of the limitation of the deductibility of employer contributions to a qualified (see n. 2 supra) profit-sharing plan under section 404(a)(3)(A). 6 That 123 section limits an employer's deduction for contributions to a profit-sharing trust to 15 percent of compensation paid or accrued during the taxable year "to all employees under the * * plan." Respondent contends that, in determining the 15-percent limitation on deductible contributions, petitioner should not have included the compensation paid to certain employees whose employment terminated within the taxable years for which the contributions were made. The question turns on an interpretation of the phrase "employees under the * * * plan" as used in subsection 404(a)(3)(A).148 The employees whose services were terminated can be divided into three categories. The first category consists of individuals who had been employed by petitioner for more than a year at the time their employment terminated. These employees' interests in the plan were 10-percent vested and they received part of the contribution allocated to their accounts in the year their services terminated. Respondent has, on brief, conceded that the compensation of these employees was properly included in the determination of the 15-percent limitation on contributions since these employees received some benefit from the allocation made to their accounts in the year their services terminated.The second category consists of those individuals who were employed by petitioner for less than 5 months in a calendar year. It is clear from the terms of the plan itself that these individuals were not "employees under the * * plan." "Employee" is defined in article I of the plan as "any employee, other than seasonal or part time employees." (Emphasis added.) Seasonal employment is defined to include all employees working less than 5 months in any calendar year. Article IV provides that all employees149 employed as of January 1, 1971, or thereafter, excluding part time and seasonal workers, are eligible to participate in the plan. The language of the plan leaves no doubt 124 as to the ineligibility of individuals employed less than 5 months to participate in the plan. 7 Where the language of a plan is clear and unambiguous, a taxpayer is not entitled to deduct a contribution greater than that allowed by the terms of the plan. Irwin B. Schwabe Co. v. Commissioner, 17 T.C. 1215 (1952). 8 Therefore, we hold that the respondent properly excluded the compensation paid to individuals employed by petitioner for less than 5 months in computing the limitation on deduction for contributions to the plan under section 404(a)(3)(A).150 The third and final category of employees includes those who were employed for at least 5 months but less than 1 year. These employees had no vested rights in the plan. Under article VIII of the plan, a portion of petitioner's contribution for the year in which they were employed was allocated to their accounts. But, since their employment had already terminated by the end of the taxable year with respect to which the contribution was made, the subsequent allocations to their accounts were immediately forfeited 9 and, under the terms of article IX, allocated to the accounts of those who were participants at the beginning of the taxable year. The question is whether the compensation of such employees should be included for purposes of determining the 15-percent limitation in compensation "to all employees under the * * plan" as provided in section 404(a)(3)(A).151 We have found no authority directly in point. 10 Moreover, as is often the case, we have not been furnished with any clear guidance as to the meaning of the statutory language. Indeed, the statutory provision itself uses different language, i.e., "to the beneficiaries under the plan," in dealing with the treatment of excess contributions. Compare the first and second sentences of section 404(a)(3)(A), n. 6 supra. And the legislative history of the predecessor of section 404(a)(3)(A) which uses the same 125 language (sec. 23(p), I.R.C. 1939) displays considerable ambiguity. See H. Rept. 2333, 77th Cong., 2d Sess. (1942), 2 C.B. 372">1942-2 C.B. 372, 451 ("employees who are the beneficiaries of the trust"); S. Rept. 1631, 77th Cong., 2d Sess. (1942), 2 C.B. 504">1942-2 C.B. 504, 541 ("employees who are covered by the plan"), and 608 ("15 percent of the aggregate compensation of persons who are made the beneficiaries of such compensation"); H. Rept. 2586, 77th Cong., 2d Sess. (1942), 2 C.B. 701">1942-2 C.B. 701, 713 ("15 per cent of compensation otherwise paid employees").152 Respondent in his regulations ( sec. 1.404(a)-9(b), Income Tax Regs.), has dealt with the ambiguity of the statute and the legislative history by providing as follows:(b) The amount of deductions under section 404(a)(3)(A) for any taxable year is subject to limitations based on the compensation otherwise paid or accrued by the employer during such taxable year to employees who are beneficiaries under the plan. For purposes of computing this limitation, the following rules are applicable:(1) In the case of a taxable year of the employer which ends with or within a taxable year of the trust for which it is exempt under section 501(a), the limitation shall be based on the compensation otherwise paid or accrued by the employer during such taxable year of the employer to the employees who, in such taxable year of the employer, are beneficiaries of the trust funds accumulated under the plan. [Emphasis added.]During the period of their employment, the employees in the third category had no interest in the trust funds because no funds had yet been allocated to their accounts. As of the end of the taxable year, they were no longer employees and, having had less than 1 year of service, 153 it was clear that they would never derive any benefit from any allocation that might be made to their accounts, since any amount so allocated was subject to immediate forfeiture. At no time did these employees have a beneficial interest in the trust. The critical factor is not whether the interests of these employees were vested or not vested, forfeitable or nonforfeitable. Rather, it is the fact that they never had any expectation of benefiting, or indeed any right to benefit, from the funds in the trust because the only allocations which might be made on their behalf were immediately forfeited. Such an ephemeral interest in the trust was insufficient to constitute such persons "employees, who in such taxable year of the employer, are beneficiaries of the trust funds accumulated under the plan," as provided in section 1.404(a)-9(b)(1), Income Tax Regs., supra. As applied to the facts herein with respect to 126 the third category of petitioner's employees, we hold that regulation to be a reasonable interpretation of the statute. 11154 Petitioner is not entitled to increase the limitation on deductibility of contributions to the plan by providing for a merely technical allocation at the end of a year to individuals who had no interest in the trust at the end of the taxable year.We note that this case is not governed by the Employee Retirement Income Security Act of 1974, Pub. L. 93-406, 88 Stat. 829, and we express no opinion as to whether a different result should be reached for subsequent years in light of the provisions of that act. 12Decision will be entered under Rule 155. Footnotes1. All references are to the Internal Revenue Code of 1954, as amended and in effect during the taxable years at issue.↩2. Although the record does not contain any written determination by respondent that petitioner is exempt under sec. 501(a), respondent has raised no issue herein as to qualification and we, accordingly, assume, for the purposes of this case, that petitioner was exempt during each of the taxable years at issue.↩3. The plan was amended twice. The first amendment was effective retroactively to Jan. 1, 1971, and the second amendment↩ was effective as of July 1, 1972. We have utilized the language of the original plan or the amendments as appropriate. Neither party has raised any issue or presented any argument which turns upon a choice of provisions.4. Petitioner contends that this phrase was intended to read "termination of employment on account of retirement, disability, or death." We find it unnecessary to our decision to determine whether this contention should be sustained or rejected.↩5. The amounts of these contributions are not in dispute.↩6. SEC. 404. DEDUCTION FOR CONTRIBUTIONS OF AN EMPLOYER TO AN EMPLOYEES' TRUST OR ANNUITY PLAN AND COMPENSATION UNDER A DEFERRED-PAYMENT PLAN.(a) General Rule. -- If contributions are paid by an employer to or under a stock bonus, pension, profit-sharing, or annuity plan, or if compensation is paid or accrued on account of any employee under a plan deferring the receipt of such compensation, such contributions or compensation shall not be deductible under section 162 (relating to trade or business expenses) or section 212 (relating to expenses for the production of income); but, if they satisfy the conditions of either of such sections, they shall be deductible under this section, subject, however, to the following limitations as to the amounts deductible in any year:* * * * (3) Stock bonus and profit-sharing trusts. -- (A) Limits on deductible contributions. -- In the taxable year when paid, if the contributions are paid into a stock bonus or profit-sharing trust, and if such taxable year ends within or with a taxable year of the trust with respect to which the trust is exempt under section 501(a), in an amount not in excess of 15 percent of the compensation otherwise paid or accrued during the taxable year to all employees under the stock bonus or profit-sharing plan. If in any taxable year there is paid into the trust, or a similar trust then in effect, amounts less than the amounts deductible under the preceding sentence, the excess, or if no amount is paid, the amounts deductible, shall be carried forward and be deductible when paid in the succeeding taxable years in order of time, but the amount so deductible under this sentence in any such succeeding taxable year shall not exceed 15 percent of the compensation otherwise paid or accrued during such succeeding taxable year to the beneficiaries under the plan↩ * * * [Emphasis added.]7. Theoretically, there could be distinctions among employees based upon length of service in a calendar year as against the petitioner's and the trust's fiscal year. But neither party has drawn any such distinction.↩8. See also Progressive Welder Co. v. Commissioner↩, a Memorandum Opinion of this Court dated Aug. 31, 1953.9. The record does not indicate the dates on which the annual contributions were paid into the trust. It is clear, however, from the terms of arts. VIII and IX of the plan that the allocation of contributions to participants' accounts could not be made before the end of the taxable year.↩10. William M. Bailey Co. v. Commissioner, 15 T.C. 468 (1950), affd. per curiam 192 F.2d 574">192 F.2d 574 (3d Cir. 1951), cited by respondent, was decided under sec. 23(p)(1)(D), I.R.C. 1939↩, dealing with nonqualified plans, and turned on an interpretation of the word "nonforfeitable" as used in that subsection. It is not dispositive of the issue herein.11. Respondent argues that the result should be the same for any individual with a nonvested interest whose employment is terminated during the taxable year at issue. But, since the question is not presented herein, we take no position as to whether an individual is an "employee under the plan" if his interest was not vested during the year his employment terminated but allocations were made to his account under the plan in prior years. Similarly, we do not have before us (and express no opinion as to the status of) employees with 5 months but less than 1 year of service at the time of termination, which occurs after the close of the taxable year but before the employer's contribution and the allocation thereof is made. Cf. Rev. Rul. 65-295, 2 C.B. 148">1965-2 C.B. 148↩.12. See Employee Retirement Income Security Act of 1974, Pub. L. 93-406, 88 Stat. 829, tit. I, sec. 3(7) and 3(8) defining "participant" and "beneficiary," respectively, for the purposes of that act, and secs. 410 and 411 of the Internal Revenue Code↩, added by Pub. L. 93-406, establishing minimum participation and vesting standards.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625466/	Estate of Lottie Hamar, Deceased, Myron Hamar, Executor v. Commissioner.Estate of Hamar v. CommissionerDocket No. 69575.United States Tax CourtT.C. Memo 1960-107; 1960 Tax Ct. Memo LEXIS 183; 19 T.C.M. (CCH) 575; T.C.M. (RIA) 60107; May 27, 1960Richard Katcher, Esq., B. F. Keith Building, Cleveland, Ohio, and Sheldon J. Gitelman, Esq., for the petitioner. Maurice B. Townsend, Esq., for the respondent. RAUM183 Memorandum Findings of Fact and Opinion The Commissioner determined a deficiency of $27,314.42 in estate tax and an addition to tax in the amount of $13,657.21 1 under Sections 894(a) and 3612(d)(2), Internal Revenue Code of 1939. The issues are: 1. Whether a gift of $20,000 made by the decedent to her son, Myron Hamar, on January 12, 1953, within184 three years prior to her death, was made in contemplation of death within the meaning of Section 811(c)(1)(A), Internal Revenue Code of 1939. 2. Whether Myron Hamar, executor of the will of Lottie Hamar, filed a false or fraudulent estate tax return for her estate. Findings of Fact Some of the facts have been stipulated and, as stipulated, are incorporated herein by reference. Lottie Hamar died testate on April 15, 1953, at the age of 60, while residing in Cleveland, Ohio. Her husband, Nathan Hamar, died on April 26, 1950. Her son and only child, Myron Hamar, presently residing in Scarsdale, New York, is the duly appointed and acting executor of her will. At the time of her death he was 30 years old and resided in Shaker Heights, Ohio. He filed an estate tax return for her estate with the district director of internal revenue at Cleveland, Ohio, on July 15, 1954. Early in March of 1952 the decedent, Lottie Hamar, went to the Mt. Sinai Hospital in Cleveland where a biopsy was taken of a lump on her neck which she had had for many years. She was in the hospital for approximately two hours. The diagnosis was giant follicular lymphoblastoma, which is a malignancy of the lymph185 glands, and she was given X-ray treatments. In October or November 1952 she went to Martinsville, Indiana, for a physical checkup. She developed pain in her abdomen and glands in her neck, loss of weight, and increasing size of her abdomen. She was again admitted to Mt. Sinai Hospital on or about March 1, 1953 and was given additional X-ray treatments. After approximately two weeks of those treatments the mass near her abdomen disappeared and she seemed to be improving. The doctor who was attending her at that time felt that she was going to get better temporarily. She then developed a depression of her bone marrow, probably due to the X-ray treatments, and died in the hospital on April 15, 1953. Prior to her death decedent maintained an apartment in Cleveland and was active in handling her investments. In January 1953, decedent's son, Myron Hamar, and his wife purchased a home on Attleboro Road in Cleveland. On January 12, 1953, decedent visited them in their new home and asked them how they were "fixed financially." When her son indicated that they could use some money to furnish their home, decedent asked if $20,000 would help. When her son replied that it would decedent gave186 him a check for $20,000. Part of the proceeds of this check was used by him and his wife to purchase furnishings for their new home. At the time of this gift, decedent did not say or do anything which indicated to her son that she had a premonition that she would die in the near future. Myron Hamar first became aware of the seriousness of his mother's condition about March 15, 1953, when her doctor informed him that he did not like the way things were going and suggested that a specialist be employed. At that time, decedent asked Philip Lustig, who had been the attorney for her and her deceased husband for many years, to prepare a will. Myron Hamar was present with his mother and Lustig when the will was discussed and knew he was to be the principal beneficiary. The will was drawn about the middle of March and Lustig advised Myron Hamar of its contents. When decedent called her son and Lustig to the hospital for the drawing of her will, she asked her son to go to her apartment and get her bank books from the table in which they were kept and bring them to the hospital. He complied with her request. At that time she had a checking account and a savings account with the Cleveland187 Trust Company, a savings account with the Society for Savings in Cleveland, and a savings account with the National City Bank of Cleveland. All of these accounts were in her name only. Myron Hamar was advised by Lustig to go to these banks and have the money in each of his mother's accounts transferred into a joint account with his mother, and then into an account in his name only. On March 31, 1953, the balance in the amount of $2,808.71, in decedent's National City Bank of Cleveland savings account No. X6918, was transferred into a joint savings account with Myron Hamar in the same bank. On April 3, 1953, the balance of $2,808.71 in this joint savings account was transferred to a savings account No. XX3136 in the name of Myron Hamar only, such account also being with the National City Bank of Cleveland. On April 1, 1953, a deposit in the amount of $3,443 was made to the Cleveland Trust Company checking account in the name of Myron Hamar. The source of the funds for this deposit was dividend checks on securities in the name of decedent. On April 2, 1953, the amount of $820.68 was transferred from decedent's Cleveland Trust Company checking account to a checking account with188 the same bank in the name of Myron Hamar only. On April 10, 1953, the balance in decedent's savings account No. X-XX8076 with the Society for Savings in Cleveland was in the amount of $64,692.03. On that date this account was changed to a joint account with Myron Hamar in the same bank. On April 13, 1953, this joint savings account was closed and $59,692.03 was transferred to a savings account, No. X-XX3955, with the Society for Savings in the name of Myron Hamar only. The remainder of the proceeds of the joint savings account in the amount of $5,000 was, at the same time, transferred to a checking account in the name of Myron Hamar only. Lustig accompanied Myron Hamar to the Society for Savings and the National City Bank of Cleveland and was with him when the transfers were made in those banks. Lustig advised that all of the foregoing transfers, including the April 1, 1953 deposit, be made, and Hamar followed his advice in making them. On April 3, 1953, decedent executed her last will and testament in which Myron Hamar was named as the executor and principal beneficiary. The will was drawn by Lustig. After decedent's death on April 15, 1953, Lustig was employed by Myron Hamar189 to act as attorney for the estate of decedent. Lustig prepared the "Application with itemized statement for determination of Inheritance Tax" (hereinafter sometimes referred to as the Ohio inheritance tax return) which Myron Hamar, as executor of decedent's will, was required to file for the determination of the Ohio inheritance tax. He received from Myron Hamar the information as to assets and liabilities of decedent which he included in the Ohio inheritance tax return. He did not ask Hamar to give him the bank books or records of decedent's bank accounts and Hamar never gave any of them to him. In Schedule D of the Ohio inheritance tax return it was reported that there was no joint or survivorship property standing in the name of decedent; that there were no "transfers of property made by the decedent within two years prior to death * * which are admitted to have been made in contemplation of death * * "; and that there were no "transfers of property made by the decedent within two years prior to death without a valuable consideration substantially equivalent in money or moneys worth to the full value of such property which are not admitted to have been made in contemplation of190 death or intended to take effect in possession or enjoyment at or after death". The application was signed and sworn to by Myron Hamar on June 15, 1953. After the Ohio inheritance tax return had been prepared, Myron Hamar employed A. P. Annan, an attorney, to prepare the Federal estate tax return which he was required to file for the estate of decedent. Annan asked Hamar where he could obtain the information to be reported in the return. Hamar referred him to Lustig and told him that Lustig had complete information as to the affairs of the estate and had prepared the Ohio inheritance tax return. Annan talked with Lustig and received from him a copy of the Ohio inheritance tax return. Annan prepared the estate tax return from the information contained in the Ohio inheritance tax return. At the time he prepared this return he did not know about the bank accounts decedent had prior to her death and was not told about the transfers of funds in those accounts to Hamar. In Schedule G of the estate tax return it was reported that the decedent did not after September 8, 1916, make any transfer in contemplation of death; that decedent, within two years immediately preceding her death, did191 not make any transfer of a material part of her property without an adequate and full consideration in money or money's worth; and that the decedent did not, at any time, make a transfer of an amount of $5,000 or more without an adequate and full consideration in money or money's worth, but not believed to be includible in her gross estate. Myron Hamar signed the "Declaration of Person or Persons Filing Return" on Sheet XXI of the return which read, in part, as follows: "We/I, Myron Hamar * * declare under the penalties of perjury that we/I have carefully examined this return (including the additional sheets inserted, if any); that to the best of our/my knowledge, information, and belief, herein is listed all of the property constituting the decedent's gross estate, as defined by the statute * * ; that we/I have no knowledge of any transfers made * * by the decedent during his lifetime of the value of $5,000 or more, other than bona fide sales for an adequate and full consideration in money or money's worth, except as stated in Schedule G * * ." Annan signed the declaration required of the attorney who prepared the return. Myron Hamar, the executor of the will of Lottie192 Hamar, knowingly and willfully filed a false and fraudulent Federal estate tax return for the estate of Lottie Hamar with intent to evade estate taxes. Opinion RAUM, Judge: 1. Petitioner contends that the gift of $20,000, made by decedent to her son, Myron Hamar, on January 12, 1953, was not a transfer in contemplation of death which would require the inclusion of the amount of the gift in decedent's gross estate under the provisions of Section 811(c)(1)(A), Internal Revenue Code of 1939. 2 It urges that the dominant motive of decedent in making the gift was associated with life, rather than with death, and therefore the gift does not fall within the statute. The motive relied upon was the desire of decedent to give her son financial assistance in furnishing his new home and, according to petitioner, in making this gift she was following a pattern established in previous years of making substantial gifts to her son. 193 The testimony of Myron Hamar as to gifts received by him from decedent prior to January 1953, is as follows: "Q. I direct your attention to the period prior to January 1, 1953, and I would like to know whether or not, did your mother ever give you any substantial gifts? By that I mean gifts in excess of $1,000. "A. Yes, many times. "Q. And would you tell us when, if you remember, and under what circumstances and the amounts, if you recall? "A. I cannot recall specific amounts. She helped us on many occasions. "Q. Well, can you limit your recollection, if you cannot recall specific amounts, to gifts in excess of $1,000? "A. Yes; she helped us, for example, when we purchased a home when we lived in Los Angeles. My business was in Los Angeles, and we bought a home there, and my mother and dad helped us. "Q. When was that, if you recall? "A. That was approximately July of 1948. "The Court: Who are 'we'? "The Witness: My wife and myself, I refer to as 'we'. "Q. Were there any other similar gifts? "A. Yes; she had given us gifts from time to time. I cannot recollect any in particular, but from time to time she had given us gifts. * "Q. Going back, you194 referred to a gift for a home. Do you recall how much that gift was? "A. Approximately $5,000." This testimony does not convince us that decedent was following any pattern of making substantial gifts to her son when she gave him $20,000 on January 12, 1953. Although Myron Hamar testified that his mother had made many gifts in excess of $1,000, the only substantial gift he could recall having received prior to that date was one of $5,000 made in 1948, during the lifetime of his father who died in 1950. Petitioner had the burden of proving that the $20,000 gift was not made by the decedent in contemplation of death. This gift was made approximately three months prior to her death, and approximately ten months after a biopsy disclosed that she had a malignancy of the lymph glands on her neck. During that ten month period she received X-ray treatments. Nowhere in the record is there any convincing evidence which would permit us to find that on January 12, 1953, she was unaware of the serious implications of those treatments, and that she was not motivated by the thought of death when she made this unusual gift on that date. The doctor who made the original diagnosis and treated her, 195 and who knew of her condition at the time of the gift, whether she had been informed of the nature of her illness, and whether she had been given any assurance that she need have no concern over the state of her health, was not called as a witness. Petitioner's unexplained failure to produce him as a witness strongly suggests that his testimony would have been unfavorable. Wichita Terminal Elevator Co., 6 T.C. 1158">6 T.C. 1158, 1165, affirmed, 162 F. 2d 513 (C.A. 10). The doctor who attended decedent subsequent to March 1953, and her son, both of whom testified, were unable to state whether she had, in fact, been advised as to the results of the biopsy in 1952. Her son did testify that at the time of the gift she did not say or do anything which indicated that she had a premonition that she would die in the near future. But the fact that she may not have had such a premonition does not preclude the taxation of the gift, if the though of death was the impelling cause of the transfer. The Supreme Court in United States v. Wells, 283 U.S. 102">283 U.S. 102, 117-118, said: "As the test, despite varying circumstances, is always to be found in motive, it cannot be said that196 the determinative motive is lacking merely because of the absence of a consciousness that death is imminent. It is contemplation of death, not necessarily contemplation of imminent death, to which the statute refers. It is conceivable that the idea of death may possess the mind so as to furnish a controlling motive for the disposition of property, although death is not thought to be close at hand. * * * The words 'in contemplation of death' mean that the thought of death is the impelling cause of the transfer, and while the belief in the imminence of death may afford convincing evidence, the statute is not to be limited, and its purpose thwarted, by a rule of construction which in place of contemplation of death makes the final criterion to be an apprehension that death is 'near at hand'." The proof submitted by petitioner establishes only that decedent, who had received X-ray treatments for a malignancy of her lymph glands, went to the home of her son and only child three months prior to her death, armed with her check book; asked her son and his wife how they were "fixed financially", and, when they indicated they could use some money to furnish their new home, gave her son a check197 for $20,000. On the basis of this evidence, and in the absence of any convincing evidence that in making this substantial gift she was carrying out a policy of making liberal gifts to her son during her lifetime, or had some other motive associated with life rather than death, we cannot find that petitioner has sustained its burden of proving that the respondent erred in his determination that the gift was in contemplation of death. This issue is, therefore, decided in favor of the respondent. 2. The remaining question is whether Myron Hamar, as executor of the will of decedent, filed a false or fraudulent estate tax return for her estate which rendered it liable for the 50 per cent addition to tax for fraud provided for in Sections 894(a) and 3612(d)(2) of the Internal Revenue Code of 1939. The evidence with respect to the foregoing $20,000 gift is, of course, not sufficiently strong to satisfy respondent's burden of proof in respect of fraud. However, we are of the opinion that the various transfers from decedent to Myron Hamar during the period March 31-April 13, 1953, followed by the omission of such transfers from the estate tax return amply support the Commissioner's determination198 of fraud. Petitioner concedes that these transfers were made in contemplation of death and should have been included in the decedent's gross estate. We reach our conclusion as to fraud with some reluctance because Myron Hamar as a witness was fair and candid and because the guiding spirit behind these transfers was the attorney who had counseled the devious steps that were taken in respect of the bank accounts. Nevertheless, we are satisfied on the evidence that Hamar knew what he was doing, and that he knowingly and willfully filed a false and fraudulent estate tax return. We have made a finding to that effect. Decision will be entered under Rule 50. Footnotes1. By amended answer the Commissioner alleged that the addition should be redetermined to be in the amount of $29,432.20. The petitioner does not contest the redetermination if the Commissioner should otherwise prevail on the issues presented for decision.↩2. Section 811(1), Internal Revenue Code of 1939 (applicable to estates of decedents dying after September 23, 1950) reads as follows: Contemplation of Death. - If the decedent within a period of three years ending with the date of his death (except in case of a bona fide sale for an adequate and full consideration in money or money's worth) transferred an interest in property, relinquished a power, or exercised or released a power of appointment, such transfer, relinquishment, exercise, or release shall, unless shown to the contrary, be deemed to have been made in contemplation of death within the meaning of subsections (c), (d), and (f); but no such transfer, relinquishment, exercise, or release made prior to such three-year period shall be deemed or held to have been made in contemplation of death.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625468/	S. DAVIDSON & BROS. INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.S. Davidson & Bros., Inc. v. CommissionerDocket Nos. 25623-25625.United States Board of Tax Appeals21 B.T.A. 638; 1930 BTA LEXIS 1821; December 11, 1930, Promulgated 1821 1. Upon the evidence, held that petitioner changed its method of computing income to the installment basis by an original return for 1917, and respondent erred in determining deficiencies for 1917, 1919, and 1920 upon the basis of net incomes which included amounts collected in those years on account of installment sales made in 1916. 2. Respondent's action in excluding from invested capital for 1919 and 1920 the unrealized profits in 1916 installment sales contracts uncollected at the beginning of those years, approved upon authority of Blum's, Inc.,7 B.T.A. 737">7 B.T.A. 737, and Jacob Bros. Co.,19 B.T.A. 59">19 B.T.A. 59. 3. Invested capital for 1919 and 1920 may not be reduced on account of additional taxes for 1918 when assessment and collection of such taxes are barred by the statute of limitations. 4. Consolidated invested capital for 1920 should not be reduced by additional taxes assessed against an affiliated company for 1919, under the circumstance that the former stockholders agreed to assume and pay, and did pay, such additional taxes. Houston Belt & Terminal Railway Co.,6 B.T.A. 1364">6 B.T.A. 1364. 5. Upon the evidence, held that the1822 petitioner and the Iowa Furniture Store were affiliated during the period May 26 to December 31, 1920. Denver A. Busby, C.P.A., for the petitioner. Arthur Carnduff, Esq., for the respondent. LANSDON 638 In these proceedings, which were duly consolidated for hearing and decision, the petitioner seeks a redetermination of the deficiencies 639 which the respondent has asserted for the years and in the amounts as follows: Docket No.YearDeficiency256251917$8,428.682562319196,624.5225624192019,813.78Petitioner makes the following assignments of error: (1) Net income for 1917, 1919, and 1920 has been increased by the amounts of $77,658.37, $11,403.33, and $3,378.10, respectively, representing profits realized through collections on 1916 installment sales; (2) invested capital for 1919 and 1920 has been reduced by the amounts of $16,260.68 and $4,488.18, respectively, representing the unrealized profits in 1916 installment-sale contracts outstanding and unpaid at the beginning of those years; (3) the adjustments of invested capital for 1919 and 1920, on account of additional income and profits taxes1823 for 1917, are excessive in amounts; (4) invested capital for 1919 and 1920 has been reduced by the amounts of $15,623.96 and $36,971.02, respectively, on account of additional income and profits taxes due for 1918, the assessment and collection of which are barred by the statute of limitations; (5) the adjustment of invested capital for 1920 on account of 1919 income and profits taxes is excessive in amount; (6) invested capital for 1920 has been reduced by $16,799.58 on account of the 1919 income and profits taxes of an affiliated company, which were assumed and paid by the former stockholders; and (7) respondent holds that the petitioner and the Iowa Furniture Store were not affiliated during 1920, and computed the tax upon the basis of a separate return. FINDINGS OF FACTS. Petitioner, an Iowa corporation with its principal office at Des Moines, was engaged, throughout the taxable years on appeal, in a retail furniture business, selling for cash, on credit, and on the installment plan. Under the method of accounting regularly employed in keeping the books prior to 1917, petitioner took into the accounts of each accounting period all sales made during the period, whether1824 for cash, on credit, or on the installment plan, and accounted for the profits on installment sales as income of the period in which such sales were made. The net income reported by the petitioner in the several income-tax returns filed during the same period was computed in accordance with the method of accounting regularly employed in keeping the books. 640 In 1917 petitioner changed its accounting method so as to defer the accounting for profits from installment sales to the year or years in which such profits were reduced to possession. At the close of 1917 and subsequent years, entries were made in the journals and properly posted to the ledgers, reducing gross sales by the estimated amount of uncollected deferred payments on installment sales of the year, and increasing the closing inventory with the estimated unrecovered cost of sales represented in such deferred payments. Net income reported by the petitioner in the original return for 1917 was computed in accordance with the method of accounting employed in keeping the books. Respondent added to net income for 1917, 1919, and 1920 the amounts of $77,658.37, $11,403.33, and $3,378.10, respectively, representing1825 profits on 1916 installment sales collected and reduced to possession in those years. Respondent reduced invested capital for 1919 and 1920 by the amounts of $16,260.68 and $4,488.18, respectively, representing profits on 1916 installment sales which had not been collected and reduced to possession at the beginning of those years. Respondent reduced invested capital for 1919 and 1920 by the amounts of $9,707.20 and $13,674.14, respectively, on account of additional income and profits taxes alleged to be due for 1917. Respondent reduced invested capital for 1919 and 1920 by the amounts of $15,623.96 and $36,971.02, respectively, on account of additional income and profits taxes alleged to be due for 1918. The additional taxes have not been paid and assessment and collection were barred by the statute of limitations when the deficiencies were asserted for the year 1918 and the taxable years here involved. On January 2, 1920, petitioner purchased the entire outstanding capital stock of L. Harbach Sons Co. from the heirs of L. Harbach. Under the terms of the agreement, the vendors agreed to pay any and all additional income and profits taxes which might be assessed against1826 L. Harbach Sons Co., for any year prior to 1920. Subsequently, an assessment was made against that company for additional income and profits taxes for 1919 in the amount of $39,866.10, which was paid by the vendors. Respondent reduced the consolidated invested capital for 1920 by $16,799.58 on account of the additional taxes above referred to. On or about May 26, 1920, petitioner organized the Iowa Furniture Store, a corporation, under the laws of Iowa, for the purpose of selling through that organization all merchandise repossessed from persons defaulting in their installment obligations to the petitioner, and other merchandise in petitioner's stock which had become damaged or obsolete. All such merchandise was charged to the Iowa Furniture Store at prices fixed by petitioner's officers. 641 During 1920 the capital stock of the petitioner and the Iowa Furniture Store was held as follows: S. Davidson & Bros. Iowa Furniture (Inc.)StoreStockholdersSharesPercentageSharesPercentageS. Davidson1,82531.205321.2J. Davidson1,82531.205421.6L. Davidson1,82531.205321.2J. J. Garry62 1/21.07104.0W. H. Cotton112 1/21.92104.0A. Davidson1502.56104.0S. H. Nelson50.85M. Kohan5020.0H. G. Roth104.0Total5,850100.00250100.01827 M. Kohan and H. G. Roth were employees of the petitioner at the time the Iowa Furniture Store was organized. They were permitted to purchase shares of capital stock of the latter company, under an agreement which reads as follows: AGREEMENT made and entered into on the date at the foot hereof, by and between S. Davidson & Bros. Inc., a corporation of the city of Des Moines, Iowa, as first party, and of said city, as second party, and Iowa Furniture Store, third party WITNESSETH: THAT, WHEREAS, second party has borrowed from first party the sum of , and therewith second party has purchased and paid for in cash, shares of common stock issued to him by third party, each of a par value of one hundred dollars ($100.00), the same being of the aggregate par value of . NOW, THEREFORE, these presents witness, that for the sum so borrowed, second party shall execute his negotiable promissory note in the sum of , payable to first party, on or before five years from the date thereof, the same to bear interest from its date, at the rate of six (6) per cent per annum until paid. IT IS FURTHER AGREED by the parties hereto that as collateral security for the payment of said promissory1828 note second party shall transfer to first party the certificate for the common stock so issued and all dividends declared and paid on said stock, said transfer to be by the usual indorsement upon the back of said certificate, and the secretary of third party as provided by law, note upon the stub of said certificate that the same is held as collateral security for the payment to S. Davidson & Bros. Inc., of the principal of said promissory note for with interest thereon from the date of said note at the rate of six (6) per cent per annum, until paid in accordance with the terms of the contract between S. Davidson & Bros. Inc., , and the Iowa Furniture Store, dated Jan. 1, 1920. It is further agreed by the parties hereto that second party shall write upon the margin or across the face of said certificate, date and sign the same a clause to the effect that "this certificate of stock is issued subject to the right of said Iowa Furniture Store to re-purchase the same in accordance with the contract between said stockholder and said Iowa Furniture Store & S. Davidson & Bros. Inc." dated on the 1st day of January, 1920. 642 IT IS FURTHER AGREED between all of the parties hereto, 1829 that any and all dividends declared and paid on this certificate, shall be paid to first party and applied by it first upon interest due and unpaid upon said above described promissory note at the date said money is received by first party and the balance of any shall be applied upon the principal of said note. IT IS FURTHER AGREED by the parties hereto, that second party may, at any time, pay to apply upon the principal and interest of said promissory note, the sum of Fifty dollars ($50.00), or any multiple thereof, the same to be applied first upon accrued interest and the balance upon the unpaid principle thereof; and second party may, at any time, pay off the whole of said promissory note or the part thereof remaining unpaid, with interest as therein provided, and thereupon said certificate or certificates for said stock shall be re-delivered to second party, his legal representatives or assigns, and third party shall cause a cancellation in proper form of the entry upon the stub of the stock books of the holding of the same as collateral security for the payment of said promissory note and interest. It is further expressly agreed by the parties hereto that, in the event1830 that second party, for any reason or in any manner, ceases to be an employee of first party, or of some corporation fifty per cent or more of whose stock is owned by the owners of fifty per cent or more of stock of first party, then in that case, third party reserves the right to purchase from second party, and second party hereby agrees to offer in writing for a period of thirty days to sell, assign and transfer to third party, the certificate or certificates, evidencing said shares of stock so deposited as collateral security and third party agrees that if it decides to purchase said stock, it will pay to second party therefor, whatever sum or sums he has paid to apply in whole or in part upon said promissory note, exclusive of interest paid thereon, added to interest on said principal sum so paid at the rate of six (6) per cent per annum from the date of the last annual declaration of dividend, but subject to the deduction of any amount owing by second party to first party. It is further agreed that; notwithstanding this agreement, second party shall, at each and every meeting of the stockholders have the right to vote the shares evidenced by said certificate, in person or by1831 proxy, as if said stock had not been so deposited as collateral security. DATED at Des Moines, Iowa, this 1st day of Jan. A.D. 1920. The certificates of capital stock issued to Kohan and Roth bore the following notations: May 27, 1920. This Certificate of Stock is issued subject to the right of said Iowa Furniture Store to repurchase same in accordance with the contract between said stockholder, Iowa Furniture Store and S. Davidson & Bros., Inc., Dated 1/1/20. The articles of incorporation of the IOWA FURNITURE STORE contain the following provisions and this certificate is subject thereto: "No stockholder shall at any time sell any of his shares of capital stock of this corporation without first offering in writing to sell the same to the corporation and to its other stockholders for a period of at least sixty (60) days at the value of such shares as shown by the books of the corporation and no purchaser of any such shares shall obtain any title to any of such shares until they have been so offered by the holders to the corporation and to its other stockholders but nothing herein contained shall prevent any stockholder from pledging his shares for money borrowed. (Signed) 1832 MOSE KOHAN, Sec'y.643 Kohan made an initial payment of $1,000 for the stock of the Iowa Furniture Store out of his personal funds. The balance of his subscription, $4,000, and the entire subscription of Roth, $1,000, were paid for from funds borrowed from the petitioner on their personal notes, and their stock certificates were held by petitioner as collateral security for the payment of such notes. Kohan was placed in charge of the operations of the Iowa Furniture Store. He strongly opposed the charges which the petitioner was making for merchandise sent to the Iowa Furniture Store for sale, on the ground that they were entirely too high and resulted in consistent losses to the latter. Because of this opposition, Kohan was requested to resign, which he did in 1922; whereupon he sold his stock in the Iowa Furniture Store to the petitioner. Roth left the petitioner's employ in 1925, and, in accordance with the terms of the purchase agreement, surrendered his stock in the Iowa Furniture Store. OPINION. LANSDON: No brief having been filed, or oral argument made, in respondent's behalf, we are not advised of his views on the several issues raised by the petition, 1833 or the reasons for his several acts against which petitioner complains. Respondent has added to net income as returned by petitioner for 1917, 1919, and 1920, the amounts of $77,658.37, $11,403.33, and $3,378.10, respectively, representing profits received in those years on account of installment sales made in 1916. Petitioner attacks this as improper under the provisions of section 705 of the Revenue Act of 1928, which read as follows: (a) If any taxpayer by an original return made prior to February 26, 1926, changed the method of reporting his net income for the taxable year 1924 or any prior taxable year to the installment basis, then, if his income for such year is properly to be computed on the installment basis - (1) No refund or credit of income, war-profits, or excess-profits taxes for the year in respect of which the change is made or any subsequent year shall be made or allowed, unless the taxpayer has overpaid his taxes for such year, computed by including, in computing income, amounts received during such year on account of sales or other dispositions of property made in any prior year; and (2) No deficiency shall be determined or found in respect of any such1834 taxes unless the taxpayer has underpaid his taxes for such year, computed by excluding, in computing income, amounts received during such year on account of sales or other dispositons of property made in any year prior to the year in respect of which the change was made. (b) Nothing in this section shall be construed as in any manner modifying section 607, 608, 609, or 610 of this Act, relating to the effect of the running of the statute of limitations. 644 Respondent admits in his answer that net income for each of the years on appeal is properly to be computed on the installment basis. Therefore, whether respondent is correct in adding to net income of the years on appeal the profits received in those years on account of installment sales made in 1916, depends entirely upon whether the petitioner changed its method of reporting income to the installment basis by an original return for a taxable year prior to 1924. The facts we have found leave no doubt that the change in method of reporting income to the installment basis was made by an original return for 1917. The effect of the adjustments made in the books at the close of that year and the two later years on1835 appeal was to defer the accounting for the estimated profits represented in the uncollected deferred payments to a later period than that in which the sales were made. Whatever may be said as to the correctness of the accounting procedure followed, its purpose and effect were of place the accounting for income from installment sales on the installment basis. Since the net income reported in the original return for 1917 was computed in accordance with the method employed in keeping the books, it must be held that the change in method of computing income to the installment basis was made by that return. Accordingly, we must hold that respondent erred in determining deficiencies for the years on appeal upon the basis of net incomes which included amounts received in those years on account of installment sales made in 1916. The respondent's action in excluding from invested capital for 1919 and 1920 the amounts of $16,260.68 and $4,488.18, respectively, representing the unrealized profits in 1916 installment sales contracts outstanding and unpaid at the beginning of those years, is approved upon authority of 1836 , and . The proper adjustments of invested capital for 1919 and 1920 on account of any additional taxes found to be due for 1917 under this decision will be made upon final order of redetermination under Rule 50. The respondent's action in reducing invested capital for 1919 and 1920 by the amounts of $15,623.96 and $36,971.02, respectively, on account of additional income and profits taxes for 1918, the assessment and collection of which were barred by the statute of limitations when the deficiencies for 1918 and the taxable years were asserted, is held to be erroneous upon authority of ; ; and . The proper adjustment of invested capital for 1920 on account of any additional tax found to be due for 1919 under this decision, will be made upon final order of redetermination under Rule 50. 645 In view of the agreement on the part of the former stockholders of L. Harbach Sons Co. to assume and pay any and all additional income1837 and profits taxes which might be assessed against that company for any year prior to 1920, and the fact that they did assume and pay the assessment of additional taxes for 1919 in the amount of $39,866.10, the respondent's action in reducing consolidated invested capital for 1920 by the amount of $16,799.58 on account of such additional taxes for 1919 is held to be erroneous, upon authority of . The last question for consideration is whether the petitioner was affiliated, during the period May 26 to December 31, 1920, with the Iowa Furniture Store within the meaning of section 240(b) of the Revenue Act of 1918. During the period in question, 76 per cent of the capital stock of the Iowa Furniture Store was owned outright by the same persons who owned 99.15 per cent of petitioner's capital stock. Of the remaining 24 per cent of the stock of the Iowa Furniture Store, 4 per cent was owned by Roth, an employee of the petitioner, and 20 per cent was owned by Kohan, an employee of the Iowa Furniture Store, who had formerly been in the petitioner's employ. Both Roth and Kohan had acquired their stock under agreements in1838 which the right of repurchase of the stock was reserved in the Iowa Furniture Store should said individuals, "for any reason or in any manner," cease to be employees of the petitioner or "of some corporation fifty per cent or more of whose stock is owned by the owners of fifty per cent or more of the stock" of the petitioer company. The events related in the findings of fact clearly demonstrate the significance of this reservation and the futility of any opposition to the policies of the Davidsons, on the part of Roth or Kohan. Any opposition from that source which seriously challenged the control of the Davidsons over the affairs of the Iowa Furniture Store, or their right alone to determine, to the fullest extent, its business policies without interference on the part of stockholder-employees, could be effectively removed by peremptory discharge of the offending party with the consequent relinquishment of status as a stockholder. This, in effect, is precisely the course they finally took in dealing with Kohan, when they deemed it no longer advisable to tolerate his continued objections to the prices which they determined should be made by the petitioner for merchandise furnished1839 to the Iowa Furniture Store. Kohan's objections led only to a forced severance of his relations with the Iowa Furniture Store, as an employee and stockholder. All circumstances considered, we find that substantially all of the stock of the petitioner and the Iowa Furniture Store was owned or controlled by the same interests, and that respondent erred in 646 holding that these two corporations were not affiliated for the period May 26 to December 31, 1920. Cf. ; and . Reviewed by the Board. Judgment will be entered under Rule 50.MORRIS, TRAMMELL, and MURDOCK dissent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625470/	APPEAL OF SAMUEL E. PRATHER.Prather v. CommissionerDocket No. 2516.United States Board of Tax Appeals5 B.T.A. 623; 1926 BTA LEXIS 2818; November 26, 1926, Decided 2818 The petitioner created a trust by a conveyance of a life estate in certain real property. Subsequently he expended certain moneys in the construction of a levee upon the premises, the life estate in which he had conveyed, and deducted the amount of such expenditure on his return for that year. The Commissioner disallowed the deduction and determined that the expenditure should be amortized over the petitioner's expectancy as a life tenant. Held, that the expenditure was an additional gift to the trust and that the petitioner is entitled to no deduction by reason thereof. W. Frank Gibbs, Esq., for the Commissioner. GREEN 624 The petitioner has appealed from the determination of a deficiency in income tax for the year 1919 in the sum of $840.32, and in his petition alleges the following errors: (1) The Commissioner erred in transferring from taxable income of Ida Prather, wife of the petitioner, to the taxable income of the petitioner the sum of $2,800. (2) The Commissioner erred in disallowing depreciation claimed in the return of the petitioner for the year 1919. (3) The Commissioner erred in amortizing the petitioner's claim for improvements2819 made upon the property in which he held a life interest. FINDINGS OF FACT. For many years prior to March 1, 1906, the petitioner held a life estate in certain Illinois farm lands. The remainder of the estate was vested in his children. On that date he created a trust by conveying to a trustee certain properties, including the life estate above referred to. By the terms of the trust there was to be paid to him annually a stipulated sum of money, the amount of which is not disclosed by the record, and to his wife, Ida Prather, the sum of $2,000 per annum. In the year 1919 the trustee paid to Ida Prather the sum of $2,800, which amount was reported by her as separate income. The Commissioner concluded that this amount was income to the husband and added it to his gross income for such year. In 1918 the petitioner expended $3,865.96 in the construction of a levee on the lands in which he had previously had a life estate and which had been conveyed to the trustee, and claimed such amount as a deduction in his return for that year. This deduction was denied by the Commissioner and the amount thereof amortized over the petitioner's expectancy as a life tenant. In the recomputation2820 of the petitioner's income for the year 1919, the Commissioner deducted the sum of $441.67 by reason of the expenditures so amortized. OPINION. GREEN: The first allegation of error relates to the inclusion in the petitioner's income of the sum of $2,800 paid by the trustee to the wife of the petitioner. In his answer the Commissioner concedes that of this amount $2,000 was the separate income of the wife and that it should not have been included in the income of the husband. As to the remaining $800, there is neither evidence nor admission, and we therefore hold that the petitioner's net income should be reduced by the sum of $2,000. 625 The second allegation of error relates to the depreciation disallowed. No evidence having been introduced, and there being no admissions in the pleadings as to this allegation of error, we must approve the action of the Commissioner in this regard. There remain only the questions presented by the third allegation of error. The petitioner, by certain conveyances, created a trust. Among the properties conveyed to the trustee was his life estate in certain lands. After the creation of the trust and the conveyance above referred2821 to, the petitioner expended the sum of $3,865.96 in the construction of a levee upon the lands in which he had held a life estate. The petitioner on his tax return for 1918 deducted as an expense the amount expended by him in the construction of the levee. This deduction was disallowed by the Commissioner upon the theory that the total expenditure should be amortized over the petitioner's expectancy as a life tenant. In his answer the Commissioner concedes that his action in this regard was in error and contends that the petitioner is entitled to no deduction whatever by reason of the expenditure. If we are correct in our understanding of the facts in this proceeding, both parties have misconceived the situation, for both are apparently proceeding upon the theory that the expenditure was made by the petitioner upon properties in which he held a life estate. It seems to us that the petitioner made the expenditure as a gift to the trust. He had prior thereto definitely parted with any interest which he had as a life tenant and his only interest in the property was that of cestui que trust. We conclude that the expenditure was by way of enlargement of the trust res or*2822 an additional contribution to the trust, and that therefore the petitioner is entitled to no deduction by reason thereof. Judgment will be entered after 15 days' notice, under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625473/	Simon Bloom v. Commissioner.Bloom v. CommissionerDocket No. 12982.United States Tax Court1948 Tax Ct. Memo LEXIS 128; 7 T.C.M. (CCH) 517; T.C.M. (RIA) 48138; July 29, 1948Simon Bloom, pro se. Whitfield J. Collins, Esq., for the respondent. JOHNSON Memorandum Findings of Fact and Opinion JOHNSON, Judge: The Commissioner determined a deficiency of $309.12 in petitioner's income and victory tax for 1943 by adding to gross income reported for 1942 $1,268, and by disallowing a deduction of $563 claimed as medical expense and a deduction of $500 claimed as an attorney's fee paid for defense against criminal prosecution. The year 1942 is involved by virtue of section 6, Current Tax Payment Act of 1943. Petitioner contends that the addition to gross income was arbitrary and without factual basis and that the two deductions were improperly disallowed. The case was submitted upon a stipulation and exhibits, which we hereby incorporate as findings of fact, and upon testimony. From129 these we make the following: Findings of Fact Petitioner, a resident of New York, New York, filed his income tax returns for 1942 and 1943 with the collector of internal revenue for the second district of New York. He has been engaged there in the practice of medicine since 1911. In September 1941 an investigation was instituted by the Bureau of Narcotics which resulted in the discovery of 749 narcotic prescriptions issued by petitioner. Representing himself as a drug addict, an investigator on March 3, 1942, presented himself at petitioner's office and purchased such a prescription for $5, petitioner's usual fee. Petitioner was immediately arrested, but was released on the posting of $500 bail, and continued to practice medicine. Late in 1942 he spent seven weeks in a hospital on account of illness, and paid for medical attention $612, of which he was reimbursed for $291 by benevolent societies under insurance contracts. In November 1945 he was convicted of the illegal sale of narcotic prescriptions and given a prison sentence of a year and a day. He was committed in December 1945 and released on June 1, 1946. His license to practice medicine was revoked on May 28, 1947, and has130 not been renewed. Of the 749 prescriptions discovered, 173 were issued by petitioner in 1942 prior to March 3. These prescriptions were found by the Narcotic Bureau agents in about 50 pharmacies visited, and the number is not necessarily the total which petitioner issued. It was petitioner's practice to note down the fees received by him, and at the end of a week to enter the total in a book, which he claims is now lost. On January 1, 1942, petitioner held $550 in a postal savings account and war savings bonds which cost $900; on March 2, 1942, he held $1,100 in the account and bonds of a cost of $1,350; on December 31, 1942, he held $650 in the account and bonds of a cost of $300. On the three dates his bank balances were $127.05, $201.62 and $55.03, respectively. His wife, who had no independent income, opened a bank account with $225 on May 22, 1942. At the end of the year its balance was $79.61. Petitioner and his wife lived simply and frugally. On his income tax return for 1941 petitioner reported gross income of $2,281.70; for 1942, $2,315.10; for 1943, $903.28. For 1941 and 1943 his claimed deductions were less than $20. For 1942 he claimed aggregate deductions of $1,681.40, 131 which subtracted from gross income of $2,315.10, resulted in a net income of $633.70. Of the deductions claimed, $560 was for medical expenses and $500 was an attorney's fee paid for defense against the criminal charges. The Commissioner disallowed those two deductions and increased gross income to $3,583.10 by adding $1,268 as "average daily sales to March 3 of prescriptions." Opinion Petitioner filed a 1942 income tax return on which he reported gross income of $2,315.10 and claimed certain deductions. He testified that the amount reported was correct, but alleging the loss of a record book in which he entered the total of weekly receipts from patients' fees, he could not buttress his testimony by any documentary evidence. The Commissioner added to gross income reported $1,268 described as "Average daily sales to March 3, 1942, of prescriptions as per records of Narcotic Bureau." The explanation is not clear, but he defends the determination by the argument that the increase in petitioner's bank deposit and bonds between January and March, 1942, was in excess of $1,000, and conceding that petitioner's income likely diminished after arrest for the selling of narcotic prescriptions, 132 he makes a computation of petitioner's expenditures - those deducted on the return and others such as the $500 for bail - and finds that petitioner's gross income exceeded these expenses by only $182.80. To this figure he adds the $291 received as an insurance payment for hospital treatment, thereby arriving at a total of $473.80 remaining after expenses. This figure he insists was inadequate to provide a year's living expenses for petitioner and his wife, or at least "it is not feasible to believe that the petitioner, a doctor of thirty years experience, would have found such an existence necessary during a period of an acute shortage of doctors." Respondent admits that petitioner's net worth, on the evidence adduced, was only $7.59 greater at the end than at the beginning of 1942, but urges approval of the determination of additional income because circumstances indicate that petitioner's "normal income continued to be sufficient to meet his living expenses." Petitioner protests that he and his wife live most penuriously and could and did subsist on the income reported. If a taxpayer keeps no records or if those kept fail to reflect income correctly, a computation may be made in133 accordance with such method as in the Commissioner's opinion does truly reflect income. Section 41, Internal Revenue Code; Bishoff v. Commissioner, (C.C.A., 3rd Cir.) 27 Fed. (2d) 91. And in many such cases a computation based on a disclosed annual increase in wealth has received judicial approval as a measure for taxable receipts. Hoefle v. Commissioner, (C.C.A., 6th Cir.) 114 Fed. (2d) 713; O'Dwyer v. Commissioner, (C.C.A., 5th Cir.) 110 Fed. (2d) 925; Louis Halle, 7 T.C. 245">7 T.C. 245. In some cases estimated living expenses have been approved as a proper addition to the increase in wealth so treated. Kenney v. Commissioner, (C.C.A., 5th Cir.) 111 Fed. (2d) 374; Joseph Calafato, 42 B.T.A. 881">42 B.T.A. 881, aff'd (C.C.A., 3rd Cir.) 124 Fed. (2d) 187. In all such cases, however, the determination approved was based on the Commissioner's ascertainment that the taxpayer held cash, bank accounts, securities or other property at the end of the year in excess of what he had held at the beginning. It was the taxpayer's failure to account for these increments in wealth which the courts stressed in134 sustaining this treatment of them as taxable income. As said in Estate of Hague v. Commissioner, (C.C.A., 2nd Cir.) 132 Fed. (2d) 775, cert. den. 318 U.S. 787">318 U.S. 787: "* * * the determinations of the Commissioner were based on inferences properly drawn from the facts proved by the evidence and were therefore entitled to be accepted as prima facie correct. * * " The Commissioner's determination here, however, lacks the support of any ascertained facts or inferences indicating receipts in excess of the gross income reported. The 173 prescriptions, sold normally at $5 each, would indicate income of only $865, or much less than reported. Petitioner swore that he prepared his return from records, now allegedly lost; stresses that the amount stated was greater than gross incomes reported by him in 1941 and 1943, which he alleges were accepted by the Commissioner as correct, and charges that the Commissioner acted in a purely arbitrary manner in adding the $1,268 as additional income. The Commissioner, in the deficiency notice, by his evidence and on brief, does not purport to have based his addition to income on any ascertained finding of receipts, and attempts to135 justify it merely by the inadequacy of $2,310 to cover petitioner's known expenses and probable living requirements. We think that such a determination was arbitrary and should not be approved. Cf. Helvering v. Taylor, 293 U.S. 507">293 U.S. 507. The record establishes that petitioner and his wife lived frugally. There are not even extravagant expenditures to support an inference of unexplained receipts. The determined addition of $1,268 to income reported is therefore not sustained. Petitioner complains further of the Commissioner's disallowance of $560 for medical expenses and of $500 paid an attorney for defending petitioner against the criminal charges. The parties have stipulated that petitioner paid $612 for medical attention and received $291 under insurance contracts with benevolent societies because of his illness. A proper deduction should be computed and allowed on this account in accordance with section 23(x), Internal Revenue Code. The attorney's fee, being incurred in connection with a criminal prosecution leading to petitioner's conviction, was properly disallowed as a deduction. Burroughs Bldg. Material Co. v. Commissioner, (C.C.A., 2nd Cir.) 47 Fed. (2d) 178.*136 Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625475/	Elko Realty Company, Petitioner, v. Commissioner of Internal Revenue, RespondentElko Realty Co. v. CommissionerDocket No. 60420United States Tax Court29 T.C. 1012; 1958 U.S. Tax Ct. LEXIS 238; February 28, 1958, Filed 238 Decision will be entered for the respondent. Petitioner, a corporation, acquired all of the stock of two corporations which were operating at a loss at the time of their acquisition and which continued to operate at a loss. Petitioner filed consolidated returns with the two corporations for the years 1951, 1952, and 1953. Held, the petitioner has failed to show by a preponderance of the evidence that the principal purpose of the acquisitions in question was not the evasion or avoidance of Federal income tax, so that the Commissioner did not err in disallowing, under section 129 of the Internal Revenue Code of 1939, the deduction by the petitioner of the losses of the two acquired corporations; held, further, the petitioner has failed to show by a preponderance of the evidence that the acquisitions in question had a bona fide business purpose, other than tax avoidance, so that the Commissioner did not err in his determination that the acquired corporations were not affiliates within the meaning of section 141 of the 1939 Code (relating to the filing of consolidated returns). Logan Morris, Esq., and Joseph J. Pugh, Esq., for the petitioner.William J. Hagan, Esq., for the respondent. Train, Judge. TRAIN1013 The respondent determined the following deficiencies in the income taxes of the petitioner:1951$ 8,656.15195216,766.11195322,369.83The main question presented is whether the acquisition of certain corporations by the petitioner had as its principal purpose the evasion or avoidance of Federal income tax within the meaning of section 129 of the Internal Revenue Code of 1939.FINDINGS OF FACT.Some of the facts are stipulated and are hereby found as stipulated.The petitioner, Elko Realty Company, is a New Jersey corporation organized in 1923, with principal office at Wildwood, New Jersey.The petitioner240 filed a consolidated return with Spiegel Apartments, Inc., and Earl Apartments, Inc., for 1951 with the then collector of internal revenue for the first district of New Jersey. Consolidated returns for 1952 and 1953 were filed with the district director, Camden, New Jersey.The petitioner's charter authorizes it to engage in a wide range of activities, including owning, operating, managing, and insuring real estate. With the exception of owning and operating the two corporations whose acquisition is here involved, the petitioner was engaged exclusively in the real estate brokerage and insurance brokerage business during the years here at issue and those immediately preceding. Petitioner's business had been inactive from 1940 until the latter part of 1948.The Spiegel Apartments, Inc., and Earl Apartments, Inc., were organized on October 25, 1948, and March 23, 1949, respectively, under the laws of the State of New Jersey, each to build and own a Section 608 Federal Housing Administration insured apartment project. Pursuant thereto, Spiegel Apartments, Inc., constructed an apartment house at Vineland, New Jersey, consisting of 48 units at a cost of $ 387,352.22 and Earl Apartments, 241 Inc., constructed an apartment house at Vineland, New Jersey, consisting of 108 units at a cost of $ 876,815.07. The Federal Housing Administration, hereinafter referred to as F. H. A., guaranteed mortgages on these two projects in the amounts of $ 388,000 and $ 889,200, respectively. The Spiegel Apartments were approved for occupancy on May 10, 1949, and the Earl Apartments on December 12, 1949, by the Federal Housing Administration. Both projects were of brick construction and funds 1014 were provided in their operating budgets, under the F. H. A. analysis, for maintenance so that it could be expected that there would not be very much depreciation in value over the approximately 34-year life of the mortgages.The vice president and executive head of petitioner, Elko Realty Company, was Harold J. Fox, who had been an officer since at least 1948. Fox owned about 80 per cent of petitioner's stock and controlled it. Fox had had many years' experience in the real estate mortgage and related fields. He had been managing officer of a savings and loan association since 1926, and president and managing officer since 1937 of a private mortgage company, which was approved as an242 F. H. A. mortgagee. He controlled the Seaboard Fidelity Corporation and another company called Credit Rating Services.Toward the end of 1950, Fox learned from a broker in Vineland that Spiegel Apartments, Inc., and Earl Apartments, Inc., were for sale and considered their acquisition. He did not see any operating statements or books of either corporation and was told that they were not available as the then owner of the two corporations, Harry Spiegel, kept only very informal and fragmentary records which were merged with his own personal records. With the possible exception of certain data concerning the degree of occupancy of the two apartment projects, Fox received no information from Harry Spiegel as to the overall financial condition of the two corporations. He did not seek or receive any information from F. H. A. as to the actual operations of either corporation because it was his understanding that F. H. A. does not disclose such information to a prospective investor but only to the mortgagee. He likewise did not seek or receive any such information from the mortgagees of the two projects. It was not until July 1951, some 7 months after his acquisition of their stock, 243 that Fox saw firm figures of the operations of the two corporations.Fox was a frequent visitor to Vineland, and both projects were well known to him. He knew of his own observation that both properties were fully occupied. On January 1, 1951, both projects were 100 per cent occupied, and both had substantial waiting lists. Harry Spiegel's rental agent prepared a report for Fox showing the rent being derived from each apartment. This agent did not have any information as to the financial condition of the two corporations.Fox examined the project analyses prepared by F. H. A. with respect to the two properties. Such analyses are prepared by F. H. A. in connection with its determination as to whether or not a given project qualifies for a Government guarantee of its mortgage. In each case, the project analysis made a detailed estimate of income, annual operating expenses, including maintenance, taxes, and the annual mortgage payments including both interest and principal. In each case, the project analysis showed a net income in excess of all 1015 expenses more than sufficient to meet the mortgage requirements. Based upon an occupancy of 93 per cent, as estimated by the244 F. H. A. analysis, the gross income expectancy in the case of the Spiegel Apartments was $ 43,245, total expenses and taxes $ 18,406, leaving an annual balance of $ 24,839 to cover annual payments under the mortgages, including both amortization and interest, of $ 21,339.96. Based upon the same estimated occupancy of 93 per cent, the project analysis showed a gross income expectancy in the case of the Earl Apartments of $ 91,557, total expenses and taxes of $ 30,542, leaving a net income balance of $ 61,015 to cover annual payments under the mortgage, including amortization and interest of $ 48,906. The analyses called for payments of a management fee, including rental commissions, in each case of 5 per cent of the gross profits. In addition, the analyses provided for insurance on which the commissions would be about $ 1,000 annually.The project analysis of the Spiegel Apartments was prepared September 7, 1948, and that of the Earl Apartments was prepared February 9, 1949.At the time he was considering acquisition of the two projects, Fox had received and was familiar with the annual report for 1949 of the F. H. A. The report showed, as of December 31, 1949, that a cumulative245 total of 5,190 Section 608 projects had been insured by F. H. A. Of this total, 5,083 mortgages were still in force. Eighty-four mortgages on completed projects were reported by lending institutions as being in default at the close of 1949. Lending institutions are required to report F. H. A. mortgages as being in default when a payment is 30 days delinquent. In addition, Fox had previously received and was familiar with the 1948 report of F. H. A. which showed a comparable picture of successful operation of Section 608 projects for that year.On January 1, 1951, Fox acquired 324 shares of the common stock of Spiegel Apartments, Inc., and 440 shares of the common stock of Earl Apartments, Inc. The shares in question represented the only outstanding common stock of both corporations. Fox acquired the stock of the two corporations by arranging loans to each corporation for working capital and for loans to Harry Spiegel for the payment of accrued obligations in the total amount of $ 15,800, which was paid in cash on January 4, 1951, the date of settlement. The loans were made either by Fox personally or by the Seaboard Fidelity Corporation and the Credit Rating Services, both 246 corporations controlled by him. Almost immediately after his acquisition of the stock, Fox transferred the stock to petitioner in exchange for 9 shares of petitioner's common stock having a stated value of $ 900. Petitioner entered on its books the stock received at $ 900, plus an account of $ 15,000 as an open account.1016 Petitioner's income in 1950 was about $ 10,000 or $ 11,000. At the time of its acquisition of the two corporations, petitioner had no contracts or exceptional plans which indicated it would realize abnormal income for the next few years. However, it hoped to grow. The city of Vineland, where petitioner's real estate and insurance business was located, was growing, and there was a demand for housing in the area that could not be met. Seaboard Fidelity Corporation had a net income during this period of between $ 35,000 and $ 50,000 a year, and Credit Rating Services a net income of approximately $ 20,000.The operation of the two apartment projects by petitioner was unsuccessful. Earl Apartments, Inc., and Spiegel Apartments, Inc., were in financial difficulties and operating at a loss at the time of their acquisition by Fox and their subsequent acquisition247 by petitioner. Earl Apartments, Inc., was actually in default on its mortgage at that time. This default was occasioned by the nonpayment of principal installments for November and December 1949 as well as shortages in the tax and mortgage insurance premium accounts. Notice of this default was furnished F. H. A. on December 15, 1950, by the Bowery Savings Bank, mortgagee, through the South Jersey Mortgage Company, its mortgage-servicing agents. This notice of default assigned as the reason for nonpayment: "Income reduced due to rental concessions."Fox knew that, of the approximately $ 16,000 paid to Harry Spiegel as part of the purchase arrangement, some $ 11,000 went to the mortgagee of the projects in payment of accrued obligations. He had drawn the checks so that they could be traced. Spiegel had told Fox that this was his own personal debt, and Fox considered Spiegel's business methods to be unorthodox. Fox also knew that about $ 2,000 of the $ 16,000 went in payment of a fuel bill of one or both corporations. Either Fox or petitioner caused the approximately $ 16,000, including the $ 11,000 which went to the mortgagee, to be entered on the books of the two acquired corporations248 as an account or accounts payable.Fox was aware at the time that he acquired the stock of Earl Apartments, Inc., and Spiegel Apartments, Inc., that neither corporation had working capital. Petitioner loaned money, in amounts unknown, to the two corporations as working capital in the spring of 1951.Spiegel Apartments, Inc., and Earl Apartments, Inc., sustained the following operating losses for the indicated years:YearSpiegelEarlTotal1951$ 7,706.91$ 23,679.35$ 31,386.2619528,525.0520,339.9728,865.02195323,814.2023,862.4747,676.67Because of defaults under the mortgages, they were foreclosed in March 1954.1017 With regard to both projects in the years in question, the actual gross receipts were less than the gross receipts estimated by the F. H. A. project analyses. At the same time, actual expenses exceeded the F. H. A. estimates.The following schedule shows the estimated gross receipts and certain of the estimated expenses as set forth in the F. H. A. project analysis of the Spiegel Apartments, the actual receipts, and certain of the actual expenses of the same project:F. H. A.Actualprojectanalysis195119521953Gross receipts (based on 100per cent occupancy)$ 46,500$ 42,054.09$ 41,937.90$ 28,119.82Excess of analysis grossreceipts over actual4,445.914,562.1018,380.18Heating and ventilating2,9586,445.388,116.116,436.92Lighting288Water400501.34946.09109.67Maintenance2,9944,129.472,127.078,465.28Taxes5,3987,697.707,654.808,983.08Payroll1,8004,562.641,581.501,040.00Sewer149.63149.63Total of above expenses13,83823,486.1620,575.2025,034.95249 The following schedule shows the estimated gross receipts and certain of the estimated expenses as set forth in the F. H. A. project analysis of the Earl Apartments, the actual receipts, and certain of the actual expenses of the same project:F. H. A.Actualprojectanalysis195119521953Gross receipts (based on 100per cent occupancy)$ 98,448$ 85,321.72$ 93,210.21$ 88,325.02Excess of analysis grossreceipts over actual13,126.285,237.7910,122.98Heating and ventilating7,12812,719.5816,659.5614,517.88Lighting648Water865561.50987.23358.19Maintenance5,2519,040.169,955.1416,029.57Taxes5,14516,216.8611,757.1213,708.40Payroll3,3007,120.004,126.253,860.00Sewer3,060.002,160.001,080.00Total of above expenses22,33748,718.1045,645.3049,554.04The turnover of tenants in both projects was higher than normal due to the increasing ease of home ownership in the area. Higher maintenance, including redecorating, costs were one result of this turnover. Occupancy in both projects was reduced by the necessity of redecoration. Gross receipts were also reduced in the case of the Earl250 Apartments by reason of the fact that, for at least a portion of the period in question, the rental level was lower than the level called for in the F. H. A. project analysis. On the other hand, at some point during its operation of the two projects, petitioner sought and obtained a slight increase in rents in at least one of the projects.1018 The F. H. A. project analyses provided for a limited operating payroll in the case of both projects. In the case of Earl, the analysis called for 1 janitor and 1 helper at a combined annual payroll of $ 3,300. In the case of Spiegel, the analysis called for 1 handy man and 1 part-time helper at a combined annual payroll of $ 1,800. In September 1951, on the occasion of an inspection by an F. H. A. construction examiner, the combined payroll included a project manager at the Earl Apartments and a 5-man maintenance crew working on both projects.The fact that sewer expenses were incurred which were not included in the F. H. A. estimate was due to the fact that prior to 1951 this charge was included in the local taxes but, starting in 1951, was charged separately.The increase in heating expenses over the F. H. A. estimates was due, 251 in part at least, to the fact that the wrong type of fuel burner was installed in the Earl Apartments. Subsequent to its acquisition of the project, petitioner endeavored unsuccessfully to have the improper equipment replaced.As of September 24, 1951, and for at least the preceding 3 months, petitioner was making a positive effort in the case of at least the Earl Apartments to provide the project with good management and maintenance.In the years in question, petitioner had a net profit (unconsolidated) as follows:1951$ 26,818.76195244,066.61195343,133.95After consolidation with Earl Apartments, Inc., and Spiegel Apartments, Inc., petitioner had a net loss in 1951 of $ 4,567.50; a net income in 1952 of $ 12,193.59 before application of a net operating loss from 1951; and a net loss in 1953 of $ 4,542.72.The principal purpose of the acquisition by petitioner of Earl Apartments, Inc., and Spiegel Apartments, Inc., was the evasion or avoidance of Federal income tax. No bona fide business purpose was served by the acquisition.OPINION.The deficiencies in this case were determined by the respondent on two separate, although related, grounds.First, in the computation252 of consolidated net income for the years 1951, 1952, and 1953, the respondent disallowed under section 129 of the 1939 Code, the text of which is set out in the margin, 1 the deductions 1019 attributable to the losses sustained by Earl Apartments, Inc., and Spiegel Apartments, Inc. This disallowance was based on respondent's determination that the acquisition of the two corporations by petitioner had as its principal purpose the avoidance of Federal income tax by securing the benefit of deductions, credits, or other allowances which petitioner would not otherwise have enjoyed.253 Second, the respondent determined that Earl Apartments, Inc., and Spiegel Apartments, Inc., were not affiliates, within the intendment of section 141 of the 1939 Code, of petitioner in the years 1951, 1952, and 1953, so as to permit the filing of consolidated returns. The basis for this determination was respondent's finding that there was no business purpose served by the acquisition and holding of the stock of Earl Apartments, Inc., and Spiegel Apartments, Inc., by petitioner in those years, but that such acquisition was solely for tax-reducing purposes.Petitioner here is a person within the meaning of section 129. Sec. 3797 (a) (1), 1939 Code. It acquired control of the corporations in question after October 8, 1940. It thereby secured the benefit of deductions which it would not otherwise have enjoyed. The sole remaining requirement to be met in order for section 129 to be operative here is that the acquisitions in question had as their principal purpose the evasion or avoidance of Federal income tax.The respondent having determined that the principal purpose of the acquisition was the avoidance of income tax, the burden is on the petitioner to prove otherwise. American Pipe & Steel Corporation, 25 T. C. 351, 366 (1955),254 affd. 243 F. 2d 125 (C. A. 9, 1957). In the instant case, the petitioner has failed to carry this burden.1020 The petitioner seeks to defeat the application of section 129 by offering evidence to prove, first, that tax avoidance was not the principal purpose of the acquisition, and second, that a bona fide business motive was the principal purpose.Petitioner's argument in support of its first proposition is summarized in its brief as follows:The Petitioner expected no abnormal profits nor did it know whether losses had been or would be sustained by the subsidiaries. All known facts indicated that the operations of the subsidiaries would be successful.Petitioner argues that its situation at the time of the acquisition was such that a tax avoidance motive could not exist because it had only nominal income and income tax liability and did not expect any abnormal increase in income. Granting that petitioner's income at the time of the acquisition was relatively small and granting that there is no evidence that it expected an "abnormal" increase in income, petitioner has nevertheless failed to demonstrate by this showing that a tax avoidance purpose255 could not have existed.Petitioner was a newly reactivated business, and, in the words of Fox, it hoped to grow. Vineland, where petitioner's operations were centered, was a growing city and the demand for housing in the area was so great that it could not be met. As a real estate brokerage concern, petitioner could expect its profits to increase which they in fact did rather substantially.Additionally, however, the mere fact that an acquiring corporation has a modest income with a consequent small tax liability and no expectation of growth does not as a matter of law negate the existence of a tax avoidance motive. If a corporation with a net income of $ 10,000 and a Federal tax liability of $ 3,000 acquires another corporation with the principal purpose of wiping out or significantly reducing its own $ 3,000 tax, section 129 would be applicable. This is not to say that the amount of a tax saving may not be significant in determining the existence of a tax avoidance purpose. A very small actual or potential tax saving to a taxpayer with a very large regular tax liability may tend to show the improbability of a tax avoidance motive. However, the value of a tax benefit must be256 measured in relative terms. Thus, a tax saving, small in dollar amount, may loom large in terms of the particular taxpayer's tax liability and form the basis of an avoidance motive.The petitioner states that Fox could have transferred the stock of the two apartment projects to the Seaboard Fidelity Corporation or to the Credit Rating Services, both of which had larger taxable incomes at the time of the acquisition than did petitioner. From the fact that Fox actually transferred the stock to petitioner, which had the lowest income of the three, petitioner argues that there could not have been an avoidance purpose in the transaction.1021 Since the evidence indicates it was reasonable to expect petitioner's business and income to grow, this argument lacks validity. Moreover, we do not know in what business Seaboard Fidelity Corporation or Credit Rating Services was engaged. We do not know what operations their corporate charters authorized. We infer from their names that their business activities were less related to the ownership and management of real estate than was that of petitioner, and perhaps completely unrelated to such a business. If this was the case, and petitioner257 has offered no evidence to the contrary, a transfer of the Earl and Spiegel stock to Seaboard Fidelity Corporation or Credit Rating Services would have been even more lacking in realism than was the actual transfer to petitioner.In further support of its proposition that the principal purpose of the acquisition in question was not tax avoidance, petitioner maintains, as pointed out above, that it did not know that the two acquired corporations had been sustaining losses or that they would sustain losses subsequent to their acquisition. Petitioner steadfastly maintains that all the facts known to it at the time of acquisition indicated that the operations of the subsidiaries were and would be successful.We have found that Earl Apartments, Inc., and Spiegel Apartments, Inc., were, in fact, in financial difficulties and operating at a loss at the time of their acquisition by petitioner. The former was actually in default on its mortgage during the 2 months immediately prior to its acquisition by petitioner. Fox, who initially acquired both corporations and almost simultaneously transferred them to petitioner, knew that, of the approximately $ 16,000 he paid to Harry Spiegel at the258 time of settlement, some $ 11,000 went to the mortgagees. He knew this because the checks were made payable to Spiegel and the creditors for the specific purpose of making it possible to trace the money. Fox testified that Spiegel told him that he owed this amount personally and that he believed Spiegel had been diverting funds from the two corporations to his own use. Yet at the same time, either he or petitioner caused the approximately $ 16,000 to be entered on the books of the two subsidiaries as an account or accounts payable, an action completely inconsistent with the asserted belief that the $ 16,000 represented personal obligations of Harry Spiegel.The testimony of Fox, the only witness in the case, in describing the transaction whereby he acquired the stock of the two corporations from Spiegel is unclear and at times inconsistent, although Fox himself conducted the negotiations and the facts of the transaction were peculiarly within his own knowledge. He testified that the approximately $ 16,000 was reflected on the books of a corporation or corporations as an account or accounts payable. Since petitioner only assigned a book value of $ 900 to the 9 shares of its own259 stock 1022 which it transferred to Fox in exchange for his stock in the Earl and Spiegel Apartments, we must assume that petitioner was not at the same time assuming a liability in the neighborhood of $ 16,000. The incurring of such a liability would have been inconsistent with the value assigned to the stock transferred. This being the case, we have concluded that it was on the books of Earl Apartments, Inc., and Spiegel Apartments, Inc., that the $ 16,000 was entered as an account or accounts payable.Fox knew that neither subsidiary had any working capital at the time of their acquisition. Moreover, both subsidiaries had substantial losses in each of the years 1951, 1952, and 1953. With the exception of a sharp increase in the loss of Spiegel Apartments, Inc., in 1953, which was due primarily to a substantial drop in rental receipts, the pattern of the losses of both subsidiaries remained constant throughout the 3-year period. In fact, their aggregate losses for the full year 1951, the first year of their ownership by petitioner, were somewhat larger than in 1952. With the exception of sewer expenses, petitioner has not shown that these losses were the result of events260 or conditions arising only subsequent to the acquisition. No statements or records of the operation of either corporation have been submitted with respect to the period prior to 1951 (or for later years for that matter). In view of the conceded default in 1950 of at least one of the corporations, in view of a continuous pattern of substantial losses of both corporations from the date of acquisition on, and in the absence of any showing to the contrary, we have found that both corporations were operating at a loss when acquired. Petitioner does not suggest otherwise, but only that it was unaware of that fact at the time of acquisition.Petitioner asserts that its belief in the financial soundness of the two subsidiaries and its expectation of continued success was based mainly on (1) the fact that most Section 608 projects were operating successfully throughout the United States in general and throughout New Jersey in particular, (2) the fact that the project analyses prepared by F. H. A. with respect to the Earl and Spiegel Apartments estimated that both projects would operate at a profit, and (3) the fact that both projects were fully occupied and had substantial waiting lists261 at the time of their acquisition.In determining the weight to be attached to these assertions, it must be borne in mind that Fox, who made the investigation of the two projects prior to their acquisition, had had by his own testimony many years of business experience in the real estate mortgage and related fields.Petitioner, and its alter ego Fox, would have us believe that, since Fox knew that most Section 608 projects were operating successfully, he therefore believed that the Earl and Spiegel Apartments were 1023 operating successfully and would continue to do so. It is obvious that such a conclusion does not follow logically from the stated premise. The argument is totally unconvincing. The most that could have been inferred reasonably from this information was that Section 608 projects were a promising area for investment generally but certainly not that any specific project necessarily represented a sound investment.Similarly, the project analyses themselves provided no logical basis for the asserted conclusion that the two projects were operating successfully and would continue to do so. The most that could be deduced reasonably from the analyses was that, 262 under their stated assumption as to receipts and expenses, the projects would operate at a profit. Assuming those assumptions to have been reasonable at the time of the preparation of the analyses, there was no basis for concluding that they were still valid at the time Fox and petitioner acquired the two corporations.In the case of the Spiegel Apartments, the project analysis had been prepared approximately 8 months prior to the time the project was ready for occupancy and approximately 28 months prior to the time it was acquired by Fox and petitioner. The project analysis of the Earl Apartments had been prepared approximately 10 months prior to the time the project was ready for occupancy and approximately 23 months prior to the time it was acquired. The Spiegel Apartments had been operating for 20 months and the Earl Apartments for 13 months at the time of their acquisition. Under the circumstances, we find no support for petitioner's assertion that the project analyses formed a reasonable basis for its belief at the time of acquisition that the two projects were operating successfully and would continue to do so.Finally, petitioner claims its belief in the financial soundness263 of the two projects was based in part on the fact that both were fully occupied and had substantial waiting lists. A high percentage of occupancy was certainly a prerequisite to their successful operation. However, in order to be meaningful in terms of actual gross receipts, the degree of occupancy had to be related to the rental level. Fox testified that the rental level was the same as that provided in the F. H. A. analyses and that there was no lowering of rents. If this had been so, then, at least on the gross receipts side of the ledger, the projects would have been operating up to expectations.When questioned about the official report of an F. H. A. examiner to the effect that in May 1951, some 4 months after their acquisition, the Earl Apartments were renting at a scale considerably lower than that called for by the F. H. A. analysis, Fox simply declared that the examiner must have been mistaken. Furthermore, petitioner has offered no explanation of the report of default submitted by the mortgagee 1024 to F. H. A. in December 1950, immediately prior to the acquisition, which assigned as the principal reason for the default in the Earl mortgage "reduced income due264 to rental concessions." Fox testified that prior to the acquisition he had a report prepared by Harry Spiegel's rental agent showing the occupancy and rental of each apartment. This report was not offered in evidence. No books and records of either Earl Apartments, Inc., or Spiegel Apartments, Inc., covering their operations either prior to or subsequent to their acquisition were offered in evidence. Such books and records would be the best evidence of the actual rents. Under the circumstances, we have found that, at least with respect to the Earl Apartments, the rental level for at least a portion of the period involved was lower than the F. H. A. scale.However, even if we found full occupancy at F. H. A. rental levels, which we do not, such a finding would not support the conclusion that petitioner had a reasonable basis for believing that the two projects were operating successfully and would continue to do so. It is obvious that receipt figures are meaningless insofar as net income is concerned unless accompanied by expense figures. It is inconceivable that an experienced businessman such as Fox would have assumed otherwise. Yet, insofar as the evidence indicates, Fox 265 and petitioner failed to obtain a single shred of information as to the actual expenses of the two corporations prior to their acquisition. We recognize that, in certain types of business which operate typically on a wide margin of profit with expenses playing a relatively unimportant part in the overall success of the operation, a knowledge of receipts alone might offer a fair basis for knowledge of the general profitableness of the business as a whole. Such is not the case here. The very F. H. A. analyses upon which petitioner insists it placed so much reliance showed a relatively small operating margin in each case.Since both Earl Apartments, Inc., and Spiegel Apartments, Inc., were in fact operating at a loss at the time of their acquisition by petitioner, to support its claim that it actually believed otherwise petitioner must show a reasonable basis for such a belief and not a mere speculative hypothesis without foundation in reality. Petitioner here has failed to do so.Petitioner likewise has failed to furnish any convincing evidence that the two acquisitions had as their principal motivation a bona fide business purpose.Petitioner argues that by acquiring the two corporations266 it would secure annual rental commissions in the neighborhood of $ 6,000 and annual insurance commissions of about $ 1,000. The acquisition of the two corporations by petitioner was unnecessary to the objective of securing these commissions. Fox controlled petitioner and when once 1025 he himself had purchased all of the stock of Earl Apartments, Inc., and Spiegel Apartments, Inc., he could thereafter have placed the commissions in the hands of petitioner, if that was the desired objective, without the necessity of transferring the stock to petitioner. Acquisition of the stock by petitioner added nothing of substance to its ability to secure the commissions.As a further factor of alleged bona fide business purpose, petitioner declared that it anticipated acquiring eventual title to two very valuable pieces of property after the mortgages, with a life of about 34 years, had been paid off. The validity of this argument in turn depends upon the validity of petitioner's asserted belief that the two corporations were and would continue to operate profitably so that the mortgages would be paid off. We have already decided that petitioner has failed to produce any convincing 267 evidence that it had a basis for such a belief. This being the case, petitioner's argument here must also fail.The entire circumstances surrounding the acquisition by the petitioner of these two corporations fail to support its contention that a bona fide business purpose existed.The consideration paid for the stock of the two corporations was at best nominal. While petitioner on brief asserts that the decision to acquire the stock of the two corporations was reached "only after a most thorough investigation," the evidence leads inevitably to the opposite conclusion.As we have seen, neither Fox nor the petitioner saw any operating books of the two corporations prior to their acquisition. Nor does the record suggest that they made any effort to develop such information. Harry Spiegel was the owner and operator of the two corporations and, even if he had had no books and records whatsoever, it would seem reasonable to expect a prospective purchaser of his business to make at least informal inquiry of him concerning its operations. Aside from Spiegel's apparent assurance that both projects were fully occupied, the record fails to disclose that petitioner, either through Fox or268 otherwise, made any inquiry of Spiegel as to the financial success or lack of it of the two corporations. There is certainly no suggestion that Spiegel or anyone else for that matter actually represented to Fox or the petitioner that the two corporations, or either of them, were operating at a profit.Under the circumstances, for petitioner to expect us to give serious credence to its assertion that through Fox, a thoroughly experienced businessman, it entered into the transaction in question for a bona fide business purpose requires a degree of naivete which we do not possess.1026 The petitioner having failed to carry its burden of proof, the determination of the respondent that the principal purpose of the acquisition of the Earl Apartments, Inc., and the Spiegel Apartments, Inc., by petitioner was the avoidance of Federal income taxes is sustained. It follows that the respondent did not err in disallowing the losses of the two corporations.The second ground asserted by the respondent in support of its determination of the deficiencies is that Earl Apartments, Inc., and Spiegel Apartments, Inc., were not affiliates of the petitioner within the meaning of section 141 of269 the 1939 Code so as to permit the filing of consolidated returns in the years at issue.The provisions of section 141, insofar as here pertinent, are set out in the margin. 2270 In J. D. & A. B. Spreckels Co., 41 B. T. A. 370 (1940), we laid down the rule that where the ownership of a subsidiary's stock by a parent corporation served no business purpose, as distinguished from a tax-reducing purpose, the subsidiary is not an affiliate within the intent of section 141.We agree with petitioner that the facts of the instant case differ in a number of respects from the facts in J. D. & A. B. Spreckels Co., supra. However, the rule of that case is applicable, regardless of distinctions of fact, where the petitioner is unable to show that a business purpose, as distinguished from a tax-reducing purpose, was served by the acquisition in question. We have already discussed at considerable length the evidence presented in this proceeding, and it is unnecessary to repeat that discussion here. After a careful examination of all the evidence, we conclude that the petitioner here has failed to show that a business purpose, as distinguished from a 1027 tax-reducing purpose, was served by its acquisition of Earl Apartments, Inc., and Spiegel Apartments, Inc.It follows that the respondent's determination271 of deficiencies is, in all respects, sustained.Decision will be entered for the respondent. Footnotes1. SEC. 129. ACQUISITIONS MADE TO EVADE OR AVOID INCOME OR EXCESS PROFITS TAX.(a) Disallowance of Deduction, Credit, or Allowance. -- If (1) any person or persons acquire, on or after October 8, 1940, directly or indirectly, control of a corporation, or (2) any corporation acquires, on or after October 8, 1940, directly or indirectly, property of another corporation, not controlled, directly or indirectly, immediately prior to such acquisition, by such acquiring corporation or its stockholders, the basis of which property, in the hands of the acquiring corporation, is determined by reference to the basis in the hands of the transfer corporation, and the principal purpose for which such acquisition was made is evasion or avoidance of Federal income or excess profits tax by securing the benefit of a deduction, credit, or other allowance which such person or corporation would not otherwise enjoy, then such deduction, credit, or other allowance shall not be allowed. For the purposes of clauses (1) and (2), control means the ownership of stock possessing at least 50 per centum of the total combined voting power of all classes of stock entitled to vote or at least 50 per centum of the total value of shares of all classes of stock of the corporation.(b) Power of Commissioner to Allow Deduction, Etc., in Part. -- In any case to which subsection (a) is applicable the Commissioner is authorized -- (1) to allow as a deduction, credit, or allowance any part of any amount disallowed by such subsection, if he determines that such allowance will not result in the evasion or avoidance of Federal income and excess profits tax for which the acquisition was made; or(2) to distribute, apportion, or allocate gross income, and distribute, apportion, or allocate the deductions, credits, or allowances the benefit of which was sought to be secured, between or among the corporations, or properties, or parts thereof, involved, and to allow such deductions, credits, or allowances so distributed, apportioned, or allocated, but to give effect to such allowance only to such extent as he determines will not result in the evasion or avoidance of Federal income and excess profits tax for which the acquisition was made; or(3) to exercise his powers in part under paragraph (1) and in part under paragraph (2).↩2. SEC. 141. CONSOLIDATED RETURNS.(a) Privilege to File Consolidated Returns. -- An affiliated group of corporations shall, subject to the provisions of this section, have the privilege of making a consolidated return for the taxable year in lieu of separate returns. * * *(b) Regulations. -- The Secretary shall prescribe such regulations as he may deem necessary in order that the tax liability of any affiliated group of corporations making a consolidated return and of each corporation in the group, both during and after the period of affiliation, may be returned, determined, computed, assessed, collected, and adjusted, in such manner as clearly to reflect the income- and excess-profits-tax liability and the various factors necessary for the determination of such liability, and in order to prevent avoidance of such tax liability.(d) Definition of "Affiliated Group". -- As used in this section, an "affiliated group" means one or more chains of includible corporations connected through stock ownership with a common parent corporation which is an includible corporation if -- (1) Stock possessing at least 95 per centum of the voting power of all classes of stock and at least 95 per centum of each class of the nonvoting stock of each of the includible corporations (except the common parent corporation) is owned directly by one or more of the other includible corporations; and(2) The common parent corporation owns directly stock possessing at least 95 per centum of the voting power of all classes of stock and at least 95 per centum of each class of the nonvoting stock of at least one of the other includible corporations.As used in this subsection, the term "stock" does not include nonvoting stock which is limited and preferred as to dividends.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625476/	Lillian Boehm v. Commissioner.Boehm v. CommissionerDocket No. 111621.United States Tax Court1943 Tax Ct. Memo LEXIS 69; 2 T.C.M. (CCH) 954; T.C.M. (RIA) 43467; October 23, 194369 Petitioner's stock in The Hartman Corporation became worthless prior to 1937 and, therefore, deduction therefor is not allowed in that year. Louis Boehm, Esq., 60 Broad St., New York, N. Y., for the petitioner. P. J. Cavanaugh, Esq., for the respondent. VAN FOSSAN Memorandum Finding of Fact and Opinion The Commissioner determined deficiencies in the amount of $125.63 and $7,537.46 in the petitioner's income tax for the years 1936 and 1937, respectively. All the issues with reference to the 1936 deficiency and certain of those concerned with that of 1937 have been conceded or abandoned by the parties, and effect will be given thereto in the computation under Rule 50. The following issues are presented for the year 1937: (1) Whether the petitioner's stock in The Hartman Corporation became worthless in 1937. (2) Whether the respondent properly included in her gross income for 1937 the sum of $12,500 received by the petitioner in dismissing a stockholder's suit. Findings of Fact The facts were stipulated and as so stipulated are adopted as findings of fact. In so far as material to the issues presented, the facts are as follows: The petitioner, a married woman, resides in New70 York, N. Y. She filed her separate income tax return for the year 1937 with the collector of internal revenue for the third district of New York. In 1929 the petitioner purchased 1,100 shares of the Class A stock of The Hartman Corporation, hereinafter called Hartman (Virginia), for $32,440. Hartman (Virginia) was incorporated in 1916 in the State of Virginia to acquire the capital stock of the Hartman Furniture and Carpet Company, hereinafter referred to as Hartman (Illinois), and its affiliates. Hartman (Illinois) and its affiliates were engaged in the business of selling furniture, carpets, and household goods. In June 1932, Martin L. Straus and Elias Mayer were appointed equity receivers for Hartman (Virginia) by the District Court of the United States for the Northern District of Illinois, Eastern Division. The receivers entered into possession of the property of Hartman (Virginia)and continued its business of buying and selling furniture and other household articles from the time of their appointment until on or about May 26, 1933. The petitioner received a letter from Hartman (Virginia) enclosing its balance sheet of December 31, 1931, which showed assets and liabilities71 of $15,401,097.97 with a total net worth of $9,410,659.50. Accompanying the balance sheet was a statement of the board of directors dated April 4, 1932 addressed to the stockholders, setting forth the policy and procedure of the corporation due to the business depression and stressing the reduction of loans payable and of operating costs. On May 4, 1932, Martin L. Straus, president of Hartman (Virginia), sent another letter to the stockholders stating that business had not shown any improvement and outlining the measures being taken to counteract the existing business conditions. In 1933 a new corpoation called Hartman's, Inc., was organized under the laws of the State of Delaware. As of May 26, 1933 Hartman's, Inc. purchased at a bankruptcy sale the assets of Hartman (Illinois), the wholly-owned subsidiary of Hartman (Virginia), for the sum of $501,000 in cash and an agreement to procure a waiver of certain inter-company claims against the bankrupt estate. The stock of the new company was issued to the creditors of Hartman (Illinois) in settlement of claims, and to the stockholders of Hartman (Virginia) by subscription thereto. The stockholders of Hartman (Virginia) were given the72 right to subscribe for debentures and capital stock of Hartman's, Inc. The petitioner did not exercise the right of subscribing to the debentures and stock of Hartman's, Inc. and did not acquire any interest in that company in 1933 or thereafter. On August 10, 1934, the receivers of Hartman (Virginia) filed a report with the court listing as assets $39,593.13 in cash and a suit pending against the directors (the Graham suit) and as liabilities total outstanding claims amounting to $707,430.67. The receivers recommended that claims totaling $630,574.57 be allowed. By an order dated August 10, 1934, the court approved the report and also awarded $3,500 as compensation to each of the receivers and $5,000 as attorneys' fees. The receivers filed a second report on July 11, 1935, listing as assets $27,192.51 in cash and the Graham suit pending against the directors and as liabilities the same amount of $707,430.67, representing the total outstanding claims. The receivers recommended that a dividend of 4 per cent be paid on the claims of $630,574.57 allowed and that one claim amounting to $176,856.10 be disallowed. By an order dated the same day the court adopted the report and73 recommendations of the receivers. On August 26, 1935, one of the two receivers was released from further duties. The remaining receiver filed a final report with the court on September 30, 1937. The sole remaining asset was cash in the amount of $1,909.94. Claims totaled $630,574.57. It was recommended that compensation $900totaling be allowed the receiver and counsel, and the remainder be distributed to the creditors. The court adopted the recommendations and discharged the receiver by an order dated Sptember 30, 1937. A suit against the directors, hereinafter called the Graham suit, was instituted on December 16, 1932 in the Supreme Court of the State of New York. The petitioner and eight other stockholders of Hartman (Virginia) were plaintiffs. The defendants were the corporation, Hartman (Virginia), and nine members of the company's board of directors, all of whom were financially responsible and several of whom were prominent business men. The plaintiffs brought the suit "on behalf of themselves as stockholders of The Hartman Corporation and on behalf of the said Company and all other stockholders of said Company similarly situated, who may join with the plaintiffs-in, 74 and contribute to the expenses of this suit." The complaint set forth the plaintiffs' respective holdings of the capital stock of Hartman (Virginia), 1 its corporate existence and purposes, the number of shares outstanding of Class A and Class B stocks, and alleged the facts that Class A was preferred over Class B as to dividends; that the individual defendants were elected to the board of directors in 1929 and thereafter (excepting two who acted until April 26, 1932); and that certain individual defendants were the officers of the company from 1929 and thereafter (excepting the two who served until April 26, 1932). The plaintiffs then charged the defendants with waste, extravagance, mismanagement, neglect, and the fraudulent violation of their duties as officers and directors of the corporation and demanded that the defendants render an accounting and pay into the treasury of the corporation the amount of the loss and damage sustained by it by reason of their wrongful acts. The complaint charged the defendants with issuing false letters, statements75 and reports to the stockholders relating to the assets, liabilities and financial condition of the corporation and with concealing the true state and condition of the corporation from the stockholders, including the plaintiffs. The complaint concluded with the following demand for judgment: 1. That the defendants and each of them, except The Hartman Corporation, be directed to account to the defendant Corporation for their official conduct as officers and/or directors thereof, as the case may be, in the management and disposition of the property and affairs of the said Corporation, and in respect to all of the matters set forth in this complaint; 2. That the liability of the defendants and each of them, be ascertained and determined, and that they be adjudged and decreed to pay into the Treasury of the defendant Corporation the amount of the loss and damage which shall be found to have been sustained by the Corporation by reason of their aforesaid wrongful acts and conduct; 3. That this Court make and award suitable allowance to the plaintiffs for counsel fees and other necessary disbursements incurred in the prosecution of this action on behalf of the defendant Corporation and76 stockholders, and that it be decreed that the defendant Corporation pay the same to the plaintiffs, and that the plaintiffs have judgment therefor, together with the costs and taxable disbursements of this action. 4. That the plaintiffs have such other and further relief as may be just, equitable, and proper. During the years 1933 to 1936, inclusive, extensive examinations were made of certain of the defendants. Many hundreds of pages of testimony were taken and numerous exhibits were offered in evidence. Pursuant to an order of the New York Supreme Court the petitioner and her co-plaintiffs paid expenses and counsel fees of certain of the defendants' attorneys amounting to approximately $800. The plaintiffs in the Graham suit expended approximately $2,000, exclusive of fees, in defraying expenses of their counsel while attending the examinations, in stenographic costs and printing charges. At the conclusion of the examinations and shortly before the trial, negotiations were commenced for a settlement of the action and on February 20, 1937 such settlement was consummated. Under its terms the defendant directors paid the petitioner and the other plaintiff stockholders the sum77 of $50,000 in full settlement and discharge of the claims and cause of action of the petitioner and her co-plaintiffs. In connection with the settlement the petitioner and the other stockholders released all their rights and claims arising out of the acts committed by the defendants as alleged in the complaint. The suit was dismissed on May 14, 1937. At the time of the settlement the assets of Hartman (Virginia) consisted of $1,909.94 in cash and the Graham suit and its liabilities amounted to $630,574.57, representing the claims allowed by the court. The petitioner's proportionate share of the $50,000, after payment of counsel fees and expenses, amounted to $12,500. In her income tax return for 1937 she claimed a deduction from gross income in the amount of $19,940 as a loss due to the worthlessness of her Hartman (Virginia) stock. The respondent denied the deduction and included in her gross income for that year the sum of $12,500 which she received pursuant to the settlement. The petitioner claimed a deduction from gross income in her 1934 income tax return in the amount of $32,302 as a loss due to the worthlessness of the 1,100 shares of Class A Hartman (Virginia) stock. 78 The deduction was denied by the Commissioner on the ground that her stock did not become worthless in the year 1934. The petitioner at no time received any deduction from her gross income in the determination of her income tax liability by reason of her investment in Hartman (Virginia) stock. We further find that the petitioner's stock in Hartman (Virginia) did not become worthless in 1937. Opinion VAN FOSSAN, Judge: The first issue presents the question of when the petitioner's stock in Hartman (Virginia) became worthless. The petitioner contends that the identifiable event which determined the fact and the extent of her loss due to the worthlessness of the stock was the negotiated settlement of the Graham suit in 1937, and argues that before that occurrence she had no means of ascertaining what, if any, her loss would be. We are of the opinion that petitioner can not be sustained on this issue. Not only is the evidence insufficient to establish that the stock had any value at the beginning of 1937 and became worthless during that year, it clearly shows that the stock was worthless prior to that year. The financial history of the company, including the receivership in 1932, 79 the report of August 10, 1934, showing the only assets to be some $39,000 in cash and the Graham suit, against outstanding claims of some $707,000 and the second report in 1935 showing less cash with the same outstanding claims demonstrate the hopeless condition of the corporation. We have no evidence on which to base a conclusion that the Graham suit was an asset of any substantial value. We know nothing of the merits of the suit, the probability of recovery, the assurance of the collection of a judgment, or other essential factors. The stipulated fact that the defendants were men of financial responsibility is not sufficient to establish the collectibility of a recovery equal to the outstanding claims. These claims aggregated more than half a million dollars and had to be satisfied before there would be anything for the stockholders. In our opinion, all value had gone from the stock prior to 1937. We sustain respondent in his disallowance of the claimed loss. The second issue presents the question whether the payment of $12,500 was income to petitioner. According to the stipulated facts the complaining stockholders were paid $50,000 "in full settlement and discharge of80 the claims and cause of action of petitioner and the plaintiff stockholders as set forth in the complaint." How the sum was arrived at we do not know. Apparently it was a negotiated lump-sum settlement. Whether the defendants merely "brought their peace" we can only conjecture. It is noted that the payment did not go through the corporate treasury although the prayer of the complaint specifically asked that the defendants "be adjudged and decreed to pay into the treasury." The reason is obvious. If a judgment had been entered and payment had been made into the corporate treasury, the proceeds would have been applied first to the creditors' claims and nothing would have remained for the stockholders. On the record we are unable categorically to catalog and characterize the payment. We can not determine whether it was replacement of capital, restoration of lost profits, compensation for damages suffered, nuisance value, or some other type of payment. In this situation we have no alternative to holding that petitioner, on whom rested the burden of proof, has not proven that the item was not income. Decision will be entered under Rule 50.Footnotes1. Each of the plaintiffs owned a block of Class A stock. A plaintiff other than the petitioner also owned a block of Class B stock.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625478/	APPEAL OF WALTER NEUSTADT.Neustadt v. CommissionerDocket No. 2896.United States Board of Tax Appeals3 B.T.A. 491; 1926 BTA LEXIS 2646; January 28, 1926, Decided Submitted November 10, 1925. 2646 Walter Neustadt pro se. John W. Fisher, Esq., for the Commissioner. 491 Before SMITH, JAMES, LITTLETON, and TRUSSELL. This is an appeal from the determination of a deficiency for the year 1919 in the amount of $1,096.15. The question in issue is whether the taxpayer is liable to income tax upon the difference between the cost of a share of stock purchased in 1919 and sold within the year at $9,900 more than the purchase price. FINDINGS OF FACT. The taxpayer is an oil and lease broker and a resident of Oklahoma. He filed an income-tax return for the year 1919, in which he stated that he was married and living with his wife on December 31, 1919, and that his wife did not make a separate return. In the return he claimed a deduction from gross income of an alleged loss of $3,333.33 upon the sale of one share of stock of the Hog Creek Oil Co., which share was purchased within the year for $100 and sold within the year for $10,000. The Commissioner has disallowed the deduction of the alleged loss of $3,333.33, and added to the gross income reported $9,900, representing the difference between the cost and the sales price. In June or July, 1919, 2647 the taxpayer turned over to his wife the certificate for the share of stock in question, which certificate stood in his own name. He had promised to give her the share of stock some time prior thereto. The taxpayer's wife placed the certificate 492 in a bureau drawer, where it remained for some weeks. At the time she was living in New York City. On July 30, 1919, the taxpayer telegraphed to his wife as follows: Shall I sell your one share of Hog Creek for ten thousand. She replied on the same date: Sell as cash can be reinvested advantageous. The share of stock was sold at the price indicated and $10,000 was placed to the credit of Mrs. Dorris W. Neustadt in the Guaranty State Bank of Ardmore, Okla., on August 28, 1919. Against this account, increased by a deposit of $450 on October 15, 1919, checks were drawn on September 24 and October 14 for $9,000 and $1,050, respectively. These checks were signed by D. W. Neustadt in the handwriting of the taxpayer. The Guaranty State Bank knew at the time that the signature D. W. Neustadt was made by the taxpayer. Securities purchased with the funds withdrawn were purchased in the name of the taxpayer's wife. The*2648 certificate for the one share of Hog Creek Oil Co. stock always stood upon the books of said company in the name of Walter Neustadt. Under date of August 2, 1919, the certificate was assigned by Walter Neustadt to Dorris W. Neustadt, of Ardmore, Okla.On or before August 1, 1919, there were certain reports in a number of newspapers that either the Standard Oil Co., the Sinclair Oil Co., or the Magnolia Petroleum Co., had offered to purchase the capital stock of the Hog Creek Oil Co. at the price of $13,333.33 per share. DECISION. The determination of the Commissioner is approved.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625479/	John W. Seaman, Jr., and Bettye H. Seaman, et al., 1 Petitioners v. Commissioner of Internal Revenue, RespondentSeaman v. CommissionerDocket Nos. 1235-81, 1236-81, 1237-81, 1238-81, 1239-81, 1596-81, 1598-81United States Tax Court84 T.C. 564; 1985 U.S. Tax Ct. LEXIS 98; 84 T.C. No. 38; April 2, 1985. April 2, 1985, Filed 98 Decisions will be entered under Rule 155. Petitioners deducted their distributive shares of the losses claimed during the years in question by the Knox County Partners, Ltd., a limited partnership organized and operated for the avowed purpose of exploiting certain coal rights. The partnership's loss for 1976 was attributable to deductions for advanced royalties, which the partnership "paid" in the form of cash and a nonrecourse note. Respondent disallowed petitioners' distributive shares of the partnership's loss for 1976. Respondent also disallowed certain of petitioners' distributive shares of the partnership's loss for 1977 attributable to the partnership's claimed deductions for accrued interest and "costs of goods -- development costs." Held: Petitioners have not carried their burden of proving that Knox County Partners, Ltd., was organized and operated with the primary and predominant objective of realizing an economic profit. Therefore, the advanced royalties are not deductible by the partnership under sec. 162(a), I.R.C. 1954, and petitioners are not entitled to deduct their distributive shares of the claimed partnership loss for 1976. Held, further, respondent's disallowance 99 of certain of petitioners' distributive shares of the partnership's loss for 1977 attributable to the partnership's claimed deduction for accrued interest is sustained, since the partnership's nonrecourse note did not constitute true indebtedness. Held, further, respondent's disallowance of certain of petitioners' distributive shares of the partnership's loss for 1977 attributable to the partnership's claimed deduction for "costs of goods -- development costs" is sustained, since petitioners have failed to carry their burden of proving that respondent's determination with respect to the issue was erroneous. Elliot I. Miller and Richard S. Kestenbaum, for the petitioners.Patricia A. Donahue and John Ferrante for the respondent. Sterrett, Judge. STERRETT565 Respondent issued statutory notices of deficiency in these consolidated cases that determined deficiencies in petitioners' Federal income taxes as follows:Docket No.PetitionerYearDeficiency1235-81John W. Seaman, Jr.,1976$ 43,451.00and Bettye H. Seaman19773,342.981236-81Bruce A. Samson1976130,035.80and Adajean L. Samson19777,874.981237-81Harold G. Nix197643,343.0019772,624.161238-81Richard F. Lockey197629,682.70and Anne S. Lockey1239-81William J. Schifino1976$ 28,062.70and Lois A. Schifino1596-81Edward Hoornstra197629,346.19and Mildred Hoornstra1598-81Charles A. Kottmeier19762 20,908.25and Eloise L. Kottmeier100 566 The ultimate issue for decision is the amount, if any, that petitioners, as limited partners, are entitled to deduct as their distributive shares of the losses claimed during the years in question by the Knox County Partners, Ltd. (the partnership). Specific issues posed by the parties include the following:(1) Whether the coal mining activity of the partnership was an activity engaged in for profit;(2) Whether, and if so to what extent, are the advanced royalties claimed by the partnership deductible for the 1976 taxable 101 year;(3) Whether petitioners in docket Nos. 1235-81, 1236-81, and 1237-81 are entitled to deduct their distributive shares of interest expense claimed by the partnership for the 1977 taxable year; and(4) Whether petitioners in docket Nos. 1235-81, 1236-81, and 1237-81 are entitled to deduct their distributive shares of "cost of goods -- development costs" claimed by the partnership for the 1977 taxable year.FINDINGS OF FACTSome of the facts have been stipulated and are so found. The stipulation of facts, together with the exhibits attached thereto, is incorporated herein by this reference.All of the petitioners herein were residents of Florida at the time their petitions were filed. The income tax returns for the periods involved were filed by each of the petitioners with the 567 Office of the Internal Revenue Service at Chamblee, Georgia. All of the determined deficiencies in these cases are attributable to petitioners' participation, as limited partners, in the Knox County Partners, Ltd., a limited partnership organized and operated for the avowed purpose of exploiting certain coal rights.Knox County Partners, Ltd., was organized through the joint efforts of Ralph Musicant, Michael 102 Glantz, Carl Anderson, and Samuel Winer. Ralph Musicant is a graduate of Northwestern University, from which he received his Bachelor of Arts degree in 1968, and of Harvard Law School, from which he received his Juris Doctorate in 1971. After he graduated from law school, Musicant practiced tax and securities law, first with a firm in Illinois and later with a firm in Florida. Subsequently, he became a vice president of acquisitions and general counsel of a real estate investment firm. He then became a visiting professor of finance at the Northwestern University Graduate School of Management. In the spring of 1976 Musicant began working, as director of real estate and assistant general counsel, for Financial Analytics Corp. (Finalco), an equipment leasing firm. Prior to that time, Musicant could boast of no background in the coal mining industry. By his own admission, his prior work history largely involved the structuring of tax shelters.It was as an employee of Finalco that Musicant first became involved in the transactions that eventually led to this litigation. During the early summer of 1976, Musicant began to investigate the coal industry as an area for expansion by Finalco. 103 In his efforts to learn about the industry, Musicant talked to an accountant in Florida who informed him that one Michael Glantz had been involved in the coal business. Glantz's experience in the coal industry began in 1975 or 1976 when some people he knew approached him with respect to joining them in a strip mining venture. In late August or early September 1976, Musicant contacted Glantz and set up a meeting to discuss the coal mining business. The meeting was held the following day in Finalco's offices in Vienna, Virginia, and was attended by Musicant, Jack Olmstead, who was vice president of Finalco, Glantz, and Carl Anderson. Anderson was Glantz's partner in at least one coal mining venture in Kentucky. Glantz indicated that American Coal & Coke, Inc. 568 (American Coal & Coke), of Nashville, Tennessee, had a substantial number of coal leases, and the parties agreed to a mutual meeting with the principals of that corporation.Thereafter, Glantz set up the meeting with American Coal & Coke. The meeting was held at the offices of American Coal & Coke in early September 1976 and was attended by Musicant, Olmstead, Glantz, Anderson, and various officers of American Coal & Coke, 104 Cliff E. Hooper, Reginald Keene, Raymond Rhodes, and John Ozier. During the meeting, which lasted the better part of the day, the attendees discussed such matters as the nature of American Coal & Coke's involvement in the coal mining business, the sums necessary to open up a mine, the type of mining equipment that should be used, and the manner in which a possible deal might be structured. The name "American Blue Gem Coal Co., Inc." (American Blue Gem) was mentioned in the course of the conversation as a mining corporation that performed functions for American Coal & Coke.Shortly after the meeting in Nashville, Musicant resigned from Finalco. The reason for the resignation was a dispute with Olmstead, who allegedly wanted to cut Glantz and Anderson out of any forthcoming deal that might be reached between Finalco and American Coal & Coke. Musicant then got in touch with Glantz to inform the latter that he had resigned from Finalco. It was agreed that Musicant would join Glantz and Anderson in an effort to structure a deal with American Coal & Coke.In early October, Musicant and Glantz flew to Nashville to meet again with the principals of American Coal & Coke for purposes of discussing 105 a possible sublease of mineral property. 3 The lease under inquiry was known as the Detherage lease. At this juncture the property in question was described by American Coal & Coke as an approximately 2,600-acre piece of property located in Knox County, Kentucky, and containing Blue Gem coal, the highest quality coal available. It was represented that the property was worth $ 2 million and that it would cost $ 400,000 to open a mine. The parties 569 pursued discussions regarding the structuring of the deal, particularly the use of an advanced royalty. Musicant believed that use of an advanced royalty would maximize the tax benefits to all participants. It was decided that the advanced royalty would be in the amount of $ 1,825,000. The deal agreed upon was that Glantz, Anderson, and the investors would supply the capital and that American Coal & Coke would run the business. It was contemplated that an affiliate of American Coal & Coke, American Blue Gem, would assume the role of the contract miner of the property. Unbeknownst to Musicant, and apparently Glantz and Anderson as well, American Blue Gem was not at this time an existing corporation. Musicant and Glantz explained that 106 they would need until the end of December to raise money for the venture from outside investors. The parties, therefore, agreed to a $ 50,000 liquidated damages figure in the event that a sufficient number of investors could not be located by December 31, 1976.Sometime in early October, Glantz and Anderson formed the Knox County Partners, Ltd. Glantz was the initial general partner and Anderson was the initial limited partner. Musicant was requested to prepare a limited partnership certificate and agreement. The certificate, with attached agreement, was signed and notarized on October 10, 1976. The principal place of business of the partnership was 3428 Lakewood Road, Tampa, Florida, which was Glantz's home address. American Coal & Coke also made some space available to the partnership in its offices in Nashville.On October 15, 1976, a lease agreement was entered into between American 107 Coal & Coke, as "lessor," and Knox County Partners, Ltd., as "lessee," entitling the lessee to mine and produce coal from the Blue Gem seams of coal on the Detherage property. The term of the lease was stated to be for such period of time as might be necessary to mine and remove the commercially minable Blue Gem seams of coal on the property. However, it was agreed that, if at any time further mining operations on the leased premises were not economically justifiable, the lessee, upon notice to the lessor and provided that the lessee was not in default on any of its obligations under the lease, could terminate the lease and preclude the accrual of any further obligations of the lessee under the lease. Under the terms of the lease, the lessee 570 agreed, inter alia, to submit to the lessor a plan for the course of development of the property and to submit annual reports with respect to the course of development of the mine; to commence mining operations not later than May 1, 1977; to employ a competent registered engineer to prepare surveys, maps, etc.; and to keep accurate books of account with respect to all coal mined. In addition, the lease contained the following provisions concerning 108 the payment of royalties:Royalties: (a) Lessee shall pay to Lessor a minimum royalty annually throughout the term of this lease in the amount of Two Hundred Thousand ($ 200,000.00) dollars per annum. However, Lessor recognizes that time will be required to commence operations and hereby agrees that such minimum royalty shall not commence until May 1, 1977 and shall be prorated based upon a full calendar year. (b) Lessee shall pay to Lessor a tonnage royalty on all merchantable coal mined, as follows: The sum of Two Dollars and Ten Cents ($ 2.10), for each net ton of 2,000 pounds of merchantable coal mined and sold. * * (c) Lessee shall pay an advance minimum royalty in the amount of One Million Eight Hundred Twenty-Five Thousand ($ 1,825,000.00) Dollars in cash and nonrecourse promissory notes on or before December 31, 1976. If Lessee does not fulfill its obligation hereinabove, to wit, to pay Lessor such advance minimum royalty by December 31, 1976 then Lessor will accept such $ 50,000.00 as liquidated damages for Lessee's non-performance. Such $ 50,000.00 to be evidenced by Lessee's promissory note, Number 2, dated October 15, 1976 attached hereto.The lease specifically stated 109 that the royalties would be treated and considered as rent reserved for the leased premises. It was agreed that the lessor would retain a lien for such rent upon the lessee's improvements and property located on the leased premises, as well as upon the leasehold estate.The property covered by the foregoing lease was originally leased by American Coal & Coke on September 28, 1976, from Ed Detherage, as president of White Log Jellico Coal Co., Inc. American Coal & Coke was obligated to pay Detherage a tonnage royalty of $ 0.70 for each net ton of 2,000 pounds of merchantable coal mined and was further obligated to pay Detherage a minimum coal royalty of $ 250 per month.Subsequent to the execution of the lease agreement between Knox County Partners, Ltd., and American Coal & Coke, it was agreed between Musicant, Glantz, and Anderson that, 571 through his corporation, RCM Associates, Inc. (later to be known as Reserve Associates, Inc.), Musicant would join Glantz as a general partner in Knox County Partners, Ltd. In addition, there would be two more general partners, the Anderson Family Trust, of which Carl Anderson was the trustee, and Samuel L. Winer. By letter dated November 27, 1976, 110 it was agreed that Winer would attempt to raise $ 600,000 from the sale of limited partnership interests in the partnership.At the time that the lease agreement between Knox County Partners, Ltd., and American Coal & Coke was signed, no other agreements between the parties were in effect, and the partners, particularly Musicant, set themselves to the task of arranging various collateral agreements with American Coal & Coke. In addition, the partners began to do some research into the background of the corporation and the nature of the leased premises.In the process of investigating the background of American Coal & Coke, Glantz checked with references provided by the corporation and with a "couple of miners" who were selling coal through the corporation. Those references met with Glantz's satisfaction. However, he did not verify the resumes of the corporate officers that were subsequently included in the partnership's offering memorandum. He also did not ask to examine any books and records or tax returns of the corporation. Furthermore, he never attempted to determine whether there were any judgments against the corporation or whether any of the corporation's assets were encumbered. 111 The research undertaken by the partners generally revealed that the corporation was not as strong as it originally had appeared.In early November 1976, Glantz, on behalf of the partnership, engaged the services of Gary R. Cummings of Cummings, Binkley & Associates, Inc., to prepare an engineering report and coal reserve estimate on the Detherage tract. Cummings, whose services had been recommended by Cliff Hooper of American Coal & Coke, was a surveyor, but he was not a mining engineer. The report estimated the existence of approximately 7,444,286 tons of Blue Gem coal on the acreage purportedly leased (approximately 2,600 acres), of which 5,211,000 tons were estimated to be recoverable by deep 572 mining, using a 70-percent recovery factor. The report specifically stated that "Inasmuch as the coal reserves are estimated, it is recommended that core drilling as per standard procedure be utilized to verify and prove the reserves."On December 1, 1976, the charter of American Blue Gem was registered and certified by the State of Tennessee. Apparently, the initial shareholders of the corporation were Hooper, Keene, Rhodes, and Ozier of American Coal & Coke. At least one, if not all, 112 of the general partners was unaware of the fact that American Blue Gem was a newly formed entity.By a private placement memorandum (offering memorandum), dated December 2, 1976, Knox County Partners, Ltd., sought subscriptions for a maximum of 20-limited-partnership units at $ 30,000 per unit. It was noted that of the proceeds of the offering, all sums would be applied toward payment of the "advanced minimum royalty," with the exception of $ 15,000, which would be retained as working capital. It was further noted that American Coal & Coke would pay $ 185,000 of the $ 585,000 cash portion of the advanced royalty to the general partners as a consulting fee.The offering memorandum informed potential investors that the partnership had executed a sublease with American Coal & Coke, pursuant to which the partnership had obtained the coal rights to mine the Blue Gem seam of coal on the approximately 2,600 acres covered by the sublease. It further informed investors that the sublease called for a $ 200,000-per-year minimum royalty and that $ 1,825,000 of the "advanced minimum royalty" would be paid on the closing date, $ 585,000 in cash and $ 1,240,000 by the execution of a nonrecourse note. 113 The note, which was to bear interest at the rate of 6-percent per annum, would be dated the closing date and would be due May 1, 1986. Principal and interest payments were to be paid quarterly. The offering memorandum explained that the note would be wholly without recourse to any partner and that the sole remedy of American Coal & Coke in the event of default was to terminate the sublease. Recoupment of the "advanced minimum royalty" of $ 1,825,000 was to occur at the rate of $ 2 per ton of coal mined and sold and was to continue until 912,500 tons had been mined and sold.The offering memorandum also described the general nature of the mining contract that the partnership would 573 execute with American Blue Gem as contract miner of the leased premises. The memorandum stated that American Coal & Coke and American Blue Gem, in conjunction, would determine the type of mining equipment to be used on the premises. It was represented that American Blue Gem would guarantee the mining of 100,000 tons per year and that the partnership, in turn, would pay American Blue Gem a base price of $ 17 per ton for each ton mined and sold. The base price was subject to escalation. It was further 114 represented that, in the event that American Blue Gem was unable to satisfy its guarantee to mine 100,000 tons per year, thereby resulting in the partnership's inability to pay the portion of the advanced royalty represented by the nonrecourse note, American Blue Gem would be obligated to pay the partnership liquidated damages in an amount sufficient to amortize the note. It was specifically contemplated that the liquidated damages could be paid in the form of promissory notes executed by American Blue Gem, and it was represented that American Coal & Coke had agreed to accept such notes in lieu of any payments to be applied as credits against the partnership's note to American Coal & Coke.The offering memorandum set forth a substantial number of risk factors inherent in the investment. It was noted that there could be no assurances made with respect to the coal reserves; that coal prices had peaked in 1974 and 1975 and had declined since that time; that the general partners had little experience in the operation of a coal mining business; that certain potential conflicts of interest existed; and that there was no assurance that the contract cost of American Blue Gem's services would 115 be maintained at the initial contract price and no assurance that American Blue Gem would be financially responsible with respect to its guarantee.A substantial portion of the offering memorandum was devoted to a discussion of the tax aspects of the transaction. In addition, a generally favorable tax opinion prepared by Robert M. Levin, Esq., was attached to the offering memorandum. Levin was a friend of Musicant's, with whom Musicant shared office space upon his return to Chicago, after leaving the employ of Finalco. The offering memorandum noted that there were substantial tax risks associated with an investment in the partnership and cautioned that "Since so-called 'tax 574 shelters' are generally under attack by the Internal Revenue Service, it is reasonable to expect that upon an audit, the Internal Revenue Service may differ with legal Counsel in the application of the Internal Revenue Code to the Partnership."In addition to the tax opinion, various other exhibits were attached to the offering memorandum, including, for example, a copy of the amended and restated partnership agreement, financial projections prepared by Musicant from information provided by American Coal & Coke, 116 the engineering report and coal reserve estimate prepared by Cummings, and resumes of the principals of American Coal & Coke and American Blue Gem.On December 2, 1976, the partnership, American Coal & Coke, American Blue Gem, and American Coal & Coke's attorney, as escrow agent, entered into an escrow agreement, whereby the parties agreed to deposit with the escrow agent executed copies of a coal mining agreement between the partnership and American Blue Gem, coal brokerage and coal purchase agreements between the partnership and American Coal & Coke, and a joint agreement between the partnership, American Coal & Coke, and American Blue Gem. These documents were to be released to the parties upon the receipt by American Coal & Coke of the advanced royalty payment called for by the lease agreement dated October 15, 1976. The documents were to be of no force and effect in the event that the advanced royalty payment was not made on or before December 31, 1976.As contemplated in the offering memorandum, pursuant to the terms of the executed mining agreement, American Blue Gem guaranteed that it would mine or cause to be mined a minimum of 100,000 tons of coal per year, beginning May 117 1, 1977, and continuing throughout the term of the agreement. In return, the partnership agreed to pay American Blue Gem, subject to adjustments, the sum of $ 17 for each ton of coal so mined. The term of the agreement was to be for an initial period of 10 years and could thereafter be extended at the option of American Blue Gem. However, if either party failed to perform any of its obligations set forth in the agreement, the nondefaulting party was granted the right to terminate the agreement.575 The agreement jointly executed by the partnership, American Coal & Coke, and American Blue Gem elaborated on the latter corporation's minimum mining guarantee and set forth the following provisions with respect to the payment of liquidated damages on the failure to satisfy the guarantee:If the Miner [American Blue Gem] in any month after May 1, 1977, should fail to mine coal under the Mining Contract for any reason other than as may be set forth in paragraph 12 (the Force Majeure provision) of the Mining Contract, it shall pay to the Lessee [Knox County Partners, Ltd.] as liquidated damages for such failure the sum of $ 16,666 on the last day of such month. * * Payments which may be required 118 of the Miner under paragraphs 1 and 2 hereof to the Lessee may be made at the election of the Miner in either cash or non-interest bearing negotiable promissory notes payable to the Lessor (American Coal & Coke, Inc.). * * The Lessor by the execution hereof agrees to accept from the Lessee without recourse any promissory notes received by Lessee from the Miner pursuant to this Agreement and Lessor shall apply such promissory notes as credits against the Lessee's obligations under the Lease and Note.Pursuant to the coal brokerage agreement executed on December 2, 1976, the partnership appointed American Coal & Coke as its exclusive agent for the sale of coal. The corporation would receive an escalating commission for its brokerage services, the amount of which was dependent upon the amount of the gross proceeds from coal sales. Pursuant to the coal purchase agreement also executed on December 2, 1976, the partnership generally agreed to sell, and American Coal & Coke generally agreed to buy, 75,000 net tons of coal per year at a price of $ 21.50 per net ton for a period of 2 years.At some time after the offering memorandum was prepared and the escrow agreement signed, the partnership 119 had a title report prepared on the Detherage tract. That report disclosed a problem with respect to the title on over 1,000 acres of the land. At that juncture, the partners presented the matter to Chicago Title Insurance Co. and were able to obtain a title insurance policy with respect to 1,100 acres of the Detherage tract. After he learned of the title defect on the Detherage tract, Musicant approached American Coal & Coke and requested that an additional property be added to the lease. Thereafter, on December 28, 1976, the lease agreement was amended to add an additional property known as the Jones property. The lease was again amended on December 30, 1976, 576 making it clear that the royalty provisions contained in the original lease were not to apply to the Jones property. On December 31, 1976, an agreement was entered between the partnership and American Blue Gem providing that American Blue Gem had the option of extending the mining agreement of December 2, 1976, to cover the Jones property. 4120 On December 31, 1976, the partnership, American Coal & Coke, and American Blue Gem entered into an agreement whereby the former corporation agreed to loan the latter corporation the sum of $ 206,000 for purposes of establishing the initial mining operations on the property leased by the partnership. By the same agreement, the parties agreed that all decisions with respect to the establishment of the initial mining operations would rest solely within the discretion of American Coal & Coke or American Blue Gem. The amount of the loan of $ 206,000 from American Coal & Coke was almost 100 percent less than the amount originally stated by the corporation to be necessary for purposes of opening the mine.The limited partners of the partnership were not located until sometime in December 1976, and the record fails to disclose the exact date of their entry into the partnership. However, although at least one of the general partners, Musicant, had lost faith in American Coal & Coke by the end of December, the partnership nevertheless consummated the deal with American Coal & Coke by the originally contemplated closing date, 121 December 31, 1976. On that date, a check in the amount of $ 585,000 was issued by the partnership to American Coal & Coke as payment of the cash portion of the advanced royalty. In addition, the partnership executed a nonrecourse promissory note in the amount of $ 1,240,000, representing the balance of the advanced royalty payable on or before December 31, 1976. By its terms, the note bore interest at the rate of 6 percent per annum beginning May 1, 1977. The note provided that American Coal & Coke's sole remedy on default would be the eviction of the partnership from the subleasehold created by the lease agreement between American Coal & Coke and the partnership dated October 15, 1976, as amended. In a separate agreement dated December 577 31, 1976, the partnership granted American Coal & Coke a security interest in the partnership's leasehold interest, and American Coal & Coke agreed that the partnership would never be personally liable for any money damages in the event of default in the payment of the $ 1,240,000 promissory note. The entire amount of the cash and note turned over to American Coal & Coke on December 31, 1976, was intended by the partnership to represent a royalty 122 payment and no portion of the total was allocable to a turnkey agreement.Subsequent to the consummation of the transaction, Glantz and Anderson assumed certain operational responsibilities. Glantz apparently undertook to make certain that American Blue Gem complied with certain legal requirements with respect to the licensing of the mine. 5 In addition, he participated in locating a Wilcox mining machine to be used on the property. In early 1977, Glantz was informed that American Blue Gem had subcontracted the mining to a company called R & M Mining Co., which was operated by Bill Ridings and a gentleman named "Monk."On March 31, 1977, the partnership entered into an agreement with American Coal & Coke to sublease a tract of land known as the Logan property. The partnership agreed to pay a tonnage royalty of $ 1.35 per ton of merchantable coal mined from the property, wheelage of $ 0.15 per ton of coal transported across the property from other properties, and a minimum royalty of $ 300 per month that could be recouped against the tonnage royalty or the wheelage. The Logan tract interfaced the Detherage 123 tract and the latter tract had to be entered through the former tract.The results of the partnership's mining operations were unimpressive, at best. At no time was any coal mined from the Jones property. In fact, the mining equipment was never carried to that tract of property.Mining activities began on the Detherage or Logan tract in the last week of April 1977 and continued through May 1977 or perhaps into June 1977. Some coal actually was mined from the Detherage tract, and by letter dated May 24, 1977, the following distributions from the sale of that coal were made to petitioners as limited partners: 578 PetitionerAmountJohn W. Seaman, Jr.$ 120Bruce A. Samson360Harold G. Nix120Richard F. Lockey80William J. Schifino80Edward Hoornstra60Charles A. Kottmeier60These distributions were premature and no further distributions were ever made. In fact, at the time the distributions were made, mining operations already had been plagued with a number of problems. To begin with, initial progress was impeded by a harsh winter. In addition, difficult mining conditions were encountered at the mine opening, further slowing progress. Other problems also were encountered at the Detherage mine. 124 The coal was dirty and had substantial impurities and a high sulphur content. The coal that was removed did not come out in lumps but rather as fines, a condition that results in a substantially reduced selling price. The crowning blow apparently occurred about a month after the commencement of mining activities, in late May or early June when difficulties with roof conditions in the mine were encountered. It was determined that the Wilcox mining equipment could not operate within the mine. At this point, efforts to continue mining the Detherage property were abandoned.On July 18, 1977, the partnership and American Coal & Coke entered into another sublease agreement covering property known as the Waligorski property. Thereafter, some of the mining equipment that had been located on the Detherage tract was moved to the Waligorski tract, and some coal actually was mined from the property. Eventually, however, the partnership was evicted from the Waligorski tract as the result of a dispute between American Blue Gem and Bill Waligorski, the owner of the property. The eviction apparently occurred in the late summer or early fall of 1977.Although there is evidence of attempts to 125 locate additional properties for mining, the record fails to reveal that the partnership ever engaged in any further actual mining activities after the eviction from the Waligorski property. The evidence indicates that total tonnage mined and sold by the 579 partnership throughout its existence was 6,086.415 tons, all of which was mined and sold in 1977.By at least sometime in August 1977, there had developed a dispute between Winer and the other general partners. The partnership was in serious financial straits and Winer refused to advance additional funds to the partnership. By letter dated September 27, 1977, Winer reminded Glantz and Anderson that it had been his responsibility to raise the capital necessary to form the partnership and their responsibility to get the partnership operational. Winer felt that he had lived up to his side of the agreement, but that Glantz and Anderson had not done so. By October 20, 1977, there had been a "complete deterioration of the relationships" between Winer, on the one hand, and Glantz and Anderson, on the other, as memorialized by a letter from one of the limited partners who happened to represent Winer as an attorney.To make matters worse, 126 a number of the limited partners were becoming disillusioned with the general partners. By letter dated February 14, 1978, one of the limited partners, Frank N. Fleischer, on behalf of himself and four other limited partners, wrote to Glantz informing him that they had learned of an Internal Revenue Service audit of the partnership and requesting information respecting the same, as well as information respecting the current status of the partnership. According to Fleischer's letter, the limited partners had received only two reports on the activities of the partnership. It was the belief of the limited partners that Glantz was not meeting his fiduciary responsibility to the limited partners.Glantz responded to Fleischer's letter through a series of communications to the limited partners. By letter dated February 24, 1978, Glantz informed the limited partners of the audit and requested their presence at a meeting to be held a month later for the purpose of reviewing the partnership's situation. Glantz sent another letter to the limited partners dated March 29, 1978, informing them of matters discussed at the meeting, including such matters as the relocation of the partnership mine 127 to a new unspecified leased property, the subleasing of the partnership's Jones property to a strip miner, the need for all of the limited partners to sign an amendment to the limited partnership agreement ratifying Winer's resignation, and the status of the tax audit. The next 580 written correspondence from Glantz to the limited partners was dated June 30, 1978. This letter conveyed the unfortunate news that the partnership had been unable to lease the new property referred to in the letter of March 29, 1978, and that the partnership had not been able, in fact, to sublease the Jones property. In addition, the letter advised the limited partners that the partnership was continuing to prospect for suitable property and also advised the limited partners of the status of the tax audit.The displeasure of the limited partners apparently continued to increase as time went on. By letter dated September 4, 1979, Fleischer again corresponded with Glantz, stating that a number of the limited partners were very much concerned about their investments in the partnership and further stating that they had received no information with respect to their investments for well over 2 years. By letter 128 dated April 16, 1980, five of the limited partners reminded the general partners of their agreement to lend the partnership $ 15,000 in connection with the defense of the partnership's tax return and threatened to institute a fraud suit against the general partners.By further letter dated July 24, 1981, Fleischer, on behalf of himself and four other limited partners, reminded Glantz and Musicant that it had been "some time" since the limited partners had heard from the general partners and requested information regarding any attempts, or lack thereof, to get the partnership operational. In a response letter dated August 12, 1981, Glantz advised Fleischer that the partnership had been dormant for 3 years and that the partnership had no working capital with which to evaluate and acquire additional leases.Beginning in 1977, Glantz and Anderson became interested, as officers and/or shareholders, in the corporate entities dealing with the partnership. By February 28, 1977, Anderson was serving as vice president of American Blue Gem, and by May 1977, Glantz also was serving as vice president of American Blue Gem. According to Glantz, Anderson became an officer in American Blue Gem as a 129 part of an overall agreement that Anderson would assist the corporation in procuring financing on the mining equipment. Further, according to Glantz, he, himself, became an officer in the corporation because he was disappointed with its operations. 581 Eventually, in early 1978, Glantz and Anderson purchased all the outstanding shares of American Blue Gem from Hooper, Keene, Rhodes, and Ozier. Although there is no indication that the limited partners were informed of Glantz's and Anderson's status as officers of American Blue Gem in 1977, they were informed in the latter part of March 1978 that Glantz and Anderson had purchased a controlling interest in the corporation.In April or May 1977, Glantz became an officer of American Coal & Coke. In May 1977, a corporation known as New American Coal & Coke was formed by Hooper and Keene. At the time of its formation, or shortly thereafter, New American Coal & Coke was owned 50 percent by Glantz and Anderson. Hooper and Keene owned the other 50 percent. 6 Glantz, and apparently Anderson as well, also served as officers of New American Coal & Coke after its formation. The address of New American Coal & Coke was the same as that of American 130 Coal & Coke (hereinafter sometimes referred to as Old American Coal & Coke), the lessor of the partnership's property. In June 1977, Old American Coal & Coke changed its name to A. C. & C., Inc., and in July 1977, New American Coal & Coke changed its name to American Coal & Coke, Inc. The relationship of Old American Coal & Coke to New American Coal & Coke is entirely unclear from the record. After New American Coal & Coke was formed, Old American Coal & Coke apparently ceased operating as a going concern. According to Glantz's recollection, New American Coal & Coke took over the physical office assets of Old American Coal & Coke, but did not assume Old American Coal & Coke's financial obligations and did not deal with Knox County Partners, Ltd. In January 1978, Glantz and Anderson purchased the other 50-percent stock ownership in New American Coal & Coke. The record fails to reveal that the limited partners were informed of Glantz's and Anderson's involvement with either Old American Coal & Coke or New American Coal & Coke.The charter of American Blue 131 Gem was revoked on March 12, 1979, for nonpayment of franchise tax. The charter of New American Coal & Coke was revoked on August 15, 1979, for nonpayment of franchise tax. The charter of Old American 582 Coal & Coke was revoked on April 14, 1981, for nonpayment of franchise tax.The Knox County Partners, Ltd., opened a bank account at the National Bank in St. Petersburg, Florida. That account was closed in October 1979. The partnership maintained another account at the Third National Bank in Nashville, Tennessee. The partnership used the address of American Coal & Coke for its bank account with the Third National Bank. Some of the checks written on this account were signed by James D. Perry, accountant for American Coal & Coke, and Hooper's wife. The partnership maintained yet another account with American Fidelity Bank & Trust Co., in Barbourville, Kentucky. The partnership used American Coal & Coke's address for this account, as well.During 1977, the books and records of Knox County Partners, Ltd., were kept by Perry, who did not receive a fee from the partnership with respect to his bookkeeping services. Perry was given authority to sign checks using a signature machine with 132 Glantz's signature as an imprint.Knox County Partners, Ltd., used the accrual method of accounting. The partnership returns of the Knox County Partners, Ltd., reveal the following:GrossCost ofInterestOtherOtherOrdinary incomeYearreceiptsgoods solddeductionincomedeductions(loss)1976$ 1,825,000($ 1,825,000)1977$ 95,545$ 200,305$ 49,207$ 99,97737,129(91,119)197886,675199,9925,091108,226 197970,910199,9922,368126,714 198066,138199,9921,739132,115 198156,768199,99230143,194 198252,064199,992147,928 The interest deductions were attributable to the $ 1,240,000 nonrecourse note delivered by the partnership to American Coal & Coke on December 31, 1976. There is no evidence that any interest actually ever was paid on the note.The "other income" reported by the partnership constitutes so-called "mining penalty income," the "liquidated damages" arising out of American Blue Gem's failure to satisfy its minimum mining guarantee. Two notes, each entitled "Negotiable Promissory Note" (hereinafter referred to as mining penalty notes), were executed sometime in April 1979. One 583 was dated December 31, 1977, and the other was dated December 31, 1978. These notes were intended to evidence transactions 133 that were to have occurred at the end of 1977 and 1978. Pursuant to the notes, American Blue Gem promised to pay Knox County Partners, Ltd., $ 99,976.90 with interest at the rate of 6 percent per annum, in the case of the note dated December 31, 1977, and $ 199,920 with interest at the rate of 6 percent per annum, in the case of the note dated December 31, 1978. The notes were signed by Glantz as the authorized officer of American Blue Gem. Glantz did not personally guarantee the notes from American Blue Gem to Knox County Partners, Ltd. The mining penalty notes were then endorsed by Musicant on behalf of Reserve Associates, Inc., as a general partner of Knox County Partners, Ltd., and assigned to American Coal & Coke in satisfaction of the principal and interest payable on the partnership's $ 1,240,000 note. Glantz, in turn and on behalf of American Coal & Coke, accepted the assignment in satisfaction of the partnership obligation under the $ 1,240,000 note. The mining penalty notes never actually were paid. In fact, it never was contemplated that they actually would be paid. No further promissory notes were executed to evidence American Blue Gem's minimum mining commitment. 134 For 1979 and thereafter, amortization of the partnership's note via the liquidated damages allegedly was accomplished by means of some sort of journal entries. Nothing in the record suggests that actual cash payments of principal or interest on the partnership's nonrecourse note ever were made. Although the partnership's returns for 1977 through 1982 and the Schedules K-1 issued to the partners in conjunction therewith reported mining penalty income, there is nothing in the record to establish whether the partners actually reported their distributive shares of the mining penalty income through 1982.On their 1976 and 1977 income tax returns, petitioners John W. Seaman, Jr., and Bettye H. Seaman claimed $ 86,688 and $ 1,993, respectively, as their distributive shares of the partnership's losses for those years.On their 1976 and 1977 income tax returns, petitioners Bruce A. Samson and Adajean L. Samson claimed $ 260,062 and $ 5,982, respectively, as their distributive shares of the partnership's losses for those years.584 On their 1976 and 1977 income tax returns, petitioner Harold G. Nix claimed $ 86,687 and $ 1,994, respectively, as his distributive shares of the partnership's losses 135 for those years.On their 1976 income tax return, petitioners Richard F. Lockey and Anne S. Lockey claimed $ 57,792 as their distributive share of the partnership's loss for that year.On their 1976 income tax return, petitioners William J. Schifino and Lois A. Schifino claimed $ 57,792 as their distributive share of the partnership's loss for that year.On their 1976 income tax return, petitioners Edward Hoornstra and Mildred Hoornstra claimed $ 43,334 as their distributive share of the partnership's loss for that year.On their 1976 income tax return, petitioners Charles A. Kottmeier and Eloise L. Kottmeier claimed $ 43,343 as their distributive share of the partnership's loss for that year.Respondent disallowed all of the foregoing losses on a variety of grounds.OPINIONRoyalty DeductionsOn its 1976 partnership return, Knox County Partners, Ltd., deducted $ 1,825,000 as an "advance minimum royalty" and claimed an overall ordinary loss in the same amount. Respondent advances several alternative grounds to support his disallowance of petitioners' distributive shares of the partnership's loss for 1976. Respondent's primary argument, and the one most vigorously advanced, is that the partnership 136 was not engaged in the trade or business within the meaning of section 162, I.R.C. 1954, of mining or selling coal because the mining activity of the partnership was not an activity engaged in for profit and that therefore petitioners are not entitled to any loss deductions in 1976 arising out of their status as limited partners.Before turning to respondent's profit motive argument, alternative arguments raised with respect to the applicability of section 1.612-3(b), Income Tax Regs., as it existed either prior to amendment or thereafter, warrant a brief discussion.Prior to its amendment in 1977, section 1.612-3(b), Income Tax Regs., read, in part, as follows:585 (b) Advanced Royalties. (1) If the owner of an operating interest in a mineral deposit * * * is required to pay royalties on a specified number of units of such mineral * * * annually whether or not extracted * * * within the year, and may apply any amounts paid on account of units not extracted * * * within the year against the royalty on the mineral * * * thereafter extracted * * ** * * (3) The payor, at its option, may treat the advanced royalties so paid or accrued in connection with mineral property as follows:(i) As deductions137 from gross income for the year the advanced royalties are paid or accrued * * [Emphasis added.]In Rev. Rul. 70-20, 1 C.B. 144">1970-1 C.B. 144, and particularly in Rev. Rul. 74-214, 1 C.B. 148">1974-1 C.B. 148, the Service indicated that lump-sum advanced royalties were currently deductible.By News Release IR-1687, October 29, 1976, the Service announced a proposed amendment of section 1.612-3(b)(3), Income Tax Regs., and suspended Rev. Rul. 70-20 and Rev. Rul. 74-214. With respect to the effective date of the proposed amendment, IR-1687 provided as follows:Under the proposed amendment, the treatment of advanced royalties would be revised, effective October 29, 1976, unless the advanced royalties are required to be paid pursuant to a mineral lease which (i) was binding prior to that date upon the party who in fact pays or accrues such royalties, or (ii) was required pursuant to a written contract, to be executed by the party who in fact pays or accrues such royalties, provided that such party establishes, to the satisfaction of the Secretary or his delegate, that under all of the facts and circumstances the contract was binding upon such party prior to that date. For purposes of clause (ii) above, a contract 138 will in no event be considered to be binding upon such party if the obligations imposed on such party prior to October 29, 1976 were not substantial or were illusory.In December 1977, the Service issued the final version of the amended regulation, retroactive to October 29, 1976. T.D. 7523, 1 C.B. 192">1978-1 C.B. 192. Respondent at that time issued Rev. Rul. 77-489, 2 C.B. 177">1977-2 C.B. 177, announcing the revocation of Rev. Rul. 70-20 and Rev. Rul. 74-214.Under section 1.612-3(b)(3), Income Tax Regs., as amended, advanced royalties generally may be deducted only in the year that the mineral product, in respect of which the advanced royalties were paid or accrued, is sold. However, the regulation recognizes an exception in the case of advanced royalties paid 586 or accrued "as a result of a minimum royalty provision." Under the exception, advanced minimum royalties may, at the option of the payor, be deducted in the year that they are paid or accrued. According to the regulation, a minimum royalty provision is a provision that "requires that a substantially uniform amount of royalties be paid at least annually either over the life of the lease or for a period of at least 20 years, in the absence of mineral 139 production requiring payment of aggregate royalties in a greater amount." (Emphasis added.)The parties herein disagree with respect to whether petitioners are subject to section 1.612-3(b)(3), Income Tax Regs., before amended or as amended.Respondent argues that the partnership was not subject to a binding obligation to pay advanced royalties on or before October 29, 1976, because the obligation to pay royalties was illusory and not substantial on that date and that therefore the partnership is subject to the regulation as amended. See Gauntt v. Commissioner, 82 T.C. 96">82 T.C. 96, 104 (1984) (holding that a limited partnership's obligations under a coal sublease were "illusory" within the meaning of IR-1687, so that the transaction was subject to the amended regulation). Respondent further argues that, even assuming that the partnership was obligated on or before October 29, 1976, the limited partners were not bound by that date and that therefore the partnership is still subject to the regulation as amended. In this connection, respondent urges us to reconsider Elkins v. Commissioner, 81 T.C. 669">81 T.C. 669 (1983), in which we held that the "party" required to be bound by a mineral lease or a written 140 contract prior to October 29, 1976, in order for the old regulation to continue to apply, was the partnership and not the individual limited partner. It is respondent's position that, if the partnership is subject to the amended regulation, it is not entitled to a deduction in 1976 since no coal was mined and sold in that year.Petitioners' counter to respondent's foregoing arguments is that the partnership is clearly subject to the regulation before amendment, because the partnership was bound prior to October 29, 1976, and it is irrelevant under Elkins v. Commissioner, supra, that the limited partners were not similarly so bound on that date. It is petitioners' position that under the regulation before amendment, as interpreted by Rev. Rul. 587 70-20 and Rev. Rul. 74-214, the partnership is entitled to deduct the entire advanced royalty, both the cash portion and the portion represented by the nonrecourse note. Petitioners add as an aside that, even if the partnership were subject to the regulation as amended, the royalties in question meet the definition of advanced minimum royalties and thus still would be currently deductible.We do not intend to base our decision on any of the foregoing 141 contentions and, therefore, we need not consider them fully. However, we do note that on two separate occasions we have considered royalty arrangements structured in substantially the same manner as was employed in the instant case. See Maddrix v. Commissioner, 83 T.C. 613 (1984); Estate of Blay v. Commissioner, T.C. Memo 1984-565">T.C. Memo. 1984-565. There was no dispute but that section 1.612-3(b)(3), Income Tax Regs., as amended , applied in those cases. In both, we held that the royalties were not paid as the result of a minimum royalty provision and that no deduction was allowable during the years in issue since no coal was sold during those years. We think it also important to note that it is exceedingly doubtful that the old regulation permitted the deduction of lump-sum advanced royalty payments. See Redhouse v. Commissioner, 728 F.2d 1249">728 F.2d 1249, 1251 (9th Cir. 1984); Wendland v. Commissioner, 79 T.C. 355">79 T.C. 355, 385 (1982), affd. 739 F.2d 580">739 F.2d 580 (11th Cir. 1984), affd. sub nom. Redhouse v. Commissioner, supra.7 Such a deduction would be not only inconsistent with the language of the old regulation, specifying that the advance royalties were required to be paid "annually," but also contrary to the well-entrenched 142 principle of tax accounting that a payment that creates an asset having a useful life that extends substantially beyond the close of the taxable year must be deducted over the years to which the payment relates. See, e.g., sec. 1.461-1(a)(2), Income Tax Regs.; Commissioner v. Boylston Market Association, 131 F.2d 966">131 F.2d 966 (1st Cir. 1942); Baton Coal Co. v. Commissioner, 51 F.2d 469">51 F.2d 469 (3d Cir. 1931), cert. denied 284 U.S. 674">284 U.S. 674 (1931); University Properties, Inc. v. Commissioner, 45 T.C. 416">45 T.C. 416 (1966), affd. 378 F.2d 83">378 F.2d 83 (9th Cir. 1967). Accordingly, respondent properly revoked the two revenue rulings that extended coverage of the old regulation 588 to the payment of lump-sum advanced royalties. Wendland v. Commissioner, 79 T.C. at 385.With this background in mind, we turn to address respondent's profit motive argument.Royalties traditionally have been described as akin to rent and are deductible by the payor as a trade or business expense under section 162(a)(3). Commissioner v. Jamison Coal & Coke Co., 67 F.2d 342">67 F.2d 342, 344 (3d Cir. 1933); Burnet v. Hutchinson Coal Co., 64 F.2d 275">64 F.2d 275, 278 (4th Cir. 1933); Ramsay v. Commissioner, 83 T.C. 793">83 T.C. 793, 810 (1984); 143 Surloff v. Commissioner, 81 T.C. 210">81 T.C. 210, 232 (1983). In this case, the deduction, if allowable, would be allowable to the partnership rather than directly to the partners. In order to find that the partnership's coal venture constituted the carrying on of a trade or business, we must first find that the partnership engaged in the activity with the primary and predominant purpose and objective of making a profit. Brannen v. Commissioner, 722 F.2d 695">722 F.2d 695, 704 (11th Cir. 1984), affg. 78 T.C. 471">78 T.C. 471 (1982); Ramsay v. Commissioner, supra at 810; Surloff v. Commissioner, supra at 232-233. As used in this context, "primary" means "of first importance" or "principally," and "profit" means economic profit, independent of tax savings. Surloff v. Commissioner, supra at 233. While a reasonable expectation is not required, the profit objective must be bona fide. Fox v. Commissioner, 80 T.C. 972">80 T.C. 972, 1006 (1983), affd. without published opinion 742 F.2d 1441">742 F.2d 1441 (2d Cir. 1984), affd. sub nom. Barnard v. Commissioner, 731 F.2d 230 (4th Cir. 1984), affd. without published opinion sub nom. Krasta v. Commissioner, 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).The 144 determination of whether the requisite objective exists is one of fact to be resolved on the basis of all of the surrounding facts and circumstances. Ramsay v. Commissioner, supra at 810; Flowers v. Commissioner, 80 T.C. 914">80 T.C. 914, 931-932 (1983). The burden of proving the existence of the requisite objective rests with petitioners. Rule 142(a), Tax Court Rules of Practice and Procedure; Golanty v. Commissioner, 72 T.C. 411">72 T.C. 411, 426 (1979), affd. without published opinion 647 F.2d 170">647 F.2d 170 (9th Cir. 1981). Greater weight should be given to the objective facts than to mere statements of intent. Sec. 1.183-2(a), Income Tax Regs.; Surloff v. Commissioner, supra at 233; 589 Dreicer v. Commissioner, 78 T.C. 642">78 T.C. 642, 645 (1982), affd. without opinion 702 F.2d 1205">702 F.2d 1205 (D.C. Cir. 1983).In determining whether the requisite profit objective was present in the instant case, our profit objective analysis must be made at the partnership level. Brannen v. Commissioner, 78 T.C. at 505; Siegel v. Commissioner, 78 T.C. 659">78 T.C. 659, 698 (1982). Therefore, we must examine the motives and objectives of the promoters and the general managers of the partnership. Surloff v. Commissioner, supra at 233.Having examined all of the evidence, 145 we conclude that petitioners have not carried their burden of proving that Knox County Partners, Ltd., was organized and operated with the primary and predominant objective of realizing an economic profit. Petitioners' case was built largely around the self-serving testimony of their two witnesses, Musicant and Glantz. Although we found those witnesses to be generally forthright and credible, and do believe that they made some commitments to getting the partnership operational, when we look behind their self-serving testimony to the objective facts, we are left with the undeniable impression that the primary objective behind the formation of Knox County Partners, Ltd., was to secure attractive tax writeoffs for the limited partners.It is undisputed that Musicant had no prior experience in coal mining. He did, however, have experience in structuring tax shelters. Furthermore, petitioners' contention that Glantz and Anderson possessed considerable experience in coal mining prior to their involvement in Knox County Partners, Ltd., is not supported by the evidence. By Glantz's own admission, he first became acquainted with the coal mining industry in 1975 or 1976, when some people 146 he knew approached him with respect to joining them in a strip mining venture. At most, the evidence suggests that the involvement of Glantz and Anderson in the coal mining business was primarily that of investors in various unsuccessful coal ventures. In addition, the offering memorandum for the Knox County Partners, Ltd., itself cautions potential investors that the general partners had little experience in operating a coal mining business.That the primary objective behind the formation of Knox County Partners, Ltd., was to market tax shelters is evident from the very earliest planning stages. In their haste to execute all of the necessary documents in time to locate 590 investors interested in claiming substantial deductions for their 1976 tax years, the general partners unreasonably neglected to investigate the leased properties in a timely and responsible fashion. There is no evidence that any of the partners actually saw the Detherage tract prior to the execution of the lease on October 15, 1976. Furthermore, it was not until after the execution of the lease that Glantz engaged Cummings to prepare a report on the property. Although none of the general partners contemplated being 147 involved in the day-to-day operations of the mine, the general partners took the risk, at the time they executed the lease that collateral agreements with respect to the mining and selling of coal would be forthcoming. The general partners merely accepted on faith the viability of American Coal & Coke and the representations made by it concerning the value and economic potential of the property. In their haste, the general partners were satisfied with putting the cart before the horse. In doing so, they failed to discover a title defect in about one-half of the leased property. Such a cursory investigation of the leased premises cannot be squared with a primary economic profit objective.In marked contrast with the general partners' initial failure to investigate properly the background of American Coal & Coke, an entity that was destined to play an essential role in the overall transaction, and the conditions of the leased property, were the partners' diligent efforts to pin down the tax consequences to potential investors. It was determined from the very outset that, in order to maximize tax benefits, the lease would be structured using an advanced royalty. After the lease was 148 executed, the general partners wasted no time in engaging the services of an attorney to write a tax opinion to be included in the offering memorandum. Petitioners contend that the partnership is permitted to take advantage of tax deductions provided by law without destroying the validity of its profit objective. Of course, in so contending, petitioners miss the mark. The point is that the actions of the general partners, in elevating the importance of securing tax advantages over the importance of investigating the economic viability of the venture, belie a primary economic profit objective.591 It is true that, after the preliminary stages, the partners did make inquiries into the background of American Coal & Coke. However, when one considers the very substantial role that the corporation and its related corporation, American Blue Gem, were to play in the partnership's operations, it becomes apparent that the inquiries were superficial. Glantz allegedly checked a number of references; however, all of the references checked were supplied by American Coal & Coke, and Glantz admitted that he subsequently discovered that some of those references worked for American Coal & Coke or were 149 affiliated in some manner. At no time did the general partners verify the resumes of the corporate officers or request to examine American Coal & Coke's books and records. Nor did they attempt to discover whether there were any judgments against American Coal & Coke, or whether, and if so, to what extent, the corporation's assets were encumbered. The superficiality of the investigations is revealed clearly by the general partners' subsequent discovery that American Blue Gem was not even in existence when discussions with American Coal & Coke commenced.It is also true that the general partners engaged Cummings to prepare an engineering report and coal reserve estimate on the Detherage tract. However, they did not do so until after the lease was executed. Moreover, several facts call into question the general partners' good-faith reliance on Cummings' report. In the first place, the services of Cummings, who was a surveyor and not a mining engineer, were engaged at the recommendation of Cliff Hooper, one of the officers of American Coal & Coke. In the second place, Cummings' report was merely a description of the Detherage tract and an estimate of coal reserves on the property. 150 It did not address the economic feasibility of mining coal from the Blue Gem seam. The report, however, did contain the caveat that "Inasmuch as the coal reserves are estimated, it is recommended that core drilling as per standard procedure be utilized to verify and prove the reserves." We find the failure to heed this recommendation significant.In addition to the foregoing, the substantive correctness of Cummings' report was called into question by respondent's experts, Marilyn D. Maisano and E. D. Conaway. For example, Conaway concluded that the data in the offering memorandum 592 with respect to recoverable coal reserves was too optimistic and did not represent a sound basis for a profitable mining operation. According to Conaway, the in place and recoverable estimates of coal seam reserves were not documented by actual measurements, the average coal thickness used in reserve calculations was greater than could be measured, and the recovery factor of 70 percent used by Cummings was too high. Conaway's computations of probable and recoverable reserves fell far short of Cummings' computations.It is unnecessary for us to attempt to resolve the differences between Cummings' report 151 and Conaway's report, because such an endeavor would serve only to distract us from the crucial question of whether, regardless of the amount of recoverable reserves, Knox County Partners, Ltd., had a good faith objective of mining and selling coal for economic profit. As we have suggested in other cases, the existence of minable seams of coal is meaningless without a thorough study of the methods that would be required to mine the coal, the equipment that would be used, the costs of such mining, and the prospects for selling any coal mined. Surloff v. Commissioner, 81 T.C. 210">81 T.C. 210, 235 (1983). 8There is no evidence that the general partners prepared any meaningful study of the economic feasibility of mining coal from the various tracts of property leased from American Coal & Coke and delivering the coal to the marketplace. In preparing the financial projections included in the offering memorandum, Musicant relied substantially upon information conveyed to him by American Coal & Coke, hardly a disinterested party.Petitioners contend that the general partners, in structuring the lease transaction, did investigate the costs of operations and 152 took responsible steps to assure that these costs could be met. In this connection, petitioners further contend that the amount of the advanced royalty was determined by the needs of the mining operation and the commitment of American Coal & Coke to advance to American Blue Gem enough of the advanced royalty to provide for equipment and working capital adequate to open a mine. The evidence, however, in several respects, belies petitioners' contention. First, the 593 general partners, in relying upon American Blue Gem's exclusive discretion to perform all of the mining operations, entrusted the future economic viability of the partnership to a corporation that was not even in existence until December 1, 1976. The record does not disclose clearly what sort of staff was employed by American Blue Gem. In fact, there is little evidence that American Blue Gem was anything other than a paper corporation, owned and controlled by the principals of American Coal & Coke. On December 31, 1976, American Coal & Coke loaned American Blue Gem $ 206,000 for purposes of establishing the initial mining operation. This sum was about one-half of the cost estimated by American Coal & Coke, prior to 153 the execution of the lease, as being necessary to open the mine. The alleged reason for the decrease in assumed costs was that American Coal & Coke had recommended that less expensive mining equipment be used, which equipment, of course, subsequently proved incompatible with the conditions existing in the Detherage mine.Furthermore, petitioners' contention that the general partners took steps to assure that the cash portion of the advanced royalty would be sufficient to provide working capital adequate to open the mine runs athwart the testimony of Glantz that he and Anderson were placed in the position of having to loan substantial sums of money to American Blue Gem to pay for equipment. Certainly, the partnership itself did not possess the wherewithal to pay the costs of mining operations, since it was seriously undercapitalized. After paying the advanced royalty, the partnership apparently retained only $ 15,000 as working capital.Another indication that the primary objective behind the formation of the partnership was to secure attractive tax writeoffs for the limited partners is the disproportionately large royalty required to be paid by the partnership to American Coal & Coke. 154 By lease dated September 28, 1976, American Coal & Coke was obligated to pay a tonnage royalty of $ 0.70 for each net ton of coal mined from the Detherage tract and a minimum royalty of $ 250 per month, or $ 3,000 per year. American Coal & Coke almost immediately turned around and subleased the property to the partnership, which agreed to pay a tonnage royalty of $ 2.10 for each net ton of coal mined and a minimum royalty of $ 200,000 per year. Such 594 a phenomenal increase in rates fairly may be described as magical and, under the facts of this case, only can be explained as a means of inflating the deductions for the limited partners. Cf. Surloff v. Commissioner, 81 T.C. at 235-236. 9We flatly reject petitioners' argument that the overvaluation was justified because the transaction negotiated with American Coal & Coke was in the nature of a turnkey contract. According to petitioners, the ancillary services and obligations to be performed by American Coal & Coke and American Blue Gem, such as developing the mine, acquiring the necessary mining equipment, and arranging for the sale of coal, were what made the property valuable. The fallacy 155 of petitioners' argument is obvious if for no other reason than the fact that, at the time the lease was executed on October 15, 1976, obligating the partnership to pay a tonnage royalty of $ 2.10 and an advanced royalty of $ 1,825,000, no other collateral agreements had been reached with American Coal & Coke and, of course, none had been reached with American Blue Gem, since that entity did not exist at that time. Absolutely no credible evidence exists upon which we could conclude that any portion of the royalties was allocable to a turnkey contract. In fact, when questioned about what portion of the cash and note delivered to American Coal & Coke on December 31, 1976, was allocable to royalties and what portion was allocable to the alleged turnkey contract, Musicant admitted that the entire amount was allocable to royalties. Moreover, we note that, although various collateral agreements eventually were executed between the partnership, on the one hand, and American Coal & Coke or American Blue Gem, on the other, those agreements were not executed until December 2, 1976, at which time they were placed in escrow, to be destroyed in the event that the advanced royalty was not paid 156 on or before December 31, 1976. These agreements made independent provision for compensation to be paid to American Coal & Coke or American Blue Gem for services rendered. In short, we are left with the inescapable conclusion that the royalties were grossly overstated in relation to the value of the leased property.595 In our view, the unbusinesslike and hurried manner in which the partnership's coal venture was put together clearly foreshadowed the many disasters that shortly thereafter befell the partnership. Although the partnership did engage in some mining activities, they were forced to admit defeat within less than a year after they had located the limited partners. As far as we can determine from the record, actual mining activities occurred during, at most, a total of 5 or 6 months. Moreover, total tonnage of coal mined and sold by the partnership was only 6,086.415 tons, far from an outstanding achievement when compared to the 912,500 total tonnage required to be mined and sold in order to recoup the $ 1,825,000 advanced royalty.Petitioners' contention that the ultimate demise of the partnership's business was caused by one circumstance, the fact that the price of coal never 157 increased, but rather stayed steady and then declined, is without merit under the facts. Moreover, this risk was specifically noted in the offering memorandum, which cautioned investors that the market price of coal had been declining since 1975.We are not persuaded by petitioners' contentions that the general partners kept the limited partners fully advised of all developments. The majority of the written communications from the general partners were sent only after the Service had begun to audit the partnership and in response to letters from the limited partners complaining about the lack of communications and threatening to bring a fraud suit against the general partners. It is reasonable to assume that the letters were sent, not in response to any bona fide intent to keep the limited partners current on the partnership's status, but in an effort to build the record for whatever future litigation might ensue.Respondent asserts that the corporate histories of American Coal & Coke and American Blue Gem also indicate the lack of a bona fide profit objective. We are inclined to agree with respondent that the convoluted and incestuous corporate and personal interrelationships are 158 highly suspicious and suggest less than arm's-length dealings between the partnership, American Coal & Coke, and American Blue Gem.The use of the large nonrecourse note, under the facts of this case, is another indication of the lack of a bona fide profit 596 objective, because that note was contingent, illusory, and without any real economic substance. We have indicated on numerous occasions that the existence of large nonrecourse notes in circumstances where it is unlikely that the notes will be paid is itself an indication that the primary objective of an activity is to generate tax deductions rather than to earn an economic profit. Ramsay v. Commissioner, 83 T.C. 793">83 T.C. 793, 820 (1984); Estate of Baron v. Commissioner, 83 T.C. 542">83 T.C. 542, 556 (1984); Surloff v. Commissioner, 81 T.C. at 237-238; Flowers v. Commissioner, 80 T.C. 914">80 T.C. 914, 937 (1983).The facts herein reveal that sometime towards the end of 1976 potential investors with incomes taxed at the rate of at least 50 percent received copies of the offering memorandum seeking subscriptions for 20 limited partnership units at $ 30,000 per unit. Because of the presence of the nonrecourse note, upon making a $ 30,000 investment, an investor claimed 159 an immediate tax loss of $ 86,688. That fact, on its face, warrants some scrutiny. This is particularly true in the instant case, since it was never contemplated that the partnership would make actual cash payments on the note in the event and to the extent that the partnership failed to mine and sell coal from the property. Petitioners contend, however, that, even in the event that the partnership failed to mine and sell coal, the note nevertheless would be paid "inexorably and immutably, year after year" by the application of the "liquidated damages" owed by American Blue Gem on its failure to satisfy the minimum mining guarantee.In our view, the arrangement for the "payment" of liquidated damages was as devoid of economic substance as was the original nonrecourse note. It was admitted at trial that it was never contemplated by the parties that the liquidated damages actually would be paid in cash. All that was necessary was for American Blue Gem to deliver its notes in "payment" of liquidated damages to the partnership, which, in turn, would endorse them over to American Coal & Coke in satisfaction of the partnership's nonrecourse note. American Coal & Coke never intended to 160 enforce American Blue Gem's notes and, as far as the record reveals, never did so. Perhaps, in recognition of the glaring transparency of this arrangement, notes representing liquidated damages allegedly owing in 1977 and 1978 were not executed until April 1979, at which time they were 597 backdated. The circularity of the arrangement is apparent when one considers that Glantz signed the notes on behalf of American Blue Gem, Musicant endorsed the notes on behalf of Knox County Partners, and Glantz then again signed the notes on behalf of American Coal & Coke. In 1979, the parties, apparently recognizing the arrangement for what it was, a meaningless exchange of paper, abandoned even its form in that they did not bother to execute and endorse any additional notes. Instead, for 1979 and for each year thereafter, amortization of the partnership's nonrecourse note via the liquidated damages was allegedly accomplished by means of some sort of journal entries, which were never produced at trial. We find it somewhat difficult to understand how liquidated damages generated journal entries for 1979 and each year thereafter as alleged by petitioners, when it appears that the corporate entities 161 involved ceased operating as going concerns in 1979 or shortly thereafter. In fact, Glantz's testimony suggested that Old American Coal & Coke ceased operating as a going concern as early as 1977, when New American Coal & Coke was formed. The fact of the matter is that no cash ever changed hands, or ever was intended to change hands, as a result of the liquidated damages arrangement. The arrangement was merely an illusory mechanism by which to reduce a debt that itself lacked any economic substance. As such, the arrangement must be ignored.We recognize that the partnership reported on its partnership returns the liquidated damages as non-cash taxable income up until at least 1982. However, the reporting of this phantom income, alone, does not justify the conclusion that the provision for liquidated damages had economic substance in reality. Although Schedules K-1, reflecting as income the liquidated damages, were prepared up until 1982, we have no way of knowing from the record which, if any, of the partners actually took these amounts into income throughout this period. To the extent that they did so, they did so erroneously, since neither the original nonrecourse note that 162 was allegedly amortized by the liquidated damages nor the liquidated damages, themselves, should be respected for tax purposes. 10598 In sum, based on a review of the objective facts established in the record, we hold that petitioners have failed to carry their burden of proving that the Knox County Partners, Ltd., was organized and operated with the primary and predominant objective of realizing an economic profit. Accordingly, respondent's disallowance of petitioners' distributive shares of the partnership's loss for 1976 is sustained. 11Interest DeductionsOn its 1977 partnership return, Knox County Partners, Ltd., deducted $ 49,207 as interest accrued on the $ 1,240,000 nonrecourse note. In his notices of deficiency to petitioners in docket Nos. 1235-81, 1236-81, and 1237-81, respondent disallowed the partnership's deduction for accrued interest on the grounds that 163 the nonrecourse note lacked economic substance and did not represent true indebtedness. We agree with respondent's determination.Section 163(a) provides that "There shall be allowed as a deduction all interest paid or accrued within the taxable year on indebtedness." For the deduction to be allowable, however, the indebtedness must be genuine. Knetch v. United States, 364 U.S. 361">364 U.S. 361 (1960); Elliott v. Commissioner, 84 T.C. 227 (1985); Surloff v. Commissioner, 81 T.C. at 242; Narver v. Commissioner, 75 T.C. 53">75 T.C. 53, 98 (1980), affd. per curiam 670 F.2d 855">670 F.2d 855 (9th Cir. 1982). Whether the nonrecourse note created a bona fide debt is a question of fact, the burden of proof of which is on petitioners. Rule 142(a), Tax Court Rules of Practice and Procedure.We have already concluded that the nonrecourse note lacked economic substance. It is readily apparent that the advance royalties called for in the note greatly exceeded the fair market value of the leasehold interest in the Detherage property. At about the same time that the partnership agreed to pay American Coal & Coke a $ 200,000-per-year minimum royalty, American Coal & Coke agreed to pay the owner of the property a $ 3,000-per-year minimum 164 royalty. Musicant, himself, admitted that the amount of the note probably exceeded the value of the land and that the amount of the royalties was not determined on the basis of the fair market value of the 599 leasehold interest. According to Musicant, the amount of the note took into account the services that American Coal & Coke was to render to the partnership. However, we have already rejected petitioners' argument that the overvaluation was due to the alleged turnkey nature of the arrangement. Thus, we are left with but one conclusion -- the nonrecourse indebtedness unreasonably exceeded the fair market value of the leasehold interest. In addition, while we believe it well may be that the partnership would have paid the note when, as, and if coal was mined, it is conceded that the parties never intended an actual cash payment of principal or interest if coal was not mined. Thus, in our view, the note was contingent in nature. We reject petitioners' contention that the liquidated damages arrangement cured the contingency. Maddrix v. Commissioner, 83 T.C. 613">83 T.C. 613, 623-625 (1984); Estate of Blay v. Commissioner, T.C. Memo. 1984-565. As we previously noted, the liquidated damages arrangement 165 itself was devoid of economic substance.Since the nonrecourse note did not constitute true indebtedness by reason of its lack of economic substance, the requirement of section 163(a) that interest be paid or accrued on indebtedness is not met. Therefore, the partnership is not entitled to a deduction for accrued interest in 1977. 12Deductions for "Costs of Goods -- Development Costs"On its 1977 partnership return, the Knox County Partners, Ltd., deducted $ 200,305 for "cost of goods sold and/or operations" and $ 37,129 for "other deductions." The latter category of deductions, according to the partnership return, was comprised of mine development expenses ($ 23,800), professional fees ($ 5,883), travel 166 and promotion ($ 5,332), license fees ($ 1,000), utilities ($ 1,000), and miscellaneous ($ 114). Respondent's notices of deficiency to petitioners in docket Nos. 1235-81, 1236-81, and 1237-81 state as follows: "A deduction for costs of goods -- development costs in the amount of $ 110,457.64 claimed on the partnership return for 1977 is disallowed because the partnership has failed to establish that 600 the claimed deduction (a) was paid, and if paid, was paid for the purpose stated, and (b) ordinary and necessary business expenses." 13 On brief, respondent contends that petitioners have not substantiated the deduction since it has not been established what expenses the deduction relates to or whether the expenses have been paid. The record fails to so much as reveal precisely what deductions comprised the $ 110,457.64 disallowance. There was a passing reference at trial to alleged mining development expenditures in the amount of $ 37,129. Petitioners' brief does little more than cursorily discuss the matter in a paragraph as an "ancillary 167 issue."Since the deductions claimed by the partnership in 1977 for "cost of goods sold and/or operations" and "other deductions" total $ 237,434, respondent apparently allowed over one-half of the deductions claimed. However, precisely which deductions were allowed and which deductions were disallowed we cannot say based on the record before us. It was incumbent upon petitioners to enlighten the Court, since they bear the burden of proof. Under the circumstances, we must hold that they have failed to carry their burden of proof on the issue, and we must sustain respondent's disallowance of the deductions.Decisions will be entered under Rule 155. Footnotes1. Cases of the following petitioners are consolidated herewith: Bruce A. Samson and Adajean L. Samson, docket No. 1236-81; Harold G. Nix, docket No. 1237-81; Richard F. Lockey and Anne S. Lockey, docket No. 1238-81; William J. Schifino and Lois A. Schifino, docket No. 1239-81; Edward Hoornstra and Mildred Hoornstra, docket No. 1596-81; and Charles A. Kottmeier and Eloise L. Kottmeier, docket No. 1598-81.↩2. The parties in the following docketed cases have agreed to be bound by the final decision in these consolidated cases: Lewis J. Hirsch and Suzanne L. Hirsch, docket No. 13500-80; Frank N. Fleischer and Barbara C. Fleischer, docket Nos. 1234-81 and 1077-83; Stanley Rosewater and Maureen Rosewater, docket No. 1597-81; Lawrence Goodwin and Nancy Goodwin, docket No. 12541-81; Ralph S. Glover and Ruth Glover, docket No. 24583-81; Samuel S. Wexler and Charlene Wexler, docket No. 27941-81; Edward N. Hoornstra and Mildred S. Hoornstra, docket No. 20530-82; Ronald R. Willey and Luanne Willey, docket No., 27188-82; and Samuel L. Winer and Judith Winer, docket No. 29243-83.↩3. It so happened that Olmstead was on the same flight and also had arranged a meeting with American Coal & Coke. He met separately with representatives of the corporation; however, after this point Finalco dropped out of the picture. Apparently no deal was reached between American Coal & Coke and Finalco.↩4. An undated Errata Addendum to the partnership's offering memorandum included an amended engineering and coal reserve estimate for the portion of the Detherage tract on which the partnership had secured valid title and a reserve estimate for the Jones tract.5. It should be noted, however, that no licenses were made part of the record.↩6. The other 50 percent of the stock actually may have been held by Hooper's and Keene's wives or family trusts set up by them.↩7. See also Tallal v. Commissioner, T.C. Memo. 1984-486↩.8. Tallal v. Commissioner, T.C. Memo. 1984-486↩.9. Cf. also Tallal v. Commissioner, supra↩.10. We note that there was some suggestion at trial that all of the years in which petitioners allege they have reported "mining penalty income" are open tax years, and apparently protective refund claims may have been filed in some cases.↩11. Since the partnership generated no income in 1976, sec. 183(b)(2) is not applicable.↩12. Petitioners argue that Commissioner v. Tufts, 461 U.S. 300 (1983), requires that the nonrecourse note be recognized and treated as the functional equivalent of recourse debt. However, this argument has been rejected on a number of occasions. See Odend'hal v. Commissioner, 748 F.2d 908">748 F.2d 908, 912-913 (4th Cir. 1984), affg. 80 T.C. 588">80 T.C. 588 (1983); Elliott v. Commissioner, 84 T.C. 227 (1985); Fuchs v. Commissioner, 83 T.C. 79">83 T.C. 79, 102 n. 10 (1984); Dean v. Commissioner, 83 T.C. 56">83 T.C. 56, 78↩ n. 10 (1984).13. The notice of deficiency to petitioners in docket No. 1236-81 actually disallows a deduction in the amount of $ 110,456.64, instead of $ 110,457.64.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625480/	RICHARD E. FLEMING AND DOROTHEA D. FLEMING, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentFleming v. CommissionerDocket No. 39979-86United States Tax CourtT.C. Memo 1989-323; 1989 Tax Ct. Memo LEXIS 323; 57 T.C.M. (CCH) 858; T.C.M. (RIA) 89323; July 5, 1989Ronald Wyse, for the petitioners. Andrew D. Weiss, for the respondent. COHENMEMORANDUM FINDINGS OF FACT AND OPINION COHEN, Judge: Respondent determined deficiencies of $ 16,354.26 and $ 11,954.55 in petitioners' Federal income tax for 1978 and 1979, respectively. The sole issue for decision is whether petitioners are entitled to deductions for a charitable contribution pursuant to section 170. Unless otherwise indicated, all section references are to the Internal Revenue Code, as amended and in effect for the years in issue, and all rule references are to the Tax Court Rules of Practice and Procedure. FINDINGS OF FACT Some of the facts have been stipulated. The facts set forth in the stipulations are incorporated in our findings by this reference. Richard E. and Dorothea D. Fleming (petitioners) resided in San Luis Obispo, California, at the time they filed their petition. Pursuant to a sales agreement dated August 21, 1967 (the 1967 sales agreement), Wayne L. Romney, Joan E. Romney, and Jack R. Young and Associates, Sellers, agreed to sell a motel property located in Gila Bend, Arizona, to Calvin N. Ashton, Buyer, for a sales price325 of $ 600,000. The terms of the 1967 sales agreement required an initial payment of $ 60,000 designated as prepaid principal and interest, monthly payments of principal and interest of $ 4,250, and a balloon payment at the end of a 10-year period in an amount equal to the difference between the purchase price and any mortgage debt then outstanding against the property not in excess of the purchase price. The 1967 sales agreement provided, in pertinent part, that: 2. (a) Buyer is purchasing the property subject to the existing indebtedness thereon and is not assuming any of said indebtedness, and Buyer's liability and obligation hereunder shall be limited to his investment in the property in accordance with the terms and provisions of this agreement and there shall be no personal liability on the part of Buyer, nor may any deficiency be assessed against Buyer, and Sellers will be limited to look solely to the real and personal property involved in this transaction. * * 10. Notwithstanding any of the terms and conditions hereinabove set forth, it is agreed between the parties that Buyer shall no later than ten (10) years from close of escrow pay in full Sellers' equity in326 the premises, in which event Buyer shall assume the outstanding mortgages of record against the property. Sellers' equity at the end of the tenth year, or at any given time, shall be the difference between the outstanding encumbrances as of the date of the computation of the equity and the principal balance due under this contract of sale as of the date of said computation. 11. The parties further agree that Sellers may refinance the existing obligations against the property so long as the net proceeds from said refinancing are applied after payment of all loan costs, including discount and loan expenses, on the balances then owing on the obligations now existing, provided further that such refinancing shall not exceed the principal balance still owing under this agreement, and the parties agree to sign the necessary documents to permit said refinancing so long as the refinancing is in accordance with the terms and provisions hereof. In accordance with the terms of the 1967 sales agreement, on February 15, 1971, Romney International Hotels, Inc., Wayne L. Romney, and Joan E. Romney (the Romneys) mortgaged the motel property for $ 600,000 with Western Financial Corporation327 (Western). Under the terms of the 1967 sales agreement, this mortgage remained the sole obligation of the Romneys until the end of the 10-year period, at which time the investors were to assume it. Pursuant to a warranty deed dated September 9, 1967, Wayne L. Romney, Joan E. Romney, and Jack R. Young and Associates, grantors, conveyed the motel property to Calvin N. Ashton subject to the terms of the 1967 sales agreement. By a "Deed and Assignment" dated September 11, 1967, Calvin N. Ashton then conveyed all of his right, title and interest in the motel property and the 1967 sales agreement to the following investors: InterestAssignee0.40Robert A. & Dorothy R. Pullman0.10Edward A. & June W. Kemler0.10Edd Ralph Dickman0.10Richard I. & Betty Jane Benz0.10Joseph C. & Marjorie S. Hayward0.10Paul G. & Betty D. Aten0.10Petitioners1.00The investors, including petitioners, leased the motel property to Cambridge Management Company (Cambridge) for a 10-year term beginning September 11, 1967, and ending September 11, 1977. Jack R. Young (Young) signed the lease on behalf of Cambridge. Under the terms of the lease, Cambridge agreed to make328 monthly rental payments as follows: $ 750 per month for the first 12 months, $ 2,750 per month for the next succeeding 12 months, and $ 4,250 per month for the 25th through 120th month. Cambridge subleased the motel property to Romney Hotels, Inc., for the same 10-year term and monthly rental payments as were provided in the lease. Wayne L. Romney signed the sublease on behalf of Romney Hotels, Inc. Except for the $ 60,000 prepayment of principal and interest, no cash passed between the sellers and the investors during the 10-year lease term. The transaction was designed so that the lease payments would service the debt on the property and there would be no cash flow, either positive or negative, during the 10-year lease term. Petitioners learned about Jack R. Young and Associates through friends who had invested with that firm. The motel property was the first real property that petitioners purchased for investment purposes. Petitioners did not consult with an attorney or other expert regarding this transaction and relied entirely on Young to determine the value of the property and the form of the transaction. Petitioners did not visit the property before making329 their investment and did not know any of the other investors. Sometime in 1976 or 1977, near the end of the 10-year lease term, petitioners informed Young that he could dispose of the property. Petitioners left the decision of how to dispose of the property entirely up to Young. In August 1977, Young purportedly received an offer to purchase the motel property for $ 850,000. This offer was rejected. In 1978, Young advised petitioners to donate the property to charity. Petitioners received a pamphlet outlining the charitable activities of the Pacific Institute for Advanced Studies (the Institute). The Institute was an exempt organization listed in Internal Revenue Service Publication No. 78, the "Cumulative List of Organizations Described in Section 170(c) of the Internal Revenue Code of 1954," during 1978. In March 1978, petitioners and the other investors executed a document entitled Assignment of Sales Agreement under which their interest in the 1967 sales agreement was to be assigned to the Institute. An "Acceptance" of the assignment was executed May 16, 1978, by J. A . Maillian (Maillian), who represented that he signed as "agent" for the Institute. 330 The Assignment of Sales Agreement provided, in pertinent part, that: By accepting this Assignment, Pacific Institute for Advanced Studies accepts the property "as is" and agrees to assume and perform all obligations to be performed by the below named Assignee under such contract as assigned, and to indemnify the below named Assignee harmless from any liability for performance or non-performance of such obligations. In March 1978, petitioners and the other investors also executed a document entitled Assignment of Lease under which their interest in the 1967 lease with Cambridge Management Company was to be assigned to the Institute. An "Acceptance" of that assignment was also executed by Maillian as "agent" for the Institute. Petitioners had not heard of the Institute prior to executing the assignments. Petitioners' only communication with the Institute was a letter dated July 21, 1978, and purportedly signed by Mason Rose (Rose), Chancellor, acknowledging the gift of their equity in the motel property. The letterhead listed an address for the Institute of 9465 Wilshire Boulevard, Suite 515, Beverly Hills, California 90212. Rose did not sign the letter from the Institute331 to petitioners acknowledging their gift. The address on the letterhead was not the address of the Institute but was the address of Maillian. During 1978, Maillian had been appointed business manager of the Institute. As business manager, Maillian had no authority to accept donations on behalf of the Institute. Despite his lack of authority to do so, Maillian purportedly accepted donations on behalf of the Institute. The Institute, however, did not receive any property as a result of donations purportedly accepted by Maillian. In early January 1978, Allen Hom (Hom) responded to a newspaper advertisement describing a motel property for sale. Hom met with Maillian to discuss the property and made an offer to purchase the motel in mid to late January 1978. The February 15, 1971, mortgage on the motel property with an original balance of $ 600,000 was released by Western on March 22, 1978. Hom received a warranty deed to the motel property dated May 16, 1978, and signed by Maillian as "Authorized Agent" for the Institute. Throughout this transaction Hom dealt only with Maillian, who purported to represent the Institute. At the time of the purported gift of the motel property332 to the Institute and the subsequent sale to Hom, the Institute's financial books and records were prepared by Maillian. In early 1982, after learning that the Internal Revenue Service was planning an audit of its activities, the Institute hired a certified public accountant, Philip Tesler (Tesler). When Tesler received the Institute's financial records from Maillian, the general ledger reflected a note receivable from Hom in the amount of $ 292,397. Because he could not find that the Institute ever received any payment pursuant to the note receivable, Tesler reversed the entry from the Institute's books to reflect a zero balance. Petitioners reported adjusted gross income of $ 112,345.13 and $ 120,613.23 on their Federal income tax returns for 1978 and 1979, respectively. Petitioners claimed deductions for cash contributions of $ 2,204.08 and $ 3,163.30 and noncash contributions of $ 31,499.42 and $ 22,138.00, respectively, on their 1978 and 1979 Federal income tax returns. The noncash amounts were represented to result from the gift of their 10-percent interest in the motel property to the Institute, limited in 1978 by the 30 percent of adjusted gross income limitation in333 section 170(b)(1)(C) and (E) and carried over to 1979. In calculating the amount of these deductions, petitioners placed a fair market value on the motel property of $ 1,000,000 less the outstanding mortgage balance that petitioners believed to be $ 463,000. When preparing their 1978 and 1979 tax returns, petitioners relied on an unsigned appraisal report on the printed stationery of Allied Property Analysts, dated March 14, 1978, for Jack R. Young, Trustee, that valued the motel property at $ 1,000,000. Respondent disallowed these deductions in full because petitioners had not established (1) the fair market value of their donations, (2) that the donations were contributed to a qualified organization, or (3) that the donations met the requirements of section 170. OPINION The sole issue for decision is whether petitioners are entitled to deductions for a noncash charitable contribution pursuant to section 170. Petitioners bear the burden of proving that they are entitled to the deductions that they claim. Rockwell v. Commissioner, 512 F.2d 882">512 F.2d 882, 886 (9th Cir. 1975); Rule 142(a). Petitioners argue that they had a sufficient interest in the motel property334 to support a charitable contribution based on the fair market value of the property. Petitioners also assert that they had the requisite donative intent to make a gift of the property to the Institute and that they did not receive a quid pro quo for their contribution. Finally, petitioners contend that, notwithstanding Maillian's lack of authority to accept contributions on behalf of the Institute, they and the other investors validly conveyed a gift of their interest in the motel property to the Institute. Respondent argues that the purported transfer to the Institute was a sham, that the purported transfer was made for petitioners' benefit rather than out of their detached and disinterested generosity, and that the Institute never accepted the property nor received any benefit from the purported contribution. Petitioners argue that they had a sufficient interest in the motel property to support a charitable contribution. Respondent argued at trial and in his trial memorandum that the instant case is the fifth in a series of cases involving tax shelters set up by Young: Estate of Franklin v. Commissioner, 64 T.C. 752">64 T.C. 752 (1975), affd. 544 F.2d 1045">544 F.2d 1045 (9th Cir. 1976);335 Hilton v. Commissioner, 74 T.C. 305">74 T.C. 305 (1980), affd. 671 F.2d 316">671 F.2d 316 (9th Cir. 1982); Narver v. Commissioner, 75 T.C. 53">75 T.C. 53 (1980), affd. 670 F.2d 855">670 F.2d 855 (9th Cir. 1982); and Pacific Gamble Robinson and Affiliated Cos. v. Commissioner,T.C. Memo 1987-533">T.C. Memo. 1987-533. Respondent contended that petitioners were trying to extricate themselves from a "burned-out" tax shelter, where the tax advantages of the investment were no longer present. On brief, petitioners argue that the facts in the instant case are distinguishable from the prior Young tax shelters and that the legal principles set forth in Estate of Franklin compel a conclusion that petitioners had an interest in the donated property. Because respondent did not respond to petitioners' arguments in his (seriatim) answering brief, petitioners argue that respondent has effectively conceded that petitioners did have an interest in the motel property sufficient to support a charitable contribution. Assuming that petitioners' 10-percent interest in the 1967 sales agreement is sufficient to support a charitable contribution, petitioners have nonetheless failed to provide336 any admissible or persuasive evidence to support the deductions claimed. Estate of Franklin involved the deductibility of interest and depreciation payments claimed with respect to an Arizona motel purchased by a limited partnership. Under the terms of the sales agreement, which were similar to the terms in the instant case, the sellers, the Romneys, agreed to sell a motel property to a partnership organized by Young for $ 1,224,000. Although the Court of Appeals for the Ninth Circuit disallowed the deductions, the court stated that "the characteristics set out above can exist in a situation in which the sale imposes upon the purchaser a genuine indebtedness * * which will support both interest and depreciation deductions." Estate of Franklin v. Commissioner, 544 F.2d at 1047. The taxpayers in Estate of Franklin failed to prove that the purchase price was at least approximately equivalent to the fair market value of the motel property. Thus, that court held that the taxpayers had not made an investment which would yield an equity in the property and that the transaction lacked the economic substance necessary to justify treating it as a sale. Likewise, 337 petitioners have not provided any evidence of an arm's-length purchase or that the purchase price they paid was approximately equivalent to the fair market value of the motel property. Petitioners argue that the $ 1,000,000 appraisal valuation of the motel property upon which their tax returns were prepared reflects the actual fair market value of the property interests contributed. Additionally, petitioners contend that factual evidence submitted at trial, the purported offer to purchase the property in August 1977 for $ 850,000 and Hom's testimony that he purchased the property from the Institute, support a conclusion that the fair market value was not less than $ 668,000 (an amount that erroneously includes $ 18,000 apparently paid by Hom for other assets). Petitioners offered an unsigned appraisal report on the printed stationery of Allied Property Analysts, dated March 14, 1978, for Jack R. Young, Trustee, that valued the motel property at $ 1,000,000. The report was admitted into evidence for the limited purpose of showing that petitioners relied on the valuation when preparing their 1978 and 1979 tax returns. The appraiser did not testify at trial, and the opinions expressed338 in the unsigned appraisal report were therefore not subject to cross-examination. The appraisal was inadmissible hearsay under Rules 801(c) and 802, Federal Rules of Evidence. Thus, the appraisal was not admitted as evidence of the value of the motel property and its use as such was specifically rejected by this Court. Nonetheless, petitioners contend that the appraisal meets the requirements of Rev. Proc. 66-49, 2 C.B. 1257">1966-2 C.B. 1257, for appraisals that are used to support charitable contributions. Petitioners have, however, disregarded the requirements that the appraisal report contain the appraiser's qualifications and signature. Similarly, the revenue procedure makes it clear that the weight to be accorded an appraisal depends on the competence and knowledge of the appraiser as well as the probative facts supporting the opinion. Petitioners have failed to present admissible evidence that the appraisal valuation did approximate the fair market value of the motel property at the time the 1967 sales agreement was assigned. In any event the revenue procedure does not establish rules of evidence for proceedings in this Court. Sec. 339 7453; Rule 143(a). Petitioners argue that the August 1977 offer to purchase the property for $ 850,000 represents factual evidence supporting the appraisal valuation. Respondent argues, and we agree, that the letters purporting to be an offer to purchase the property are not reliable evidence of the value of the property. Petitioners presented no evidence that the offer was an arm's-length transaction between unrelated parties or otherwise bona fide. The offer, therefore, does not represent credible evidence of the value of the property. Hom testified that he paid between $ 650,000 and $ 675,000 for the motel property. Approximately $ 290,000 of the purchase price was purportedly paid in cash and the remainder by note. Hom, however, was unable to recall the details of the transaction, and the terms are not otherwise in evidence. Petitioners did not produce any documents to corroborate the sale transaction. Hom's uncorroborated testimony carries insufficient weight to meet petitioners' burden of proof of the fair market value of the motel property at the time of the assignment. Accordingly, petitioners have failed to present admissible or persuasive evidence on which the340 Court can determine the fair market value of the property or of petitioners' interest in it. Most importantly, petitioners' conduct as owners belies a belief of any significant fair market value of their "gift." Petitioners were disinterested investors who proceeded as if they had no concern about whether the purchase price or rental rate accurately reflected the value of the property or its use. Petitioners were similarly disinterested in the disposition of the property. The only indication of a relationship between petitioners and the Institute is through the "gift" transaction arranged by Young and Maillian. Petitioners claim that they gave to the Institute their interest in an asset having an unencumbered value in excess of 50 percent of their adjusted gross income for either of the years in issue. Based on the entire record, we do not accept petitioners' claims that they gave to a charity unknown to them an asset that was worth any significant value. See Snyder v. Commissioner, 86 T.C. 567">86 T.C. 567, 581 (1986). (Compare Suna v. Commissioner, T.C. Memo 1988-541">T.C. Memo. 1988-541.) Not a single piece of objective evidence or expert opinion supports their position, *341 and their own conduct undermines their position. Petitioners failed to carry their burden of proof on the value, if any, of their "gift." We, therefore, need not decide whether, as petitioners contend, Maillian had the apparent or actual authority to accept the contribution or whether, as respondent contends, the Statute of Frauds applies to this transaction. Although respondent disallowed petitioners' noncash charitable deductions in full, he has "charitably" refrained from asserting additions to tax or additional interest for which petitioners might be liable. Under the circumstances of this case, we decline to do so on our own motion. Compare, however, Johnson v. Commissioner, 85 T.C. 469">85 T.C. 469, 483-484 (1985), where we applied sua sponte section 6621(c) (formerly 6621(d)) based upon our finding of a valuation overstatement with respect to a contribution to charity. To reflect the foregoing, Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625482/	John David Hawn and Bette Hawn, Petitioners, v. Commissioner of Internal Revenue, RespondentHawn v. CommissionerDocket No. 40246United States Tax Court23 T.C. 516; 1954 U.S. Tax Ct. LEXIS 15; 4 Oil & Gas Rep. 208; December 23, 1954, Filed 15 Decision will be entered under Rule 50. Petitioner was the owner of an oil payment which had an original face value of $ 1,000,000 but a face value of $ 854,993.25 at the time of transfer herein. On October 1, 1949, petitioner transferred this oil payment to a contractor, who agreed to build him a residence, with a provision that all of petitioner's right, title, and interest in and to said oil payment was transferred to said contractor until he should receive from the proceeds of the sale of said interest in said oil the sum of $ 120,000, whereupon the interest conveyed to the contractor should terminate and revert to petitioner without the necessity of the execution of any character of release or reconveyance. In 1949 petitioner, who was on the cash basis, received $ 20,809.79 from the contractor. Petitioner had no cost basis for the oil payment and concedes that the entire amount received in 1949 was taxable gain without any allowance for depletion but should be taxed as long-term capital gain under section 117 of the 1939 Code. Respondent contends the amount is taxable as ordinary income with an allowance to petitioner of depletion. Held, the oil payment which petitioner16 transferred to the contractor was a capital asset which had been held for more than 6 months and the gain is taxable as long-term capital gain. Marvin K. Collie, Esq., and John G. Heard, Esq., for the petitioners.W. B. Riley, Esq., for the respondent. Black, Judge. Arundell, J., dissenting. Kern, Opper, Raum, Rice, and Bruce, JJ., agree with this dissent. BLACK 516 The Commissioner has determined a deficiency in petitioners' income tax for the year 1949 of $ 30,457.06. The deficiency is due to two adjustments made by the Commissioner to the net income reported by petitioners on their joint return, as follows:(a) Oil payment, net adjustment$ 27,000.00(b) Hewit Estates1,329.8517 Adjustment (a) is explained by the Commissioner in his deficiency notice, as follows:(a) It is held that the consideration received by you for the assignment of the oil payment made by you to A. E. Hinman is ordinary income subject to the depletion allowance. The total of $ 120,000.00 received by you therefore has been included in ordinary income and 27 1/2% thereof, or $ 33,000.00, has been allowed as depletion, and the amount $ 60,000.00 reported by you as capital gain upon the transaction has been eliminated from your taxable income.Petitioners assign error as to the correctness of the foregoing adjustment and contend that the gain received from the transfer of the oil payment in question is properly taxable as long-term capital gain. Petitioners also assign error, as follows:517 (e) The Commissioner erred in failing to hold that only part of the consideration for the sale of said oil payment was received by, and therefore was taxable to, the Petitioner John David Hawn in the year 1949; which error resulted further in the failure of the Commissioner to allow the Petitioners a refund for the year 1949.FINDINGS OF FACT.The facts were stipulated except the income tax18 return of petitioners which was placed in evidence. The facts as stipulated are so found.John David Hawn and Bette Hawn are husband and wife, residing at Corpus Christi, Texas. Their joint income tax return for the calendar year 1949 was filed with the collector of internal revenue at Austin, Texas. For the year 1949 petitioners used the calendar year reporting period and the cash receipts and disbursements method of accounting for Federal income tax purposes.On October 1, 1949, John David Hawn, hereinafter referred to as petitioner, had owned for a period of more than 6 months an oil payment in the original amount of $ 1,000,000 in certain oil properties located in Refugio County, Texas. His basis at that time in the oil payment was zero.On October 1, 1949, petitioner entered into the following agreement with A. E. Hinman, a general contractor:Mr. A. E. HinmanWilson BuildingCorpus Christi, TexasDear Sir:In consideration of my assignment to you of an oil payment in the amount of $ 120,000.00 out of an oil payment in the amount of $ 1,000,000.00 which was given to me by my grandmother, Mrs. Christie Hewit, which assignment to me is of record in Volume 68, page 107-11119 of the Deed Records of Bee County, Texas, 1 you agree to erect for me a one (1) story, ranch type, combination masonry and frame residence to be located in Hewit Estates in Corpus Christi, Texas, pursuant to a contract executed between yourself and me on the 1st day of October, 1949.As a part of this agreement you agree to furnish me all bills for materials, labor, furnishings, etc., in connection with the above mentioned residence to the extent of $ 115,000.00.It is understood and agreed that you are financing the furnishing of the above mentioned items with one of the local banks. You are to reimburse yourself for any interest paid out of the difference between the $ 120,000.00 oil payment and the amount you are paying for the oil payment, namely, $ 115,000.00 and any excess of any amount above the $ 115,000.00 with interest at 5% will be returned to me out of the oil payment.Should, however, the amount of $ 115,000.00 plus interest at 5% exceed $ 120,000.00 I will personally be liable to you for such amount.518 If the above is in accordance with our agreement will you please execute and return to me the original of this letter.Yours very truly,/s/ John D. HawnAccepted: 20 October 1, 1949/s/ A. E. HinmanPursuant to this agreement and on the same date, petitioner executed the following instrument which was notarized and thereafter recorded in the deed records of Refugio County, Texas:The State of TexasCounty of RefugioWhereas, on the 14th day of May, 1948 Christie Hewit, Individually and as Independent Executrix of the Estate of W. E. Hewit, deceased, assigned and delivered to John David Hawn an oil payment in the sum of One Million ($ 1,000,000.00) Dollars payable out of five percent of one-half of seven eighths (5% of 1/2 of 7/8) of all oil in and under and which may be produced from the following described property:[Description of property here omitted.]said assignment being recorded in Volume 68, pages 107-111 of the Deed Records of Refugio County, Texas, to which reference is made for all purposes.Now, 21 therefore, in consideration of the sum of Ten ($ 10.00) Dollars and other good and valuable consideration, the receipt of which is hereby acknowledged, to me in hand paid by A. E. Hinman, of Nueces County, Texas, I, John David Hawn, to [sic] hereby grant, sell, transfer, assign and convey unto the said A. E. Hinman all of my right, title and interest in and to said oil payment above described until the said A. E. Hinman shall have received from the proceeds of the sale of said interest in said oil the sum of One Hundred Twenty Thousand ($ 120,000.00) Dollars, whereupon the interest herein conveyed to said A. E. Hinman shall terminate and revert to and revest in said John David Hawn, his heirs, representatives and assigns without the necessity of the execution of any character of release or reconveyance.To have and to hold the same unto the said A. E. Hinman, his heirs, successors and assigns, subject to the terms and provisions of the assignment from said Christie Hewit, I do hereby bind myself, my heirs, executors and administrators to warrant and forever defend, all and singular, said interest herein conveyed to said A. E. Hinman, his heirs, successors and assigns against every22 person whosoever lawfully claiming or to claim the same or any part thereof.This conveyance shall become effective at 12:01 a. m. on the 1st day of October, 1949.In witness whereof, this instrument is executed this the 1st day of October, 1949./s/ John David HawnThe house referred to in the agreement between petitioner and Hinman was constructed on a city lot owned by petitioner in the city of Corpus Christi, Texas. Petitioner did not receive any note or other security for the contractual obligation of Hinman to construct the house.As of the date of the above assignment to Hinman the balance remaining out of the original $ 1,000,000 production payment was 519 $ 854,993.25. This oil payment automatically reverted to petitioner on approximately May 1, 1951, in accordance with the terms of the assignment to Hinman. Hinman on or about that date had received an aggregate amount of $ 120,000 from said oil payment directly from the companies purchasing the production.The lease, as to which this oil payment applied, was fully developed and producing oil at the time of the assignment to Hinman, and also at the time of the reversion to petitioner. The production from this lease23 was fairly consistent at such times, the allowable production being regulated by the Railroad Commission of the State of Texas and the field price for the production at the time of the assignment of the production payment to Hinman was ascertainable. On the basis of the information available at the time of the assignment of the production payment to Hinman and assuming the production from the lease in question continued to produce at its then average rate and assuming that the field price of the production remained substantially the same, it could have been estimated that $ 120,000 would be received from said production payment within a period of approximately 2 years.Construction of the house was begun on October 17, 1949, and the expenditures of Hinman in the construction of the house during the calendar year 1949 amounted to a total of $ 20,809.79.From October 1, 1949, the date of the assignment of the said production payment to Hinman, through December 31, 1949, of the $ 120,000 Hinman received a total of only $ 12,782.53 from the production of the lease to which the said production payment was applicable.Petitioners were not dealers or brokers in oil and gas properties during24 the calendar year 1949.In their joint income tax return for the year 1949, petitioners reported the assignment of the oil payment to Hinman on their schedule of capital gains, as follows:AmountrecognizedSale of oil payment$ 120,000Cost0Long-term capital gain$ 120,000$ 60,000The amount of $ 60,000 was included on the income schedule attached to their return as a "Net Long Term Capital Gain."OPINION.Petitioner states the issues in his brief, as follows:The primary issue in this proceeding is whether, for Federal income tax purposes, the consideration received during the calendar year 1949 by Petitioner 520 John David Hawn in exchange for an oil payment constituted long-term capital gain proceeds, or whether such proceeds constituted ordinary income subject to depletion.The second and subsidiary issue is the extent of the consideration received by and taxable to Petitioner John David Hawn during the calendar year 1949 in connection with the exchange of such oil payment.With reference to the primary issue stated by petitioner as above, respondent contends that the consideration received by petitioner for the assignment of an in-oil payment25 right carved out of a larger in-oil payment right, such consideration not being pledged for use in further development, is ordinary income subject to the depletion allowance, not capital gain as contended by petitioner.There is no difference between the parties as to the oil payment owned by petitioner in the original amount of $ 1,000,000 being a capital asset under the provisions of section 117, Internal Revenue Code of 1939. Respondent's contention is not directed toward a holding that such oil payment right owned by petitioner was not a capital asset. His contention, rather, is that the transactions between petitioner and Hinman did not add up to a transfer of any part of such right to Hinman but that what was done amounted to a mere assignment of income and that the income when received by Hinman was taxable to petitioner, notwithstanding such assignment, under the doctrine of such cases as Lucas v. Earl, 281 U.S. 111">281 U.S. 111; Helvering v. Eubank, 311 U.S. 122">311 U.S. 122; and Helvering v. Horst, 311 U.S. 112">311 U.S. 112.Respondent, in support of his determination, strongly relies on G. C. M. 24849, 1946-1 C. B. 66.26 The headnote of that G. C. M. reads as follows:Consideration received for the assignment of a short-lived in-oil payment right carved out of any type of depletable interest in oil and gas in place is ordinary income subject to the depletion allowance where such consideration is not pledged for use in further development.In the course of this G. C. M. it is said as follows:In-oil payment rights, royalty rights, and operating rights are analogous in that they are essentially rights to production income characterized as ordinary income when realized. All are regarded as depletable economic interests in oil and gas in place entitling the owner to tax-free return of his investment through the depletion allowance. In-oil payment rights are distinguishable from royalty interests and operating rights in that the latter interests, by definition, extend to the entire oil and gas resource content of the land and, as such, represent forms of fractional property rights into which the property interests in oil and gas in place are commonly divided, whereas an in-oil payment right is a right to income for a limited time or amount. This difference is emphasized by the fact that an in-oil 27 payment right may be carved out of either of the specified property interests in oil and gas in place, but the reverse is not true. Thus, sales of royalty rights or operating rights are sales of property rights, whereas assignments of in-oil payment rights carved out of such property rights, are, with 521 respect to the assignor, essentially mere assignments of expected income from such property rights for a fixed or determinable period of time.Later on, the foregoing G. C. M. was clarified by I. T. 4003, 1950-1 C. B. 10, in the following manner:After careful study and considerable experience with the application of G. C. M. 24849, supra, it is now concluded that there is no legal or practical basis for distinguishing between short-lived and long-lived in-oil payment rights. It is, therefore, the present position of the Bureau that the assignment of any in-oil payment right (not pledged for development), which extends over a period less than the life of the depletable property interest from which it is carved, is essentially the assignment of expected income from such property interest. Therefore, 28 the assignment for a consideration of any such in-oil payment right results in the receipt of ordinary income by the assignor which is taxable to him when received or accrued, depending upon the method of accounting employed by him. Where the assignment of the in-oil payment right is donative, the transaction is considered as an assignment of future income which is taxable to the donor at such time as the income from the assigned payment right arises.It will be noted that in the foregoing I. T. it is said: "Where the assignment of the in-oil payment right is donative, the transaction is considered as an assignment of future income which is taxable to the donor at such time as the income from the assigned payment right arises."Recently our Court had before it the case of Lester A. Nordan, 22 T. C. 1132, which involved a donative transfer of an oil payment right. In that proceeding the facts may be briefly stated as follows: The taxpayers had executed a deed of gift to a church of an oil payment having a face value of $ 115,000 but which had a fair market value on the date of gift of $ 111,925.95. The taxpayers claimed a deduction of that amount29 on their 1949 return as a charitable contribution on the ground that they had made a completed gift of the oil payment. The Commissioner in determining the deficiency disallowed the deduction. He explained that the deduction "was based upon the donative in-oil assignment of $ 115,000" to the church which received no payments during 1949 and "you donated only a right to share in future income." The Commissioner added $ 109,825 to the taxpayers' income in the following year, 1950, and allowed a like amount as a charitable deduction and $ 30,201.87 as depletion on that income. Under these facts, we held that the taxpayers' contribution was deductible under section 23 (c) of the 1939 Code in the year of transfer, 1949, even though payments from production were not available until the next year. In other words, we held in the Nordan case, supra, that the taxpayers had made more than a mere assignment of income to the church; they had, in the taxable year 1949, made a transfer of the property itself which produced the income in the following year and they were entitled to the deduction of the fair market value 522 of their gift in the year when the transfer of the oil 30 payment was made. They were not the owners of the oil payment in the following year, 1950, when the new owner made collection of it.In T. W. Lee, 42 B. T. A. 1217, affd. 126 F. 2d 825, cited by us in the Nordan case, supra, after quoting the Supreme Court's decision in Anderson v. Helvering, 310 U.S. 404">310 U.S. 404, we stated the principle involved as follows:It seems clear * * that the Supreme Court regards any oil payment right (a right to a specified sum of money payable only out of a specified percentage of oil or the proceeds received from the sale of such oil, if, and when produced) as an economic interest in oil in place, the holder thereof being the owner of the share of gross income from production represented by the payments to him and being entitled to the attending depletion allowance.While our decision in the recent Nordan case, supra, involved an oil payment which had been transferred as a gift and the instant case involves one which had been transferred for a valuable consideration, we do not see any distinction in principle between the consequences of the two transfers31 insofar as the issue, whether the transfer was of property itself as the taxpayers contend or a mere assignment of income as the Commissioner contends, is concerned. In the Nordan case the deed provided that as soon as the $ 115,000 had been received by the church from the production under the leases the conveyance would expire and title to the remaining oil, gas, and minerals under the land would revert to the grantors. In the instant case the conveyance of the oil payment from petitioner to Hinman provided:I, John David Hawn, to [sic] hereby grant, sell, transfer, assign and convey unto the said A. E. Hinman all of my right, title and interest in and to said oil payment above described until the said A. E. Hinman shall have received from the proceeds of the sale of said interest in said oil the sum of One Hundred Twenty Thousand ($ 120,000.00) Dollars, whereupon the interest herein conveyed to said A. E. Hinman shall terminate and revert to and revest in said John David Hawn, * * without the necessity of the execution of any character of release or reconveyance.What happened in the instant case, as we view it, is briefly this: For a valuable consideration, namely, 32 Hinman's contract to build him a residence, petitioner transferred to Hinman an oil payment. Thereafter, Hinman was the owner of the oil payment until he had collected $ 120,000, when it was to revert to petitioner. In 1949, the taxable year which we have before us, Hinman collected $ 12,782.53 from the oil payment. That amount was gross income to him from oil production and he was entitled to depletion. It was not income to petitioner. T. W. Lee, supra.In the same year Hinman paid to petitioner from whom he had acquired the oil payment, $ 20,809.79. This was part payment to petitioner for the capital asset which 523 Hinman had purchased from petitioner and the gain realized therefrom is taxable as capital gain. Sec. 117, Internal Revenue Code of 1939.We hold for petitioner on the first issue.With respect to the second issue respondent concedes error. In his brief respondent says:Respondent here concedes that petitioners realized and received during 1949 only $ 20,809.79, of the consideration due them for the assignment of the oil payment. No greater amount should be included in their income for said year.Effect to this concession33 will be given in a computation under Rule 50. Petitioners are not entitled to any depletion deduction from this $ 20,809.79. See Alice G. K. Kleberg, 43 B. T. A. 277. It is our understanding that petitioners do not claim any deduction for depletion in case we decide the primary issue in their favor. Having decided that issue in their favor, it is clear they are not entitled to any deduction for depletion. They were not the owners of the oil payment which Hinman received.Decision will be entered under Rule 50. ARUNDELLArundell, J., dissenting: There is no dispute that the oil payments constituted ordinary income and if they had been collected by the taxpayer they would have been taxable to him. But, petitioner assigned his right to collect these oil payments to the extent of $ 120,000 to a builder in consideration of the latter's erecting a house for petitioner. In the terms of the assignment the oil payments were transferred to the builder until the latter "shall have received from the proceeds of the sale of said interest in said oil the sum of One Hundred Twenty Thousand ($ 120,000.00) Dollars, whereupon the interest herein conveyed34 to said A. E. Hinman [builder] shall terminate and revert to and revest in said John David Hawn [petitioner], his heirs, representatives and assigns without the necessity of the execution of any character of release or reconveyance." Approximately 2 years were estimated to pay out the builder for erecting petitioner's house.It can no longer be successfully argued that one vested with the right to receive income can "escape the tax by any kind of anticipatory arrangement, however skillfully devised, by which he procures payment of it to another, since, by the exercise of his power to command the income, he enjoys the benefit of the income on which the tax is laid." Harrison v. Schaffner, 312 U.S. 579">312 U.S. 579. See Lucas v. Earl, 281 U.S. 111">281 U.S. 111; Helvering v. Horst, 311 U.S. 112">311 U.S. 112; Helvering v. Eubank, 311 U.S. 122">311 U.S. 122.524 The majority seem to think there is a different treatment called for when income from an oil well is assigned and that the assignment of such income constitutes an assignment of a property interest in the corpus from which flows the income35 assigned even though the amount assigned is limited and is temporary in nature. It is true the Supreme Court has held where the entire interest in the income of a trust was disposed of that the transaction may be regarded as a transfer of the corpus from which flowed the income. Blair v. Commissioner, 300 U.S. 5">300 U.S. 5. But, this has not been the Court's holding where there has been a temporary disposition of the income from property even though the transfer takes the form of a temporary disposition of the property itself. Harrison v. Schaffner, supra.In all such cases the income has been taxed to the grantor.In my opinion the oil payments constituted ordinary income to petitioner and should be taxed accordingly. Footnotes1. This must be in error for the transfer from Hawn to Hinman states the assignment is recorded in volume 68, pages 107-111, of the deed records of Refugio County, Texas.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625483/	VAN L. ROWND, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentRownd v. CommissionerDocket No. 3394-93United States Tax CourtT.C. Memo 1994-465; 1994 Tax Ct. Memo LEXIS 473; 68 T.C.M. (CCH) 738; September 21, 1994, Filed 473 Decision will be entered under Rule 155. Van L. Rownd, pro se. For respondent: Julie M. T. Foster and Willard N. Timm, Jr.GOLDBERGGOLDBERGMEMORANDUM OPINION GOLDBERG, Special Trial Judge: This case was heard pursuant to the provisions of section 7443A(b)(3) and Rules 180, 181, and 182. 1Respondent determined a deficiency in petitioner's 1990 Federal income tax in the amount of $ 768.22. The sole issue for decision is whether petitioner is entitled to dependency exemptions for his two children under section 151. Some of the facts have been stipulated and are so found. The stipulation of facts and attached exhibits are incorporated herein by this reference. Petitioner resided in Acworth, Georgia, on the date the petition was filed in this case. Petitioner timely filed his 1990 Federal income tax return claiming474 dependency exemptions for his two children, William L. Rownd (William) and Christopher L. Rownd (Chris). Petitioner married Joan G. Rownd on March 22, 1969, and two children were born of their marriage. Chris was born on August 17, 1971, and William was born on January 22, 1975. Petitioner was divorced from Joan G. Rownd on May 8, 1989. The written property settlement agreement between petitioner and his former wife, which was incorporated into a judicial decree of divorce, provided that petitioner's former wife gained permanent custody of Chris and William, who were minors, and was entitled to claim the dependency exemptions for them for income tax purposes. As part of the child support, the divorce decree required petitioner to pay his former wife $ 500 per month, per child, until such child attained the age of 18. The divorce decree further required petitioner to pay for the cost of a 4-year college education, including tuition, expenses for room and board, books, and any related incidental expenses for both of his children, and to maintain his children's health insurance and pay their medical expenses. During 1990, William was age 15, a high school sophomore, and Chris, 475 age 19, was a college freshman attending the University of Georgia. Petitioner paid his former wife $ 8,100 in child support for William. Except for every other weekend and occasional holidays when petitioner had visitation rights, as provided in the divorce decree, William lived with petitioner's former wife. Also during 1990, petitioner paid directly to Chris $ 5,968 for college tuition, expenses for room and board, books, and related incidental expenses. Petitioner paid no child support to his wife for Chris during 1990 because Chris was 19 years old. The property settlement provided that petitioner's obligation to pay child support ended when each minor child reached age 18. Throughout the year, Chris lived away at college and stayed with both parents an equal amount of time. Additionally, petitioner paid $ 3,999.57 for medical insurance, which included coverage for himself and his sons, and $ 775.10 for medical expenses on behalf of both sons. 2 Petitioner's former wife provided less than half of the children's support. 476 Petitioner argues that since he paid more than half the children's support during 1990, he is entitled to claim dependency exemptions for them. The determination of respondent, as contained in her notice of deficiency, is presumed to be correct. Petitioner bears the burden of proving that respondent erred in her determination. Rule 142(a); Welch v. Helvering, 290 U.S. 111">290 U.S. 111, 115 (1933). Section 151(c) allows a taxpayer an annual exemption amount for each dependent as defined in section 152. According to section 152(a), the term "dependent" means certain individuals, such as a son, "over half of whose support, for the calendar year in which the taxable year of the taxpayer begins, was received from the taxpayer (or is treated under subsection (c) or (e) as received from the taxpayer)". Generally, in the case of divorced parents, the custodial parent can claim the exemption where there exists a decree of divorce or separate maintenance and a child is in the custody of one or both of his parents for more than half of the year. Sec. 152(e)(1). With regard to his younger son, William, age 15 in 1990, petitioner testified that he and his former wife477 entered into an oral agreement modifying the divorce decree, whereby he would be entitled to claim William as a dependent. There was no evidence presented at trial reflecting this arrangement, other than petitioner's self-serving testimony. Section 152(e)(2) allows the noncustodial parent to obtain the exemption if: (a) The custodial parent signs a written declaration stating that such custodial parent will not claim such child as a dependent for the taxable year; and (b) the noncustodial parent attaches such written declaration to the noncustodial parent's return for the taxable year. The language of section 152(e)(2) has specific requirements that any such declaration by the custodial parent be in written form and attached to the noncustodial parent's tax return; therefore, the requirements of this statutory exception are not fulfilled. Consequently, petitioner is not entitled to claim a dependency exemption for William. With regard to his other son, Chris, petitioner argues on brief that since his son was age 19 and lived on the campus of the University of Georgia and away from his mother, she did not have custody of him in the year at issue. Petitioner contends that, with478 respect to Chris, the support test of section 152(a) controls in the instant case, rather than the custody provisions of section 152(e). The resolution of this alternative argument depends upon the definition of the term "custody". Section 1.152-4(b), Income Tax Regs., states that "custody" is determined by the terms of the most recent decree of divorce. Pursuant to the Settlement Agreement between petitioner and his former wife, paragraph 2 entitled "CUSTODY", petitioner's former wife was given permanent custody of the minor children. Furthermore, the provision of the divorce decree entitled "Income Taxes" states that petitioner's former wife was entitled to declare her minor children as dependents. However, pursuant to Georgia State law, a child reaches majority upon attaining age 18, Ga. Code Ann. sec. 39-1-1 (Michie Supp. 1994), and the parental control terminates when the child reaches majority, Ga. Code Ann. sec. 19-7-1 (Michie Supp. 1994). Gaskins v. Beasley, 216 Ga. 19">216 Ga. 19, 114 S.E.2d 373">114 S.E.2d 373 (1960). Chris was born on August 17, 1971. Therefore, since Chris reached majority prior to the year at issue, the custody and the income*479 tax provisions of the settlement agreement incorporated into the divorce decree no longer applied to him in 1990. Since the custody and dependency provisions of the divorce decree were not applicable to Chris in 1990, and since Chris was a full-time student as described in section 151(c)(4), we must apply the support test as required by section 152(a). A son who receives over half of his support from the taxpayer is within the section 152(a) definition of the term "dependent". In the instant case, petitioner paid the amount of $ 5,968 directly to Chris for tuition, books, and living expenses. Furthermore, petitioner provided health and life insurance for Chris and paid all his medical expenses. Also, Chris testified at trial that his mother provided him with no support during the year at issue. Accordingly, we find that petitioner provided over half of Chris' support during 1990 and therefore is entitled to claim Chris as a dependent. Decision will be entered under Rule 155. Footnotes1. Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the year in issue. All Rule references are to the Tax Court Rules of Practice and Procedure.↩2. Petitioner deducted such amounts as medical and dental expenses on Schedule A for his 1990 Federal income tax return pursuant to sec. 213(d)(5).↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625484/	Donna Jo Campbell v. Commissioner.Campbell v. CommissionerDocket No. 3668-70 SC.United States Tax CourtT.C. Memo 1971-51; 1971 Tax Ct. Memo LEXIS 281; 30 T.C.M. (CCH) 226; T.C.M. (RIA) 71051; March 25, 1971, Filed. 281 Held, section 152, I.R.C. 1954, does not contravene any constitutional guarantee secured to petitioner under the Ninth Amendment to the Constitution of the United States. Donna Jo Campbell, pro se, 2809 Folsom Lane, Bowie, Md. R. S. Erickson, for the respondent. DAWSONMemorandum Opinion DAWSON, Judge: This case was heard by Commissioner John H. Sacks at the trial session of small tax cases held in Washington, D.C., in December 1970. The case was later reassigned by the Chief Judge to me because the petitioner raised a constitutional question. Respondent determined a deficiency in the income tax of petitioner for282 the taxable year 1967 in the amount of $205.92. The only question presented for decision is whether section 152 of the Internal Revenue Code of 1954 violates the edict of the Ninth Amendment to the Constitution of the United States. The parties have agreed that if the Court sustains the constitutionality of section 152, then the deficiency as determined by respondent is correct. Most of the relevant facts have been stipulated, and they are so found. Donna Jo Campbell (hereinafter called petitioner) is an individual, who at the time 227 of the filing of her petition herein, resided in Bowie, Maryland. Her Federal income tax return for the calendar year 1967, the year at issue, was filed with the district director of internal revenue at Baltimore, Maryland. Petitioner is the mother of two minor children - Donald Joseph, a boy born August 13, 1958, and Jean Katherine, a girl born June 22, 1960. She and her former husband, Walter V. Kolon, were divorced in 1964 and, subsequent to the divorce, both of the children - Donald Joseph and Jean Katherine - remained in the custody of, and resided with, petitioner. Pursuant to an agreement between petitioner283 and Walter V. Kolon, he was to provide $250 per month for the support and maintenance of the two children. During the year 1967 Walter V. Kolon did provide this $250 per month, or a total of $3,000 for the year, for the support and maintenance of Donald Joseph and Jean Katherine, and this sum was expended for their support and maintenance. The total support for Donald Joseph in 1967 was $2,033 and the total support for Jean Katherine in the same year was also $2,033. Petitioner did not provide over half the total support for either Donald Joseph or Jean Katherine during the year 1967. It is petitioner's position that section 152 of the Internal Revenue Code of 1954 contravenes the Ninth Amendment to the Constitution of the United States. In essence, she asserts that section 152 has forced the Internal Revenue Service to interject itself into - and become a negative force in complicating - the unpleasant personal, domestic affairs of taxpayers. The Ninth Amendment, apparently designed to insure protection of the people from an overbearing Government, provides: The enumeration in the Constitution, of certain rights, shall not be construed to deny or disparage284 others retained by the people. Under the Sixteenth Amendment to the Constitution the Federal Government is given the power to lay and collect taxes on incomes from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration. That the Federal Government is thus empowered to levy a tax on gross income (i.e., income not subject to any kind of deduction) is no longer seriously open to question. This being so, all deductions from gross income in arriving at net income (i.e., that income subject to tax) are matters of legislative grace. New Colonial Ice Co.,inc. v. Helvering, 292 U.S. 435">292 U.S. 435 (1934). One of the allowable deductions is that pursuant to sections 151 and 152 of the Internal Revenue Code of 1954. Section 151 permits a deduction for personal exemptions and those of dependents. Section 152 defines the term "dependent." This Court has previously held that nothing contained in sections 151 and 152 is repugnant to the Constitution. See and compare Allen F. Labay, 55 T.C. 6">55 T.C. 6, 14 (1970), on appeal (C.A. 5). Although we do not doubt the sincerity of petitioner's beliefs or arguments, they are*285 legally unsound. The power to levy a tax and concomitantly the power to determine how such tax will be computed is within the power given the Congress under the Sixteenth Amendment. See Brushaber v. Union P.R. Co., 240 U.S. 1">240 U.S. 1 (1916). And we think it is clear that the exercise by Congress of that power, in enacting section 152, does not contravene any constitutional guarantee secured to this petitioner under the Ninth Amendment. Decision will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625485/	ROBERT L. AND DEBORAH SMITH, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentSmith v. CommissionerDocket No. 9762-92United States Tax CourtT.C. Memo 1994-270; 1994 Tax Ct. Memo LEXIS 269; 67 T.C.M. (CCH) 3086; June 13, 1994, Filed 269 For petitioners: Kirk A. McCarville. For respondent: Andrew J. Gottlieb. JACOBSJACOBSMEMORANDUM FINDINGS OF FACT AND OPINION JACOBS, Judge: Respondent determined a deficiency in petitioners' 1988 Federal income tax in the amount of $ 109,315 and an addition to tax pursuant to section 6651(a) in the amount of $ 4,895. After concessions by petitioners, the issues remaining for decision are: (1) Whether petitioners timely filed an election (on Form 2553) to have Mindies Eloy/Casa Grande, Inc., an Arizona corporation, treated as an S corporation for 1988; and (2) whether petitioners are liable for an addition to tax for failure to timely file their 1988 income tax return pursuant to section 6651(a). All section references are to the Internal Revenue Code in effect for the year in issue. FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. The stipulation of facts and attached exhibits are incorporated herein by this reference. Petitioners, husband and wife, resided in Chandler, Arizona, at the time the petition in this case was filed. They untimely filed a joint Federal income tax return for 1988 on August 28, 1989. During the year in issue, 270 petitioners were the sole shareholders of Mindies Eloy/Casa Grande, Inc. (Mindies Eloy), 1 the corporation involved in this case. On May 29, 1987, Robert Smith (petitioner) mailed an election to have Mindies Eloy treated as an S corporation for tax purposes (on Form 2553). The envelope containing the form was properly addressed to the Internal Revenue Service (IRS) at its Service Center in Ogden, Utah, with the correct postage affixed, but it was not sent by registered or certified mail. Respondent never received the form. Mindies Eloy reported a loss in the amount of $ 121,279 for 1988 on Form 1120S (U.S. Income Tax Return for an S Corporation). Petitioners reported said loss, as well as losses from two other corporations, on their 1988 tax return. Respondent disallowed all of the losses claimed (totaling $ 210,957) on the grounds that the purported271 elections to have the three corporations treated as S corporations were invalid. Petitioners concede that the elections for two of the three corporations were invalid, and thus petitioners are not entitled to $ 89,678 of the claimed losses. Petitioners disagree with respondent's determination as to the S corporation election for Mindies Eloy for 1988. Because respondent did not possess a Form 2553 for Mindies Eloy at the time the 1988 Form 1120S was filed, respondent converted the Form 1120S to a Form 1120 (U.S. Corporation Income Tax Return). In October 1989, respondent informed petitioners that Mindies Eloy had not been granted S corporation status because respondent had no Form 2553 on file. Petitioner sent a copy of the form that he had mailed on May 29, 1987, to the IRS at its Ogden Service Center. On October 23, 1989, respondent received the copy and date stamped it. The copy of the Form 2553 was processed as an original, and respondent granted S corporation status to Mindies Eloy effective January 1, 1989. OPINION In general, a corporation may elect to be an S corporation by filing a completed Form 2553 with the appropriate IRS Service Center within certain specified272 times. Sec. 1362; sec. 1.1362-2, Income Tax Regs.Petitioners argue that for purposes of making an election under section 1362, timely mailing equals timely filing. 2 Respondent argues that in order for petitioners to prevail, they must (pursuant to section 7502) offer proof of postmark, not mere evidence of mailing. Turning first to respondent's argument, section 7502(a)(1) provides that if a document is delivered to the IRS at the proper address after its due date by United States mail, then the date of postmark shall be the date of delivery. Thus, under section 7502(a), a taxpayer may prevail by providing evidence of the postmark; that is, a timely postmark satisfies the timely filing requirement when the document reaches the IRS after the deadline. 3 When mailing and postmark are timely, delivery will be presumed273 unless rebutted by the IRS. Estate of Wood v. Commissioner, 92 T.C. 793">92 T.C. 793, 799 (1989), affd. 909 F.2d 1155">909 F.2d 1155 (8th Cir. 1990). Here, there was no evidence of postmark. Therefore, section 7502 is not applicable. However, enactment of section 7502 does not displace the common law presumption of delivery. Anderson v. United States, 966 F.2d 487">966 F.2d 487, 491 (9th Cir. 1992); Estate of Wood v. Commissioner, supra at 799; cf. Carroll v. Commissioner, T.C. Memo. 1994-229. As the Court of Appeals for the Ninth Circuit stated: "Section 7502 carves out an exception to the [common law] physical delivery rule [pursuant to which 274 tax documents had to be physically received by the IRS on time to be timely filed] by creating a statutory 'mailbox rule'." Anderson v. United States, supra at 490. Pursuant to the common law mailbox rule, proper mailing of an envelope creates a rebuttable presumption of receipt. And whether the Government is able to rebut such presumption of receipt is a credibility determination. Id. at 492. Petitioners presented credible testimony as to proper mailing; they assert that a presumption of receipt arises from the testimony. Even assuming that the facts raise such a presumption, however, we find that the evidence given by respondent is sufficient to rebut it. 4 In the instant case, an employee of respondent conducted a nationwide search on respondent's computer system and found that no Form 2553 for Mindies Eloy was received or filed prior to October 23, 1989. Respondent presented credible testimony as to the standard procedures followed for processing documents received at the Ogden Service Center. Documents are received, extracted from their envelopes, and placed in shelves containing like documents. The envelopes275 are then "candled" (passed in front of a bright light) at two different times, to ensure they are empty before they are discarded. The documents are sent to the appropriate areas in the Service Center where they are collected in batches of 25 or less. Each batch is assigned to a tax examiner. The information contained in each document is entered onto the Integrated Data Retrieval System (IDRS), where computer records of taxpayers' accounts are maintained. IDRS contains histories of taxpayers' accounts across the nation. Where taxpayers prove mailing and the IRS proves nonreceipt, we are left with the conclusion that the mailed document was lost in transit. See Walden v. Commissioner, 90 T.C. 947">90 T.C. 947, 951 (1988). In Walden, we ruled that when a tax return is lost by the276 U.S. Postal Service, it is the taxpayer who bears the risk of nondelivery. Following the Walden ruling, we sustain the deficiency as determined by respondent. We now turn to respondent's determination with regard to the delinquency addition to tax. Petitioners have the burden of proof to show that their late filing of their 1988 tax return was due to reasonable cause. Abramo v. Commissioner, 78 T.C. 154">78 T.C. 154, 163 (1982); Adamson v. Commissioner, 745 F.2d 541">745 F.2d 541 (9th Cir. 1984), affg. T.C. Memo. 1982-371. They offered no evidence and presented no testimony to show that their late filing was due to reasonable cause. Accordingly, we sustain the deliquency addition to tax as determined by respondent. To reflect the foregoing and concessions by petitioners, Decision will be entered for respondent. Footnotes1. Mindies Eloy owns and operates a Burger King franchise in Arizona. Mindies is an acronym standing for "McDonalds is not a dirty word; it's an endangered species".↩2. If we determine that the Form 2553 was filed when deposited in the mail, then apparently petitioners are entitled to the $ 121,279 loss claimed on their 1988 tax return with respect to Mindies Eloy.↩3. Had petitioner mailed the Form 2553 by U.S. registered or certified mail, the registration or certification would be prima facie evidence that the form was delivered to the IRS office to which addressed. See sec. 301.7502-1(d)(1), Proced. & Admin. Regs.↩4. Cf. Mitchell Offset Plate Serv., Inc. v. Commissioner, 53 T.C. 235↩ (1969), wherein we found that respondent's evidence was not sufficient to overcome the presumption of delivery.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625487/	Estate of Edgar F. Luckenbach, Deceased, Roscoe H. Hupper, Executor v. Commissioner.Estate of Luckenbach v. CommissionerDocket No. 16997.United States Tax CourtT.C. Memo 1958-38; 1958 Tax Ct. Memo LEXIS 192; 17 T.C.M. (CCH) 167; T.C.M. (RIA) 58038; March 7, 1958192 George E. Cleary, Esq., 52 Wall Street, New York, N. Y., for the petitioner. William A. Schmitt, Esq., for the respondent. OPPERMemorandum Findings of Fact and Opinion OPPER, Judge: Respondent determined a $10,940,964.09 deficiency in petitioner's estate tax. The issue is the fair market value on April 26, 1944 of 52,282 1/2 shares of Luckenbach Steamship Company, Inc., stock. Certain expenses of petitioner were not ascertainable at the time of the trial and will be disposed of under Rules 50 and 51. Other issues were settled by stipulation. Findings of Fact Some of the facts were stipulated and are found accordingly. Edgar F. Luckenbach, hereafter called decedent, died April 26, 1943, a resident of Nassau County, New York. Roscoe H. Hupper, the executor under decedent's will, duly filed an estate tax return with the collector of internal revenue for the first district of New York, dated October 26, 1944, showing taxes due of $64,021.48. He elected under section 811(j), Internal Revenue Code of 1939, to use the optional valuation date. By a rider attached to the estate tax return, the executor stated that the value of decedent's interest in 52,282 1/2 shares193 of common stock of Luckenbach Steamship Company, Inc., hereafter called Steamship, could not be fixed or estimated pending the conclusion of litigation then pending in the Surrogate's Court of New York, requiring decedent to account for trusts under the will of his father, Lewis Luckenbach, who died on August 18, 1906. This stock has always been closely held and has never been listed on any stock exchange. Respondent determined the value of decedent's interest in the Steamship stock to be $15,023,615.92, which amount allegedly represented the full adjusted net worth of Steamship as of the optional valuation date. This determination did not take into account the Lewis Luckenbach trust estate accounting litigation. Prior to 1906, Lewis Luckenbach engaged in joint venturing with certain tugs, coal barges and other floating property including letting of steamships for hire under charter, in which vessels and property he, his brother, Edward, and decedent owned varying fractional interests. Edward died in 1904 leaving his fractional interest in the floating property to his wife and their two children. Lewis suffered a stroke in 1902 and from that date on the operations were under decedent's194 sole control. By his will Lewis left his residuary estate in trust to pay from income $15,000 annually to his wife, Mary E. Luckenbach, for life and to pay the balance of income to decedent for life. Lewis' widow died on January 24, 1926. Lewis' will provided that upon decedent's death the trust created by his will should be paid over to decedent's lawful issue. Article Sixth of Lewis' will in substance authorized his executors and trustees to carry on and continue his business of transportation of freight, wrecking and towing during the lifetime of decedent or as long after Lewis' death as decedent might desire to continue the business. Decedent was survived at his death by three children, Lewis, hereafter called Lewis, Jr., Andrea, and Edgar F. Luckenbach, Jr., then ages 44, 23 18, respectively. Differences had developed between decedent and Lewis, Jr., who by a trust agreement in 1936, and by an assignment in 1943 transferred all his right, title and interest in his grandfather's trust estate to three trustees. By will decedent left 2/3 of his residuary estate to his son, Edgar F., Jr., to be held in trust until age 26, and 1/3 of his residuary estate to his daughter, Andrea, 195 to be held in trust until age 31. His will left a total of $5,000 to Lewis, Jr. Upon decedent's death, the trustees and assignees of Lewis, Jr., became entitled to 1/3 of the grandfather's trust estate and to none of decedent's residuary estate; Andrea became entitled to 1/3 of her grandfather's trust estate and 1/3 of decedent's residuary estate; and Edgar F., Jr., became entitled to 1/3 of his grandfather's trust estate and 2/3 of decedent's residuary estate. As of April 3, 1908, the fractional shares in floating property of the estate of decedent's father amounted to $380,147.47. Decedent received this property as trustee and he held it as such from April 3, 1908 until his death. For a few years decedent continued operations under his own name, but new and larger vessels were added, paid for out of his income or capital or money belonging to the Lewis Luckenbach estate or Edward Luckenbach's heirs proportionately to their interest in the floating property. As floating equipment was lost or disposed of, the realized proceeds, together with income belonging to decedent, were invested in new vessels or other floating equipment. On January 10, 1913, decedent organized Steamship, 196 a Delaware corporation, with an original capital of $10,000, all contributed by decedent. Steamship thereafter managed the operations of the vessels which continued up to 1918 to be owned in fractional shares by individuals and trustees. When the Panama Canal opened in 1914, Steamship used the adaptable floating equipment to carry cargo to and from the west coast. Steamship, at this time, acquired no ownership of floating equipment but transitorily operated the vessels, tugs and barges owned in fractional shares by individual owners. In 1915, decedent formed Luckenbach Company, Inc., which contracted to build three new 10,000-ton steamships. The stock of this corporation was owned partly by decedent and partly by the heirs of Edward, but the latter's stock interests were later liquidated upon the receipt by them of certain fractional interests in vessels. In August 1918, Luckenbach Company, Inc., merged into Steamship. The fractional interests in floating equipment owned by decedent and the Lewis Luckenbach trust, including decedent's undrawn income, were transferred to Steamship. Its authorized stock was increased to $25 million of which 52,282 1/2 shares of $100 par value each, 197 the total issued and outstanding stock, were issued to decedent. All of these share were placed in the name of "Roscoe H. Hupper, as Trustee for Edgar F. Luckenbach" in March 1943 and he, after qualifying as executor of decedent, has continuously held all of these shares as registered in his name on the books of Steamship. In 1926, Steamship made a purchase settlement with Edward's heirs covering all fractional vessel interests owned by them. From the date of decedent's mother's death until his death only he and his father's estate had an interest in Steamship or its assets. Decedent filed an accounting of the Lewis Luckenbach trust in the New York Surrogate's Court in 1939, pursuant to an application made in 1938. Objections to this accounting were filed on behalf of decedent's daughter, Andrea, and by the trustees of the trust to which his son, Lewis, Jr., had transferred his interest. Late in 1939, a more detailed amended accounting was filed which showed the fractional interests in steamers, tugs and barges in the amount of $380,147.47 which constituted the trust at its inception in 1908. This accounting also showed the disposition of these property interests, the reinvestment198 of part thereof in vessels later sold, and the fractional interests of the Lewis Luckenbach trust in 9 vessels which together with other vessels were being operated in intercoastal trade by Steamship, which fractional interests had a cost of $2,229,176.22. Objections were again filed based primarily on the ground that the trust estate consisted not merely of the physical assets which were in existence in 1908, but of a business formerly carried on by decedent's father which included intangible as well as tangible assets. This matter was referred to a referee on March 1, 1940. After the taking of testimony, the contestants united in a motion for an order directing the trustee to file an account of the operations and transactions of the going business received and conducted by the trustee under the provisions of the will of Lewis, including the full statement of all receipts and disbursements, and requesting detailed information as to the operation of the going business. Prior to decedent's death, an oral contention was made on behalf of Lewis, Jr., and Andrea, that the remaindermen were entitled to a considerable portion of the stock of Steamship, and this claim went as high as about199 97 per cent of the stock. The referee denied the contestants' motion on December 24, 1941 and held that the business as carried on by the decedent was not the same business as was carried on by the testator, Lewis, or the continuation thereof, and that in 1908 the trustee took over fractional interests in certain specific vessels rather than a going business. The trustee was held chargeable only with the physical assets received by him from the executors, as shown in the 1908 decree settling the accounts, together with all increments derived therefrom by reason of proceeds from insurance collected or from the sales prices of the assets. On March 27, 1942, a motion to reject the referee's report was heard and decision on this motion was reserved, conferences being suggested in order to reach an amicable adjustment. On June 28, 1943, the surrogate rendered his decision on the motion and held: "(1) The business conducted by the deceased trustee, directly or indirectly, by corporations, the stock in which was issued in his name or that of his nominees or otherwise controlled by him, is the same business conducted by the testator, Lewis Luckenbach, at the time of his death or the200 natural out-growth or development thereof and which testator directed to be held in trust by Paragraph 'Sixth' of his will. "(2) The deceased trustee was accountable for such business and his legal representative must presently account for the same to the date of the death of the deceased trustee. "(3) The legal representative of the deceased trustee must account for the income of the trust including such business in order to determine whether the deceased trustee is accountable for any amounts withdrawn from such business in excess of the true income thereof or whether there is any income not received by him to which his estate is presently legally entitled. "(4) The Court cannot presently determine whether or not the trust or the remaindermen thereof are entitled to elect to participate in the benefits, if any, in the purchase by the deceased trustee of the interest of the estate of Edward Luckenbach, nor can it presently determine the extent of the interest of the trust estate in the floating equipment or whether the entire business was the property of the trust or, if not, the extent of the interest of the trust estate in said business and the floating equipment. Such questions201 are expressly reserved for future determination. 1" This decision was put into effect by a decree dated July 6, 1943. On May 13, 1943, the surrogate had decided on the appointment of a successor trustee and in an opinion dated June 14, 1943, had refused to stay the appointment of the successor trustee pending the determination of an appeal by decedent's executor and Edgar F., Jr. The successor trustee made a motion to require decedent's executor to turn over all of the Steamship stock and that a new certificate be issued to him as successor trustee to enable him to control the operations of the company. The appellate division of the New York Supreme Court stayed action on this motion and on December 29, 1943 the order appointing the successor trustee was reversed by that Court. The contestants to the accounting appealed from this decision, which appeal was argued and pending for decision in the New York Court of Appeals on April 26, 1944. The decision of the appellate division was affirmed on May 18, 1944. On April 13, 1946, decedent's executor filed a further accounting covering the period from April 3, 1908 to202 December 31, 1942 and showing that on the latter date the Lewis Luckenbach trust consisted of varying fractional interests in 10 vessels at a cost of $1,960,088.20, plus uninvested proceeds of $702,318.67, or a total of $2,662,406.87. On May 22, 1946, a supplement to this accounting was filed, carrying it down to the date of decedent's death. Objections to these accountings were filed by decedent's son, Lewis, Jr., his assignees and trustees, and Andrea, and the matter was again referred to a referee. The contestants claimed that the remaindermen were entitled to 58.46 per cent of the Steamship stock. However, on August 10, 1950, the referee rejected this contention and confirmed the accountings as filed by the executor with an amendment agreed to by the executor for addition of $157,724.19, which amount increased the total of the trust to $2,820,131.06. A decree based on the referee's findings was rendered on December 14, 1950. The contestants appealed to the appellate division of the New York Supreme Court on several occasions and also to the New York Court of Appeals, only to have the decree affirmed by both courts. On July 30, 1953, decedent's executor filed an account which203 carried the accounting of the Lewis Luckenbach trust from the date of decedent's death to July 30, 1953. Objections were filed to this account but were later compromised and withdrawn. On May 4, 1955, decedent's executor filed an affidavit to bring his account to date. On May 27, 1955, a decree was rendered by the Surrogate's Court charging the executor with $4,442,967.76. The portion of this amount which represented the corpus of the Lewis Luckenbach trust on April 26, 1944 was $3,860,717.19. In 1918, Steamship owned a substantial fleet of recently built cargo vessels and engaged primarily in operating them in the intercoastal trade between the east and west coasts of the United States through the Panama Canal. It also chartered vessels to Luckenbach Gulf Steamshipcompany, an affiliated corporation, for operation between North Atlantic and Gulf ports, and from time to time chartered some of its vessels to others, also occasionally chartering vessels from other owners. It was one of the major operators in the United States intercoastal trade. The selling values of vessels and the chartering rates rose in August 1939 when the demand for shipping increased. Steamship continued its204 regular intercoastal business but used or chartered out some of its vessels in foreign trade to other ship operators, including the British Government which chartered vessels to carry supplies to the Red Sea to meet the war emergency in Egypt. An approximate classification of its business voyages for 1941 is: VoyagesIntercoastal service88Chartered to Luckenbach GulfSteamship Company47Chartered to British Govern-ment for Red Sea12Chartered to others7Chartered to the Orient6 Engagement in these various activities cut down the usual extent of intercoastal service. In 1941, Steamship had time charters with rates as high as $7.50 per dead weight ton per month, and the Red Sea charters in 1941 produced about $6.37 per dead weight ton per month. Thereafter the charter rates and values of vessels were reduced. On November 26, 1943, Steamship was notified by the Maritime Commission of its intention to renegotiate the Red Sea charters. On January 13, 1950, the chairman of that Commission determined that Steamship had derived excessive profits of $1,438,801.36 of which amount allocations of $1,172,753.88, $65,049, and $75,000 were made to 1941, 1942205 and 1944, respectively, for the purpose of determining the applicable credit for Federal income and excess profits taxes. Steamship petitioned the Tax Court for a redetermination and this case is still pending. The net amount of income after taxes involved is $302,524.93 for 1941, $12,359.31 for 1942 and $10,875 for 1944. Both petitioner and respondent included these amounts in their computation of Steamship's net income. The United States Government recaptured the amounts in dispute and is presently holding these funds subject to the decision of the Tax Court. On December 7, 1941, Steamship owned 23 freight vessels ranging from about 8,000 to 14,000 dead weight tons with speeds of 10.5 to 13.1 knots per hour. Five of these vessels were built between 1910 and 1918 and the others between 1918 and 1920. One of these vessels was lost on January 29, 1942 and the remaining 22 were requisitioned for use by the War Shipping Administration, henceforth called W.S.A., such requisitions becoming effective on various dates from January 8 to June 3, 1942. Some months after this requisition Steamship entered into time charters with the W.S.A. fixing the time charter hire and agreeing on valuations206 in the event of loss. The time charter rates agreed to by it used a basic rate of $4.00 per dead weight ton per month which with speed differentials gave an average time charter rate of about $4.20 per dead weight ton per month. Initially, the time charter hire was currently paid. However, questions later arose as to what speed premiums should be allowed, and an additional question arose as to whether the time charter hire rates agreed to by the W.S.A. were more than proper under the law. Thereafter Steamship received from time to time anywhere from 75 per cent to 50 per cent of the agreed charter hire. Current payment of the agreed time charter hire was not restored until 1944, and it was not until 1945 that Steamship was assured of being paid on the agreed basis. The time charter hire payable to Steamship was subject to renegotiation and on January 13, 1950 a determination was made that $800,000 represented the portion of its profits derived from contracts and subcontracts subject to renegotiation for the year ending December 31, 1943, which was claimed to be excessive. Steamship petitioned the Tax Court and this matter is still pending. The net amount of 1943 income involved207 after credit for taxes is $194,432. Both petitioner and respondent include this amount in Steamship's 1943 income. The Government has collected this net amount from Steamship and is presently holding it subject to the decision of the Tax Court. In November 1943, the W.S.A. proposed to reduce the time charter rates applicable to requisitioned vessels. Steamship refused to agree to this reduction in its time charter rates, whereupon the Government requisitioned all of the remaining vessels for use on a bareboat basis effective at various dates from December 10, 1943 to July 4, 1944. Under a bareboat charter, the owner has no obligation to furnish crews for the vessel. The W.S.A. offered to pay bareboat charter hire at a basic rate of $1.25 per dead weight ton. Steamship refused to accept this proposal and relied on just compensation. Payments of bareboat charter hire were made for a time on the basis of 75 per cent of the amount offered by the W.S.A. In May 1946, the Government owed Steamship bareboat charter hire of some $4,600,000. After the requisition of Steamship's vessels in 1942, it could no longer function as a common carrier but acted only as the charter agent in operating208 its own ships for the Government. It secured the crews and supplied and maintained the ships. However, it did not secure any cargo. For these services, Steamship received certain commissions and allowances. There was a recapture clause in the agency agreement under which for the years 1942 and 1943, 75 per cent of Steamship's proceeds from its agency services was subject to recapture, and for 1944 and 1945, 90 per cent of these proceeds was subject to recapture. Under these recapture provisions, Steamship repaid the Government $351,643.49, $857,125.16, $381,930.92, and $231,883.23 for the years 1942 through 1945, respectively. Both petitioner and respondent reflect the effects of the recapture provisions in their computation of Steamship's income. The net income of Luckenbach Steamship Company, Inc., as determined by petitioner and respondent, for the years 1934 through 1943 is: As determined by petitionerExcludingIncludingcapital gainsCapital gains orcapital gainsYearor (losses)(losses) on vesselsor (losses)1934[1,317,889)[1,317,889)1935(264,524)$ (262,384)(526,908)1936306,839306,8391937(17,845)(17,845)1938257,249257,2491939323,388490,938814,32619401,099,2461,099,24619412,156,2132,156,21319421,068,0972,867,6803,935,77719431,165,6953,496,0284,661,72310-year average: 1934-1943477,6471,136,8735-year average: 1939-19431,162,5282,533,4573-year average: 1941-19431,463,3353,584,5711 year: 19431,165,6954,661,723209 As determined by respondentExcludingIncludingcapital gainsCapital gains orcapital gainsYearor (losses)(losses) on vesselsor (losses)1934[1,285,529)[1,285,529)1935(233,624)$ (262,384)(496,008)1936350,460350,4601937124,456124,4561938252,016252,0161939330,090487,983818,07319401,088,1251,088,12519412,200,5752,200,57519421,269,8332,867,6844,137,51719431,398,2373,496,0284,894,26510-year average: 1934-1943549,4641,208,3955-year average: 1939-19431,257,3722,627,7113-year average: 1941-19431,622,8823,744,1191 year: 19431,398,2374,894,265Steamship had substantial net income in 1918 through 1920. From 1921 through 1939 its operations, after excluding capital gains, abnormal items and taxes, showed a net loss of $5,698,190.05, or an average of $299,904.74 per year, according to petitioner's income computations. Respondent's computations for the same period show a total loss of $5,409,855.72, or an average of $284,729.25 per year. From 1946 through 1954, Steamship had a net loss after taxes and after excluding capital gains of $1,111,711.69, 210 or an average annual loss of $123,523.52. On April 26, 1944, Steamship owned 14 freight vessels with total dead weight tonnage of 158,347. These vessels were from 24 to 31 years old, all of them being under requisition of the W.S.A. and being under, or about to change to, a bareboat status, with no agreement as to the bareboat charter hire or values in the event of loss or requisition for title. At that time, Steamship did not know when it would recover possession and control of its vessels, nor how many vessels would be returned to it or their condition when released. The net book value of Steamship on December 31, 1943 was $12,203,663.53. It had current assets of $10,526,150.92 and vessel replacement fund assets, consisting of cash and insurance receivables, of $9,418,853.00. Its current liabilities amounted to $7,344,097.71 and it had Federal taxes payable from replacement fund assets amounting to $2,117,389.41. Its total liabilities were $10,796,699.67. In addition its vessels were carried at a valuation of $1,333,804.65 which is a valuation of approximately $8.08 per dead weight ton. Of the 14 vessels owned by Steamship on April 26, 1944, the titles of 5 were requisitioned211 by the W.S.A. in the years 1944 through 1946 for an average price, after taxes, of $41.76 per dead weight ton, and the remaining 9 were sold in the years 1946 through 1951 for an average price, after taxes, of $24.26 per dead weight ton. On the basis of reconstruction cost less depreciation, Steamship had vessels totaling 158,347 tons worth approximately $68.68 per dead weight ton on April 26, 1944. During the year in issue there were 6 companies which derived most of their revenues from coastwise and intercoastal operations and which had common stock traded on an exchange. The price-earnings multiples of these companies were: Based on: 10-year5-year3-yearaverageaverageaverage1-yearearningsearningsearningsearnings(1934-1943)(1939-1943)(1941-1943)(1943)Excluding capital gains on fixedassetsAmerican-Hawaiian Steamship12.367.266.8911.23CompanyAtlantic Gulf and West Indies Steamship Linesa19.7411.367.798.16Eastern Steamship Lines, Inc.a16.4310.017.25Inter-Island Steam Navigation 15.6315.8314.2513.18Co., Ltd.Matson Navigation Company19.9016.0114.9815.43Merchants & Miners Transportation43.75159.5684.7714.90Co.Average b16.9113.3810.7811.69Including capital gains on fixedassetsAmerican-Hawaiian Steamship10.906.296.8011.15CompanyAtlantic Gulf and West Indies Steamship Linesa10.495.643.684.11Eastern Steamship Lines, Inc.a10.786.537.25Inter-Island Steam Navigation 15.2314.8613.0312.56Co., Ltd.Matson Navigation Company14.6110.299.0313.75Merchants & Miners Transportation13.919.585.7012.56Co. Average13.039.577.4610.23212 The company which was most comparable to Steamship was American-Hawaiian Steamship Company, hereafter called American-Hawaiian, which, along with Steamship, had been a principal common carrier operating in United States intercoastal trade. It and Steamship had vessels of like and comparable types and from 1939 through 1944 they were faced with similar conditions, complications and problems. On December 31, 1939, American-Hawaiian owned 39 freight vessels with a dead weight tonnage of 408,225. By December 31, 1943, its fleet had been reduced to 16 vessels with a dead weight tonnage of 170,365. Its published balance sheet on the latter date showed: Capital stock and surplus$11,335,115Reserve for vessel replacements8,041,336Reserve for insurance1,150,000Total net book value$20,526,451 It was a self-insurer against marine risks and continued its insurance reserve on December 31, 1943, although under bareboat requisition all insurance risks were assumed by213 the W.S.A. Its assets were conservatively stated on its books and on December 31, 1943 its vessels, less reserve for depreciation, were carried at $336,785 which is approximately $1.92 per dead weight ton. American-Hawaiian's adjusted income for the 5-year period of 1939 through 1943 was $8,932,521. Its stock was listed and actively traded in on the New York stock exchange from 1939 through 1944 and had an average price on April 26, 1944 of $34 per share. The market value of all of its stock on this date was $14,133,000. The shares of Steamship stock had a fair market value of $175 per share on April 26, 1944 totaling $9,149,437.50 for the 52,282 1/2 shares then issued and outstanding. Opinion The foregoing ultimate finding of fact disposes of the only issue. No controversy remains between the parties except as to the value on the optional valuation date of the Luckenbach Steamship Company stock owned by decedent on the date of his death. A difficulty of this proceeding at the outset is that the parties have not sharply defined nor agreed upon the issue. While the question litigated is said to be the fair market value of the 52,282 1/2 shares of Luckenbach stock owned by214 the estate, petitioner phrases it that it is the value of "decedent's interest in" these shares, while at the same time contending that the "question here" is "of stock values." The suggestion is on the one hand that the Luckenbach Company did not own all its assets free and clear, and on the other that decedent did not have clear title to all 52,282 1/2 shares of the stock. Of course the two are quite different, 2 and we begin by recognizing that all 52,282 1/2 shares were listed as an asset of the estate, and that the same statement is repeated in the petition herein. It may be of course that the contesting parties might have made good a claim against the estate in some amount, as in fact they did. It is not clear whether this was claimed as a deduction in computing the net estate but it is not here in controversy as such. 215 But it seems to us the stock must be valued on a per share approach and if the estate did not own all of it, in the end, only its part would have been in the estate. The litigation, accordingly, might be effective to diminish the value on the valuation date of each share, but that would be so depending upon its effect upon the property and operations of the Company and not based upon the ultimate determination of who finally succeeded in his claim to ownership of specific numbers of shares of the Company. Petitioner contends that American-Hawaiian is the most nearly comparable similar business. In this respect the parties are not in disagreement. The record contains figures for the earnings of American-Hawaiian only for the 5 years immediately preceding the valuation date. In view of petitioner's concession, and since the burden of proof is upon it, we think it reasonable that any comparison with the Luckenbach earnings should be limited to the 5 years thus shown. On that approach the price-earnings ratio of American-Hawaiian applied to the earnings of the Luckenbach Company would give a relevant figure for the stock of the latter. See Rogers v. Helvering, (C.A. 2) 107 Fed. (2d) 394,216 affirming on this point 31 B.T.A. 994">31 B.T.A. 994. Petitioner, it is true, insists that a more accurate method of valuation would be to compare the net asset value of the two companies. But even this approach on the figures we have found to be best supported by the record and as these appear in our findings results in an estimated value of the Luckenbach stock of not very much less than the price-earnings approach. While it may be reasonable to discount these figures to some extent for the litigation then pending between petitioner and the Lewis Luckenbach heirs, see Champlin Refining Co. v. Commissioner, (C.A. 10) 123 Fed. (2d) 202, affirming a Memorandum Opinion of this Court, both the character of the litigation and its status on the valuation date lead us to conclude that any influence upon the fair market value of the shares themselves would be very much less than that asserted by petitioner. After consideration of the entire record, and without employing any single factor as conclusive but giving such effect to all elements including the litigation, as we consider warranted, see May Rogers, 31 B.T.A. 994">31 B.T.A. 994, 1006, supra, we have arrived at the figure217 for the value of the shares as set forth in our ultimate finding. Decision will be entered under Rules 50 and 51. Footnotes1. In re Luckenbach's Will, 42 N.Y.S. 2d 791, 800↩.a. Based on relating market value of total invested capital to adjusted net earnings available for invested capital. ↩b. Excluding Merchants & Miners Transportation Co. except for 1-year basis.↩2. Even in its reply brief petitioner refuses to come to grips with this divergent statement of the issue. It says (p. 3) of "the real question (designated "b" by respondent)," that it is "the market value of decedent's interest in the stock of the Company," whereas respondent's actual language is "(b) What was the fair market value on the optional valuation date of 52,282 1/2 shares of the common stock of Luckenbach Steamship Co., Inc. * * *" (Italics added.)↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625497/	Bercy Industries, Inc., and Subsidiaries, Petitioner v. Commissioner of Internal Revenue, RespondentBercy Industries, Inc. v. CommissionerDocket No. 5879-76United States Tax Court70 T.C. 29; 1978 U.S. Tax Ct. LEXIS 138; April 17, 1978, Filed 138 Decision will be entered under Rule 155. Petitioner, a wholly owned subsidiary of B, was a shell corporation with no business activity. Pursuant to a plan of reorganization, B transferred some of its voting common shares to petitioner and petitioner transferred said shares to the shareholders of T, a target corporation. All T stock was canceled and T merged into petitioner, petitioner receiving all T's assets and assuming its liabilities. After the merger petitioner's business was a continuation of T's business and it incurred a net operating loss. Petitioner carried back net operating loss to the pre-reorganization taxable income of T. Held, the transaction does not qualify as a (B), (E), or (F) reorganization and, accordingly, pursuant to sec. 381(b)(3), petitioner is not entitled to carry back a post-reorganization net operating loss to a taxable year of T. Don M. Pearson and Robert P. Beckham, for the petitioner.Marion L. Westen, for the respondent. Sterrett, Judge. STERRETT30 Respondent determined deficiencies in petitioner's Federal income taxes for its fiscal years ended May 25, 1968, and May 31, 1969, in the amounts of $ 18,786143 and $ 367,638, respectively. Due to petitioner's previous acceptance of many of respondent's adjustments the remaining issue for decision is whether petitioner may carry back, under section 172, I.R.C. 1954, a post-reorganization net operating loss, for the short period April 23, 1970, through December 31, 1970, to the pre-reorganization income of an acquired corporation for its taxable years ended May 25, 1968, and May 31, 1969.FINDINGS OF FACTSome of the facts have been stipulated and are so found. The stipulation of facts, together with the exhibits attached thereto, is incorporated herein by this reference.Petitioner Bercy Industries, Inc., and subsidiaries, is a corporation organized under the laws of the State of California with its principal office in Pasadena, Calif. Bercy Industries, Inc., is the corporate successor to Beverly Manor Inc. of Santa Clara to whom the statutory notice of deficiency was also sent. Petitioner's corporate tax returns for the taxable years ended May 25, 1968, and May 31, 1969, were timely filed with the Internal Revenue Service Center, Ogden, Utah.On April 12, 1968, petitioner was incorporated under the laws of the State of California under144 the name of Beverly Manor Inc. of Santa Clara (hereinafter Beverly Manor). From its incorporation until April 23, 1970, Beverly Manor was a shell corporation and had no operating business activity whatsoever. Since its incorporation, and at all times thereafter, Beverly Manor's sole shareholder was Beverly Enterprises (hereinafter Beverly). 1 As of April 17, 1968, Beverly Manor's directors and officers were as follows:Roy E. Christensenpresident, treasurer, and directorEdward L. Rimpau, Jrvice president, secretary, and directorWilliam F. Rinehartassistant secretary and directorOn July 19, 1968, Orlin C. Munns replaced Edward Rimpau as vice president and director; Christensen and Rinehart served as directors of the corporation until August 15, 1971.31 On July 29, 1965, an entity, Bercy, was incorporated under the laws of the State of California. On September 8, 1966, Bercy changed its name145 to Bercy Industries, Inc. (hereinafter Old Bercy). The directors and officers of Old Bercy at the date of its incorporation were as follows:Bernard Fleisherpresident and directorSeymour Katzvice president-treasurer and directorHarned Petetus Hoosesecretary and directorFleisher and Katz continued as directors and officers of Old Bercy until April 23, 1970.Old Bercy's business, from date of incorporation to April 23, 1970, was the design, manufacture, and distribution of personal care products. The major product lines were incandescent and fluorescent lighted travel and vanity mirrors. Fleisher and Katz were in charge of the daily operation and management of Old Bercy from its incorporation through April 23, 1970. From the summer of 1969 to April 23, 1970, its principal office was located at 1741 North Ivar Avenue, Hollywood, Calif. Additionally, Old Bercy had a manufacturing plant located in Torrance, Calif.On April 23, 1970, pursuant to a plan and agreement of reorganization among Beverly, Beverly Manor, Old Bercy, and the shareholders of Old Bercy, Old Bercy merged into Beverly Manor. Beverly Manor, the surviving corporation, pursuant to the merger agreement, 146 changed its name to Bercy Industries, Inc. (hereinafter New Bercy or petitioner). Shareholders of Old Bercy received 171,429 voting common shares of Beverly in sole consideration for the merger. 2 Said shares represented approximately 4.4 percent of the 3,908,536 Beverly shares then outstanding. On the merger date all outstanding shares of Old Bercy were canceled and the Old Bercy shareholders ceased to have any rights to said stock, except the right to participate pro rata in the distribution of shares of Beverly common stock. 332 Moreover the plan and agreement of reorganization provided as follows:(c) Financing Commitment.On March 4, 1970 Beverly loaned Bercy $ 200,000 in return for a promissory note of even date. On the Merger Date, said note shall be continued or shall be forgiven by Beverly as a contribution to the capital of the Surviving Corporation. Within thirty (30) days after the Merger Date Beverly will provide an additional $ 300,000 to the Surviving Corporation either by capital contribution, director loan or guarantee of a bank loan, or any combination of the foregoing or otherwise. * * (d) Tax Free Reorganization.The parties adopt this147 Plan intending that it shall constitute a tax-free reorganization under the provisions of Section 368(a)(1)(A) and related sections of the Internal Revenue Code of 1954, as amended.148 Only one set of operating assets was involved in the reorganization, only one set of accounting books was maintained and only one "tax history" was involved. New Bercy received all the assets and assumed all the liabilities of Old Bercy and New Bercy's business was a continuation of Old Bercy's business.In May 1970 the officers and directors of New Bercy were as follows:Bernard FleisherpresidentSeymour Katzexecutive vice presidentJ. Robert Holtvice presidentGrover Rogersvice presidentOrlin C. Munnssecretary & directorRoy E. ChristensendirectorWilliam F. RinehartdirectorFleisher and Katz were in charge of the daily operations of 33 New Bercy and they were employed on a month-to-month basis. In November or December of 1970, Fleisher and Katz were no longer employed by New Bercy and Holt assumed the responsibility for petitioner's operations. 4149 New Bercy's offices, after the reorganization, were located at the same addresses as Old Bercy's. In the latter part of 1970 the office at Ivar Avenue was closed and thereafter petitioner's principal offices were located at, what was, Old Bercy's manufacturing plant in Torrance, Calif.For the short period April 23, 1970, through December 31, 1970, New Bercy incurred a net operating loss. The loss was incurred in connection with the same business activity which was formerly conducted by Old Bercy. 5 Thereafter petitioner filed an application for a tentative carryback adjustment, pursuant to section 6411, offsetting its post-reorganization net operating loss against pre-reorganization taxable income of Old Bercy. Initially, respondent tentatively allowed the application but in the notice of deficiency, dated March 31, 1976, he determined that the refund was erroneous explaining as follows:(c) It is determined that the net operating loss deduction you claimed in the amount of $ 729,313 attributable to Bercy Industries, Inc., for the period April 24, 1970 through December 31, 1970 from the consolidated return of Beverly Enterprises & Subsidiaries for its period ended December 31, 150 1970 and carried back to the consolidated return of Bercy Industries, Inc., for its period ending May 31, 1969 is not allowable, because the merger effective April 23, 1970 between you, Bercy Industries, Inc., and Beverly Manor of Santa Clara, Inc., a subsidiary of Beverly Enterprises, Inc. in exchange for voting stock of Beverly Enterprises, Inc. the only asset of Beverly Manor of Santa Clara, Inc., was a reorganization within the meaning of Section 368(a)(1)(A) of the 1954 Internal Revenue Code. It is further determined that the reorganization did not qualify under the provisions of Sections 368(a)(1)(B) or 368(a)(1)(F) of the 1954 Internal Revenue Code. Accordingly, the full amount of the net operating loss deduction has been disallowed and the tentative allowance must be recouped.OPINIONSection 381(a) 6152 provides the general rule for carryovers "In 34 the case of the acquisition of assets of a corporation151 by another corporation," and section 381(b) provides the operating rules thereto. Under section 381(b)(3) 7 the acquiring corporation in a reorganization described in subparagraph (A), (C), or (D) of section 368(a)(1) is not entitled to carryback a post-reorganization net operating loss to a taxable year of the transferor (acquired) corporation. Specifically, 381(b)(3) does not apply in the case of an acquisition in connection with a (B), (E), or (F) reorganization. Sec. 1.381(a)-1(b)(3)(i), Income Tax Regs.Section 368(a)(1) 8 lists six types of transactions that are included within the term "reorganization." Except for the statutory exception under section 368(a)(2)(A), treating a transaction as a (D) reorganization when it meets the description of both a (C) and (D) reorganization, the six reorganization definitions are not mutually exclusive. Berger Machine Products, Inc. v. Commissioner, 68 T.C. 358">68 T.C. 358, 364 (1977). For example, 35 it has been held that a transaction qualifying as an (A) reorganization may also be an (F) reorganization and carryback of a post-reorganization net operating loss to a taxable year of the acquired corporation will be permitted. Estate of Stauffer v. Commissioner, 403 F.2d 611">403 F.2d 611, 617 (9th Cir. 1968),153 revg. 48 T.C. 277">48 T.C. 277 (1968), but see Berger Machine Products, Inc. v. Commissioner, supra at 364.154 Cognizant of the above we note, at the outset, that petitioner, on brief, concedes that the transaction in the instant case does not qualify as an (E) or (F) reorganization. However petitioner contends that, although the transaction is an (A) and/or (C) reorganization, it also is a (B) reorganization, to wit, the shareholders of Old Bercy received, from Beverly Manor, voting common stock of petitioner's parent, Beverly, as the sole consideration for their stock. Petitioner, citing Rev. Rul. 67-448, 2 C.B. 144">1967-2 C.B. 144; Rev. Rule 74-564, 2 C.B. 124">1974-2 C.B. 124; and Rev. Rul. 74-565, 2 C.B. 125">1974-2 C.B. 125, submits that respondent has recognized that this type of triangular reorganization is a constructive (B) reorganization.In Rev. Rul. 67-448, 2 C.B. 144">1967-2 C.B. 144, 9 corporation P wanted to acquire 100 percent of corporation Y and preserve Y's corporate status. An outright (B) reorganization was not possible as some Y shareholders might not agree to the transaction. Therefore the plan of reorganization was consummated as follows:(a) 155 P transferred shares of its voting stock to its newly formed subsidiary, S, in exchange for shares of S stock.(b) S (whose only asset consisted of a block of the voting stock of P) merged into Y in a transaction which qualified as a statutory merger under the applicable state law.(c) * * the S stock owned by P was converted into Y stock. At the same time the Y stock held by its shareholders was exchanged for the P stock received by Y on the merger of S into Y. The end result of these actions was that P acquired from the shareholders of Y in exchange for its own voting stock more than 95 percent of the stock of Y.The ruling stated that the transaction was not an (A) or (C) reorganization "because no assets of Y were transferred to nor acquired by another corporation," but that it qualified as a (B) reorganization, explaining as follows:It is evident that the shortest route to the end result described above would 36 156 have been achieved by a transfer of P voting stock directly to the shareholders of Y in exchange for their stock. This result is not negated because the transaction was cast in the form of a series of interrelated steps. The transitory existence of the new subsidiary, S, will be disregarded. The effect of all the steps taken in the series is that Y became a wholly owned subsidiary of P, and P transferred solely its voting stock to the former shareholders of Y.We note that the (B) subsidiary reverse merger technique was codified, liberalized, and qualified as a hybrid (A) reorganization in January 1971 with the enactment of section 368(a)(2)(E), 10 Pub. L. 91-693, sec. 1(a).157 Respondent contends that the above revenue ruling is not applicable herein and the transaction cannot be classified as a (B) reorganization. He asserts that, pursuant to article I of the agreement of merger, petitioner did not acquire Old Bercy stock in exchange for its parent stock. At the date of merger all outstanding shares of Old Bercy were canceled and petitioner did not receive the stock of a viable corporation. Therefore immediately after the acquisition, petitioner did not have control of Old Bercy within the meaning of section 368(a)(1)(B). Moreover, in Rev. Rul. 67-448, supra, the subsidiary corporation, S, had a transitory existence; it was formed solely for the purpose of effectuating an exchange of P stock for Y stock. Herein petitioner had been in existence since 1968 and continued to exist, receiving Old Bercy's assets and assuming all its liabilities.We agree with respondent that the transaction is not a (B) reorganization although we disagree, somewhat, with his reasoning. We are unable to see any difference, in substance, between (1) Old Bercy transferring its stock to petitioner in exchange for Beverly stock 158 followed by cancellation of said Old Bercy stock, and (2) cancellation of Old Bercy stock prior to its shareholders' receiving Beverly stock.The decisive element disqualifying the transaction as a (B) 37 reorganization is the fact that, after the dust had settled, the acquired corporation (Old Bercy) and its stock were no longer in existence. Old Bercy had disappeared into petitioner and its stock had been canceled. Thus, instead of acquiring stock, what petitioner acquired were assets and that simply is not a (B) reorganization. That the transaction could have been structured differently to accomplish the same result with carryback benefits is beside the point. In the name of practicality or equity we are not permitted to rewrite history except in the rarest of circumstances. This is not a case where the economic realities of the situation require a different result.Even the fact that we could have a (B) reorganization followed by liquidation of Old Bercy into petitioner would not change our conclusion. Combination of the two interrelated steps would properly be regarded as a (C) reorganization. See sec. 1.382(b)-1(a)(6), Income Tax Regs.; Dana v. Commissioner, 103 F.2d 359">103 F.2d 359, 362 (3d Cir. 1939),159 affg. 36 B.T.A. 97">36 B.T.A. 97 (1937); Vest v. Commissioner, 57 T.C. 128">57 T.C. 128, 141 n. 5 (1971), revd. and affd. on other issue 481 F.2d 238">481 F.2d 238 (5th Cir. 1973); R. Goldman, "The C Reorganization," 19 Tax L. Rev. 31">19 Tax L. Rev. 31, 37 (1964); and M. Ferguson and M. Ginsburg, "Triangular Reorganizations," 28 Tax L. Rev. 159">28 Tax L. Rev. 159, 171-173 (1973). 11The transaction in the instant case, a triangular merger is, also, a hybrid (A) reorganization pursuant to section 368(a)(2)(D). 12161 However section 368(a)(2)(D) is only of use if Old Bercy's assets could have been conveniently transferred to petitioner. Therefore, as previously noted, to codify and liberalize the (B) subsidiary reverse merger, section 368(a)(2)(E) was enacted in 1971, to allow, for example, petitioner to merge160 into Old Bercy with Old Bercy shareholders receiving Beverly stock. We believe there are substantial differences between a triangular merger and a reverse triangular merger. In this respect, we 38 note that the House Ways and Means Committee report on section 368(a)(2)(E) 13 stated that a triangular merger in either direction would be tax free and indicated its awareness that a reverse triangular merger was more than formally distinguishable from the triangular merger. 14 See also 28 Tax L. Rev., supra at 182-183.We turn next to petitioner's second contention, advanced in the alternative, that "when a shell corporation with no prior tax162 history is combined with an operating business in a tax-free reorganization, none of the allocation or tracing problems which section 381(b)(3) was designed to avoid are present, and under such circumstances Congress intended that any net operating loss under section 172 could be carried back regardless of the label put on the type of reorganization." Aetna Casualty & Surety Co. v. United States, 568 F.2d 811">568 F.2d 811 (2d Cir. 1976), rehearing denied 568 F.2d at 823 (2d Cir. 1977).In Aetna Casualty & Surety Co. v. United States, supra, Aetna Life Insurance Co. (Life) owned 61.61 percent of the outstanding voting common stock of Aetna Casualty accordingly, the Court could "see no reason why the result should be different simply because the redemption occurs in the course of merging one corporation into a different shell." Casco Products Corp. v. Commissioner, 49 T.C. 32">49 T.C. 32, 37 (1967); Reef Corp. v. Commissioner, 368 F.2d 125">368 F.2d 125, 130 (5th Cir. 1966), cert. denied 386 U.S. 1018">386 U.S. 1018 (1967).Moreover in denying the Government's petition for rehearing the 163 court stated 568 F.2d at 823:In ruling that sec. 381(b)(3) did not bar the loss carryback, we concluded that the reorganization was exempted from the prohibition of sec. 381(b)(3) because it fell within the definition of sec. 368(a)(1)(F), and (F) reorganizations are specifically exempted from the bar of sec. 381(b)(3). We ruled that the reorganization was an (F) reorganization only for purposes of determining the reach of sec. 381(b)(3). We specifically declined to decide whether classifying a reorganization as an (F) reorganization for purposes of sec. 381(b)(3) would 39 necessarily mean it is an (F) reorganization for purposes of other provisions of the Code F.2d , slip op. 6074.* * * We are concerned here with a reorganization in which a corporation is merged into a corporate shell with no prior business or tax history of its own. Since this reorganization presents none of the accounting or allocation problems that might arise in reorganizations involving two corporations each with a prior business and tax history, we concluded that Congress did not intend the loss carryback to be unavailable. In our view, it makes no difference whether164 effectuating Congressional intent in the circumstances of this reorganization is achieved by construing sec. 368(a)(1)(F) somewhat broadly to include the reorganization and Surety Co. (Old Casualty). Life wished to remove Old Casualty from its tax base and formed a wholly owned shell subsidiary, Farmington Valley Insurance Co., (Farmington) for the purpose of acquiring the assets of Old Casualty. Life transferred 13.3 million of its voting shares to the new subsidiary in exchange for all 1,000 shares of Farmington. Then, pursuant to a reorganization plan, Farmington exchanged its sole assets (Life stock) for the voting common stock held by Old Casualty shareholders. Life stock received by Life (in return for its 61.61 percent in Old Casualty) was retired and Old Casualty stock was canceled. Farmington changed its name to New Casualty and by operation of State merger law succeeded to all of the assets and liabilities of Old Casualty.The Second Circuit, in reversing the District Court, 15 stated that (1) absent a shift in the proprietary interest of Old Casualty, the transfer of Old Casualty to a shell corporation constitutes an (F) reorganization and (2) a corporation which 165 merely redeems its minority shareholders' stock has not undergone a reorganization under section 368(a)(1). Under both premises the corporation would be entitled to carryback its net operating losses and,of Old and New Aetna, or by construing sec. 381(b)(3), somewhat narrowly so as to be inapplicable to this particular reorganization. Either way, a loss carryback favored by the policies of the Code, see secs. 172 and 832(c)(10), and not presenting the problems with which the prohibition of sec. 381(b)(3) was concerned, is allowed. * Obviously, petitioner would like us to follow the Second Circuit's above quoted reasoning, "construing section 381(b)(3) somewhat narrowly," and allow the carryback.We need not here take exception to the approach of the Second Circuit. There the court was able to root its argument on a finding that an (F) reorganization had taken place, at least for 40 the166 purposes of section 381(b)(3). We have no such lifeline here and we cannot apply that approach in a statutory vacuum.Clearly, in the instant case, there has been a major shift in the proprietary interests of Old Bercy. Shareholders of Old Bercy received approximately 4.4 percent of Beverly stock and Beverly, through its wholly owned subsidiary gained control of, what was, Old Bercy's business. Even under the holding of Aetna Casualty & Surety Co., supra, this was "hardly 'a mere change in identity, form, or place of [reorganization]'." Helvering v. Southwest Corp., 315 U.S. 194">315 U.S. 194, 202-203 (1942).In sum, the transaction does not fall within the statutory exclusionary framework nor, most probably, the congressional intent embodied in section 381(b)(3). Petitioner's loss carryback must be denied.Decision will be entered under Rule 155. Footnotes1. Beverly owns 50 shares of Beverly Manor common stock. The stock certificate is dated Jan. 15, 1970.↩2. The plan provided that Beverly issue the required number of its shares to Beverly Manor. Of the 171,429 Beverly shares, 42,857 were placed in escrow to be distributed at a later date. Moreover, we note the stipulation of facts herein provides that 173,572 shares of Beverly voting stock were to be distributed while the reorganization documents provided for 171,429 shares.↩3. Art. I of the agreement of merger provided:"Upon the effective date of merger (the 'Merger Date') the separate corporate existence of Bercy shall cease, and the Surviving Corporation shall without other transfer succeed to and possess all the properties, rights, privileges, powers and franchises, either of public or private nature, and be subject to all of the obligations, liabilities, restrictions, disabilities and duties of each of the Constituent Corporations."The shareholders of Old Bercy at the time of merger received Beverly shares as follows:↩Old BercyBeverly sharesShareholdershares ownedreceived and in escrowBernard L. Fleisher66,600108,465Seymour Katz22,20036,156Penny F. Pynes5,2638,572Richard V. Weiss2,5004,063Morton L. Fisher2,0003,257Melvin L. Sommer1,0001,628Hamilton O. Stanford1,0001,628John R. Stahr1,0001,628Richard Von Zup1,0001,628Hohenberg & Associates, Inc1,0001,628Thomas Baptie1,0001,628William Doornbos600977Myron Emery100171105,263171,4294. Holt was vice president of corporate development for Beverly in 1970 and negotiated the acquisition of Old Bercy on behalf of Beverly. He was an officer of Beverly Manor prior to the merger.↩5. At the time of the merger it was anticipated that Old Bercy's business would continue to be profitable.↩6. SEC. 381. CARRYOVERS IN CERTAIN CORPORATE ACQUISITIONS.(a) General Rule. -- In the case of the acquisition of assets of a corporation by another corporation * * (2) in a transfer to which section 361 (relating to nonrecognition of gain or loss to corporations) applies, but only if the transfer is in connection with a reorganization described in subparagraph (A), (C), (D) * * * or (F) of section 368(a)(1).↩the acquiring corporation shall succeed to and take into account, as of the close of the day of distribution or transfer, the items described in subsection (c) of the distributor or transferor corporation, subject to the conditions and limitations specified in subsections (b) and (c).7. SEC. 381 (b) Operating Rules. -- Except in the case of an acquisition * * *(3) The corporation acquiring property in a distribution or transfer described in subsection (a) shall not be entitled to carry back a net operating loss or a net capital loss for a taxable year ending after the date of distribution or transfer to a taxable year of the distributor or transferor corporation.↩8. SEC. 368. DEFINITIONS RELATING TO CORPORATE REORGANIZATIONS.(a) Reorganization. -- (1) In general. -- For purposes of parts I and II and this part, the term "reorganization" means -- (A) a statutory merger or consolidation;(B) the acquisition by one corporation, in exchange solely for all or a part of its voting stock (or in exchange solely for all or a part of the voting stock of a corporation which is in control of the acquiring corporation), of stock of another corporation if, immediately after the acquisition, the acquiring corporation has control of such other corporation (whether or not such acquiring corporation had control immediately before the acquisition);(C) the acquisition by one corporation, in exchange solely for all or a part of its voting stock (or in exchange solely for all or a part of the voting stock of a corporation which is in control of the acquiring corporation), of substantially all of the properties of another corporation, but in determining whether the exchange is solely for stock the assumption by the acquiring corporation of a liability of the other, or the fact that property acquired is subject to a liability, shall be disregarded;(D) a transfer by a corporation of all or a part of its assets to another corporation if immediately after the transfer the transferor, or one or more of its shareholders (including persons who were shareholders immediately before the transfer), or any combination thereof, is in control of the corporation to which the assets are transferred; but only if, in pursuance of the plan, stock or securities of the corporation to which the assets are transferred are distributed in a transaction which qualifies under section 354, 355, or 356;(E) a recapitalization; or(F) a mere change in identity, form, or place of organization, however effected.↩9. The other cited revenue rulings reached results based, in part, upon this earlier ruling.↩10. SEC. 368(a)(2)(E). Statutory merger using voting stock of corporation controlling merged corporation. -- A transaction otherwise qualifying under paragraph (1)(A) shall not be disqualified by reason of the fact that stock of a corporation (referred to in this subparagraph as the "controlling corporation") which before the merger was in control of the merged corporation is used in the transaction, if --(i) after the transaction, the corporation surviving the merger holds substantially all of its properties and of the properties of the merged corporation (other than stock of the controlling corporation distributed in the transaction); and(ii) in the transaction, former shareholders of the surviving corporation exchanged, for an amount of voting stock of the controlling corporation, an amount of stock in the surviving corporation which constitutes control of such corporation.↩11. Of course, to qualify as a (C) reorganization, petitioner's assumption of Old Bercy's liabilities would have to meet the test of sec. 368(a)(2)(B).↩12. SEC. 368(a)(2)(D). Statutory merger using stock of controlling corporation. -- The acquisition by one corporation, in exchange for stock of a corporation (referred to in this subparagraph as "controlling corporation") which is in control of the acquiring corporation, of substantially all of the properties of another corporation which in the transaction is merged into the acquiring corporation shall not disqualify a transaction under paragraph (1)(A) if (i) such transaction would have qualified under paragraph (1)(A) if the merger had been into the controlling corporation, and (ii) no stock of the acquiring corporation is used in the transaction.↩13. H. Rept. 91-1778, 91st Cong., 2d Sess. 2 (1970).↩14. Finally we find no merit in petitioner's argument that if Old Bercy survived in a subsidiary reverse merger and then, subsequently, a new corporation located in a different State was formed to carry on the business of Old Bercy, we would have a (B) followed by an (F) reorganization and the loss carryback would be allowed. Once again, the step-transaction, integrated-transaction, doctrine would be applicable. See, for example, American Potash & Chemical Corp. v. United States, 399 F.2d 194">399 F.2d 194, 202 (Ct. Cl. 1968); King Enterprises, Inc. v. United States, 418 F.2d 511">418 F.2d 511, 516 (Ct. Cl. 1969); Resorts International, Inc. v. Commissioner, 60 T.C. 778">60 T.C. 778, 789 (1973), affd. and revd. in part 511 F.2d 107">511 F.2d 107 (5th Cir. 1975); Yoc Heating Corp. v. Commissioner, 61 T.C. 168">61 T.C. 168, 177↩ (1973).15. Aetna Casualty & Surety Co. v. United States, 403 F. Supp. 498↩ (D.C. Conn. 1975).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625498/	OKLAHOMA OPERATING CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Oklahoma Operating Co. v. CommissionerDocket No. 12660.United States Board of Tax Appeals17 B.T.A. 1127; 1929 BTA LEXIS 2173; October 31, 1929, Promulgated 2173 Value of tangible assets taken in payment of capital stock, determined for invested capital purposes. B. A. Ames, Esq., for the petitioner. L. A. Luce, Esq., for the respondent. LANSDON 1127 The respondent asserted deficiencies in income and profits taxes for the years 1919, 1920, and 1921, against petitioner, in the aggregate of $24,199.76, of which only $6,924.90 is involved in this appeal. The petitioner alleges that the respondent erred (1) in reducing its invested capital for the years in question, and (2) in his determination of allowable deductions on account of depreciation for the years in question. The parties have stipulated that the value found to be correct for invested capital purposes shall be the basic value for determining depreciation. FINDINGS OF FACT. The petitioner is an Oklahoma corporation, engaged in the operation of laundries in Oklahoma City. It was organized June 2, 1912, with a capital of $150,000, paid for by assets taken over from four laundry companies which were merged in the corporation. Following the organization of petitioner, the names of these companies and the cash value which was assigned to2174 their assets taken over were set up on its books as follows: NameTangible assetsGood willStock issuePalace Laundry$39,091.26$8,908.74$48,000King Laundry25,261.994,738.0130,000White Swan Laundry28,489.488,510.5237,000New State Laundry28,271.606,728.4035,000121,114.3328,885.68150,0001128 For a number of years prior to June 1, 1912, the business of the four companies affected by this merger had been conducted at a loss, and it was though by their respective owners that their economic problems could be solved by the reduction of operating expenses and the elimination of competition through consolidation. With this object in mind, these men agreed to organize petitioner and to convey to it their respective plants, business and good will for the fixed price, in stock for each, as shown in the above table. The value of the tangible assets conveyed by each company was roughly estimated to be as is shown in the tabulation and the difference between their valuation and the purchase price in stock was attributed to good will. In addition to the assets taken over from the four companies merged, the petitioner, to2175 reduce competition, purchased at a cash expenditure of $21,000, the business, plants, equipment, and good will of the Model Laundry, Inc., and certain other small concerns that either were or had been engaged in operating laundries in Oklahoma City. Each conveyance of these laundry concerns contained, as a part of the consideration, a stipulation binding the seller to refrain from engaging, directly or indirectly, in the laundry business in Oklahoma County for periods ranging from three to five years, respectively. In making up its property account as of June 1, 1912, the petitioner added the $21,000 paid for the purchase of plants not in the merger, to its stock issue of $150,000, paid to the owners of the absorbed corporations, and set the same upon its books at $171,000. In July, 1913, petitioner caused an inventory, based upon an estimated sale price value as of said date, to be made of all its physical assets, the result of which it entered upon its books in 1914. This inventory showed physical assets valued at $104,447.59, to which petitioner made additions from year to year and took depreciation on its books up to and including the taxable years in question. In auditing2176 petitioner's returns for 1919, 1920, and 1921, the respondent adopted the values set forth in the aforesaid inventory as correctly reflecting its invested capital on June 1, 1912, the date of its incorporation. The basis thus employed by respondent resulted in a reduction of the amount claimed in the returns for the years in question. Upon being advised of respondent's determinations in respect to its invested capital at the date of its incorporation, the petitioner 1129 thereupon employed a firm of auditors to make a retrospective appraisal of all of its assets, as of June 1, 1912, for the purpose of determining their true value for invested capital purposes on the date they were received by it in payment for stock. In making such appraisal the auditors adopted the inventory of June 1, 1913, from which they first eliminated all items acquired after June 1, 1912. With the list thus corrected, they then ascertained the cost price of each and every item appearing thereon at the date of its purchase from the manufacturers. To the cost they added freight and installation charges, which total they then depreciated to the basic date. The result of this appraisal indicated2177 a total value of all physical assets taken over by the petitioner on June 1, 1912, of $138,693.35. The actual cash value of the petitioner's tangible property, bona fide paid in for stock, at the time of its organization on June 1, 1912, was $121,114.33. OPINION. LANSDON: The single issue for our determination here is the actual cash value of the tangible property which the petitioner acquired in payment of its capital stock. The term "invested capital" as used in the various revenue acts, is defined by the acts themselves as the "actual cash value of tangible property, other than cash, bona fide paid in for stock or shares, at the time of such payment." The property in this case was the assets of the four companies merged, and the time of payment was the date of the merger, or the organization of petitioner, when it came into possession of the assets. Three valuations have been put in evidence. The first is shown as that part, not assigned to good will, of the sale price fixed by the owners of the four companies merged before the organization and for which credit was given to the incorporators in payment of stock. This value was fixed and set up on petitioner's2178 books at $121,114.33. The second valuation was the result of an appraisal which the petitioner caused to be made of all its physical assets one year after its incorporation, by an audit company, which determined the cash sale value of petitioner's assets on June 1, 1913. The third valuation was the result of a retrospective appraisal made on May 5, 1925, whereby the petitioner sought to determine the actual value of its tangible assets as of June 1, 1912, the date it took the same over in payment of its capital stock. This value was fixed at $138,693.35. In respect to the first mentioned valuation, it is not contended by either of the parties that it was anything more than a rough estimate of the cash value of the property taken over. It did, however, in the aggregate, represent the price which all of the parties agreed should 1130 be assigned to the tangible assets when taken into the company and paid for in stock, and is the only evidence we have as to what the organizers of petitioner, who were both sellers and purchasers, believed them to be worth for said purpose at that time. The respondent adopted the valuations established by the appraisal made June 1, 1913, as2179 the basis of his determination of petitioner's invested capital on the basic date, while the petitioner contends that the retrospective appraisal made in 1925 correctly fixed the value of its assets for said purposes on said date. It is very clear that the determinations of this last mentioned appraisal can not be accepted as correctly establishing the value of petitioner's invested capital on the date of its organization. The evidence shows that the method employed in this appraisal sought only to establish the depreciated cost of these assets to June 1, 1912, rather than the cash value on said date. We have previously held that the original cost of properties acquired separately and at different times, can not be considered in determining their combined value, for invested capital, when they are subsequently taken over by a new corporation. . We have also found that properties, after consolidation under conditions that add to their economic development, may have a greater sale value than when separately owned; and, therefore, have greater value for invested capital purposes when paid in to a corporation. 2180 . We think the facts in this case may well bring it within this last mentioned rule, and that the assets of these several corporations, when assembled for employment under a single management, as shown here, had a sale value that should not be limited to the sums total or aggregate selling prices that might be obtained from the separate sales of the various plants, or parts of plants included in the whole. The basis adopted by the Commissioner was established by the cash sale price of the different plants as of June 1, 1913, method, while the values contended for by the petitioner were obtained by the method of original cost price per unit, plus freight and installation charges, depreciated to June 1, 1912. We do not think that the valuations contended for in either of these cases correctly reflect the petitioner's invested capital on June 1, 1912, when measured by the actual cash value of these assets to this corporation at the time it took them over. The testimony as to the facts attending the organization of the petitioner show that prior to the incorporation the owners of the four companies agreed that they would sell their2181 respective businesses to the new corporation for the sum total of $150,000. Under the circumstances it can hardly be contended that good will, as an asset, figured in the purchase price. However, the parties agreed, for accounting purposes, to ascertain the actual value of the physical 1131 assets to be conveyed to the corporation. They appointed a committee for this purpose, and this committee decided that these physical assets were worth the sum of $121,114.33. This value was assigned to these assets on the date that the corporation took them up on its books and issued its capital stock in payment therefor. The committee which determined these values was made up of the officers of the several corporations selling, and while their work of appraisal was not attended by the detailed survey usually made by experts, yet for practical purposes, it is evident that these officers knew these values without exhaustive examinations. Concerning this appraisal, one of these officers testified at the hearing that "we put down the figures for what we thought was the physical values, and then added them when we were through." We think, in view of the appraisal made one year later, *2182 which found that these assets then had an aggregate sale price, if sold separately, of $104,447.59, and the retrospective appraisal made in 1925, which determined their depreciated cost at date of petitioner's organization to be $138,693.35, that this first appraisal, made by the committee prior to the merger, under the circumstances fairly established the actual cash value of these assets when assembled and delivered over to the petitioner for invested capital purposes, and therefore adopt the same as the correct basis of our determination. This appraisal fixed the value of these tangible assets at $121,114.33, which we find to be the correct measure of the petitioner's invested capital on the basic date. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625501/	MALCOLM & DYER CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Malcolm & Dyer Co. v. CommissionerDocket No. 11769.United States Board of Tax Appeals13 B.T.A. 37; 1928 BTA LEXIS 3325; July 24, 1928, Promulgated 3325 Where the Commissioner has based depreciation on an estimated life of 25 years and the petitioner maintains that an allowance based on a 10-year life is proper, the building having been continuously in use by the petitioner for a period of 12 years, the valuation for depreciation purposes will not be disturbed where no other evidence is adduced. William D. Smith, Esq., for the petitioner. Albert S. Lisenby, Esq., for the respondent. MURDOCK 37 This is a proceeding for the redetermination of a deficiency in income and profits taxes for the calendar year 1920 amounting to $45.50. The petitioner alleged that the Commissioner erred in disallowing a portion of the 10 per cent depreciation taken as a deduction in the calendar year in question. 38 FINDINGS OF FACT. The petitioner is a corporation organized under the laws of the State of Maine. The building, depreciation upon which is the subject of dispute, was built in the year 1910. The nature of the tenancy of the ground upon which the building was erected was one at will as the petitioner could not obtain a lease of the property. The municipal government of the City of Augusta3326 had power at any time to request the petitioner to remove the building, since it was erected over a regular street of the city. It was constructed of wood, with a corrugated iron siding. The cost of the building at commencement of the term over which depreciation is claimed was the basis of arriving at the amount of depreciation to be taken each year. When the building was erected it was erected by a partnership of the same name as the petitioner. The petitioner was organized in 1915, all the assets of the partnership being turned over to the corporation at that time. At the beginning of the year 1920, there had been written off on account of depreciation the total sum of $1,067. At the date of incorporation the total depreciable value set upon the books was $2,860.67. It had become necessary at the time the building was taken over by the corporation to make certain improvements and the basic fugure at the date of incorporation was arrived at by taking the entire cost less depreciation to the date on which the corporation had taken it over. No attempt was over made on the part of the city to require the petitioner to remove the building, although there was some difficulty3327 experienced when it was erected in getting the consent of the proper authorities. While the structure was built over the street, it did not constitute an obstruction to traffic. OPINION. MURDOCK: There is but one issue before the Board in this case and that is one of fact involving the amount of the depreciation allowance to which the petitioner is entitled for the taxable year in question. The statute allows to taxpayers a reasonable allowance for exhaustion, wear and tear, and it has been the practice of the Commissioner in determining this allowance on buildings to estimate the life of the particular building in question and to spread the deduction for depreciation evenly over the period of such estimated life. The petitioner contends that if at the time of incorporation it was determined by reason of the high cost of maintenance or the imminence of removal that the useful life of the property would be shortened, the portion of the cost or other basis of the property 39 not already provided should be spread over the remaining useful life as reestimated in the light of the subsequent facts. At the time of the trial of the case the building in question was still*3328 in use. The estimated life had in fact been exceeded at the date of the trial. Nor does the record show facts occurring between the acquisition of the property by the taxpayer and the date of trial which would tend to accelerate depreciation. We are therefore forced to the conclusion that the petitioner had incorrectly estimated its life. While it might have been possible to show that although the petitioner's allowance for depreciation in the taxable year was excessive, the Commissioner's allowance was not adequate, no evidence was adduced to show that such was the case, and in the absence of such showing the determination of the Commissioner must be affirmed. Judgment will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625502/	Ralph Bellamy and Alice Bellamy, Petitioners, v. Commissioner of Internal Revenue, RespondentBellamy v. CommissionerDocket No. 989-63United States Tax Court43 T.C. 487; 1965 U.S. Tax Ct. LEXIS 138; January 27, 1965, Filed January 27, 1965, Filed 138 Decision will be entered under Rule 50. Held, that an amount received by the petitioner did not represent proceeds from the sale of a capital asset, and that such amount is taxable as ordinary income. Dana Latham, Henry C. Diehl, and Henry J. Steinman, for the petitioners.Lawrence S. Kartiganer and Michael P. McLeod, for the respondent. Atkins, Judge. ATKINS487 The respondent determined a deficiency in income tax for the taxable year 1957 in the amount of $ 44,864.77.The parties having reached agreement as to certain issues, the issue remaining for decision is whether the sum of $ 89,000 paid to the petitioner Ralph Bellamy in 1957 was proceeds from the sale by him of property which was a capital asset, resulting in the receipt of long-term capital gain as contended by him, or is taxable as ordinary income as determined by the respondent.FINDINGS OF FACTSome of the facts have been stipulated and are incorporated herein by this reference.The petitioners are husband and wife, now residents of Los Angeles, Calif. They filed a joint income tax return on the cash method for the taxable year 1957 with the district director of internal revenue, 488 New York, N.Y. Hereinafter, Ralph Bellamy will be referred to as the petitioner.Petitioner is a professional actor and has140 been engaged in his profession for over 40 years. He is the president of Actors Equity Association and is also a member of the Screen Actors Guild. Prior to October 1, 1949, he appeared on the stage, screen, and radio, but had never appeared on television, which at that time was in its infancy.On October 1, 1949, petitioner entered into a written employment contract (hereinafter sometimes referred to as the Esty agreement) with William Esty Co., Inc. (hereinafter referred to as Esty), as agent for R. J. Reynolds Tobacco Co. to render his artistic services by performing over a specified period the leading male role in a live television series then entitled "Man Against Crime." The contract also contained specific provisions precluding the petitioner from appearing in any other television program during the term of the contract and limiting his right to appear in any radio or television program for a period of 6 months thereafter. The agreement provided in pertinent part as follows:1. We hereby employ you to render your services as herein described in a series of television programs presently entitled "MAN AGAINST CRIME" to be broadcast on behalf of and advertising the products141 of R. J. Reynolds Tobacco Company, its subsidiaries and affiliates (herein collectively called "Sponsor"). You hereby accept such employment and agree to perform such services in a competent and artistic manner, to the best of your talents and abilities, for and as directed by us. * * 4. (a) The term of this agreement shall be for a period of thirteen (13) consecutive weeks commencing with the week ending October 7th, 1949 and ending December 30th, 1949. The said term is herein sometimes called the "principal period". * * 5. In full consideration for the services to be rendered by you hereunder and the rights and options granted to us, and in complete discharge of our obligations hereunder, we hereby agree to pay you, and you hereby agree to accept, the sum of Fifteen Hundred Dollars ($ 1500.00) per week during the principal period hereof. Such weekly sums shall be paid to William McCaffrey, as your agent, within ten (10) days after the completion of each broadcast.6. (a) You hereby grant to us the following exclusive and irrevocable options to extend the term of this agreement for the respective periods hereinafter set forth, upon all of the terms and conditions hereof, 142 except as otherwise hereinafter provided with respect to compensation:(i) Thirteen (13) consecutive weeks commencing with the week ending January 6th, 1950 and ending with the week ending March 31st, 1950 at Fifteen Hundred Dollars ($ 1500.00) per week;(ii) Thirteen (13) consecutive weeks commencing with the week ending April 7th, 1950 and ending with the week ending June 30th, 1950 at Fifteen Hundred Dollars ($ 1500.00) per week;(iii) Twenty-six (26) consecutive weeks commencing on a date in October, 1950 to be designated by us at Two Thousand Dollars ($ 2,000.00) per week;489 (iv) Thirteen (13) consecutive weeks commencing immediately upon the expiration of the preceding option period described in the foregoing subdivision (iii) at Two Thousand Dollars ($ 2,000.00) per week;(v) Thirty-nine (39) consecutive weeks commencing on a date in October, 1951 to be designated by us at Twenty-Five Hundred Dollars ($ 2500.00) per week. * * 8. Each program shall be essentially a live program, with the interpolation of such film or still sequences as we may determine. We shall have the right, without any additional compensation to you, to make television recordings (which term143 shall mean and include film or motion picture transcription or any other record of the physical form, aural and/or visual, of the said program) of the program by any method. Such recordings, insofar as you are concerned, shall become our sole and absolute property for use as permitted hereunder and may be used for file and reference purposes and for additional, delayed or supplemental coverage, but shall be broadcast only once over such stations which did not carry the original broadcast. Said use shall be subject to the codes, rules and regulations of any Union having jurisdiction, and in no event shall such transcriptions be broadcast later than sixty (60) days after the date of the original broadcast. * * ** * * 10. (a) You hereby grant to us, the Sponsor and the broadcasting system, the right to use and permit others to use, during the term hereof, and for a period of sixty (60) days thereafter, your name, photograph, likeness, biography, facsimile signature and voice, in and in connection with the television program and the advertising, exploiting and publicizing the products and services of the Sponsor and the said television program, it being understood, however, that 144 such use shall not be made for the purpose of endorsement or testimonial without your written consent.(b) You agree that during the term hereof you will not use or authorize the use of your name, photograph, biography, likeness or voice, or render any services in advertising, exploiting or publicizing any person, firm, corporation, product, services or commercial enterprise competitive to the Sponsor or its products.(c) We shall have the exclusive right to issue publicity concerning the television program and your connection therewith, and you agree not to release or authorize the release of any publicity matter concerning the aforesaid television program and the rendition of your services in connection therewith.* * * 15. Nothing contained in this agreement shall be construed to obligate us to utilize your services or afford you the opportunity of rendering performances on the television programs, and we shall have fulfilled our entire obligation hereunder by paying to you such sums as provided herein. * * 20. If this agreement shall remain in full force and effect for its principal period and all option periods, then and in such event during the period of sixty (60) days145 prior to the expiration of the last option period, you and we will negotiate in good faith for the terms and conditions for an extension of this agreement.* * * 23. * (b) This agreement is entire and complete and embodies all understandings and agreements between you and ourselves and no representations or warranties 490 of any kind or nature have been made by either you or ourselves, except as in this agreement expressly set forth.(c) This agreement cannot be changed or modified except by an instrument in writing signed by you and ourselves.(d) This contract shall be construed in accordance with the laws of the State of New York.Under the agreement Esty had the right to make kinescope films of the live productions. However, the quality of these films was inferior and would not permit the use and reuse to which television films are subject today. Accordingly, in January 1952, Esty proposed to petitioner that the program be filmed with a high-quality film so that the shows could be rerun extensively. As a consequence the petitioner and Esty executed, on January 7, 1952, an amendment to the agreement which granted Esty additional options to extend petitioner's employment146 for periods totaling 130 weeks over the period through June 1955, at compensation of $ 3,500 per week. This amendment provided in part as follows:2. We shall have the right to broadcast the program as a live program or by means of motion pictures in lieu of live broadcasts as we may from time to time determine. * ** * * 3. (a) If we shall elect to broadcast these programs by means of motion pictures, you agree to render all such services as an actor as shall be necessary in acting, performing, rehearsing and taking part in such motion pictures as we may require. * ** * * 4. (a) All motion pictures which are produced hereunder shall become and remain our sole and absolute property and during the term hereof and for a period of twenty six (26) weeks thereafter may be used by us for any and all broadcasting purposes for a first use (as hereinafter defined) over each and every station as we may designate from time to time without notice to you in the United States of America, its territories and possessions and Canada and at any times, without restriction or limit whatsoever, and in addition may be used by us for file, reference, promotional, sales and exploitation purposes. 147 (b) We shall have the further right to broadcast the motion pictures over stations which shall have begun operations after the expiration of the term of this agreement and the aforesaid twenty six (26) week period upon condition that we shall pay you the sum of twenty (20%) percent of the published net time card rate charged by each such station, but in no event shall you receive a total of more than One thousand seven hundred and fifty ($ 1,750) Dollars with respect to broadcasts over all such stations.5. (a) As used herein:i The term "first use" shall mean the first broadcast of any motion picture hereunder over any station in a city.ii The term "second use" shall mean the second broadcast of any motion picture hereunder over any station in a city in which the motion picture shall have been previously broadcast.iii The term "subsequent uses" shall mean any broadcast of any motion picture hereunder over any station following the "second use".iv The term "category of use" shall mean the nature of the use, that is to say whether a "first use", "second use" or "subsequent use".491 (b) We shall have the right during the term of this agreement and for a period of twenty six148 (26) weeks thereafter, to broadcast any motion pictures hereunder for a second use and subsequent uses upon condition, however, that for each second use or subsequent use we shall pay you a sum equal to twenty (20%) percent of the published net card time rate charged by such respective station, but in no event shall you receive more than the sum of One thousand seven hundred and fifty ($ 1,750) Dollars for all such second or subsequent uses in each category of use.6. After the expiration of the term of this agreement, we shall have the right to sell, lease or otherwise dispose of such motion pictures to any other person, firm or corporation for television broadcasting on a sustaining or sponsored basis in any country of the world and for theatrical and non-theatrical purposes in any country outside of the continental United States of America, subject to the following conditions:(a) Such motion pictures may not be sponsored by or advertise any deodorant, laxative, articles of feminine hygiene or similar products.(b) We agree to pay to you or cause you to be paid a sum equal to twenty (20%) percent of the net proceeds received by us from the sale, lease, license or other disposition149 of such motion pictures. "Net proceeds" shall mean the sum remaining after deducting agent's commissions and distribution charges which we may be required to pay.7. Any agreements made for television broadcasting of such motion pictures after the expiration of the term of this agreement and twenty six (26) weeks thereafter shall be subject to cancellation upon your giving us not less than twenty six (26) weeks written notice to such effect if the sponsor, or the products advertised thereon, of any such program shall be competitive to any sponsor of or product advertised on any program on which you shall be rendering your services at such time, or if after using your best efforts in good faith you shall be unable to effect an agreement for your television services to be rendered on behalf of any other person, firm or corporation, without effecting such cancellation.In early 1954 Esty requested that the petitioner agree to extend, from 26 weeks to 104 weeks, the period during which the films might be shown without any right of cancellation on the part of the petitioner. Petitioner believed that he might become too closely identified with the character "Mike Barnett" which he played150 in the films (that is, become "typed") and that this might prove detrimental to his professional career after the filming of this series was concluded. He was willing to agree to the extension requested only if Esty would agree to relinquish its right to show the film (and hence its right to sell the films for showing) after the expiration of the 104-week period. On February 23, 1954, the petitioner and Esty entered into the following letter agreement:This will refer to the agreement entered into between us dated October 1, 1949, as amended by agreements dated June 8, 1951, January 8, 1952 and April 15, 1953 (all of which agreements are herein collectively sometimes called "Agreement"), relating to your services in the series of television programs presently entitled "MAN AGAINST CRIME". It is hereby agreed that the said Agreement shall be further amended and supplemented as follows:1. In addition to the rights granted to us under the aforesaid Agreement, we shall have the right for a period commencing on the date hereof and ending 104 weeks after the expiration of the term of the aforesaid Agreement, to sell, lease, 492 license, or otherwise dispose of the motion pictures151 covered by the Agreement, to any person, firm or corporation for television broadcasting on a sponsored basis for a first use, second use and subsequent uses (as such terms are defined in the aforesaid Agreement) on behalf of any other advertisers or sponsors regardless of number, and on any stations, or on a sustaining basis, all as we may determine, in the United States of America, its territories and possessions, and the Dominion of Canada, and in such connection to use and permit the use of your name and photograph to advertise and exploit such motion pictures, subject to the following terms and conditions:(a) First use on behalf of any advertisers or sponsors other than ourselves may occur only in such cities where we have not theretofore telecast such motion pictures on behalf of ourselves.(b) The motion pictures may not be sponsored by, or advertise any deodorant, laxative, articles of feminine hygiene, or similar products.(c) With respect to the first use on behalf of any advertiser or sponsor (other than R. J. Reynolds Tobacco Company), we shall pay you a sum equal to ten (10%) percent of the net proceeds received by us from such sale, lease, license, or other disposition152 of such motion pictures consummated prior to May 1, 1954, and twenty (20%) percent of the net proceeds received by us from such sale, lease, license, or other disposition of such motion pictures consummated on and after May 1, 1954. With respect to second use or subsequent uses, we shall pay you twenty (20%) percent of the net proceeds received by us from such sale, lease, license or other disposition of such motion pictures. Net proceeds means the sums remaining to us after deducting agent's commissions and distribution charges, costs and expenses, including but not limited to advertising, prints, editorial and other costs which we may be required to pay.We shall render to you quarterly accountings and pay you simultaneously therewith such amount as may be shown thereon to be due to you.As herein modified, the aforesaid Agreement shall continue in full force and effect.The term of the Esty agreement expired in June 1954 (options to extend it not having been exercised), and thereafter no further acting services were performed by petitioner pursuant to the agreement and no further films were produced by Esty. The 104-week period described in the agreement dated February 23, 1954, 153 expired on or prior to June 30, 1956, and thereafter no film made pursuant to the Esty agreement was authorized by Esty to be broadcast in any manner whatsoever over any station either in the United States or abroad.During the term of the Esty agreement and during the ensuing 104-week period, Esty did not sell, lease, or otherwise dispose of the films made pursuant to the agreement, except that on April 1, 1953, it made a distribution agreement with Music Corp. of America-TV (MCA) for that organization to distribute the films in markets not used by R. J. Reynolds Tobacco Co. Accountings were rendered to petitioner with respect to payments made by MCA to Esty for such distribution rights, and petitioner reported the amounts paid to him as ordinary income for the taxable years 1953 to 1957, inclusive.In the latter part of 1954 MCA contacted petitioner in an attempt to have him alter his agreement with Esty to extend the time within which the films could be shown under the syndication which MCA had 493 arranged. The petitioner, through his agent, the William Morris Agency, informed MCA that he was not interested in having the films on the air after the 104-week period. In 154 1956, after the expiration of the 104-week period, MCA again contacted petitioner in an effort to obtain permission to use the films. However, again the petitioner refused to negotiate with MCA; rather, he considered the possibility of securing Esty's interest in the films and any rights held by others, and syndicating and distributing the films himself. The William Morris Agency investigated this possibility but nothing was accomplished.Although its negotiations with petitioner had been unsuccessful, MCA decided to purchase whatever rights other parties might have in the films. On June 13, 1957, R. J. Reynolds Tobacco Co., by its agent, Esty, entered into an agreement with a subsidiary of MCA, Revue Products, Inc. (hereinafter referred to as Revue), transferring to Revue all interests which it had in the films. Such agreement provided in part as follows:3. We warrant and represent that we are the owner of the physical motion pictures or other physical articles transferred to you hereunder.* * * 8. You shall give us, simultaneously with the execution of this agreement, assumption agreements called for by any union or unions having jurisdiction, and you shall pay all fees, 155 charges, taxes or other costs in connection with any use of the photoplays hereafter.* * * 10. In consideration of the grant made by us to you, you shall pay to us the sum of Twelve Thousand Five Hundred ($ 12,500.00) Dollars on signing of this agreement. In the event that you enter into an agreement or agreements between you and RALPH BELLAMY and/or MESSRS. KLEE and/or COOPER, their estates, successors, or assigns and such other persons, firms or corporations as may be necessary to clear your rights for broadcasting of the photoplays, as hereinabove provided, to the photoplays, you shall pay to us an additional sum of Five Thousand ($ 5,000) Dollars within thirty (30) days after the execution of all such agreements or the first broadcast, whichever is sooner.After petitioner's performances in the "Man Against Crime" series terminated in June 1954, he worked in one motion picture and made guest appearances on television shows. In 1957 he appeared in the stage play "Sunrise at Campobello," which ran for over 2 years in New York City. At about that time petitioner considered that it might be helpful to have television exposure while he was engaged in the New York play. The William156 Morris Agency then entered into negotiations with MCA.On December 27, 1957, petitioner and Revue executed an agreement which provided in pertinent part as follows:Actor [petitioner] has rendered services as Actor and/or otherwise in connection with a Series of photoplays and/or television programs entitled "MAN AGAINST CRIME", also known as "FOLLOW THAT MAN". The photoplays 494 in the series are hereinafter referred to collectively and severally as the "Series". Said Series was produced by William Esty Company as agent for and on behalf of R. J. Reynolds Tobacco Company (herein called "Producer") and said Actor rendered his services as an employee of Producer. On or about May 20, 1957 Producer sold, transferred, assigned and quitclaimed unto Revue Productions, Inc. (herein called "Corporation") in perpetuity, all of its right, title and interest in and to said Series, and the Property (as hereinafter defined) including all rights and properties acquired from said Actor and others.Now, Therefore, the said Actor and the said Corporation do hereby agree as follows:1. In addition to the rights, interest and property that Corporation acquired from Producer in connection with157 said Series, Actor hereby grants to said Corporation, subject only to the limitations hereinafter explicitly set forth, the unrestricted right, in perpetuity, throughout the world to sell, lease, exhibit, license, mortgage, hypothecate or otherwise dispose of and exploit said Series, the photoplays and all rights and interests in connection with said Series. * * * The rights herein granted by Actor are in addition to, and not in any way a limitation on, the rights Corporation acquired from Producer, and the Actor agrees that Corporation is assigned any and all rights granted by the Actor to Producer in connection with said Series and the property rights to Series. Without limiting the generality of the foregoing in any way whatsoever, the grant is hereby deemed a grant of all rights the Actor ever had, does now have, or acquires in the future in and to Series, including but not limited to the results and proceeds of the Actor's services rendered to the Producer in connection with Series.2. Corporation and Actor expressly understand and agree that all dialogue, all photoplays of Series, all films, recordings, prints and copies thereof and all rights therein, and all results and 158 proceeds of Actor's services in and in connection with Series and rendered to Producer shall, as between Actor and Corporation be the sole and absolute property of the Corporation for any and all purposes whatsoever, in perpetuity, * ** * * 4. (a) Actor warrants that Actor has the right to make this Agreement and that except as set forth in Paragraph 4(b) Actor has no present contract or commitment and agrees not to enter into any contract which can or may prevent Corporation from exhibiting or causing to be exhibited the said Series or any of the photoplays in said Series, in any media whatsoever throughout the world, in perpetuity, without restriction, or prevent the Corporation from enjoying any of the rights acquired hereunder, or from the Producer.(b) Corporation agrees that it will not authorize the telecasting in the United States of the Series, while Actor is regularly appearing as the star performer on any hereafter produced and telecast United States national television network series of programs of which Actor has notified Corporation as hereafter provided (hereinafter referred to as Actor's Program), on behalf of any Sponsor whose products are competitive with the159 products of the sponsor of not less than one-half hour of Actor's Program. Such restriction shall apply notwithstanding any other provision of this agreement to the contrary * * ** * * (d) Artist agrees that in the event the said Series is licensed for use on a U.S. national television network for not more than one Sponsor during each one-half hour, Artist will not regularly render his services on any U.S. Series of programs, nor permit the use of any such Series of programs in which he regularly appears on behalf of, nor permit his name or likeness to be used by or 495 for any Sponsor, in connection with such Series, whose products are competitive with the said national network Sponsor of the Series. * * ** * * 6. Actor agrees that rights and warranties granted and made herein are in addition to any rights or warranties granted or made to Producer in connection with Actor's agreement with Producer, which rights and warranties were assigned (and to which assignment Actor hereby consents) to and for the benefit of said Corporation. * * 9. The Actor grants to the Corporation the exclusive right to use and to permit others to use the Actor's name, photograph, biography160 and soubriquet and Actor's actual or simulated likeness, signature and voice in connection with advertising or publicizing the Series, or any part thereof, alone or in conjunction with other photoplays, or Actor's services in the Series. * * ** * * 12. Actor agrees that the payments provided for in Paragraph 13 hereof shall, as between Actor and Corporation, be and are in lieu of any and all payments that are or might become due or payable to the Actor pursuant to any agreements between the Actor and Producer or otherwise, by way of series compensation, theatrical exhibition compensation, percentage of gross receipts or net profits compensation or otherwise. Nothing contained in this agreement shall require Actor to violate any applicable collective bargaining agreement. There shall be applied against any additional compensation due Actor pursuant to the provisions of any applicable collective bargaining agreement, whether by reason of re-runs or any other uses of the Series or exercise of Corporation's rights hereunder, all amounts heretofore, now or hereafter received by Actor, in connection with the Series in excess of the minimum compensation required by the applicable collective161 bargaining agreement, whether such payments were or are made by producer, Corporation or otherwise or by way of lump sums, percentages of receipts or otherwise.13. (a) In consideration of the foregoing, Corporation agrees to pay to Actor the sum of $ 89,000.00 simultaneously with execution of this agreement by Corporation and in addition thereto an amount equal to 30% of the net receipts derived from the exploitation, distribution and licensing of the said Series as hereinafter provided.(b) Net receipts, as used in this agreement, shall mean the balance remaining after the deduction from the gross receipts of all of the following:* * * (4) the sum of $ 89,000.00 representing the amount paid by Corporation to Actor pursuant to Paragraph 13(a) of this agreement.(5) the sum of $ 17,500.00 representing amounts paid by Corporation to Producer in connection with obtaining ownership of the Series.As of the end of 1963 petitioner had received no payment from Revue in excess of the $ 89,000. Upon the receipt of the $ 89,000 from Revue, the petitioner paid the William Morris Agency 10 percent thereof, or $ 8,900. He also paid $ 8,900 to William McCaffrey, who was his agent throughout162 the term of the Esty contract and who negotiated such contract and the amendments thereto.Agency agreements ordinarily provide, in accordance with union rules, that no double commission shall be paid agents for services rendered, 496 but neither union rules nor agency agreements bar such double payment when a sale of rights is involved.It is the trade practice to include in contracts of this nature affirmative provisions respecting the right to use films after termination of the employment. Generally, contracts provide that the producer shall have perpetual rights to do whatever he wishes with the film.In their joint income tax return for the taxable year 1957, the petitioners reported long-term capital gain of $ 71,200 from the sale in that year of "Television rights 'Man Against Crime,'" showing date of acquisition as 1954, gross sales price of $ 89,000, no cost or other basis, and expense of sale as $ 17,800.In the notice of deficiency the respondent increased by $ 89,000 the amount of ordinary income reported by the petitioner and, consistently, excluded from taxable income any capital gain. He explained his determination as follows: "It has been determined that the163 proceeds from the 'Man Against Crime' television shows are ordinary income. Hence, the capital gain deduction claimed in your return in respect to this income is not allowable, and your taxable income is increased $ 53,400 accordingly."OPINIONThe petitioner contends that the amount of $ 89,000 which he received from Revue in 1957 constituted proceeds from the sale of a capital asset under section 1221 of the Internal Revenue Code of 1954, 1 and that the gain derived upon such sale is taxable as long-term capital gain under the provisions of section 1222 of the Code. It is his position that, although he did not own the films themselves, he had the absolute right under the agreement with Esty, as amended by the letter agreement 497 of February 23, 1954, to prevent the distribution and showing of the films; that this right constituted a proprietary interest in the films, and hence "property"; that since such "property" does not fall within any of the exclusions of section 1221, it must be considered as a capital asset; and that such capital asset was sold to Revue for $ 89,000, resulting in the receipt of long-term capital gain.164 The respondent contends that the February 23, 1954, amendment to the Esty agreement did not deprive Esty of the right to distribute and show the films after the expiration of the 104-week period set forth in such amending agreement and leave the petitioner with the absolute right to thereafter prohibit the showing of the films. He points out that such agreement of February 23, 1954, specifically recites that any rights granted therein to Esty are in addition to any rights granted to Esty under the original agreement and prior amendments thereto, and claims that in the February 23, 1954, agreement there is no specific prohibition against the use of the films by Esty after the expiration of the 104-week period. He contends that in any event, however, any right which the petitioner granted or transferred to Revue did not constitute a capital asset, and that the full amount of $ 89,000 constituted ordinary income.The petitioner testified, in substance, that the purpose and effect of the amending agreement of February 23, 1954, was to accomplish a trade whereby Esty obtained an extension of the period, from 26 weeks to 104 weeks, within which it had the unfettered right to sell, lease, 165 license, or otherwise dispose of the films, and gave up the restricted right, which it theretofore had, to thereafter sell, lease, license, or otherwise dispose of the films. We find it unnecessary to decide whether the petitioner's interpretation of the agreement is correct. Even if it be assumed, arguendo, that after the execution of the agreement of February 23, 1954, the petitioner had an absolute right to prohibit the distribution or showing of the films after the expiration of the 104-week period, and that he in effect sold such right to Esty when he granted Esty the right (qualified to the extent provided in par. 4(b) of the agreement of Dec. 27, 1957) in perpetuity to distribute and show the films, we think that there was not the sale of a capital asset within the meaning of section 1221 of the Code.It is well established that not everything which can be called property in the ordinary sense, and which is outside the statutory exclusions, qualifies as a capital asset; and that a capital asset is something in which the taxpayer has an investment, and hence a basis. In Commissioner v. Gillette Motor Transport, Inc., 364 U.S. 133">364 U.S. 133, the166 Supreme Court stated in part:While a capital asset is defined in § 117(a)(1) as "property held by the taxpayer," it is evident that not everything which can be called property in the 498 ordinary sense and which is outside the statutory exclusions qualifies as a capital asset. This Court has long held that the term "capital asset" is to be construed narrowly in accordance with the purpose of Congress to afford capital-gains treatment only in situations typically involving the realization of appreciation in value accrued over a substantial period of time, and thus to ameliorate the hardship of taxation of the entire gain in one year. Burnet v. Harmel, 287 U.S. 103">287 U.S. 103, 106. Thus the Court has held that an unexpired lease, Hort v. Commissioner, 313 U.S. 28">313 U.S. 28, corn futures, Corn Products Co. v. Commissioner, 350 U.S. 46">350 U.S. 46, and oil payment rights, Commissioner v. P. G. Lake, Inc., 356 U.S. 260">356 U.S. 260, are not capital assets even though they are concededly "property" interests in the ordinary sense. And see Surrey, Definitional Problems in Capital Gains167 Taxation, 69 Harv. L. Rev. 985">69 Harv. L. Rev. 985, 987-989 and Note 7.In the present case, respondent's right to use its transportation facilities was held to be a valuable property right compensable under the requirements of the Fifth Amendment. However, that right was not a capital asset within the meaning of §§ 117(a)(1) and 117(j). * * That right is not something in which respondent had any investment, separate and apart from its investment in the physical assets themselves. Respondent suggests no method by which a cost basis could be assigned to the right; yet it is necessary, in determining the amount of gain realized for purposes of § 117, to deduct the basis of the property sold, exchanged, or involuntarily converted from the amount received. § 111(a). Further, the right is manifestly not of the type which gives rise to the hardship of the realization in one year of an advance in value over cost built up in several years, which is what Congress sought to ameliorate by the capital-gains provisions. * To the same effect are Miller v. Commissioner, (C.A. 2) 299 F. 2d 706, affirming 35 T.C. 631">35 T.C. 631,168 certiorari denied 370 U.S. 923">370 U.S. 923; Commissioner v. Ferrer, (C.A. 2) 304 F. 2d 125, affirming in part and reversing in part 35 T.C. 617">35 T.C. 617; United States v. Woolsey, (C.A. 5) 326 F. 2d 287; and Holt v. Commissioner, (C.A. 9) 303 F.2d 687">303 F. 2d 687, affirming 35 T.C. 588">35 T.C. 588. See also Graham v. Commissioner, (C.A. 2) 304 F. 2d 707, affirming 36 T.C. 612">36 T.C. 612. In Holt v. Commissioner, supra, it was stated:The essence of a capital transaction within the tax statutes and decided cases is that the sale or exchange of an asset results in a return of a capital investment coupled with realized gain or loss (as the case might be) which accrues to the investment over a certain period of time. The petitioner invested nothing for the return of 25% of the excess gross receipts of the films except his services as a producer. There was no return of a capital outlay in this case. * * While the right which the petitioner granted to Revue to169 distribute and show the films might, in the ordinary sense, be characterized as a property right, he had no investment therein, aside from the services which he had performed in connection with the making of the films, and hence such right had no cost basis in his hands. Such right was "not of the type which gives rise to the hardship of the realization in 1 year of an advance in value over cost built up in several years, which is what Congress sought to ameliorate by the capital gains provisions."499 We note that in the agreement between the petitioner and Revue it was provided that the grant to Revue included the petitioner's rights to "the results and proceeds of the Actor's services rendered to the Producer in connection with the Series" and that the $ 89,000 payment and any additional percentage payments were "in lieu of any and all payments that are or might become due or payable to the Actor pursuant to any agreements between the Actor and Producer or otherwise, by way of series compensation, theatrical exhibition compensation, percentage of gross receipts or net profits compensation or otherwise." Whether the $ 89,000 which the petitioner received from Revue represented, 170 in whole or in part, commutation of the petitioner's right to compensation for past services, or whether it represented, in whole or in part, proceeds from the sale of property which was not a capital asset, the result would be the same, i.e., the $ 89,000 would be taxable as ordinary income.We have given careful consideration to the petitioner's contention that the instant case is governed by Commissioner v. Ferrer, supra. There the taxpayer had obtained from the author of a novel and a play based thereon the exclusive right, as "lessee," to produce the stage play within a specified time upon the payment of specified amounts as advances against royalties, and within an additional time upon the payment of a specified additional advance. All these advances were paid. As an incidental part of his right as "lessee," the taxpayer had the right to prevent the sale by the author, until after the production of the play, of the motion picture and other rights. Instead of producing the play, the taxpayer later surrendered to the author his "lease" of the play, his power incident to the lease to prevent any disposition of the motion picture rights, and171 his right to share in 40 percent of the proceeds of any motion picture and other rights had he produced the play. Thereupon the author sold to a third party all motion picture and other rights to his novel, and the taxpayer received from such third party the right to specified percentages of net profits from distribution of the motion picture. The court held that the portion of the percentage payments received which was properly allocable to the taxpayer's surrender of the "lease," and the right incident thereto to prevent the sale of the motion picture and other rights, were proceeds from the sale of a capital asset, namely, the "lease." It will be seen that the facts in the Ferrer case are substantially different from those obtaining here. There the right which was transferred was incidental to a property interest, namely, the "lease" of the play, in which the taxpayer had an investment, and was not a right stemming from a 500 contract of employment. Clearly the amount in question in the instant case did not represent, to any extent, consideration for the transfer of any property interest comparable to that involved in the Ferrer case. We do not consider that *172 case as applicable here.The parties have agreed that if, as we have decided, the amount paid petitioner by Revue is taxable as ordinary income, the respondent properly disallowed the deduction of the amount of $ 17,800 which petitioner paid to William McCaffrey and the William Morris Agency.Decision will be entered under Rule 50. Footnotes1. SEC. 1221. CAPITAL ASSET DEFINED.For purposes of this subtitle, the term "capital asset" means property held by the taxpayer (whether or not connected with his trade or business), but does not include -- (1) stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business;(2) property, used in his trade or business, of a character which is subject to the allowance for depreciation provided in section 167, or real property used in his trade or business;(3) a copyright, a literary, musical, or artistic composition, or similar property, held by -- (A) a taxpayer whose personal efforts created such property, or(B) a taxpayer in whose hands the basis of such property is determined, for the purpose of determining gain from a sale or exchange, in whole or in part by reference to the basis of such property in the hands of the person whose personal efforts created such property;(4) accounts or notes receivable acquired in the ordinary course of trade or business for services rendered or from the sale of property described in paragraph (1); or(5) an obligation of the United States or any of its possessions, or of a State or Territory, or any political subdivision thereof, or of the District of Columbia, issued on or after March 1, 1941, on a discount basis and payable without interest at a fixed maturity date not exceeding one year from the date of issue.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625504/	ARMANDO MENDEZ and MARGARITA MENDEZ, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentMendez v. CommissionerDocket No. 3545-68.United States Tax CourtT.C. Memo 1973-137; 1973 Tax Ct. Memo LEXIS 152; 32 T.C.M. (CCH) 658; T.C.M. (RIA) 73137; June 25, 1973, Filed Robert J. Carluccio, for the petitioners. Kimball K. Ross, for the respondent. FORRESTERMEMORANDUM FINDINGS OF FACT AND OPINION FORRESTER, Judge: Respondent determined deficiencies in petitioners' income taxes as follows: YearAmount 1964$974.2219651,033.46 2 The sole issue for our decision is whether petitioners were entitled to net operating loss deductions under section 172 1 in 1964 and 1965 in respect of losses153 they incurred prior to such years by reason of confiscation of certain assets by the government of Cuba. FINDINGS OF FACT Some of the facts were stipulated and are so found. Petitioners Armando Mendez (hereinafter referred to as petitioner) and Margarita Mendez are husband and wife who, at the time they filed their petition herein, resided in Brooklyn, New York. They filed their joint Federal income tax returns for the taxable years 1964 and 1965 with the district director of internal revenue, Brooklyn, New York. Prior to 1961, petitioners were Cuban nationals residing in Havana, Cuba. In 1957 petitioner's father died and, pursuant to his father's will, he inherited the following assets: 1. One-third interest in rental property located at Alambique Street, Havana, Cuba (the Alambique property); 2. Rental property located at 1058 Eleventh Street, Havana, Cuba (the Eleventh Street property); 3. One-third interest in the uncollected balance of a $60,000 (Cuban currency) debt owed to Armando's father from 3 Maderas Mendez y Compania, S.A. (the Maderas154 Company). The Alambique property consisted of 12 apartments plus a ground floor which was used commercially. Petitioner managed this property for himself and on behalf of his sister and brother, who had inherited the remaining two-thirds interest in the property. The Eleventh Street property consisted of eight apartments, which petitioner also managed. Pursuant to his father's will, petitioner paid his niece $20,000 (Cuban currency) so that he would be the sole owner of the Eleventh Street property. The debt petitioner inherited arose when his father sold an interest in the Maderas Company in 1954. The payment of the sales price was to be made at the rate of $10,000 (Cuban currency) per year for six years. Petitioner estimated that in 1960 the balance owed on this debt was $20,000 (Cuban currency). No further payments were ever made. On October 14, 1960, the Cuban Government enacted the Urban Realty Reform Law, which took away from the owners almost all urban rental property, including petitioner's two apartment buildings. The law gave occupying tenants the right to purchase ownership of their apartments, and promised indemnification to the former owners in an amount155 determined 4 by a formula which took into account the age and rental value of the property. In order to obtain indemnification, owners of rental property were required only to file a declaration listing the rental property they owned. Petitioner made the required declaration, began receiving monthly payments, and ceased to exercise any control over his property. He was promised indemnification in the approximate amounts of $16,634.80 (Cuban currency) for his one-third interest in the Alambique property, and $16,261 (Cuban currency) for the Eleventh Street property. The indemnification was to be paid in monthly installments over the period of 84 months. Petitioner's calculations were made entirely from his recollection because he was unable to bring any business records or other documents of substantiation with him from Cuba. On September 13, 1961, petitioner left Cuba and came to the United States to join his wife who had left Cuba in March 1961. Prior to leaving Cuba, he had received monthly payments of the two apartment buildings in the total amount of $3,132.98 (Cuban currency). After departing Cuba, he received no further monthly payments for his two properties. 156 Though petitioner had no intention of returning as long as the Castro regime remained 5 in power, his exit permit allowed him either 30 or 60 days within which to return to Cuba. On December 5, 1961, the Cuban Government enacted Law No. 989 which provided for the total confiscation of all Cuban properties owned by Cuban nationals who failed to return to Cuba within a designated time. Because petitioner's exit permit had expired prior to the enactment of this law, he lost all his property in Cuba, including indemnification rights, on this date. At all relevant times the official exchange rate in Cuban pesos per United States dollar was one to one. The free market or commercial exchange rate at the end of November and at the end of December of 1961 was 5.35 and 5.50 pesos per one U. S. dollar, respectively. Petitioners did not claim any losses when they filed their 1961 joint Federal income tax return. However, on April 16, 1965, they filed an amended return for 1961 wherein they claimed a total loss of $66,666.66. The claimed loss consisted of the two apartment buildings and the debt obligation petitioner had inherited from his father. 6 Petitioners filed joint157 Federal income tax returns for the years 1962 through 1965. Only on their returns for 1964 and 1965 did they claim deductions in respect of the Cuban loss. The following table presents a summary of the relevant information in petitioners' tax returns for the years 1961 through 1965: YearGross Income ReportedTaxable Income Per ReturnNet Operating Loss Claimed on Return 1961$ 986.32-O--O-19625,948.85-0-19637,454.004,908.60-0-19648,079.00-0-52,987.6919659,045.99-0-45,605.39In his notice of deficiency to petitioners for each of the years 1964 and 1965, respondent disallowed the claimed carryover net operating loss deductions. The petitioners reduced their claimed loss from $66,666.66 in their petition filed herein and now claim losses as follows: 7 Claimed LossDate of ConfiscationAmount Lost Indemnification Payments - Alambique PropertyDec. 5, 1961$15,050.56Lost Indemnification Payments - Eleventh Street PropertyDec. 5, 196114,712.36Debt Due from Maderas CompanyDec. 5, 19616,666.67$36,429.59158 OPINION Petitioners contend that as a result of losses sustained on December 5, 1961, by reason of the confiscation of their Cuban assets, they are entitled to net operating loss deductions in 1964 and 1965 under the carryover provisions of section 172. We hold that petitioners are not entitled to their claimed deduction because their alleged loss is not in an amount sufficient to produce a deduction for 1964 or 1965. Petitioners claim losses in the total amount of $36,429.59. While their claim is based largely on petitioner's recollections this is not fatal to their case in view of the circumstances. Cf. Andrew P. Solt, 19 T.C. 183">19 T.C. 183, 188-189 (1952); Benjamin Abraham, 9 T.C. 222">9 T.C. 222, 226 (1947). We are of the opinion that petitioner was an honest and credible witness, and note that he had extensive knowledge of the seized assets, having formerly managed the seized properties and having filed the indemnification claims. Nevertheless, even if we fully accept petitioners' 8 testimony, they are not entitled to the deduction. Petitioners' claimed loss represents seized Cuban obligations which were payable in "pesos" not dollars, and although a peso159 was equal to a dollar under the "official" exchange rate, its "free" market value was far less favorable. The "free" market rather than the "official" market establishes petitioners' loss for Federal income tax purposes. See Marko Durovic, 54 T.C. 1364">54 T.C. 1364, 1388-90 (1970) and cases there cited. The parties have stipulated that on December 5, 1961, the date petitioners claim they suffered their loss, the "free" exchange rate was between 5.35 and 5.50 pesos per one U. S. dollar. Accordingly, using the rate most favorable to petitioners, their claimed loss must be reduced from $36,429.59 to $6,810 (rounded). 2Section 172(b) (2) requires that the net operating loss shall be carried to the earliest allowable taxable year. Petitioners' taxable income for 1963 was $4,908.60. They did not compute their taxable income on their income tax return for 1962. However, in the absence of any evidence of unusually 9 large deductions for 1962, we have160 found as a fact that petitioners' taxable income for 1962 was at least $3,000. It is therefore clear that any loss sustained by petitioners in respect of their Cuban properties would have been absorbed by their taxable income in 1962 and 1963, and therefore no loss remains to be carried over to 1964 or 1965. Ellery Willis Newton, 57 T.C. 245">57 T.C. 245 (1971). Because we have held that petitioners' claimed loss was in an amount insufficient to generate a carryover loss to 1964 or 1965, we need not consider whether their loss otherwise qualifies as a net operating loss under section 172.Cf. Bosch v. Commissioner, 448 F.2d 1026">448 F.2d 1026 (1971), affirming a Memorandum opinion of this Court, and cases cited. Decision will be entered for the respondent. Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as amended, unless otherwise specified. ↩. In 1962 petitioners used the optional tax tables and therefore did not compute their taxable income on their return. However taxable income for 1962 was at least $3,000. ↩2. Further reductions of this amount would be needed to arrive at an actual net operating loss as defined by section 172. Sec. 172(c) and (d). We have not made such reductions as they are not necessary to our decision. ↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625505/	VALLEY DIE CAST CORPORATION, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent; INTERCONTINENTAL INDUSTRIES, INC. AND CONSOLIDATED SUBSIDIARIES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentValley Die Cast Corp. v. CommissionerDocket Nos. 904-73, 6592-74.United States Tax CourtT.C. Memo 1983-103; 1983 Tax Ct. Memo LEXIS 682; 45 T.C.M. (CCH) 791; T.C.M. (RIA) 83103; February 17, 1983. 682 V and I were consolidated in 1968. The Commissioner determined deficiencies against V for certain preconsolidation years and against I for certain postconsolidation years. Both V and I filed petitions in this Court. Thereafter, V filed a petition in bankruptcy and was adjudicated a bankrupt. The IRS filed a proof of claim in the bankruptcy proceeding including the deficiencies determined against V and I. The IRS claim was allowed in full. The determination of the bankruptcy court was not appealed and has become final. Held, the prior determination of the bankruptcy court effectively disposed of all of the issues in the Tax Court proceeding against V. Therefore, that case will be dismissed. Comas, Inc. v. Commissioner,23 T.C. 8">23 T.C. 8 (1954), followed. Held, further, I is properly before this Court; since the parties have reached a basis of settlement in that case, the Court will enter a decision in accordance with their settlement. Cyril David Kasmir, for the petitioners. Gary A. Benford, for the respondent. SIMPSONMEMORANDUM OPINION SIMPSON, Judge: The Commissioner determined deficiencies in the petitioners' Federal income taxes as follows: Docket No.PetitionerPeriod EndingDeficiency904-73Valley Die Cast Corporation5/31/65$132,368.315/31/6625,438.495/31/6774,262.001/31/68149,920.286592-74Intercontinental Industries,4/1/67 to 7/31/67886.74Inc. and Consolidated7/31/68483,763.71Subsidiaries7/31/691,029,192.64684 Many of the issues in this case have been settled; but we must now decide what action to take with respect to cross motions for summary judgment in docket No. 904-73 and with respect to the Commissioner's motion for partial summary judgment in docket No. 6592-74. The decision turns on whether this Court has jurisdiction over these dockets.The petitioner, Valley Die Cast Corporation (Valley Die), was a Michigan corporation with its principal office in Detroit, Mich., at the time it filed its petition in this case. Valley Die filed its Federal corporate income tax returns for the taxable years ended May 31, 1965, May 31, 1966, May 31, 1967, and January 31, 1968, with the District Director of Internal Revenue, Detroit, Mich. The petitioner, Intercontinental Industries, Inc. (Intercontinental), was a Delaware corporation with its principal office in Dallas, Tex., at the time it filed its petition in this case. On February 9, 1968, Intercontinental acquired all of the outstanding stock of Valley Die. For its taxable years ending July 31, 1967, July 31, 1968, and July 31, 1969, Intercontinental filed consolidated Federal corporate income tax returns with the District Director of685 Internal Revenue, Dallas, Tex. For the taxable years ending after January 31, 1968, such returns included the income of Valley Die. On November 6, 1972, the Commissioner issued his notice of deficiency to Valley Die; and on February 5, 1973, Valley Die filed a petition with this Court (Docket No. 904-73). On May 3, 1974, the Commissioner issued his notice of deficiency to Intercontinental; and on July 31, 1974, Intercontinental filed a petition with this Court (Docket No. 6592-74). On August 1, 1974, a petition in bankruptcy was filed by or against Valley Die in the U.S. District Court for the Eastern District of Michigan, and on July 25, 1975, Valley Die was adjudicated a bankrupt. On November 3, 1975, the Internal Revenue Service filed a proof of claim in the bankruptcy proceeding. Such proof of claim amounted to $1,909,064.11 and included all of the deficiencies determined in both docket No. 904-73 and docket No. 6592-74 together with FUTA, FICA, and withholding taxes of $13,231.94. Valley Die did not contest its liability in the bankruptcy proceeding, and the IRS claim was allowed in full by the trustee. By an order dated January 30, 1979, the court approved the trustee's686 report and directed him to distribute Valley Die's remaining assets which, at that time, amounted to only $8,099.18. Specifically, the court directed the trustee to pay the IRS a total of $311.46 for withholding and FICA taxes. In June 1979, the estate was closed. The judgment of such court was not appealed and has become final. On July 14, 1982, Valley Die made a timely motion for summary judgment pursuant to Rule 121, Tax Court Rules of Practice and Procedure, wherein it asserts that all of the matters pending before this Court in Docket No. 904-73 have already been determined by the bankruptcy court and are, therefore, not properly before this Court. In opposing such motion, the Commissioner subsequently filed a cross motion for summary judgment, in which he requests that this Court enter a decision against Valley Die for the amounts set forth in the notice of deficiency. The Commissioner has also filed a motion for partial summary judgment in docket No. 6592-74. In such motion, he seeks to establish that all of the issues for the taxable years ended July 31, 1968, and July 31, 1969, were decided in the bankruptcy proceeding and requests that this Court enter a decision687 for the amounts set forth in the notice of deficiency for such years. On September 7, 1982, at a hearing on such motions, the parties informed this Court that they had reached a basis of settlement for all of the issues in docket No. 6592-74. In their motions, the parties have each requested that this Court rule that the doctrine of res judicata applies to preclude our redetermination of the deficiencies pertaining to Valley Die, since the matters were previoiusly determined in the bankruptcy proceeding.A motion for summary judgment is granted only when it is shown that "there is no genuine issue as to any material fact and that a decision may be rendered as a matter of law." Rule 121(b). However, in essence, the petitioner is asking us to hold that we lack jurisdiction to consider the deficiencies determined by the Commissioner in docket No. 904-73 since the bankruptcy court has entered a final judgment with respect to the liability of Valley Die for such deficiencies. Since the petitioner's motion goes to the jurisdiction of the Court, we will consider it first. The jurisdiction of this Court is properly invoked upon the timely filing of a petition (sections 6213, 7442, 688 Internal Revenue Code of 1954), and such jurisdiction remains in force until it is either superseded by an authorized action of another court or is terminated by our entry of decision or dismissal. Comas, Inc. v. Commissioner,23 T.C. 8">23 T.C. 8 (1954); see Dorl v. Commissioner,57 T.C. 720">57 T.C. 720 (1972), affd. 507 F. 2d 406 (2d Cir. 1974); Main-Hammond Land Trust v. Commissioner,17 T.C. 942">17 T.C. 942 (1951), affd. 200 F. 2d 308 (6th Cir. 1952). Where the jurisdiction of the Tax Court and another court is concurrent, the applicable rule is that the court first reaching the cause on its calendar may proceed to decide the matter. See Ohio Steel Foundry Co. v. United States,69 Ct. Cl. 158">69 Ct. Cl. 158, 38 F.2d 144">38 F. 2d 144, 150 (1930); Fotochrome, Inc. v. Commissioner,57 T.C. 842">57 T.C. 842, 847 (1972); Comas, Inc. v. Commissioner,supra at 10-11; Ellis v. Commissioner,14 T.C. 484">14 T.C. 484, 487 (1950); see generally Camp v. United States,44 F. 2d 126, 129 (4th Cir. 1930). Specifically with respect to bankruptcy matters, where a taxpayer filed a petition in bankruptcy after having689 filed a petition in this Court, the Tax Court and the bankruptcy court had concurrent jurisdiction to redetermine the deficiencies before the 1978 changes in the bankruptcy law. 11 U.S.C. sec. 362(a)(8), An Act of Nov. 6, 1978, Pub. L. 95-598, 92 Stat. 2570. 1Fotochrome, Inc. v. Commissioner,supra;Comas, Inc. v. Commissioner,supra;Missouri Pacific Railroad Co. v. Commissioner,30 B.T.A. 587">30 B.T.A. 587 (1934); Plains Buying and Selling Association v. Commissioner,5 B.T.A. 1147">5 B.T.A. 1147 (1927); accord In Re Fotochrome, Inc.,346 F. Supp. 958">346 F. Supp. 958 (E.D.N.Y. 1972).Since the bankruptcy proceeding involving the petitioner was commenced before October 1, 1979, the 1978 changes in the bankruptcy law are not applicable in this case. An Act of Nov. 6, 1978, Pub. L. 95-598, sec. 402(a), 92 Stat. 2682. 690 In Comas, Inc. v. Commissioner,supra, we had to decide whether we had jurisdiction to redetermine a deficiency on facts strikingly similar to those in the present case. In Comas, the petitioner had also filed a petition in bankruptcy after filing a petition in the Tax Court. Thereafter, the IRS filed a proof of claim in the bankruptcy proceeding which was allowed in full. As in the present case, the claims against the bankrupt far exceeded the assets available for distribution, and the IRS received but a fraction of the amount allowed by the court. In discussing the effect of the bankruptcy proceeding, the Court observed: "since the judgment of the bankruptcy court has become final, we think such judgment effected a final disposition of all questions before us and rendered the instant proceeding of no avail." 23 T.C. at 11. The Court also considered that the statute specifically established the procedures for collecting any unpaid portion of a claim allowed in bankruptcy. For such reasons, the Court dismissed the case. We find Comas to be controlling with respect to the question of our jurisdiction in docket No. 904-73. The allowance*691 of the proof of claim filed by the IRS with respect to the liability of Valley Die in docket No. 904-73 effected a valid determination of the existence and amount of such claim, and it would serve no useful purpose for this Court to consider such matter anew. Accordingly, we will dismiss the proceeding in docket No. 904-73. In view of that action, we will deny the Commissioner's cross motion for summary judgment in such docket. Since we have concluded that we have no jurisdiction over the matters considered and adjudicated by the bankruptcy court with respect to Valley Die, we will also deny the Commissioner's motion for partial summary judgment in docket No. 6592-74. However, since the bankruptcy proceeding did not concern the tax liability of Intercontinental, we do have jurisdiction to consider the tax liabilities of that company. As the parties have agreed to settle all of the issues in docket No. 6592-74, we will abide by the terms of such settlement. To reflect these conclusions, In docket No. 904-73, an order dismissing the case will be entered.In docket No. 6592-74, decision will be entered under Rule 155.Footnotes1. Under the 1978 changes in the bankruptcy law, the filing of a petition in bankruptcy causes an automatic stay of institution or continuation of a proceeding before the Tax Court concerning the debtor. 11 U.S.C. sec. 362(a)(8), An Act of Nov. 6, 1978, Pub. L. 95-598, 92 Stat. 2570; see also Bankruptcy Tax Act of 1980, Pub. L. 96-589, 94 Stat. 3409. The new law allows the bankruptcy judge to lift the stay and permit the debtor to litigate in the Tax Court. 11 U.S.C. sec. 362(d). If such stay is not lifted by the bankruptcy court, and if it decides the tax liabilities, all parties will be bound by its decision. See Bankruptcy Tax Act of 1980, Pub. L. 96-589, 94 Stat. 3409; sec. 6871, I.R.C. 1954↩.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625506/	SALLY MARILYN GARST TRUST, JOHN CHRYSTAL, TRUSTEE, AND SALLY MARILYN GARST HAERR, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, RespondentGarst Trust v. CommissionerDocket No. 11024-86.United States Tax CourtT.C. Memo 1987-177; 1987 Tax Ct. Memo LEXIS 172; 53 T.C.M. (CCH) 506; T.C.M. (RIA) 87177; April 1, 1987. 172 R determined deficiencies against a trust, directing the notices of deficiency to the trustee (T). The trust had terminated and all assets had been distributed to the beneficiary (B) prior to the issuance of the notices of deficiency. A timely petition was filed on behalf of the trust by T and B and by B individually. Held, the trust as a nonexistent party cannot litigate before this Court. Thus, neither T nor B can file a petition on behalf of the trust. Held further, that B cannot file a petition in her individual capacity since no notice of deficiency or notice of liability was issued to her. Held further, that this matter is dismissed for lack of jurisdiction. Frank J. Carroll, for the petitioners. Julie Tamuleviz and Rogelio A. Villageliu, for the respondent. FEATHERSTONMEMORANDUM OPINION FEATHERSTON, Judge: This case was assigned to Special Trial Judge Peter J. Panuthos for the purpose of hearing, consideration and ruling on respondent's Motion to Dismiss for Lack of Jurisdiction as to the Petitioner Sally Marilyn Garst Haerr and to Change Caption. 1 After a review of the record, we agree with and adopt his opinion which is set forth below. OPINION OF SPECIAL TRIAL JUDGE PANUTHOS, Special Trial Judge: This matter came before the Court on respondent's175 Motion to Dismiss for Lack of Jurisdiction as to the Petitioner Sally Marilyn Garst Haerr and to Change Caption. Two notices of deficiency were issued on January 30, 1986. One notice relates to the taxable years 1974 and 1975 and the other notice concerns the taxable years 1977 through 1979. The notices were addressed to and determined deficiencies as follows: The Sally Marilyn Garst Trust, John Chrystal, Trustee, c/o Iowa Savings Bank, P.O. Box 75, Coon Rapids, Iowa 50058 YearDeficiency1974$574.001975$4,303.001977$37,758.001978$8,173.001979$15.00A timely petition was filed from both notices of deficiency on April 24, 1986 on behalf of the trust by the trustee and Sally Marilyn Garst Haerr, and by Sally Marilyn Garst Haerr, individually (hereinafter Haerr), the sole beneficiary and distributee of the trust assets. 2 The petition is executed by counsel on behalf of both petitioners. Respondent's motion is premised on the theory that Haerr does not have176 the authority to litigate on behalf of the trust and has no cause of action individually because no liability has been asserted against her. The parties agree that for purposes of the pending motion, the trust was terminated prior to the issuance of the notices of deficiency. In light of this agreement, the Court raised the issue of whether the trust has capacity to commence and maintain an action in this Court. The Court ordered the parties to file Memorandum Briefs on the issues of (1) whether the trustee may litigate this case on behalf of the trust and (2) whether Haerr may litigate this case either individually or on behalf of the trust. The capacity of a fiduciary or other representative to litigate in this Court must be determined according to the law of the jurisdiction from which he derives his authority. Rule 60(c). The parties agree that there is no Iowa law authorizing a trustee to litigate on behalf of a trust after its termination. However, petitioners point to the Restatement of Trusts for the position that when the time for termination of a trust arrives, the trustee has such powers and duties as are appropriate for winding up the trust. 1 Restatement, Trusts 2d, section 344177 (1957). However, comment A to section 344 states that "the period for winding up a trust is the period after the time for termination of the trust has arrived and before the trust is terminated by the distribution of the trust property." Here, the parties agree that all trust property was distributed to Haerr on December 30, 1983. 3 Thus, any "winding up powers" the trustee had, ceased on December 30, 1983. It is a fundamental prerequisite to the existence of a trust that there be a trust corpus consisting of real or personal property. 1 Restatement, Trusts 2d, section 74 (1957). Here, because all trust property has been distributed to the beneficiary, the trust has ceased to exist. A trust which has ceased to exist, no longer possesses the capacity to litigate. Harold Patz Trust v. Commissioner,69 T.C. 497">69 T.C. 497, 501 (1977); Main-Hammond Land Trust v. Commissioner,17 T.C. 942">17 T.C. 942 (1951),178 affd. 200 F.2d 308">200 F.2d 308 (6th Cir. 1952); Fancy Hill Coal Works v. Commissioner,2 B.T.A. 142">2 B.T.A. 142 (1925). "The Tax Court has no jurisdiction to entertain a proceeding purporting to be brought by a nonexistent party." Harold Patz Trust v. Commissioner,supra at 501; National Committee to Secure Justice in the Rosenberg Case v. Commissioner,27 T.C. 837">27 T.C. 837, 839 (1957). 4Petitioners acknowledge that there is no Iowa law authorizing a beneficiary to litigate on behalf of a trust. But, they argue, based on the Restatement of Trusts, that if the trustee does not have the capacity to litigate, then Haerr may litigate this case if necessary to protect her interest. See 2 Restatement, Trusts 2d, section 282(3) (1957). We find that inasmuch as all trust property has been distributed and the trust terminated, Haerr no longer has an interest in the trust to protect. Thus, she does not have179 the capacity to litigate on behalf of the trust. Nor may Haerr maintain this action in her own behalf. Petitioners argue that since Haerr is contractually obligated to pay any tax liability asserted against the trust and since she is the sole transferee of the trust assets, she is a proper party to litigate this matter. 5 This Court has limited authority and may exercise jurisdiction only to the extent expressly provided by Congress. Section 7442; Kluger v. Commissioner,83 T.C. 309">83 T.C. 309 (1984). Our jurisdiction is premised upon the issuance of a notice of deficiency or notice of liability and the filing of a timely petition by the taxpayer. Sections 6212, 6213, and 6901; Medeiros v. Commissioner,77 T.C. 1255">77 T.C. 1255, 1260 (1981); Rule 13(a). In this case, no notice of deficiency or notice of liability has been issued by respondent to Haerr. We conclude that neither the trustee nor Haerr may petition this Court on behalf of the trust. Nor may Haerr petition this Court in her own behalf in this matter. 180 For the reasons stated herein, respondent's Motion to Dismiss for Lack of Jurisdiction as to Petitioner Sally Marilyn Garst Haerr and to Change Caption, will be granted, in that, this matter is dismissed for lack of jurisdiction as to Sally Marilyn Garst Haerr; this case is also dismissed, sua sponte, for lack of jurisdiction as to the Sally Marilyn Garst Trust. 6An appropriate order will be entered.Footnotes1. This case was assigned pursuant to section 7456 (redesignated as section 7443A by the Tax Reform Act of 1986, Pub. L. 99-514, section 1556, 100 Stat. 2755) and Rule 180. All section references are to the Internal Revenue Code of 1954, as amended, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩2. At the time of filing the petition herein, the beneficiary resided at 761 42nd Avenue, San Francisco, California. From the record, it is not clear where the trustee resided.↩3. Under the definition in comment A of the Restatement, the period for winding up the affairs of this trust was February 14, 1983 (the time for termination of the trust) to December 30, 1983 (the date the trust was terminated by distribution of all trust property).↩4. We have similarly ruled that a dissolved corporation does not have capacity to file a petition under Rule 60(c). Bloomington Transmission Services v. Commissioner,87 T.C. 586">87 T.C. 586↩ (1986).5. By an instrument dated December 30, 1983, Sally Marilyn Garst Haerr agreed to "pay any and all taxes * * assigned or billed to the trust."↩6. Dismissal of this proceeding will not necessarily deprive the trustee or Haerr from a determination of the merits of the liability if respondent proceeds against them under sections 6901 through 6903.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625509/	ARNOLD I. KRAMER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentKramer v. CommissionerDocket No. 42548-85.United States Tax CourtT.C. Memo 1989-565; 1989 Tax Ct. Memo LEXIS 578; 58 T.C.M. (CCH) 398; T.C.M. (RIA) 89565; October 19, 1989. Joseph D. Wolgel and Sharon Kramer, for the petitioner. James M. Cascino, for the respondent. WOLFEMEMORANDUM FINDINGS OF FACT AND OPINION WOLFE, Special Trial Judge: This case is before the Court on petitioner's motion for order to bar use of deficiency notice and respondent's notice of objection thereto. 1In the deficiency notice dated August 29, 1985, respondent determined deficiencies in, and additions to, tax as follows: Additions To TaxYearDeficiencySection 6653(a)Section 6651(a)(1)1976$101,585$5,079 $25,396 197747,0672,35311,7671978174,2708,71443,56819796,0983051,525579 Petitioner contends that the deficiency notice is invalid on its face and that respondent's failure to follow his own administrative procedures amounts to unconstitutional conduct by respondent. FINDINGS OF FACT Petitioner was a resident of Evanston, Illinois, when he filed the petition in this case. Prior to issuance of the deficiency notice in this case, in April of 1979, Berle Littman (Agent Littman), a special agent for the Criminal Investigation Division of the IRS, began an investigation of petitioner's tax liability. Agent Littman conducted his investigation in conjunction with Carl Humowiecki (Agent Humowiecki), a revenue agent specially assigned to the criminal division. In the course of their investigation, both agents met with petitioner on several occasions to request documentation of his income and expenses. Because petitioner, an attorney with an accounting degree, was uncooperative, they obtained most of their information from summonses issued to banks in which petitioner had accounts. Following this investigation, in August of 1981, Agent Humowiecki completed preparation of a revenue agent report (1981 RAR) with respect to petitioner's income, expenses and580 tax liability for the years 1976 through 1979. In August of 1982, attorneys from the Criminal Section of the Department of Justice met with petitioner's representatives as part of their process of evaluating petitioner's case for criminal prosecution. The purpose of the meeting was to allow petitioner to present any evidence or defenses on his behalf. Petitioner's representatives alleged that petitioner had net operating losses from prior years which could be carried forward to eliminate his tax liability. They were unable to document these losses and admitted that they had been trying unsuccessfully for three years to obtain the documentation from petitioner. Petitioner filed his tax returns for 1976 through 1979 in September of 1983. The gross income figures on these returns were greatly in excess of the amounts in the 1981 RAR but because of higher deductions and net operating loss carryovers, the returns reflected no tax liability. The gross income indicated on the 1981 RAR and the tax return as filed is as follows: Gross Incomeper 1981 RARper return1976$215,766$494,7161977137,585259,1861978287,5681,076,915197951,374980,711581 In December of 1983, petitioner was convicted of four counts of wilfully failing to file timely income tax returns for the years 1976 through 1979 and one count of filing a false document. In February of 1984, petitioner was sentenced to four consecutive one year prison terms and five years probation and was fined $10,000. After a hearing, the Parole Commission classified petitioner as a "Category 5," a parole classification which includes tax offenses in which "the amount of the tax evaded or evasion attempted is more than $100,000 but not more than $500,000." 28 C.F.R. sec. 2.20-501(b). Pursuant to Category 5 guidelines, the Parole Commission recommended that petitioner serve 36 months before parole. After petitioner's conviction, Nathaniel White (Agent White), an employee of the Chicago District Examination Division of the IRS, was assigned petitioner's file to determine petitioner's civil tax liability. Agent White reviewed the 1981 RAR and other exhibits in petitioner's file. He also reviewed the tax returns petitioner filed for 1976 through 1979. Agent White did not allow the net operating losses which petitioner carried forward to his 1976 and 1978 amended returns582 because the returns from which the losses arose never had been signed and respondent did not consider them valid returns. Agent White's government time sheets indicate that he spent 67 hours working on petitioner's file between June 10, 1985 and August 2, 1985. During the second or third week in August of 1985, Philip Turner (Turner), the Assistant U.S. Attorney who prosecuted petitioner's criminal case, called Agent White's supervisor to request that he expedite the mailing of petitioner's deficiency notice. Turner wanted the deficiency notice to be issued by August 29, 1985, so that it would be available at the hearing on petitioner's motions attacking the basis for his sentencing. On August 28, 1985, petitioner's case file was sent to Michael Gibbons (Gibbons) so that he could process the notice of deficiency. Because Agent White had made no changes to the 1981 RAR, the figures in this report were used in the notice of deficiency. Gibbons' staff prepared, typed and proofread the deficiency notice and it was issued on August 29, 1985. After his sentencing petitioner conducted extended litigation to challenge his conviction, sentence, and parole decision. Much of this litigation583 is summarized in Kramer v. Jenkins,803 F.2d 896">803 F.2d 896 (7th Cir. 1986). In that case the Court of Appeals upheld the Parole Commissioner's treating the deficiency notice as conclusive evidence of petitioner's tax liability in determining petitioner's eligibility for parole. The Court of Appeals stated (page 901) that "The IRS offers taxpayers an opportunity to discuss and present evidence on tax liability before it issues a deficiency notice" and that "This opportunity to be heard is at least as much as the Constitution demands for parole factfinding." On petition for rehearing, in Kramer v. Jenkins,806 F.2d 140">806 F.2d 140, 141 (7th Cir. 1986), the Court of Appeals remanded to the District Court to "allow Kramer to prove, if he can, that he did not have an opportunity to present his contentions to the IRS 'at a meaningful time and in a meaningful manner.'" On remand, the District Court found that respondent gave petitioner a meaningful opportunity to be heard prior to the issuance of the deficiency notice. Kramer v. Jenkins, No. 85 C 9926 (N.D. Ill., Feb. 13, 1987), affd. without published opinion 860 F.2d 1082">860 F.2d 1082 (7th Cir. 1988). The District Court584 stated that (slip op. at p.10): Although the IRS did not issue a thirty-day letter, it contacted Kramer many times over a period of years, made countless request for documents, and has always, even up to the present date, been ready and willing to receive the much talked about, but never produced, exculpating documents. Therefore, the court finds that the procedures the IRS actually used afforded Kramer the process due him.The District Court's denial of petitioner's petition for a writ of habeas corpus was affirmed by the Court of Appeals. OPINION In the present deficiency proceedings, petitioner seeks to bar respondent from using the statutory notice. Petitioner contends that respondent's failure to issue a 30-day letter or provide an administrative hearing as provided in the Statement on Procedural Rules sections 601.105 and 601.106 and the expedited issuance of the deficiency notice at Turner's request amount to unconstitutional conduct by respondent. Petitioner also contends that the deficiency notice is invalid on it face. Petitioner asks us to consider the conduct and motives of respondent in preparing and issuing the deficiency notice. As a general rule, this585 Court will not look behind a deficiency notice to examine the evidence used or the propriety of respondent's motives or of the administrative policy or procedure involved in making his determinations. Greenberg's Express, Inc. v. Commissioner,62 T.C. 324">62 T.C. 324, 327 (1974); Raheja v. Commissioner,725 F.2d 64">725 F.2d 64, 66 (7th Cir. 1984), affg. a Memorandum Opinion of this Court; Vallone v. Commissioner,88 T.C. 794">88 T.C. 794, 806 (1987); Jackson v. Commissioner,73 T.C. 394">73 T.C. 394, 400 (1979). The rationale for this rule is that a trial before the Tax Court is a proceeding de novo. Raheja v. Commissioner,supra at 66. An exception is made on occasion when there is substantial evidence of unconstitutional conduct by respondent in connection with the determination of a deficiency. Frazier v. Commissioner,91 T.C. 1">91 T.C. 1, 9 (1988); Greenberg's Express, Inc. v. Commissioner,supra at 328. If in "looking behind" the deficiency notice we find that respondent did not have sufficient information to make a determination, the notice will not be afforded the usual presumption of correctness. Respondent586 then would have the burden of going forward with the evidence. Jackson v. Commissioner,supra at 401. As indicated below, in the present case petitioner has not shown sufficient evidence of unconstitutional conduct to warrant our looking behind the deficiency notice. On the record here, even if we were to look behind the deficiency notice, respondent plainly did have sufficient information to make a determination of petitioner's tax liability. Respondent did not violate petitioner's due process rights by failing to follow the rules set forth in the Statement of Procedural Rules. These rules are issued by the Commissioner without the need for approval by the Secretary. The rules serve merely as guidelines for the conduct of the internal affairs of the Internal Revenue Service. The authority of the Commissioner to issue such rules derives from 5 U.S.C. section 301 (1982) which authorizes him to promulgate rules "for the government of his department, the conduct of its employees, the distribution and performance of its business, and the custody, use, and preservation of its records, papers, and property." These procedural rules are directory587 and not mandatory in nature and do not confer any rights upon petitioner. Boulez v. Commissioner,810 F.2d 209">810 F.2d 209, 214-215 (D.C. Cir. 1987), affg. 76 T.C. 209">76 T.C. 209 (1981); Cleveland Trust Co. v. United States,421 F.2d 475">421 F.2d 475, 481-482 (6th Cir. 1970). Petitioner was not prejudiced by the absence of a formal administrative review. Petitioner has had the opportunity since 1979, when the criminal investigation began, to present evidence of his tax liability. Petitioner or his representatives had numerous meetings with respondent's agents. The testimony of those agents indicates that petitioner was uncooperative and failed to document his claims. Petitioner testified before the District Court that he provided criminal investigators with all relevant documents and that there were no other documents which he wished to offer on the issue of his tax liability. We see no merit in petitioner's contention that his due process rights were violated when the issuance of the deficiency notice was expedited. The deficiency notice was prepared from the 1981 RAR. Agent White spent 67 hours reviewing the 1981 RAR and the other information in petitioner's588 file before the deficiency notice was issued. There is no indication that petitioner provided any new evidence after the 1981 RAR had been prepared other than the tax returns for 1976 through 1979 which he filed in 1983. These returns are petitioner's self-serving and unsubstantiated statements of his tax liability, and Agent White examined them in the course of preparing the deficiency notice. According to White's supervisor once an RAR is in a taxpayer's file, the notice of deficiency can be prepared in four to eight hours. Assistant U.S. Attorney Turner did not suggest the figures to be used in the deficiency notice nor the manner in which it was to be prepared. Under these circumstances we are not persuaded that respondent's agents acted improperly in issuing the notice of deficiency, or that they would have determined a different tax liability for petitioner had they acted less swiftly. Petitioner relies on Scar v. Commissioner,814 F.2d 1363">814 F.2d 1363 (9th Cir. 1987), revg. 81 T.C. 855">81 T.C. 855 (1983). We find the holding in Scar inapplicable to the facts in this case. In Scar, respondent conceded that the tax shelter referred to in the deficiency notice589 had no connection to the taxpayers or their returns and that the notice was invalid on its face. The Court of Appeals held that respondent must determine a deficiency with respect to the particular taxpayer to whom the notice is issued. In the present case the determinations set forth in the notice of deficiency were made with respect to petitioner. The notice of deficiency is valid on its face. Neither the Internal Revenue Code nor the regulations specify the form required for a valid notice of deficiency. Foster v. Commissioner,80 T.C. 34">80 T.C. 34, 229 (1983), affd. in part and vacated in part 756 F.2d 1430">756 F.2d 1430 (9th Cir. 1985). The notice must at least indicate that the Commissioner has determined a deficiency for a particular year and specify the amount of the deficiency. Benzvi v. Commissioner,787 F.2d 1541">787 F.2d 1541, 1542 (11th Cir. 1986), affg. an order of this Court. The deficiency notice in this case meets those requirements. Although the deficiency was not determined from the returns which petitioner filed in 1983, respondent did not act unreasonably in failing to rely on those returns. The gross income figures in petitioner's returns were590 substantially higher than the amounts in the 1981 RAR. Respondent chose to rely on the lower income and expense figures in the 1981 RAR rather than using petitioner's gross income figures and disallowing his higher, but undocumented, loss and expense figures. Respondent's personnel reviewed the tax returns and much other information concerning petitioner's income, which they had ascertained through summonses issued to banks in which petitioner had accounts and through other investigation. They afforded him many opportunities to discuss his income and expenses and to provide documentation. Respondent served a valid deficiency notice on petitioner. Petitioner has had the opportunity to request a prompt trial before this Court to determine his tax liability. At the hearing on this motion the Court repeatedly asked petitioner whether he wished an expedited trial with respect to his taxes for 1976-1979, but petitioner declined these offers. We conclude that petitioner's motion should be denied and that his case should proceed to trial in due course. An appropriate order will be entered.Footnotes1. This case was assigned pursuant to section 7443A and Rule 180 et seq. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954, as amended, and as in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4477210/	OPINION. Opper, Judge: Respondent determined a deficiency of $7,038.25 in estate tax for the Estate of Herman Hohensee, Sr., deceased. Petitioner claims an overpayment of $5,686.63. The first issue presented is whether the contribution of property to an inter vivos trust, jointly created by decedent and his wife, and the retention of certain income interests therein, require inclusion of any part of the corpus in his gross estate, and if so, what part. If includible, there are further issues of whether the estate is entitled to the marital deduction, and whether certain charitable bequests are deductible. Herman Hohensee, Sr., hereafter sometimes referred to as decedent, died on November 10,1949. His widow, Anne, hereafter referred to as his wife, has already been discharged as executrix under decedent’s will. She was appointed special administratrix for the purpose of prosecuting this proceeding. All facts, other than that last stated, have been stipulated and are hereby found. A Federal estate tax return was filed on November 15, 1950, with the collector of internal revenue for the district of Wisconsin, disclosing liability of $5,686.63. On May 1, 1933, decedent and his wife, as settlors, transferred certain property to an irrevocable trust, their three children to act as trustees. The settlors were each to receive one-half of the income for life, with the entire income to the survivor for the remainder of his or her life. The remainder at the death of the surviving settlor was to go to the three children or their issue. This trust was still in effect at the time of decedent’s death. Upon its creation, decedent transferred to the trust a tract of land located in Milwaukee County, Wisconsin, having a fair market value on November 10, 1949, of $17,500. This property had been owned just prior to the transfer solely by decedent. On November 10,1949, it was still a part of the trust. At the same time, each settlor transferred to the trust 160 shares of $100-par-value stock of Herman Hohensee, Inc., a Wisconsin corporation. At decedent’s death, 160 shares of this stock had a fair market value of $88,443.20. At that time all 320 shares originally transferred to the trust were still part of the corpus. On November 10, 1949, the total value of property transferred to the trust by decedent was $105,943.20, and by his wife $88,443.20, making the total amount $194,386.40. The wife was 83 years of age at decedent’s death. On that date, the present value of the right to the entire income of an $8,750 portion of the trust corpus for the remainder of the expected life of the wife was $1,043.08. The present value on that date of the right to receive the entire income on a $105,943.20 portion of the corpus for the remainder of the wife’s expected life was $12,629.45. Decedent’s last will and testament provided for distribution of the entire residue of the general estate to his wife, after three charitable and religious bequests totaling $900. On December 2,1949, the will was admitted to probate in the County Court of Milwaukee County, Wisconsin. The general estate of decedent, subject to administration, consisted only of the following assets: Stocks and bonds-$1,810.27 Cash_ 15,482.00 Miscellaneous property- 1,566.48 Total assets in tbe estate subject to probate-$18,858.75 If the expenses of administration, debts of the deceased, widow’s allowance, Wisconsin inheritance tax, and Federal estate tax, as asserted, bad been paid out of the general estate, the assets would have been insufficient to pay all claims, and there would be nothing remaining for the payment of bequests or for distribution to the surviving spouse. On November 27,1950, the final account was filed with the County Court. On April 4, 1951, a supplemental final account was filed. The trust advanced to the general estate the sum of $5,686.63. The trust also advanced for the payment of Wisconsin State inheritance tax and attorneys’ fees and disbursements the sum of $4,853.80. These sums are shown in the final account and supplemental final account as follows: Final Account Monies advanced on behalf of heirs-at-law of decedent on account of Federal estate tax_$5,686.63 Supplemental Final Account Monies advanced by heirs-at-law on account of Wisconsin State inheritance tax- 2,700. 00 Monies advanced by heirs-at-law of decedent on account of additional Wisconsin State inheritance tax_ 152.30 Monies advanced by heirs-at-law of decedent on account of attorneys’ fees and disbursements_ 2,001.50 By reason of these advancements, the general estate had sufficient funds to make the disbursements outlined in the final account and supplemental final account, and to leave $8,818.70 for distribution to the wife under the residuary clause of the will. On November 4, 1953, the wife, as special administratrix, filed a claim for refund of the entire $5,686.63 with the director of internal revenue at Milwaukee, Wisconsin. Respondent disallowed the deduction of $900 claimed in the return as charitable and religious bequests. In computing its estate tax petitioner claimed a marital deduction under section 812 (e), Internal Revenue Code of 1939, of $34,367.94. This aggregate amount is made up of the following items: 1. Assets of the general probate estate_$18,858.75 2. Life insurance proceeds payable to surviving spouse_ 5,675.18 8. Jointly owned property_. 287. 50 4. Value of the life interest of surviving spouse in the property transferred by decedent to the trust_ 12,063.17 Total properties passing to surviving spouse_$36,884.60 Less: Federal estate tax and other death taxes payable out of the above-listed properties_ 2,516.66 Claimed marital deduction-$34,367.94 Respondent has disallowed in the computation of the marital deduction items 1 and 4. The general estate was liable for the following expenses, debts, and taxes > Funeral and administration expenses_ $3,433.03 Debts of decedent_ 381.45 Widow’s allowance- 5,500.00 State inheritance tax_ 2,852.30 Federal estate tax (not less than)1 _:_ 11,162.53 Total_$23,329.31 Decedent owned a fee simple interest in real estate valued at $17,500. From it he carved out, by means of a trust, an estate in one half for the life of another. What remained — everything else — he voluntarily divided into two parts: That which would exist during his life; and that which would take effect only after his death. He retained all of the first part and parted only with all of the second part. At first blush,'an action more testamentary in nature is difficult to conceive. See Commissioner v. Church's Estate, 335 U. S. 632. The part which he retained constituted, in effect, a life estate in one half and a reversionary life estate in the remainder after the prior estate for his wife’s life. As of the date of the transfer it was impossible to tell how much decedent would get without knowing when he would die — in other words, a time not ascertainable without reference to his death. This retained interest, in fact, yielded him less than it might have because of the circumstance that he predeceased his wife. See Helvering v. Hallock, 309 U. S. 106. But in prospect, when the trust was created, any contingency merely contributed to the question of valuation. The value of the transfer for estate tax purposes is determined by reducing the value of the transferred property by the amount of the outstanding income interest1 in the wife. Estate of Milton J. Budlong, 7 T. C. 756, 764, reversed' other issues sub nom. Industrial Trust Co. v. Commissioner, (C. A. 1) 165 F. 2d 142. If there were doubt about the correctness of this construction of section 811 (c), Internal Bevenue Code of 1939, it should be completely dispelled by the committee reports in connection with the Technical Changes Act of 1949.2 This decedent died after the enactment of that, legislation. In reenacting section 811 (c) so as to apply in full to transfers after June 7, 1932 (which this was), the Conference Committee states explicitly: “The expression ‘not ascertainable without reference to his death’ as used in section 811 (c) (1) (B) * * * includes the right to receive the income from transferred property after the death of another person who in fact survived the transferor * * (Conf. Kept. No. 1412,81st Cong., 1st Sess. (1949). Emphasis added.) The committee réport does not make it clear whether the enacting Congress considered this to be a change from existing law. Nor are we required to speculate in this respect. But one thing is certain. Section 811 (c) either applied to this situation from its original enactment in 1932, or it was changed in 1949 to include it. If the Technical Changes Act worked a change from the previous statutory provision, then Estate of Charles Curie, 4 T. C. 1175, even if correct under the law as it then stood, would not govern the present situation in view of the change in the legislation after the decedent in the Curie case died. On either approach, the present decedent’s reservation of a sec-: ondary life estate was a testamentary disposition covered by a section 811 (c). Into the same trust and at the same time, petitioner transferred personal property valued at $88,443.20. This was exactly matched by an equal contribution to the same trust by his wife. The income was to be shared with a residuary life estate to the survivor. Whether these are treated as reciprocal trusts, see Lehman v. Commissioner, (C. A. 2) 109 F. 2d 99, certiorari denied 310 U. S. 637, or as separable trusts in which the income of the property contributed by petitioner was reserved to himself for life, see sec. 811 (c) (1) (B); Claire Giannini Hoffman, 2 T. C. 1160, 1185, affd. (C. A. 9) 148 F. 2d 285, certiorari denied 326 U. S. 730; Estate of Henry H. Scholler, 44 B. T. A. 235, the result that the value of the personal property is includible in his estate seems inescapable. Petitioner’s reliance upon Guggenheim v. United States, (Ct. Cl., 1953) 116 F. Supp. 880, seems to us misplaced. That case dealt only with, section 811 (c) (1) (C)3 and with the 5 per cent provision which is applicable only to that subsection. That the present situation cannot be forced into the area covered by section 811 (c) (1) (C) is apparent, not only by the express language of subdivision (c) (1) (B), which does include this situation, but by the prohibition of section 811 (c) (2) that “reversionary interest” within the meaning of the 5 per cent provision does not include a possibility “that the income alone from such property may return to him,” a precise description of what would have happened under this decedent’s transfer. Since, as we have said, the situation falls squarely within subdivision (B) and is ruled out of subdivision (C), only the provisions of the former are relevant. In the alternative, there is a contention that the widow’s interest in the trust entitles the estate to the marital deduction. Sec. 812 (e), I. R. C. 1939. But it seems clear that as to her share there was such a terminable interest that no marital deduction is permissible. Estate of Louis B. Hoffenberg, 22 T. C. 1185, affirmed per curiam (C. A. 2) 223 F. 2d 470; Estate of Frank E. Tingley, 22 T. C. 402, affirmed sub nom. Starrett v. Commissioner, (C. A. 1) 223 F. 2d 163. Nor was there any residuary estate left out of which the widow could secure any bequest “from the decedent”4 and hence enable the estate to claim the marital deduction as to this portion. The facts show that expenses and taxes- more than consume the entire value of the estate actually left at death. True, certain sums were distributed to the widow but these are shown to have been made possible only by contributions on the part of the trust, or of decedent’s “heirs-at-law,” presumably the children who were also trustees and remain-dermen under the trust. The widow did not receive these sums from the decedent 5 and if debts, expenses, and taxes reduce the residuary legacy to nothing, the legatee is not considered to have received anything from the estate. Rogan v. Taylor, (C. A. 9) 136 F. 2d 598. No contention that the tax should be apportioned between the trust and the residuary estate is permissible under the law of Wisconsin, In re Uihlein's Will, 264 Wis. 362, 59 N. W. 2d 641, 648, which is determinative of the matter. Riggs v. del Drago, 317 U. S. 95. By reasoning similar to that used in considering the marital deduction, the deduction claimed for charitable bequests 6 must be denied. The assets subject to probate are exhausted in payment of debts, expenses, and taxes, including Federal estate taxes. Insurance proceeds payable directly to the widow are not part of the estate, see Hutson v. Jenson, 110 Wis. 26, 38, 85 N. W. 689, and the value of jointly held property is tod insignificant to affect the result. There are no assets in the estate available to pay charitable bequests. See Rogan v. Taylor, supra. Reviewed by the Court. Decision will be entered for the respondent. Omitting disallowance of both the marital deduction for the general estate and the charitable deduction. The deficiency has been determined by that approach; reduction was made to the extent of $1,043.08, present value at decedent’s death of the widow’s right to income for life In the one-half interest amounting to $8,730. SEC. 7. TRANSFERS TAKING EFFECT AT DEATH. (a), Section 811 (c) of the Internal Revenue Code (relating to transfers In contemplation of or taking effect at death) Is hereby amended to read as follows: "(c) Transfers in Contemplation of, oh Taking Effect at, Death.— “(1) General RULE. — To the extent of any interest therein of which the decedent has at any time made a transfer (except In case of a bona fide sale for an adequate and full consideration In money or money’s worth), by trust or otherwise— **»»• “(B) 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 hie death (1) the possession or enjoyment of, or the right to the Income from, the property, or (ii) the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom; or "(C) intended to take effect in possession or enjoyment at or after Ms death.” ••• (b) The amendment made by subsection (a) shall be applicable with respect to estates of decedents dying after February 10, 1039. The provisions of section 811 (c) of the Internal Revenue Code, as amended by subsection (a), shaU (except as otherwise specifically provided in such section or In the following sentence) apply to transfers made on, before, or after February 26, 1926. The provisions of section 811 (c) (1) (B,) of such code shall not, in the case of a decedent dying prior to January 1,1050, apply to— (1) a transfer made prior to March 4,1931; or (2) a transfer made after March 8, 1931, and prior to June 7, 1932, unless the property transferred would have been includible in the decedent's gross estate by reason of the amendatory language of the joint resolution of March 8, 1931 (46 Stat. 1516). Technical Changes Act of 1949. SEC. 7. TRANSFERS TAKING EFFECT AT DEATH. (a) Section 811 (c) of the Internal Revenue Code (relating to transfers in contemplation of or taking effect at death) is hereby amended to read as follows : “(c) Transfers in Contemplation op, ob Taking Effect at, Death.— “(1) General bule. — 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 fnU consideration in money or money’s worth), by trust or otherwise— ******* “(C) intended to take effect in possession or enjoyment at or after his death. “(2) Transfers taking effect at death — transfers' prior to octobeb 8, 1949.— An interest in property of which the decedent made a transfer, on or before October 7, 1949, intended to take effect in possession or enjoyment at or after his death shall not be included in his gross estate under paragraph (1) (C) of this subsection unless the decedent has retained a reversionary interest in the property, arising by the express terms of the instrument of transfer and not by operation of law, and the value of such reversionary interest immediately before the death of the decedent exceeds 6 per centum of the value of such property. For the purposes of this paragraph, the term ‘rever-sionary interest’ includes a possibility that property transferred by the decedent (A) may return to him or his estate, or (B) may be subject to a power of disposition by him, but such term does not Include a possibility that the income alone from such property may return to him or become subject to a power of disposition by him. The value of a reversionary interest immediately before the death of the decedent shall be determined (without regard to the fact of the decedent’s death) by usual methods of valuation, including the use of tables of mortality and actuarial principles, pursuant to regulations prescribed by the Commissioner with the approval of the Secretary. In determining the value of a possibility that property may be subject to a power of disposition by the decedent, such possibility shall be valued as if it were a possibility that such property may return to the decedent or his estate.” SEC. 812. NET ESTATE. For the purpose of the tax the value of. the net estate shall be determined, in the case of a citizen or resident of the united States by deducting from the value of the gross estate— (e) Bequests, Etc., to Surviving Spouse.— (1) Allowance of marital deduction.— (A) In General. — An amount equal to the value of any interest In property which passes or has passed from the decedent to his surviving spouse, but only to the extent that such interest is included in determining the value of the gross estate. [Emphasis added.] The interest passing to the surviving spouse from the decedent is only such interest as the decedent can give. If the decedent by his will leaves the residue of his estate to the surviving spouse and she pays, or if the estate income is used to pay, claims against the estate so as to increase the residue, such increase in the residue is acquired by purchase and not by bequest. Accordingly, the value of any such additional part of the residue passing to the surviving spouse cannot be included in the amount of the marital deduction. [S. Rept. No. 1013 (Part 2), 80th Cong., 2d Sess. (1948).] SEC. 812. NET ESTATE. For the purpose of the tax the value of the net estate shall be determined, in the case of a citizen or resident of the United States by deducting from the value of the gross estate— * ft ft ft • ft ft (d) Transfers for Public, Charitable, and Religious Uses. — The amount of all bequests * * * to or for the use of any corporation organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, ' *	01-04-2023	01-16-2020
https://www.courtlistener.com/api/rest/v3/opinions/4477211/	OPINION. Rice, Judge: This proceeding involves the following deficiencies in income tax determined by the respondent under the provisions of the 1939 Code: Income tas Tear deficiency 1949_$1,951.48 1950_ 3,11459 1951_ 5,203.77 The sole issue is whether royalties from oil and gas leases and penalties received from mortgage debtors, who prepaid their loans, constitute “rents” and “interest,” respectively, within the meaning of section 201 (c) (1) óf the 1939 Code.1 All of the facts were stipulated, are so found, and are incorporated herein by this reference. Petitioner is a Missouri corporation engaged in the life insurance business as a mutual life insurance company issuing various types of life, health, accident, and sickness insurance policies and annuity contracts. Its principal office is in St. Louis. Petitioner filed its returns for the calendar years in issue with the former collector of internal revenue for the first district of Missouri. During the years in issue, petitioner received the following royalties from the production of oil and gas under leases which it owned in various States: 1949- $44,803.31 1950_ 36,985.11 1951- 38,570.47 In most cases in which penalty payments were received, the notes evidencing the mortgagor’s indebtedness to petitioner recited a specific charge for such prepayment. In other instances, the mortgage notes did not contain such prepayment penalty provisions and, in those cases, the penalty received by petitioner was the result of negotiations between it and the mortgagors. Petitioner did not include the above-mentioned royalties or penalty payments in its gross income for tax purposes during the years in issue. The respondent determined that such sums should have been included. In Pan-American Life Insurance Co., 24 T. C. 901 (1955), we held that royalties on oil and gas leases received by a life insurance company did not constitute “rents” within the meaning of section 201 (c) (1), relying on Campbell v. Great National Life Insurance Company, 219 F. 2d 693 (C. A. 5, 1955). On the authority of those cases, we hold that the respondent erred in determining that the royalties received by the petitioner constituted taxable income to it. The petitioner argues in opposition to the respondent’s determination that the penalty payments received by it from mortgagors who prepaid their mortgage indebtedness constituted taxable interest income, that interest cannot be both compensation paid for the use, detention, or forbearance of money and a consideration paid for the privilege to return money before the indebtedness becomes due and payable. It argues that these concepts are fundamentally inconsistent and, in support of its argument, cites a number of State court decisions which have held that similar penalty payments did not constitute interest within the meaning of State usury statutes. Petitioner also points out that the respondent in Revenue Ruling 55-12, 1955-1 C. B. 259, held that a similar penalty payment did not. meet the definition of interest under section 23 (b) of the Code in order to qualify as a deduction. That ruling states in part: In order for a payment to be deductible as interest, it must’ be made for the use of borrowed money. A payment made for the privilege of prepaying an indebtedness is not one which can be said to be for the use of the borrowed money; it is in the nature of a penalty to gain release from a preexisting con-tractural liability to make payments in the future. Such a payment cannot be classified as a payment of interest within the meaning of section 23 (b) of the Code. This is true whether the payment is made pursuant to a prepayment clause in the original indebtedness agreement or through a negotiated release. * * * In support of his determination that such penalty payments do constitute interest, the respondent argues that this Court is not bound by State court decisions defining interest. He further argues that the penalties paid by mortgagors for prepayment of their indebtedness to petitioner in reality do constitute interest because such penalty payments are simply an additional charge for the use of petitioner’s money for a short period of time, rather than for a longer period as originally agreed upon at the time the money was borrowed; and that the cost of short-term money is generally higher than for long-term. We have examined the legislative history of section 201 (c) (1) but are unable to find any indication as to whether Congress intended to include such penalty payments within the meaning of the word “interest” as used in that section. However, we are persuaded that the respondent’s argument here is right and that the penalties which mortgagors paid to petitioner for the privilege of using its money for a shorter period of time than that for which they originally borrowed the funds constituted, for all practical purposes, an additional interest charge for the use of such money for such shorter period. Clearly, penalty payments are a cost to the borrowers for using petitioner’s money and we are, therefore, satisfied that interest as used in section 201 (c) (1) includes such cost. Our examination of existing authority has not disclosed a case in which the particular issue raised here has been decided; but, we do not believe that Congress intended to restrict the meaning of the word “interest” in section 201 (c) (1) to some narrower interpretation than the meaning which that word has in other sections of the Code. In Seaboard Loan & Savings Association, Inc., 45 B. T. A. 510 (1941), we said that a 2 per cent charge which the taxpayer made for investigating the financial responsibility of its borrowers constituted interest within the meaning of section 353 (a) of the 1936 Kevenue Act, as amended. So also in Bond Auto Loan Corp. v. Commissioner, 153 F. 2d 50 (C. A. 8, 1946), affirming a Memorandum Opinion of this Court dated October 5, 1944, the Court of Appeals said that an “extra hazard charge” which the loan company made in addition to the 8 per cent interest charged, constituted additional interest income to it. Looking beyond the nomenclature used to describe the various charges which lenders made in those cases and here, the common denominator present throughout is that the charges were, in fact, a part of the cost to the borrowers for the use of the lenders’ money. And, being part of such cost, it seems to us that such charges are clearly interest as defined by the Supreme Court in Deputy v. du Pont, 308 U. S. 488 (1940): “In the business world ‘interest on indebtedness’ means compensation for the use or forbearance of money.” See also Old Colony Railroad Co. v. Commissioner, 284 U. S. 552 (1932). We, therefore, hold that the penalty payments which petitioner received from mortgagors constituted interest within the meaning of section 201 (c) (1). In reaching such conclusion we have not commented on Eevenue Ruling 55-12, supra, since it purports to interpret a different section of the Code which deals with deductions from gross income. It might be appropriate to say, however, that consistency would seem to require the word “interest” to mean the same thing throughout the entire Code. Eeviewed by the Court. Decision will be entered under Rule 50. SEC. 201. LIFE INSURANCE COMPANIES. (c) Other Definitions. — In the case of a life Insurance company— (l)i Gross income. — The term “gross Income” means the gross amount of Income received during the taxable year from Interest, dividends, and rents.	01-04-2023	01-16-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625510/	Appeal of WEST VIRGINIA & PENNSYLVANIA COAL & COKE CO.West Virginia & Pennsylvania Coal & Coke Co. v. CommissionerDocket No. 633.United States Board of Tax Appeals1 B.T.A. 790; 1925 BTA LEXIS 2794; March 17, 1925, decided Submitted March 2, 1925. 2794 A deduction of $625 claimed in 1920 for exhaustion of a lease on 65 acres of coal land purchased in 1919 at a cost of $5,000, allowed. Twenty-five per cent depreciation for 1920 allowed by Commissioner on an automobile truck used seven months of that year, approved. A debt which the evidence does not show was determined to be worthless and charged off within the year can not be allowed as a deduction from gross income. Frank A. Willson, C.P.A., for the taxpayer. Ward Loveless, Esq., for the Commissioner. 790 Before GRAUPNER, LANSDON, LITTLETON, and SMITH. This appeal involves income and profits taxes for the calendar year 1920 in the amount of $2,669.40, as set forth in the deficiency letter mailed to the taxpayer on September 29, 1924. 791 FINDINGS OF FACT. Taxpayer is a West Virginia corporation having its principal office at Buckhannon, W. Va., and is engaged in the mining of bituminous coal at Pecks Run, W. Va. The taxpayer was incorporated on April 23, 1919. It kept its books and rendered its returns upon an accrual basis. During 1918, O. S. Talbott, George A. Quertinmont, Gustave Quertinmont, and A. M. Minard purchased2795 a lease of certain mineral rights underlying 65 acres of coal land situate at Pecks Run, W. Va., at a cost of $2,000. During the year 1918, and up to July 22, 1919, these individuals made certain improvements preparatory to commencing operations, such as erecting a tipple, making an opening to the mine, etc. On July 22, 1919, this lease was purchased by taxpayer for $5,000, the consideration being $375 in cash and $4,625 par value of its capital stock. The taxpayer has continuously since July, 1919, mined coal under this lease. The corporation showed an earned surplus at the close of 1919 of $18.92 and at the close of 1920 of $36,439.90. The capital stock of the corporation sold during 1919 and 1920 at par and has at no time sold for less than par. In its return for the year 1920 taxpayer deducted $625 for exhaustion of the lease, basing this deduction upon an estimated life of eight years for the mine covered thereby. The Commisioner, upon an office audit of the return for 1919, disallowed the claimed deduction of $625 upon the ground that the lease had not been shown to have a value, taxpayer having omitted to state the value thereof in Schedule A-18 of its return. At2796 the time of beginning operations in 1919, taxpayer was without railroad facilities at the mine and it was necessary to transport the coal mined by automobile some distance to the railroad. It purchased new on June 2, 1919, an automobile truck at a cost of $3,736.81, which was used during the remainder of the year 1919 and until July, 1920, at which time the installation of railroad facilities to its mine was completed; having no further use for the truck it was stored and subsequently, in May, 1922, sold for $1,200. In its return for 1920 depreciation of $1,860.40, being 50 per cent of the cost of this truck based upon an estimated useful life in this service of 12 months, was taken. The Commissioner determined that depreciation of 25 per cent was reasonable for the seven months of 1920 and only allowed the deduction of $934.21. Taxpayer deducted as worthless a debt amounting to $4,243,82 for coal sold during 1920 to the Central West Virginia Fuel Co., a coal brokerage firm of Huntington, W. Va. This firm was slow in making payments and, efforts by correspondence to obtain payment of the amount during 1920 being unsuccessful, the account was placed in the hands of local counsel2797 at Huntington during December, 1920, for collection by suit. The evidence as to whether this amount was determined to be worthless and charged off on the books prior to January 1, 1921, is equivocal. It was stated by an officer of taxpayer, who was the only witness, that the accountant who prepared its return and audited its books for 1920 charged the debt off as of December 31, 1920, and then stated that the debt was charged off prior to December 31, 1920. He stated further that taxpayer determined the debt to be worthless upon information furnished 792 in a report by the local counsel at Huntington, W. Va., showing the inability of the Central West Virginia Fuel Co. to pay the amount due and as to the uncollectibility thereof by suit; that counsel reported after investigation and efforts to obtain payment that the debtor had no assets out of which the amount could be collected and that suit thereon would be useless. The evidence as to whether taxpayer was in possession of facts showing that the debtor was without assets and that the account was worthless at the close of December 31, 1920, is indefinite and unsatisfactory. The witness did not himself charge the debt off2798 and could not state positively just when it was actually charged off - that is, whether before or after the close of 1920. Taxpayer's determination that the debt was worthless was based upon the report furnished it by counsel at Huntington, W. Va., and the evidence as to whether that report was received by the taxpayer before or after the close of 1920 is not clear. DECISION. The deficiency determined by the Commissioner is allowed in part and disallowed in part. The deduction of $625 claimed by the taxpayer for exhaustion of its lease during 1920 is allowed. Additional depreciation of $934.21 and a deduction of $4,243.82 as a bad debt are disallowed. The correct deficiency will be determined by the Board upon recomputation on consent or on seven days' notice in accordance with Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/437260/	736 F.2d 998 116 L.R.R.M. (BNA) 2884, 101 Lab.Cas. P 11,081 CLINCHFIELD COAL COMPANY, McClure River Coal Co., Inc., BigStar Coal Co., # 1, Berry Mining, Mullins Enterprises, Inc.,of Va., Fox-Ten Mining Co., Inc., Westwood Coal Co., OliverCoal Co., Inc., Golden Chip Coal Co., Chestnut Ridge MiningCo., Chestnut Ridge Fuels, Inc., Dale Energy Corp., AlvyCreek Coal Co., Inc., Heritage Mining Co., Honey Camp CoalCorp., C.B.S. Coal Co., Bob's Branch Coal Co., Inc., J & JCoal Co., Inc., Morgan Mining Co., Inc., South Hollow CoalCo., Inc., B.M. Coal Co., No. 2, Big T Coal Co., Inc.,Condor Coal Co., Inc., Big Valley Coal Co., M.M. & S. CoalCo., Inc., T.J.T. Corp., Apache Coal Co., Inc., Blue ChipCoal Co., Inc., Old Ralph Mining, Inc., Bird Coal Co., Inc.,Lynn K. Coal Co., Inc., Sandy Lane Coal Co., Inc., B and BMining Co., Inc., Warrior Coal Co., Inc., Coleman and YatesCoal Co., Black Gold Coal Co., Ivy Branch Coal Co., Inc.,Big Track Coal Co., Inc., Little Six Corp., Sandy Ridge CoalCorp., Norma-A Coal Corp., White Oak Coal Co., C.D.F. CoalCo., Inc., Mining Energy Coal Co., Skeens Fork Coal Co.,French Contractors, D.D. & W. Coal Co., Inc., Appellees,v.DISTRICT 28, UNITED MINE WORKERS OF AMERICA & UMWA, LOCALUNION NO. 1098, Appellants. No. 83-1758. United States Court of Appeals,Fourth Circuit. Argued May 9, 1984.Decided June 21, 1984. Gerald F. Sharp, Castlewood, Va., on brief, for appellants. S.W. Zanolli, Washington, D.C., Ronald E. Meisburg, Paul R. Thomson, Jr., U.S. Atty., Roanoke, Va. and Forrest H. Roles, Charleston, Va., for appellees. Before WINTER, Chief Judge, PHILLIPS, Circuit Judge, and HAYNSWORTH, Senior Circuit Judge. PER CURIAM: 1 The United Mine Workers of America, Local 1098 and District 28 appeal from the district court's order vacating an arbitral decision against the Clinchfield Coal Company. 2 Clinchfield has extensive coal operations in Virginia, a substantial portion of which are licensed out to independent contractors. Article IA Section (h) of the collective bargaining agreement signed with the Union provides that such licensing is prohibited "unless the licensing out does not cause or result in the layoff of Employees of the Employer." 3 In May 1982, Clinchfield laid off approximately 35% of its employees in response to a serious downturn in the demand for coal in April 1982. As part of this reduction, Clinchfield closed down permanently the Moss # 2 mine in Russell County, whose employees were represented by Local 1098. The Union filed a grievance alleging that but for the licensing out of other coal mining operations the employees of Moss # 2 would not have been laid off. The case went to an arbitrator who ordered reinstatement of the laid off employees, despite his finding that 4 [s]pecifically, Management decided to close the subject mine (Moss # 2) since it was about to be depleted and because it didn't have a stockpile facility; and this was viewed as being highly disadvantageous at a time when coal sales were slow. In essence, Moss # 2 was closed down because of declining market conditions and matters related directly thereto. Thus, the mine was sealed, upon undisputed reports showing that there wasn't enough coal left to justify reopening it. 5 The arbitrator held that Section (h) limits the ability of management in such circumstances to lay off its own employees. The district court found that the arbitral decision did not "draw its essence" from the contract because it ignored the common law of the industry, and vacated the award. See United Steelworkers of America v. Enterprise Wheel and Car Corp., 363 U.S. 593, 597, 80 S.Ct. 1358, 1361, 4 L.Ed.2d 1424 (1960). This appeal followed. 6 Clinchfield contends that affirmance is compelled by a recent decision of this Court, Clinchfield Coal Company v. District 28, United Mine Workers of America, 720 F.2d 1365 (4th Cir.1983) (Clinchfield I), which affirmed an order of the same district court vacating an arbitral decision awarding reinstatement to laid off miners. We agree. 7 At issue in that case was the same series of layoffs by Clinchfield in May 1982 due to the downturn in demand for coal. We held there that the arbitrator had failed to recognize the "common law" of the industry as expressed in past arbitral decisions, and incorporated in the current collective bargaining agreement. This common law holds that the company can lay off employees for economic reasons, such as a decline in demand, without violating Section (h) despite the continued leasing out of other operations. Only when a decision to license out is the "proximate cause" of a subsequent layoff is Section (h) violated. At 1370. Because the arbitrator had failed to consider the economic motivation for the layoff, the arbitral decision did not draw its essence from that provision of the contract proscribing only those lay offs proximately caused by licensing out. Id. at 1369. 8 In this case the arbitrator specifically found that the decision to shut down Moss # 2 was motivated by economic conditions. Thus the arbitral decision here even more clearly than that in Clinchfield I did not draw its essence from the contract under the Clinchfield I rationale.* The judgment is therefore 9 AFFIRMED. * The binding effect of Clinchfield I is the sole and sufficient basis for our decision. In so confining it, we disapprove the district court's expressed view, adverting to other arbitral decisions in conflict with that under review, that when two arbitral decisions on the "identical factual situation" are in direct conflict, both cannot "be in accordance with (sic) the essence of the contract," and that a reviewing court must, to insure uniformity, therefore reject one or the other. 567 F.Supp. 1431 at 1433 (emphasis added). This misapprehends the judicial function in review of arbitral decisions under bargained agreements Insuring uniformity of arbitral decisions is not a compelled function of judicial review. The parties to the controlling contract may well have bargained for possibly disparate results on "identical factual situations" as a price willingly paid for the perceived virtues of the arbitral process. In appropriate circumstances a reviewing court may quite properly, therefore, uphold "conflicting" arbitral decisions on the "identical factual situation" on the basis that, though conflicting in result, each nevertheless sufficiently "draws its essence" from a controlling contractual provision. Stare decisis may, however, require that a reviewing court defer to a prior, authoritative judicial decision that a particular arbitral decision indistinguishable in its critical elements from one under present review did, or did not, draw its essence from the controlling contractual provision. That is the narrow basis for our decision here.	01-04-2023	08-23-2011
https://www.courtlistener.com/api/rest/v3/opinions/4625512/	THOMAS HENRY, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Thomas Henry, Inc. v. CommissionerDocket No. 12327.United States Board of Tax Appeals13 B.T.A. 1234; 1928 BTA LEXIS 3090; October 25, 1928, Promulgated 3090 Respondent was not in error in reducing the amount of bad debt reserve. William Surosky, Esq., for the petitioner. J. E. Marshall, Esq., for the respondent. GREEN 1234 In this proceeding the petitioner seeks a redetermination of its income and profits taxes for the calendar year 1921, for which year the respondent has determined a deficiency in the amount of $3,385.09. 1235 The petitioner alleges that the respondent erred in disallowing a reserve for bad debts in the amount of $7,411.42. FINDINGS OF FACT. The petitioner is a corporation organized under the laws of the State of New Jersey in 1920, with its principal office at Union Hill, N.J., where it is engaged in the sale of building material at retail. The petitioner filed its return for the calendar year 1921, deducting therefrom for bad debts, the sum of $24,150, made up as follows: Bad debts actually charged off$16,738.58Additions to reserve7,411.4224,150.00It appears from the evidence that the opening balance sheet for the year 1921 showed accounts receivable outstanding in the amount of $104,000.81, against which a reserve for bad debts3091 of $2,000 was set up. It also appears that the petitioner was not aware of its right to set up an addition to reserve for bad debts, but followed the practice under the Act of 1918 and wrote off bad debts in the sum of $16,738.58, ascertained to be worthless, leaving a balance of accounts receivable outstanding at the close of the year in the sum of $249,459.04. The petitioner then set up a reserve of $9,411.42 to cover the probable loss on the outstanding accounts receivable at that date, an increase of $7,411.42 over the reserve at the beginning of the year. The respondent has disallowed this addition to the reserve for bad debts. OPINION. GREEN: Section 214(a)(7) of the Revenue Act of 1921, reads as follows: SEC. 214. (a) That in computing net income there shall be allowed as deductions: * * * (7) Debts ascertained to be worthless and charged off within the taxable year (or, in the discretion of the Commissioner, a reasonable addition to a reserve for bad debts); * * * Under this section a taxpayer may do one of two things, to wit, deduct the debts ascertained to be worthless and charged off within the taxable year, or, in the discretion of the Commissioner, he3092 may deduct a reasonable addition to a reserve for bad debts. The petitioner has deducted both the reserve set up for bad debts and also the bad debts. Obviously it is not entitled to deduct both the amount of debts ascertained to be worthless and charged off in the taxable year and an addition to a reserve for bad debts. The respondent has allowed the amount claimed for bad debts ascertained 1236 to be worthless and properly disallowed the addition to the reserve set up for bad debts. See , and . Judgment will be entered for the respondent.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625516/	Stanley D. Beard, Petitioner, v. Commissioner of Internal Revenue, RespondentBeard v. CommissionerDocket No. 3711United States Tax Court4 T.C. 756; 1945 U.S. Tax Ct. LEXIS 232; February 9, 1945, Promulgated 232 Decision will be entered for the petitioner. Where an individual owner of preferred shares of a corporation, L, all the common shares of which are owned by another corporation, C, being advised that his shares will soon be redeemed by L and that C offers to buy his shares before the forthcoming redemption, of his own volition sells his shares to C and later the shares, when owned by C, are redeemed by L, held, the gain of the individual is taxable to him as a long term capital gain from sale and not as an ordinary gain, as it would have been if he had held the shares until the redemption by L. Floyd F. Toomey, Esq., and John P. Lipscomb, Jr., Esq., for the petitioner.William F. Evans, Esq., for the respondent. Sternhagen, Judge. STERNHAGEN 756 A deficiency of $ 2,731.85 in the taxpayer's 1939 income tax is grounded upon the233 Commissioner's determination that a transaction in shares of Lederle Laboratories, Inc., was a partial liquidation, the gain in which was taxable in its entirety, and not a sale, the gain in which was taxable only to the extent of 50 percent.FINDINGS OF FACT.The taxpayer, a resident of Pearl River, New York, filed his 1939 income tax return on the cash receipts basis in Albany. In 1939 he was in the employ of Lederle Laboratories, Inc., as a scientist, and owned 1,379 preferred shares of the corporation, the basis of which was $ 4,122. The American Cyanamid Co. owned all the common shares of Laboratories and 15,500 of the 75,000 preferred shares. The taxpayer was not a shareholder or an employee of Cyanamid. The preferred shares were subject to the right of Laboratories to redeem them upon notice at $ 18 2/3 plus accrued dividends. On September 5, 1939, Cyanamid resolved to lend Laboratories up to $ 1,400,000, as Laboratories might require in connection with the redemption of its preferred shares. It also resolved in the event of such call for redemption on November 15, 1939, to make an offer to such preferred shareholders to buy their shares before October 31, 1939, at $ 234 18 2/3 plus accrued dividend. On September 6, 1939, Laboratories resolved to redeem its preferred shares on November 15, 1939, at $ 18 2/3 plus accrued and unpaid dividends on that date, the redemption to be out of capital to the extent of $ 1,400,000 and out of surplus or net profits to the extent of $ 21,000; to send notice to the shareholders to that effect, and also to enclose with the notice a form of written offer of Cyanamid to purchase the shares at $ 18 2/3; to borrow from Cyanamid 757 on open account any amount required for such redemption up to $ 1,400,000; and to perfect the cancellation of such redeemed shares. Cyanamid's offer to the shareholders to buy their shares was actuated by a desire to avoid their displeasure at the redemption of an attractive high-yielding investment by suggesting to them a transaction with a more favorable income tax effect, although this was not stated to them. The taxpayer was not informed by anyone of this motive and inquired of no one as to the tax effect. He made no agreement with Cyanamid. He thought of this tax effect himself, and without suggestion or assistance he selected the method of sale instead of holding for redemption. 235 On October 25, 1939, he sent his certificate of 1,379 shares of Laboratories preferred to the agent for Cyanamid for its purchase in accordance with its offer at $ 18 2/3 plus dividend accrued to date of delivery. On October 26, 1939, he received from the agent in payment for said shares $ 25,949.41, which was the sale price of $ 26,045.94 less stamp tax of $ 96.53. He included in his income tax return $ 25,643.88 as proceeds of a long term sale and $ 304.61 as dividends. On November 15, 1939, Cyanamid delivered all its then owned Laboratories preferred shares to Laboratories and received the redemption price, whereupon the shares were redeemed.OPINION.The taxpayer on October 25, 1939, sold his 1,379 shares of Laboratories stock to Cyanamid for $ 25,949.41. Because of the circumstances preceding the sale, from which it is clear that Cyanamid knew that its purchase of the Laboratories shares of any shareholder would have the effect of a lower tax upon the shareholder than if the shares were redeemed by Laboratories while owned by him, the Commissioner argues that the amount received by the shareholder should be treated not as sale price, but as if it were the redemption price236 which Laboratories would have paid him if he had waited for the redemption and thus received substantially the same amount from Laboratories. The taxpayer's motive of selecting the sale to Cyanamid instead of the redemption transfer to Laboratories was to avoid the higher tax, but this is not a vicious motive which vitiates the transaction adopted or one requiring that to him must be imputed the more onerous tax effect of the alternative transaction which he avoided.There is in the evidence no indication of sham on the taxpayer's part. He did not go through an empty form, like the setting up of a pseudo corporation ( ; ), which the Commissioner is permitted to disregard, or a pseudo sale which was promptly rescinded, or which the revenue act warned might not be recognized. Cf. . He had an election as between two transactions, and bona 758 fide he elected the one with less onerous tax consequences. He was not bound to retain his shares and await the redemption by the Laboratories237 corporation with its inevitably higher tax. He was permitted to sell them to Cyanamid or any other purchaser he could find ( ); and when he sold, he could not escape the tax imposed by the statute upon the gain from the sale that actually occurred. If it were to his tax advantage to do so, he would not be heard to say that not the actual transaction, but a fictitious transaction which might have been, must be recognized as the occasion for his tax.The Commissioner is no less required to tax him in accordance with what occurred, and he is not permitted to distort the transaction by giving it an artificial character upon which a larger tax could be imposed if it were true. When the Laboratories redemption occurred, this taxpayer was not the owner of the shares; he had already sold them and realized his gain. The only question as to his tax was what was the proper statutory provision to be applied to the gain so realized, and this he correctly found to be section 117, defining the gain from the sale of property held more than 24 months as a long term capital gain and requiring recognition of such gain to the extent of 50 percent238 thereof. This, we think, the Commissioner is required to recognize. The determination that the gain from the sale to Cyanamid was received in partial liquidation of Laboratories and as such was 100 percent taxable under section 115 (c) is reversed.Decision will be entered for the petitioner.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625517/	Desert Palace, Inc., Petitioner v. Commissioner of Internal Revenue, RespondentDesert Palace, Inc. v. CommissionerDocket No. 8531-74United States Tax Court72 T.C. 1033; 1979 U.S. Tax Ct. LEXIS 63; September 11, 1979, Filed 63 Held: Receivables arising from the extension of credit for gambling purposes do not represent taxable income until collected. Petitioner's right to collect upon them is subject to the defense of the obligor that the receivables were incurred for gambling purposes. Robert E. Frisch, David W. Bernstein, and Victor F. Ganzi, for the petitioner.Lawrence G. Becker, for the respondent. Irwin, Judge. IRWIN1034 OPINIONRespondent determined deficiencies in petitioner's Federal income64 taxes as follows:Year endedDeficiencyApr. 30, 1967$ 461,793.32Apr. 30, 19681,194,270.15Apr. 30, 19693,019,061.24Sept. 30, 19691,898,022.126,573,146.83The issues in this case have been severed and the one now presented for our decision is whether winnings from petitioner's customers who gamble on credit must be recognized as income at the time the receivable arises, or subsequently, when it is paid.If we hold that petitioner must immediately recognize as income winnings from customers who gamble on credit, the parties have stipulated that petitioner is entitled to deductions under section 165 1 or section 166 as follows:Taxable period endedDeductionApr. 30, 1967$ 987,389Apr. 30, 19681,489,932Apr. 30, 1969$ 1,384,806Sept. 30, 19691,102,598However, we would then have to decide under which section petitioner is entitled to said deductions.All of the facts 65 relating to this issue have been stipulated. The stipulation of facts and the exhibits attached thereto are incorporated herein by this reference.Desert Palace, Inc. (hereafter DPI), is a Nevada corporation. DPI's tax returns for the taxable years ended April 30, 1967, 1968, and 1969 and the short taxable period ended September 30, 1969 (including an amendment on Form 1120X), were prepared on the accrual method. 2 The returns for the taxable years ended 1035 April 30, 1967 and 1968, were filed with the Office of Internal Revenue Service in Reno, Nev. The returns for the taxable year ended April 30, 1969, and the short taxable period ended September 30, 1969, were filed with the Office of the Internal Revenue Service in Ogden, Utah. The filing of a return for the short taxable year was due to the fact that Caesars World, Inc., acquired DPI in the summer of 1969.66 DPI was located in Caesars Palace, a building situated on a portion of Las Vegas Boulevard South known as the "Strip." During the period in question, there were approximately 17 hotel-casinos located on or near the "Strip." Within Caesars Palace, DPI operated a hotel and various entertainment, restaurant, and bar facilities. In addition, firms not affiliated with DPI leased space in the building from which they sold various types of merchandise.Under the laws of Nevada, a properly licensed firm or person may legally operate a gambling casino. During the entire period from August 1, 1966 (when DPI began its operations), to and including September 30, 1969 (the "period in question"), DPI held all licenses and permits necessary to enable it to operate the casino (hereafter Casino) at Caesars Palace Hotel & Casino (hereafter Caesars Palace) in Las Vegas, Nev., including an unrestricted license issued by the Nevada Gaming Commission (hereafter commission). During the entire period in question, DPI did, in fact, operate the Casino.The principal games played in the Casino were blackjack, dice, roulette, and baccarat. In blackjack, dice, and roulette, Casino customers would make bets67 using chips, 3 which would be redeemed at the cashier's cage (an area, similar to a tellers, area in a bank, which was adjacent to, and had an opening onto, the gambling area of the Casino) by the Casino for specified sums of money. In each of those games, if the customer won a bet, he 1036 would receive additional chips from the Casino, and if the customer lost a bet, the Casino would retain the chips bet by him. The odds on the bets which could be made at these games in most, if not all, instances favored the Casino. In baccarat, bets were made with cash. To the extent the Casino was able to control it, the cash which was used was bills which had been specially soaped to keep them from sticking together.68 Credit OperationsAt all times during the period in question, as part of the normal and regular operation of the Casino, DPI extended credit to certain customers of the Casino. The magnitude of the gambling done on credit relative to the overall operation of the Casino is reflected in the following table:Receivable 2 receivedTotal casinoat tables otheraccountsthan baccarat as aPeriod endedDrop 1receivable 2percentage of dropApr. 30, 1967$ 67,501,453$ 16,793,78523% Apr. 30, 196885,699,05126,273,62023.4%Apr. 30, 1969101,386,64639,443,72622.4%Sept. 30, 196947,931,74221,436,99430.4%Gaming activities in the State of Nevada are regulated by the commission and the Nevada Gaming Control Board (hereafter board). The commission from time to time promulgates formal regulations relating to gaming. During the portion of the period in question69 prior to April 1968, although regulation 6.030-1(c) and (g) referred to accounting for uncollectible casino accounts receivable, the regulations of the commission did not specify the procedures which should be used by casinos in connection with "credit play." In April 1968, the commission adopted regulation 6.043 governing procedures for "credit play" at various types of gaming establishments, and from that time to the end of the period in question, "credit play" procedures at the Casino were governed by that regulation.Regulation 6.043 provided five alternate procedures for granting credit in a casino such as the Casino. These procedures were 1037 based upon procedures in use in various casinos at the time regulation 6.043 was originally adopted.The Casino utilized the following authorized "credit play" procedure (regulation 6.043, par. 3) for baccarat during the period in question: A serialized record would be kept in the game area. All credit transactions involving each player would be kept on that form or in conjunction with a table card which would contain all or a portion of the required information. The required information would be when, where, and in what amount70 credit was extended. At the end of the shift, accounting day, or other period of time, when play was ultimately concluded by the player, an accounting would be made at the cashier's cage for any indebtedness; that indebtedness would be evidenced by a check or IOU, 4 and a credit slip would be sent to the table.The Casino utilized the following authorized "credit play" procedure (regulation 6.043, par. 4) for games other than baccarat: A pre-numbered master card would be maintained in the pit area (a grouping of gaming tables) by a representative of the auditing department. The master card would show the name of the player receiving credit and when, where, and in what amount credit was granted. 71 A separate master card would normally be used for each shift. The master card would be supported by a "table card" maintained by the boxman or dealer at each table. The table card would show the name of each player receiving credit and the amount of credit given. The pit boss who authorized a credit would prepare a signed "receipt" in the form of an "advance card," "counter-check," "marker," or "IOU" and would make every reasonable effort to obtain the player's signature on the receipt. The information on the receipt would immediately be transcribed on the master card. If during the course of play or at the end of play, a player paid with cash or chips all or a portion of the sum he owed, the pit boss would return an appropriate amount of customer-signed receipts and the amount and nature of payment would be noted on the master card and the table card. When a player completed playing, any balance due, which would be represented by checks, advance slips, or similar receipt forms, would be delivered to the 1038 cashier who would send a credit slip to the table. Notation would be made on the master card and on the table card that settlement had been made at the cashier's 72 cage, and the credit slip would be dropped in the box.The "credit play" procedure used at the Casino during the period in question was identical both prior and subsequent to the adoption of regulation 6.043. Although the "credit play" procedures at the Casino during the period in question were not invariable (exceptions having been made from time to time to meet the desires of particularly valued customers, and changes having been made in the prevailing procedures, resulting primarily from improved technology), the procedures with regard to the vast majority of transactions at the Casino were identical throughout the entire period in question.When a typical customer first requested credit at the Casino, he was required to provide the credit manager information which would enable the credit manager to verify the credit worthiness of the customer. This information typically consisted of the names of the customer's principal banks and a statement of the maximum amount the customer wished to gamble. Before granting credit, DPI would verify with the customer's banks the customer's normal balances and would inquire of a Las Vegas information clearing service whether the customer had73 a history of paying, or refusing to pay, gambling debts.Once the credit check was completed, the customer would be permitted credit up to a specified maximum amount, which would be dependent upon the result of that check and the credit limit requested by the customer. Thereafter, if the customer wished to gamble at the Casino, he could obtain on credit chips (or, if he was a baccarat customer, cash in the form of bills which had been rubbed with soap) up to the amount of his credit limit, plus such additional amounts as the Casino executives in charge might from time to time authorize.Once a customer was authorized to receive credit, it could be obtained either at gambling tables or at the cashier's cage. If a customer requested credit at a table, he was given chips (or soaped bills at the baccarat tables) in the requested amount, up to his credit limit. At the time of each extension of credit, the amount of the credit would be noted in a master book maintained in the area of the Casino where the customer was playing and on a card at the table at which he was playing. Also, at the 1039 time of each extension of credit, the customer would execute an IOU evidencing the extension74 of credit. Typically, each request for credit and each corresponding IOU, would be for a sum which was relatively small in relation to the customer's credit limit. If the customer lost the chips and wanted to continue play, he would request additional credit and execute additional IOU's. 5A customer's IOU's would be held in the Casino area either until the customer finished play at the particular group of tables at which the credit was extended (i.e., in the dice area or in the blackjack and roulette area) or until a shift changed, or, on particularly busy days, until the end of the day. At that point, the customer's75 IOU's would be transferred to the cashier's cage. If a customer with an outstanding IOU still had chips when he completed play, an effort, consisting of a request by an employee in the area of the Casino in which the customer had been playing, and sometimes other Casino executives as well, was made to have the customer apply the chips toward a portion of his outstanding IOU's. In some instances, when a regular customer was staying at Caesars Palace for several days, no effort was made to have the customer apply his chips to redeem his IOU's until his stay was ending, but an effort was made at that time. The efforts to have chips applied to redeem IOU's were successful in most, but not all, instances. Therefore, with regard to most customers, the aggregate outstanding IOU's when the customer terminated play, or his stay, would be approximately the same as his net loss during the period of play or the stay. In some instances, a customer who had several outstanding IOU's when his play, or his stay at Caesars Palace, was completed would be asked to execute a new IOU in the total amount of the indebtedness and exchange it for the several IOU's he had previously issued.When a table76 transferred IOU's to the cashier's cage, the cage would note receipt of the IOU's on an IOU control sheet (a sheet showing, with regard to each shift, all IOU's received in the cage and all IOU's held in the cage which were paid). The cage would 1040 also issue to the table a credit slip in the amount of the transferred IOU's. 677 For the management control purpose of determining the efficiency of particular tables, and as required by regulation 6.043 of the commission, this credit slip would be inserted in the "drop" box and included in the revenues of the table. However, for the purpose of determining the win of the Casino as a whole, all items at the table were transferred to the cage at or near the end of each shift (money having been counted in a count room before being delivered to the cage), and the win (or loss) of the Casino was the difference between the chips, cash, and IOU's in the Casino at the beginning of the shift and the chips, cash, and IOU's in the Casino at the end of the shift. This win for the Casino as a whole represented the total Casino revenue for the shift. 7If credit was granted at the cashier's cage, the customer would be given chips (or bills for baccarat), and would be required to sign an IOU. No entry was made in a master book or on a table card in the Casino area, and, because there was no transfer of IOU's from the tables to the cashier's cage, no credit slip was issued. Rather, receipt of an IOU was recorded directly on the IOU control sheet maintained in the cage.During the period in question, 77.63 percent of the credit transactions in the Casino involved credit issued at tables, and 22.37 percent involved credit issued at the Casino cashier's cage. Of the transactions involving credit granted at the Casino cashier's cage, 43.24 percent of those transactions (9.67 percent of the total credit78 transactions) involved issuances of credit to specifically identifiable customers who were known to employees of the Casino and who DPI believed it could demonstrate obtained chips or cash on credit for gambling purposes.As frequently as practicable when credit was extended at the Casino cashier's cage, particularly when the customer requested more than minor amounts of cash, a Casino employee would be called to the Casino cashier's cage, and that employee would attempt to escort the customer to a gambling table. Also, the Casino cashier's cage would not issue significant amounts of cash 1041 to customers on credit unless the customers were known to be active baccarat players.There were occasional deviations from the usual credit procedures (all of which DPI believes were permitted by regulation 6.043). For example, some customers disliked having to sign IOU's when they were playing games other than baccarat. For some of those customers, unsigned IOU's were prepared and held in the Casino area until the customer completed play, at which time the customer would be asked to execute IOU's evidencing his entire credit balance then outstanding. Deviations from the usual credit79 procedures in the Casino occurred in only a small percentage of the total transactions at the Casino (both in number and dollars involved). Efforts were made by DPI to minimize the number of transactions in which there were deviations from normal credit procedures.No interest was charged by DPI on outstanding Casino account receivable balances and these balances were not secured.Nevada LawA debt incurred for gambling purposes is not enforceable in the courts of Nevada, nor is it enforceable in the courts of any State of the United States. However, in an action for collection, the debtor must raise the defense that the debt was incurred for that purpose. This applies both to the Casino and the customer. In other words, the obligation of a Nevada casino to redeem chips issued to, or won by, customers also is not enforceable in the courts of Nevada or in the courts of any State of the United States.The Supreme Court of Nevada has held that a debt incurred with credit granted at a gaming table while play is in progress is presumed to be a debt incurred for gambling purposes, and the courts of Nevada have without exception refused to enforce a debt of that type. There is no80 such presumption as to whether a debt arising from credit granted at a Casino cashier's cage is a debt incurred for gambling purposes. A person attempting to assert that such a debt was incurred for gambling purposes will have the burden of proving that the sums advanced were in fact used for gambling purposes.In some instances, as part of its collection efforts, DPI has sued people who owed it money as a result of gambling 1042 transactions, and the people have failed to assert that the debt was incurred for gambling purposes. In some of those instances, DPI has obtained judgments against the people who owed it money. DPI has never obtained a judgment against a person who demonstrated that the debt in question arose from a gambling transaction. However, notwithstanding a valid defense to the enforcement of the IOU's, DPI's collection rate on the IOU's was close to 95 percent.At all times during the period in question, it was the position of the board that any casino which failed to redeem chips issued by it was operating in an unsuitable manner, as that term is used in regulation 5.010 of the commission. This could lead to disciplinary action, including a fine or suspension81 or loss of the casino's license to conduct gambling operations.During the period in question, a chip issued at the Casino, or at other casinos in Nevada, would be exchanged by most casinos for their chips and accepted as payment by many merchants in Nevada, including those in Caesars Palace. Those chips would then be redeemed from the other casino or the merchant by the issuing casino. Subsequent to the period in question, many casinos in Nevada stopped accepting chips issued by other casinos in exchange for their own chips, and most, if not all, merchants stopped accepting chips in payment for merchandise.Outstanding ReceivablesWhen a customer completed play, or terminated his stay at Caesars Palace, the customer would be asked when he intended to pay the IOU's. If the customer indicated a specific date, his IOU's would be held by DPI until the specified date, at which time the date would be inserted on the IOU and DPI would deposit the IOU with its bank for presentation through the banking system for payment by the customer's bank (the names of the bank and of the payee having been inserted on the IOU's), or the IOU would otherwise be presented to the customer for payment82 in the manner requested by the customer. If a customer did not specify a date, DPI would immediately deposit his IOU with DPI's bank for presentation through the banking system for payment by the customer's bank.With regard to most IOU's, DPI treated the IOU as paid (debiting cash and crediting accounts receivable) and DPI's bank gave DPI credit for the amount of the IOU, when the IOU was 1043 deposited with DPI's bank. In some instances, however, DPI did not treat an IOU as paid, and DPI's bank did not give DPI credit for the amount of the IOU, until DPI's bank had been informed that the customer's bank had accepted and paid the IOU. If an IOU which was treated as paid when it was deposited was returned unpaid, DPI's bank would debit DPI's account for the amount of the IOU, and DPI would resume treating the IOU as an account receivable (crediting cash and debiting accounts receivable).In some instances, a customer would give the Casino a personal check when he completed play. If the customer did not ask that his check be held uncashed, the check would be treated as immediate payment, subject to collection. If, however, a customer asked that a check be held uncashed for83 a period (at which point the check was called a "hold check"), or a personal check was returned unpaid (at which point the check was called a "returned check"), the check would be treated as an IOU for all purposes. The Casino accounts receivable of DPI at any point of time consisted of all outstanding indebtedness to DPI at that point of time evidenced by IOU's, including hold checks and returned checks, issued in connection with extensions of credit in the Casino.If a customer did not pay his IOU's within a reasonable period of time, Casino personnel would contact the customer by telephone or in person on one or more occasions, and attempt to obtain payment. If that failed, unless there was a reason (such as death or bankruptcy of the customer) that the Casino decided it would not be fruitful to pursue the customer further, the IOU would be sent for collection to an attorney or collection agency where the customer resided. Although the fact that an IOU (including a personal check) was issued in connection with a gambling transaction was an absolute defense available to the customer, in many instances the attorney or collection agent was able to collect the amount evidenced by84 the IOU, either because the customer paid it voluntarily or because the customer failed to assert the defense that the debt was incurred for gambling purposes. If the efforts of the attorney or collection agent were not successful, the IOU would be returned to the Casino. Thereafter, either Casino employees would continue to attempt to collect the sum represented by the IOU, or a decision would be 1044 made by the management of the Casino that the IOU was uncollectible.Records were maintained by DPI for each customer showing the amount of all outstanding IOU's from the customer and indicating the efforts made to collect those outstanding IOU's.Accounting PracticesThe revenue from the Casino included by DPI for Federal income tax purposes in its gross revenue for a given period was the difference between the cash and chips on hand in the Casino at the beginning and at the end of the period (treating all Casino cash deposited in banks or used for non-Casino purposes as being on hand). Casino accounts receivable were not taken into account in determining income for tax purposes. As a result of this mechanism, DPI did not treat revenues from "credit play" as taxable revenue85 until the accounts receivable were actually collected. At the time an account receivable was collected, the proceeds of the collection were added to the cash on hand, and thus the full amount of the proceeds of the collection of that account receivable was treated as taxable revenue by DPI.The table on p. 1045 illustrates the accounts receivable balances of DPI throughout the period in issue and, in addition, indicates the balances of these accounts receivable remaining outstanding as of July 31, 1975.The revenue from the Casino included by DPI for financial statement purposes (as opposed to income tax purposes) in its overall revenue for a period was the difference between the cash, chips, and accounts receivable, net of a provision for doubtful accounts, on hand in the Casino at the beginning and at the end of the period (treating all Casino cash deposited in banks or used for non-Casino purposes as being on hand). The provision for doubtful accounts represented the estimate of the management of DPI of the ultimate amount of accounts receivable which would not be collected. That estimate was based primarily on an analysis by management or others of the collection history of86 the Casino, both with regard to its accounts receivable in general and with regard to specific customers. The accumulated provision for doubtful accounts, less writeoffs of bad debts, was shown on the balance sheet of DPI as an allowance for doubtful collections.The combined financial statements of DPI and an affiliated 1045 Casino Accounts ReceivableTotal receivedduring periodApr. 30, 1967endedApr. 30, 1967Apr. 30, 1968I O U's and hold checks$ 16,793,785I O U's and hold checksuncollected$ 2,431,447$ 913,131Returned checks uncollected304,484257,131Subtotal1,170,262Total Casino receivablesuncollected Apr. 30, 19672,735,931Apr. 30, 1968I O U's and hold checks$ 26,273,620I O U's and hold checksuncollected3,541,074Returned checks uncollected473,545Subtotal4,014,619Total Casino receivablesuncollected Apr. 30, 19685,184,881April 30, 1969I O U's and hold checks$ 39,443,726I O U's and hold checksuncollectedReturned checks uncollectedSubtotalTotal Casino receivablesuncollected Apr. 30, 1969September 30, 1969I O U's and hold checks$ 21,436,994I O U's and hold checksuncollectedReturned checks uncollectedSubtotalTotal Casino receivablesuncollected Sept. 30, 196987 Casino Accounts ReceivableTotal receivedduring periodApr. 30, 1967endedApr. 30, 1969Sept. 30, 1969I O U's and hold checks$ 16,793,785I O U's and hold checksuncollected$ 799,973785,650Returned checks uncollected244,964238,689Subtotal1,044,9371,024,339Total Casino receivablesuncollected Apr. 30, 1967Apr. 30, 1968I O U's and hold checks$ 26,273,620I O U's and hold checksuncollected1,298,1891,235,504Returned checks uncollected402,065384,124Subtotal1,700,2541,619,628Total Casino receivablesuncollected Apr. 30, 1968April 30, 1969I O U's and hold checks$ 39,443,726I O U's and hold checksuncollected4,419,7541,729,655Returned checks uncollected399,912355,311Subtotal4,819,6662,084,966Total Casino receivablesuncollected Apr. 30, 19697,564,857September 30, 1969I O U's and hold checks$ 21,436,994I O U's and hold checksuncollected4,640,492Returned checks uncollected198,470Subtotal4,838,962Total Casino receivablesuncollected Sept. 30, 19699,567,895Casino Accounts ReceivableTotal receivedduring periodApr. 30, 1967endedJuly 31, 1970July 31, 1971I O U's and hold checks$ 16,793,785I O U's and hold checksuncollected$ 772,290$ 763,760Returned checks uncollected236,749234,064Subtotal1,009,039997,824Total Casino receivablesuncollected Apr. 30, 1967Apr. 30, 1968I O U's and hold checks$ 26,273,620I O U's and hold checksuncollected1,179,8841,154,284Returned checks uncollected373,044364,360Subtotal1,552,9281,518,644Total Casino receivablesuncollected Apr. 30, 1968April 30, 1969I O U's and hold checks$ 39,443,726I O U's and hold checksuncollected1,190,8901,103,800Returned checks uncollected340,607331,430Subtotal1,531,4971,435,230Total Casino receivablesuncollected Apr. 30, 1969September 30, 1969I O U's and hold checks$ 21,436,994I O U's and hold checksuncollected1,434,5341,035,426Returned checks uncollected153,433140,513Subtotal1,587,9671,175,939Total Casino receivablesuncollected Sept. 30, 196988 Casino Accounts ReceivableTotal receivedduring periodApr. 30, 1967endedJuly 31, 1975I O U's and hold checks$ 16,793,785I O U's and hold checksuncollected$ 759,590Returned checks uncollected227,799Subtotal987,389Total Casino receivablesuncollected Apr. 30, 1967Apr. 30, 1968I O U's and hold checks$ 26,273,620I O U's and hold checksuncollected1,136,671Returned checks uncollected353,262Subtotal1,489,933Total Casino receivablesuncollected Apr. 30, 1968April 30, 1969I O U's and hold checks$ 39,443,726I O U's and hold checksuncollected1,067,583Returned checks uncollected317,225Subtotal1,384,808Total Casino receivablesuncollected Apr. 30, 1969September 30, 1969I O U's and hold checks$ 21,436,994I O U's and hold checksuncollected969,286Returned checks uncollected133,313Subtotal1,102,599Total Casino receivablesuncollected Sept. 30, 19691046 partnership which owned the real estate on which Caesars Palace is located for the fiscal years ended April 30, 1967, 1968, and 1969, were audited by Harris, Kerr, Forster & Co., certified public accountants. In accordance89 with generally accepted accounting principles, these financial statements included as an asset of DPI the Casino accounts receivable on hand, net of writeoffs and allowances for doubtful collections. Each of the audits by Harris, Kerr, Forster & Co., included a review of the adequacy of the allowance for doubtful accounts at the end of the fiscal year being audited. The combined financial statements of DPI and the partnership for each of those fiscal years were certified without qualification by Harris, Kerr, Forster & Co.The income or loss of DPI reported on its Federal income tax returns for the taxable years ended April 30, 1967, 1968, and 1969 and its amended Federal income tax return for the short taxable period ended September 30, 1969, before net operating loss deductions, was as follows:Year orperiod endedIncome (loss)Apr. 30, 1967($ 1,945,721)Apr. 30, 1968700,186 Apr. 30, 1969$ 4,439,581 Sept. 30, 1969(1,098,740)At all times during the period in question, the State of Nevada imposed various license fees upon holders of gaming licenses. These fees included, with regard to the Casino and similar licensees, a quarterly fee based on gross revenues90 of the licensee. This fee was on a graduated basis, reaching 5 1/2 percent of gross revenues in excess of $ 40,000. In computing quarterly gross revenues, a casino operator was permitted to include revenues from credit play in gross revenues or to exclude such revenues from gross revenues until the accounts receivable were actually collected.In preparing its Federal income tax returns for the taxable years ended April 30, 1967, 1968, and 1969, DPI treated outstanding chips as liabilities, and therefore reduced taxable income for the year by an amount equal to any increase in the face amount of outstanding chips or increased taxable income by an amount equal to any reduction in the face amount of outstanding chips. In preparing its Federal income tax return for the short taxable period ended September 30, 1969, DPI did not treat outstanding chips as liabilities, although it had $ 64,668 1047 in chips outstanding on that date. Therefore, taxable income for that period was increased by an amount equal to the face amount of chips outstanding at April 30, 1969. The face amounts of chips outstanding at April 30, 1967, 1968, and 1969 and September 30, 1969, and the amounts by91 which taxable income reported by DPI with regard to the taxable years or period ended on those dates was reduced or increased because outstanding chips were treated as liabilities at April 30, 1967, 1968, and 1969, were as follows:Chips treated as aReduction or (increase)Year orliability at endin taxable income forperiod endedof year or periodthe year or periodApr. 30, 1967 $ 66,075$ 66,075 Apr. 30, 1968 193,750127,675 Apr. 30, 1969 127,712(66,038)Sept. 30, 19690(127,712)Because a holder of a chip may not enforce in the courts of Nevada or any other State of the United States, the obligation of a casino in Nevada to redeem outstanding chips, DPI concedes that, based upon its view of the law applicable to taxability of income from gambling transactions, it was not correct in treating the face amount of the chips outstanding at April 30, 1967, 1968, and 1969 as liabilities.The issue in this case is the point at which DPI must accrue as income the receivables generated by customers who gamble on credit extended them by DPI, i.e., at the time they arise or when collected. Petitioner contends the application of accrual method92 accounting for tax purposes requires it not to recognize those receivables as income until collected. Respondent contends otherwise, asserting the receivables are income at the time the amounts they represent are won by the casino, notwithstanding the fact that they are subject to a complete defense in an action brought for their collection.In support of its position of nonaccrual, petitioner emphatically argues that, with respect to the receivables in question, the "all events" test of section 1.446-1(c)(1)(ii), Income Tax Regs., and the judicial gloss thereon have not been satisfied. The all events test utilizes a two-prong test in order to determine if income should be accrued in any given taxable year. That test states "income is to be included for the taxable year when all the events have occurred which fix the right to receive such income 1048 and the amount thereof can be determined with reasonable accuracy." Sec. 1.446-1(c)(1)(ii), Income Tax Regs. Petitioner contends that while the second element of this test, that the item of income must be determinable with reasonable accuracy, has been satisfied, the first element, that all events have occurred which fix the93 right to receive the income, has not. Petitioners reasoning in support of this position is simply that gambling debts are unenforceable and since that unenforceability can be asserted as a complete defense to any action by petitioner for collection of the accounts receivable, all events necessary to fix the right to receive the income have not, in fact, occurred. Thus, petitioner argues, it acted properly in not accruing the accounts receivable as income at any time prior to collection.Despite the legalization of gambling by the State of Nevada, Nevada courts have steadfastly refused to enforce debts incurred for gambling purposes if the debtor has pled and proved that the debt was so incurred. Scott v. Courtney, 7 Nev. 419">7 Nev. 419 (1872); Evans v. Cook, 11 Nev. 69 (1876); Burke v. Buck, 31 Nev. 74">31 Nev. 74, 99 P. 1078">99 P. 1078 (1909) (Nevada Supreme Court held the debt instrument void); Craig v. Harrah, 66 Nev. 1">66 Nev. 1, 201 P.2d 1081">201 P.2d 1081 (1949) (defendant failed to carry the burden of proof); West Indies, Inc. v. First National Bank of Nevada, 67 Nev. 13">67 Nev. 13, 214 P.2d 144">214 P.2d 144 (1950)94 (plaintiff-casino denied recovery of $ 86,000 in gambling debts); Wolpert v. Knight, 74 Nev. 322">74 Nev. 322, 330 P.2d 1023">330 P.2d 1023 (1958) (defendant failed to carry the burden of proof as to four of the five loans involved). Nor are gambling debts incurred in Nevada enforceable in the courts of any other State in the United States ( Dunes Hotel & Country Club of Las Vegas v. Mayo, 44 Misc. 2d 439">44 Misc. 2d 439, 354 N.Y.S.2d 62">354 N.Y.S.2d 62 (N.Y. County Civ. Ct. 1974)). A negotiable instrument issued as payment of a gambling debt has been held void by the Nevada Supreme Court ( Burke v. Buck, supra;Menardi v. Wacker, 32 Nev. 169">32 Nev. 169, 105 P. 287">105 P. 287 (1909)).Conversely, under Nevada law a casino is under no legal obligation to redeem chips issued to its customers or to pay wagers lost to its customers. Weisbrod v. Fremont Hotel, 74 Nev. 227">74 Nev. 227, 326 P.2d 1104">326 P.2d 1104 (1958); Corbin v. O'Keefe, 87 Nev. 189">87 Nev. 189, 484 P.2d 565">484 P.2d 565 (1971); Berman v. Riverside Casino Corp., 323 F.2d 977 (9th Cir. 1963).95 Respondent agrees with petitioner that gambling debts are unenforceable under Nevada law. In a request for supplemental briefs, we posed the question:1049 If the Court should reject respondent's theory that the accounts receivable in issue may properly be disassociated from the gambling transactions whereby the borrowed money was lost, should the taxpayer nevertheless be required to accrue the amounts represented thereby as income prior to the receipt of payment?In briefing this question, the parties were to specifically consider:(1) Whether the right which DPI has in the receivables is a legally enforceable right under applicable local law at the time the money represented by such borrowing is lost in gambling; and(2) Whether legal enforceability of such receivables is a necessary ingredient of a fixed right to receive income from them.In his supplemental brief, respondent stated:If the Court should reject respondent's theory disassociating casino accounts receivable from gambling transactions, the taxpayer should not be required to accrue the amounts represented [sic] casino accounts receivable as income prior to the receipt of payment, except to the extent of the96 casino receivables which were given to the casino at the cage.Respondent agreed that petitioner's right to the receivables was not legally enforceable under Nevada law and that legal enforceability is a prerequisite to accrual under section 1.446-1(c)(1)(ii), Income Tax Regs.Respondent's position favoring accrual of the receivables is not so straightforward. He does not deal with petitioner's argument favoring application of the "all events" test, but, rather, argues for application of what he denotes the "two step transaction" theory (step one being the loan transaction, step two being the gambling transaction). Using this theory, respondent would treat the winnings from customers who have received chips on credit the same as winnings from customers who have purchased chips with money borrowed from someone other than petitioner. In other words, respondent would have us deem irrelevant the fact petitioner also happens to be the lender in the loan transaction, thus arguing that the source of the credit used in obtaining the chips used to gamble has no effect on the requirement that DPI accrue as income its winnings from those customers gambling on credit.Conceding that gambling97 debts are subject to the defense that they are not enforceable in an action to recover upon them, 1050 respondent attempts to isolate the issuance of chips or cash for the IOU from the gaming transactions which followed, asserting that the winning of chips or cash constitutes the totality of the income-earning process. The problem, as we see it, with respondent's analysis is that it is myopic.The substance of a gambling transaction is the wagering of something of value on the fortuitous occurrence or nonoccurrence of certain events. In order to make the gambling casino administratively workable, at the time relevant herein, the casinos required that bets be made with chips (except in baccarat). Therefore, a party could not bet goods, services, cash (except in baccarat) or IOU's, although these could normally be proper subjects of a bet. The key is that chips (or cash in baccarat) stand in the place of these other items of value (specifically relevant to the case before us, the chips (or cash) stand in place of IOU's) to provide a uniform medium of exchange. Respondent concedes that if the IOU's were the actual subject of the betting, they would not be accruable. We believe, 98 based on this concession, that the result is the same where the casino receives the IOU's and issues chips (or cash) in order that they be used as the medium of exchange. Expressed another way, we believe, based on respondent's concession, 8 that to the extent a customer's IOU to a casino would be treated by State courts as a gambling debt, and therefore unenforceable, it does not represent accruable income until paid.A distinction exists, however, between IOU's issued at the gambling99 tables and those issued at the cages. Unlike table credit, cage credit does not carry a presumption of use for gambling purposes. Burke v. Buck, supra;Craig v. Harrah, supra;Wolpert v. Knight, supra.As stipulated by the parties and indicated in the findings of fact, 22.37 percent of the credit extended by the petitioner was cage credit. Petitioner bears the burden of proof that cage credit was actually used by borrowers for gambling. Welch v. Helvering, 290 U.S. 111">290 U.S. 111 (1933); Rule 142(a), Tax Court Rules of Practice and Procedure. Petitioner's belief that it could demonstrate that certain customers obtained cage credit for gambling purposes does not, by itself, satisfy *1051 petitioner's burden of proof. Accordingly, petitioner must accrue the cage credit as income at the time of issuance.An appropriate order will be entered. Footnotes1. All statutory references are to the Internal Revenue Code of 1954, as in effect during the years at issue.↩2. By stipulating that DPI filed Federal income tax returns for the taxable periods ended Apr. 30, 1967, 1968, 1969, and Sept. 30, 1969, "on the accrual method," respondent does not agree that the accrual method was properly applied by DPI in computing its casino income. Respondent asserts that the manner in which petitioner treated accounts receivable arising from credit granted in the casino in computing its income for Federal income tax purposes was an incorrect application of the accrual method of accounting. The parties do, however, agree that in its Federal income tax returns for the period in question, DPI correctly applied the accrual method to all income and expense items other than (1) the items which are the subject of the petition in this case, (2) reserves, allowances, or deductions which may relate to items which are the subject of the petition, (3) items which may change because of the resolution of issues which are the subject of the petition, and (4) the treatment of outstanding chips.↩3. After Apr. 1, 1968, a casino was prohibited by regulation 6.090 (subsequently regulation 6.100(1)) of the commission from playing these games for cash. Prior to that date the Casino, and most other casinos in Nevada, played these games with chips because use of chips made operation of the games easier.↩2. Not including accounts receivable represented by IOU's redeemed by customers during or at the conclusion of play.↩1. The "drop" for any given period was the cash and IOU's (represented by credit slips) taken in by any table, group of tables, or the Casino for that period.↩4. An IOU signed by a customer in the Casino was in the form of a counter check (i.e., a check form with the name of the bank and the account number left blank). If the Casino inserted the name of a customer's bank and named itself as payee, the IOU could be presented for payment as a check drawn on the customer's bank.↩5. Extensions of credit to a customer at the baccarat table were recorded with buttons placed on the table until the customer left the table. They were also recorded on a master card in the baccarat area. The customer did not sign IOU's while he was playing. When the customer left the table, he would sign an IOU evidencing the outstanding balance of the credit granted to him while he was playing.↩6. Copies of each credit slip were retained by the cashiers and by the accounting department and became a permanent record of the Casino.↩7. In computing the net income of DPI for book and tax purposes, entries were made to reflect factors believed by DPI to relate to the ability to collect the accounts receivable evidenced by the IOU's (a reserve for book purposes, and elimination until collection for tax purposes). These entries were made, however, after Casino revenues were recorded.↩8. The problems in this area may be more complex than perceived by the parties. See Travis v. Commissioner, 406 F.2d 987">406 F.2d 987, 989-990 (6th Cir. 1969); Barker v. Magruder, 95 F.2d 122">95 F.2d 122 (D.C. Cir. 1938); Herberger v. Commissioner, a Memorandum Opinion of this Court dated June 28, 1950, affd. 195 F.2d 293">195 F.2d 293 (9th Cir. 1952). See also Eastman Kodak Co. v. United States, 209 Ct. Cl. 365">209 Ct. Cl. 365, 534 F.2d 252">534 F.2d 252↩ (1976).	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625518/	Addison International, Inc., Petitioner v. Commissioner of Internal Revenue, RespondentAddison International, Inc. v. CommissionerDocket No. 6058-82United States Tax Court90 T.C. 1207; 1988 U.S. Tax Ct. LEXIS 76; 90 T.C. No. 78; June 21, 1988. June 21, 1988, Filed 76 Decision will be entered for the respondent with respect to taxable year 1977.Decision will be entered for the petitioner with respect to taxable year 1976. P, a DISC, was organized and operated in reliance upon the handbook, a guidebook for DISC's issued by the Department of the Treasury. P held no property, had neither employees nor place of business, and conducted no activity beyond those steps necessary to ensure qualification as a DISC. R sent a statutory notice of deficiency to P in which R determined that P failed to qualify as a DISC for taxable years 1976 and 1977 on the ground that a commission payment was not made within the 60-day period allowed by regulation. Held: Because P was entitled to rely on the handbook, the regulation cannot be applied retroactively to P with respect to taxable year 1976. Therefore, P was disqualified as a DISC for taxable year 1977 only. Held, further, P was the proper taxpayer with respect to its current income for taxable year 1977. Ernest Getz, Michael D. Horlick, Timothy G. Reaume, and Joseph M. Persinger, for the petitioner.Beth L. Williams, for the respondent. Wright, Judge. Sterrett, Nims, Parker, 77 Shields, Cohen, Swift, Jacobs, Parr, Williams, and Wells, JJ., agree with the majority opinion. Whalen, J., dissents. Gerber, J., dissenting. Ruwe, J., dissenting. Chabot, Whitaker, Korner, Hamblen, Clapp, and Gerber, JJ., agree with this dissent.WRIGHT1207 By notice of deficiency dated December 15, 1981, respondent determined deficiencies in petitioner's Federal income taxes for the taxable years 1976 and 1977 in the amounts of $ 1,100,583 and $ 1,170,603, respectively.After concessions by the parties, the issues for our decision are (1) whether petitioner Addison International, Inc., failed to qualify as a Domestic International Sales 1208 Corporation (DISC) under sections 991 through 997 during its taxable years 1976 and 1977 and, if so, (2) whether petitioner Addison International, Inc., is properly taxable under section 11 on its taxable income.FINDINGS OF FACTSome of the facts have been stipulated and are so found. The stipulated facts and attached exhibits are incorporated herein by this reference.Petitioner Addison International, 78 Inc. (AI), was incorporated on September 21, 1973, under the laws of the State of Michigan as a Domestic International Sales Corporation (DISC) pursuant to sections 991 through 997 of the Internal Revenue Code. 1 Since its inception, AI has been the wholly owned subsidiary of Addison Products Co. (APC), a corporation organized and operated under the laws of the State of Michigan. AI's outstanding stock consists of 2,500 shares of common stock with a par value of $ 1 per share. Both AI and APC use the accrual method of accounting and report taxable income on a calendar year. APC and AI have never filed consolidated returns.APC manufactures heating and air-conditioning equipment for commercial and residential use. At the time of trial, APC had its primary manufacturing plant in Addison, Michigan, 79 and additional facilities in Michigan and in Texas. Initially, APC sold heating and air-conditioning equipment exclusively in domestic markets. Using the Original Equipment Manufacturing (OEM) method, APC would sell its product to a retailing company which was usually a major manufacturing company with brand-name recognition. In addition to selling its own manufactured products, the retailer would affix its own brand-name to the APC product for sale. Neither the names "Addison" nor "APC" achieved name-brand recognition because the products manufactured by APC did not carry either name. Furthermore, under the OEM method of selling, APC saved costs by not having to maintain a retail or distribution network.1209 In the mid-1960's, APC began exporting its products overseas. When it commenced its export operations, APC did not use the OEM method of selling; instead, its products were exported under its own name through the sales management firm of J.D. Marshall International (Marshall). Marshall purchased the products from APC and exported them independently. Although Marshall was not APC's agent, Marshall was granted an exclusive right to sell APC products bearing the Addison80 name on the retail level in the overseas market. The products proved very marketable and successful, particularly with respect to the sales of air-conditioners in the Middle East.In 1964 or 1965, APC expanded its export activities and began exporting products under the OEM method. APC sold its products to name-brand retailers who in turn sold the APC products overseas under their own names and labels. Often these export retailers were the same companies or individuals who purchased APC products for domestic resale. Although APC was selling its products to both Marshall and to Marshall's competitors, the name-brand retailers, during this period, there was no conflict because the products prepared for OEM resale were cosmetically and superficially altered to satisfy the retailer's specifications. Under both arrangements, the export of APC products proved highly successful.In September 1973, as a result of information learned at a seminar, APC organized and incorporated AI as a DISC. On the certificate of incorporation AI's sole purpose was listed as "any activity permitted to be carried on by a Domestic International Sales Corporation." Donald L. Ball (Ball) who was vice president81 and treasurer for APC during the years in issue, stated that APC's sale reason for incorporating AI was to receive the tax-[ILLEGIBLE WORD] benefits available to a DISC. According to Ball, there were no additional economic considerations for such action.On October 1, 1973, APC and AI executed an agreement pursuant to which AI promised that it would conduct its business at all times in such a fashion as to ensure its status as a DISC. In return, APC granted a franchise to AI with respect to all qualified export property sold for use outside of the United States and Puerto Rico. APC agreed to 1210 be responsible for the solicitation and satisfaction of orders. APC agreed to pay AI the maximum amount allowable as a commission, occasionally in advance. Such commissions were to be determined and paid within 8 months of the end of each accounting period. 282 On November 30, 1973, AI elected DISC status, and APC simultaneously filed its consent to the election. For all taxable years subsequent to this election, including taxable years 1976 and 1977, AI reported income by filing Forms 1120-DISC, the income tax return for DISC's.Throughout 1976 and 1977, AI maintained a separate bank account at the Detroit Bank & Trust Co. and kept books and records. The books and records consisted of a cash journal, a general journal, and a general ledger. AI had no employees, and maintained no office or facilities separate from those owned by APC. The officers of AI were V.C. Knight (Knight) as president, Ball as vice president and treasurer, Fred W. Freeman (Freeman) as secretary in 1976, and John Coyne (Coyne) as secretary in 1977. The board of directors consisted of Knight, Freeman, and Ball in 1976, and Knight, Coyne, and Ball in 1977. During this period Knight, Coyne, and Ball also served as officers of APC. In all matters relating to the organization and operation of AI, the officers and directors were guided by the "DISC-Handbook for Exporters" (the handbook) which was issued by the Treasury Department in January of 1972. This handbook 83 explained how to handle the affairs of the DISC in such a way as to ensure DISC qualification.After incorporating AI, APC made no changes in its routine business conduct. APC continued to sell to brand-name retailers and to Marshall. Robert E. Dyas (Dyas), who was vice president of appliance and export sales during the years in issue, explained that after the incorporation of AI, business continued as usual. Indeed, AI had "absolutely no bearing on" the manufacturing department, of which Dyas was in control. AI had no assets and no employees. Except for services relating to qualification, AI performed no services for APC or anyone else, nor did AI request the 1211 performance of services from APC or anyone else. AI did not ship goods under its own name and did not issue documents of title or invoices. However, AI's shareholders and officers did hold annual meetings.During taxable years 1976 and 1977, AI computed income under the methods prescribed by section 1.994-1, Income Tax Regs. These methods relate to the proper allocation of income between related entities. Under the 50/50 method, the price charged by the parent corporation to the DISC for the exported products84 may be set at a price which allows the DISC to obtain taxable income up to 50 percent of the combined taxable income of the parent corporation and the DISC, plus 10 percent of the export promotion expenses. The 4-percent method allows the parent corporation to set the price charged to the DISC for the exported products at 4 percent of the qualified export receipts plus 10 percent of the export promotion expenses incurred by the DISC. Petitioner's income for taxable year 1976 was computed in accordance with section 1.994-1(a), Income Tax Regs., by using the 50/50 method, resulting in income in the amount of $ 2,185,016, and in conjunction with the 4-percent method, resulting in income in the amount of $ 4,730, for total commission income of $ 2,189,746. Income for taxable year 1977 was computed using these same two formulas, resulting in income in the amount of $ 2,313,141, under the 50/50 method, and resulting in income in the amount of $ 594 under the 4-percent method, for total commission income of $ 2,313,146. In addition to the commission income reported for taxable years 1976 and 1977, AI reported interest income derived from a producer's loan in the amounts of $ 108,591 85 and $ 125,626, respectively. After deducting expenses in the amounts of $ 5,456 in 1976 and $ 10 in 1977, AI reported taxable income for the years in issue in the amounts of $ 2,292,881 and $ 2,438,757, respectively.Although APC claimed commission expense deductions attributable to commissions payable to AI for taxable years 1976 and 1977 in the amounts of $ 2,189,746 and $ 2,313,141, respectively, the money was not actually paid by the close of AI's taxable year. On October 19, 1977, APC issued a check to AI in payment of the commission owing for the taxable year 1976. The payment was made at this time 1212 because it was APC's practice to pay AI at or about the time the DISC tax returns were filed. 3 The next day, AI made a producer's loan to APC in the amount of $ 1,141,400. 4 The remainder of the commission payment, in the amount of $ 1,048,346, was distributed by AI to APC as previously taxed income. On March 21, 1978, APC issued a check in the amount of $ 2,324,840 to AI in payment of the commissions and interest owing for the taxable year 1977. Of this amount, AI made an advance payment for a producer's loan to APC in the amount of $ 979,112, and made a distribution86 of the remainder to APC in the amount of $ 1,345,728. AI's only other expenditures for taxable years 1976 and 1977 were payments for Michigan franchise taxes in the amounts of $ 5,456 and $ 10, respectively.In March 1978, independent auditors informed APC's officers and directors that they had failed to follow one of the procedures required to qualify AI as a DISC. Specifically, the memorandum advised that sections 1.993-2(d)(2) and 1.994-1(e)(3), Income Tax Regs., were no longer in proposed form but had been promulgated in final form. In brief, those regulations required, among other things, that the commission87 payment made by a related supplier to a DISC had to be paid within the 60 days following the close of the DISC's taxable year (the 60-day payment rule). 5 The 60-day payment rule was not included in the handbook. Immediately upon learning of the change, APC made the required payments on March 21, 1978. On September 6, 1978, the officers and directors of APC received an internal memorandum from their management consultant which confirmed the warning APC had received from independent auditors.The statute of limitations with respect to APC was extended for the taxable years 1976 and 1977 to June 30, 1982, pursuant to written agreement. The statute of limitations with respect88 to APC for taxable years 1976 and 1977 1213 expired at midnight on June 30, 1982. Respondent issued a timely notice of deficiency to AI for taxable years 1976 and 1977 on December 15, 1981.OPINIONIn his notice of deficiency to AI, respondent determined that the commissions receivable reported by AI in the taxable years 1976 and 1977 did not constitute qualified export assets because those amounts had not been paid by APC to AI within 60 days after the close of each taxable year. Respondent therefore determined that AI did not qualify as a DISC under section 992 in the taxable years 1976 and 1977. Respondent allocated the income and expenses to AI, itself, rather than to APC.Petitioner contends that the regulations containing the 60-day payment rule are invalid but that, if they are valid, retroactive application of the regulations in this case would be improper. In the alternative, petitioner argues that it substantially complied with the regulations. With respect to the second issue for our consideration, petitioner contends that if AI is not qualified as a DISC for the taxable years 1976 and 1977 then the taxable income is properly taxable to APC rather than AI. Petitioner89 bears the burden of proof on all issues. Welch v. Helvering, 290 U.S. 111">290 U.S. 111, 115 (1933); Rule 142(a).The DISC provisions were enacted by Congress in 1971 6 to provide tax deferral for that portion of income earned by U.S. corporations from the sale or lease of domestic products to foreign buyers and lessees. Generally, a corporation that qualifies as a DISC is not taxable on its profits. Secs. 991 and 995(a). Approximately half of the profits is taxed as a constructive distribution to the shareholders, whether or not such distribution actually occurs, while taxation on the remaining half is deferred. Sec. 995(b); Westinghouse Electric Corp. v. Tully, 466 U.S. 388">466 U.S. 388, 391-392 (1984); Gehl Co. v. Commissioner, 795 F.2d 1324">795 F.2d 1324, 1327 (7th Cir. 1986), affg. in part and revg. in part a Memorandum Opinion of this Court. Any distributions that are made by the DISC to its shareholders out of previously untaxed 1214 earnings and profits are taxable to the shareholders under sections 301 and 316. The retained earnings and profits of a DISC that are not taxed currently remain exempt from taxation90 until they are actually distributed to the shareholders, until a shareholder disposes of his DISC stock in a taxable transaction, or until the corporation ceases to qualify as a DISC. Secs. 996(a)(1), 995(c), and 995(b)(2). Subject to certain restrictions, a DISC is allowed to transfer additional funds to its shareholders in the form of a "producer's loan."In order to qualify as a DISC, at least 95 percent of the adjusted basis of all assets of the corporation, measured on the last day of the taxable year, must be qualified export assets. Sec. 992(a)(1)(B); Goldberger, Inc. v. Commissioner, 88 T.C. 1532">88 T.C. 1532, 1542 (1987). The term "qualified export asset," as defined in section 993(b), includes accounts receivables. Sections 1.993-2(a)(3) and 1.993-2(d)(2), Income Tax Regs., provide generally that a DISC's accounts receivable will be qualified export assets if the receivables arise as commissions earned91 by a commission DISC. 7 Where, however, the domestic parent corporation of the commission DISC is a "related supplier" of the DISC, the circumstances under which commissions receivable are treated as qualifying export assets are restricted by the regulations. A related supplier is a person or corporation who is owned or controlled by the same parties who own or control the DISC and who deals individually with the DISC in a transaction which is controlled by section 994. The purview of section 994 includes a transaction in which the DISC is a commission agent for the related supplier on sales of export property to third parties such as the transactions between APC and AI. Sec. 1.994-1(a)(3) and (b)(1), Income Tax Regs. In such a case, the amount of commissions receivable that qualify as qualified export assets for each tax year must be paid by the parent corporation to the DISC within 60 days after the close of the DISC's taxable year. Sec. 1.994-1(e)(3)(i), Income Tax Regs.892 1215 Since APC was a related supplier with respect to AI, AI's commissions receivable from APC had to be paid within 60 days following the close of AI's taxable year in order for such commissions receivable to constitute trade receivables and, accordingly, qualified export assets, under section 1.993-2(d)(2), Income Tax Regs. It is undisputed that APC did not, in fact, pay the commissions it owed to AI within the 60 days following the close of AI's taxable years 1976 and 1977, and that therefore, under the unambiguous language of the regulations, the commissions owed for the taxable years 1976 and 1977 do not constitute qualified export assets. Therefore, if the commissions in issue are not qualified export assets, AI was not qualified as a DISC in 1976 and 1977 because less than 95 percent of the basis of its total assets was attributable to qualified export assets.Petitioner first argues that the regulations imposing the 60-day payment rules are invalid. Petitioner maintains that the regulations are interpretive, rather than legislative regulations, and, as such, they exceed the scope of the Secretary's authority under section 7805. This very question has been considered93 on several prior occasions and the regulations have consistently been upheld as representing a proper exercise of the Secretary's authority. Gehl Co. v. Commissioner, supra;CWT Farms, Inc. v. Commissioner, 755 F.2d 790">755 F.2d 790 (11th Cir. 1985), affg. 79 T.C. 1054">79 T.C. 1054 (1982); LeCroy Research Systems Corp. v. Commissioner, 751 F.2d 123">751 F.2d 123 (2d Cir. 1984), revg. on other grounds T.C. Memo 1984-145">T.C. Memo. 1984-145; Thomas International Ltd. v. United States, 773 F.2d 300">773 F.2d 300 (Fed. Cir. 1985). Because this point is well settled, we will not exhume it today.Petitioner next contends that, even if the regulations which contain the 60-day payment rules are valid, the regulations may not be retroactively applied to it. Section 1216 1.994-1(e)(3), Income Tax Regs., which contained the 60-day payment rule, was proposed on September 21, 1972, and promulgated in final form on September 29, 1976. Section 1.993-2(d)(2), Income Tax Regs., which applied the 60-day payment rule to the accounts receivable of commission DISC's, was proposed on October 4, 94 1972, and promulgated in final form on October 14, 1977. APC's commission payment to AI for the taxable year 1976 occurred on October 19, 1977, just 5 days after the regulations were promulgated in final form. Although the officers and directors of APC were aware that the regulations existed in proposed form, they did not know that the regulations had been promulgated in final form until nearly 6 months later, in March of 1978. At that time, APC made the commission payment owing to AI for the taxable year 1977. The 60-day-payment rule was not mentioned in the handbook. 9Petitioner argues that because it relied on promises contained in the handbook, 95 the regulations cannot, in fairness, be retroactively applied to it. Specifically, petitioner relied on the section of the handbook which stated that "The Internal Revenue Service will follow the rules and procedures set forth in this part until such time as they may be modified in regulations or other Treasury publications. Any such modifications which may be adverse to taxpayers will apply prospectively only." "DISC: A Handbook for Exporters," U.S. Department of the Treasury, January 1972, at 10. Because the handbook clearly promised that adverse treatment would not be retroactively applied, petitioner maintains that its reliance on the handbook immunizes it from retroactive application.We may quickly dispense with petitioner's argument with respect to taxable year 1977. Both regulations had been fully promulgated in final form by October 14, 1977, but APC's payment to petitioner did not occur until March 28, 1978. As a calendar year taxpayer, petitioner's taxable year ended December 31, 1977. AI should have made the payment by March 1, 1978, in order to comply with the 60-day payment rule contained in the regulations. Surely 1217 petitioner did not believe that the96 regulations, once fully and finally promulgated, would not have prospective application. Although the evidence shows that petitioner was unaware of the final promulgation, petitioner would have us allow it immunity against the effect of the regulations until such time as it actually learned of their promulgation in final form. This we cannot do, and find petitioner's argument concerning the retroactive application of the regulations with respect to taxable year 1977, unfounded.With respect to the retroactive application of the 60-day-payment rule for taxable year 1976, petitioner has raised a question which has caused disagreement among the Circuit Courts of Appeals. In CWT Farms, Inc. v. Commissioner, supra, the U.S. Court of Appeals for the 11th Circuit considered a DISC whose parent corporation had failed to pay the commissions owing within the 60-day period. In that case, the parent had relied on the handbook and argued that retroactive application would be unfair. The 11th Circuit held that Government publications do not bind the Commissioner regardless of the promises they contain. Because the regulations existed in proposed form, the taxpayer's wisest course would97 have been to comply with the regulations' requirements even before their enactment in final form.In contrast, the U.S. Court of Appeals for the Second Circuit held, in a factually similar case, that the regulations could not be retroactively applied. LeCroy Research Systems Corp. v. Commissioner, supra. According to the Second Circuit, the very nature of the DISC provisions, which attempted to induce export activity by promises of tax benefits, purposefully elicited taxpayer reliance. Therefore, it was an abuse of discretion for the Secretary to ignore such promises when they succeeded in eliciting the desired behavior. The Second Circuit held that the taxpayers were entitled to rely on the promises contained in the handbook.In Gehl Co. v. Commissioner, supra, the U.S. Court of Appeals for the Seventh Circuit agreed with the Second Circuit. The Seventh Circuit noted that the appropriate test is (1) whether the taxpayer had justifiably relied on settled law that is altered by the regulations, and (2) whether the 1218 retroactive application of the regulations would create "an inordinately harsh result." 795 F.2d 1332">795 F.2d 1332.98 The court held that because the handbook made express promises and was designed to elicit certain behavior from the taxpayer, it was an abuse of discretion to attempt to renege on the promises contained in the handbook.This Court has not directly addressed this question since the controversy arose in the Circuit Courts of Appeals. In Gibbons International, Inc. v. Commissioner, 89 T.C. 1156">89 T.C. 1156 (1987), we upheld the validity of the regulations in question but did not pass on the question of retroactive application because the tax years in issue occurred subsequent to the enactment of the regulations in final form. 1099 In considering the arguments with respect to the retroactive application of sections 1.993-2(d)(3) and 1.994-1(e)(3), Income Tax Regs., we initially note that our decision should have limited impact. The tax years in question must, by definition, precede 1978, because the regulations became final on October 14, 1977. Commencing with the tax year 1978, all taxpayers were responsible for complying with the enacted regulations.The Seventh Circuit and the Second Circuit both base their decisions to deny retroactive application on the narrow grounds of the singular and unusual nature of the DISC. Because the entire purpose of the DISC legislation was to entice taxpayers into following a path of behavior which satisfied the congressional objective of increasing U.S. exports, taxpayer compliance with the handbook implicitly served congressional objectives. The handbook promised the taxpayers that any modifications would be prospective, and many taxpayers relied on that. As the Seventh Circuit noted, regulations are subject to change, even substantial change, prior to final promulgation. Strict compliance with proposed regulations could cause extra time and labor if the proposed regulations100 undergo substantial modification upon final promulgation. In the uncharted sea of structuring and operating a DISC, taxpayers who followed the guidelines in the handbook were adhering to the most reliable information 1219 available. Because the DISC is a creature of statutory artifice, a taxpayer would have no independent reasons for any actions taken with respect to the organization and operation of a DISC. Thus, we conclude that the positions taken by the Second and the Seventh Circuits are well founded. When sections of the Internal Revenue Code are designed to invoke taxpayers to follow a course of behavior for which they have no other motives, respondent cannot, in fairness, complain when the desired compliance is forthcoming and the taxpayers take the Commissioner at his word.Petitioner did not maintain that the commission payment made by APC to AI on October 19, 1977, was motivated by the discovery that the regulations had been promulgated in final form. Although payment was made within 5 days of the promulgation, the timing was purely coincidental. Nonetheless, even if petitioner had been aware of the final promulgation of the regulations, it would not have expected101 that they affected it, because it believed it was protected according to the promises contained in the handbook. While we cannot condone willful ignorance, we conclude that petitioner's failure to comply with the 60-day payment rule stemmed from its reliance on the handbook. Accordingly, sections 1.993-2(d)(3) and 1.994-1(e)(3), Income Tax Regs., may not be retroactively applied to petitioner for taxable year 1976.Petitioner's next argument is that the payments, although late, were sufficiently timely to constitute substantial compliance with the regulations in issue. This argument has been considered and rejected on several occasions. Gehl Co. v. Commissioner, supra at 1331; Thomas International Ltd. v. United States, supra at 305. 11 Because the regulations in this case are substantive rather than procedural, compliance must be strict and total. Tipps v. Commissioner, 74 T.C. 458">74 T.C. 458, 468 (1980). Petitioner's position that substantial compliance with sections 1.993-2(d)(3) and 1.994-1(e)(3), Income Tax Regs., will suffice, is without merit.102 The second issue for our consideration is whether AI is properly taxable on the income which results from AI's disqualification as a DISC in taxable year 1977. In his notice 1220 of deficiency to AI, respondent determined that AI did not qualify as a DISC under section 992 for the taxable years 1976 and 1977. Respondent allocated the income and expenses to AI rather than to APC.Although neither party discussed this issue extensively on brief, it appears that the statutory notice of deficiency was sent to AI, alone, and APC did not receive a notice of deficiency. Furthermore, with respect to APC, the statute of limitations has run and respondent is precluded from sending a notice of deficiency to APC. Respondent urges us to hold AI liable for the deficiency which results from its disqualification.Petitioner argues that, if AI is disqualified as a DISC, then AI's current income should be taxed to APC rather than AI. In support of this position, petitioner stresses the total absence of economic purpose or activity behind AI's incorporation and operation. Although income was entered on AI's books and reported on AI's DISC income tax returns, petitioner maintains that this103 was done purely to comply with the directives of the DISC legislation. Petitioner also contends that the assignment of income doctrine, articulated in Lucas v. Earl, 281 U.S. 111">281 U.S. 111 (1930), precludes taxing AI, a mere paper corporation. 12Petitioner argues that the principles of Lucas v. Earl, supra, and subsequent cases, require that the income which was attributed to AI, but which was, in fact, earned by APC, be taxed to APC. Petitioner contends that after incorporating AI, APC made no significant changes in procedure or personnel. Manufacturing, marketing, and sales operations104 were conducted exactly as they had been prior to AI's incorporation. Although the organization and operation of the DISC necessitated some bookkeeping and accounting modifications, there were no substantive economic or business practice changes. Furthermore, in organizing and incorporating AI, APC merely followed the dictates of the Internal Revenue Code or the handbook. Beyond the steps necessary to incorporate and qualify AI, AI engaged in no 1221 other activity. Petitioner argues that none of those steps was motivated by an independent business purpose, and none of them constitutes business activity within the meaning of Moline Properties, Inc v. Commissioner, 319 U.S. 436">319 U.S. 436 (1943). See Noonan v. Commissioner, 52 T.C. 907">52 T.C. 907 (1969), affd. 451 F.2d 992">451 F.2d 992 (9th Cir. 1971); Aldon Homes, Inc. v. Commissioner, 33 T.C. 582">33 T.C. 582 (1959).Respondent counters that AI earned the income which was attributed to it on its books and ledgers. Respondent also argues that petitioner chose the corporate form and should be bound by that election. Because petitioner elected the DISC105 form, respondent maintains, all of AI's activities were imbued with that business purpose and thus cannot be disregarded under Moline Properties, Inc. v. Commissioner, supra.Respondent further suggests that AI conducted sufficient business activity to satisfy the minimal-business-activity test of Moline Properties.In the abstract, petitioner's argument is not without appeal. A DISC such as AI does not generate the income which it enters on its books. As is noted in the regulations under section 992, a DISC might not be recognized as a corporation for tax purposes if it were not a DISC. Sec. 1.992-1(a), Income Tax Regs. Nonetheless, if we were to hold as petitioner requests we would, in effect, be calling a DISC a sham corporation, and this we cannot do. Congress created the DISC to implement certain objectives and we cannot undermine the statutory purpose. Rather, we must look to the regulations and the legislative history to determine how to treat the current income of a disqualified DISC.The regulations distinguish between three different types of DISC income. A DISC can have "previously taxed income," "accumulated income," and "other106 earnings and profits." Sec. 1.996-3(a), Income Tax Regs. Generally, accumulated income is taxed when actually distributed to shareholders while previously taxed income is taxed at the time it is deemed to have been distributed at the close of the DISC's taxable year. Other earnings and profits are defined only as being income which falls into neither of the other two categories. Sec. 1.996-3(d), Income Tax Regs.1222 Upon disqualification, the DISC becomes a "former DISC." A DISC remains a former DISC for 5 years based on its original election, but if it fails to requalify as a DISC by the end of that 5-year period, the election expires. Section 995 provides that upon disqualification, either by revoking the election or by failing to satisfy one of the many qualifying conditions, the former DISC's accumulated income, which it continues to hold, is taxable to the DISC's shareholders. Sec. 995(b)(2)(A). The accumulated income is distributed to the shareholders over a period of up to 10 years. Sec. 1.995-3(b), Income Tax Regs. The shareholders are not taxed on receipt of the previously taxed income when it is distributed.The proper tax treatment of the third category of107 DISC income, other earnings and profits, is less clear. Especially with respect to income received by a DISC which is subject to a valid DISC election but which has been disqualified, an initial analysis indicates that the underlying benefit accorded to DISC's and their shareholders is the deferral of the income which is ultimately taxable to the shareholders. Thus, at first blush it seems that disqualification would eliminate the benefit, ending deferral and making the shareholder immediately taxable on the DISC's current earnings.However, the legislative history contains a brief reference which indicates that congressional intent dictates an opposite conclusion. Although other earnings and profits would appear to be generally comprised of income earned prior to DISC qualification, the Senate Finance Committee report noted that:The third division of a DISC's earnings and profits, is referred to as "other earnings and profits." This has reference to those earnings and profits of a DISC which were accumulated while the corporation was not taxed as a DISC (i.e., in a year prior to the corporation's election, or subsequent to the election if it did not qualify for the year). These108 are the "normal" earnings and profits of a DISC which are the same as the earnings and profits of an ordinary corporation which never was a DISC. As a result, these earnings and profits when distributed are eligible for the dividends received deduction and are not treated as foreign source income. [S. Rept. 92-437, at 122-123 (1972), 1 C.B. 559">1972-1 C.B. 559, 628.]Thus, the legislative history indicates that the disqualified DISC was meant to be taxed as a separate corporation within the meaning of subchapter C on any income which 1223 was neither previously taxed income nor accumulated income. Although this aspect of Congress' framework for DISC taxation does not appear in the statute or the regulations, we shall accord it the proper weight. See Burnet v. S. & L. Building Corp., 288 U.S. 406">288 U.S. 406 (1933). Thus, we conclude that the current income of a disqualified DISC which is subject to a valid DISC election, is taxable to the DISC itself and the dividends, when paid to the shareholders, qualify for the dividends received deduction.Accordingly, we find that the notice of deficiency was properly sent to the proper taxpayer, 109 AI, and that AI is liable for the deficiency determined with respect to taxable year 1977 only.To reflect the foregoing,Decision will be entered for the respondent with respect to taxable year 1977.Decision will be entered for the petitioner with respect to taxable year 1976. GERBER; RUWEGerber, J., dissenting: The majority has overruled our recent and well-reasoned opinion in CWT Farms, Inc. v. Commissioner, 79 T.C. 1054">79 T.C. 1054 (1982), which was embraced and affirmed by the Court of Appeals for the 11th Circuit at 755 F.2d 790">755 F.2d 790 (11th Cir. 1985). I respectfully dissent because the majority has not provided adequate rationale in support of its decision to overrule our established and affirmed precedent. Also, the majority has ignored long-established principles concerning the retroactive application of regulations.All courts which have considered the final regulations in question have found them to be valid and "consistent with 1224 the statutes' origin and purpose." CWT Farms, Inc. v. Commissioner, 755 F.2d 790">755 F.2d 790, 797-802 (11th Cir. 1985), affg. 79 T.C. 1054">79 T.C. 1054, 1061-1067 (1982);110 Gehl Co. v. Commissioner, 795 F.2d 1324">795 F.2d 1324, 1327 (7th Cir. 1986); LeCroy Research Systems Corp. v. Commissioner, 751 F.2d 123">751 F.2d 123 (2d Cir. 1984); Thomas International Ltd. v. United States, 773 F.2d 300">773 F.2d 300 (Fed. Cir. 1985). The Courts of Appeals for both the Second and Seventh Circuits have decided that the regulations should not be retroactively applied, whereas this Court and Court of Appeals for the 11th Circuit have held otherwise.Judge Simpson, in his thorough analysis of the retroactivity of regulations, set forth the following three principles (each of which was, at the very least, supported by a Supreme Court citation), as follows: (1) "Internal Revenue regulations are retroactive in effect unless the Commissioner provides otherwise." (2) "The Commissioner's failure to make regulations nonretroactive may not be disturbed unless it amounts to an abuse of discretion." (3) "An abuse of discretion may be found if the retroactive regulations alter settled prior law or policy upon which the taxpayer justifiably relied and if the change causes the taxpayer to suffer inordinate harm." CWT Farms, Inc. v. Commissioner, 79 T.C. at 1068.111 Our Court and the Court of Appeals for the 11th Circuit considered two bases in deciding whether the situation involved herein presented an exception to the general rule that regulations are to be retroactively applied. First considered was the principle that statements contained in publications, such as the handbook in question, do not bind the Commissioner in subsequent litigation. See cases cited at 79 T.C. 1069">79 T.C. 1069. Although that general principle is appropriate in most circumstances, one might reasonably argue that the handbook in question had a more significant stature or that it was in other ways extraordinary. 1112 The second basis presents a more persuasive rationale for finding that the general rule of regulation retroactivity should apply. The handbook containing the guidelines or, 1225 lack of same, was published and issued by the Treasury Department during January 1972. "The handbook provided that its rules would be followed until modified 'in regulations or other Treasury publications.'" CWT Farms, Inc. v. Commissioner, 79 T.C. at 1069. The Treasury Department published and issued proposed regulations containing the disputed requirements during October 1972. The petitioner in this case did not rely upon the handbook or proposed regulations or apparently consider DISC status until "September 1973, as a result of information learned at a seminar." The final regulations were adopted in final form on September 29, 1976, and October 14, 1977. The dates of the final regulations were both before the commission payment in question occurred and at least one of the final regulations was adopted before petitioner's income tax return for the period in question was due to be filed.In our finding that petitioner in CWT Farms, Inc., v. Commissioner, failed113 to demonstrate that respondent abused his discretion in applying the subject regulations retroactively, the following reasoning and principles, amply supported by precedent, were provided: (1) Respondent's regulatory interpretation did not alter settled prior law and taxpayers had no "'vested interest in a hypothetical decision in * * * [their] favor prior to the advent of the regulations.' CWT Farms, Inc. v. Commissioner, 79 T.C. at 1070; Helvering v. Reynolds, 313 U.S. at 433; Chock Full O'Nuts Corp. v. United States, 453 F.2d at 303." (2) The respondent made his position publicly known in proposed regulations during 1972, and that constituted adequate notice. See Wendland v. Commissioner, 79 T.C. 355">79 T.C. 355, 382 n. 15 (1982). (3) A published proposed regulation, at very least, complied with the terms for modification or variance from the terms (or lack thereof) of the handbook. CWT Farms, Inc. v. Commissioner, 79 T.C. at 1069-1070.Our reasoning in support of retroactive application in CWT Farms, Inc. v. Commissioner, is equally114 appropriate here, where petitioner did not consider use of a DISC until after issuance of both the handbook and proposed regulations. In light of the respondent's published intent, petitioner was taking a risk in blindly following the handbook. Moreover, it appears that the handbook was not dispositive 1226 or in any way concise about the circumstances covered in the proposed or final regulations. Most importantly, the majority does not set forth any changed conditions or law to justify overruling our established and affirmed precedent in CWT Farms, Inc. v. Commissioner.The opinions of the Courts of Appeals for the Second and Seventh Circuits which overruled memorandum opinions of this Court and supported a position contrary to the Court of Appeals for the 11th Circuit and this Court, essentially, offered the following reasoning: (1) That the handbook in question was something more than a statement of current law, because it contained promises to be relied upon in the future; and (2) that proposed regulations are merely "suggestions made for comment" and are not intended to modify anything. Gehl Co. v. Commissioner, 795 F.2d 1324">795 F.2d 1324 (7th Cir. 1986);115 LeCroy Research Systems Corp. v. Commissioner, 751 F.2d 123">751 F.2d 123 (2d Cir. 1984).Although I agree that proposed regulations do not have the authority or standing of temporary or final regulations, they are regularly used to present the Treasury Department's position on a particular subject. The purpose for issuing proposed regulations is to put taxpayers on notice and to elicit commentary that may be considered in finalizing the regulation. See sec. 601.601(a) and (b), Procedural Regs. As jurists, we have adhered to the principle that respondent's revenue rulings and procedures are nothing more than the position of a party and they are afforded little or no weight as authority. Estate of Lang v. Commissioner, 613 F.2d 770">613 F.2d 770, 776 (9th Cir. 1980), affg. on this point 64 T.C. 404">64 T.C. 404 (1975); Stubbs, Overbeck & Assoc. v. United States, 445 F.2d 1142">445 F.2d 1142 (5th Cir. 1971); Sims v. United States, 252 F.2d 434">252 F.2d 434 (4th Cir. 1958), affd. 359 U.S. 108">359 U.S. 108 (1959); Minnis v. Commissioner, 71 T.C. 1049">71 T.C. 1049, 1057 (1979).116 The opinions of the Courts of Appeals for the Second and Seventh Circuits have placed proposed regulations below the level afforded revenue rulings and procedures and placed the handbook in the same status as temporary or final regulations. This approach is both divisive and disruptive to a long-established order of significance upon which both taxpayers and Government have long relied.1227 To reiterate, in effect, the Government made no promises to this petitioner or any taxpayer with a taxable year after 1972. The handbook and proposed regulations were published within 9 months of each other during 1972. I find the majority's position that a proposed regulation is insufficient to put the public on notice to be simply incorrect.For the foregoing reasons, I respectfully dissent from the majority's opinion.Ruwe, J., dissenting: For the following reasons, I do not agree with the majority's holding that petitioner, a former DISC, was the proper taxpayer with respect to income attributed to it for the year 1977.The majority opinion is based on a concern that were we to find petitioner totally lacking in substance, this "would, in effect, be calling a DISC a sham corporation" 117 and thus undermine the purpose of the DISC legislation. Majority opinion at p. 1221. We need not be concerned with undermining the purpose of the DISC legislation in this case for the simple reason that petitioner was not a DISC during 1977.The majority opinion implies that even though petitioner was disqualified, it was still a DISC for some purposes. Sec. 992(a)(1) defines a DISC. Petitioner failed to meet the qualifications for DISC status which are contained in section 992(a)(1)(B) and section 993(b) and the regulations thereunder. This is undisputed. Section 992(a)(3) defines a "former DISC" as "with respect to any taxable year, a corporation which is not a DISC for such year but was a DISC in a preceding taxable year." (Emphasis added.) Section 1.992-1(e), Income Tax Regs., states that "A corporation is a DISC for a taxable year only if such an election is in effect for that year and the corporation also satisfies the requirements of paragraphs (a) through (d) of this section." (Emphasis added.) The majority opinion has already found that petitioner failed the test contained in section 1.992-1(c), Income Tax Regs., which is the same requirement set forth in118 section 992(a)(1)(B).1228 It is true that once having made an election to be treated as a DISC, a corporation that fails to qualify as a DISC for a particular year will be considered as a DISC for subsequent years in which it meets DISC qualifications. There is no need to make another election. See sec. 1.992-2(d), Income Tax Regs. However, the benefits of tax deferral available through the DISC arrangement are simply unavailable for export transactions occurring during a year when the former DISC is disqualified. Arrangements related to foreign sales transactions during a year when a former DISC is not qualified should be judged using the same criteria that we would use in judging the substance of any other corporate transactions. 1119 The DISC legislative history quoted on page 1222 of the majority opinion is consistent with the above analysis. It is unquestioned that a corporate entity that is a DISC or former DISC can have "'normal' earnings and profits * * which are the same as the earnings and profits of an ordinary corporation which never was a DISC." S. Rept. 92-437, at 123 (1972), 1 C.B. 559">1972-1 C.B. 559, 628. There is nothing, however, in this legislative history indicating that when a former DISC ostensibly earns "normal" profits, that the bona fides of its corporate activities should be judged on standards other than those applied to other corporations which are not DISC's. The legislative history describes as "normal" those earnings and profits generated before the corporation became a DISC and those generated during a period when it was disqualified as a DISC. S. Rept. 92-437, supra, 1972-1 C.B. at 628. It seems beyond question that corporate activities preceding initial DISC election and qualification would be judged on the basis of business purpose and economic substance without any regard to the DISC provisions. Since the legislative history120 equates pre-DISC earnings with earnings during a disqualification period, why would we use DISC concepts in judging the latter and not the former? The DISC provisions simply don't apply in making that judgment.1229 Having eliminated the problem of potentially undermining the DISC statutory framework, this transaction should be judged on the basis of the facts presented. Petitioner contends that, in reality, it had no income because it did nothing to earn the income. Indeed, it could not have done anything based upon the findings of fact since it had no employees, performed no services, dealt with no customers, and did not even receive the payment of the amounts of income, which respondent argues it earned, until the following year. 2121 Normally, the choice of doing business in corporate form will be respected.Whether the purpose be to gain an advantage under the law of the state of incorporation or to avoid or to comply with the demands of creditors or to serve the creator's personal or undisclosed convenience, so long as that purpose is the equivalent of business activity or is followed by the carrying on of business by the corporation, the corporation remains a separate taxable entity. * * [Moline Properties, Inc. v. Commissioner, 319 U.S. 436">319 U.S. 436, 438-439 (1943). Emphasis added.]However, tax avoidance, standing alone, is not sufficient to meet the business purpose test in Moline Properties and the fact finding in this case indicates clearly that there was no other business purpose and no business activity. See National Carbide Corp. v. Commissioner, 336 U.S. 422">336 U.S. 422 (1949); Noonan v. Commissioner, 52 T.C. 907">52 T.C. 907 (1969), affd. 451 F.2d 992">451 F.2d 992 (9th Cir. 1971); Aldon Homes, Inc. v. Commissioner, 33 T.C. 582">33 T.C. 582 (1959). The only thing that petitioner did that might122 be construed as corporate activity was to maintain a bank account and separate records, and act as a conduit regarding funds of APC. 3 These are minimum DISC requirements. See sec. 1.992-1(a)(1) through 1230 (8). Even respondent's own regulations explicitly recognize that DISC qualification (which requires incorporation, books and records, a bank account, and payments) entitles a corporation to be recognized for tax purposes "even though such corporation would not be treated (if it were not a DISC) as a corporate entity for Federal income tax purposes." Sec. 1.992-1(a), Income Tax Regs. One can hardly imagine a corporate entity more devoid of substance than petitioner during the year 1977.123 Having failed to qualify as a DISC, the only purpose for petitioner's existence, i.e., tax deferral, became impossible. Petitioner had no other business purpose and no business activity during the year 1977. To the extent that it received funds, it served as a conduit of the income earned by APC. As a mere conduit, petitioner was essentially acting as an agent for APC. Under the principles set forth in Commissioner v. Bollinger, 485 U.S. (1988), APC, rather than petitioner, is the proper taxpayer with respect to the income earned during the taxable year 1977. 4This is not a case where we need be concerned with the equities of allowing a taxpayer to unfairly avoid taxation under a form which it chose. 124 It is clear that APC formed petitioner solely to take advantage of the DISC provisions, but for which there would have been no tax advantages under the facts of this case. When respondent determined that petitioner was not qualified as a DISC, the statute of limitations was still open with respect to APC and respondent had the knowledge and ability to totally disregard this purely tax-motivated transaction. 5 Instead, respondent chose form over substance. This should not be allowed in a situation where a taxpayer fails to meet highly technical provisions of a statutory scheme that was intended to encourage and benefit taxpayers who engaged in exporting activities. 6125 Footnotes. This opinion was reviewed by the Court prior to Chief Judge Sterrett's resignation from the Court.↩1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954 as amended and in effect during the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩2. On Dec. 28, 1979, APC and AI entered into a subsequent franchise agreement which amended certain aspects of the initial franchise agreement. However, the alterations were minor and do not concern the taxable years in issue here.↩3. Under sec. 6072(b), a DISC's tax return is due on or before the 15th day of the ninth month following the close of its taxable year.↩4. The parties have stipulated that the producer's loan of Oct. 20, 1977, was not, in its entirety, a qualified producer's loan. Of that amount, only $ 634,299 was a qualified producer's loan, and the balance, in the amount of $ 507,101, did not qualify as a producer's loan.↩5. Oct. 19, 1977, the actual date of the commission payment for the taxable year 1976, was more than 7 months after the date when payment should have been made in order to comply with the 60-day payment rule. The due date was Mar. 1, 1977. When APC made the payment, it included a portion labeled "interest accruing" for this 7-month extension.↩6. Secs. 501-507 of the Revenue Act of 1971, Pub. L. 92-178, 85 Stat. 497, 535-553.↩7. The parties agree that AI is a commission DISC rather than a buy-sell DISC.↩8. The pertinent provisions of sec. 1.993-2(d)(2), Income Tax Regs., provide:(2) Trade receivables representing commissions. If a DISC acts as commission agent for a principal in a transaction * * * which results in qualified export receipts for the DISC, and if an account receivable or evidence of indebtedness held by the DISC and representing the commission payable to the DISC as a result of the transaction arises * * * such account receivable or evidence of indebtedness shall be treated as a trade receivable. If, however, the principal is a related supplier (as defined in section 1.994-1(a)(3)) with respect to the DISC, such account receivable of evidence of indebtedness will not be treated as a trade receivable unless it is payable and paid in a time and manner which satisfy the requirements of section 1.994-1(e)(3) * * Sec. 1.994-1(e)(3)(i), Income Tax Regs., provides in pertinent part:(i) The amount * * a sales commission (or reasonable estimate thereof) actually charged by a DISC to a related supplier * * * must be paid no later than 60 days following the close of the taxable year of the DISC during which the transaction occurred.↩9. Where taxpayers rely on a plausible interpretation of the plain meaning of settled law "We see no reason to add to this burden by requiring them anticipatorily to interpret ambiguities in respondent's rulings to conform to his subsequent clarifications." Corn Belt Hatcheries of Arkansas, Inc. v. Commissioner, 52 T.C. 636">52 T.C. 636, 639↩ (1969).10. In Fritzsche Dodge & Olcott, Inc. v. Commissioner, T.C. Memo 1983-56">T.C. Memo. 1983-56, 45 T.C.M. (CCH) 607">45 T.C.M. 607, 52 P-H Memo T.C. par 83,056 (1983), we followed the precedent established prior to the recent disagreement among the circuits, citing to our opinion in CWT Farms, Inc. v. Commissioner, 79 T.C. 1054">79 T.C. 1054 (1982), affd. 755 F.2d 790">755 F.2d 790↩ (11th Cir. 1985).11. See also Fritzsche Dodge & Olcott, Inc. v. Commissioner, supra↩, 45 T.C.M. at 609-610, 52 P-H Memo T.C. par. 83,056, at 83-163 -- 83-164.12. Respondent maintains that sec. 482 is a tool which only he may wield, but this argument is misplaced because petitioner urges us to consider the source of AI's income under the case law doctrine of assignment of income rather than under the statutory authority of sec. 482. * This opinion was reviewed by the Court prior to Chief Judge Sterrett↩'s resignation from the Court.1. Although one might make that argument, it is a matter of judgment and would appear to be a close call. In this regard, we have already taken a position on this aspect in CWT Farms, Inc. v. Commissioner, 79 T.C. 1054">79 T.C. 1054↩ (1982), and numerous Memorandum Opinions. In close situations, such as this one, we have a duty of consistency and should not change our opinion or judgment unless it is clearly wrong.1. Sec. 1.992-2(d) also indicates that a "former DISC" is subject to the DISC provisions of the Code. This is necessary only because prior accumulations of earnings and profits earned while qualified as a DISC must be accounted for. S. Rept. 92-437, at 93 (1972), 1 C.B. 559">1972-1 C.B. 559↩, 611. It does not and cannot be meant to attribute all DISC corporate attributes to a former DISC. To do so would render the qualification requirements meaningless.2. Even the amount which petitioner received in March 1978, ostensibly due to commissions earned in 1977, was immediately paid back to APC in the form of an advance payment on a producer's loan and a distribution of previously taxed income on the assumption that petitioner qualified as a DISC. Since these characterizations of amounts petitioner paid back to APC depend on petitioner's DISC qualification, they must be disregarded. It is then clear that petitioner was merely a conduit.↩3. The majority suggests that because petitioner maintained a bank account, kept books and records, and held annual meetings, it must be recognized as a corporation for Federal income tax purposes under Moline Properties, Inc. v. Commissioner, 319 U.S. 436">319 U.S. 436 (1943). I disagree. This Court has held that, although an entity has engaged in similar activities, it would not be recognized as a corporation for tax purposes where it lacked a substantial business purpose for organization and had not engaged in any substantive business activities. See Aldon Homes, Inc. v. Commissioner, 33 T.C. 582">33 T.C. 582 (1959). See also Visnapuu v. Commissioner, T.C. Memo. 1987-354; Horn v. Commissioner, T.C. Memo. 1982-741↩.4. If we were to recognize petitioner as the bona fide recipient of sales commissions which are really a portion of APC's profits, we would also be violating the principle that income must be taxed to the person or entity that earned it. Lucas v. Earl, 281 U.S. 111">281 U.S. 111↩ (1930).5. The majority does not, and could not, apply principles of equitable estoppel given the facts in this case. See Century Data Systems, Inc. v. Commissioner, 86 T.C. 157">86 T.C. 157↩ (1986).6. In similar cases respondent has disallowed the parent's commission expense or reallocated the former DISC's "income" back to the parent under sec. 482. It is possible that respondent will now feel free to choose whichever alternative produces the most tax.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625519/	APPEAL OF COLLINS & WHEELAND, INC.Collins & Wheeland, Inc. v. CommissionerDocket Nos. 2293 and 2294.United States Board of Tax Appeals2 B.T.A. 699; 1925 BTA LEXIS 2281; September 30, 1925, Decided Submitted June 18, 1925. 2281 Frank I. Ford, Esq., for the taxpayer. John D. Foley, Esq., for the Commissioner. 699 Before GRAUPNER, TRAMMELL, and PHILLIPS. This is an appeal from the determination of deficiencies in income and profits taxes for the calendar years 1918 and 1919 in the respective amounts of $215.42 and $1,667.79, a total deficiency of $1,883.21. The question at issue is whether the taxpayer is entitled to a deduction for obsolescence of good will claimed to have a value of $25,000 as of March 1, 1913. 700 FINDINGS OF FACT. 1. The taxpayer is a California corporation with its principal place of business at San Francisco. 2. During 1905, and for many years prior thereto, a partnership known as Collins & Wheeland conducted a saloon in San Francisco, and in connection therewith operated a free-lunch counter and also sold steaks and chops. 3. In the latter part of 1905, E. G. Rodolph, acting for himself and others, entered into negotiations with S. M. Collins, the surviving member of the partnership, for the purchase of the business of Collins & Wheeland. During the course of the negotiations it was discovered that the lease on the premises occupied2282 by Collins & Wheeland was about to expire. Collins secured a lease in his own name for a period of five years and upon resumption of negotiations demanded $15,000 for the lease. 4. In January, 1906, the taxpayer, Collins & Wheeland, Inc., was organized with a capital of $40,000, divided into 4,000 shares of stock having a par value of $10 each, all of which was subscribed for and paid for in cash. 5. During the same month Rodolph purchased the business and assets of the partnership, including the five-year lease, for $38,000 cash. 6. The business was conducted by the taxpayer in the same manner as it had been by the partnership until April 18, 1906, when it was destroyed by fire. It was reopened in 1908 on the same location and conducted in the same manner as it had been previously until July 1, 1919. 7. In a suit brought by the administratrix of the estate of Wheeland, in which S. M. Collins was joined as a defendant, the Superior Court of the City and County of San Francisco, in a judgment rendered November 27, 1908, held that the sum of $15,000 which had been paid by Rodolph to Collins individually for the five-year lease was "in fact part of the selling price2283 of said business, including said leasehold interest." 8. In March, 1909, John Farley purchased from Rodolph 1,000 shares of the capital stock of the taxpayer for $10,000. 9. In the taxpayer's balance sheets for the years ended December 31, 1909, 1910, 1911, and 1912, there appear the items "Good will, $10,000," and "Leases, $15,000." 10. On July 1, 1919, the War Prohibition Act became effective, and the taxpayer discontinued the saloon business. It continued the operation of its restaurant and added new equipment thereto. The net profits from 1908 to 1912 were: 1908, loss of $3,891; 1909, gain of $3,201.47; 1910, gain of $4,476.16; 1911, gain of $4,931.18; and 701 1912, gain of $6,489.47. In 1920 the taxpayer sustained a net loss of $40.25. 11. During the period January, 1906, to December 31, 1919, the taxpayer paid dividends in the amount of $71,600. 12. On December 16, 1920, John E. Tobin purchased all the capital stock of the taxpayer for $12,500. DECISION. The determination of the Commissioner is approved. ARUNDELL not participating.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625521/	Estate of S. E. Vance, Deceased, by Margaret Vance, Cyrus B. Vance, and William Vance, His Executors, and Margaret Vance v. Commissioner.Estate of Vance v. CommissionerDocket No. 78035.United States Tax CourtT.C. Memo 1960-167; 1960 Tax Ct. Memo LEXIS 122; 19 T.C.M. (CCH) 904; T.C.M. (RIA) 60167; August 19, 1960J. Eben Hart, Esq., Liberty Bank Building, Oklahoma City, Okla., for the petitioners. John P. Higgins, Esq., for the respondent WITHEYMemorandum Opinion WITHEY, Judge: Respondent has determined a deficiency in income tax against petitioners for the taxable year 1954 in the amount of $2,963.05. The sole issue is whether the Commissioner has erred in treating as ordinary income $5,189.20 received by S. E. Vance in the year at issue as the sale price of a quantity of dirt removed from his farm property by the City of Tulsa, Oklahoma. All the facts have been stipulated and are found accordingly. S. E. Vance and petitioner Margaret Vance, sometimes hereinafter referred to as the Vances, were husband and wife living in Tulsa, Oklahoma, during the years 1951 to 1956, inclusive. They timely filed joint123 income tax returns for those years with the director of internal revenue for the district of Oklahoma. The Vances used the cash receipts and disbursements method for reporting their income and reported on a calendar year basis for all of the years involved herein. S. E. Vance, sometimes hereinafter referred to as the decedent, died on or about September 23, 1958, and petitioner Margaret Vance, Cyrus B. Vance, and William Vance were appointed coexecutors of his estate by the County Court of Tulsa County, Tulsa, Oklahoma. On or about December 19, 1925, the decedent purchased 144.47 acres of land located just west of the Arkansas River on what is now described as Fifty-First Street in the City of Tulsa, Oklahoma, for a total consideration of $13,745.45. Prior to 1951 additional capitalized costs were incurred so that the total cost of the property to decedent on January 1, 1950, was $14,647.00. The principal value of the land when purchased was agricultural and the land was used for that purpose by decedent either by a rental arrangement or actually farming the land himself for the years prior to and including the year 1951. Since 1951 all the land except 15 acres from which the124 dirt involved in this proceeding was taken has been similarly used for agricultural purposes. The bulk of the 15 acres was leased out for use as a drive-in theater in 1953 and is still being used for such purpose. Prior to January 1, 1950, the United States, the State of Oklahoma, Tulsa County, and the City of Tulsa entered into a contract to construct what is now known as the Fifty-First Street Bridge across the Arkansas River and to construct a highway leading to said bridge, which highway was contiguous to and formed the south boundary of the above-described property. Under said contract the City of Tulsa was required to purchase the right-of-way and furnish any fill dirt required for the construction of the highway on that portion of the land located within the boundaries of said city. At various dates prior to the year at issue the decedent sold parcels of land from his farm to the City of Tulsa for highway and bridge approach construction and use. Such sales and the gain realized thereon were reported in the joint income tax returns of the Vances for the respective years of sale. On May 25, 1954, decedent sold 2.06 acres of the land for a consideration of $5,400, from which125 sale was realized long-term capital gain in the amount of $5,192.08 which was properly reported in the Vances' joint income tax return for 1954. The remaining cost of decedent's farm on September 1, 1954, was $13,439.38. Prior to January 1, 1951, engineers employed by the City of Tulsa determined that it was economically necessary that the city should obtain in excess of 200,000 cubic yards of fill dirt to be used in the construction of the approach to the Fifty-First Street Bridge from land owned by Sam and Pearl Hardesty and from decedent's farm land which was contiguous thereto. On or about the 26th day of January 1951 the City of Tulsa entered into a contract with Sam and Pearl Hardesty for the removal and use of dirt from the Hardesty land for the construction of the approach to the Fifty-First Street Bridge. Prior to February 22, 1951, engineers employed by the City of Tulsa contacted decedent with the proposal that he enter into a contract with the City of Tulsa permitting the City of Tulsa to remove and use fill dirt to be obtained from approximately 15 acres of his land. After negotiations, decedent entered into such an agreement on February 22, 1951. During the period126 of their negotiations with the decedent the employees of the City of Tulsa concluded that the city had the power to condemn the property in question, if necessary. The decedent's attorney during the period of negotiations advised him that the city had such power. No proceedings were instituted by the City of Tulsa to condemn the property. Pursuant to its agreement of February 22, 1951, with the decedent, the City of Tulsa prior to February 17, 1953, removed from the approximately 15 acres of his farm land and used 101,679 cubic yards of dirt for which it paid him $5,189.20 on September 7, 1954. The decedent under the terms of the contract received the same price per cubic yard of dirt taken from his land as was paid Sam and Pearl Hardesty per cubic yard for dirt taken from their land. The removal of the top soil from the approximately 15 acres of the decedent's land destroyed the then present agricultural value of that acreage, but the leveling of such acreage required by the above-mentioned agreement, and in fact done, and the construction of the bridge and highway on the boundary of the farm increased its total prospective value. The decedent did not hold dirt for sale to customers127 in any of the years involved herein nor was the dirt removed from his farm by the City of Tulsa includible in inventory. On January 1, 1954, decedent had excess net capital loss carryover in the amount of $15,500.54 which represented unused net capital loss incurred in the years 1951 and 1952. During 1954 decedent had no losses from transactions enumerated in section 1231 of the Internal Revenue Code of 1954. In executing an agreement with the City of Tulsa for the sale of dirt from his farm property decedent did not do so under a threat of or the imminence of condemnation of the property by the city. The petitioners have failed to show that decedent's agreement with the City of Tulsa for the removal of earth from his farm was entered into under a threat of or the imminence of condemnation. Consequently, the gain from the sale of dirt from decedent's land may not be accorded the treatment provided in section 1231 of the 1954 Code for gains from sales of property used in trade or business entered into under threat of or the imminence of condemnation. However, the question whether under the agreement decedent sold a capital asset or sold property held128 for sale to customers is another matter. The parties have, it seems to us, resolved the issue by their stipulation of facts. They there agree that the dirt removed by the City of Tulsa from decedent's land was not property held for sale by decedent to customers and was not property of a nature which would be includible in inventory. By a process of elimination then it appears such property must have been capital in nature and that its sale could only produce capital gain. Robert M. Dann, 30 T.C. 499">30 T.C. 499. We think the cited case is controlling here for the facts there are in principle indistinguishable from those of the instant case. Respondent's theory seems to be that decedent, by virtue of the city's performance of its contract in leaving the involved land in such condition that it was usable for drive-in-theater purposes, realized ordinary income and the contract provides for a sale of such character that the proceeds constitute ordinary income. We are unable to follow respondent's reasoning however for in so contending he cites mineral lease cases such as Burnet v. Harmel, 287 U.S. 103">287 U.S. 103, Crowell Land & Mineral Corporation, 25 T.C. 223">25 T.C. 223, revd. *129 242 F.2d 864">242 F. 2d 864, and William Louis Albritton, 24 T.C. 903">24 T.C. 903, affd. in part and revd. in part (C.A. 5) 248 F. 2d 49, as authority for his position. We have considered the application of the principles enunciated by such cases in Robert M. Dann, supra, and rejected them because, as here, we have found such contracts to constitute sales in the entirety of all of the top soil (usable and theretofore used for farming purposes) of a portion of a farm which is a capital asset. There is no question here of a retention in decedent of an economic interest in the asset removed by the city. Once removed the soil became the property of the City of Tulsa and a part of a bridge approach. No further dealing with it on the part of decedent and the city remained to be carried out and decedent's interest of every nature in the dirt ended with its removal. Decision will be entered under Rule 50.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625522/	Reco Industries, Inc., Common Parent Corporation of Consolidated Group Consisting of Reco Industries, Inc., and Subsidiaries, Petitioner v. Commissioner of Internal Revenue, RespondentReco Industries, Inc. v. CommissionerDocket No. 4861-81United States Tax Court83 T.C. 912; 1984 U.S. Tax Ct. LEXIS 5; 83 T.C. No. 49; December 10, 1984. December 10, 1984, Filed 5 Decision will be entered under Rule 155. Petitioner, a manufacturer of custom-order steel products, reported its income under the completed contract method of long-term contract accounting. Petitioner maintained raw materials and work-in-process inventories. The costs of raw materials, labor, and overhead associated with the completion of a long-term contract were accumulated in work-in-process inventory accounts. In the year of contract completion, income was recognized, and associated contract costs were deducted from inventory and charged to cost of goods sold.Prior to 1974, petitioner valued its inventories on the first-in, first-out (FIFO) basis. Petitioner filed an election to value its inventories under the last-in, first-out (LIFO) method with its 1974 return. Petitioner used the LIFO method from 1974 through 1976, the years in issue. Respondent determined deficiencies on the ground that a completed contract method taxpayer may not use LIFO inventories to account for the costs of completing long-term contracts. Held:1. Petitioner's method of computing contract costs by using inventories conformed to both the regulations and generally accepted accounting principles, 6 was consistently used, and therefore clearly reflected income.2. Petitioner's use of the LIFO method of inventory valuation clearly reflected income. Peninsula Steel Products & Equipment Co. v. Commissioner, 78 T.C. 1029 (1982), followed. Robert S. Parker, Jr., and B. Cary Tolley III, for the petitioner. 8 Marion B. Morton and William L. Ringuette, for the respondent. Jacobs, Judge. JACOBS913 OPINIONRespondent determined the following deficiencies in the income taxes of RECO Industries, Inc., and its wholly owned subsidiaries:TYE Dec. 31 --Deficiency1974$ 799,448.7319755,157.681976393,002.56The sole issue for decision is whether petitioner, which reports its income for Federal income tax purposes under the completed contract method of accounting, may compute its costs using the last-in, first-out (LIFO) method of inventory valuation.The facts of this case have been fully stipulated and are so found. The parties' stipulation together with the accompanying exhibits are incorporated herein by this reference.Petitioner RECO Industries, Inc., is a Virginia corporation whose principal place of business at the time of the filing of the petition was located in Richmond, VA. RECO Industries, Inc., and its wholly owned subsidiaries (hereinafter collectively referred to as petitioner) timely filed consolidated income tax returns 9 for the years at issue with the Internal Revenue Service Center at Memphis, TN.During the years 1974 through 1977, petitioner was engaged in the business of manufacturing and selling steel products, principally large steel tanks and steel pipes. Petitioner maintained manufacturing plants in Richmond, VA, as well as in North Carolina, South Carolina, Mississippi, Florida, Pennsylvania, and New Jersey.914 Typically, petitioner manufactured steel tanks pursuant to the terms of a purchase order. A purchase order would usually contain a specific identification of the tanks to be manufactured, the quantities, the price, the payment terms, the shipment date, and the destination. Substantially all of the purchase orders provided for advance payments.The principal raw material used in the manufacture of petitioner's products was "raw" steel in the form of plate shape, structural shape, structural steel items such as channel, beams, and angles, and other steel items such as flanges, fittings, couplings, and weld rod. Petitioner's manufacturing process generally involved bending, rolling, drilling, and cutting the raw steel into components in the needed shapes and then welding the10 components together. Only petitioner's equipment and employees were involved in the manufacturing process.Some of petitioner's steel tanks were manufactured in stages and were shipped in kit form. These tanks were assembled at the customer's site and were not accepted until onsite assembly was completed. Occasionally, petitioner was required to perform additional work after the tank was assembled at the site, which sometimes resulted in back charges. Petitioner retained all risk of loss associated with the manufactured steel tanks until the tanks were accepted by the customer.Petitioner's general purchasing policy for raw steel and other steel materials was to make frequent purchases, taking into consideration market fluctuations in price and supply, as well as the desirability of maintaining good relationships with steel mills. Petitioner usually maintained a stock of raw steel and other steel-related materials on hand.Approximately 25 to 28 percent of the raw steel and related materials were purchased to be held as stock on hand. The balance of the raw steel and other steel materials used by petitioner was purchased for specified contracts. In these instances, the contract11 or job number was designated on the purchase order sent to the supplier. Petitioner's need for raw materials in connection with other contracts, rather than the purchase order designation, dictated whether or not the materials so purchased were actually used on any given contract.915 Petitioner maintained inventory accounts for raw materials and for work-in-process. During petitioner's manufacturing process, its costs of raw materials, labor, and overhead attributable to unfinished purchase orders (or long-term contracts) were accumulated in work-in-process inventory accounts. Petitioner recognized income upon the completion of a contract, at which time the associated costs were relieved from the inventory accounts and charged to its cost of goods sold.Petitioner calculated its cost of goods sold by adding purchased raw materials, direct labor, and overhead to beginning inventory (including work-in-process inventory) and subtracting ending inventory (including work-in-process inventory). In computing gross profit in the year of completion of a contract, the costs petitioner attributed to the contract reduced gross sales.In 1974, petitioner obtained the Commissioner's 12 consent to report income on advance payments in accordance with section 1.451-5 of the Income Tax Regulations. Thus, during the relevant tax years, petitioner did not recognize income when it received advance payments under a long-term contract.Petitioner sought permission to use the LIFO method of valuing inventories by filing a Form 970 with its 1974 consolidated return. Petitioner had theretofore employed the first-in, first-out (FIFO) method of valuing its inventories.From 1974 through 1977, petitioner used the LIFO method of inventory valuation. In determining the LIFO value of its inventories, petitioner used the dollar-value method based upon one natural business unit. Petitioner used the earliest-acquisitions-during-the-year method to determine the cost of goods in closing inventories in excess of those in opening inventories. The total inventory balances shown on the schedules attached to petitioner's returns for 1970 through 1977 were as follows:TABLE I1970$ 812,59519711,386,44519721,291,63319732,292,31019747,015,758197516,671,708197622,960,998197729,342,329916 From 1970 through 1973, gross sales, cost of goods sold, and gross13 profit reported on petitioner's returns, and the ratio of gross profits to gross sales were as follows:TABLE II1970197119721973Gross sales$ 13,136,413$ 12,105,635$ 15,051,301$ 21,418,253Cost of goods sold10,687,2969,841,26312,543,43217,928,073Gross profit2,449,1172,264,3722,507,8693,490,180Ratio of gross profitto gross sales18.64%18.71%16.66%16.29%Gross sales, cost of goods sold, and gross profit reported on petitioner's returns for 1974, 1976, and 1977, and the ratio of gross profit to gross sales were as follows:TABLE IIIPer returnAs proposed by IRS1974 Gross receipts/sales$ 32,645,993$ 32,645,993Cost of goods sold28,139,44126,886,983Gross profit4,506,5525,759,101Ratio of gross profitto gross sales13.80% 17.64% 1976 Gross receipts/sales$ 37,715,898$ 37,715,898Cost of goods sold32,076,55331,486,206Gross profit5,639,3456,229,692Ratio of gross profitto gross sales14.95% 16.51% 1977 Gross receipts/sales$ 42,601,935$ 42,601,935Cost of goods sold38,375,33437,906,094Gross profit4,226,6014,695,841Ratio of gross profitto gross sales9.92% 11.2% 14 During 1974, 1975, 1976, and 1977, petitioner added to its LIFO inventories all costs related to uncompleted long-term contracts. As a result of computing the uncompleted long-term contract costs under the LIFO method, petitioner's consolidated LIFO reserves were increased by $ 1,252,458, $ 590,347, and 917 $ 469,239 for 1974, 1976, and 1977, respectively. Petitioner's consolidated LIFO reserve for 1975 was reduced by $ 17,309. Because of these adjustments to petitioner's LIFO reserves, petitioner's cost of goods sold was increased by $ 1,252,458, $ 590,347, and $ 469,239 for 1974, 1976, and 1977, respectively, and was reduced by $ 17,309 for 1975.Respondent disallowed the adjustments to petitioner's consolidated LIFO reserve for 1974, 1975, and 1976 on the ground that the costs of completing the contracts were not inventory but deferred expenditures and therefore only deductible in the year in which the contract price is reported as income, i.e., the year in which the contract is completed. Using the same reasoning, respondent reduced petitioner's cost of goods sold for 1977 by $ 469,239 during the examination that preceded respondent's deficiency notice.Petitioner executed, 15 and respondent accepted, a Form 870-AD, pursuant to which petitioner agreed not to file a claim for refund or credit, and respondent agreed not to reopen the determination of petitioner's income tax liability with respect to the years 1974 through 1977, with the exception as to whether petitioner was entitled to employ the LIFO method of inventorying materials purchased specifically for long-term contracts and labor and other costs related to the completion of the contracts, or whether all of these costs were to be treated as deferred expenditures (and therefore only deductible as part of the cost of a particular contract in the year of contract completion). 116 Respondent seeks in this proceeding reversal of our decision in Peninsula Steel Products & Equipment Co. v. Commissioner, 78 T.C. 1029 (1982). In that case, on facts identical in all material respects to those presented in the instant case, we held (1) that the taxpayer's use of inventories to determine the 918 cost of goods sold was proper, even though the taxpayer was a manufacturer who reported income from long-term contracts under the completed contract method of accounting, and (2) that the taxpayer's use of the LIFO (last-in, first-out) method of inventory valuation in valuing the inventoried contract costs clearly reflected the taxpayer's income.Respondent's arguments in support of his contention that petitioner, a manufacturer who employs the completed contract method of accounting, may not use LIFO inventories in computing its contract costs are the same as those that he advanced in Peninsula Steel, namely: (1) That the use of the completed contract method of accounting and the use of inventories are mutually exclusive, and (2) that the use of the LIFO method of inventory valuation in conjunction with the completed contract method17 of accounting distorts petitioner's income by accelerating and exaggerating the deductions for contract costs.Alternatively, respondent argues that if petitioner's method of deferring its contract costs by accumulation in LIFO inventories is proper, then petitioner must allocate the deferred contract costs to the long-term contract in the year the materials are assigned to the contract, and not in the year of completion. Respondent maintains that materials which have been specifically ordered for a long-term contract or that can be associated specifically with a long-term contract should be directly allocated to the contract.Petitioner, in addition to contesting the deficiencies asserted by respondent, has requested an award of reasonable attorneys' fees in its petition.Because we find the case before us to be indistinguishable from Peninsula Steel, we hold that Peninsula Steel controls our decision herein. In so holding, we have, however, taken this occasion to reexamine our opinion in Peninsula Steel, particularly in view of a recent contrary decision by the U. S. Claims Court; 2 but, for the reasons set forth below, we have found nothing to dissuade us from following18 the views espoused in Peninsula Steel.Because respondent's determination in the notice of deficiency constitutes a challenge to the propriety of petitioner's 919 choice of accounting methods, 3 our analysis begins with a discussion of the rules governing accounting methods generally.19 Section 446(a) 4 requires a taxpayer to compute his taxable income by using the method of accounting under which he regularly computes his income in keeping his books. 5 The term "method of accounting" denotes not only the taxpayer's overall method of accounting, but it also includes the accounting treatment of any material item, such as inventory. Sec. 1.446-1(a)(1), Income Tax Regs.While section 446(c) 6 and the regulations thereunder authorize the use of certain specified methods, sections 1.451-3 and 1.451-5, Income Tax Regs., provide special methods of accounting for income from long-term contracts. As we pointed out in Peninsula Steel, 78 T.C. at 1043,20 these provisions of the Code and the regulations in effect afford a taxpayer with income from long-term contracts the choice of using one of the following overall accounting methods: (1) Cash, (2) accrual (including accrual shipment method), (3) percentage of completion, (4) completed contract, or (5) a combination of the foregoing to the extent permissible under section 1.446-1(c)(1)(iv), Income Tax Regs.Although a taxpayer is free generally to choose his method of accounting, his choice will be respected only where, in the 920 opinion of the Commissioner, it clearly21 reflects income. Sec. 446(b); sec. 1.446-1(a)(2), Income Tax Regs. Section 446(b) specifically authorizes respondent to compute a taxpayer's income under a method that clearly reflects income where the taxpayer's chosen method does not satisfy the clear reflection standard.The discretion granted respondent under section 446(b) is quite broad, and, therefore, respondent's determination that an accounting method does not clearly reflect income is entitled to more than the usual presumption of correctness. Commissioner v. Hansen, 360 U.S. 446">360 U.S. 446, 467 (1959); United States v. Catto, 384 U.S. 102">384 U.S. 102, 114 (1966). The taxpayer's burden in overcoming respondent's determination is consequently a heavy one. Peninsula Steel, 78 T.C. at 1044-1045. However, where a taxpayer succeeds in proving that his chosen method clearly reflects income, respondent must respect the taxpayer's choice.The question of whether a particular accounting method clearly reflects income is primarily a factual question that varies from business to business. Sam W. Emerson Co. v. Commissioner, 37 T.C. 1063">37 T.C. 1063, 1067 (1962).22 Where the taxpayer demonstrates that his chosen method accords with generally accepted accounting principles and complies with respondent's regulations, the taxpayer's choice ordinarily will be regarded as clearly reflecting income if that method has been consistently used. Secs. 1.446-1(a)(2), 1.471-2(b), Income Tax Regs.; Peninsula Steel, 78 T.C. at 1045.In the present case, we are concerned with two "methods of accounting" used by petitioner. Petitioner has reported its income and expenses attributable to its long-term contracts under the completed contract method of accounting, and it has used LIFO inventories to compute the costs allocable to its long-term contracts. Respondent does not dispute the propriety of petitioner's use of the completed contract method. Rather, respondent contends that petitioner may not use LIFO inventories in computing its contract costs because the use of any inventory method in conjunction with the completed contract method is not permitted under the regulations. More specifically stated, it is respondent's contention that inventories and the completed contract method are mutually exclusive.921 The completed23 contract method of accounting, the use of which is specifically authorized by section 1.451-3, Income Tax Regs., allows a taxpayer whose income is derived from long-term contracts to account for the entire results of a contract at one time. Peninsula Steel, 78 T.C. at 1046. Consequently, in the year that a contract is completed, income from the contract is recognized, and the costs of completing the contract are deducted. Sec. 1.451-3(d)(1), Income Tax Regs. As we pointed out in Fort Pitt Bridge Works v. Commissioner, 24 B.T.A. 626">24 B.T.A. 626 (1931), revd. on other grounds 92 F.2d 825">92 F.2d 825 (3d Cir. 1937), this method is especially appropriate to a taxpayer engaged in the business of performing contracts where the contracts overlap accounting periods and where the ultimate profit or loss from the contract cannot be ascertained until the contract is completed.The use of inventories is governed by section 471 and the regulations thereunder. Section 471 provides as follows:Whenever in the opinion of the Secretary the use of inventories is necessary in order clearly to determine the income of any taxpayer, inventories24 shall be taken by such taxpayer on such basis as the Secretary may prescribe as conforming as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting the income.The regulations provide that "inventories * * are necessary in every case in which the production, purchase or sale of merchandise is an income-producing factor," and further provide that inventories are to include both raw materials and work-in-process. Sec. 1.446-1(a)(4)(i) and sec. 1.471-1, Income Tax Regs. (Emphasis added.) Numerous courts, including this one, have recognized that the rule that inventories are required wherever the production and sale of merchandise is an income-producing factor also applies to those cases where merchandise is produced in accordance with customer specifications. See Frank G. Wikstrom & Sons, Inc. v. Commissioner, 20 T.C. 359 (1953).In the present case, there is no dispute that petitioner was engaged in the production and sale of merchandise. Thus, under section 1.471-1 of the Income Tax Regs., petitioner would appear to fall within the rule requiring inventories. Respondent, however, reads25 section 1.451-3 of the Income Tax Regs., as precluding the use of inventories by a taxpayer who 922 employs the completed contract method. Section 1.451-3 of the Income Tax Regs., in relevant part, provides as follows:(d) Completed contract method -- (1) In general. Except in cases to which subparagraph (2), (3), or (4) of this paragraph applies, under the completed contract method, gross income derived from long-term contracts must be reported by including the gross contract price of each contract in gross income for the taxable year in which such contract is completed (as defined in paragraph (b)(2) of this section). All costs which are properly allocable to a long-term contract (determined pursuant to subparagraph (5) of this paragraph) must be deducted from gross income for the taxable year in which the contract is completed. In addition, account must be taken of any material and supplies charged to the contract but remaining on hand at the time of completion. [Emphasis added.]Respondent interprets the direction that the deduction of costs "properly allocable to a long-term contract" be deferred until the year of contract completion, as prohibiting the26 use of inventories in accumulating contract costs, and requiring, instead, the specific identification of costs to the long-term contract.In Peninsula Steel, we expressly found that nothing in the regulations prohibits the conjunctive use of inventories and the completed contract method. We read there, as we do here, the language upon which respondent relies as simply a direction as to the timing of the deduction, and not a direction as to the manner in which contract costs should be accumulated. Other than the quoted language from section 1.451-3, Income Tax Regs., supra, respondent has not directed our attention in this case to (and indeed we fail to find) anything in the regulations prescribing the method for accumulating contract costs in an orderly fashion until the time arrives for recognition of income and expense.Respondent's interpretation of the "properly allocable" language in section 1.451-3, Income Tax Regs., was accepted by the Claims Court in Spang Industries, Inc. v. United States, 6 Cl. Ct. 38">6 Cl. Ct. 38 (1984). Despite the Claims Court's endorsement of respondent's reading of the regulation as requiring the specific identification 27 of the costs of raw materials, labor, and overhead applied to any given contract, we believe that such an interpretation requires reading into the regulation a requirement that simply is not there.923 As we pointed out in Peninsula Steel, the function of inventories is to determine the amount of deductible costs. The completed contract method, on the other hand, only addresses itself to timing. Section 1.451-3(d)(1), Income Tax Regs., simply requires the deferral of income and expenses associated with a long-term contract until the year of contract completion. The regulation is clearly designed to provide for the matching of income and expense associated with a particular contract. The fact that petitioner, by using inventories, computed the value of its contract costs by pooling the costs of raw materials, labor, and overhead attributable to the contracts, and then allocating a portion of that pool to the costs of goods sold in computing the income from a particular contract does not impair the matching function of the completed contract method.The Claims Court in Spang Industries, Inc., however, held that inventories were incompatible with the completed28 contract method 7 because the computation of costs under the inventory method violated the matching principle underlying the completed contract method. The Claims Court described the perceived mismatching as follows:Under plaintiff's system of accounting for tax purposes, the costs of long-term work in process are accumulated on a FIFO basis (i.e., actual cost) and, upon completion of the contract, are then retrieved from the in-process accounts and charged to cost of sales. So far, so good. Then, however, there is added to the cost of sales the LIFO value of the accumulated costs of work remaining in process. In other words, the measure of inflation inherent in the costs of current work in process (their LIFO value) is attributed to the current year's completed contracts. And therein lies the problem. Whereas the regulation demands that costs be deferred and matched with the revenue they helped produce, plaintiff's use of LIFO does neither: it permits the current costs of long-term contracts in process (for which the regulation prescribes deferral) to affect the measure of income realized under contracts other than those for which those costs were incurred. The result, 29 in other words, is to match current costs with current sales.The governing regulation, however, prescribes that current costs be deferred and matched with future sales. And in that framework -- where the scheme is to relate cost and revenue on a contract-by-contract basis -- deferral is as much a mechanism of cost determination (i.e., valuation) as it is a mechanism of cost timing. It cannot be otherwise without offense to the 924 notion of pairing the revenue from a long-term contract activity with its identified costs as accumulated over time.[Spang Industries, Inc. v. United States, 6 Cl. Ct. 38">6 Cl. Ct. 38, 44 (1984).]As we see it, the misalignment of cost and revenue that the Claims Court perceived in Spang was30 due to the taxpayer's use of the LIFO method of inventory valuation and not to the taxpayer's use of inventories. Further, the Claims Court assumed that the actual flow of costs through the taxpayer's manufacturing process was that of FIFO (first-in, first-out). While one would expect, based upon this analysis, that a completed contract method taxpayer would be permitted to compute its contract costs by using FIFO inventories (if one accepts the assumption that costs actually flow on a FIFO basis), the Claims Court nonetheless held that inventories may never be used by a completed contract method taxpayer. The inherent inconsistency of this analysis leaves us unpersuaded.As previously discussed, we do not believe that the matching function of the completed contract method is undermined by the use of inventories to value deferred contract costs. Because, in our view, the pertinent regulation does not demand the specific identification and segregation of costs to a particular contract, we cannot accept the premise that the cost-deferral requirement means that the values of costs allocated to a contract must necessarily be the actual or historical costs, or even costs computed on31 a FIFO basis.While recognizing that both inventories and the completed contract method are designed to match income and expense, respondent maintains that inventories and the completed contract method are conceptually incompatible. Respondent maintains that inventories operate to determine income or loss on an annual basis, whereas he perceives the completed contract method as "an exception to the annual accounting period." Respondent's perception of the completed contract method as an adjustment of the annual accounting requirement is, in our opinion, in error. The Code requires that every taxpayer must compute his taxable income on the basis of his taxable year (or annual accounting period). Sec. 441; sec. 1.446-1(a)(4), Income Tax Regs. In computing his taxable income, the taxpayer must account for all items of income and expense that are properly includable or deductible within his taxable year as determined by his accounting method. Secs. 925 451, 461. The completed contract method, which is a variant of the strict accrual method ( Fort Pitt Bridge Works, 24 B.T.A. at 641), simply determines which items of income and deduction are to32 be taken into account in computing taxable income for any given taxable year. Thus, we do not view the completed contract method as posing any exception to the requirement that taxable income must be computed and reported on an annual basis, 8 and, therefore, we fail to see any inherent incompatibility between the completed contract method and inventories.33 In summary then, we find nothing in the regulations that would preclude the use of inventories in conjunction with the completed contract method. Nor do we find any inherent conflict between the two methods on the functional or conceptual level. Consequently, we conclude that a completed contract method taxpayer (such as petitioner) may, consistent with the regulations, use inventories in computing the costs of completing contracts.Given our conclusion that petitioner's use of inventories in conjunction with the completed contract method conforms to the regulations, we must next consider the other factors relevant to the question of whether petitioner's use of inventories clearly reflected its income, namely, (1) whether petitioner's use of inventories conformed to generally accepted accounting principles, and (2) whether petitioner's use of inventories in conjunction with the completed contract method was consistent.We find that petitioner's practice is in accordance with generally accepted accounting principles. The Claims Court in Spang Industries, Inc., correctly pointed out that Accounting 926 Research Bulletin No. 45, issued by the Committee on Accounting Procedure34 of the American Institute of Certified Public Accounts (AICPA), suggests that the excess of accumulated contract costs over related billings (which is reported as a current asset) should be described in the balance sheet as "'costs of uncompleted contracts in excess of related billings' rather than as 'inventory' or 'work in process.'" ARB No. 45, "Long-Term Construction-Type Contracts," par. 12 (October 1955). However, as we noted in Peninsula Steel, 78 T.C. at 1048-1049 & n. 30, the American Institute of Certified Public Accountants, in its guidelines for applying ARB No. 45, states that none of the characteristics of the completed contract method require "accounting for contract costs to deviate in principle from the basic framework established in existing authoritative literature applicable to inventories or business enterprises in general." See par. 71, Statement of Position 81-1, "Accounting for Performance of Construction-Type and Certain Production-Type Contracts" (July 15, 1981), appended to AICPA, Audit and Accounting Guide, "Construction Contractors" 105-149 (1981). We therefore attach little weight to the AICPA's suggestion as to the labels35 to be used on the financial statements in view of its recognition of the applicability of inventory principles in accounting for deferred contract costs.Respondent claims that Peninsula Steel was incorrectly decided based upon his contention that "the Court erroneously rejected a long standing accounting practice for long-term contracts that a taxpayer who reports income from such contracts on the completed contract method may not consider as inventory the cost of material, labor, supplies etc. accumulated with respect to such contracts." Although respondent does not directly cite any authority or introduce any evidence to demonstrate the existence of this "long standing accounting practice," we think it fair to assume that respondent relies here upon Rev. Rul. 59-329, 2 C.B. 138">1959-2 C.B. 138, which is cited elsewhere in his brief.As we pointed out in Peninsula Steel, Rev. Rul. 59-3299 must 927 be read in context. All of the authorities cited in Rev. Rul. 59-329 address the question of whether a particular expense, incurred in connection with a long-term36 contract, is deductible in the year incurred or in the year the contract is completed. None of these authorities set forth any rules for determining the manner of accumulating costs once the determination has been made that a particular cost is a deferred contract cost. Thus, we concluded in Peninsula Steel, 78 T.C. 1051">78 T.C. 1051-1052, as follows:Rev. Rul. 59-329, then, rests on a foundation that is consistent with our reconciliation of the regulations, and which does not conflict with * * * [the] use of inventories for the purpose of determining amounts of cost of goods sold.37 We find further support for limiting the scope of Rev. Rul. 59-329 by the fact that the ruling was published at a time when the regulations recognized the use of the completed contract method only by taxpayers engaged in long-term construction. Sec. 1.451-3, Income Tax Regs. (1957). 10 These taxpayers were generally not allowed the use of inventories. E.g., Gersten v. Commissioner, 28 T.C. 756 (1957), affd. and revd. on other issues 267 F.2d 195">267 F.2d 195 (9th Cir. 1959); Colony, Inc. v. Commissioner, 26 T.C. 30 (1956), affd. that issue 244 F.2d 75">244 F.2d 75 (6th Cir. 1957), and revd. on the other issue 357 U.S. 28">357 U.S. 28 (1958). On the other hand, the propriety of the use of inventories by manufacturers of custom order goods has been recognized by a number of courts. See Frank G. Wikstrom & Sons, Inc. v. Commissioner, 20 T.C. 359">20 T.C. 359 (1953). We doubt that the ruling was ever intended to apply to manufacturers and, therefore, reject respondent's attempted application of the ruling to petitioner. 38 Given our determination that petitioner's use of inventories conformed to both the regulations and generally accepted 928 accounting principles, we next turn to the question of whether petitioner's use of inventories was consistent. The record before us clearly shows that petitioner has consistently used inventories in computing costs of goods sold since at least 1970. This consistent use of inventories is, as was the case39 in Peninsula Steel, a factor weighing heavily in petitioner's favor.In view of our fundamental disagreement with the Claims Court on the compatibility of the inventory and completed contract methods, distinguishing the present case from Spang Industries, Inc., is not essential to our determination herein. Nevertheless, we believe that it is, at least, worth noting in this context that the genesis of the dispute in Spang can be traced to the taxpayer's adoption of an inventory method following a practice of accumulating the specifically identified costs of each long-term contract. 11 This change in method by the taxpayer in Spang contrasts markedly with petitioner's consistent use of inventories in determining the cost of goods sold.In summary, we find that petitioner's use of inventories in conjunction with the completed contract method was in accord with generally accepted40 accounting principles and that it was consistently applied from 1970 through the years at issue. Respondent has not persuaded us that the combined use of inventories and the completed contract method is inconsistent with the regulations. We hold therefore that petitioner's use of the two methods clearly reflected petitioner's income.In so holding, we are mindful that the regulations expressly recognize that a uniform accounting method cannot be prescribed for all taxpayers and that the appropriateness of any given method will depend upon the particular taxpayer's needs. Sec. 1.446-1(a)(2), Income Tax Regs. In the present case, we find that petitioner's use of inventories was appropriate in view of petitioner's method of operation. Petitioner maintained a stock of raw materials on hand, besides purchasing materials for specific contracts. However, the materials purchased for specific contracts were not necessarily used on that contract. To require petitioner to ascertain the cost of each flange, coupling, beam, or angle used on any particular contract would be, in our view, clearly impracticable. Thus, 929 here, as in Peninsula Steel, practical considerations dictated41 the use of inventories to accumulate in an orderly manner the costs of raw materials and of work-in-process until the time arrived for the matching of revenues and expenses.Having determined that petitioner's use of inventories in conjunction with the use of the completed contract method of accounting was proper, we turn to respondent's second objection to petitioner's accounting method. Respondent contends that the valuation of inventories under the LIFO method results in the deduction of the costs of uncompleted contracts prior to the year of completion and, therefore, results in a distortion of petitioner's income.Section 472(a) 12 allows a taxpayer who is either required or permitted to maintain inventories the option of valuing inventories under the LIFO method. The LIFO method is based on the accounting convention that the goods purchased last are deemed to be the first goods sold and that ending inventories are deemed to be composed of the earliest purchased goods. This convention reverses the assumed order of goods flowing through inventories valued under the FIFO (first-in, first-out) method. The theory justifying the LIFO method is generally that the determination42 of income may be more accurate by matching current costs with current revenues, thereby eliminating from income any inflation-induced and therefore artificial profit. Peninsula Steel, 78 T.C. at 1054; Fox Chevrolet, Inc. v. Commissioner, 76 T.C. 708">76 T.C. 708, 723 (1981).An initial election of LIFO is a change in accounting method. Sec. 1.446-1(e)(2)(i), Income Tax Regs. As a general rule, a taxpayer may only initiate an accounting method change43 after he obtains the Commissioner's consent. Sec. 446(e). However, where a taxpayer properly elects the LIFO method, the taxpayer is excepted from the prior consent requirement of section 446(e), and is, instead, subject to the requirements governing the election under section 472 and the regulations thereunder. John Wanamaker Philadelphia, Inc. 930 , 175 Ct. Cl. 169">175 Ct. Cl. 169, 175, 359 F.2d 437">359 F.2d 437, 440 (1966); Peninsula Steel, 78 T.C. at 1055. Respondent's discretion as to an initial election of LIFO is much more circumscribed than in the case of changes of accounting methods generally. Peninsula Steel Products & Equipment Co. v. Commissioner, 78 T.C. at 1055.Respondent does not maintain that petitioner's manner of electing LIFO was improper. It is his contention that petitioner's use of LIFO violates the clear reflection of income standard of section 446(b) because, he claims, the LIFO method necessarily results in the deduction of the costs of contracts in progress in a year prior to the year of completion.At the outset, we note that Congress authorized the44 LIFO method of inventory valuation by all taxpayers properly maintaining inventories. Sec. 472(a); Peninsula Steel Products & Equipment Co. v. Commissioner, 78 T.C. 1029">78 T.C. 1029 (1981); Basse v. Commissioner, 10 T.C. 328">10 T.C. 328 (1948); Hutzler Bros. Co. v. Commissioner, 8 T.C. 14 (1947). We have held, supra, that petitioner's use of inventories was proper, and therefore find that this precondition to the use of LIFO was satisfied. While the regulations under section 472 provide detailed rules for the use of LIFO, neither these regulations nor the long-term contract regulations restrict in any way the use of the LIFO method by a taxpayer using the completed contract method of accounting. Thus, we do not find that the use of the LIFO method of inventory valuation is legally inconsistent with the completed contract method of accounting.It is not true, as respondent would have us find, that petitioner's use of LIFO in valuing its inventories resulted in the acceleration of deductions for contract costs. By its very nature, the LIFO method of inventory valuation results in the assignment of the costs45 of the most recently purchased materials to the contracts completed during the year. But the adjustments which petitioner made on its books to convert from FIFO to LIFO are not additional deductions claimed with respect to the completed contracts (i.e., for costs that otherwise would not yet be deductible because allocable to currently unfinished contracts) but instead represent the difference between valuing the costs under the two different inventory valuation methods. Peninsula Steel, 78 T.C. at 1057. The determination of the value to be placed upon an inventory, and 931 therefore upon the cost of goods sold, is an inquiry that is separate and distinct from the determination of when income is to be recognized and expenses are to be deducted. American Can Co. v. Bowers, 35 F.2d 832">35 F.2d 832, 835 (2d Cir. 1929).In this case, as in Peninsula Steel, respondent has perceived a distortion from petitioner's use of LIFO that we simply fail to find. A comparison of the gross profit to gross sales ratios for the years in issue (table III supra) and the preceding years (table II supra) does not disclose any significant46 distortion of petitioner's income. What we said in Peninsula Steel in this context is equally applicable here.Since respondent's perceived distortion of income appears to merely be the difference in the deduction for costs of completed contracts when the most recent costs (LIFO) are used rather than earliest costs (FIFO), we are convinced, on the facts of the instant case, that respondent's determination is more of an expression of preference for FIFO over LIFO than a determination that petitioner's consistent use of LIFO to value inventories will not reasonably reflect consolidated income. See Klein Chocolate Co. v. Commissioner, 36 T.C. at 147. While we recognize that respondent possesses broad powers under section 446(b) to determine whether an accounting method clearly reflects income, we do not believe respondent may compel a change from a permissible method of accounting which clearly reflects income in accordance with the regulations to another permissible method that is preferred by respondent. * * * We think such a rule is particularly appropriate with respect to LIFO, a method expressly authorized by statute, and intended to be available47 to all taxpayers properly maintaining inventories * * [78 T.C. at 1058; citations omitted.]Having determined that petitioner's use of LIFO inventories clearly reflects its income and is consistent with the regulations, we find that respondent has no authority to compel petitioner to change to the method that he proposes herein. 1348 In conclusion, we hold that the present case is indistinguishable from, and therefore controlled by, Peninsula Steel. Accordingly, we hold that petitioner's use of LIFO inventories to accumulate the costs associated with the performance of its 932 long-term contracts was proper, and that respondent lacked the authority to change the accounting method employed by petitioner.With respect to petitioner's request in the petition for an award of attorneys' fees, petitioner has not cited to any statute that would authorize such an award nor has it advanced any arguments on brief justifying an award. As we stated in McQuiston v. Commissioner, 78 T.C. 807">78 T.C. 807 (1982), affd. without published opinion 711 F.2d 1064">711 F.2d 1064 (9th Cir. 1983), this Court has no power to award attorneys' fees or costs under the Equal Access to Justice Act (28 U.S.C. sec. 2412). Section 7430 of the Internal Revenue Code, as added by Pub. L. 97-248, only authorizes awards of reasonable litigation costs in cases begun after February 28, 1983. 96 Stat. 324, 572. Because petitioner filed its petition in March of 1981, section49 7430 does not apply. Therefore, in this case, we have no jurisdiction to award attorneys' fees.To reflect the foregoing,Decision will be entered under Rule 155. Footnotes. By order of the Chief Judge, this case was reassigned from Judge Edna G. Parker to Judge Julian I. Jacobs.↩1. The parties have stipulated that if petitioner's use of LIFO inventory accounts to accumulate the costs of long-term contracts, which were accounted for under the completed contract method of long-term contract accounting, is determined to be a permissible accounting method, then petitioner would be entitled to the 1977 net operating loss carryback, investment tax credit carryback, and new jobs credit carryback that respondent disallowed in his notice of deficiency.In addition, the parties have stipulated that in the event of a favorable decision herein for petitioner, petitioner would be entitled to a new jobs credit carryback from 1978 to 1976 in the amount of $ 17,768, a net operating loss carryback from 1979 to 1976 in the amount of $ 44,5534, and an investment tax credit carryback from 1979 to 1976 in the amount of $ 27,068. Petitioner would not be entitled to any investment tax credit carryback from 1978 to 1976 because the credit would be carried back entirely to 1975.↩2. Spang Industries, Inc. v. United States, 6 Cl. Ct. 38↩ (1984).3. Because respondent did not specifically refer to the clear reflection of income standard of sec. 446(b) in either the notice of deficiency or the answer, petitioner maintains on brief that the question of whether petitioner's accounting method clearly reflects income is not properly before the Court. We do not agree. In our view, any challenge by the Commissioner to a taxpayer's accounting method is necessarily grounded upon the authority granted him by sec. 446(b). In addition, petitioner has premised its contest of the deficiencies asserted by respondent on Peninsula Steel↩, which was decided under sec. 446(b). We fail to see any "unfair surprise" to petitioner and are bolstered in our conclusion by the fact that the evidence relevant to respondent's mutual exclusivity argument is the same as that apposite to the clear reflection question.4. All section references are to the Internal Revenue Code of 1954 as amended and as in effect during the years at issue.↩5. SEC. 446. GENERAL RULE FOR METHODS OF ACCOUNTING.(a) General Rule. -- Taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books.↩6. SEC. 446. GENERAL RULE FOR METHODS OF ACCOUNTING(c) Permissible Methods. -- Subject to the provisions of subsections (a) and (b), a taxpayer may compute taxable income under any of the following methods of accounting -- (1) the cash receipts and disbursements method;(2) an accrual method;(3) any other method permitted by this chapter; or(4) any combination of the foregoing methods permitted under regulations prescribed by the Secretary.↩7. Because the Claims Court held that the taxpayer could not use inventories while reporting its long-term contract income on the completed contract method, the Court did not address the issue as to whether the taxpayer could use the LIFO method of inventory valuation.↩8. We note that in Spang Industries, Inc., supra↩, the Claims Court, in holding that the completed contract method and the use of inventories are mutually exclusive, subscribed to the view that the completed contract method is not "an annual accounting system." We do not dispute the court's description of the completed contract method as allowing a taxpayer to report the economic results of long-term contracts in the year of completion, rather than reporting the results annually based upon interim estimates. It is, however, an accounting method and, like any accounting method recognized by the tax laws, only operates to determine which transactions, or items of income or expense, are to be accorded tax significance in any given tax accounting period (taxable year). Our tax system embraces numerous accounting methods and special accounting rules that postpone the tax recognition of transactions to a taxable year other than the year incurred. None of these methods or special rules, including the completed contract method, excuse a taxpayer from accounting for income annually; all of them, including the completed contract method, simply allocate to any given taxable year the items of income and expense that must be reported within that year.9. Rev. Rul. 59-329, provides, in relevant part, as follows:"A taxpayer who, under section 1.451-3 of the Income Tax Regulations, reports income from long-term contracts on the completed contract method may not consider as inventory, for Federal income tax purposes, the cost of materials, labor, supplies, depreciation, taxes, etc., accumulated with respect to such contracts. Such costs merely represent deferred expenditures which are to be treated as part of the cost of the particular contract and are to be allowed as a deduction for the year during which the contract is completed and the contract price reported as gross income. See Revenue Ruling 288, C.B. 1953-2, 27, at 28; I.T. 3434, C.B. 1940-2, 90; and A.R.R. 8367↩, C.B. III-2, 57 (1924). * * *"10. The regulations were revised in 1976 to authorize use of the completed contract method by manufacturers. T.D. 7397, filed Jan. 14, 1976, 1 C.B. 115">1976-1 C.B. 115. Prior to the amendment of the regulations, case law recognized the availability of this method to manufacturers. See Stephens Marine, Inc. v. Commissioner, 430 F.2d 679">430 F.2d 679 (9th Cir. 1970); McMaster v. Commissioner, 69 T.C. 952">69 T.C. 952 (1978); Fort Pitt Bridge Works v. Commissioner, 24 B.T.A. 626↩ (1931).11. Spang Industries, Inc. v. United States, 6 Cl. Ct. at 48↩, Appendix, Findings of Fact No. 6.12. SEC. 472. LAST-IN, FIRST-OUT INVENTORIES.(a) Authorization. -- A taxpayer may use the method provided in subsection (b) (whether or not such method has been prescribed under section 471) in inventorying goods specified in an application to use such method filed at such time and in such manner as the Secretary may prescribe. The change to, and the use of, such method shall be in accordance with such regulations as the Secretary may prescribe as necessary in order that the use of such method may clearly reflect income.↩13. Respondent alternatively argues that, assuming that the LIFO inventory method is available to a completed contract method, petitioner's income would be more clearly reflected if petitioner is only allowed to accumulate costs in inventory until either the materials are assigned to a long-term contract or until the materials are specifically ordered for a long-term contract. This in effect is the position adopted in the proposed regulations issued on Mar. 14, 1983. Sec. 1.472-1(m), Proposed Regs., 48 Fed. Reg. 10718↩ (Mar. 14, 1983). In view of our holding that petitioner's accounting method clearly reflected income, we need not consider respondent's alternative argument beyond noting that nothing in the current regulations applicable to this case would require adopting respondent's approach here.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4669077/	2021 WI 27 SUPREME COURT OF WISCONSIN CASE NO.: 2018AP1952-CR COMPLETE TITLE: State of Wisconsin, Plaintiff-Respondent-Petitioner, v. Mark D. Jensen, Defendant-Appellant. REVIEW OF DECISION OF THE COURT OF APPEALS OPINION FILED: March 18, 2021 SUBMITTED ON BRIEFS: ORAL ARGUMENT: November 17, 2020 SOURCE OF APPEAL: COURT: Circuit COUNTY: Kenosha JUDGE: Chad G. Kerkman JUSTICES: DALLET, J., delivered the majority opinion of the Court, in which ROGGENSACK, C.J., ANN WALSH BRADLEY, REBECCA GRASSL BRADLEY, and HAGEDORN, JJ., joined, and in which ZIEGLER and KAROFSKY, JJ., joined except for ¶35. KAROFSKY, J., filed a concurring opinion, in which ZIEGLER, J., joined. NOT PARTICIPATING: ATTORNEYS: For the plaintiff-respondent-petitioner, there were briefs filed by Aaron R. O’Neil, assistant attorney general; with whom on the briefs was Joshua L. Kaul, attorney general. There was an oral argument by Aaron O’Neil. For the defendant-appellant, there was a brief filed by Lauren J. Breckenfelder and Dustin C. Haskell, assistant state public defenders. There was an oral argument by Lauren Jane Breckenfelder. 2021 WI 27 NOTICE This opinion is subject to further editing and modification. The final version will appear in the bound volume of the official reports. No. 2018AP1952-CR (L.C. No. 2002CF314) STATE OF WISCONSIN : IN SUPREME COURT State of Wisconsin, Plaintiff-Respondent-Petitioner, FILED v. MAR 18, 2021 Mark D. Jensen, Sheila T. Reiff Clerk of Supreme Court Defendant-Appellant. DALLET, J., delivered the majority opinion of the Court, in which ROGGENSACK, C.J., ANN WALSH BRADLEY, REBECCA GRASSL BRADLEY, and HAGEDORN, JJ., joined, and in which ZIEGLER and KAROFSKY, JJ., joined except for ¶35. KAROFSKY, J., filed a concurring opinion, in which ZIEGLER, J., joined. REVIEW of a decision of the Court of Appeals. Modified and, as modified, affirmed. ¶1 REBECCA FRANK DALLET, J. Fourteen years ago, Mark Jensen was on trial for killing his wife, Julie.1 Before the start of that trial, we held that certain hearsay statements made by Julie were testimonial. State v. Jensen (Jensen I), 2007 WI 26, ¶2, 299 Wis. 2d 267, 727 N.W.2d 518. To avoid confusion——and to remain consistent with previous 1 decisions in this case——we refer to Mark Jensen as "Jensen" and Julie Jensen as "Julie." No. 2018AP1952-CR For that reason, and because Jensen had no opportunity to cross- examine Julie about those statements, the statements were inadmissible under the Confrontation Clause.2 We are now asked to determine whether the law on testimonial hearsay has since changed to such a degree that, at Jensen's new trial,3 the circuit court was no longer bound by Jensen I. We hold that it has not. We therefore affirm the court of appeals' decision.4 I ¶2 Julie died from poisoning in 1998. Prior to her death, she made several statements suggesting that, if she died, the police should investigate Jensen. She wrote a letter and gave it to her neighbor with instructions to give the letter to the police should anything happen to her. She also left two voicemails with Pleasant Prairie Police Officer Ron Kosman two weeks before she died stating that if she were found dead, Jensen should be Kosman's "first suspect." In 2002, Jensen was charged with first-degree intentional homicide. Over the next several years, the circuit court held a series of pretrial hearings addressing the admissibility of Julie's letter and voicemails. 2 U.S. Const. amend. VI, cl. 4 ("In all criminal prosecutions, the accused shall enjoy the right . . . to be confronted with the witnesses against him . . . ."). 3 The Honorable Chad G. Kerkman of the Kenosha County Circuit Court presiding. 4 State v. Jensen, No. 2018AP1952-CR, unpublished slip op. (Wis. Ct. App. Feb. 26, 2020). 2 No. 2018AP1952-CR ¶3 The circuit court initially ruled that Julie's letter was admissible but her voicemails were not. After that ruling, however, the United States Supreme Court decided Crawford v. Washington, 541 U.S. 36 (2004), which established that an unavailable witness's hearsay statement is inadmissible under the Confrontation Clause if the statement is testimonial and the defendant had no prior opportunity to cross-examine the witness. Id. at 50-54. In light of that decision, Jensen asked the circuit court to reconsider its previous ruling. Upon reconsideration, the circuit court determined that, under Crawford, Julie's letter and voicemails ("Julie's statements") were testimonial hearsay and were inadmissible because Jensen had no opportunity to cross-examine Julie. ¶4 The State appealed and we affirmed, applying Crawford and the United States Supreme Court's subsequent decision, Davis v. Washington, 547 U.S. 813 (2006).5 Jensen I, 299 Wis. 2d 267. Davis set out what has come to be known as the "primary purpose test": a statement is testimonial if its primary purpose is "to establish or prove past events potentially relevant to later criminal proceedings." 547 U.S. at 822. The Court explained that although statements made in response to police questioning are generally testimonial, such statements are nontestimonial if their primary purpose is to help the police "meet an ongoing emergency." Id. at 822. Applying that test, we determined in 5 Unless otherwise noted, all references to Davis v. Washington, 547 U.S. 813 (2006), are also references to Hammon v. Indiana, which the Court consolidated with Davis. 3 No. 2018AP1952-CR Jensen I that the primary purpose of Julie's statements was not to help the police resolve an active emergency but to "investigate or aid in prosecution in the event of her death." Jensen I, 299 Wis. 2d 267, ¶¶27, 30. Thus, under Crawford and Davis's interpretation of the Confrontation Clause, Julie's statements were inadmissible. Id., ¶34. ¶5 We remanded the cause to the circuit court to determine whether Julie's statements were nevertheless admissible under the forfeiture-by-wrongdoing doctrine, which we adopted in Jensen I. See id., ¶¶2, 52. At the time, that doctrine stated that a defendant forfeits his constitutional right to confront a witness when the defendant caused that witness's unavailability. See id., ¶57. On remand, the circuit court found that the State had shown by a preponderance of the evidence that Jensen caused Julie's unavailability. Therefore, the Confrontation Clause notwithstanding, Julie's statements were admissible after all. Relying at least in part on those statements, a jury convicted Jensen of Julie's murder. ¶6 Jensen again appealed. State v. Jensen (Jensen II), 2011 WI App 3, 331 Wis. 2d 440, 794 N.W.2d 482. While that appeal was pending, the United States Supreme Court decided another case directly affecting Jensen, Giles v. California, 554 U.S. 353 (2008). There, the Court refined the forfeiture-by-wrongdoing doctrine, holding that it applies only when the defendant caused the witness's unavailability with the specific intent of preventing the witness from testifying. See id. at 361-68. In Jensen II, the court of appeals "assum[ed]" 4 No. 2018AP1952-CR that Jensen had not killed Julie specifically to keep her from testifying at trial; therefore, under Giles, Jensen had not forfeited his Confrontation Clause rights and the circuit court had erred in admitting Julie's statements. But the court of appeals also held that the circuit court's error was harmless, given the "voluminous" other evidence supporting the jury's guilty verdict. See Jensen II, 331 Wis. 2d 440, ¶35. ¶7 That harmless error conclusion formed the basis for Jensen's federal habeas corpus litigation.6 There, the federal courts agreed with Jensen that it was not harmless error to admit Julie's testimonial statements in violation of the Confrontation Clause. Jensen v. Schwochert, No. 11-C-0803, 2013 WL 6708767 (E.D. Wis. Dec. 18, 2013), aff'd, Jensen v. Clements, 800 F.3d 892, 908 (7th Cir. 2015) (holding that was it was "beyond any possibility for fairminded disagreement" that admitting Julie's statements "had a substantial and injurious effect" on the jury's verdict (quoted source omitted)). Concluding that the Wisconsin court of appeals' decision in Jensen II was an "unreasonable application of clearly established federal law," the federal court ordered Jensen's conviction vacated. Schwochert, 2013 WL 6708767, at 16-17. The State immediately initiated new proceedings against Jensen. 6 We denied Jensen's petition for review regarding Jensen II. See Jensen v. Schwochert, No. 11-C-0803, 2013 WL 6708767, at 5 (E.D. Wis. Dec. 18, 2013), aff'd, Jensen v. Clements, 800 F.3d 892 (7th Cir. 2015). 5 No. 2018AP1952-CR ¶8 In this new pretrial period, Jensen filed a motion to exclude Julie's statements, per our holding in Jensen I. The State urged the circuit court to address anew whether Julie's statements were admissible, arguing that the United States Supreme Court had since "narrowed" the definition of "testimonial" to such a degree that the circuit court was not bound by Jensen I. The circuit court agreed. It explained that "a lot has happened" since Jensen I and that "based upon the law that we have today," Julie's statements were not testimonial. The circuit court reached that conclusion by "applying the factors in Ohio v. Clark, the more recent cases including Michigan v. Bryant, and other cases that came out since Crawford v. Washington and Jensen I."7 The State then moved the circuit court to forgo a new trial and reinstate Jensen's original conviction and life sentence on the grounds that, if Julie's statements were again admissible, the evidence now was identical to that in Jensen's first trial. The circuit court granted the State's motion. Jensen appealed. ¶9 The court of appeals reversed, holding that neither it nor the circuit court was "at liberty to decide" that Julie's statements were nontestimonial, given our holding in Jensen I. State v. Jensen (Jensen III), No. 2018AP1952-CR, unpublished slip op., at 12 (Wis. Ct. App. Feb. 26, 2020). The court of 7The circuit court noted, incorrectly, that Davis (and Hammon) was decided after Jensen I. Not only was Davis decided before Jensen I but in Jensen I we expressly followed Davis. See State v. Jensen (Jensen I), 2007 WI 26, ¶19, 299 Wis. 2d 267, 727 N.W.2d 518. 6 No. 2018AP1952-CR appeals explained that under Cook v. Cook, 208 Wis. 2d 166, 560 N.W.2d 246 (1997), this court is the only one with the power to modify or overrule one of our previous decisions. The court of appeals concluded that, because we have never modified or overruled Jensen I, the circuit court erred in finding Julie's statements admissible and, in turn, failing to hold a new trial. It then remanded the cause "for a new trial at which Julie's letter and [voicemails] may not be admitted into evidence." Id. Having decided Jensen's appeal under Cook, the court of appeals declined to address Jensen's other challenges, including claims that the circuit court judge was biased against him and that the circuit court violated the federal court's habeas order by reinstating his conviction without a trial. ¶10 We granted the State's petition for review of the following three issues: (1) whether the court of appeals erred in reviewing the circuit court's decision under Cook instead of the law of the case; (2) if so, whether the circuit court permissibly deviated from the law of the case and correctly determined that Julie's statements are nontestimonial hearsay; and (3) whether we should remand the cause to the court of appeals to decide Jensen's remaining challenges. ¶11 Although we agree with the court of appeals' ultimate conclusion that the circuit court is bound by Jensen I, we hold that the court of the appeals erred in relying on Cook to reach that decision. In Cook, we held that the court of appeals has no power to overrule, modify, or withdraw language from one of its own published decisions; only this court has that power. 7 No. 2018AP1952-CR See Cook, 208 Wis. 2d at 189. The issue here, however, is about the law of the case, to which Cook does not apply. Accordingly, we modify the court of appeals' decision to the extent it relies on Cook. Our analysis proceeds under the doctrine of the law of the case. II ¶12 Whether a decision establishes the law of the case is a question of law that we review de novo. State v. Stuart (Stuart I), 2003 WI 73, ¶20, 262 Wis. 2d 620, 664 N.W.2d 82. Although lower courts have the discretion to depart from the law of the case when a "controlling authority has since made a contrary decision of the law," State v. Brady, 130 Wis. 2d 443, 448, 388 N.W.2d 151 (1986), whether such a contrary decision has been made is a question of law that we review de novo. See Kocken v. Wis. Council, 2007 WI 72, ¶¶25-26, 301 Wis. 2d 266, 732 N.W.2d 828. ¶13 The law of the case is a "longstanding rule" that requires courts to adhere to an appellate court's ruling on a legal issue "in all subsequent proceedings in the trial court or on later appeal." Stuart I, 262 Wis. 2d 620, ¶23 (quoting Univest Corp. v. Gen. Split Corp., 148 Wis. 2d 29, 38, 435 N.W.2d 234 (1989)). The rule ensures stability for litigants and reinforces the finality of a court's decisions. See Univest Corp., 148 Wis. 2d at 37-38. Courts in subsequent proceedings should therefore "be loathe" to revisit an appellate court's decision absent "extraordinary circumstances." Christianson v. Colt Indus. Oper. Corp., 486 U.S. 800, 817 (1988). That 8 No. 2018AP1952-CR admonition aside, absolute adherence to the law of the case is not required. As is relevant here, lower courts may depart from the initial decision if "a controlling authority has since made a contrary decision of the law" on the same issue.8 Stuart I, 262 Wis. 2d 620, ¶24 (quoting Brady, 130 Wis. 2d at 448). ¶14 Our analysis thus proceeds in two parts. First, we determine which case established the law of the case that Julie's statements are testimonial hearsay. Second, we analyze whether a controlling court has since issued a contrary decision on the same point of law. A ¶15 The parties largely agree that Jensen I established the law of the case. Jensen also argues that either federal habeas case, Schwochert or Clements, could establish the law of the case because both concluded that admitting Julie's statements violated the Confrontation Clause. But a federal habeas proceeding cannot establish the law of the case because it "is not a subsequent stage of the underlying criminal proceedings; it is a separate civil case." E.g., Edmonds v. Smith, 922 F.3d 737, 739 (6th Cir. 2019). Therefore, Jensen I Courts may also depart from the law of the case in two 8 other situations: when the evidence at a subsequent trial is "substantially different" than that at the initial trial; and when following the law of the case would result in a "manifest injustice." See State v. Stuart, 2003 WI 73, 262 Wis. 2d 620, 664 N.W.2d 82. Neither of those situations applies here. 9 No. 2018AP1952-CR is the only decision establishing the law of the case that Julie's hearsay statements are testimonial.9 B ¶16 We next analyze whether the current law regarding the admissibility of testimonial hearsay is contrary to that relied upon in Jensen I. We decided Jensen I under both Crawford and Davis. Therefore, we must determine whether the United States Supreme Court has since contradicted Crawford or Davis. See State v. Stuart (Stuart II), 2005 WI 47, ¶3 n.2, 279 Wis. 2d 659, 695 N.W.2d 259. As Jensen's Confrontation Clause issue arises under the federal Constitution, we are bound by the United States Supreme Court's jurisprudence interpreting that clause. See, e.g., State v. Delebreau, 2015 WI 55, ¶43, 362 Wis. 2d 542, 864 N.W.2d 852. ¶17 Since Jensen I, the United States Supreme Court has decided two cases that address the definition of testimonial hearsay: Michigan v. Bryant, 562 U.S. 344 (2011), and Ohio v. Clark, 576 U.S. 237 (2015). The State argues that Bryant and Clark narrowed the definition of "testimonial" so extensively that Jensen I no longer applies, thereby allowing the circuit 9Even if Schwochert or Clements could establish the law of the case, our conclusion would be the same because both agreed with our holding in Jensen I that Julie's statements are testimonial hearsay. See Schwochert, 2013 WL 6708767, at *17 ("Jensen's rights under the Confrontation Clause of the Sixth Amendment were violated when the trial court admitted" Julie's statements); Clements, 800 F.3d at 908 (adding that "there is no doubt that" admitting Julie's statements violated "Jensen's rights under the Confrontation Clause"). 10 No. 2018AP1952-CR court to re-evaluate Julie's statements and conclude that they are admissible nontestimonial statements. Jensen counters that neither Bryant nor Clark altered the Confrontation Clause analysis set forth in Crawford and Davis in any way that undermines our reasoning in Jensen I. ¶18 We agree with Jensen. At the time we decided Jensen I, the Confrontation Clause barred the admission at trial of an unavailable witness's hearsay statement that the defendant had no prior meaningful opportunity to cross-examine and that was made for the primary purpose of creating prosecutorial evidence. Bryant and Clark represent developments in applying the primary purpose test, but neither is contrary to it. 1 ¶19 Prior to Crawford, an unavailable witness's hearsay statement was admissible under the Confrontation Clause if it met a certain "reliability" threshold. See Ohio v. Roberts, 448 U.S. 56, 66 (1980). A statement met that threshold if it fell within a "firmly rooted hearsay exception" or if it bore some other "indicia of reliability." Id. The United States Supreme Court had read traditional hearsay rules and the Confrontation Clause as somewhat redundant, reasoning that "certain hearsay exceptions rest upon such solid foundations that admission of virtually any evidence within them comports with" the Confrontation Clause. See id. ¶20 Crawford "fundamentally change[d]" that analysis. Jensen I, 299 Wis. 2d 267, ¶14. Crawford first focused the scope of the Confrontation Clause analysis on the circumstances 11 No. 2018AP1952-CR in which one makes a statement, explaining that the Constitution is "acute[ly]"——but not exclusively——concerned with "formal statement[s] to government officers" rather than "casual remark[s] to an acquaintance." Crawford, 541 U.S. at 51. The Court then turned to the statement itself, holding that the Confrontation Clause's application to an unavailable witness's hearsay statement turns on two key factors: the statement's purpose and whether the statement had been "tested" on cross- examination. Id. at 50-56.10 ¶21 On the former, Crawford held that the Confrontation Clause applied only to statements that are "testimonial," which it defined as a statement "made for the purpose of establishing or proving some fact." Id. at 51 (quoted source omitted). The Court declined, however, to "spell out a comprehensive definition of 'testimonial.'" Id. at 68; see also Davis, 547 U.S. at 822 (declining to "produce an exhaustive classification of all conceivable statements"). Rather, it identified three broad "formulations" of testimonial statements: (1) "ex parte in-court testimony," such as "prior testimony that the defendant was unable to cross-examine"; (2) out-of-court statements "contained in formalized testimonial materials," such as an Before Crawford, cross-examination was but one method of 10 proving that a testimonial hearsay statement was acceptably reliable. See Ohio v. Roberts, 448 U.S. 56, 70-73 (1980); Mancusi v. Stubbs, 408 U.S. 204, 216 (1972). But Crawford went further, holding that a prior opportunity for meaningful cross- examination was the only way to show that a testimonial hearsay statement was sufficiently reliable under the Confrontation Clause. Crawford v. Washington, 541 U.S. 36, 55-56 (2004). 12 No. 2018AP1952-CR affidavit or a deposition; and (3) "statements that were made under circumstances [that] would lead an objective witness reasonably to believe that the statement would be available for use at a later trial." Crawford, 541 U.S. at 51-52 (quoted sources omitted). Putting these factors together, but again declining to limit its holding to the specific facts in Crawford, the Court held that, "at a minimum," the definition of "testimonial" includes prior testimony and a statement made during police interrogation. Id. at 68. ¶22 In Davis and its companion case, Hammon, however, the Court explained that not all statements to police are testimonial. There, the Court analyzed statements made to police during their response to two domestic violence incidents. It applied Crawford to both situations, but factual differences between the two cases led the Court to divergent conclusions. In Davis, the victim told the 911 operator that Davis was "jumpin' on [her] again" and beating her with his fists. She "described the context of the assault" and gave the 911 operator other identifying information about Davis. Davis, 547 U.S. at 817-18. In Hammon, the police had responded to a report of domestic violence, finding the victim on the front porch and Hammon inside the house. The victim allowed the police to go inside, where they first questioned Hammon and then her. At the end of that questioning, the victim "fill[ed] out and sign[ed] a battery affidavit" in which she explained that Hammon broke a glass heater, pushed her into the broken glass, hit her in the 13 No. 2018AP1952-CR chest, damaged her van so that she could not leave, and attacked her daughter. Id. at 819-21. ¶23 The Court held that the victim's statements in Davis were not testimonial because their primary purpose was to "enable police assistance with an ongoing emergency." Id. at 828. The Court differentiated these "frantic" statements, made "as they were actually happening" and while the victim was "in immediate danger," from those in Crawford, which were made "hours after the events . . . described had occurred." Id. at 827, 831 (emphasis removed). The statements also helped the police "assess the situation, the threat to their own safety, and possible danger to the potential victim." Id. at 832 (quoting Hiibel v. Sixth Jud. Dist. Ct., 542 U.S. 177, 186 (2004)). Thus, the victim "simply was not . . . testifying" because "[n]o 'witness' goes into court to proclaim an emergency." Id. at 828. ¶24 The Court reached the opposite conclusion in Hammon. There, it held that the victim's statements were testimonial because their primary purpose was to provide a "narrative of past events." Id. at 832. Even though Hammon was present while the police took the victim's statements, there "was no emergency in progress." Id. at 829. Her statements did not describe what was happening at that very moment, as in Davis, but rather what happened before the police arrived. Id. at 830. ¶25 We decided Jensen I by analyzing Julie's statements under the primary purpose test as explained in Davis. See Jensen I, 299 Wis. 2d 267, ¶¶18-19. We must therefore examine 14 No. 2018AP1952-CR the United States Supreme Court's more recent decisions in Bryant and Clark to determine if either decision is contrary to that test, thereby justifying the circuit court's departure from Jensen I. 2 ¶26 The Court's main task in Bryant was to clarify what it means, outside of Davis's specific factual context, for a statement to have the primary purpose of "enabl[ing] police assistance to meet an ongoing emergency." See Bryant, 562 U.S. at 359 (quoting Davis, 547 U.S. at 822). Indeed, the Court noted that it "confront[ed] for the first time circumstances in which the 'ongoing emergency' discussed in Davis extends beyond an initial victim to a potential threat to the responding police and the public at large." Id. In Bryant, the police found the victim, Covington, at a gas station bleeding badly from a gunshot wound and having trouble speaking. They asked Covington who shot him and where the shooting occurred. Covington told the police that Bryant shot him through the back door of Bryant's house. Covington was then taken to a hospital, where he died a few hours later. Id. at 349-50. The Michigan Supreme Court held that Covington's statements were inadmissible testimonial hearsay similar to those in Hammon because he made them after the shooting occurred and the police did not "perceive[] an ongoing emergency at the gas station." Id. at 351. ¶27 The United States Supreme Court reversed. It held that the primary purpose of Covington's statements was to help 15 No. 2018AP1952-CR the police resolve an ongoing emergency, because when the police arrived on the scene, they did not know whether the person who shot Covington posed an ongoing threat to the public. Id. at 371-72. Covington's behavior——profusely bleeding from the stomach, repeatedly asking when an ambulance would arrive, having difficulty breathing——objectively revealed that he was answering the officers' questions only to give them information about what might be an active-shooter scenario. Id. at 373-74. Other evidence supporting that conclusion included the fact that, like the 911 call in Davis, Covington's statements were "harried" and made during a "fluid and somewhat confused" situation. Id. at 377. Because the primary purpose of the statements was to help the police resolve an ongoing emergency, they were not testimonial. ¶28 In reaching that conclusion, Bryant emphasized that the test for determining a statement's primary purpose is an objective one. Id. at 360. When deciding whether a statement is made to assist the police in resolving an ongoing emergency, courts must consider the overall circumstances in which the statement is made, such as whether the statement is made near the scene of the crime or later at the police station. Id. at 360–61. Ultimately, the crux of the inquiry is whether the statement is made to "end[] a threatening situation" (not testimonial) or to "prove[] past events potentially relevant to later criminal prosecution" (testimonial). Id. at 361 (quoting Davis, 547 U.S. at 822, 832). On that point, the Court 16 No. 2018AP1952-CR cautioned against construing Davis's "ongoing emergency" definition too narrowly: Domestic violence cases like Davis and Hammon often have a narrower zone of potential victims than cases involving threats to public safety. An assessment of whether an emergency that threatens the police and public is ongoing cannot narrowly focus on whether the threat solely to the first victim has been neutralized because the threat to the first responders and public may continue. Id. at 363–64. ¶29 Bryant also reminded courts that whether an ongoing emergency exists is only one factor for determining a statement's primary purpose. Id. at 366. Other factors are also relevant, such as the statements and actions of both the declarant and the interrogators and formality of the encounter. Id. at 366-67. But just as formal police interrogations do not always produce testimonial statements, informal questioning "does not necessarily indicate . . . the lack of testimonial intent." Id. at 366; see also Davis, 547 U.S. at 822 & n.1. Courts must objectively analyze the declarant's and the interrogator's "actions and statements." Bryant, 562 U.S. at 367-68. The Court noted that this approach was the one it "suggested in Davis" when it first articulated that statements made to resolve an ongoing emergency are not testimonial. Id. at 370. 3 ¶30 Whereas Bryant's contextual analysis focused on the person making the statement, Clark focused on the person to whom 17 No. 2018AP1952-CR the statement was made. In Clark, the Court was asked to resolve "whether statements to persons other than law enforcement officers are subject to the Confrontation Clause." 576 U.S. at 246. There, Clark had been convicted of assaulting his girlfriend's three-year-old child due, in part, to statements the child made to his teachers identifying Clark as his abuser. The child made those statements in response to his teachers' inquiries about visible injuries on his body. Concerned that the child was being abused, the teachers asked him questions "primarily aimed at identifying and ending the threat" of potentially letting him go home that day with his abuser. Id. at 247. When the teachers were questioning the child, their objective was "to protect" him, "not to arrest or punish his abuser"; they "were not sure who had abused him or how best to secure his safety." Id. ¶31 The Court held that the Confrontation Clause applied to "at least some statements made to individuals who are not law enforcement," but not the child's statements here. Id. at 246. Reiterating Bryant's guidance to consider all of the relevant circumstances, the Court explained that "[c]ourts must evaluate challenged statements in context, and part of that context is the questioner's identity." Id. at 249 (explaining that it is "common sense that the relationship between a student and his teacher is very different from that between a citizen and the police"). The Court then considered "all the relevant circumstances," including the child's age, the school setting, the teachers' objective, and the overall informality of the 18 No. 2018AP1952-CR situation, and concluded that the primary purpose of the child's statements was not to "creat[e] evidence" for Clark's prosecution. Id. at 246. Although the Court again "decline[d] to adopt a categorical rule" on the issue, id., it pointed out that statements by someone as young as this child "will rarely, if ever, implicate the Confrontation Clause," id. at 248. C ¶32 Bryant and Clark neither contradicted Crawford or Davis nor drastically altered the Confrontation Clause analysis. Given that both Crawford and Davis declined to "comprehensive[ly]" define "testimonial statement," it was inevitable that future cases like Bryant and Clark would further refine that term. See Crawford, 541 U.S. at 68; Davis, 547 U.S. at 821-22. In the "new context" of a potential threat to the responding police and the public at large, Bryant "provide[d] additional clarification with regard to what Davis meant by 'the primary purpose of the interrogation is to enable police assistance to meet an ongoing emergency.'" Bryant, 562 U.S. at 359. Similarly, in Clark, the Court applied the primary purpose test to answer a question it had "repeatedly reserved: whether statements made to persons other than law enforcement officers are subject to the Confrontation Clause." Clark, 576 U.S. at 246. ¶33 The Court's own reflections on its post-Crawford decisions demonstrate that it did not see those decisions as contradicting Crawford or Davis but rather as efforts to "flesh out" the test it first articulated there. See id. at 243-46; 19 No. 2018AP1952-CR see also id. at 252 (Scalia, J., concurring) (plainly stating in 2015 that Crawford "remains the law"). Federal courts of appeals' interpretations of Bryant and Clark confirm that progression. See, e.g., United States v. Norwood, 982 F.3d 1032, 1043-44 (7th Cir. 2020); Issa v. Bradshaw, 910 F.3d 872, 876 (6th Cir. 2018); United States v. Lebeau, 867 F.3d 960, 980 (8th Cir. 2017). The Seventh Circuit Court of Appeals, for instance, recently noted that Bryant "further elaborated" on Davis's ongoing emergency analysis by "ma[king] clear that the totality of the circumstances guides the primary purpose test, not any one factor." Norwood, 982 F.3d at 1043-44 (emphasis removed). That court has likewise cited Clark as a continuation in the primary purpose test's development. See, e.g., United States v. Amaya, 828 F.3d 518, 528-29, 529 n.4 (7th Cir. 2016). ¶34 Our recent jurisprudence also reveals that Crawford and Davis——and therefore our analysis in Jensen I——have not been contradicted. Even after Bryant and Clark, we continue to cite Crawford and Davis in resolving whether an unavailable witness's statement is testimonial. See State v. Reinwand, 2019 WI 25, ¶¶19-22, 385 Wis. 2d 700, 924 N.W.2d 184; State v. Nieves, 2017 WI 69, ¶¶26-29, 376 Wis. 2d 300, 897 N.W.2d 363; State v. Zamzow, 2017 WI 29, ¶13, 374 Wis. 2d 220, 892 N.W.2d 367; State v. Mattox, 2017 WI 9, ¶¶24-25, 373 Wis. 2d 122, 890 N.W.2d 256. Even more to the point, on the limited occasions we have cited Bryant or Clark, we have interpreted them as continuing to apply the primary purpose test. See Reinwand, 385 Wis. 2d 700, 20 No. 2018AP1952-CR ¶¶22, 24; Mattox, 373 Wis. 2d 122, ¶32 ("Clark reaffirms the primary purpose test"). We have never interpreted Bryant or Clark to be a departure from Crawford or Davis, much less the type of drastic departure required to justify deviating from the law of the case. ¶35 In some ways, Jensen I anticipated Bryant and Clark. For instance, we decided Jensen I by not only analyzing the content of Julie's statements but also objectively evaluating the relevant "circumstances" under which she made them. Jensen I, 299 Wis. 2d 267, ¶¶26-30. That is what the United States Supreme Court held in Bryant. See 562 U.S. at 359 (requiring courts to "objectively evaluate the circumstances" surrounding the statement's creation when determining its primary purpose). In Jensen I, we rejected the State's argument that "the government needs to be involved in the creation of the statement" for that statement to be testimonial. See Jensen I, 299 Wis. 2d 267, ¶24. This mirrors the holding in Clark. See 576 U.S. at 246 (recognizing that "at least some statements to individuals who are not law enforcement officers could conceivably raise confrontation concerns"). Far from being contrary to Jensen I, Bryant and Clark are consistent with it. IV ¶36 Our decision in Jensen I that Julie's statements constituted testimonial hearsay established the law of the case. Subsequent developments in the law on testimonial hearsay are not contrary to Jensen I. Therefore, the circuit court was not 21 No. 2018AP1952-CR permitted to deviate from our holding in Jensen I. Accordingly, we affirm the court of appeals' decision. We modify that decision, however, to the extent that the court of appeals incorrectly relied upon Cook. By the Court.—The decision of the court of appeals is modified, and as modified, affirmed. 22 No. 2018AP1952-CR.jjk ¶37 JILL J. KAROFSKY, J. (concurring). I join the majority opinion, with the exception of ¶35, because I agree that our decision in Jensen I that Julie's statements constituted testimonial hearsay established the law of the case and a controlling court has not issued a contrary decision on the same point of law. State v. Jensen (Jensen I), 2007 WI 26, 299 Wis. 2d 267, 727 N.W.2d 518. I write separately, however, because I disagree with the majority's assertion that the Jensen I court "objectively evaluat[ed] the relevant 'circumstances' under which she made [her statements]." Majority op., ¶35. In other words, I conclude that the Jensen I court completely failed to consider the context in which Julie made her statements. ¶38 Had this court in Jensen I truly considered that context, it would have recognized that Julie was undeniably a victim of domestic abuse and that prior to her death she lived in terror born of the unimaginable fear that her husband was going to kill her and claim that her death was a suicide. It was under these circumstances that she left two voicemails for Pleasant Prairie Police Officer Ron Kosman and wrote a letter which she gave to a neighbor with instructions to give it to the police should anything happen to her. ¶39 This writing begins with a discussion of domestic abuse and how Crawford v. Washington, 541 U.S. 36 (2004), impacted the prosecution of domestic abuse cases. Next, I summarize the United States Supreme Court's decisions in Crawford, Davis v. Washington, 547 U.S. 813 (2006), and Davis' 1 No. 2018AP1952-CR.jjk companion case, Hammon v. Indiana. I follow with an examination of Jensen I, since it was decided less than a year after Davis and Hammon, and with a discussion of three cases from the United States Supreme Court and this court that were decided post-Jensen I. This case overview reveals how the United States Supreme Court and this court have increasingly given weight to context when assessing whether the hearsay statement of an unavailable witness is testimonial in nature. Next, to assist future courts in assessing context, I supply a non-exhaustive list of contextual questions based off the previously summarized cases. Finally, I conclude this concurrence with a discussion of assessing context in domestic abuse cases and an objective evaluation of the circumstances under which Julie made her statements. I. DOMESTIC ABUSE AND VICTIMLESS PROSECUTION ¶40 Domestic abuse, or interpersonal violence, is a significant public health issue. About one in four women and one in seven men have experienced an act of physical violence from an intimate partner in their lifetime. Caitlin Valiulis, Domestic Violence, 15 Geo. J. Gender & L. 123, 124 (2014). In addition, and far more sobering, the nation's crime data suggests that over half of female homicide victims in the United States are killed by a current or former intimate partner. See Natalie Nanasi, Disarming Domestic Abusers, 14 Harv. L. & Pol'y Rev. 559, 563 & n.16 (2020) (citing statistics from the Center for Disease Control and Prevention regarding the role of intimate partner violence). 2 No. 2018AP1952-CR.jjk ¶41 To counteract this public health issue, prosecutors have worked to hold abusers accountable. This is often a difficult, if not impossible, task because abusers' actions often render their victims unavailable to testify. Beginning in the mid-1990s, prosecutors pursued these so-called "victimless" prosecutions by seeking to introduce reliable evidence using victims' out-of-court statements through 911 operators, medical professionals, social workers, and law enforcement officers. See Andrew King-Ries, Crawford v. Washington: The End of Victimless Prosecution?, 28 Seattle U. L. Rev. 301 (2005). Victim advocates and prosecutors applauded this approach because it maintained victims' safety and avoided retraumatization. Id. This practice, however, came to a screeching halt after the United States Supreme Court's decision in Crawford,1 in which the Court profoundly altered the analysis as to when an unavailable witness's hearsay statement is admissible under the Confrontation Clause of the Sixth Amendment. In a 2004 survey of 64 prosecutors' offices in California, 1 Oregon, and Washington, 63 percent of respondents reported that Crawford v. Washington, 541 U.S. 36 (2004) had significantly impeded domestic violence prosecution. Tom Lininger, Prosecuting Batterers After Crawford, 91 Va. L. Rev. 747, 750 (2005). Further, 76 percent of respondents indicated that after Crawford their offices were more likely to dismiss domestic violence charges when the victims refused to cooperate or were unavailable. Id. at 773. 3 No. 2018AP1952-CR.jjk II. PRECEDENT FROM THE UNITED STATES SUPREME COURT ABOUT NONTESTIMONIAL HEARSAY ¶42 In Crawford, the United States Supreme Court fundamentally changed the analysis regarding the admissibility of an out-of-court witness's statement by deciding that when such a statement is testimonial in nature, the witness must testify and face cross-examination. 541 U.S. at 68. Consequently, if that witness is unavailable, his or her testimony will be excluded. Id. The Crawford Court did not further explain what it meant by "testimonial." Writing for the majority, Justice Scalia reasoned: Where testimonial evidence is at issue, however, the Sixth Amendment demands what the common law required: unavailability and a prior opportunity for cross- examination. We leave for another day any effort to spell out a comprehensive definition of 'testimonial.' Whatever else the term covers, it applies at a minimum to prior testimony at a preliminary hearing, before a grand jury, or at a former trial; and to police interrogations. Id. (Footnote omitted.) ¶43 The United States Supreme Court first applied its reasoning in Crawford to situations of domestic abuse in Davis and Hammon. In doing so, the Court created a primary-purpose test to determine whether or not a statement is testimonial. In short, the test is designed to ascertain whether the primary purpose of an interrogation is to enable police to meet an ongoing emergency. Statements are "testimonial when the circumstances objectively indicate that there is no such ongoing emergency, and that the primary purpose of the interrogation is to establish or prove past events potentially relevant to later criminal prosecution." Davis, 547 U.S. at 822. 4 No. 2018AP1952-CR.jjk ¶44 In Davis, the Court analyzed a 911 call in which the victim reported that Davis was "jumpin' on [her] again" and beating her with his fists. Id. at 817. The victim also "described the context of the assault" and gave identifying information about Davis. Id. at 818. The Court held that these statements were admissible because their primary purpose was to "enable police assistance to meet an ongoing emergency." Id. at 828.2 The Court distinguished this statement from the one at issue in Crawford, reasoning that the statements were made "as they were actually happening" and while the victim was "in immediate danger." Id. at 827, 831 (emphasis in original). The Court also determined that the statements were helpful to the police because they allowed them to assess any potential threats towards them or the victim. Id. at 832. In sum, the Court decided that the victim was not testifying because "[n]o 'witness' goes into court to proclaim an emergency and seek help." Id. at 828. The Davis Court described these statements as "frantic," 2 547 U.S. at 827, a word that connotes a lack of thought or good judgment. This type of language is emblematic of the obstacles domestic abuse victims face in effectively conveying the truth of their experiences to institutional gatekeepers. "[D]omestic violence complainants can find themselves in a double bind. The symptoms of their trauma—the reliable indicators that abuse has in fact occurred—are perversely wielded against their own credibility in court. [Post-traumatic stress disorder] symptoms can . . . contribute to credibility discounts that may be imposed by police, prosecutors, and judges." Deborah Epstein & Lisa A. Goodman, Discounting Women: Doubting Domestic Violence Survivors' Credibility and Dismissing Their Experiences, 167 U. Penn. L. Rev. 399, 422 (2019). 5 No. 2018AP1952-CR.jjk ¶45 The Court reached a different conclusion in Hammon, in which police called to a domestic violence incident found the victim on the front porch and Hammon inside the house. Id. at 819. As part of their investigation, the officers asked the victim to fill out and sign a "battery affidavit." Id. at 820. In filling out the affidavit, the victim described how Hammon broke a glass heater, pushed her into the broken glass, hit her in the chest, prevented her from leaving by damaging her van, and attacked her daughter. Id. The Court determined the primary purpose of this statement was to provide a "narrative of past events," and the Court reasoned that giving a statement about past events meant there was "no emergency in progress." Id. at 829, 832. For these reasons, the Court decided the victim's affidavit was inadmissible hearsay. Id. at 834. III. JENSEN I ¶46 Shortly after the United States Supreme Court decided Davis and Hammon, this court determined in Jensen I that the primary purpose of Julie's letter was not to help the police in an ongoing emergency, but to "investigate or aid in prosecution in the event of her death." Jensen I, 299 Wis. 2d 267, ¶27. Additionally, the court also reasoned that the voicemails "were entirely for accusatory and prosecutorial purposes." Id., ¶30. ¶47 In Julie's second voicemail, she told Officer Kosman that she thought Jensen was going to kill her. The letter that Julie gave her neighbor read as follows: I took this picture [and] am writing this on Saturday 11-21-98 at 7AM. This 'list' was in my husband's business daily planner—not meant for me to see, I don't know what it means, but if anything happens to 6 No. 2018AP1952-CR.jjk me, he would be my first suspect. Our relationship has deteriorated to the polite superficial. I know he's never forgiven me for the brief affair I had with that creep seven years ago. Mark lives for work [and] the kids; he's an avid surfer of the Internet.... Anyway—I do not smoke or drink. My mother was an alcoholic, so I limit my drinking to one or two a week. Mark wants me to drink more—with him in the evenings. I don't. I would never take my life because of my kids— they are everything to me! I regularly take Tylenol [and] multi-vitamins; occasionally take OTC stuff for colds, Zantac, or Immodium; have one prescription for migraine tablets, which Mark use[s] more than I. I pray I'm wrong [and] nothing happens . . . but I am suspicious of Mark's suspicious behaviors [and] fear for my early demise. However, I will not leave David [and] Douglas. My life's greatest love, accomplishment and wish: "My 3 D's"—Daddy (Mark), David [and] Douglas. Id., ¶7. ¶48 Although the record in this case was replete with references to domestic abuse and the Jensen I majority took great pains to explain that it reached its decision by examining "[t]he content and the circumstances surrounding the letter" and applied the same reasoning to the voicemails, id., ¶27, nowhere in the majority opinion, not even in a passing phrase or fleeting word, did this court acknowledge that Julie was the victim of domestic abuse. Instead, employing an ill-suited analogy, the majority compared Julie's letter and voicemails to Lord Cobham's letter at Sir Walter Raleigh's trial for treason. Id., ¶29. Drawing a parallel between a 1603 treason trial—where Cobham, the missing (but still very much alive) accomplice, wrote a letter maintaining his innocence while accusing Raleigh— and a 1998 domestic homicide makes for a particularly inapt 7 No. 2018AP1952-CR.jjk analogy; it draws a comparison remote in time, place, content, and circumstance in every possible aspect. IV. POST-JENSEN I ¶49 Post-Jensen I, the United States Supreme Court issued two decisions that further illuminated the import of assessing context when courts are determining the primary purpose of an unavailable witness's hearsay statement, Michigan v. Bryant, 562 U.S. 344 (2011), and Ohio v. Clark, 576 U.S. 237 (2015). In Bryant, the police found a gunshot victim at a gas station. 562 U.S. at 349. Although the victim was bleeding profusely and was having trouble speaking, he told police that Bryant shot him through the back door of Bryant's house. Id. Unfortunately, the victim died within hours. Id. The Bryant Court decided that the victim's statement was admissible because its primary purpose was to help the police resolve an ongoing emergency, especially in light of the fact that Bryant posed an ongoing threat to the community at large. Id. at 371-73. The Court emphasized that determining the primary purpose of a statement is an objective test and clarified that an ongoing emergency is only one factor to be considered. Id. at 360, 366. The Court outlined other important factors, including the statements and actions of both the declarant and the interrogators, and the formality of the encounter. Id. at 366-67. The court noted that victims may have "mixed motives" when making a statement to the police. Id. at 368 ("During an ongoing emergency, a victim is most likely to want the threat to her and to other potential 8 No. 2018AP1952-CR.jjk victims to end, but that does not necessarily mean that the victim wants or envisions prosecution of the assailant."). ¶50 Clark, 576 U.S. 237, involved a different type of violence in the home: child abuse. In that case, Clark was accused of abusing his girlfriend's three-year old son after the victim disclosed the abuse to a teacher who observed visible injuries on the boy's body. Id. at 240-41. The statements to the teacher were determined to be nontestimonial because the teacher's objective in asking questions was to protect the victim, not to arrest or punish his abuser. Id. at 247. The Clark Court reiterated the importance of context, explaining "[c]ourts must evaluate challenged statements in context, and part of that context is the questioner's identity." Id. at 249. In considering "all the relevant circumstances," including the child's age, the school setting, the teacher's objective, and the overarching informality of the situation, the Court concluded that the primary purpose of the victim's statements was not to "creat[e] evidence" for Clark's prosecution. Id. at 246. Rather, the teacher's questions were intended to identify the abuser "to protect the victim from future attacks." Id. at 247. ¶51 Subsequently, we interpreted Clark in Reinwand, in which Joseph Reinwand was convicted of first-degree intentional homicide for killing his daughter's former partner. State v. Reinwand, 2019 WI 25, 385 Wis. 2d 700, 924 N.W.2d 184. Reinwand's daughter and the victim were planning to mediate a custody dispute and in the days leading up to the mediation, 9 No. 2018AP1952-CR.jjk Reinwand threatened to harm or kill the victim if he continued to seek custody. Id., ¶6. The victim reported these threats to family and friends, saying he was scared for his life and that if anything happened to him, people should look to Reinwand. Id. A short time later, the victim was found dead in his home. This court looked to four relevant factors in deciding whether Reinwand's statements were testimonial: (1) the formality/informality of the situation producing the out-of-court statement; (2) whether the statement is given to law enforcement or a non-law enforcement individual; (3) the age of the declarant; and (4) the context in which the statement was given. Id., ¶25 (citing State v. Mattox, 2017 WI 9, ¶32, 373 Wis. 2d 122, 890 N.W.2d 256). ¶52 The Reinwand court concluded that the statements were nontestimonial because: (1) they were given in informal situations, primarily inside people's houses and at an Arby's restaurant; (2) none of the statements were given to law enforcement or intended for law enforcement; (3) the age of the victim was irrelevant; and (4) the victim's statements were made to friends and family and his demeanor suggested genuine concern because he seemed "concerned, stressed, agitated . . . and genuinely frightened." Id., ¶¶27-30. The court concluded that the victim's "demeanor suggests that he was expressing genuine concern and seeking advice, rather than attempting to create a substitute for trial testimony." Id., ¶30. V. ASSESSING CONTEXT ¶53 The post-Crawford cases emphasized the importance of assessing context when courts are determining whether the 10 No. 2018AP1952-CR.jjk hearsay statement of an unavailable witness is testimonial. The following non-exhaustive list of questions summarizes the contextual inquiries the United States Supreme Court and this court made in post-Crawford cases:  Is there an ongoing emergency? (Davis)  Do the statements help the police assess whether there is a potential threat? (Davis)  Is the victim in immediate danger? (Davis)  Is the statement a narrative of past events? (Hammon)  Is the statement related to an ongoing threat to the community at large? (Bryant)  What's the declarant's actual statement? (Bryant)  What are the actions of the declarant? (Bryant)  What are the actions and statements of the interrogators? (Bryant)  Are the interrogators' intentions to protect the victim or arrest/prosecute the abuser? (Clark)  Is the encounter formal (at a police station) or informal? (Bryant)  Was the statement given to law enforcement? (Clark)  Were the statements intended for law enforcement? (Clark)  How old is the declarant? (Clark)  What is the relationship between the declarant and the suspect? (Clark)  What was the demeanor of the declarant at the time the statements were made? (Reinwand) 11 No. 2018AP1952-CR.jjk  Is the statement a prediction of future events? (Reinwand) VI. CONTEXT IN DOMESTIC ABUSE CASES ¶54 Applying the above considerations to situations of domestic abuse can be challenging because domestic abuse rarely takes place in a vacuum. That is, there are often multiple incidents and the abuse can span the course of days, weeks, months, or years. See, e.g., Eleanor Simon, Confrontation and Domestic Violence Post-Davis: Is There and Should There Be a Doctrinal Exception?, 17 Mich. J. Gender & L. 175, 206 (2011) ("[A] domestic violence victim exists in a relationship defined by long-term, ongoing, powerful, and continuous abuse . . . it is illogical and impractical to attempt to find the beginning and end of an 'emergency' in such a context."). In addition, victims of domestic abuse are often afraid to report acts of violence, or they recant or refuse to cooperate after initially providing information because they fear retaliation. Id. at 184-85. Therefore, victims may not make a report or they may minimize or deny incidents of abuse. It is also important to understand that no one knows an abuser better than the abuser's victim. And the most dangerous time for a victim of domestic abuse is when he or she decides to leave the relationship. See Lisa A. Goodman & Deborah Epstein, Listening to Battered Women: A Survivor-Centered Approach to Advocacy, Mental Health, and Justice 76 (2008) ("Substantial data show that separation from the batterer is the time of greatest risk of serious violence and homicide for battered women and for their children."). 12 No. 2018AP1952-CR.jjk ¶55 Having suggested some contextual questions and acknowledging the challenges of understanding context in cases of domestic abuse, I conclude this concurrence by objectively evaluating the relevant circumstances under which Julie made her statements, a task the majority opinion erroneously claims the Jensen I court did. That evaluation reveals that Julie:  was a victim of domestic abuse;  believed there was an ongoing emergency as she feared her husband was going to kill her;  perceived herself to be in immediate danger because her husband was engaging in behavior that did not make sense to her;  had significant safety concerns;  was afraid her death was going to be made to look like a suicide;  loved her sons;  wanted her sons to know she did not intend to kill herself;  was making a prediction about her husband's future behavior;  was not questioned/interrogated in this case; and  did not have a formal encounter in a police station. ¶56 When looking at this evidence in context, it is apparent that Julie was a victim of domestic abuse and that prior to her death she lived in terror born of the unimaginable fear that her husband was going to kill her and claim that her death was a suicide. It was under these circumstances that she 13 No. 2018AP1952-CR.jjk left the voicemail messages for Officer Kosman and wrote the letter which she gave to a neighbor with instructions to give it to the police should anything happen to her. ¶57 With this context in mind, we must ask: Was Julie making statements for the future prosecution of her husband for her murder? Or was she a woman trying to survive ongoing domestic abuse, fearing and predicting an imminent attempt on her life, telling her sons that she loved them too much to commit suicide? This is the voice——Julie's voice——that this court failed to acknowledge in Jensen I. ¶58 Although the law of the case prohibits this court from reconsidering the determinations reached by the Jensen I court, had the Jensen I court actually "objectively evaluat[ed] the relevant circumstances" surrounding Julie's statements, it would have recognized the atmosphere of domestic abuse that suffused the factual background and the relationship at the center of this case and possibly reached a different conclusion. ¶59 For the foregoing reasons, I concur. ¶60 I am authorized to state that Justice ANNETTE KINGSLAND ZIEGLER joins this concurrence. 14 No. 2018AP1952-CR.jjk 1	01-04-2023	03-18-2021
https://www.courtlistener.com/api/rest/v3/opinions/4669079/	USCA11 Case: 19-15014 Date Filed: 03/18/2021 Page: 1 of 18 [DO NOT PUBLISH] IN THE UNITED STATES COURT OF APPEALS FOR THE ELEVENTH CIRCUIT ________________________ No. 19-15014 ________________________ D.C. Docket No. 1:19-cv-00040-ECM-JTA TRIP WHATLEY, SUSAN MOORE, TRACY LENTZ, Plaintiffs - Appellants, KEITH BOWERS, et al., Plaintiffs, versus THE OHIO NATIONAL LIFE INSURANCE COMPANY, OHIO NATIONAL LIFE ASSURANCE COMPANY, OHIO NATIONAL EQUITIES, INC., Defendants - Appellees. ________________________ Appeal from the United States District Court for the Middle District of Alabama ________________________ (March 18, 2021) USCA11 Case: 19-15014 Date Filed: 03/18/2021 Page: 2 of 18 Before WILSON, GRANT, and TJOFLAT, Circuit Judges. PER CURIAM: The issue presented by this appeal is whether Plaintiffs Trip Whatley, Susan Moore, and Tracy Lentz can bring claims against Ohio National and its affiliated companies (collectively, Ohio National) for failure to pay commissions under a contract to which the Plaintiffs are not parties. Plaintiffs brought claims for breach of contract as intended third-party beneficiaries, unjust enrichment, and tortious interference with business relations. The district court dismissed each claim with prejudice. After careful review, and with the benefit of oral argument, we affirm. I. Ohio National is an insurance corporation that sells financial products. The financial product relevant to this case is a variable annuity with a guaranteed minimum income benefit rider (for simplicity, referred to as an Annuity). Ohio National issues these Annuities to broker dealers pursuant to Selling Agreements. 1 The broker dealers then enlist sales representatives—including Plaintiffs Whatley, Moore, and Lentz—to sell the Annuities. Plaintiffs have separate contracts with the broker dealers and are not parties to the Selling Agreements. 1 Plaintiffs Whatley, Moore, and Lentz are registered representatives of broker dealers ProEquities, Inc., LPL Financial, and Securities America, respectively. Each of these broker dealers had a Selling Agreement with Ohio National. But because the Selling Agreements with each broker dealer—as well as the attached Commission Schedules—are substantively identical, we refer to them collectively. 2 USCA11 Case: 19-15014 Date Filed: 03/18/2021 Page: 3 of 18 Section 9 of the Selling Agreements between Ohio National and the broker dealers is entitled “Commissions Payable.” It provides: Commissions payable in connection with the contracts shall be paid to [the broker dealer] . . . according to the Commission Schedule(s) . . . . Compensation to the [broker dealer’s] Representatives . . . will be governed by agreement between [the broker dealer] and its Representatives and its payment will be the [broker dealer’s] responsibility. Section 9 further states that Ohio National’s obligation to pay commissions pursuant to the Commission Schedule “shall survive this Agreement unless the Agreement is terminated for cause by [Ohio National].” And the Commission Schedule provides, in part, that Ohio National is to pay the broker dealer “trail commissions” in return for selling and servicing Annuities.2 Plaintiffs allege that on September 28, 2018, Ohio National terminated the Selling Agreements with all broker dealers without cause and refused to pay the broker dealers trail commissions owed on existing Annuities. The result, Plaintiffs allege, was that the broker dealers were unable to pass those trail commissions along to Plaintiffs pursuant to their separate agreements. 3 2 Trail commissions are commissions on previously sold Annuities that remain in force. The Commission Schedule provides that “[t]rail commissions will continue to be paid to the broker dealer of record while the Selling Agreement remains in force and will be paid on a particular contract until the contract is surrendered or annuitized.” 3 The terms of the contracts between Plaintiffs and the broker dealers are not alleged in the First Amended Complaint. 3 USCA11 Case: 19-15014 Date Filed: 03/18/2021 Page: 4 of 18 On January 11, 2019, Plaintiffs filed this lawsuit against Ohio National, and on April 2, 2019, they filed a First Amended Complaint as a matter of course. The First Amended Complaint includes five causes of action, but only three are before us on appeal. 4 Plaintiffs’ first claim is for breach of contract, based on the theory that they have standing as third-party beneficiaries of the Selling Agreements. Second, and in the alternative to the breach of contract claim, Plaintiffs allege unjust enrichment on the basis that it is unjust for Ohio National to benefit from retaining trail commissions that should have been paid pursuant to the Selling Agreements. Plaintiffs’ third claim is for tortious interference with business relations. They claim that by failing to pay commissions, Ohio National interfered with the separate contracts between the broker dealers and Plaintiffs. The district court granted Ohio National’s motion to dismiss all claims. First, the court found that Plaintiffs’ lacked standing to bring a breach of contract claim because they were not intended beneficiaries of the Selling Agreements. The district court relied heavily on Section 9 of the Selling Agreements which provides for direct payments from Ohio National to the broker dealer, while providing that Plaintiffs’ compensation is the broker dealer’s responsibility. Second, the court 4 The First Amended Complaint includes claims for declaratory relief and promissory estoppel, but those claims are no longer raised on appeal. See Oral Argument Recording at 00:39–00:50 (Dec. 18, 2020). 4 USCA11 Case: 19-15014 Date Filed: 03/18/2021 Page: 5 of 18 held that Appellants could not bring an unjust enrichment claim based on an issue that was expressly governed by contract. Third, the court dismissed Plaintiffs’ tortious interference claim, holding that under the “refusal to deal” doctrine, Ohio National could not be held liable in tort for terminating the Selling Agreements and stopping payment on trail commissions. Rather than granting Plaintiffs leave to amend, the district court dismissed each claim with prejudice. This appeal followed. II. We review de novo a district court’s grant of a motion to dismiss with prejudice. Almanza v. United Airlines, Inc., 851 F.3d 1060, 1066 (11th Cir. 2017). “We must accept the factual allegations in the complaint as true and construe them in the light most favorable to the plaintiff.” Id. III. A. We begin by addressing Plaintiffs’ third-party beneficiary breach of contract claim. Under Ohio law, a third party has standing to sue for breach of contract only if they are an intended—rather than an incidental—beneficiary. 5 TRINOVA Corp. v. Pilkington Bros., P.L.C., 638 N.E.2d 572, 577 (Ohio 1994). To 5 This claim is governed by Ohio law because the Selling Agreements provide for Ohio choice of law. 5 USCA11 Case: 19-15014 Date Filed: 03/18/2021 Page: 6 of 18 be an intended beneficiary, a third party must show that the contracting parties intended to directly benefit the third party. Huff v. FirstEnergy Corp., 957 N.E.2d 3, 7 (Ohio 2011). “Generally, the parties’ intention to benefit a third party will be found in the language of the agreement.” Id. Plaintiffs argue that they are intended third-party beneficiaries under the plain language of the Selling Agreements. In support, they point out that the Selling Agreements refer to “Representatives” at least 25 times. Ohio National responds by pointing us to two recent Sixth Circuit decisions. Cook v. Ohio Nat’l Life Ins. Co., 961 F.3d 850 (6th Cir. 2020); Browning v. Ohio Nat’l Life Ins. Co., 819 F. App’x 306 (6th Cir. 2020). In these cases, sales representatives brought claims against Ohio National for breach of contract as third-party beneficiaries and for unjust enrichment. The claims were based on the same factual predicate alleged here. In Cook, for example, the Sixth Circuit rejected the third-party beneficiary breach of contract claims.6 961 F.3d at 856. It explained that Section 9 of the Selling Agreements requires Ohio National to pay the broker dealer directly. Id. And although the Selling Agreements frequently reference sales representatives, Section 9 explicitly provides that the representatives’ compensation remains the 6 We cite to Cook—a published decision—although Browning applied the same reasoning and reached the same result. Browning, 819 F. App’x at 308 (“Our court’s decision in Cook dictates the outcome of Browning’s appeal.”). 6 USCA11 Case: 19-15014 Date Filed: 03/18/2021 Page: 7 of 18 broker dealer’s responsibility. Therefore, the Sixth Circuit found that the plain language of the Selling Agreements does not evince the parties’ intent to directly benefit the sales representatives. Id. Cook is on point here, and, like the district court, we find its reasoning persuasive. Yet Plaintiffs argue that Ohio law demands the opposite result. See Visintine & Co. v. New York, Chi. & St. Louis R. Co., 160 N.E.2d 311 (Ohio 1959) (per curiam). In Visintine, the State of Ohio had a contract with several railroad companies and a separate agreement with a contractor to complete a single construction project. Id. at 312–14. The two contracts made the work of the railroad companies and the contractor mutually dependent. Id. at 314. When the railroad companies failed to perform their work, the contractor sued them for breach of contract. Id. at 313. Although there was no contract between the railroad companies and the contractor, the court concluded that the contractor could bring the action as a third-party beneficiary. Id. at 314. The companies had taken on a duty to perform obligations for the contractor (and vice versa) in the interest of completing the project as scheduled. Therefore, it was “apparent that [the companies’ contract with the State] was intended to benefit the contractor.” Id. (framing the core question as: “what was the performance contracted for and what is the best way to bring it about”). 7 USCA11 Case: 19-15014 Date Filed: 03/18/2021 Page: 8 of 18 The district court found that Visintine does not apply here because its holding was limited to creditor beneficiaries. But even assuming Visintine is not so limited, the contractual language in that case established that the contractor and the railroad companies had assumed reciprocal obligations to one another. In contrast, Ohio National did not take on any duty vis-à-vis Plaintiffs. To the contrary, “the performance contracted for” in the Selling Agreements was that Ohio National would issue compensation only to the broker dealer, while the broker dealer would remain responsible for Plaintiffs’ compensation. Id. Therefore, the Selling Agreements do not reflect an intent to benefit Plaintiffs. It is true, of course, that “[w]e must accept the factual allegations in the complaint as true” at this stage. Almanza, 851 F.3d at 1066. But because the plain contractual language of the Selling Agreements demonstrates that the parties did not intend to benefit Plaintiffs, the third-party beneficiary claim fails as a matter of law. 7 Accordingly, we affirm the district court’s grant of Ohio National’s motion to dismiss Plaintiffs’ breach of contract claim for lack of standing. 7 Ohio National also argues that the relief Plaintiffs seek— enforcement of the Selling Agreements as third-party beneficiaries—would violate FINRA Rules, which prohibit direct payments to broker dealers’ sales representatives. See FINRA Rule 2320(g)(1) (providing that “no associated person of a [FINRA] member shall accept any compensation from anyone other than the member with which the person is associated”). Because we conclude that the plain language of the Selling Agreements does not evince an intent to benefit Plaintiffs, we need not decide whether the relief Plaintiffs seek would trigger a violation of FINRA rules. 8 USCA11 Case: 19-15014 Date Filed: 03/18/2021 Page: 9 of 18 B. We turn next to Plaintiffs’ unjust enrichment claim. As with the breach of contract claim, Plaintiffs pled this claim under Ohio law. To recover for unjust enrichment under Ohio law, a plaintiff must prove three elements: “(1) a benefit conferred by a plaintiff upon a defendant; (2) knowledge by the defendant of the benefit; and (3) retention of the benefit by the defendant under circumstances where it would be unjust to do so without payment.” See Hambleton v. R.G. Barry Corp., 465 N.E.2d 1298, 1302 (Ohio 1984) (per curiam). “Unjust enrichment is an equitable doctrine . . . that operates in the absence of an express contract.” Wuliger v. Mfrs. Life Ins. Co., 567 F.3d 787, 799 (6th Cir. 2009) (quoting Beatley v. Beatley, 828 N.E.2d 180, 192–93 (Ohio Ct. App. 2005)). “Thus, Ohio law is clear that a plaintiff may not recover under the theory of unjust enrichment or quasi-contract when an express contract covers the same subject.” Wuliger, 567 F.3d at 799 (internal quotation mark omitted). As a result, Plaintiffs cannot recover for unjust enrichment. See Cook, 961 F.3d 858–59. Again, Cook is on point and persuasive. The subject of Plaintiffs’ claim is that Ohio National owes them commissions. But, as the Sixth Circuit explained, the Selling Agreements address that subject directly, stating that Ohio National is not responsible for the compensation of a broker dealer’s sales representatives. Id. Therefore, the subject of Plaintiffs’ claim is covered by an 9 USCA11 Case: 19-15014 Date Filed: 03/18/2021 Page: 10 of 18 express contract. And as a result, Plaintiffs cannot recover under a theory of unjust enrichment. C. Plaintiffs also appeal the dismissal of their tortious interference claim. 8 This time relying on Alabama law, Plaintiffs allege that Ohio National’s refusal to pay commissions had the effect of interfering with contracts between Plaintiffs and the broker dealers. Under Alabama law, tortious interference with business relations requires: “(1) the existence of a protectible business relationship; (2) of which the defendant knew; (3) to which the defendant was a stranger; (4) with which the defendant intentionally interfered; and (5) damage.” White Sands Grp., L.L.C. v. PRS II, LLC, 32 So. 3d 5, 14 (Ala. 2009). Plaintiffs’ theory is that Ohio National knew about the contracts between the broker dealers and their sales representatives, and that Ohio National’s termination of the Selling Agreements interfered with those contracts by preventing the broker dealers from passing a portion of the trail commissions to Plaintiffs. The district court found that, based on the Alabama Supreme Court’s decision in Barber v. Business Products Center, Inc., Plaintiffs’ claim fails on the fourth element—intentional interference. 677 So. 2d 223 (Ala. 1996), overruled 8 Tortious interference was not at issue in the Sixth Circuit’s Cook decision. 10 USCA11 Case: 19-15014 Date Filed: 03/18/2021 Page: 11 of 18 on other grounds by White Sands Group, L.L.C., 32 So. 3d at 14. 9 Barber held that a “mere refusal to deal” does not constitute tortious interference with business relations. Id. at 228. In that case, the plaintiffs won a contract with the government to repair typewriters. Id. at 226. The government had separate contracts to buy typewriters from Panasonic and Canon. Id. These contracts required Panasonic and Canon to make available parts and repair information to local maintenance providers, such as the plaintiffs. Id. But when the plaintiffs reached out to Panasonic’s and Canon’s local dealers to obtain needed repair parts, the dealers refused to sell the parts, citing company policies to sell only to authorized dealers. Id. As a result, the plaintiffs’ ability to perform their government contract was severely impaired. The plaintiffs subsequently brought claims against Panasonic and Canon, including for wanton misconduct and tortious interference with business relations. Id. at 225. These two claims were dismissed at summary judgment, and the Alabama Supreme Court affirmed. On the wantonness claim, the court held that “a mere failure to perform a contractual obligation is not a tort.” Id. at 228. On the tortious interference claim, it held that “a mere refusal to deal is not an intentional 9 White Sands overruled Barber to the extent that it required evidence of fraud, force, or coercion as an element of the prima facie case for tortious interference with business relations. 32 So. 3d at 14. The parties here seem to agree that White Sands did not overrule Barber to the extent it held that “a mere refusal to deal is not an intentional interference with contractual relations.” Barber, 677 So. 2d at 228 (citing Bear Creek Enters., Inc. v. Warrior & Gulf Navigation Co., 529 So. 2d 959 (Ala. 1988)). 11 USCA11 Case: 19-15014 Date Filed: 03/18/2021 Page: 12 of 18 interference with contractual relations.” Id. (citing Bear Creek Enters., Inc. v. Warrior & Gulf Navigation Co., 529 So. 2d 959 (Ala. 1988)). The court explained that “intentional interference” requires evidence of “active interference”—a mere breach of contract is not enough. Id. (holding that “defendants have the right to do business with whoever they choose and, although their refusal to deal may be actionable as a breach of contract, it is not actionable in tort”). Barber relied in part on an earlier Alabama refusal-to-deal case in which a contractor’s decision to terminate a subcontractor did not amount to an “intentional interference” with the contract between the subcontractor and its employees. See Bear Creek Enters., 529 So. 2d at 960–61. Importantly, the contractor in Bear Creek did not actively induce the subcontractor to break its contract with its employees—it merely refused to deal with the subcontractor going forward. Id. at 961. So, even though the contractor’s refusal to deal disrupted the performance of the subcontractor-employee contract, it was not an intentional interference with business relations. Id. As Plaintiffs point out, Bear Creek and Barber are different from this case in at least two ways. First, those cases were decided at summary judgment rather than at the pleading stage. Second, and more fundamentally, refusal-to-deal cases involve a defendant’s decision not to transact business with another entity, or not to continue enlisting a particular subcontractor. See id. at 960–61; Barber, 677 So. 12 USCA11 Case: 19-15014 Date Filed: 03/18/2021 Page: 13 of 18 2d at 228. The twist here is that Plaintiffs are not arguing that Ohio National must do business with broker dealers going forward—only that Ohio National must pay trail commissions owed on existing Annuities that survive the termination of the Selling Agreements. Therefore, we agree with Plaintiffs that this case does not fall neatly within the refusal-to-deal line of cases. But we disagree with Plaintiffs that Alabama case law clearly resolves this issue in their favor. While Plaintiffs point us to Alcazar Amusement Co. v. Mudd & Colley Amusement Co., 86 So. 209 (Ala. 1920), that case is inapposite. The plaintiff in Alcazar sought to enjoin a third party from “enjoying the benefit” of “conscious[ly] aiding” a party in breaching an existing contract. Id. at 211. The language Plaintiffs cite from Alcazar—that a third party can be liable in tort “independent of a right of action against the other party to the contract”—does not speak to the core issue here: whether a third party’s failure to perform its own contract amounts to “intentional interference” with another contract. Id. at 212. Without any binding precedent directly on point, we are left to make “our best Erie guess” as to the viability of Plaintiffs’ claim under Alabama law. See Thai Meditation Ass’n of Ala., Inc. v. City of Mobile, 980 F.3d 821, 840 (11th Cir. 2020). To that end, although Barber and Bear Creek are not quite on point, they do provide some guidance. Despite those cases’ different procedural postures, both appear to embrace a legal rule that intentional interference requires some type 13 USCA11 Case: 19-15014 Date Filed: 03/18/2021 Page: 14 of 18 of active interference on the defendant’s part that goes beyond terminating or breaching its own contract. And looking beyond Alabama case law, there is a line of cases directly on point that have concluded, with reasoning similar to Barber and Bear Creek, that a plaintiff cannot reframe a defendant’s contract breach as tortious interference.10 We find two cases cited by Ohio National to be particularly instructive. First is Wometco Theatres v. United Artists Corp., 186 S.E. 572 (Ga. Ct. App. 1935). As Ohio National notes, this case is especially relevant since Alabama courts have closely followed Georgia case law in defining tortious interference with business relations. See Waddell & Reed, Inc. v. United Inv’rs Life Ins. Co., 875 So. 2d 1143, 1156 (Ala. 2003) (“declin[ing] to retreat from [its] earlier acceptance of precedent from Georgia,” and “find[ing] cases applying Georgia law to be helpful”). In Wometco, a Georgia appellate court held that “the 10 In this line of cases, courts have sometimes found that a tortious interference claim based on a defendant’s breach of its own contract fails on the intentional interference element; others have found that the defendant did not act improperly or without justification; and still others have treated intentional and improper interference as a single element. Compare Alvord & Swift v. Stewart M. Muller Const. Co., 385 N.E.2d 1238, 1241 (N.Y. 1978) (holding that because “the interference must be intentional, not merely negligent or incidental,” a plaintiff does not state a claim by alleging that a defendant’s breach of contract incidentally interfered with a third party’s separate contract), with R.E. Davis Chem. Corp. v. Diasonics, Inc., 826 F.2d 678, 686 n.17 (7th Cir. 1987) (holding that a defendant’s breach of contract that affects a third party’s rights in a separate contract might be considered intentional interference but might not be considered “improper” if it “was purely incidental in character”). Alabama has not squarely addressed this issue. But its refusal-to-deal line of cases suggests that the “intentional interference” element requires some “active interference” beyond a mere contract breach that incidentally affects a third party’s rights. See Barber, 677 So. 2d at 228. Therefore, it seems likely that Alabama courts would analyze this issue under the “intentional interference” element. 14 USCA11 Case: 19-15014 Date Filed: 03/18/2021 Page: 15 of 18 failure of a third person to perform an independent prior contract made with one of the parties does not give rise to a cause of action [in tort] for inducing the breach of the contract.” Id. at 575. This is true, the court held, even if the breaching party knew that its breach would render the other contracting party unable to satisfy separate contractual duties to a third party. Id. at 574–75. Georgia courts have continued to cite this rule. See Watkins v. Hereth, 570 S.E.2d 629, 630 (Ga. Ct. App. 2002); Kenimer v. Ward Wight Realty Co., 135 S.E.2d 501, 503 (Ga. Ct. App. 1964). In light of Alabama courts’ consistent reliance on Georgia case law, we find Wometco and its progeny to be persuasive. Second is Artwear, Inc. v. Hughes, a New York case in which a company, SNC, contracted with Andy Warhol’s estate for the exclusive rights to Warhol’s artwork and trademarks. 615 N.Y.S.2d 689, 690–91 (1994). Under this contract, Warhol’s estate had the final right of approval, subject to a reasonableness requirement. Id. at 691. SNC then granted Artwear a sublicense to make T-shirts using Warhol’s trademarks. Id. The sublicense agreement gave SNC and Warhol’s estate the right of final approval, not subject to a reasonableness requirement. Id. When the relationship between Warhol’s estate and SNC soured, none of Artwear’s product was approved. Id. Artwear brought claims against the estate for, among other things, breach of contract as a third-party beneficiary and tortious interference with contractual rights. Id. at 691–92. 15 USCA11 Case: 19-15014 Date Filed: 03/18/2021 Page: 16 of 18 The New York state court found that Artwear was not an intended third- party beneficiary of SNC’s license agreement with Warhol’s estate. It then dismissed Artwear’s tortious interference claim, holding that: Artwear’s cause of action for tortious interference with contract is . . . by its own terms, based on the estate’s alleged breach of the license agreement, which breach brought about SNC’s failure to perform the sublicense agreement. In reality, this is nothing more than a claim for damages incidentally flowing from the breach of the license agreement, to which Artwear was not a party and of which it is not, for the reasons indicated, a third-party beneficiary . . . . There exists no tort liability to incidental beneficiaries not in privity . . . . Thus, Artwear . . . cannot transform an alleged breach of the license agreement by the estate, a party with which it is not in privity, into a tort claim against that party. Artwear’s remedy is against the party with whom it dealt, SNC. Id. at 695. Wometco and Artwear are on point, and their reasoning meshes with that of the Alabama Supreme Court in Barber. The common thread running through the two lines of cases is that to satisfy the intentional interference element, the defendant must actively procure the breach of a separate contract; a mere failure to satisfy its own contractual obligation, which incidentally impacts the rights of a third party, does not suffice. See Barber, 677 So. 2d at 228 (“[A] mere refusal to deal is not an intentional interference with contractual relations[;] although [the] refusal to deal may be actionable as a breach of contract, it is not actionable in tort.”); Wometco Theatres, 186 S.E. at 574–75 (“The mere failure of a party to a 16 USCA11 Case: 19-15014 Date Filed: 03/18/2021 Page: 17 of 18 contract to carry out its terms will not give rise to a [tort] cause of action . . . against it” even if the breaching party knows “that the opposite party will not be able to perform its contract with [a] third party.”). Connecting Alabama’s refusal-to-deal cases with the Wometco and Artwear line of cases, “our best Erie guess” is that Alabama law does not allow plaintiffs who have failed to establish intended third-party beneficiary standing to transform the alleged contract breach into a tort claim. See Thai Meditation, 980 F.3d at 840. For this reason, we conclude that Ohio National’s refusal to pay commissions owed under the Selling Agreements is not, as a matter of law, an intentional interference with the contracts between the broker dealers and their sales representatives. Accordingly, we affirm the district court’s finding that Plaintiffs failed to state a claim for tortious interference with business relations. D. Having concluded that the district court correctly dismissed each of Plaintiffs’ claims, we must consider whether the district court correctly dismissed the claims with prejudice. Leave to amend is to be freely given when justice so requires. Bryant v. Dupree, 252 F.3d 1161, 1163 (11th Cir. 2001) (per curiam). “Generally, where a more carefully drafted complaint might state a claim, a plaintiff must be given at least one chance to amend the complaint before the district court dismisses the action with prejudice.” Id. (alteration adopted and 17 USCA11 Case: 19-15014 Date Filed: 03/18/2021 Page: 18 of 18 internal quotation mark omitted). An amendment as a matter of course does not count as this “one chance to amend.” Id. at 1163–64. But there are exceptions to this rule. A district court need not grant leave to amend where amendment would be futile. Id. at 1163. To show that amendment would not be futile, a plaintiff must show how the complaint could be amended to cure its faults. Almanza, 851 F.3d at 1075. Here, in Plaintiffs’ memorandum in opposition to Ohio National’s motion to dismiss, they included a footnote asking for leave to amend should the district court find their claims deficient. But Plaintiffs did not indicate to the district court the substance of a proposed amended complaint—nor do their briefs indicate how their complaint could be amended to cure its faults. Id. As a result, we cannot say that the district court abused its discretion in dismissing Plaintiffs’ First Amended Complaint with prejudice. AFFIRMED. 18	01-04-2023	03-18-2021
https://www.courtlistener.com/api/rest/v3/opinions/4669080/	UNITED STATES DISTRICT COURT FOR THE DISTRICT OF COLUMBIA ROBERT A. McNEIL, Plaintiff, v. Civil Action No. 20-329 (JDB) UNITED STATES OF AMERICA Defendant. MEMORANDUM OPINION This case has evolved out of a Freedom of Information Act (“FOIA”) request that the plaintiff, Robert McNeil, filed with the U.S. Department of State (“State”) seeking documentation substantiating State’s rejection of his passport application based on his apparent delinquent taxpayer status. After both parties moved for summary judgment on a FOIA claim that McNeil filed against State, McNeil requested and obtained several documents from the Internal Revenue Service (“IRS”) responsive to the request at issue in his case against State. Based on those documents, McNeil then amended his complaint with leave of the Court to add the IRS as a defendant and to add claims challenging the IRS’s determination and certification to State that he had “seriously delinquent tax debt.” The Court recently resolved cross-motions for summary judgment on McNeil’s FOIA claim in State’s favor. This ruling left only his claims against the IRS. The Government has now moved to dismiss the remainder of the amended complaint. For the reasons explained below, the Court will grant that motion. 1 Background This case concerns State’s denial of McNeil’s passport application pursuant to § 7345 of the Internal Revenue Code. 26 U.S.C. § 7345. That provision governs the “[r]evocation or denial of [a] passport in case of certain tax delinquencies.” Id. Subsection (a) provides that “[i]f the Secretary [of the Treasury] receives certification by the Commissioner of [the IRS] that an individual has a seriously delinquent tax debt, the Secretary shall transmit such certification to the Secretary of State” to deny, revoke, or limit the debtor’s passport. Id. § 7345(a). Subsection (b) defines “seriously delinquent tax debt,” and subsection (c) explains how the reversal of a certification might come about. Id. § 7345(b)–(c). Subsection (d) requires the IRS Commissioner to “contemporaneously notify an individual of any certification under subsection (a), or any reversal of certification under subsection (c).” Id. § 7345(d). Subsection (e), which provides McNeil’s cause of action, concerns judicial review of certification and reads in full: (1) In general. After the Commissioner notifies an individual under subsection (d), the taxpayer may bring a civil action against the United States in a district court of the United States, or against the Commissioner in the Tax Court, to determine whether the certification was erroneous or whether the Commissioner has failed to reverse the certification. For purposes of the preceding sentence, the court first acquiring jurisdiction over such an action shall have sole jurisdiction. (2) Determination. If the court determines that such certification was erroneous, then the court may order the Secretary [of the Treasury] to notify the Secretary of State that such certification was erroneous. Id. § 7345(e). McNeil filed this action against State after his passport application was denied pursuant to § 7345(a) in June 2018. Compl. [ECF No. 1] ¶ 6. In order to dispute the validity of his alleged tax liability, McNeil requested—first in written correspondence with State and subsequently via identical FOIA requests to State and the IRS submitted on August 17, 2018— “[a] copy of the signed, sworn Certification from the Secretary of the Treasury that was provided 2 to the State department certifying that [he had] a ‘seriously delinquent’ tax debt.” See Compl. Ex. 7 [ECF No. 1] at 33; Compl. Ex. 9 [ECF No. 1] at 41–42; Compl. Ex. 10 [ECF No. 1] at 48– 49. After unsuccessfully communicating directly with State regarding his FOIA request, McNeil filed a complaint in this Court alleging that State had “violated FOIA by failing and/or refusing to employ search methods reasonably likely to lead to the discovery” of the requested certification and thus failing to produce it. Compl. ¶ 29. McNeil and State filed cross-motions for summary judgment on June 23 and July 20, 2020, respectively. See Pl.’s Mot. for Summ. J. [ECF No. 11]; Def.’s Mot. for Summ. J. [ECF No. 12]. After McNeil received and reviewed the evidentiary materials appended to State’s motion, he submitted a further FOIA request to the IRS. See Pl.’s Consent Mot. for Enlargement of Time to Reply to Def.’s Mot. for Summ. J. [ECF No. 14] at 1. When the IRS responded to McNeil’s second FOIA request with additional documents, he amended his complaint “to 1) change its character from a FOIA lawsuit to a Judicial Review under 26 U.S.C. §7345(e); 2) add the Commissioner of Internal Revenue as a Defendant; [and] 3) include language requiring further pleadings, discovery, depositions and examination of witnesses to resolve [alleged IRS] errors.” Pl.’s Am. Rule 15(a)(2) Mot. for Leave of Ct. to Amend Compl. and for Extension of Time [ECF No. 16] at 4. McNeil’s amended complaint incorporated by reference the entirety of his original complaint and asserted new claims against the IRS challenging, inter alia, the IRS’s certification of his delinquent tax debt under § 7345. 1 Am. Compl. [ECF No. 19] ¶¶ 7, 30–38. In light of the documents produced by the IRS and the amended complaint’s shift in focus away from the initial 1 Pursuant to a consent motion filed by the Government, the Court substituted the United States in place of the IRS as the proper party defendant on November 3, 2020, see Min. Order (Nov. 3, 2020); but to avoid confusion, this opinion will refer to the claims McNeil raises in his amended complaint as against the IRS. 3 FOIA claim, the Court resolved in State’s favor the then-pending cross-motions for summary judgment on the FOIA claim. McNeil v. U.S. Dep’t of State, 2020 WL 7419673 (D.D.C. Nov. 12, 2020), (“MSJ Op.”). This left the new claims against the IRS as the only remaining part of this litigation. The Government then moved to dismiss the amended complaint. U.S. Mot. to Dismiss the Am. Compl. (“Mot.”) [ECF No. 29]. In his brief opposing that motion, McNeil abandoned much of the relief he had originally sought in his amended complaint. See Pl.’s Reply in Opp’n to U.S. Mot. to Dismiss the Am. Compl. (“Opp’n”) [ECF No. 30] at 1, 5. The Court will describe in detail the relief McNeil seeks below, but in general he maintains a challenge against the IRS’s certification to State that he had “seriously delinquent tax debt” and has dropped broader claims disputing the debt itself. See id. The motion to dismiss is now fully briefed and ripe for the Court’s consideration. 2 Legal Standard To survive a Rule 12(b)(6) motion to dismiss, a complaint must contain “‘a short and plain statement of the claim showing that the pleader is entitled to relief,’ in order to ‘give the defendant fair notice of what the . . . claim is and the grounds upon which it rests.’” Bell Atl. Corp. v. Twombly, 550 U.S. 544, 555 (2007) (quoting Conley v. Gibson, 355 U.S. 41, 47 (1957)); accord Erickson v. Pardus, 551 U.S. 89, 93 (2007) (per curiam). Although “detailed factual allegations” are not necessary, to provide the “grounds” of “entitle[ment] to relief,” plaintiffs must furnish “more than labels and conclusions” or “a formulaic recitation of the elements of a cause of action.” Twombly, 550 U.S. at 555 (citing Papapsan v. Allain, 478 U.S. 265, 286 (1986)). “To survive a motion to dismiss, a complaint must contain sufficient factual 2 Briefing on the motion includes a surreply from McNeil. Pl.’s Resp. to U.S. Reply in Supp. of its Mot. to Dismiss (“Surreply”) [ECF No. 32]. The Court has granted leave to file the surreply, but it does not alter the outcome here because it merely repeats arguments and passages from McNeil’s amended complaint and opposition brief. 4 matter, accepted as true, to ‘state a claim to relief that is plausible on its face.’” Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009) (quoting Twombly, 550 U.S. at 570); accord Atherton v. D.C. Office of the Mayor, 567 F.3d 672, 681 (D.C. Cir. 2009). Determining the plausibility of a claim for relief is a “context-specific task that requires the reviewing court to draw on its judicial experience and common sense.” Iqbal, 556 U.S. at 679 (citation omitted). The Court accepts McNeil’s factual allegations as true for purposes of evaluating a motion to dismiss. Ashcroft, 556 U.S. at 679. In addition, “[a] document filed pro se,” like all of McNeil’s filings, must be “liberally construed.” Hill v. Assocs. for Renewal in Educ., Inc., 897 F.3d 232, 236 (D.C. Cir. 2018) (quoting Erickson, 551 U.S. at 94). McNeil is entitled to “the benefit of all inferences that can be derived from the facts alleged,” Irving v. D.C., No. 19-cv- 3818, 2021 WL 495041, at 1 (D.D.C. Feb. 9, 2021) (quoting Am. Nat’l Ins. Co. v. FDIC, 642 F.3d 1137, 1139 (D.C. Cir. 2011)). Although pro se complaints are “held to ‘less stringent standards than formal pleadings drafted by lawyers’ . . . ‘a pro se complaint, like any other, must present a claim upon which relief can be granted,’ as required by Rule 12(b)(6).” Id. at 3 (first quoting Haines v. Kerner, 404 U.S. 519, 520 (1972), and then quoting Henthorn v. Dep’t of Navy, 29 F.3d 682, 684 (D.C. Cir. 1994) (citation omitted)). “In determining whether a complaint states a claim, the court may consider the facts alleged in the complaint, documents attached thereto or incorporated therein, and matters of which it may take judicial notice.” Abhe & Svoboda, Inc. v. Chao, 508 F.3d 1052, 1059 (D.C. Cir. 2007) (quoting Stewart v. Nat’l Educ. Ass’n, 471 F.3d 169, 173 (D.C. Cir. 2006)). Analysis Because of the shifting nature of McNeil’s filings, identifying the relief he seeks here requires somewhat more analysis on the front end than it would in most cases. In his amended 5 complaint, McNeil requested injunctive relief that would order the IRS to do four things: (1) “inform the state department that the certification [of McNeil as having seriously delinquent tax debt] was erroneous”; (2) “remove [McNeil’s] name and all other personal information from its list of Americans with ‘seriously delinquent federal tax debt’”; (3) “classify [his] alleged ‘debt’ as uncollectible for the years 2000 thru 2018 because no Notice of Determination or Notice of Deficiency was sent to [him]”; and (4) “return ALL monies unlawfully confiscated from [him] during the years 2000 thru 2018 . . . plus interest.” Am. Compl. at 14. 3 In his response to the Government’s motion to dismiss, McNeil informed the Court that “upon further research and reflection, [he] concede[s] that much of the relief sought in [his] Amended Complaint is unavailable.” Opp’n at 1. Accordingly, he has limited what injunctive relief he seeks. Now McNeil is only asking the Court to “[f]ind that the certification concerning [him] was erroneous, in accordance with 26 U.S.C. § 7345(e)(1),” and to “[o]rder the Secretary of the Treasury to notify the Secretary of State that [his] certification was erroneous, in accordance with 26 U.S.C. § 7345(e)(2).” Id. at 5. This paring down of the case simplifies matters in some obvious ways and complicates them in another. The complicating factor is that McNeil did not request a judicial finding concerning the erroneousness of the IRS’s certification of his debt in his amended complaint, so it is at least somewhat ambiguous whether, in making this request, he is rephrasing some other relief he had previously requested or simply laying out a prerequisite finding the Court must make before awarding him an injunction under § 7345(e)(2). See Am. Compl. at 14; Opp’n at 5. The Court believes the latter option is the best reading of his filings 3 The amended complaint also sought a court order directing “the State Department . . . to waive the passport application fee and issue [McNeil’s] new passport” once his certification is rescinded and he submits a new passport application. Am. Compl. at 14. The Court already denied this fifth requested form of injunctive relief when granting the State Department’s motion for summary judgment because McNeil had not stated any cause of action that would entitle him to such relief. MSJ Op. at 7. 6 and therefore construes the two requested forms of relief identified in McNeil’s opposition as essentially duplicative. When he restates his requested relief in his opposition, McNeil points to paragraphs (e)(1) and (e)(2) of § 7345, but only the latter lays out a form of injunctive relief that a court can award. Paragraph (e)(1) creates a cause of action: “the taxpayer may bring a civil action . . . to determine whether the [IRS’s] certification [of a taxpayer’s seriously delinquent tax debt] was erroneous.” 26 U.S.C. § 7345(e)(1); see id. § 7345(a). Paragraph (e)(2) describes the relief available in an action under (e)(1): “If the court determines that such certification was erroneous, then the court may order the Secretary [of the Treasury] to notify the Secretary of State that such certification was erroneous.” Id. § 7345(e)(2). The Court understands McNeil’s opposition to be asking that this Court make the inquiry described in (e)(1) and then reach the conclusion identified in (e)(2). This would amount to a properly stated claim, if the facts McNeil alleges meet the standard necessary to survive a motion under Rule 12(b)(6), see Iqbal, 556 U.S. at 678, but only one form of relief would be available if the claim were to succeed—the injunction described in paragraph (e)(2). See Ruesch v. Commissioner, 154 T.C. 289 (T.C. 2020) (“The statute specifies no other form of relief that we may grant.”); see also Maehr v. Dep’t of State, No. 18-cv-2948, 2020 WL 967754 at 3 (D. Colo. Feb. 28, 2020) (“This section permits a taxpayer to challenge the . . . certification of delinquency, not the resulting passport revocation by the Secretary of State.”). Although the Court is mindful of its obligation to “construe a pro se plaintiff’s filings liberally,” Schnitzler v. United States, 761 F.3d 33, 38 (D.C. Cir. 2014), there is no other plausible reading of McNeil’s requested relief that helps his case. The only other plausible interpretation of McNeil’s opposition brief is that his request seeking a finding that the IRS’s 7 certification was erroneous simply rephrases his request in the amended complaint for an order requiring the IRS to remove him from “its list of Americans with ‘seriously delinquent federal tax debt.’” Am. Compl. at 14. But if the Court were to adopt this interpretation, McNeil would be no better off because the Court lacks jurisdiction to enter any such order. Section 7345(e)(1) does not allow this, and McNeil does not identify any other statute under which the Court could issue such an order removing an individual from any IRS list. 4 Read properly, McNeil’s pared-down request for relief is fairly straightforward. He is bringing an action authorized under 26 U.S.C. § 7345(e)(1) that asks the Court “to determine whether [his] certification was erroneous” and he seeks the relief authorized under 26 U.S.C. § 7345(e)(2), an order directing the IRS “to notify the Secretary of State” to that effect. The jurisdictional question—which was the subject of extensive briefing in the motion to dismiss—is simple now that McNeil has limited the scope of his requested relief. His suit is authorized by, and the remaining injunctive relief he seeks could be granted under, § 7345(e). It would seem that the Government agrees with this analysis, as its reply brief only raises jurisdictional concerns in reference to the possibility that McNeil is seeking to “challenge the underlying assessments” of his tax debts by the Government. United States’ Reply in Supp. of its Mot. to Dismiss (“Reply”) [ECF No. 31] at 2–3. Hence, the only question at this time is not jurisdiction, 4 In fact, there is not even any mention of a “list of Americans with ‘seriously delinquent federal tax debt,’” Am. Compl. at 14, anywhere in § 7345. McNeil seems to have derived the idea that such a list exists from emails contained in materials he obtained under FOIA in which one IRS officer “certif[ies] that the taxpayers listed in [a particular file attached to the email] . . . denoted with an indicator of N have a seriously delinquent tax debt,” and another concurs with the assessment that this file should “be transmitted to the State Department.” Am. Compl., Ex. A [ECF No. 19-2] at 9, 17. It appears that the “list,” to the extent there is one, is only created by the IRS as part of the process of certifying the relevant debtors to State. There is no indication that any other “list” is kept by the IRS, and even if there were, there is no reason to think that taking McNeil’s name off the list would eliminate his debts, as he sometimes seems to suggest. Undoubtedly any such “list” only reflects debts recorded and monitored elsewhere in the IRS’s files. Further, if a “list” did exist, and if removing McNeil’s name from it would functionally eliminate his debts, a lawsuit seeking to accomplish that would be untenable under the Anti-Injunction Act, 26 U.S.C. § 7421, which bars any “suit for the purpose of restraining the assessment or collection of any tax,” subject to certain statutory exemptions, none of which would be relevant here. 8 but instead whether McNeil has alleged sufficient facts to state a claim that could result in the Court ordering the Secretary of the Treasury to inform the Secretary of State that the certification of his debt was erroneous under 26 U.S.C. § 7345(e)(2). In his opposition, McNeil gives two reasons why he is entitled to the limited relief he still seeks. First, he argues that he was never notified that the IRS had certified to State that he had a seriously delinquent tax debt. Opp’n at 2. McNeil attached to his amended complaint copies of two different IRS Notices that should have informed him of the IRS’s certification of his debt. Am. Compl., Ex. A at 4–9, 12–17. He obtained these through the FOIA request he submitted to the IRS, but he claims he never received copies from the IRS when he should have because the IRS sent them to a Tucson, Arizona address where he has never lived. Am. Compl. at 11–12; Opp’n at 2. The Court takes this fact as true for purposes of this motion. See Iqbal, 556 U.S. at 678. Even if McNeil is able to prove that he never received these Notices, though, it would not mean that the IRS’s certification was erroneous. As the Government observes, § 7345 does not say that a flawed or failed notice renders a certification erroneous. Reply at 3–4. Subsections (a) and (b) describe when the the Secretary of the Treasury must transmit certification to the Secretary of State and identify which debts qualify as “seriously delinquent tax debt.” 26 U.S.C. § 7345(a)–(b). Neither subsection says that proper notice is an element of or a prerequisite to a proper certification by the IRS of a seriously delinquent tax debt. In fact, subsection (d) says that notice to the taxpayer should be “contemporaneous[]” with certification to State, so it logically cannot be a prerequisite to that certification. 26 U.S.C. § 7345(d). Further, because subsection (e) includes no statute of limitations, there is no reason why improper notice under subsection (d) would prejudice a taxpayer who, like McNeil, does not learn about the certification of his debt in 9 a sufficiently timely manner. See id. § 7345(e). The text of the statute suggests that the purpose of the notice requirement is to inform the debtor “in simple and nontechnical terms of the right to bring a civil action under subsection (e).” 5 Id. Therefore, McNeil’s argument concerning the notice requirement fails because even if notice was not effected here, it would not mean that the IRS’s certification of his debt to the State Department was erroneous. McNeil’s second argument is that the Notices sent to Arizona falsely suggest that “either a Form 1040 or 1040A had been filed for” each year from 2003 to 2006 and from 2008 to 2012 even though, according to McNeil, “no Form 1040 or 1040A exists in IRS’[s] records” for those years. Opp’n at 2. McNeil’s argument then seems to be that the IRS’s certification of his debt was erroneous because in identifying his “seriously delinquent tax debt,” the IRS pointed to flawed or fraudulent records. Even assuming the IRS did rely on faulty records, McNeil would need a different mechanism to contest that. Indeed, his argument sounds more like a challenge to the underlying tax assessments against him or to the way the IRS assesses the taxes owed by non-filers. The argument therefore goes beyond the scope of the challenge that § 7345(e) allows. Paragraph (e)(1) only allows a court “to determine whether the certification was erroneous or whether the Commissioner [of the IRS] has failed to reverse [a] certification.” 26 U.S.C. § 7345(e)(1) (emphasis added). It does not allow an action to determine the validity of an underlying tax debt. McNeil’s theory would transform the limited waiver of the government’s sovereign immunity under § 7345(e) into a mechanism for challenging any number of aspects of an underlying seriously delinquent tax debt or IRS monitoring and recordkeeping procedures. If 5 Although the Court credits McNeil’s claim that he never received notice for the purposes of this motion, it also notes, as the Government has pointed out, that McNeil did manage to bring exactly such an action. See Reply at 3–4 n.3. 10 Congress intended that a case under § 7345(e) would be such a powerful tool for scrutinizing the IRS, surely it would have provided for more extensive remedies than just the correction of the erroneous certification. See Ruesch, 154 T.C. at 295–96 (quoting Staff of J. Comm. on Taxation, General Explanation of Tax Legislation Enacted in 2015, at 93 (J. Comm. Print 2016) (“[The Court] may order the Secretary of the Treasury to notify the Secretary of State of the error. No other relief is authorized.”)); Maehr, 2020 WL 967754 at 3. Instead, the limited scope of relief available under § 7345 indicates that Congress intended for courts to scrutinize only a narrow set of grounds on which a certification might be erroneous. Section 7345 defines “seriously delinquent tax debt” as “an unpaid, legally enforceable Federal tax liability of an individual” that has been “assessed,” is “greater than $50,000” and is subject to a notice of lien or a levy. 26 U.S.C. § 7345(b)(1). The provision’s focus on these characteristics—nonpayment, enforceability, assessment, an amount over $50,000, and the appropriate lien or levy—suggests that they are the proper focus of the Court’s determination under § 7345(e). McNeil has not raised arguments that go to any of these, but has instead argued that the IRS’s procedures for calculating his underlying debt are unlawful. To be sure, the phrase “Federal tax liability” is also part of the definition of “seriously delinquent tax debt,” but treating tax liability as an element of a proper (i.e., non-erroneous) certification and allowing the accuracy of a federal tax liability to be challenged under § 7345(e) leads to counterintuitive if not absurd results. McNeil suggests that the Court should treat the reference to “Federal tax liability” as transforming § 7345 into a vehicle by which a litigant can challenge any aspect of an underlying “seriously delinquent tax debt” or of an IRS procedure that led to that debt’s assessment. This is at odds with both the very limited relief available under § 7345(e)(2) and with the types of tax-collection challenges that can generally be brought in 11 federal court. Indeed, Congress has tightly limited the availability of injunctive relief when it comes to tax assessment and collection through the Anti-Injunction Act, which deprives the federal courts of jurisdiction over any “suit for the purpose of restraining the assessment or collection of any tax,” subject to limited statutory exemptions, none of which would be relevant here. 26 U.S.C. § 7421(a). 6 The Court finds no support in § 7345 or anywhere else in the tax code for the notion that Congress wanted § 7345(e) to become a vehicle for challenging IRS procedures and tax assessments that cannot otherwise be challenged. Because the Court finds that Congress did not intend for McNeil’s argument about the Forms 1040 and 1040A to be the basis for a claim under § 7345(e), and because he cannot argue that the IRS’s certification was erroneous based on a flawed notice, he has failed to state a claim upon which the Court could grant him relief under § 7345(e)(2). Conclusion For the foregoing reasons, the Court will grant the Government’s motion to dismiss. A separate order will be issued on this date. /s/ JOHN D. BATES United States District Judge Dated: March 18, 2021 6 McNeil is undoubtedly familiar with the Anti-Injunction Act because, in the past five years, courts in this district have on multiple occasions—including just this past January—cited it when dismissing cases that he brought or joined in which he challenged IRS procedures for the assessment of taxes against non-filers. E.g., Ellis v. Jackson, 319 F. Supp. 3d 23, 29-30 (D.D.C. 2018), reconsideration denied, 2020 WL 134864 (D.D.C. Jan. 20, 2020); McNeil v. Comm’r, 179 F. Supp. 3d 1, 7–8 (D.D.C. 2016); see also Reply at 5 (collecting related cases that the IRS represents were brought by “Mr. McNeil and his associates”). 12	01-04-2023	03-18-2021
https://www.courtlistener.com/api/rest/v3/opinions/4625524/	ELVIE COBB, TRANSFEREE OF THE ESTATE OF CARRIE MAY DUNCAN, DECEASED, ET AL., 1 Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Cobb v. CommissionerDocket Nos. 11848-83, 22372-83, 22373-83, 22374-83, 22375-83.United States Tax CourtT.C. Memo 1985-208; 1985 Tax Ct. Memo LEXIS 425; 49 T.C.M. 1364; T.C.M. (RIA) 85208; April 30, 1985. Jesse T. Mountjoy, for the petitioner in Docket No. 11848-83. Joseph E. Ternes, Jr., for the petitioners in Docket Nos. 22372-83, 22373-83, 22374-83, 22375-83. Scott R. Cox, for the respondent. KORNERMEMORANDUM FINDINGS OF FACT AND OPINION KORNER, Judge: Respondent determined deficiencies in Federal gift tax, additions to tax, and Federal estate tax, either directly or as transferees, against the1985 Tax Ct. Memo LEXIS 425">428 various petitioners herein as follows: DeficiencyDeficiencyAdditionsininto Tax Sec.PetitionerEstate TaxGift Tax6651(a) 2Estate of Carrie MayDuncan, Deceased,Willie Cecil Montgomeryand Julian Heilbroner,Coexecutrices,Dkt. No. 22372-83$93,370.95Dkt. No. 22373-83$52,780.00$13,195.00Julian Heilbroner,Transferee of theAssets of the Estateof Carrie May Duncan,Deceased, TransferorDkt. No. 22374-83$93,370.95Willie Cecil Montgomery,Transferee of theAssets of the Estateof Carrie May Duncan,Deceased, TransferorDkt. No. 22375-83$93,370.95Elvie Cobb, Transfereeof the Estate ofCarrie May Duncan,Deceased, TransferorDkt. No. 11848-83$93,370.95$52,780.00$13,195.00After concessions, the issues which we must resolve are the following: 1. Whether Carrie May Duncan (decedent herein) made a taxable gift to Elvie Cobb on or about November 29, 1978, within the meaning of sections1985 Tax Ct. Memo LEXIS 425">429 2511 and 2512, and the amount thereof. 2. If so, whether decedent's estate is liable for additions to tax under section 6651(a) for decedent's failure, without reasonable cause, to file a timely gift tax return with respect thereto. 3. If a taxable gift was made under Issue 1, whether the net value of such gift is includable in decedent's gross estate for estate tax purposes under section 2035. 4. If no such taxable gift was made, whether the full fair market value of decedent's farm is includable in her gross estate under section 2033, or sections 2036 and 2043, or whether said value is controlled by a certain option agreement held by Elvie Cobb at the date of decedent's death. 5. If there is a deficiency of gift tax, interest and additions to tax, whether any such amounts should be allowed as deductions in arriving at the amount of decedent's net taxable estate under section 2053. 6. If there is a deficiency of estate tax, whether decedent's estate is entitled to a credit under section 2011 for additional state death taxes incurred with respect thereto. 7. Whether petitioners in dockets 22374-83 and 22375-83 are each individually liable, as transferees, for any1985 Tax Ct. Memo LEXIS 425">430 part of any deficiency in estate tax, together with interest, found to be due from decedent's estate, under sections 6901 or 6324. 8. Whether petitioner in docket 11848-83 is individually liable, as transferee, for any part of any deficiency in estate tax, gift tax and addition to gift tax, together with interest, found to be due from decedent's estate, under sections 6901 or 6324. Many of the facts herein were stipulated, and such stipulations, with accompanying exhibits, are incorporated herein by this reference. FINDINGS OF FACTPetitioners herein are the Estate of Carrie May Duncan, deceased (hereinafter "the estate" and "decedent", respectively), Mrs. Willie Cecil Montgomery (hereinafter "Montgomery") and Mrs. Julian Heilbroner (hereinafter "Heilbroner"), as transferees of the estate with respect to respondent's determined estate tax liability, and Elvie Cobb (hereinafter "Cobb"), as transferee of decedent's estate both with regard to respondent's determined estate tax deficiency as well as respondent's determined gift tax deficiency and additions to tax. At the time their respective petitions were filed herein, all petitioners were residents of the State of Kentucky. 1985 Tax Ct. Memo LEXIS 425">431 Decedent, who was born on June 12, 1892, died on December 13, 1979, a resident of Henderson, Kentucky. Her Last Will and Testament was duly probated thereafter in the probate courts of Kentucky, and her two sisters, Montgomery and Heilbroner, were appointed and qualified as the coexecutrices of her estate. Decedent devised and bequeathed her entire net estate in equal shares to Montgomery and Heilbroner, and each of them has received distributions of property from the estate exceeding in value the amount of estate tax liability determined by respondent against the estate and against each of them individually as transferees. Prior to her death, decedent owned a 237.4-acre farm ("the farm") located on the west side of U.S. Highway 41, in Henderson County, Kentucky, about ten miles south of the City of Henderson. The farm was conveyed to decedent and her late husband, Oscar Duncan, jointly with right of survivorship in 1967 by unrelated third parties. Oscar Duncan died on January 14, 1973, and decedent then became, by survivorship, sole owner of the farm in fee simple. In the late 1960's, Oscar Duncan had developed a 38-acre tract of the farm as a thoroughbred horse training1985 Tax Ct. Memo LEXIS 425">432 center containing, inter alia, a horse barn with 60 stalls, a 5/8's mile race track, a paddock, a lake, and a six-room farmhouse. Beginning in 1970 and up until 1975, Cobb, through his then wife, leased the training center from decedent and her husband on undisclosed terms, and operated a horse training facility there. After Cobb and his wife were divorced, and in October 1975, Cobb entered into a formal written lease (the "1975 lease") with decedent covering the horse training center portion of the farm. As material herein, that lease provided as follows: a. The initial term of the lease was for one year, with Cobb having the right to renew the lease for four successive one-year terms. b. Cobb was required to pay rental of $400 a month. Any delay in rental payments of longer than 30 days would cause a termination of the lease at decedent's option. c. Cobb was required to pay all utilities and insurance premiums for personal injury and property damage liability with respect to the lased premises, and Cobb was also responsible for current repairs and maintenance to the improvements on the leased tract. Decedent was responsible for the payment of taxes with respect to the1985 Tax Ct. Memo LEXIS 425">433 leased property, as well as the restoration of any improvements which were destroyed during the term of the lease by fire or storm. The lease contained no provisions with regard to the balance of the 237-acre farm. As to this portion, decedent had a sharecrop arrangement with a tenant farmer, one Claude Watkins, under which Watkins farmed the land, retaining for himself two-thirds of the net proceeds of the annual crops, and returning to decedent one-third of the annual proceeds. This share-crop arrangement with Watkins lasted through the year 1979. Sometime in the fall of 1978, however, decedent apparently became dissatisfied with the performance of Watkins as her tenant farmer. She complained to Cobb that payments by Watkins to her under the share-crop agreement were not only irregular but late, and that in fact Watkins had not yet paid decedent her share of the 1978 crop. At her request, Cobb went to Watkins, negotiated the matter, and apparently secured payment for decedent. Shortly thereafter, decedent told Cobb that she wanted to make a new arrangement with regard to her farm property. She expressed a desire to have a more stable and predictable income from the farm,1985 Tax Ct. Memo LEXIS 425">434 with some income from that source which she could count on in all events, for her personal financial planning purposes, and so that she would not have to go into her savings or other investments for living expenses. Her expressed concerns appeared to be twofold: she wanted to have a more predictable income from the farm, with some minimum amount guaranteed, and she wanted to divest herself of the responsibilities of managing the place. Decedent accordingly proposed to Cobb that the 1975 lease be renegotiated and expanded, and that Cobb become her manager for the farm property. After further negotiations between decedent and Cobb, which apparently all took place at decedent's home, new and expanded agreements were entered into between decedent and Cobb, and were formalized by written documents entered into between them on November 29, 1978. These documents, three in number, and a summary of their material provisions, were as follows: (1) A "lease and option" agreement (hereinafter "the 1978 option"), which contained three principal elements (a) the lease on the 38-acre horse training facility was restated to be for a term of five years, beginning October 8, 1978, giving Cobb1985 Tax Ct. Memo LEXIS 425">435 the right to renew the lease for additional five one-year terms. The rental was continued at the rate of $400 per month and the other terms of the 1975 lease were continued unchanged, except that Cobb was no longer made specifically responsible for repairs and maintenance. (b) "In consideration of the premises," Cobb agreed, upon decedent's written request, to act as her manager with respect to the entire farm for as long as decedent continued to own it, agreeing "to manage said farm in a good and workmanlike manner, returning to LESSEE [sic, should read LESSOR (decedent)] not less than one-third (1/3) of the net rents and profits or not less than the average percent of net rents and profits which LESSOR has enjoyed over the two years last past, whichever is greater." (c) "In consideration of the premises," decedent then granted to Cobb a limited option to buy the entire farm for the sum of $100,000, all cash, payable by Cobb within thirty days after the exercise of such option. Said option was exercisable by Cobb only in one of the following events: (i) During the term of the lease of the horse training facility (or any extension thereof) and during decedent's lifetime,1985 Tax Ct. Memo LEXIS 425">436 if decedent either was required to sell the property or desired to do so, decedent was required to give notice to this effect to Cobb, who would then have two weeks thereafter within which to exercise his option. (ii) In the event of decedent's death during the term of said lease, or any extension thereof, Cobb was empowered to exercise his option to purchase by giving written notice to decedent's personal representatives within thirty days of their appointment, or if no personal representatives were appointed within sixty days of decedent's death, such notice was to be given to decedent's heirs within thirty days after the close of such sixty-day period. The above agreement was made binding both upon decedent and Cobb, as well as their respective heirs, executors, administrators, successors, and assigns. (2) A "short form lease and option agreement," setting forth the essentials of the above agreement, and giving public notice of its existence, and of Cobb's rights thereunder, was duly filed among the land records of Henderson County, Kentucky. (3) Pursuant to the requirement of the "lease and option agreement," decedent executed and notarized a third document, appointing1985 Tax Ct. Memo LEXIS 425">437 Cobb to be the manager on her behalf of the farm, with full authority in the premises. This document further recited that decedent was to receive $800 per month from Cobb, which was a reference to the agreement between them that Cobb was to pay her $400 a month for the horse training facility, and a further $400 a month with respect to the balance of the farm. The second $400 monthly payment was a minimum guaranteed payment of advance by Cobb to decedent, and was creditable against the one-third annual share of the crops to which decedent was entitled under the farm management agreement, but was a guaranteed payment in all events. All the above documents were prepared by counsel, who participated in some of the negotiating discussions and advised both parties in the premises. Both decedent and Cobb were competent adults, and were aware of the legal consequences of their actions. Cobb then began operating the horse training center and the farm under the new agreements described above. For the year 1979, and until decedent's death on December 13, 1979, Cobb continued to operate the horse training center, paying decedent $400 a month rental therefor, and managed the remainder of1985 Tax Ct. Memo LEXIS 425">438 the farm, supervising the tenant farmer Watkins, and paying decedent the additional $400 per month guaranteed advance on her one-third crop share. For the crop year 1979, decedent's share of the crops was approximately $6,666, which was paid to her by Cobb, who took credit against this amount for the $4,800 guaranteed advance payments which he had already made to her. Cobb apparently received no monetary compensation for his services to decedent as her farm manager, either by way of a share of the crop or otherwise. After decedent's death, and in accordance with the provisions of the option agreement, Cobb gave written notice to the estate, exercising his option to purchase the farm for $100,000. The estate refused to honor Cobb's exercise of his option to purchase, and, in January 1980, Montgomery and Heilbroner, both individually and as coexecutrices of the estate, filed suit against Cobb in the Henderson Circuit Court in Kentucky, asking for a cancellation and recision of the 1978 agreement, including the option portion thereof. Cobb resisted this action, and filed a counterclaim in the suit, asking for specific performance of the exercise of his option to purchase the farm.1985 Tax Ct. Memo LEXIS 425">439 In February 1981, after a full and lengthy trial, the jury rendered a verdict in favor of Cobb. In accordance therewith, the Henderson Circuit Court entered judgment dismissing the complaint of the estate, and granting specific performance in favor of Cobb for the conveyance of the farm. The judgment was not appealed, and in June 1981, Montgomery and Heilbroner conveyed the farm to Cobb in accordance with the judgment of the Henderson Circuit Court. Cobb's acquaintance and relationship with decedent and her late husband, Oscar Duncan, went back many years, to when Cobb was a young man working at a local packing company. He became acquainted with Oscar Duncan through cashing his payroll checks at Oscar Duncan's nearby liquor store and bar. As the years went by, Cobb began to engage in the oil well drilling business and Oscar Duncan became a business associate of his, usually taking a one-quarter interest in every oil drilling contract which Cobb entered into. Through this relationship, Cobb came to know decedent. Later, and in the 1970's, as previously described, Cobb began renting the horse training facility portion of the farm from Oscar Duncan and, later on, from decedent.1985 Tax Ct. Memo LEXIS 425">440 Throughout all this period, their relations were apparently friendly, but businesslike, and there was no social interchange. Aside from the occasional token bottle of whiskey at Christmas time, Oscar Duncan never made any gifts to Cobb, and decedent never made any gifts of any kind to Cobb. Cobb was not related to Oscar Duncan or to decedent either by blood or marriage, and was not a natural object of decedent's bounty. No Federal gift tax return was filed by decedent or the estate with respect to the 1978 lease and option agreement between decedent and Cobb. In the Federal estate tax return filed by the estate, the farm was returned at a value of $100,000, being the value of Cobb's option price for the farm. At the date of decedent's death, as well as on November 29, 1978, the value of the farm was $270,000, 3 without considering the effect of the option agreement. ULTIMATE FINDINGS OF FACT The 1978 lease and option agreement between Cobb and decedent was entered into for full and adequate consideration. For Federal estate tax purposes, the value of the farm at the date of decedent's death was $100,000. OPINION I. The Gift Tax1985 Tax Ct. Memo LEXIS 425">441 Issues.Respondent determined that the 1978 option constituted a taxable gift, when executed, from decedent to Cobb, being in effect a transfer of the farm to him. Petitioners deny, on various grounds, that any taxable gift took place. The parties have agreed, however, that the value of the farm was $270,000 (rather than $397,000, as originally determined by respondent), and that, if a taxable gift was made, the amount thereof was $170,000, being the difference between the stipulated value of the farm and the option price at which Cobb could purchase it, which was $100,000. The dispute between the parties on this issue involves two separate but interrelated points: (a) Petitioners contend that the limited option which decedent granted to Cobb was not "property" within the meaning of the gift tax laws and thus could not be the subject of a taxable gift. Respondent contends that the option was "property," and, in effect, was a gift of the farm itself. (b) Even if the option was "property" within the meaning of the gift tax laws, petitioners contend that its grant to Cobb was the result of an arm's-length business negotiation, supported by full and adequate consideration,1985 Tax Ct. Memo LEXIS 425">442 lacking any donative intent by decedent, and thus was not a gift. Respondent, of course, contends just the opposite. As it read in the year 1978, section 2501(a) (1) provided for the imposition of the Federal gift tax "for each calendar quarter on the transfer of property by gift during such calendar quarter by any individual, resident or nonresident." Expanding upon this language, section 2511(a) further provided that "the tax imposed by section 2501 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 * ." In conformity with the above language, respondent's regulations provide that "It [the gift tax] is applicable only to a transfer of a beneficial interest in property." Section 25.2511-1(g)(1), Gift Tax Regs. On the first point of contention, we think that the parties have each taken positions which are so extreme that they go wide of the mark, one on one side, one on the other. As used in section 2501, "property" is used in the broadest and most comprehensive sense, and includes every type of property having an ascertainable value which is transferable. 1985 Tax Ct. Memo LEXIS 425">443 Smith v. Shaughnessy,318 U.S. 176">318 U.S. 176, 318 U.S. 176">180 (1943). Whether the item in question is "property," however, is a matter to be determined under state law, a point on which the parties are in agreement. Aquilino v. United States,363 U.S. 509">363 U.S. 509 (1960). We first reject respondent's contention that the option which decedent granted to Cobb in 1978 constituted a transfer of ownership of the entire farm to Cobb. It is clear to us that the option gave Cobb nothing more than (a) a right of first refusal to buy the farm during decedent's lifetime, if Cobb was still decedent's tenant of the horse training facility, andif decedent should put the farm up for sale, together with (b) an option to buy the farm after decedent's death, strictly limited as to the time of exercise, and further conditioned upon Cobb still being decedent's tenant at her death. In fact, Cobb never had an opportunity to buy the farm during decedent's life.She never put the farm on the market, and died owning the place in fee simple absolute. We accordingly agree with petitioners that there was no conveyance of the farm, or any interest therein, to Cobb by virtue of the 1978 lease1985 Tax Ct. Memo LEXIS 425">444 and option agreement. See Three Rivers Rock Co. v. Reed Crushed Stone Company, Inc.,530 S.W.2d. 202, 208 (Ky. 1975); Greater Louisville First Federal Savings & Loan Association v. Etzler,659 S.W.2d. 209, 211 (Ky. Ct. App. 1983). Petitioners, on the other hand, seize upon the word "property" in the above-quoted gift tax sections of the Code, and argue that the 1978 option could not be the subject of a taxable gift, citing copious Kentucky authorities for the proposition that an option to purchase realty does not constitute a property interest in land. We do not think petitioners' premise supports their conclusion. Even accepting petitioners' contention that the 1978 option which Cobb received from decedent was not an interest in real property, we nevertheless think that, under Kentucky law, it was "property." In Commonwealth v. Kentucky Distilleries & Warehouse Co.,143 Ky. 314">143 Ky. 314, 136 S.W. 1032">136 S.W. 1032, 136 S.W. 1032">1037 (1911), the Court of Appeals of Kentucky construed the concept of "property" to include * * everything which is the subject of ownership, or to which the right of property may legally attach, or, in other words, every class1985 Tax Ct. Memo LEXIS 425">445 of acquisitions which a man can own or have an interest in. The term is therefore said to include everything which is the subject of ownership, corporeal or incorporeal, tangible or intangible, visible or invisible, real or personal, choses in action as well as in possession, everything which has an exchangeable value, or which goes to make up one's wealth or estate. Again, in Button v. Drake,302 Ky. 517">302 Ky. 517, 195 S.W.2d. 66, 69 (1946), the highest court in Kentucky, in considering whether the rights of a beneficiary under a life insurance policy constituted "property," cited and quoted with approval from 143 Ky. 314">Commonwealth v. Kentucky Distilleries & Warehouse Co.,supra, and went on to hold that the beneficiary's rights under the life insurance policy constituted a chose in action, and thus personal property, saying, These rights undoubtedly are such that have a relation to something in contradistinction to the thing itself. They are rights which may be enforced by an action at law, consequently they must be classified choses in action. In 42 Am.Jur., under the title "Property", § 26, p. 207, it is said: "A chose in action has been defined1985 Tax Ct. Memo LEXIS 425">446 as a personal right not reduced into possession but recoverable by a suit at law. * * * a thing of which one has not the possession or actual enjoyment, but only a right to or a right to demand by an action at law. * * * a chose in action more properly includes the right both of the thing itself and of the right of action as annexed to it. * * * Choses in action are personal property, * * . In the instant case, the option which Cobb had with relation to the farm fits the definition of a chose in action. At the time it was granted to him, Cobb received no interest or ownership in the farm itself, nor even the right to possess it. What he did get was a contract right to purchase the farm for a stated sum, and demand possession of it, upon the occurrence of certain events. That such contract right was valuable and enforceable is not to be doubted in this record, since it was vindicated by Cobb's victory in the Henderson Circuit Court in a strongly contested adversary proceeding, which enforced the option contract and decreed specific performance in Cobb's favor, as we have described in our findings of fact. It is therefore clear to us that Cobb's option right was a chose in action1985 Tax Ct. Memo LEXIS 425">447 and personal property under Kentucky law. We accordingly hold that it was "property" within the meaning of the gift tax statute, sections 2501 and 2511, and could be the proper subject of a taxable gift when transferred. We accordingly turn to the next point of contention between the parties, viz, whether the option portion of the 1978 lease and option agreement constituted a taxable gift at that time by decedent to Cobb, as contended by respondent, or whether it was a legitimate business arrangement, supported by full and adequate consideration and lacking any donative intent on decedent's part, as petitioners contend. In order to resolve this problem, we must examine the factual background and the attitudes and actions of decedent and Cobb leading up to the execution of the 1978 lease and option agreement. The record discloses that decedent, an elderly widow, had known Cobb for many years. Both she and her late husband had had business dealings with Cobb over a considerable period of time, involving not only the leasing of the horse training portion of the farm to Cobb, but also the participation by decedent's husband, Oscar Duncan, in various oil drilling ventures which Cobb1985 Tax Ct. Memo LEXIS 425">448 undertook. Over this substantial period of time, their relations were apparently friendly but always businesslike, and there was no apparent element of social friendship between the Duncans and Cobb. As a result of this long-term association, decedent apparently acquired confidence in Cobb's honesty and business ability. In the fall of 1978, Cobb was the lessee of the 38-acre horse training facility on the farm, as he had been for a number of years, but had no official connection with the rest of the place. As to this remaining portion, decedent had a typical share-crop arrangement with a tenant farmer, under which the tenant farmed the land, retained two-thirds of the crop, and remitted the proceeds of one-third to decedent as the landlord. Decedent had already had some difficulty with the tenant farmer, with respect to the amount and promptness of his payments, and had sought Cobb's help in getting the matter straightened out. In November of 1978, she approached Cobb, and indicated she was dissatisfied with the existing arrangement with regard to the farm. She indicated that she no longer wanted to have the responsibility for farming the place, in view of her age, but she1985 Tax Ct. Memo LEXIS 425">449 also wanted to be assured of a steady and dependable income from the farm, to meet her present and anticipated future living expenses. She accordingly proposed to Cobb that the existing lease on the horse training facility be expanded from a one-year term to a five-year term, with certain rights of renewal, but at the same rent, and she further proposed that Cobb become her manager for the remaining portion of the farm, doing whatever was necessary to manage the place properly, and returning to her the one-third crop share which she had previously been receiving, but with a minimum guaranteed amount of $400 a month therefrom, or $4,800 annually. She then offered to give Cobb a right of first refusal to purchase the farm during her lifetime, if he was still her tenant and if she ever put the farm up for sale, with a further option to Cobb to purchase the farm if he was still her tenant at the time of her death. In either event, the price to be paid was to be $100,000, all cash. After further negotiations between decedent and Cobb, in which counsel participated, the 1978 lease and option agreement was executed along these lines, as detailed in our findings of fact. 41985 Tax Ct. Memo LEXIS 425">450 In all the above, we discern no element of donative intent on the part of decedent, but rather the desire of an elderly widow to free herself of the management responsibilities of the farm, and to provide a reasonable and assured competence for her present and anticipated future living expenses. These are attitudes which are associated with life, not with death. Although decedent was an elderly woman, we find nothing in this record to indicate that she was suffering from any terminal illness, or that she anticipated her early demise. Rather, she was planning for her future life. This brings up the question of the adequacy of the consideration which Cobb gave for his option. Respondent urges that Cobb in effect gave nothing for the option agreement; petitioners urge that the parties, both competent adults and dealing at arm's length, entered into a valid and reasonable business arrangement which should be recognized as such, regardless of later events. We agree with petitioners. We think that the agreements which decedent and Cobb entered into in November 1978 were interdependent and must be considered as a whole. In doing so, we concentrate upon the lease and option agreement,1985 Tax Ct. Memo LEXIS 425">451 and the written designation of Cobb to be petitioner's farm manager. 5 From the standpoint of consideration furnished to decedent by Cobb, we take into consideration the following: (a) The previous 1975 lease agreement covering the 38 acre horse training facility was modified so as to give Cobb a five-year term, with rights of renewal, rather than a one-year term, with renewal rights. In one sense, this may be said to have been a benefit to Cobb, since he thereby secured a longer lease. On the other hand, it is equally reasonable to say that it constituted a benefit to decedent, since she thereby secured a tenant, with an assured rent, for a longer period of time. (b) Cobb agreed, for as long as decedent should continue to hold title to the farm, to act as decedent's farm manager, paying to decedent one-third of the proceeds of the annual crops, "or not less than the average percent of net rents and profits which lessor has enjoyed over the two years last past, whichever is greater." In all events, Cobb had to pay decedent $400 a month as a guaranteed minimum under the farm management arrangement, whether there was any crop share to be paid to decedent or not, and there was no1985 Tax Ct. Memo LEXIS 425">452 provision for any financial compensation of any kind to Cobb in return for his services as the farm manager. Respondent makes light of this provision, asserting that prior history showed that decedent's one-third share of the crop would always be more than Cobb's annual guarantee of $4,800, and that Cobb risked nothing under this arrangement. We do not agree. With farming being the risky business that it is, it was entirely possible in any given year that the crop might be wiped out by fire, flood, drought, storm or pestilence, but Cobb would remain liable to decedent for the annual guaranteed $4,800 payment, or decedent's average one-third share for the preceding two years, whichever was greater. Furthermore, as long as the existing and customary share-crop arrangement was maintained with the tenant farmer, who took a two-thirds share of the crop, there was no possibility whatever for Cobb to derive any compensation for his managership. The1985 Tax Ct. Memo LEXIS 425">453 entire proceeds of the crop would go to the tenant farmer and to decedent. The only way Cobb could get any monetary reward would be to farm the place himself, and there is no indication in this record that either decedent or Cobb had any such expectation. Cobb further carried the risk of making full and timely collections of crop proceeds from the tenant, who apparently had not been too dependable in the past. Cobb thus bound himself to this arrangement, without any prospect of direct financial reward, for an indefinite period in the future, viz, for as long as decedent continued to own the property. He made himself responsible for the grunts and the squeals, without having any ownership of the pig. Had decedent lived a long time, it might have been a tedious road indeed for Cobb. "In consideration of the premises," decedent gave Cobb the option which is the subject of the dispute herein. Those "premises" clearly included the obligations which Cobb had undertaken under the farm management provisions of the agreement and, viewed as of the time the agreement was entered into, we think this consideration was substantial. No one knew at that time that decedent would die just a1985 Tax Ct. Memo LEXIS 425">454 year later. That event indeed was a windfall for Cobb, in that he was then able to exercise his option to purchase the farm at a price far below its agreed true value. That subsequent event, however, was something which was unknown to the parties at the time, and could not reasonably be foreseen. 6Thus, as later events transpired, it could be argued, as respondent does with the benefit of hindsight, that the consideration furnished by Cobb for the option to buy the farm at a bargain price was inadequate, but that is not the test to be applied here. Where the facts show, as here, that the arrangement was entered into at arm's length for business purposes and without donative intent, and that Cobb was not the natural object of decedent's bounty, the fact that decedent may, in retrospect, have made a bad bargain does not transform a business transaction into a taxable gift. Weller v. Commissioner,38 T.C. 790">38 T.C. 790 (1962); Hull v. Commissioner,T.C. Memo. 1962-199. Respondent himself has recognized1985 Tax Ct. Memo LEXIS 425">455 the realities of situations such as this. Section 25.2511-1(g)(1) of respondent's Gift Tax Regulations provides, in pertinent part: However, there are certain types of transfers to which the tax is not applicable. * * * The gift tax is not applicable to a transfer for a full and adequate consideration in money or money's worth, or to ordinary business transactions, described in section 25.2512-8. In pertinent part, section 25.2512-8 of respondent's Gift Tax Regulations further provides: Transfers reached by the gift tax are not confined to those only which, being without a valuable consideration, accord with the common law concept of gifts, but embrace as well sales, exchanges, and other dispositions of property for a consideration to the extent that the value of the property transferred by the donor exceeds the value in money or money's worth of the consideration given therefor. However, a sale, exchange, or other transfer of property made in the ordinary course of business (a transaction which is bona fide, at arm's-length, and free from any donative intent) will be considered as made for an adequate and full consideration in money or money's worth. * * * We have previously1985 Tax Ct. Memo LEXIS 425">456 recognized and approved this exception to the general rules for the determination of taxable gifts. Gross v. Commissioner,7 T.C. 837">7 T.C. 837 (1946); Jones v. Commissioner,1 T.C. 1207">1 T.C. 1207 (1943). We conclude here that the granting by decedent to Cobb of an option to purchase the farm was part of an arm's-length business transaction, entered into between parties who were competent and for valid business purposes, with no element of donative intent on decedent's part, and we accordingly hold that no taxable gift took place. 7II. The Estate Tax Issues.In support of his determination of an estate tax deficiency against the estate, and against the individual petitioners as transferees, respondent advances three alternative theories: (a) That the full value of the farm, stipulated1985 Tax Ct. Memo LEXIS 425">457 to be $270,000, should be included in decedent's taxable estate under section 2035 as a gift made within three years of decedent's death, less the $100,000 option price, which should be included as an asset of the estate under section 2033; or (b) that the full value of the farm should be included in decedent's gross estate under section 2036, less the $100,000 option price, on the theory that decedent had made a transfer of the farm during her lifetime for inadequate consideration, retaining a life estate therein, under the provisions of section 2036, with the $100,000 option price again being includable as an asset of the estate under section 2033; or (c) that the full stipulated value of the farm, in the amount of $270,000, is includable in decedent's gross estate under the provisions of section 2033, without giving effect to the option contract, which gave Cobb the right to purchase for $100,000. Respondent's first two alternative theories may be quickly disposed of. Since, as we have held, there was no transfer of the farm, or any interest therein, by decedent during her lifetime, and since we have held that the only thing that was transferred during decedent's lifetime1985 Tax Ct. Memo LEXIS 425">458 was the option contract, which was granted to Cobb for full and adequate consideration, sections 2035 and 2036 have no application herein, and need not be further discussed. We accordingly turn to respondent's final theory, and the more serious question whether the option held by Cobb operates to reduce the value of the farm to the option price of $100,000 for Federal estate tax purposes. In Estate of Bischoff v. Commissioner,69 T.C. 32">69 T.C. 32 at 69 T.C. 32">39 (1977), we quoted with approval and applied the rule enunciated some years before in Estate of Weil v. Commissioner,22 T.C. 1267">22 T.C. 1267, 22 T.C. 1267">1273 (1954), as follows: It now seems well established that the value of property may be limited for estate tax purposes by an enforceable agreement which fixes the price to be paid therefor, and where the seller if he desires to sell during his lifetime can receive only the price fixed by the contract and at his death his estate can receive only the price theretofore agreed on. Estate of Albert L. Salt,17 T.C. 92">17 T.C. 92; Lomb v. Sugden,82 F.2d 166">82 F.2d 166; Wilson v. Bowers,57 F.2d 682">57 F.2d 682. In the application of the above proposition, the1985 Tax Ct. Memo LEXIS 425">459 following tests have evolved: 1. In order to be effective for fixing the value of an asset for Federal estate tax purposes, the agreement in question must be binding both during life and at death. Wilson v. Bowers,57 F.2d 682">57 F.2d 682 (2d Cir. 1932); Brodrick v. Gore,224 F.2d 892">224 F.2d 892, 224 F.2d 892">896 (10th Cir. 1955); Fiorito v. Commissioner,33 T.C. 440">33 T.C. 440 (1959). Strictly speaking, what was present in the instant case was a right of first refusal during decedent's life, coupled with a true option at decedent's death, both being contingent upon Cobb still being decedent's tenant at that time. Be that as it may, it is clear that there were substantial restrictions on the ability of decedent or her estate to sell the farm for more than $100,000, either during decedent's life or after her death. The parties agree that such restrictions existed in this case; we agree also, and therefore do not need to consider this question further. 2. The second test is that the restrictive agreement which is claimed to be controlling for estate tax valuation purposes must have been one which was entered into for bona fide business reasons, at arm's length, and must1985 Tax Ct. Memo LEXIS 425">460 be found not to be a substitute for a testamentary disposition to a person who is the natural object of the grantor's bounty. See St. Louis County Bank v. United States,674 F.2d 1207">674 F.2d 1207 (8th Cir. 1982). We have already discussed this aspect to the case more fully above herein, and we see no need to repeat what was said there. We are satisfied that the option agreement of 1978 which was entered into between decedent and Cobb (being part of a larger package of contractual commitments) was entered into at arm's length by decedent and Cobb for reasons which were valid life oriented business reasons, were entirely reasonable in the circumstances, and were entered into by decedent with a person (Cobb) who was not related by blood or marriage to decedent and was not a natural object of her bounty. See sections 20.2031-2(h) and 20.2031-3, Estate Tax Regulations. 3. Finally, the agreement must be valid and enforceable, which contemplates that it must have been granted for full and adequate consideration. Here again, as our discussion above herein shows, there was full and adequate consideration for the option which decedent granted to Cobb, and the agreement was specifically1985 Tax Ct. Memo LEXIS 425">461 enforced in his favor by the Henderson Circuit Court in a full adversary law suit. We accordingly conclude that all the necessary tests have been met which would call for the instant option agreement to be controlling for the purposes of valuing the farm in decedent's gross estate at a value of $100,000, and we accordingly hold for the petitioners. Having arrived at these conclusions, the other issues presented in this case become moot and need not be considered further. To reflect the foregoing, Decisions will be entered for the petitioners.Footnotes1. Cases of the following named petitioners were consolidated herewith for purposes of trial, briefing and opinion: Estate of Carrie May Duncan, Deceased, Willie Cecil Montgomery and Julian Heilbroner, Coexecutrices (Docket Nos. 22372-83 and 22373-83); Julian Heilbroner, Transferee of the Assets of the Estate of Carrie May Duncan, Transferor (Docket No. 22374-83); and Willie Cecil Montgomery, Transferee of the Assets of the Estate of Carrie May Duncan, Transferor (Docket No. 22375-83).↩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. So stipulated by the parties.↩4. In considering the nature of the option agreement, we have considered the testimony of Cobb with respect to statements made and positions taken by decedent in the negotiations leading up to the execution of the 1978 agreements. Respondent, both at trial and on brief, objected to such testimony being received, on the grounds that it was inadmissible hearsay under Fed. R. Evid. 801 and 802, and was not within any of the exceptions of Fed. R. Evid. 803 or 804, although, as respondent conceded in his reply briefs, the question was largely academic, since much of the same material was contained in other evidence which the parties had stipulated. We think the evidence was properly received. What is at issue here is the nature and legal significance of the 1978 option agreement: was it a business arrangement or was it a gift? The written document in evidence may be construed either way on this question, and thus is ambiguous. As in the case of most contracts, therefore, the contemporaneous acts and statements of the moving parties can be of assistance in determining the nature and character of the transaction (without in any way varying the terms of the contract in violation of the parol evidence rule). Such contemporaneous positions and statements of the parties are therefore considered as verbal acts, or verbal parts of an act which is both spoken and written, and are not excluded under the hearsay rule. The witness Cobb having heard the words, he could testify that they had been spoken. NLRB v. Tex-Tan, Inc.,318 F.2d 472">318 F.2d 472, 318 F.2d 472">483 (5th Cir. 1963); Creaghe v. Iowa Home Mutual Casualty Co.,323 F.2d 981">323 F.2d 981, 323 F.2d 981">984 (10th Cir. 1963); Wigmore on Evidence (Chadbourn Rev. 1976), secs. 1770, 1772, 1777. With due deference to Prof. Wigmore, who much maligns the phrase, Wigmore, supra,↩ sec. 1767, we think that the testimony here was admissible because, as verbal parts of an act, it was truly part of the res gestae - the option contract whose character is the subject of the present dispute.5. The third contemporaneously executed document, the "short form lease and option agreement," which was publicly recorded, was simply a brief restatement of the lease and option provisions, and need not be referred to further herein.↩6. "Death is the ugly fact which Nature has to hide, and she hides it well." Alexander Smith, Dreamthorp, Of Death and the Fear of Dying (1863).↩7. Having so concluded, we need not consider a further potential issue which could arise if we had held that the transfer here was not↩ supported by full and adequate consideration, viz, whether a completed gift took place in 1978, in view of the contingencies in Cobb's right of first refusal. See sec. 25.2511-2, Gift Tax Regs. In any case, neither party raised the issue.	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625526/	James V. Summers v. Commissioner.Summers v. CommissionerDocket No. 282-71.United States Tax CourtT.C. Memo 1972-117; 1972 Tax Ct. Memo LEXIS 141; 31 T.C.M. 463; T.C.M. (RIA) 72117; May 22, 1972, Filed. 1972 Tax Ct. Memo LEXIS 141">141 (1) Held: Petitioner was not entitled to greater deductions for medical expenses, charitable contributions, taxes, and "miscellaneous" expenses than had been allowed by respondent. (2) Held, further: Respondent correctly imposed additions to petitioner's tax under section 6651(a) and section 6653(a). James Summers, pro se, 8555 Birwood, Detroit, Mich. Patrick R. McKenzie, for the respondent. IRWINMemorandum Findings of Fact and Opinion IRWIN, Judge: Respondent determined the following deficiency and additions to tax against petitioner: 13Income TaxAdditions to TaxYearDeficiencySec. 6651(a)Sec. 6653(a)1968$887.96$26.39$44.401972 Tax Ct. Memo LEXIS 141">142 The deficiency stems from respondent's disallowance either in whole or in part of 464 deductions for interest, taxes, charitable contributions, medical expenses, and "miscellaneous" expenses claimed on petitioner's 1968 income tax return. Findings of Fact Petitioner is James Summers whose legal residence was in Detroit, Mich., at the time the petition was filed. Petitioner filed a joint income tax return for 1968 with his wife Ketty Summers with the central service center, Covington, Ky. Ketty Summers did not join in petitioner's petition to this Court. During 1968 petitioner was employed as a school teacher. On his 1968 return petitioner claimed a deduction of $141.14 for interest paid to Co-op Services Credit Union. During 1968 petitioner paid the credit union $141.14 as interest but received a refund of $12.70 of that payment in the same year. Petitioner claimed a deduction of $652.34 for real estate taxes paid during 1968. Of the amount claimed, $82.35 constituted payment of mortgage insurance to the Federal Housing Authority (FHA). During the year in question petitioner kept a daily disbursement book which purportedly recorded "every penny that comes in and goes1972 Tax Ct. Memo LEXIS 141">143 out of our household." This book showed that in 1968 petitioner paid $541.69 to various charities and $587.75 for medical and dental fees. Petitioner claimed on his return a total charitable contribution deduction of $1,321.18 1 comprised of $582.65 of cash contributions and $838.53 in contributions of property. Petitioner donated a typewriter of unknown value to a church school. Respondent allowed petitioner a deduction for contributions of $625. Petitioner took a deduction (before subtracting three percent of his adjusted gross income) of $837.59 for medical and dental fees in addition to claiming $150 for medical insurance. Respondent allowed a medical expense deduction (before subtracting three percent of adjusted gross income) of $473. Petitioner claimed a miscellaneous deduction of $3,678.44 which consisted of amounts paid for social security taxes, payments to the Michigan State Public Retirement Fund, expenses incurred in running unsuccessfully for an elected public office, tuition costs and expenses incurred in sending his children to private school, and an amount1972 Tax Ct. Memo LEXIS 141">144 paid for state income tax. The amount of the miscellaneous deduction was designed to reduce petitioner's taxable income to zero when combined with other deductions claimed on the return and his allowable personal and dependency exemptions. Petitioner claimed a separate deduction of $73.63 for state and local income taxes which was allowed by respondent. Petitioner mailed his 1968 Federal income tax return to the Commissioner of Internal Revenue on April 26, 1969. Petitioner offered no reason for failing to file the return when due. Petitioner knew that the various items making up his "miscellaneous" deduction were not deductible. Petitioner did not sincerely believe that there was any likelihood that his "miscellaneous" deduction would be allowed if challenged in this Court. Petitioner felt that he was entitled to the deduction because his annual gross income fell short of the amount stated by the Bureau of Labor Statistics to be necessary to support a family of four moderately. Opinion Petitioner objected to respondent's determination of a deficiency on moral and philosophical grounds and because he felt the tax laws should be changed. He did not present any evidence or1972 Tax Ct. Memo LEXIS 141">145 legal argument to suggest that respondent was incorrect. Petitioner's payments of interest in 1968 amounted to $128.44 after taking into account a refund of $12.70 of 1968 interest which he reecived in that year. Accordingly, respondent correctly increased petitioner's taxable income by $12.70. Of the $652.34 claimed as real estate taxes in 1968, $82.35 constituted payment of FHA mortgage insurance for which there is no provision for deduction in the Code. Respondent correctly disallowed $82.35 of the real estate tax deduction. Even if petitioner's cash disbursement book is accepted as true, petitioner has at best shown that he contributed $541.69 in cash and a used typewriter to various charities. Respondent's allowance of $625 of petitioner's claimed contribution 465 deduction is more than reasonable, and we sustain respondent's disallowance of the balance of the deduction. Petitioner has not furnished us with any receipts or medical bills that indicate how much he spent for medical and dental care in 1968. Although his disbursement book shows that he spent $587.75 for such care, we have no idea to whom petitioner paid this sum. Petitioner did not attempt to expand upon1972 Tax Ct. Memo LEXIS 141">146 the subject of medical and dental care in his testimony at trial. Petitioner did not attempt to prove that he paid for medical insurance during 1968. Accordingly, we sustain respondent's allowance of only $473 (before subtracting three percent of adjusted gross income) for petitioner's medical expense deduction. Petitioner has brought similar claims for the items making up his "miscellaneous" deduction before this Court with respect to his income tax for 1967 ( James Summers, T.C. Memo. 1971-11). Because petitioner already knows our answer to his several claims and has conceded them to be true at trial, we merely summarize below our reasons and authorities for disallowing the items making up his "miscellaneous" deduction: Item or Claim MakingUp DeductionReason for DisallowanceState income taxAlready allowed as separate deductionTuition and other expenses for private school for petitioner's children DeJong v. Commissioner, 309 F.2d 373 (C.A. 9, 1962); New Colonial Co. v. Helvering, 292 U.S. 435 (1934)Cost of unsuccessful campaign for public office McDonald v. Commissioner, 323 U.S. 57 (1944)Social Security tax withheld from wagesSec. 275, 2 I.R.C.Payments to teachers' retirement fund John P. Davidson, Jr., 42 T.C. 766 (1964)Petitioner's salary was less than Bureau of La- bor Statistics' minimum for family of fourHelvering v. Ind. Life Ins. Co., 292U.S. 371 (1934)Federal Income Tax violates 13th Amendment to U.S. Constitution Porth v. Brodrick, 214 F.2d 925 (C.A. 10, 1954); Abney v. Campbell, 206 F.2d 836 (C.A. 5, 1953), certiorari denied 346 U.S. 924 (1954)1972 Tax Ct. Memo LEXIS 141">147 In view of the above, we sustain respondent's disallowance of petitioner's entire "miscellaneous" deduction. Respondent has imposed additions to petitioner's tax for 1968 under section 6651(a) and section 6653(a). Under section 6702 petitioner's 1968 income tax return had to be filed on or before April 15, 1969. Petitioner admitted that he mailed his return on April 26, 1969, and offered no explanation for his delay in filing. Respondent correctly asserted the late filing penalty under section 6651(a) against petitioner. On his return for 1968 petitioner overstated his charitable contribution and medical expense deductions without the slightest factual basis for his action. By his own admission petitioner knew that several of the items making up his "miscellaneous" deduction were not allowable and that there was no possible theory to support the deduction. At the very least, petitioner's conduct constitutes negligence, and we sustain respondent's imposition of the addition to tax under section 6653(a). Petitioner concluded his brief by commenting that he realized "that this [case] is an exercise1972 Tax Ct. Memo LEXIS 141">*148 in futility." For our part we agree with petitioner because we do not believe that our most patient consideration of his case could ever resolve his disputes with respondent. As respondent has made a concession with respect to petitioner's charitable contribution deduction, Decision will be entered under Rule 50. 466 Footnotes1. Petitioner made a $100 addition error in his return. The correct total should have been $1,421.18.↩2. All statutory references are to the Internal Code of 1954, as amended.↩	01-04-2023	11-21-2020
https://www.courtlistener.com/api/rest/v3/opinions/4625527/	Fred A. Hill v. Commissioner.Hill v. CommissionerDocket No. 53165.United States Tax CourtT.C. Memo 1957-2; 1957 Tax Ct. Memo LEXIS 250; 16 T.C.M. 11; T.C.M. (RIA) 57002; January 9, 19571957 Tax Ct. Memo LEXIS 250">250 Petitioner, by stipulation, waived assignment of error in his petition relating to disallowance of feed expense. Petitioner's counsel admitted in his opening statement that respondent had properly disallowed as a deduction for 1947 the cost of certain cattle bought and sold by petitioner in 1946, counsel explaining that the purpose of raising the issue was solely to obtain a determination so that a claim for refund could be filed under section 1311 of the Code (1954). Petitioner offered no evidence upon the issue of the negligence penalty determined by respondent under section 293(a) of the Code of 1939. Held: Respondent's determinations are sustained. Arthur Glover, Esq., for the petitioner. Paul M. Newton, Esq., for the respondent. FISHERMemorandum Opinion FISHER, Judge: All of the facts are stipulated and are incorporated herein by reference. [Findings of Fact] The petitioner is an individual whose present residence is Amarillo, Texas. During the year 1947, he was a resident of Whitewater, Kansas. The petitioner's individual income tax return for the taxable year 1947 was filed with the collector of internal revenue for the district of Kansas. During the years 1946 and 1947, petitioner was engaged in the cattle business. For both of those years, he kept his books and prepared his income tax returns on the accrual method of accounting. In the calendar year 1946, the petitioner purchased cattle from W. P. Dial and Vera Dial Dickey for a stated consideration of $93,371.58. In payment of said consideration, the petitioner delivered to the sellers his promissory note in the amount of $93,371.58. All of the cattle so purchased from W. P. Dial and Vera Dial Dickey were sold by petitioner in the calendar year 1946. In the1957 Tax Ct. Memo LEXIS 250">252 calendar year 1947, the petitioner paid in full the note for $93,371.58. Of said payments, $63,371.58 was claimed as purchases of cattle on the individual income tax return of the petitioner for the year 1947. [Opinion] Petitioner, by stipulation, waived the assignment of error in paragraph 4(b) of his petition relating to disallowance of feed expense. In his opening statement, in relation to the disallowance, for 1947, of cost of certain cattle, bought and sold by petitioner in 1946, petitioner's counsel said: "* * * we have entered into a stipulation of facts in this case which in effect concedes that the Government's position is correct. It involves a deduction for cattle purchases in the year 1947. It appears that in the year 1946, the Petitioners purchased cattle on a note which was never entered on their books and records. Those cattle were actually sold in the year 1946. They were claimed as a deduction against purchases in the year 1947. "The only reason that we are putting the case before the Court is to obtain a determination so that we may file a claim for refund under 1311 of the Code. There is a reasonable possibility that during the briefing time we will1957 Tax Ct. Memo LEXIS 250">253 be able to produce books and records to substantiate the position that we have taken under 1311 of the '54 Code, and if we do so, it is the intention of the parties hereto to go ahead and stipulate the case in its entirety, and thereby will not be considered by the Court. We have no real issue of fact at all, but we are forced to ask the Court for a determination in the meantime so we can preserve our rights under Section 1311." We see no need to discuss the issue further than to say that petitioner being on the accrual basis, his counsel's statement appears to have been advisedly made whether petitioner be deemed to have been in a farming or a merchandising activity. See Regulations 111, sections 29.22(a)-5; 29.22(a)-7, and 29.22(c)-1. We have no doubt that the deduction was not allowable in 1947. We therefore sustain respondent on this issue. As to the addition to tax for negligence under section 293(a), petitioner, who had the burden of proof, presented neither evidence nor argument to controvert respondent's determination. It is apparent from the statutory notice of deficiency that there were substantial adjustments made by respondent with respect to which no error was assigned1957 Tax Ct. Memo LEXIS 250">254 in the petition. Certainly there is nothing in the record which would warrant our rejection of respondent's determination in this respect. Decision will be entered under Rule 50.	01-04-2023	11-21-2020

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